Base Listing Document relating to Non-collateralised Structured Products
Issuer Morgan Stanley Asia Products Limited (Incorporated in the Cayman Islands with limited liability)
Guarantor Morgan Stanley (Incorporated in the State of Delaware, United States of America)
Manager Morgan Stanley Asia Limited (Incorporated in Hong Kong)
Hong Kong Exchanges and Clearing Limited, The Stock Exchange of Hong Kong Limited (“Stock Exchange”) and Hong Kong Securities Clearing Company Limited (“HKSCC”) take no responsibility for the contents of this document, make no representation as to its accuracy or completeness and expressly disclaim any liability whatsoever for any loss howsoever arising from or in reliance upon the whole or any part of the contents of this document. This document, for which we and the guarantor accept full responsibility, includes particulars given in compliance with the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong Limited (“Stock Exchange’s Listing Rules”) for the purpose of giving information with regard to the issuer, the guarantor and the warrants, callable bull/bear contracts (“CBBCs”) and any other structured products (together, our structured products) referred to in this document. The issuer and the guarantor, having made all reasonable enquiries, confirm that to the best of their knowledge and belief the information contained in this document is accurate and complete in all material respects and not misleading or deceptive, and there are no other matters the omission of which would make any statement herein or this document misleading. We, the issuer of our structured products, are publishing this base listing document in order to obtain a listing on the Stock Exchange of our structured products. We will publish a launch announcement and supplemental listing document for each issue of our structured products to set out the terms specific to that issue. If at that point the information in this base listing document (and any applicable addendum) needs to be updated, we will either include the updated information in the relevant launch announcement and supplemental listing document or produce an addendum to this base listing document. You should read the relevant launch announcement and supplemental listing document together with this base listing document (including any addendum) before deciding whether to buy our structured products. Neither the delivery of this base listing document nor any sale of any structured products shall under any circumstances create any implication that there has been no change in the affairs of us, the guarantor or its affiliates since the date of this base listing document. You should ask the manager if any addendum to this base listing document or any later base listing document has been issued. Our addendum does not necessarily contain the most recent information since the date of such addendum. You should read the guarantor’s most recent Annual Report on Form 10-K, any quarterly reports on Form 10-Q and any current reports on Form 8-K filed with the U.S. Securities and Exchange Commission (“SEC”) in the website of SEC: www.sec.gov. The Structured Products are complex products. You should exercise caution in relation to them. Investors are warned that the price of the structured products may fall in value as rapidly as it may rise and holders may sustain a total loss of their investment. Prospective purchasers should therefore ensure that they understand the nature of the structured products and carefully study the risk factors set out in this document and, where necessary, seek professional advice, before they invest in the structured products. The structured products constitute general unsecured contractual obligations of the issuer and of no other person and the guarantee constitutes the general unsecured contractual obligations of the guarantor and of no other person and will rank equally among themselves and with all our and the guarantor’s other unsecured obligations (save for those obligations preferred by law) upon liquidation. If you purchase the structured products, you are relying upon the creditworthiness of the issuer and the guarantor, and have no rights under the structured products against (a) the company which has issued the underlying securities, (b) the trustee or the manager of the underlying trust, or (c) the index sponsor of any underlying index or any other person. If the issuer becomes insolvent or default on its obligations under the structured products or the guarantor becomes insolvent or defaults on its obligations under the guarantee, you may not be able to recover all or even part of the amount due under the structured products (if any). The structured products are not bank deposits or protected deposits for the purposes of the Deposit Protection Scheme in Hong Kong and are not insured or guaranteed by the United States Federal Deposit Insurance Corporation (“FDIC”), or any other governmental agency. The structured products are guaranteed by Morgan Stanley and the guarantee will rank pari passu with all other direct, unconditional, unsecured and unsubordinated indebtedness of Morgan Stanley. The distribution of this base listing document, any launch announcement and supplemental listing document, any addendum and the offering, sale and delivery of structured products in certain jurisdictions may be restricted by law. You are required to inform yourselves about and to observe such restrictions. Please read Annex 3 “Purchase and Sale” in this base listing document. The structured products have not been approved or disapproved by the SEC or any state securities commission in the United States or regulatory authority, nor has the SEC or any state securities commission or any regulatory authority passed upon the accuracy or the adequacy of this base listing document. Any representation to the contrary is a criminal offence. The structured products and the guarantee have not been and will not be registered under the United States Securities Act of 1933, as amended (“Securities Act”), and the structured products may not be offered or sold within the United States or to, or for the account or benefit of, U.S. Persons (as defined in Regulation S under the Securities Act).
Dated 18 July 2019 IMPORTANT
If you are in doubt as to the contents of this base listing document, you should obtain independent professional advice.
Copies of this base listing document and the relevant launch announcement and supplemental listing document (together with a Chinese translation of each of these documents) and other documents listed under the section “Where can I read copies of the Issuer’s documentation?” in this base listing document may be inspected at the offices of Morgan Stanley Asia Limited at Level 46, International Commerce Centre, 1 Austin Road West, Kowloon, Hong Kong.
本基本上市文件及相關發行公佈及補充上市文件（及以上各份文件的英文本）連同本基本上市文 件的「本人從何處可查閱發行人的文件副本？」一節所列的其他文件，可於摩根士丹利亞洲有限 公司的辦事處（地址為香港九龍柯士甸道西1號環球貿易廣場46樓）查閱。
We do not give you investment advice; you must decide for yourself, after reading the listing documents for the relevant structured products and, if necessary, seeking professional advice, whether our structured products meet your investment needs.
CONTENTS
SUMMARY OF OUR STRUCTURED PRODUCTS ...... 1
SPECIFIC FEATURES OF OUR STRUCTURED PRODUCTS SPECIFIC FEATURES OF OUR WARRANTS ...... 3 SPECIFIC FEATURES OF OUR CBBCs ...... 5
MORE INFORMATION ABOUT OUR STRUCTURED PRODUCTS AND OUR LISTING DOCUMENTS ...... 14
RISK FACTORS ...... 18
TAXATION ...... 32
INFORMATION ABOUT US ...... 34
INFORMATION RELATING TO THE GUARANTOR ...... 36
STATUTORY AND GENERAL INFORMATION ABOUT US AND THE GUARANTOR.. 45
ANNEX 1 TERMS AND CONDITIONS OF THE CASH-SETTLED STOCK WARRANTS ...... 47 TERMS AND CONDITIONS OF THE INDEX WARRANTS ...... 57 TERMS AND CONDITIONS OF THE CASH-SETTLED WARRANTS RELATING TO THE UNITS OF A FUND OR TRUST ...... 65 TERMS AND CONDITIONS OF THE CBBCs RELATING TO SINGLE STOCK...... 76 TERMS AND CONDITIONS OF THE CBBCs RELATING TO AN INDEX ...... 89 TERMS AND CONDITIONS OF THE CBBCs RELATING TO THE UNITS OF A FUND OR TRUST ...... 98
ANNEX 2 FORM OF GUARANTEE ...... 112
ANNEX 3 PURCHASE AND SALE ...... 114
−i− ANNEX 4 A BRIEF GUIDE TO CREDIT RATINGS ...... 118
ANNEX 5 ISSUER’S FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED 31 DECEMBER 2017 ...... 120
ANNEX 6 ISSUER’S FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED 31 DECEMBER 2018 ...... 174
ANNEX 7 GUARANTOR’S CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED 31 DECEMBER 2018 ...... 233
ANNEX 8 EXTRACT OF THE GUARANTOR’S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED 31 MARCH 2019...... 424
−ii− SUMMARY OF OUR STRUCTURED PRODUCTS
The types of structured products that we may issue comprise of: cash-settled stock warrants, cash-settled warrants relating to the units of a fund or trust, index warrants, CBBCs relating to single stock, CBBCs relating to an index and CBBCs relating to the units of a fund or trust. Each type of our structured products will be subject to a separate set of master terms and conditions (Conditions) as set out in Annex 1 to this base listing document. For each issue of our structured products, we will publish a launch announcement and supplemental listing document setting out the specific terms. The specific terms set out in the relevant launch announcement and supplemental listing document supplement and amend the applicable set of master terms and conditions to form the legally binding terms and conditions of that issue of structured products.
We describe below the main features of the different types of our structured products.
General features of our structured products:
Issuer: Morgan Stanley Asia Products Limited
Guarantor: Morgan Stanley
Guarantor’s current long-term BBB+ (stable outlook) by S&P Global Ratings (“S&P”) credit ratings (as of the day immediately preceding the date A3 (stable outlook) by Moody’s Investors Service, Inc. of this base listing document): (“Moody’s”)
The long-term credit ratings are only an assessment by the rating agencies of the guarantor’s overall financial capacity to pay its debts. BBB+ is among the top four major credit rating categories and is the eighth highest investment-grade ranking of the ten investment-grade ratings (including + or − sub-grades) assigned by S&P. A3 is the seventh highest investment-grade ranking of the ten investment-grade ratings (including 1, 2 and 3 sub-grades) assigned by Moody’s. Please refer to the brief guide in Annex 4 to this base listing document to what such credit ratings mean.
Status and ranking of our Our structured products constitute our direct, unconditional, structured products: unsecured and unsubordinated obligations ranking equally with all our other present and future direct, unconditional, unsecured and unsubordinated obligations.
Our structured products are not bank deposits or protected deposits for the purposes of the Deposit Protection Scheme in Hong Kong and are not insured or guaranteed by the FDIC, or any other governmental agency. The structured products are guaranteed by Morgan Stanley and the guarantee will rank pari passu with all other direct, unconditional, unsecured and unsubordinated indebtedness of Morgan Stanley.
Guarantee in respect of our The obligations of the guarantor under the guarantee are structured products: direct, unconditional, unsecured and unsubordinated, subject to the terms of the guarantee. You can find the form of the guarantee in Annex 2.
−1− Liquidity provider: Morgan Stanley Hong Kong Securities Limited. We will describe in each launch announcement and supplemental listing document our obligations to provide liquidity in our structured products.
Form: Our structured products will be issued in registered form, subject to and with the benefit of, deed polls made by us and the guarantor. Each issue will be represented by a global certificate registered in the name of HKSCC Nominees Limited (or its successors) as holder of our structured products and deposited within the Central Clearing and Settlement System (CCASS).
We will not issue any definitive certificates for our structured products.
Use of proceeds: We will use the net proceeds from the issue of our structured products for our general working capital or any other purposes permitted under our memorandum and articles of association.
Further issues: We can issue further structured products to form a single series with an existing issue of our structured products.
Delisting of the company, fund or If the shares of the company or the units of the fund or trust trust underlying our structured (as the case may be) underlying a particular issue of our products: structured products are delisted from the Stock Exchange, we may adjust the terms of that issue as further detailed in the relevant terms and conditions of our structured products.
Adjustments upon certain events If certain events occur in connection with the company, fund affecting the company, fund, or trust underlying our structured products, or if certain trust, or the index underlying events occur which materially modify the underlying index, our structured products: we may in our discretion make adjustments to the terms of that issue to account for the effect of such events and/or determine in good faith the closing level or closing price of the underlying asset (as the case may be). Please see the relevant terms and conditions of our structured products for further details.
These events and the possible adjustments we may make are set out in detail in the applicable terms and conditions.
Early termination for illegality or We may early terminate our structured products due to impracticability: illegality or impracticability as further detailed in the relevant terms and conditions of our structured products.
Governing law: Our structured products and the guarantee are governed by Hong Kong law.
−2− SPECIFIC FEATURES OF OUR STRUCTURED PRODUCTS
The structured products are structured financial products, the value of which is derived from the price or value of another asset. The underlying asset may be shares of a company, units in funds or trusts, an index, or other asset or combination of such assets. Please refer to the “Risk Factors” section in this base listing document and the relevant launch announcement and supplemental listing document for a description of some of the risks of investing or dealing in our structured products. Below is only a descriptive explanation of some terms of our structured products; you should refer to the actual terms and conditions of the relevant structured products for the legally binding terms.
SPECIFIC FEATURES OF OUR WARRANTS
• Cash-settled stock The underlying asset of stock warrants is shares of a company. warrants: Our cash-settled stock warrants provide for cash settlement only, which means that physical delivery of the underlying shares will not be available as a method of settlement; instead, upon the exercise of each board lot of warrants, we will pay the warrantholder a cash amount equal to (1) the product of (a) the entitlement, (b) the difference between the average price of underlying share and the exercise price (in the case of call warrants) or the exercise price and the average price of underlying share (in the case of put warrants), and (c) one board lot, and divided by (2) the number of warrants per entitlement, and in each case less any exercise expenses, converted into the settlement currency of our warrants if necessary, so long as such amount is greater than zero. Please see the terms and conditions of our warrants for further details.
The average price of an underlying share is determined by reference to market closing price on each valuation date. Please see the terms and conditions of our warrants for further details.
• Index warrants: The underlying asset of index warrants is an index published by an index sponsor.
Our index call warrant gives its holders a right upon exercise of each board lot of warrants, to receive from us a cash amount equal to (1) the product of (a) difference between the closing level of an index on the date of exercise of the index call warrant and the predetermined strike level, (b) one board lot, and (c) the index currency amount and divided by (2) the divisor, converting such amount in the trading currency of the constituent stocks of the index into the settlement currency of our warrants if necessary, and less any exercise expenses, so long as such amount is greater than zero.
Our index put warrant gives its holders a right upon exercise of each board lot of warrants, to receive from us a cash amount equal to (1) the product of (a) the difference between the predetermined strike level and the closing level of the index on the date of exercise of the index put warrant, (b) one board lot, and (c) the index currency amount and divided by (2) the divisor, converting such amount in the trading currency of the constituent stocks of the index into the settlement currency of our warrants if necessary, and less any exercise expenses, so long as such amount is greater than zero.
−3− The closing level of the index on the date of exercise may be determined by reference to the official settlement price of an exchange traded contract relating to the index or some other means. Please see the terms and conditions of our warrants for further details.
• Cash-settled The underlying asset of warrants relating to the units of a fund or warrants relating to trust is units of the fund or trust (as the case may be). The units may the units of a fund be listed in Hong Kong or overseas. or trust: Our cash-settled warrants relating to the units of a fund or trust provide for cash settlement only, which means that physical delivery of the underlying units will not be available as a method of settlement; instead, upon the exercise of each board lot of warrants, we will pay the warrantholder a cash amount equal to (1) the product of (a) the entitlement, (b) the difference between the average price of the underlying unit and the exercise price (in the case of call warrants) or the exercise price and the average price of underlying unit (in the case of put warrants), and (c) one board lot, and divided by (2) the number of warrants per entitlement, and in each case less any exercise expenses, so long as such amount is greater than zero. Please see the terms and conditions of our warrants for further details.
The launch announcement and supplemental listing document will set out, without limitation, the following terms specific to our warrants to supplement the applicable set of master terms and conditions in this base listing document:
Board lot Minimum number at which our warrants trade
Shares of the company Name of underlying share (for our stock warrants only)
Company Name of the company which issues the underlying shares (for our stock warrants only)
Fund/Trust Name of the underlying fund or trust (for our warrants relating to the units of a fund or trust only)
Index Name of the underlying index (for our index warrants only)
Index sponsor Name of company that maintains the index and calculates and publishes the index levels (for our index warrants only)
Exercise price Predetermined exercise price of the underlying asset on expiry date (for our stock warrants and warrants relating to the units of a fund/trust only)
Strike level Predetermined level of the underlying index (for our index warrants only)
Closing level The level of the underlying index for the calculation of the cash settlement amount payable upon the exercise of a board lot of our warrants (for our index warrants only)
Divisor A predetermined amount which is used in the calculation of the cash settlement amount payable upon the exercise of a board lot of our warrants (for our index warrants only)
−4− Expiry date Date on which our warrants expire
Valuation date(s) Date(s) on which the closing price, closing level or spot price (as the case may be) of the underlying asset is determined for the calculation of the cash settlement amount upon exercise of our warrants
Entitlement Number of shares/units to which a specified number of warrants relates (for our stock warrants and warrants relating to the units of a fund or trust only)
Number of warrants per Number of warrants to which one entitlement relates (for our stock entitlement warrants and warrants relating to the units of a fund or trust only)
Index currency amount An amount denominated in the currency in which the constituent stocks of the index are traded, which is used in the calculation of the cash settlement amount payable upon the exercise of a board lot of our warrants (for our index warrants only)
European style European style warrants can only be exercised on the expiry date
Listing date The date on which our warrants commence trading on the Stock Exchange
SPECIFIC FEATURES OF OUR CBBCS
• CBBCs relating to The underlying asset of CBBCs relating to single stock is shares of a single stock: company. The shares may be listed in Hong Kong or overseas.
CBBCs relating to single stock are issued either as Bull CBBCs or Bear CBBCs:
Bull CBBCs relating to single stock
Generally for a series of Bull CBBCs relating to single stock, when the spot price of the underlying share as reported by the relevant exchange is at or below the predetermined call price during the observation period of the CBBCs, a mandatory call event occurs and the CBBCs will terminate. If no mandatory call event occurs during the observation period, upon expiry, for each board lot of CBBCs, we will pay the holder of such CBBCs an amount equal to (1) the product of (a) the entitlement, (b) the difference between the closing price of the underlying share and the strike price, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses, so long as such amount is greater than zero.
If a mandatory call event has occurred, whether the holder of our CBBCs may receive a residual value depends on whether the CBBCs are Category N Bull CBBCs or Category R Bull CBBCs.
For Category N Bull CBBCs (where the call price is equal to the strike price), the holder of the CBBCs will not receive any cash payment from us upon the occurrence of the mandatory call event.
−5− For Category R Bull CBBCs (where the call price is above the strike price), the holder of each board lot of CBBCs will receive from us a residual value, which will be (1) the product of (a) the entitlement, (b) the difference between the lowest spot price to which the underlying share has traded on the exchange during the MCE valuation period and the strike price, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses. However, if this residual value is a negative number then the cash settlement amount shall be zero.
Please note that during the life of a Bull CBBC relating to a share, a given percentage change in the underlying share price may not result in the same percentage change (in the same direction) in the theoretical value of the CBBC. The percentage change in theoretical value of the CBBC may be greater or smaller, in the same or opposite direction. The theoretical value of the CBBC may be different from the prices available in the market. You should be aware that you may be subject to, among other risks, a significant portion or the entire loss of your investment in our CBBCs, which will be proportionately greater than the amount of loss you would sustain from investing in the same amount directly in the underlying share, for a given change in the underlying share price. Please refer to the “Risk Factors” section of this base listing document and that of the relevant launch announcement and supplemental listing document.
Bear CBBCs relating to single stock
Generally for a series of Bear CBBCs relating to single stock, when the spot price of the underlying share as reported by the relevant exchange is at or above the predetermined call price during the observation period of the CBBCs, a mandatory call event occurs and the CBBCs will terminate. If no mandatory call event occurs during the observation period, upon expiry, for each board lot of CBBCs, we will pay the holder of such CBBCs an amount equal to (1) the product of (a) the entitlement, (b) the difference between the strike price and the closing price of the underlying share, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses, so long as such amount is greater than zero.
If a mandatory call event has occurred, whether the holder of our CBBCs may receive a residual value depends on whether the CBBCs are Category N Bear CBBCs or Category R Bear CBBCs.
For Category N Bear CBBCs (where the call price is equal to the strike price), the holder of the CBBCs will not receive any cash payment from us upon the occurrence of the mandatory call event.
−6− For Category R Bear CBBCs (where the call price is below the strike price), the holder of each board lot of CBBCs will receive from us a residual value, which will be (1) the product of (a) the entitlement, (b) the difference between the strike price and the highest spot price to which the underlying share has traded on the exchange during the MCE valuation period, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses. However, if this residual value is a negative number then the cash settlement amount shall be zero.
Please note that during the life of a Bear CBBC relating to a share, a given percentage change in the underlying share price may not result in the same percentage change (in the opposite direction) in the theoretical value of the CBBC. The percentage change in theoretical value of the CBBC may be greater or smaller, in the same or opposite direction. The theoretical value of the CBBC may be different from the prices available in the market. You should be aware that you may be subject to, among other risks, a significant portion or the entire loss of your investment in our CBBCs, which will be proportionately greater than the amount of loss you would sustain from investing in the same amount directly in the underlying share, for a given change in the underlying share price. Please refer to the “Risk Factors” section of this base listing document and that of the relevant launch announcement and supplemental listing document.
For both our Bull CBBCs and Bear CBBCs relating to single stock, the closing price of an underlying share will be determined by reference to the market closing price on the valuation date, please see the terms and conditions of our CBBCs for further details.
• CBBCs relating to The underlying asset of CBBCs relating to an index is an index an index: published by an index sponsor.
CBBCs relating to an index are issued either as Bull CBBCs or Bear CBBCs:
Bull CBBCs relating to an index
Generally for a series of Bull CBBCs relating to an index, when the level of the underlying index as published by the index sponsor is at or below the predetermined call level during the observation period of the CBBCs, a mandatory call event occurs and the CBBCs will terminate. If no mandatory call event occurs during the observation period, upon the expiry of a CBBC, for each board lot of CBBCs, we will pay the holder of such CBBC an amount equal to (1) the product of (a) the difference between the closing level of the underlying index and the strike level, (b) one board lot, and (c) the index currency amount, and divided by (2) the divisor, and less any exercise expenses, so long as such amount is greater than zero.
If a mandatory call event has occurred, whether the holder of our CBBCs may receive a residual value depends on whether the CBBCs are Category N Bull CBBCs or Category R Bull CBBCs.
−7− For Category N Bull CBBCs (where the call level is equal to the strike level), the holder of the CBBCs will not receive any cash payment from us upon the occurrence of the mandatory call event.
For Category R Bull CBBCs (where the call level is above the strike level), the holder of each board lot of CBBCs will receive from us a residual value, which will be an amount equal to (1) the product of (a) the difference between the lowest spot level of the underlying index as published by the index sponsor during the MCE valuation period and the strike level, (b) one board lot, and (c) the index currency amount, and divided by (2) the divisor, and less any exercise expenses. However, if this residual value is a negative number then the cash settlement amount shall be zero.
Please note that during the life of a Bull CBBC relating to an index, a given percentage change in the underlying index level may not result in the same percentage change (in the same direction) in the theoretical value of the CBBC. The percentage change in theoretical value of the CBBC may be greater or smaller, in the same or opposite direction. The theoretical value of the CBBC may be different from the prices available in the market. You should be aware that you may be subject to, among other risks, a significant portion or the entire loss of your investment in our CBBCs, which will be proportionately greater than the amount of loss you would sustain from investing in the same amount directly in the Index, for a given change in the Index level. Please refer to the “Risk Factors” section of this base listing document and that of the relevant launch announcement and supplemental listing document.
Bear CBBCs relating to an index
Generally for a series of Bear CBBCs relating to an index, when the level of the underlying index as published by the index sponsor is at or above the predetermined call level during the observation period of the CBBCs, a mandatory call event occurs and the CBBCs will terminate. If no mandatory call event occurs during the observation period, upon the expiry of a CBBC, for each board lot of CBBCs, we will pay the holder of such CBBC an amount equal to (1) the product of (a) the difference between the strike level and the closing level of the underlying index, (b) one board, and (c) the index currency amount, and divided by (2) the divisor, and less any exercise expenses, so long as such amount is greater than zero.
If a mandatory call event has occurred, whether the holder of our CBBCs may receive a residual value depends on whether the CBBCs are Category N Bear CBBCs or Category R Bear CBBCs.
For Category N Bear CBBCs (where the call level is equal to the strike level), the holder of the CBBCs will not receive any cash payment from us upon the occurrence of the mandatory call event.
−8− For Category R Bear CBBCs (where the call level is below the strike level), the holder of each board lot of CBBCs will receive from us a residual value, which will be an amount equal to (1) the product of (a) the difference between the strike level and the highest spot level of the underlying index as published by the index sponsor during the MCE valuation period, (b) one board lot, and (c) the index currency amount, and divided by (2) the divisor, and less any exercise expenses. However, if this residual value is a negative number then the cash settlement amount shall be zero.
Please note that during the life of a Bear CBBC relating to an index, a given percentage change in the underlying index level may not result in the same percentage change (in the opposite direction) in the theoretical value of the CBBC. The percentage change in theoretical value of the CBBC may be greater or smaller, in the same or opposite direction. The theoretical value of the CBBC may be different from the prices available in the market. You should be aware that you may be subject to, among other risks, a significant portion or the entire loss of your investment in our CBBCs, which will be proportionately greater than the amount of loss you would sustain from investing in the same amount directly in the Index, for a given change in the Index level. Please refer to the “Risk Factors” section of this base listing document and that of the relevant launch announcement and supplemental listing document.
For both our Bull CBBCs and Bear CBBCs relating to an index, the closing level of the index will be determined by reference to the index level calculated for the purpose of final settlement of the applicable futures contract specified in the relevant launch announcement and supplemental listing document, please see the terms and conditions of our CBBCs for further details.
−9− • CBBCs relating to The underlying asset of CBBCs relating to the units of a fund or trust the units of a fund is units of the fund or trust (as the case may be). or trust CBBCs relating to the units of a fund or trust are issued as either Bull CBBCs or Bear CBBCs:
Bull CBBCs relating to the units of a fund or trust
Generally for a series of Bull CBBCs relating to the units of a fund or trust, when the spot price of the underlying unit as reported by the relevant exchange is at or below the predetermined call price during the observation period of the CBBCs, a mandatory call event occurs and the CBBCs will terminate. If no mandatory call event occurs during the observation period, upon expiry, for each board lot of CBBCs, we will pay the holder of such CBBCs an amount equal to (1) the product of (a) the entitlement, (b) the difference between the closing price of the underlying unit and the strike price, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses, so long as such amount is greater than zero.
If a mandatory call event has occurred, whether the holder of our CBBCs may receive a residual value depends on whether the CBBCs are Category N Bull CBBCs or Category R Bull CBBCs.
For Category N Bull CBBCs (where the call price is equal to the strike price), the holder of the CBBCs will not receive any cash payment from us upon the occurrence of the mandatory call event.
For Category R Bull CBBCs (where the call price is above the strike price), the holder of each board lot of CBBCs will receive from us a residual value, which will be (1) the product of (a) the entitlement, (b) the difference between the lowest spot price to which the underlying unit has traded on the exchange during the MCE valuation period and the strike price, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses. However, if this residual value is a negative number then the cash settlement amount shall be zero.
Please note that during the life of a Bull CBBC relating to the units of a fund or trust, a given percentage change in the underlying unit price may not result in the same percentage change (in the same direction) in the theoretical value of the CBBC. The percentage change in theoretical value of the CBBC may be greater or smaller, in the same or opposite direction. The theoretical value of the CBBC may be different from the prices available in the market. You should be aware that you may be subject to, among other risks, a significant portion or the entire loss of your investment in our CBBCs, which will be proportionately greater than the amount of loss you would sustain from investing in the same amount directly in the underlying unit, for a given change in the underlying unit price. Please refer to the “Risk Factors” section of this base listing document and the relevant launch announcement and supplemental listing document.
−10− Bear CBBCs relating to the units of a fund or trust
Generally for a series of Bear CBBCs relating to the units of a fund or trust, when the spot price of the underlying unit as reported by the relevant exchange is at or above the predetermined call price during the observation period of the CBBCs, a mandatory call event occurs and the CBBCs will terminate. If no mandatory call event occurs during the observation period, upon expiry, for each board lot of CBBCs, we will pay the holder of such CBBCs an amount equal to (1) the product of (a) the entitlement, (b) the difference between the strike price and the closing price of the underlying unit, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses, so long as such amount is greater than zero.
If a mandatory call event has occurred, whether the holder of our CBBCs may receive a residual value depends on whether the CBBCs are Category N Bear CBBCs or Category R Bear CBBCs.
For Category N Bear CBBCs (where the call price is equal to the strike price), the holder of the CBBCs will not receive any cash payment from us upon the occurrence of the mandatory call event.
For Category R Bear CBBCs (where the call price is below the strike price), the holder of each board lot of CBBCs will receive from us a residual value, which will be (1) the product of (a) the entitlement, (b) the difference between the strike price and the highest spot price to which the underlying unit has traded on the exchange during the MCE valuation period, and (c) one board lot, and divided by (2) the number of CBBCs per entitlement, and less any exercise expenses. However, if this residual value is a negative number then the cash settlement amount shall be zero.
Please note that during the life of a Bear CBBC relating to the units of a fund or trust, a given percentage change in the underlying unit price may not result in the same percentage change (in the opposite direction) in the theoretical value of the CBBC. The percentage change in theoretical value of the CBBC may be greater or smaller, in the same or opposite direction. The theoretical value of the CBBC may be different from the prices available in the market. You should be aware that you may be subject to, among other risks, a significant portion or the entire loss of your investment in our CBBCs, which will be proportionately greater than the amount of loss you would sustain from investing in the same amount directly in the underlying unit, for a given change in the underlying unit price. Please refer to the “Risk Factors” section of this base listing document and the relevant launch announcement and supplemental listing document.
For both our Bull CBBCs and Bear CBBCs relating to the units of a fund or trust, the closing price of an underlying unit will be determined by reference to the market closing price on the valuation date, please see the terms and conditions of our CBBCs for further details.
−11− The launch announcement and supplemental listing document will set out the following terms specific to our CBBCs to supplement the applicable set of master terms and conditions in this base listing document:
Category The category of our CBBCs: Category N or Category R, Bull or Bear
Board lot Minimum number at which our CBBCs trade
Shares of the company Name of the underlying share (for our CBBCs relating to single stock only)
Company Name of the company which issues the underlying shares (for our CBBCs relating to single stock only)
Fund/Trust Name of the underlying fund or trust (for our CBBCs relating to the units of a fund or trust only)
Index Name of the underlying index (for our CBBCs relating to an index only)
Index sponsor Name of company that maintains the index and calculates and publishes the index levels (for our CBBCs relating to an index only)
Call price Predetermined call price of the underlying share (for our CBBCs relating to single stock and our CBBCs relating to the units of a fund or trust only)
Strike price Predetermined strike price of the underlying share (for our CBBCs relating to single stock and our CBBCs relating to the units of a fund or trust only)
Call level Predetermined call level of the underlying index (for our CBBCs relating to an index only)
Strike level Predetermined strike level of the underlying index (for our CBBCs relating to an index only)
Divisor A predetermined amount which is used in the calculation of the cash settlement amount (if any) payable upon the occurrence of a mandatory call event or automatic exercise on expiry (for our CBBCs relating to an index only)
Expiry date Date on which our CBBCs expires
Valuation date Date on which the closing price or the closing level of the underlying asset is determined for calculation of the cash settlement amount upon automatic exercise on expiry
Entitlement Number of shares/units to which a specified number of CBBCs relates (for our CBBCs relating to single stock and our CBBCs relating to the units of a fund or trust only)
Number of CBBC(s) per Number of CBBCs to which one entitlement relates (for our CBBCs Entitlement relating to single stock and our CBBCs relating to the units of a fund or trust only)
−12− Index currency amount An amount denominated in the currency in which the constituent stocks of the index are traded, which is used in the calculation of the cash settlement amount (if any) payable upon the occurrence of a mandatory call event or automatic exercise on expiry (for our CBBCs relating to an index only)
Observation The date on which the observation period commence commencement date
Observation period The period commences from the observation commencement date to the trading day immediately before the expiry date (both dates inclusive)
Listing date The date on which our CBBCs commence trading on the Stock Exchange
−13− MORE INFORMATION ABOUT OUR STRUCTURED PRODUCTS AND OUR LISTING DOCUMENTS
WHO IS RESPONSIBLE FOR THIS BASE WHAT ARE OUR GUARANTOR’S CREDIT LISTING DOCUMENT? RATINGS?
We and the guarantor accept full responsibility The guarantor’s long-term credit ratings (as of for the accuracy of the information contained in the day immediately preceding the date of this this base listing document. base listing document) are as set out on page 1 of this base listing document. We have included references to websites to guide you to sources of freely available information. You may visit The information on these websites does not form https://www.morganstanley.com/about-us-ir/creditor-presentations part of our listing document. Neither we nor the to obtain information about the guarantor’s credit guarantor accept any responsibility for the ratings. information on those websites. Such information has not been prepared for the purposes of our Rating agencies usually receive a fee from the structured products. You should conduct your companies that they rate. When evaluating the own web searches and consult publicly available guarantor’s creditworthiness, you should not information to ensure that you are viewing the solely rely on the guarantor’s credit ratings most up-to-date information. because:
(a) a credit rating is not a recommendation to This base listing document is accurate at the date buy, sell or hold the structured products; stated on the cover. You must not assume, however, that information in this base listing document is accurate at any time after the date of (b) ratings of companies may involve difficult- to-quantify factors such as market this base listing document. competition, the success or failure of new products and markets and managerial This base listing document has not been reviewed competence; by the Securities and Futures Commission. You are advised to exercise caution in relation to the (c) a high credit rating is not necessarily offer of the structured products. indicative of low risk. The guarantor’s credit ratings as of the day immediately The manager and the liquidity provider are not preceding the date of this base listing responsible in any way for ensuring the accuracy document are for reference only. Any of our listing documents. downgrading of the guarantor’s credit ratings could result in a reduction in the IS THERE ANY GUARANTEE OR value(s) of the structured product(s); COLLATERAL FOR THE STRUCTURED PRODUCTS? (d) a credit rating is not an indication of the liquidity or volatility of the structured Our obligations under the structured products are products; and unconditionally and irrevocably guaranteed by the guarantor. If we become insolvent or default (e) a credit rating may be downgraded if the on our obligations under the structured products credit quality of the guarantor declines. and the guarantor becomes insolvent or defaults on its obligations under the guarantee, you can THE STRUCTURED PRODUCTS ARE NOT only claim as an unsecured creditor of us, as the RATED. issuer, and the guarantor. In such event, you may not be able to recover all or even part of the The guarantor’s credit ratings are subject to amount due under the structured products (if change or withdrawal at any time within each any). rating agency’s sole discretion. You should
−14− conduct your own research using publicly WHEN WERE THE STRUCTURED available sources to obtain the latest information PRODUCTS AUTHORISED? with respect to the guarantor’s ratings from time to time. The issue of our warrants and CBBCs were authorised by resolutions of our board of IS THE ISSUER OR GUARANTOR directors on 3 April 2019. The giving of the REGULATED BY THE HONG KONG guarantee was authorised by various resolutions MONETARY AUTHORITY REFERRED TO of the board of directors of the guarantor. IN RULE 15A.13(2) OR THE SECURITIES AND FUTURES COMMISSION OF HONG WHERE CAN I READ COPIES OF THE KONG (SFC) REFERRED TO IN RULE ISSUER’S AND GUARANTOR’S 15A.13(3)? DOCUMENTATION? Neither we nor the guarantor are regulated by any of the bodies referred to in Rule 15A.13(2) or (3) You can read copies of the documents set out of the Stock Exchange’s Listing Rules. The below by going to the offices of Morgan Stanley guarantor is a corporation organised under the Asia Limited, at Level 46, International laws of the State of Delaware, and is a financial Commerce Centre, 1 Austin Road West, Kowloon, holding company regulated by the Board of Hong Kong. These offices are open only during Governors of the Federal Reserve System normal business hours and not on Saturdays, (“Federal Reserve”), and many of its Sundays or public holidays. Since we are not subsidiaries are regulated by various regulatory obliged to update the listing document of any bodies throughout the world, including broker particular issue of structured products after dealer and investment advisor subsidiaries dealing in the structured products have registered with the SEC and subsidiaries commenced on the Stock Exchange, you should regulated by the U.S. Commodity Futures Trading read the annual report(s), quarterly report(s) and Commission with respect to certain current report(s) of the guarantor that are futures-related activities. available as described below or on the website www.sec.gov. WHERE CAN I FIND MORE INFORMATION ABOUT THE ISSUER, THE These are the documents, copies of which may be GUARANTOR AND THE STRUCTURED inspected upon request while any of our PRODUCTS? structured products are in issue:
Information about us, the guarantor and our • the financial statements as of 31 December structured products is described in this base 2017 and 2016 and for each of the two years listing document, the relevant launch in the period ended 31 December 2017 of announcement and supplemental listing document the issuer; and the relevant addenda to these documents (if any). • the financial statements as of 31 December 2018 and 2017 and for each of the two years Additional and more up-to-date information in the period ended 31 December 2018 of regarding the guarantor may be available on the the issuer; website www.sec.gov. You are cautioned that this information (if available) will be of a general • the consolidated financial statements as of nature and cannot be relied upon as being 31 December 2018 and 2017 and for each of accurate and/or correct and will not have been the three years in the period ended 31 prepared exclusively for the purposes of our December 2018 of the guarantor; structured products.
We have not authorised anyone to give you any • an extract of the guarantor’s quarterly report information about us, the guarantor, our on Form 10-Q for the quarterly period ended structured products other than the information in 31 March 2019; this base listing document, the relevant launch announcement and supplemental listing document • the guarantee dated 18 July 2019 relating to and the relevant addendum (if any). the issuance of our warrants and CBBCs;
−15− • the letter from the issuer’s auditor, Deloitte DO I HAVE TO PAY STAMP DUTY OR LLP, consenting to the reproduction of their OTHER LEVIES ON THE STRUCTURED audit reports included in the issuer’s PRODUCTS? financial statements as of 31 December No, there is no Hong Kong or Cayman Islands 2018 and 2017 and for each of the two years stamp duty on issue or transfer of our cash-settled in the period ended 31 December 2018 and structured products. The levy for the investor the issuer’s financial statements as of 31 compensation fund is currently suspended. December 2017 and 2016 and for each of the two years in the period ended 31 December However, the SFC charges a transaction levy 2017 included in this base listing document; currently at the rate of 0.0027 per cent. on the value of the transaction of structured products • the letter from the guarantor’s auditor, and this amount is payable by each of the buyer Deloitte & Touche LLP, consenting to the and seller. Additionally, the Stock Exchange reproduction of their audit reports included charges a trading fee on every purchase and sale in the guarantor’s financial statements as of of listed securities calculated currently at a rate of 0.005 per cent of the amount of the transaction 31 December 2018 and 2017 and for each of and is payable by each of the buyer and seller. the three years in the period ended 31 December 2018 included in this base listing Your broker may charge commission or other document; fees. You should check with your broker what fees will be chargeable. • the Instrument dated 18 July 2019 relating to the issuance of our warrants and CBBCs; You should be aware that you may be required to and pay taxes including stamp taxes or other documentary charges in accordance with the laws and practices of the country where the structured • this base listing document including any products are transferred, or where the issuer of addenda to this document and the relevant the underlying asset is organised or resident. If launch announcement and supplemental you are in any doubt as to your tax position, you listing document (together with a Chinese should consult your own independent tax translation of each of these documents). advisers. You should also be aware that tax regulations and their application by the relevant A reasonable fee will be charged if you want to taxation authorities change from time to time. take photocopies of any of the documents while they are on display. CHANGE IN TAX LAW
Tax law and practice is subject to change, TRANSFER OF STRUCTURED PRODUCTS possibly with retrospective effect and this could adversely affect the value of our structured Settlement of transactions between members of products to the holder and/or the market value of the Stock Exchange on any business day must our structured products. Any such change may (i) take place on or before the second business day cause the tax treatment of the relevant structured thereafter. Securities executed on the Stock products to change from what the investor Exchange would normally be settled under the understood the position to be at the time of continuous net settlement system in CCASS. purchase; (ii) render the statements in this base listing document concerning relevant tax law and Dealings in the structured products will take practice in relation to our structured products to be inaccurate or to be inapplicable in some or all place in relevant board lots in the relevant respect to certain structured products or to not settlement currency. For further details on include material tax considerations in relation to transfers of structured products and their certain structured products; or (iii) give us the exercise, termination pursuant to mandatory call right to terminate the structured products if such event or settlement, see the terms and conditions change has the effect that our performance under of the relevant issue of structured products. the structured products is unlawful or impracticable.
−16− HOW DO I HOLD MY STRUCTURED PRODUCTS?
Our structured products will be issued in global registered form, represented by a global certificate registered in the name of HKSCC Nominees Limited (or its successors).
We have made all necessary arrangements to enable our structured products to be admitted for deposit, clearing and settlement in CCASS. We will not issue any definitive certificates for our structured products. Our structured products will be deposited within CCASS.
If you are a CCASS investor participant, you may hold your structured products in your account with CCASS. If you do not have a CCASS account, your broker or agent (as a CCASS participant) will arrange to hold your structured products for you in an account at CCASS. We or the guarantor will make all payments on our structured products to CCASS: you will have to check your CCASS account or rely on your broker to ensure that payments on your structured products are credited to your account with your broker. Once we have made the relevant payments in this way to CCASS, we will have no further obligations for that payment, even if CCASS or your broker fails to transmit to you your share of the payment or if it was transmitted late. Any notices we or the guarantor gives in relation to our structured products will be given in the same way: you will have to rely on CCASS and/or your broker to ensure that those notices reach you.
−17− RISK FACTORS
You should carefully consider the following information together with the other information contained in this base listing document and in the applicable launch announcement and supplemental listing document before purchasing our structured products.
This section highlights only some of the risks of dealing in the structured products but their inclusion in this document does not mean these are the only significant or relevant risks of dealing in our structured products.
Non-collateralised structured products; you must rely on our and the guarantor’s creditworthiness; you may lose all or substantially all of your investment if we and/or the guarantor become insolvent
Our structured products are not secured on any of our or the guarantor’s assets or any collateral. Our structured products represent our general contractual obligations and will rank equally with our other general unsecured obligations. The number of structured products outstanding at any given time may be substantial. When purchasing our structured products, you will be relying upon our and the guarantor’s creditworthiness and of no one else. There is no assurance of protection against a default by us in respect of our obligations under our structured products or a default by the guarantor in respect of its obligations under the guarantee. If we become insolvent or default on our obligations under the structured products or the guarantor becomes insolvent or defaults on its obligations under the guarantee, you can only claim as our or the guarantor’s unsecured creditor regardless of the performance of the underlying asset and you may not be able to recover all or even part of the amount due under the structured products (if any).
Our obligations are not deposit liability or debt obligations
We do not intend to create upon ourselves a deposit liability or a debt obligation by issue of any structured products.
Our structured products are not bank deposits or protected deposits for the purposes of the Deposit Protection Scheme in Hong Kong and are not insured or guaranteed by the United States Federal Deposit Insurance Corporation, or any other governmental agency. The structured products are guaranteed by Morgan Stanley and the guarantee will rank pari passu with all other direct, unconditional, unsecured and unsubordinated indebtedness of Morgan Stanley.
There are risks associated with investing in our structured products; our structured products are volatile instruments
Our structured products are structured financial instruments, their value may fall as rapidly as they may rise and you may sustain a total loss in your investment. Your investment in our structured products involves risks. Before investing in any of our structured products, you should consider whether our structured products are suitable for you in light of your own financial circumstances and investment objectives. Not all of these risks are described in this base listing document or a launch announcement and supplemental listing document. You should consider taking independent professional advice prior to making an investment in our structured products.
Structured products are complex and volatile instruments
Your investment in our structured products will be worthless if you are holding our structured products when they expire out-of-the-money — meaning that the closing price or level of the underlying asset, determined in accordance with the terms and conditions of our structured products, is greater (for our put warrants or our bear CBBCs) or less (for our call warrants or our bull CBBCs) than the exercise price, strike price or strike level (as the case may be) of our structured products.
−18− Our structured products are complex instruments and their values at any time prior to expiry are governed by a number of factors, including but not limited to the time left till expiry, the price or level of the underlying asset compared with the strike price/level and call price/level (in the case of our CBBCs) of our structured products, the value and volatility of price or level of the underlying asset, market interest rate movements, our and the guarantor’s financial condition and the market’s view of our and the guarantor’s credit quality. The values of our structured products may rise or fall rapidly over a short time due to changes in one or more factors. The interplay of these different factors also means that the effect on the value of our structured products from the change in one factor may offset or accentuate the effect from the change in another factor. The value or level of the underlying assets (and some of the other relevant factors) can also be unpredictable: it may change suddenly and in large magnitude or not change at all. You may risk losing your entire investment if the price or level of the underlying assets do not move in your anticipated direction. You should also note that, assuming all other factors are held constant, the value of structured products will decline over time.
The cash settlement amount of our structured products if calculated at any time prior to expiry may typically be less than the market price of such structured products at that time. The difference will reflect, among other things, a “time value” for the structured products which depends on a number of interrelated factors including those specified above.
Your ability to realise your investment in our structured products is dependent on the trading market for our structured products
Our structured products are not exercisable prior to the expiry date, therefore the only way you may be able to realise the value of your investment in our structured products is to dispose of them either in the on-exchange market or over-the-counter market. If you dispose of your investment in our structured products before expiry in this way, the amount you will receive will depend on the price you are able to obtain from the market for our structured products. That price may depend on the quantity of our structured products you are trying to sell. The market price of our structured products may not be equal to the value of our structured products, and changes in the price of our structured products may not correspond (in direction and/or magnitude) with changes in the value of our structured products.
The liquidity provider appointed for our structured products will upon request provide bid and/or ask prices for our structured products on the Stock Exchange and may (but is not obliged to) provide such prices at other times too, but under certain circumstances it may not provide bid and/or ask prices even if requested. You should refer to the section regarding liquidity provider in the relevant launch announcement and supplemental listing document for further details. The prices provided by our liquidity provider are influenced by, among other things, the supply and demand of our structured products for a particular series in the market, and may not correspond with the values of such structured products or changes in such values.
You should note that the prices available in the market for our structured products may also come from other participants in the market, although we cannot predict if and to what extent a secondary market may develop for our structured products or whether that market will be liquid or illiquid. The fact that a particular series of structured products is listed does not necessarily lead to greater liquidity. In addition, no assurance can be given that the listing of any particular series of our structured products will be maintained. If our structured products of a particular series cease to be listed, they may not be transacted through the Stock Exchange or at all, and they may even be terminated early. Off-exchange transactions may involve greater risks than on-exchange transactions. You may be unable to find any buyer for your holdings of our structured products on the Stock Exchange if the value of the structured products falls below HK$0.01.
Only the liquidity provider appointed for our structured products is obliged to provide bid and/or ask prices for our structured products upon request (subject to the terms set out in the relevant launch announcement and supplemental listing document), and at times it may be the only source of bid and/or ask prices for our structured products.
−19− The liquidity of any series of our structured products may also be affected by restrictions on offers and sales of our structured products in some jurisdiction including the restrictions described in Annex 3 “Purchase and Sale” to this base listing document.
If trading or dealing in the underlying asset on the market on which such underlying asset is listed or dealt in (including the Stock Exchange) is suspended for any reasons, trading in our structured products may also be suspended for a similar period. If suspension of the underlying asset is prolonged, our structured products may also be suspended for a prolonged period, which may in turn adversely impact the value of the relevant structured products as their time value may dissipate. Upon the resumption of trading of our structured products after a prolonged period of suspension, the price of our structured products may fluctuate significantly because of the significant impact of such prolonged period of suspension. This may adversely affect your investment in the structured product.
In view of the limited trading market of our structured products, you may need to hold our structured products until expiry.
You have no rights in the underlying assets and the market price for our structured products may fluctuate differently from that of the underlying assets
Our structured products are financial instruments issued by us and are separate from the underlying assets. You have no rights under our structured products against (i) any company, fund or trust which issues shares or units comprising the underlying assets of the relevant issue of structured products, (ii) the trustee or the manager of any underlying asset that is a fund or trust, or (iii) the sponsor of any underlying asset that is an index. In addition, buying our structured products is not the same as buying the underlying assets or having a direct investment in the underlying assets or shares comprising any underlying asset that is an index. You will not be entitled to have voting rights, rights to receive dividends or distributions or any other rights under the underlying asset or shares comprising any underlying asset that is an index. As mentioned, there are many factors influencing the value and/or market price of structured products, which are leveraged instruments. For example, increases in the price or level of the underlying assets may not lead to an increase in the value and/or market price of our call warrants or bull CBBCs by a proportionate amount or even any increase at all; however, a decrease in the price or level of the underlying assets may lead to a greater than proportionate decrease in the value and/or market price of our call warrants or bull CBBCs. There is no assurance that a change in value and/or market price of our structured products will correspond in direction and/or magnitude with the change in price or level of the underlying assets. You should recognise the complexities of utilising our structured products to hedge against the market risk associated with investing in an underlying asset or shares comprising any underlying asset that is an index.
The issuer, the trustee, the manager or the sponsor of the underlying assets will have no involvement in the offer and sale of our structured products and no obligation to you as investors in our structured products. The decisions made by them on corporate actions, such as a merger or sale of assets, or adjustment of the method for calculation of an index may also have adverse impact on the value and/or market price of our structured products.
We, the guarantor and its subsidiaries and affiliates and the manager have no responsibility to inform the holders of our structured products of any disclosure on any company which issues shares or units comprising the underlying assets of any of our structured products.
There could be conflicts of interest arising out of our other activities which may affect our structured products
We, the guarantor and its subsidiaries and affiliates may engage in transactions (whether for their proprietary accounts, including hedging, or trading for accounts under management or otherwise) involving, as well as provide investment banking and other services to, any company, or any trustee or manager of a trust or a fund underlying our structured products or their securities and may enter
−20− into transactions with the substantial shareholders of the underlying company. Those transactions may have a positive or negative impact on the price or level of the underlying asset and in turn the value and/or market price of our structured products. For example, in the case of CBBCs, these transactions may result in the price or level of the underlying asset moving closer to, or even reaching or going beyond the call price or call level of our CBBCs thus causing a mandatory call event. These transactions may also influence the price or level of the underlying asset after the occurrence of the mandatory call event and adversely impact on the residual value payable (if any, for a Category R CBBC). The mandatory call event may be triggered by a single trade in the underlying asset, regardless of the size of the trade. In addition, the unwinding of hedges at any time or after the occurrence of a mandatory call event may affect the price or level of the underlying asset and consequently affect the cash settlement amount of our CBBCs.
We, the guarantor and its subsidiaries and affiliates may have officers who serve as directors of any of the companies underlying our structured products. Our principal trading activities (which include hedging of our structured products) in the underlying securities or related structured products may affect the value and/or market price of our structured products. We, the guarantor or its subsidiaries and affiliates may issue other competing financial products which may affect the value and/or market price of our structured products. You should also note that potential conflicts of interest may arise from the different roles played by us, the guarantor and its subsidiaries and affiliates in connection with our structured products and the economic interests in each role may be adverse to your interests in our structured products. We or the guarantor owe no duty to you to avoid such conflicts.
Certain of our affiliates and certain affiliates of the guarantor may from time to time, by virtue of their status as underwriter, advisor or otherwise, possess or have access to information relating to the underlying assets and any derivative instruments referencing them. Such affiliates will not be obliged to disclose any such information to a purchaser of our structured products.
Certain of our affiliates and certain affiliates of the guarantor may be the counterparty to the hedge of our and the guarantor’s obligations under an issue of our structured products. Accordingly, certain conflict of interest may arise both among these affiliates and between the interests of these affiliates and the interests of purchasers of our structured products.
Potential conflicts of interest may exist between the issuer and the holders of our structured products, including with respect to the exercise of the discretionary powers of the issuer. For instance, in the case of stock warrants, the issuer has the authority to determine if a market disruption event has occurred on any valuation date, and the occurrence of a market disruption event results in a valuation date being postponed such that the valuation date will fall on or after the expiry date, then the valuation date will be the business day immediately preceding the expiry date and the issuer will determine the closing price of the shares on the basis of its good faith estimate of the price that would have prevailed on that day but for the market disruption event. Any such discretion exercised by the issuer shall be binding on us and the holders of the structured products.
Morgan Stanley Hong Kong Securities Limited, the liquidity provider for our structured products, is our affiliate and affiliate of the guarantor and may therefore trade or hold our structured products and enter into hedging transactions in respect of our structured products from time to time.
We may early terminate our structured products due to illegality or impracticability
We are entitled to terminate the structured products if we determine in good faith and in a commercially reasonable manner that, for reasons beyond our control, it has become or it will become illegal or impracticable (i) for us to perform our obligations under the structured products, or for the guarantor to perform its obligations under the guarantee, in whole or in part as a result of (a) the adoption of, or any change in, any relevant law or regulation (including any tax law) or (b) the promulgation of, or any change in, the interpretation by any court, tribunal, governmental, administrative, legislative, regulatory or judicial authority or power with competent jurisdiction of
−21− any relevant law or regulation (including any tax law) (each of (a) and (b), a “Change in Law Event”); or for us or any of our affiliates to maintain our hedging arrangements with respect to the structured products due to a Change in Law Event. If this happens, we or the guarantor will, if and to the extent permitted by the applicable law or regulation, pay to each holder of those structured products a cash amount that the issuer determines in good faith and in a commercially reasonable manner to be the fair market value in respect of each structured product held by such holder immediately prior to such termination (ignoring such illegality or impracticability) less our cost of unwinding any related hedging arrangement as determined by us in our sole and absolute discretion. Such fair market value of the structured products may be substantially less than your initial investment and may be zero.
Structured products relating to an index involve valuation risks
You should note that, in the case of structured products relating to an index, an investment involves valuation risks in relation to the index. The level of the index may vary over time and may increase or decrease due to various factors including changes in the formula for or the method of calculating the index. In addition, a level for the index may be published by the index sponsor at a time when one or more securities comprising the index are not trading. If this occurs on the expiry date and there is no market disruption event called under the terms of the relevant structured products, then the value of such securities used in calculating the closing level of the index will not be their up-to-date market price. Certain (but not all) events relating to the index underlying our structured products require or, as the case may be, permit us to make certain adjustments or amendments to the conditions (including, but not limited to, determining the level of the index). However, we are not required to make an adjustment for every event that can affect the index. If an event occurs that does not require us to adjust the Conditions, the market price of our structured products and the cash settlement amount upon mandatory call event or expiry of our structured products may be affected.
Risks associated with our structured products relating to the units of a fund or trust
General risks
For our structured products relating to the units of a fund or trust, neither we nor any of our affiliates have the ability to control or predict the actions of the trustee or the manager of the fund or trust. Neither the trustee nor the manager of the fund or trust (i) is involved in the offer of any structured products in any way, or (ii) has any obligation to consider the interest of the holders of any structured products in taking any corporate actions that might affect the value of any structured products. We have no role in the fund or trust. The trustee or the manager of the fund or trust is responsible for making investment and other trading decisions with respect to the management of the fund or trust consistent with its investment objectives and in compliance with the investment restrictions as set out in the constitutive documents of the fund or trust. The manner in which the fund or trust is managed and the timing of actions may have a significant impact on the performance of the units. Hence, the price which is used to calculate the performance of the units is also subject to these risks.
You should note that our structured products relating to the units of a fund or trust reference the units of the fund or trust and the cash settlement amount payable upon exercise will be calculated using the official closing prices of the units on the stock exchange on the valuation dates. If the fund or trust is designed to track the performance of an index, you should note that our structured products do not reference the index tracked by the fund or trust. Changes in the price of the units on the Stock Exchange may not correspond with changes in the level of such index, and such price at any given time may differ from the net asset value per unit of the fund or trust. In addition, the components which comprise such index may change from time to time. The price of the units of the fund or trust may rise or fall as a result of such changes. The composition of such index may also change if one of the constituent companies were to delist its shares or if a new eligible company were to list its shares and be added to such index.
−22− Exchange traded funds
In the case of our structured products linked to units of an exchange traded fund (“ETF”), you should note that an ETF is exposed to the political, economic, currency and other risks related to the underlying asset pool or index that the ETF is designed to track. There may also be disparity between the performance of the ETF and the performance of the underlying asset pool or index that the ETF is designed to track as a result of, for example, failure of the tracking strategy, currency differences, fees and expenses. In addition, where the index or market that the ETF tracks is subject to restricted access, the efficiency in the unit creation or redemption to keep the price of the fund or trust in line with its net asset value may be disrupted, causing the ETF to trade at a higher premium or discount to its net asset value. Such risks may have a negative impact on the performance of the ETF and the price of the units of the ETF may fall.
Synthetic exchange traded funds
If an ETF adopts a synthetic replication investment strategy to achieve its investment objectives by investing in financial derivative instruments linked to the performance of an underlying asset pool or index that the ETF is designed to track, you should also note that:
(a) investments in financial derivative instruments will expose the ETF to the credit, potential contagion and concentration risks of the counterparties who issued such financial derivative instruments. If the ETF has collateral to reduce the counterparty risk, there may still be a risk that the market value of the collateral has fallen substantially when the ETF seeks to realise the collateral; and
(b) the ETF may be exposed to higher liquidity risk if the ETF invests in financial derivative instruments which do not have an active secondary market.
You should read the offering document of the ETF for further information about the risks applicable to the ETF.
Real estate investment trust
If our structured products are linked to units of a real estate investment trust (“REIT”), you should note that the primary investment objective of REIT is to invest in a real estate portfolio. A REIT is exposed to risks relating to investments in real estate, including but not limited to (a) adverse changes in political or economic conditions; (b) changes in interest rates and the availability of debt or equity financing, which may result in an inability by the REIT to maintain or improve the real estate portfolio and finance future acquisitions; (c) changes in environmental, zoning and other governmental rules; (d) changes in market rents; (e) any required repair and maintenance of the portfolio properties; (f) breach of any property laws or regulations; (g) the relative illiquidity of real estate investment; (h) real estate taxes; (i) any hidden interests in the portfolio properties; (j) any increase in insurance premiums and (k) any uninsurable losses.
There may also be disparity between the market price of the units of a REIT and the net asset value per unit. This is because the market price of the units of a REIT also depends on many factors, including but not limited to (a) the market value and perceived prospects of the real estate portfolio; (b) changes in economic or market conditions; (c) changes in market valuations of similar companies; (d) changes in interest rates; (e) the perceived attractiveness of the units of the REIT against those of other equity securities; (f) the future size and liquidity of the market for the units and the REIT market generally; (g) any future changes to the regulatory system, including the tax system and (h) the ability of the REIT to implement its investment and growth strategies and to retain its key personnel.
The above risks may have a significant impact on the performance of the units and the price of our structured products.
−23− ETF investing through RQFII and/or China Connect
If our structured products are linked to units of an ETF issued and traded outside mainland China with direct investment in the mainland Chinese securities markets through the Renminbi Qualified Foreign Institutional Investor (“RQFII”) regime and/or the Shanghai-Hong Kong Stock Connect and Shenzhen-Hong Kong Stock Connect (collectively, “China Connect”), you should note that, amongst others:
(a) the novelty and untested nature of such ETF make it riskier than traditional ETFs investing directly in more developed markets. The policy and rules for RQFII and China Connect prescribed by the PRC central government are new and subject to change, and there may be uncertainty to their implementation. The uncertainty and change of the laws and regulations in mainland China may adversely impact on the performance of such ETF and the trading price of the units;
(b) such ETF primarily invests in securities traded in the mainland Chinese securities markets and is subject to concentration risk. Investment in the mainland Chinese securities markets (which are inherently stock markets with restricted access) involves certain risks and special considerations as compared with investment in more developed economies or markets, such as greater political, tax, economic, foreign exchange, liquidity and regulatory risks. The operation of such ETF may also be affected by interventions by the applicable government(s) and regulators in the financial markets; and
(c) investment by such ETF in the mainland Chinese securities market under the RQFII regime will be subject to its manager’s RQFII quota allocated to such ETF. In addition, trading of securities invested by the ETF under the China Connect will be subject to a daily quota which does not belong to such ETF and is utilised on a first-come-first-serve basis. In the event that the RQFII quota allocated to such ETF and/or the daily quota under China Connect are reached, the manager may need to suspend creation of further units of such ETF, and therefore may affect the liquidity in unit trading of such ETF. In such event, the trading price of a unit of such ETF is likely to be at a significant premium to its net asset value, and may be highly volatile.
The above risks may have a significant impact on the performance of the units and the price of our structured products. Please read the offering documents of the ETF to understand its key features and risks.
ETF traded through dual counters model
If our structured products are linked to units of an ETF that adopts the dual counters model for trading its units on the Stock Exchange in Renminbi (“RMB”) and Hong Kong dollars (“HKD”) separately, you need to consider the following additional risks in light of the novelty and relatively untested nature of the Stock Exchange’s dual counters model:
(a) our structured products may be linked to HKD-traded or RMB-traded units. If the underlying asset is HKD-traded units, movements in the trading prices of RMB-traded units should not directly affect the price of our structured products. Similarly, if the underlying asset is RMB- traded units, movements in the trading prices of HKD-traded units should not directly affect the price of our structured products;
(b) if there is a suspension of inter-counter transfer of such units between the HKD counter and the RMB counter for any reason, such units will only be able to be traded in the relevant currency counter on the Stock Exchange, which may affect the demand and supply of such units and have an adverse effect on the price of our structured products; and
−24− (c) the trading prices on the Stock Exchange of HKD-traded units and RMB-traded units may deviate significantly due to different factors, such as market liquidity, RMB conversion risk, supply and demand in each counter and the exchange rate between offshore RMB and HKD. Changes in the trading price of the underlying asset in HKD or RMB (as the case may be) may adversely affect the price of our structured products.
Liquidation of underlying company or termination of underlying fund or trust
In the event of liquidation, dissolution or winding up of the company that issues the underlying shares, or termination of a fund or trust that issues the underlying units or the appointment of a receiver or administrator or analogous person, to the company, trust or fund, the relevant structured products shall lapse and shall cease to be valid for any purpose, and the holders of the relevant structured products will sustain a total loss in their investment.
Time lag between the time of exercise or the occurrence of a mandatory call event (in the case of CBBCs) and the time of determination of the settlement amount may affect the settlement amount
There may be a time lag between the time or date (i) when our structured products are automatically exercised or (ii) (in the case of our CBBCs only) when a mandatory call event occurs and the time of determination of the settlement amount. Such delay could be significantly longer in the case of a market disruption event, delisting of the company that issues the underlying assets or shares comprising any underlying asset that is an index, termination of the trust or fund that issues the underlying unit or other adjustment events. The settlement amount may change significantly during any such period and may result in such settlement amount being zero.
We may adjust the terms and conditions of our structured products upon the occurrence of certain corporate events or extraordinary events affecting the underlying assets
We may determine that certain corporate events or extraordinary events affecting the underlying assets have occurred and may make corresponding adjustments to the terms and conditions of our structured products, including adjustments to the value or level of the underlying assets or changing the composition of the underlying assets. Such events and/or adjustments (if any) may have adverse impact on the value and/or market price of our structured products. We may also in our sole discretion adjust the entitlement of our structured products for dilution events such as stock splits and stock dividends.
However, we have no obligation to make an adjustment for every event that can affect the underlying asset. The value and/or market price of our structured products may be adversely affected by such events in the absence of an adjustment by us. If adjustments were made, we do not assure that such adjustments can negate any adverse impact of such events on the value and/or market price of our structured products.
We may modify the terms and conditions of our structured products
Under the terms and conditions, we may, without your consent, effect any modification of the terms and conditions of our structured products which, in our opinion, is:
(i) not materially prejudicial to your interests generally (without considering the circumstances of any individual holder of the structured products or the tax or other consequences of such modification in any particular jurisdiction);
(ii) of a formal, minor or technical nature;
(iii) made to correct a manifest error; or
−25− (iv) necessary in order to comply with mandatory provisions of the laws or regulations of Hong Kong.
Our determination of the occurrence of a market or settlement disruption event may affect the value and/or market price of our structured products
We may determine that a market or settlement disruption event has occurred. Such determination may affect the value and/or market price of our structured products, and may delay settlement in respect of our structured products.
If the issuer determines that a market disruption event exists, the valuation of the underlying assets for the purpose of calculating the cash settlement amount of our structured products will be postponed. If such market disruption event exists for a continuous period of time as specified in the terms of our structured products, we may determine the good faith estimate of the value or level of the underlying assets that would have prevailed on the relevant postponed valuation date but for such market disruption event.
The implied volatility of our structured products may not reflect the actual volatility of the underlying asset
The market price of our structured products is determined among other factors by the supply and demand of the structured products. This price “implies” a level of volatility in the underlying asset in the sense that such level of volatility would give a theoretical value for the structured products which is equal to that price; but such level of volatility may not be equal to the actual level of volatility of the underlying asset in the past or future.
Investment in our structured products may involve exchange rate risks and interest rate risks
An investment in our structured products may involve exchange rate risks. For example, the underlying asset may be denominated in a currency other than that of our structured products, our structured products may be denominated in a currency other than the currency of your home jurisdiction and our structured products may settle in a currency other than the currency in which you wishes to receive funds. Changes in the exchange rate(s) between the currency of the underlying asset, the currency in which our structured products settle and/or the currency of your home jurisdiction may adversely affect the return of your investment in our structured products. We cannot assure you that current exchange rates at the issue date of our structured products will be representative of the future exchange rates used in computing the value of our structured products. Fluctuations in exchange rates may therefore affect the value of our structured products.
An investment in our structured products may also involve interest rate risk as the intrinsic value of a structured product may be sensitive to fluctuations in interest rates. Fluctuations in the short term or long term interest rates of the currency in which our structured products are settled or the currency in which the underlying asset is denominated may affect the value and/or market price of our structured products.
Change in tax law
Tax law and practice is subject to change, possibly with retrospective effect and this could adversely affect the value of our structured products to the holder and/or the market value of our structured products. Any such change may (i) cause the tax treatment of the relevant structured products to change from what the investor understood the position to be at the time of purchase; (ii) render the statements in this base listing document concerning relevant tax law and practice in relation to our structured products to be inaccurate or to be inapplicable in some or all respect to certain structured products or to not include material tax considerations in relation to certain structured products; or (iii) give us the right to terminate the structured products if such change has the effect that our performance under the structured products is unlawful or impracticable.
−26− Please consult your tax advisers if you are in any doubt of your tax position
You may be required to pay taxes including stamp taxes or other documentary charges in accordance with the laws and practices of the country where our structured products are transferred or where the issuer of the underlying asset is organised or resident and such laws and practices may change from time to time. If you are in any doubt of your tax position, you should consult your own independent tax advisers.
Our structured products are issued in global registered form; you have to rely on your brokers to evidence title to your investment and to receive notices and the cash settlement amount
Our structured products are issued in global registered form and held on your behalf within a clearing system. This means that evidence of title to your interests, as well as the efficiency of ultimate delivery of the cash settlement amount, will be governed by the CCASS Rules.
Our structured products in global registered form will be registered in the name of HKSCC Nominees Limited (or its successors), which shall be treated by us as the holder of our structured products for all purposes. This means that you will not receive definitive certificates and the register will record at all times that our structured products are being held by HKSCC Nominees Limited (or its successors). You will have to rely solely upon your brokers and the statements received from your brokers to evidence title to your investments. You will also have to rely on your brokers to effectively inform you of any notices, announcements and/or meetings issued or called by us (upon receipt by those brokers as CCASS participants of the same from CCASS and ultimately from us). The Stock Exchange’s Listing Rules also provide that our obligations to deliver notices, announcements and/or meetings will be complied with by a posting on the Stock Exchange website. Our obligations to deliver any cash settlement amount to you will be duly performed by the delivery of any such amount to HKSCC Nominees Limited (or its successors) as the holder of our structured products. You will therefore have to rely on your brokers for the ultimate delivery of any cash settlement amount to you as the investor.
We and our guarantor do not give you any advice or credit analysis
Neither we nor the guarantor is responsible for the lawfulness of your acquisition of our structured products. We and the guarantor are not giving you any advice or credit analysis of the underlying assets. You shall be deemed to have made a representation to such effect for each purchase of our structured products of any series.
The application of regulatory requirements and strategies in the U.S. or other jurisdictions to facilitate the orderly resolution of large financial institutions may pose a greater risk of loss for the guarantor’s security holders, and subject the guarantor to other restrictions.
Pursuant to the Dodd-Frank Act, the guarantor is required to periodically submit to the Federal Reserve and the FDIC a resolution plan that describes its strategy for a rapid and orderly resolution under the U.S. Bankruptcy Code in the event of material financial distress or failure. If the Federal Reserve and the FDIC were to jointly determine that the guarantor’s resolution plan submission was not credible or would not facilitate an orderly resolution, and if the guarantor is unable to address any deficiencies identified by the regulators, the guarantor or any of the guarantor’s subsidiaries may be subject to more stringent capital, leverage, or liquidity requirements or restrictions on the guarantor’s growth, activities, or operations, or after a two-year period, the guarantor may be required to divest assets or operations.
In addition, provided that certain procedures are met, the guarantor can be subject to a resolution proceeding under the orderly liquidation authority under Title II of the Dodd-Frank Act with the FDIC being appointed as receiver. The FDIC’s power under the orderly liquidation authority to disregard the priority of creditor claims and treat similarly situated creditors differently in certain circumstances, subject to certain limitations, could adversely impact holders of the guarantor’s unsecured debt.
−27− Further, because both the guarantor’s resolution plan contemplates an SPOE strategy under the U.S. Bankruptcy Code and the FDIC has proposed an SPOE strategy through which it may apply its orderly liquidation authority powers, the guarantor believes that the application of an SPOE strategy is the reasonably likely outcome if either the guarantor’s resolution plan were implemented or a resolution proceeding were commenced under the orderly liquidation authority. An SPOE strategy generally contemplates the provision of additional capital and liquidity by the guarantor to certain of its subsidiaries so that such subsidiaries have the resources necessary to implement the resolution strategy, and the guarantor has entered into a secured amended and restated support agreement with its material entities, as defined in the guarantor’s 2017 resolution plan, pursuant to which it would provide such capital and liquidity.
Under the secured amended and restated support agreement, upon the occurrence of a resolution scenario, including one in which an SPOE strategy is used, the guarantor will be obligated to contribute or loan on a subordinated basis all of its contributable material assets, other than shares in subsidiaries of the guarantor and certain intercompany payables, to provide capital and liquidity, as applicable, to the guarantor’s material entities. The obligations of the guarantor under the secured amended and restated support agreement are in most cases secured on a senior basis by the assets of the guarantor (other than shares in subsidiaries of the guarantor). As a result, claims of the guarantor’s material entities against the assets of the guarantor (other than shares in subsidiaries of the guarantor) are effectively senior to unsecured obligations of the guarantor. Such unsecured obligations are at risk of absorbing losses of the guarantor and its subsidiaries.
In further development of the guarantor’s SPOE strategy, the guarantor has created a wholly owned, direct subsidiary of the guarantor, MS Holdings LLC (“Funding IHC”), to serve as a resolution funding vehicle. The guarantor expect that, prior to the submission of the guarantor’s 2019 resolution plan by July 1, 2019, the guarantor will contribute certain of its assets to the Funding IHC and enter into an updated secured amended and restated support agreement with the Funding IHC as well as certain other subsidiaries to facilitate the execution of the guarantor’s SPOE strategy. Similar to the existing secured amended and restated support agreement, the updated secured amended and restated support agreement will obligate the guarantor to transfer capital and liquidity, as revised, to the Funding IHC, and that the guarantor and/or the Funding IHC will recapitalize and provide liquidity to material entities in the event of the guarantor’s material financial distress or failure.
Although an SPOE strategy, whether applied pursuant to the guarantor’s resolution plan or in a resolution proceeding under the orderly liquidation authority, is intended to result in better outcomes for creditors overall, there is no guarantee that the application of an SPOE strategy, including the provision of support to the guarantor’s material entities pursuant to the secured amended and restated support agreement, will not result in greater losses for holders of the guarantor’s securities compared to a different resolution strategy for us.
Regulators have taken and proposed various actions to facilitate an SPOE strategy under the U.S. Bankruptcy Code, the orderly liquidation authority or other resolution regimes. For example, the Federal Reserve requires top-tier BHCs of U.S. G-SIBs, including Morgan Stanley, to maintain minimum amounts of equity and eligible long-term debt TLAC in order to ensure that such institutions have enough loss-absorbing resources at the point of failure to be recapitalized through the conversion of debt to equity or otherwise by imposing losses on eligible TLAC where the SPOE strategy is used. The combined implication of the SPOE resolution strategy and the TLAC requirement is that the guarantor’s losses will be imposed on the holders of eligible long-term debt and other forms of eligible TLAC issued by the guarantor before any losses are imposed on the holders of the debt securities of the guarantor’s operating subsidiaries or before putting U.S. taxpayers at risk.
In addition, certain jurisdictions, including the U.K. and other E.U. jurisdictions, have implemented, or are in the process of implementing, changes to resolution regimes to provide resolution authorities with the ability to recapitalize a failing entity organized in such jurisdiction by writing down certain unsecured liabilities or converting certain unsecured liabilities into equity. Such
−28− “bail-in” powers are intended to enable the recapitalization of a failing institution by allocating losses to its shareholders and unsecured creditors. Non-U.S. regulators are also considering requirements that certain subsidiaries of large financial institutions maintain minimum amounts of TLAC that would pass losses up from the subsidiaries to the guarantor and, ultimately, to security holders of the guarantor in the event of failure.
Other risks relating to the guarantor
Please refer to the section “Risk factors” in the guarantor’s Annual Report on Form 10-K for the fiscal year ended 31 December 2018 as filed with the SEC on 26 February 2019, an extract of which is reproduced in the section headed “Information Relating to the Guarantor” of this document for a description of additional risks relating to the guarantor.
Risks associated with our CBBCs
You may lose all or substantially all your investment at expiry
If you hold your CBBCs until expiry and no mandatory call event occurs during the observation period, the cash settlement amount payable upon exercise at expiry will depend on how much the closing price or level of the underlying asset is above (in the case of bull CBBCs) or below (in the case of bear CBBCs) the strike price or level. The cash settlement amount may be substantially less than your initial investment in the CBBCs, and may even be zero.
You may lose all or substantially all of your investment upon the occurrence of the mandatory call event
You may lose all or substantially all of your investment in our CBBCs if the mandatory call event occurs during the observation period of our CBBCs - meaning that the price or level of the underlying asset is at or below (for our bull CBBCs) or at or above (for our bear CBBCs) the predetermined call price or call level at any time during the observation period. The mandatory call event may be triggered by a single, small trade in the underlying share or security comprised in the underlying index, regardless of the size of the trade. The trade that triggers the mandatory call event may only be the result of a temporary fall (or rise, as the case may be) in the price or level of the underlying asset caused by a number of factors. Subsequent to the occurrence of the mandatory call event, the price or level of the underlying asset may recover to above (or below, as the case may be) the call price or call level.
Upon the occurrence of a mandatory call event, a Category N CBBC will become worthless while a Category R CBBC will be settled by the payment of a residual value (if any) by us. Such residual value is determined by reference to the amount by which the minimum trade price or index level of the underlying asset during the MCE valuation period exceeds the strike price or strike level (for our Category R bull CBBCs) or the amount by which the strike price or strike level exceeds the maximum trade price or index level of the underlying asset during the MCE valuation period (for our Category R bear CBBCs). This residual value may be as low as zero.
Where the mandatory call event occurs in a continuous trading session of the Stock Exchange, all trades in the CBBCs concluded via auto-matching or manually after the time of the occurrence of a mandatory call event will be cancelled. Where the mandatory call event occurs during a pre-opening session or a closing auction session (if applicable) of the Stock Exchange, all auction trades in the CBBCs concluded in such session and all manual trades concluded after the end of the pre-order matching period in such session will be cancelled. We will announce the occurrence of the mandatory call event in accordance with the requirements of the Stock Exchange but the announcement of the same can be delayed by among other reasons, technical errors or system failures beyond our control. Your gain or loss from a trade that is subsequently cancelled will be reversed. If in the meantime you have entered into transactions with our CBBCs as a hedge, then upon cancellation of trades in our CBBCs, you will need to find a replacement hedge and may incur losses in doing so.
−29− Revocation of mandatory call event
Termination of our CBBCs and cancellation of trades following the occurrence of the mandatory call event is irrevocable unless the mandatory call event is triggered by (i) system malfunction or other technical errors of Hong Kong Exchanges and Clearing Limited (e.g. the setting up of wrong call price or call level and other parameters) and such event is reported by the Stock Exchange to us and the Stock Exchange and we mutually agree that such mandatory call event is to be revoked, or (ii) manifest errors caused by the relevant third party price sources (e.g. any miscalculation of the index level by the index sponsor) and such event is reported by us to the Stock Exchange and the Stock Exchange and we mutually agree that such mandatory call event is to be revoked. In each of the above cases, such mutual agreement must be reached no later than 30 minutes before the commencement of trading (including the pre-opening session) (Hong Kong time) on the trading day of the Stock Exchange immediately following the day on which the mandatory call event occurs, or such other time frame as prescribed by the Stock Exchange from time to time.
Under the terms and conditions of our CBBCs, none of the Stock Exchange, us, the guarantor, the issuer or sponsor of the underlying asset or any of our or their affiliates or agent shall be responsible for any losses suffered as a result of the determination of the price or level of the underlying asset, any adjustments involved in determining the occurrence of the mandatory call event, the calculation of any cash settlement amount and the suspension of trading in connection with the mandatory call event, notwithstanding that such adjustments, calculation or suspension may have occurred as a result of an error.
A CBBC is different from a margin trading position over the same underlying asset
An investment in CBBC is similar to but not the same as a corresponding margin trading position. Both are different from an actual position in the underlying asset in that an investor does not have to pay an amount equal to the maximum potential exposure of the position upon entry. Because the initial payment is small by comparison, a given change in the price or level of the underlying asset can result in a greater percentage change in the value of the investment.
Whilst the total gain or loss of investing in a CBBC upon exercise at expiry will be substantially equal to that of an equivalent margin trading position (of same size and strike price or level) on the same underlying asset, at other times a CBBC differs from an equivalent margin trading position in many ways.
Generally a margin trading position will be marked-to-market at the end of every trading day so that the holder would realise the day’s gain or loss immediately, unless a mandatory call event or expiry occurs the gain or loss of a CBBC is realised only when it is sold. One can maintain a margin trading position even if the underlying asset price or level continues to moves against the direction anticipated, so long as the holder continues to put up additional margin, with the CBBC when the underlying asset price or level reaches the call level it is immediately terminated. Once the call level is reached, a CBBC investor would lose his entire investment (for a Category N CBBC) or would only receive the residual value (if any, for a Category R CBBC) and due to the call termination, he would not benefit from the reversal of direction of the underlying asset price or level subsequent to the mandatory call event (for a Category N CBBC) or the determination of residual value (for a Category R CBBC).
This call termination feature of CBBCs (among other reasons) also means that the theoretical value of a CBBC at a time prior to its expiry will be different from that of an equivalent margin trading position. A given percentage change in the price or level of the underlying asset may not result in the same percentage change (in the same direction for a bull CBBC or in the opposite direction for a bear CBBC) in the theoretical value of the CBBC. The percentage change in theoretical value of the CBBC may be greater or smaller (or may be zero), in the same or opposite direction.
−30− The theoretical value of a CBBC at any time will also contain an amount which reflects our cost of maintaining the corresponding hedge position in the underlying asset (e.g. the cost of funding a long position in shares, the net cost of borrowing shares for short sale, or the cost of margin in maintaining the futures position). The purchase price of a CBBC you pay may include all or part of such cost and when the mandatory call event occurs, the cash settlement amount (if any) will not contain a refund of such cost.
Other than at expiry (assuming mandatory call event does not occur prior to expiry) when the cash settlement amount will be set by the closing price or level of the underlying asset, at any time prior to the expiry you may sell your holding of CBBCs in the market and the price realised may or may not be the same as the theoretical value of the CBBCs, as the price will be determined by the levels of supply and demand in the market.
The funding costs of our CBBCs will fluctuate during the term of our CBBCs
The issue price of our CBBCs is set by reference to the difference between the spot price or spot level of the underlying asset as of the launch date and the strike price or strike level, plus the applicable funding cost. The funding cost applicable to our CBBCs is specified in the relevant launch announcement and supplemental listing document. It will fluctuate during the term of our CBBCs as the funding rate changes from time to time. The funding cost is an amount determined by us based on one or more factors, including but not limited to the strike price or strike level (as the case may be), the prevailing interest rate, the expected term of our CBBCs, any expected notional dividends in respect of the underlying asset and the margin financing provided by us.
Residual value will not include residual funding cost
The residual value (if any, for a Category R CBBC) payable by us following the occurrence of a mandatory call event will not include the residual funding cost for the CBBCs. When a mandatory call event occurs, the investors will lose the funding cost for the full period.
−31− TAXATION
We have based this summary of Hong Kong and the Cayman Islands tax on current law and practice. It is intended to give you an overview of what Hong Kong and the Cayman Islands tax you might have to pay if you hold our structured products. It is not complete and we are not giving you any tax advice. You should consult your own tax adviser about the tax consequences of investing in our structured products, particularly if you are subject to special tax rules (for example, if you are a bank, dealer, insurance company or a tax-exempt entity).
HONG KONG
Withholding Tax
We are not required under current law to make any withholding on account of Hong Kong tax from payments in respect of our structured products.
Capital Gains Tax
No capital gains tax is payable in Hong Kong on any capital gains arising from a sale or disposal of our structured products.
Profits Tax
Hong Kong profits tax may be chargeable on any gains arising from a sale or disposal of our structured products where the sale or disposal is or forms part of a trade, profession or business carried on in Hong Kong.
Stamp Duty
Our cash-settled structured products are not subject to Hong Kong stamp duty or bearer instrument duty either when issued or on any subsequent transfer.
CAYMAN ISLANDS
The Government of the Cayman Islands will not, under existing legislation, impose any income, corporate or capital gains tax, estate duty, inheritance tax, gift tax or withholding tax upon us or our investors. The Cayman Islands are not party to a double tax treaty with any country that is applicable to any payments made to or by us.
We have applied for, and received, an undertaking from the Governor-in-Cabinet of the Cayman Islands that, in accordance with section 6 of the Tax Concessions Law (2011 Revision) of the Cayman Islands, for a period of 20 years from the date of the undertaking, no law which is enacted in the Cayman Islands imposing any tax to be levied on profits, income, gains or appreciations shall apply to us or our operations and, in addition, that no tax to be levied on profits, income, gains or appreciations or which is in the nature of estate duty or inheritance tax shall be payable (i) on or in respect of our shares, debentures or other obligations or (ii) by way of the withholding in whole or in part of a payment of dividend or other distribution of income or capital by us to our investors or a payment of principal or interest or other sums due under a debenture or other obligations of us.
−32− UNITED STATES FOREIGN ACCOUNT TAX COMPLIANCE WITHHOLDING
The following overview of FATCA (as defined below) is for general information purposes only. Prospective purchasers of structured products should consult their own tax advisers regarding FATCA.
A law enacted in 2010 (commonly known as “FATCA”) could impose a withholding tax of 30 per cent. on payments on structured products paid to you or any non-US person or entity that receives such income (a “non-US payee”) on your behalf, unless you and each non-US payee comply with US information reporting, withholding, identification, certification and related requirements. This withholding tax could apply to payments on the structured products as early as 1 January 2019. However, this withholding tax will generally not apply to structured products unless they are treated as giving rise to “foreign passthru payments” and are issued after the date that is six months after the US Treasury Department issues final regulations defining “foreign passthru payments,” provided that after this date the terms of the structured products are not modified in a way that would cause the structured products to be treated as reissued for US tax purposes. There are currently no rules regarding what constitutes a “foreign passthru payment” or when this withholding would apply to structured products.
Even if this withholding tax were to otherwise apply to payments on any structured products, in the case of a payee that is a non-US financial institution (for example, a clearing system, custodian, nominee or broker), withholding generally will not be imposed if the financial institution collects and reports (to the US or another relevant taxing authority) substantial information regarding such institution’s US account holders (which would include some account holders that are non-US entities but have US owners). Other payees, including individuals, may be required to provide proof of tax residence or waivers of confidentiality laws and/or, in the case of non-US entities, certification or information relating to their US ownership.
Under this withholding regime, if it applies to any structured products, withholding may be imposed at any point in a chain of payments if the payee is not compliant. A chain may work as follows, for example: we make payment on the structured products to a clearing system. The payment is transferred to each of the clearing system’s participants, and finally to a non-US bank or broker through which you hold the structured products, who credits the payment to your account. Accordingly, if you receive payments through a chain that includes one or more non-US payees, such as a non-US bank, broker or clearing system, the payment could be subject to withholding if, for example, your non-US bank or broker through which you hold the structured products fails to comply with these requirements and is subject to withholding. This would be the case even if you might not otherwise have been directly subject to withholding.
We will not pay any additional amounts in respect of any withholding tax, so if withholding tax applies, you will receive less than the amount that you would have otherwise received.
Depending on your circumstances, in the event we are required to withhold any amounts in respect of this withholding tax, you may be entitled to a refund or credit in respect of some or all of this withholding. However, even if you are entitled to have any such withholding refunded, the required procedures could be cumbersome and significantly delay your receipt of any withheld amounts. You should consult your own tax advisors regarding FATCA. You should also consult your bank or broker through which you would hold the structured products about the likelihood that payments to it (for credit to you) may become subject to withholding in the payment chain.
−33− INFORMATION ABOUT US
History and Development
The Issuer was incorporated in the Cayman Islands on 15 July 2005 as an exempted company with limited liability, pursuant to the Companies Law (as amended from time to time) of the Cayman Islands. There is no limitation on the Issuer’s duration. Its registration number is 151867 and its registered office is c/o Maples Corporate Services Limited, PO Box 309, Ugland House, Grand Cayman, KY1-1104, Cayman Islands, telephone number (1 345) 949 8066.
Investments
All material assets of the Issuer are obligations of (or securities issued by) one or more Morgan Stanley Group companies.
Business and Principal Markets
The Issuer’s business consists of the issuance of financial instruments, with a primary focus on the Asian markets, and the hedging of obligations relating thereto.
All material assets of the Issuer are obligations of (or securities issued by) one or more Morgan Stanley Group companies (for the avoidance or doubt, Morgan Stanley Group companies in this context means Morgan Stanley and its subsidiaries and affiliates). If any of these Morgan Stanley Group companies incurs losses with respect to any of its activities (irrespective of whether those activities relate to the Issuer or not) the ability of such company to fulfil its obligations to the Issuer could be impaired, thereby exposing holders of warrants issued by the Issuer to a risk of loss. Should such companies’ prospects be impaired, holders of warrants issued by the Issuer may also be exposed to a risk of loss.
Organisational Structure and Major Shareholders
The Issuer has no subsidiaries. It is wholly owned by Morgan Stanley Asia Securities Products LLC. All decisions to issue securities are taken by the board of the Issuer.
Recent Developments and Trend Information
The Issuer issues securities and enters hedges in respect of such issues of securities.
Management
The directors of the Issuer as at the date hereof are:
• Jason Yates
• Young Lee
• Adrian Priddis
• Christopher Blackman
• Scott Honey
• Richard Smerin
−34− Save for the interests referred to above under the heading “Management”, the Issuer is not aware of any existing or potential conflicts of interest between any duties owed to the Issuer by its management (as described above) and the private interests and/or other external duties owed by these individuals.
Board Practice
The Issuer considers itself to be in compliance with all Cayman Islands laws relating to corporate governance that are applicable to it.
As of the date of this base listing document, the Issuer does not have an audit committee.
Share Capital and Memorandum and Articles of Association
The authorised share capital of the Issuer is US$50,000 divided into 50,000 shares of a par value of US$1 each, all of which have been issued and fully paid.
Under the Memorandum and Articles of Association of the Issuer, Clause 3 in the Memorandum of Association provides that the objects for which the Issuer is established are unrestricted and the Issuer shall have full power and authority to carry out any object not prohibited by the Companies Law (as amended from time to time) or as the same may be revised from time to time, or any other law of the Cayman Islands.
−35− INFORMATION RELATING TO THE GUARANTOR
Morgan Stanley is a global financial services firm that maintains significant market positions in each of its business segments — Institutional Securities, Wealth Management and Investment Management. Morgan Stanley, through its subsidiaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and customers, including corporations, governments, financial institutions and individuals. Unless the context otherwise requires, the terms “Morgan Stanley,” “Firm,” “us,” “we” or “our” mean Morgan Stanley (the “Parent Company”) together with its consolidated subsidiaries. We define the following as part of our consolidated financial statements (“financial statements”): consolidated income statements (“income statements”), consolidated balance sheets (“balance sheets”), and consolidated cash flow statements (“cash flow statements”). Morgan Stanley was originally incorporated under the laws of the State of Delaware in 1981, and its predecessor companies date back to 1924. Morgan Stanley is a financial holding company regulated by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended. Morgan Stanley’s principal executive office is at 1585 Broadway, New York, New York 10036, and its telephone number is (212) 761-4000. The registered office of Morgan Stanley is at The Corporation Trust Company, Corporation Trust Center, 1209 Orange Street, Wilmington, DE 19801, U.S.A., registration number 0923632.
Morgan Stanley is a publicly traded company with a principal listing of its ordinary shares on the New York Stock Exchange.
As of 25 March 2019, based on Schedule 13D/A or Schedule 13G (as applicable) filed with the SEC by each of the following entities, the following entities beneficially own more than 5% of Morgan Stanley’s common stock: Mitsubishi UFJ Financial Group, Inc. (24% holding); State Street Corporation (7.7% holding); BlackRock, Inc. (6.2% holding) and The Vanguard Group (5.7% holding). The percentage holdings are based on the number of common shares as of 25 March 2019.
Morgan Stanley conducts its business from its headquarters in and around New York City, its regional offices and branches throughout the U.S. and its principal offices in London, Tokyo, Hong Kong and other world financial centers. At 31 March 2019, Morgan Stanley had 60,469 employees worldwide.
A description of the clients and principal products and services of each of Morgan Stanley’s business segments is as follows:
• Institutional Securities provides investment banking, sales and trading, lending and other services to corporations, governments, financial institutions, and high to ultra-high net worth clients. Investment banking services consist of capital raising and financial advisory services, including services relating to the underwriting of debt, equity and other securities as well as advice on mergers and acquisitions, restructurings, real estate and project finance. Sales and trading services include sales, financing, prime brokerage and market-making activities in equity and fixed income products, including foreign exchange and commodities. Lending activities include originating corporate loans, commercial mortgage lending, asset-backed lending, and financing extended to sales and trading customers. Other activities include investments and research.
• Wealth Management provides a comprehensive array of financial services and solutions to individual investors and small to medium-sized businesses and institutions covering brokerage and investment advisory services, financial and wealth planning services, annuity and insurance products; securities based lending, residential real estate loans and other lending products; banking and retirement plan services.
−36− • Investment Management provides a broad range of investment strategies and products that span geographies, asset classes, and public and private markets, to a diverse group of clients across institutional and intermediary channels. Strategies and products include equity, fixed income, liquidity and alternative/other products. Institutional clients include defined benefit/defined contribution plans, foundations, endowments, government entities, sovereign wealth funds, insurance companies, third-party fund sponsors and corporations. Individual clients are served through intermediaries, including affiliated and non-affiliated distributors.
As of 23 May 2019, Morgan Stanley’s Board of Directors consists of the individuals listed below.
• Elizabeth Corley
• Alistair Darling
• Thomas H. Glocer
• James P. Gorman
• Robert H. Herz
• Nobuyuki Hirano
• Jami Miscik
• Dennis M. Nally
• Hutham S. Olayan
• Mary L. Schapiro
• Perry M. Traquina
• Rayford Wilkins, Jr.
• Takeshi Ogasawara
The Executive Vice President and Chief Financial Officer of Morgan Stanley is Jonathan Pruzan.
The Guarantor considers itself to be in compliance with all U.S. laws in all material respects relating to corporate governance that are applicable to it and taking into account the consolidated group as a whole.
Legal Proceedings of the Guarantor
For the year ended 31 December 2018:
The information in this section has been excerpted from Morgan Stanley’s Annual Report on Form 10-K for the year ended 31 December 2018. References in this section to the “Firm” mean Morgan Stanley and its consolidated subsidiaries.
−37− In addition to the matters described below, in the normal course of business, the Firm has been named, from time to time, as a defendant in various legal actions, including arbitrations, class actions and other litigation, arising in connection with its activities as a global diversified financial services institution. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some cases, the entities that would otherwise be the primary defendants in such cases are bankrupt or are in financial distress.
The Firm is also involved, from time to time, in other reviews, investigations and proceedings (both formal and informal) by governmental and self-regulatory agencies regarding the Firm’s business, and involving, among other matters, sales and trading activities, financial products or offerings sponsored, underwritten or sold by the Firm, and accounting and operational matters, certain of which may result in adverse judgments, settlements, fines, penalties, injunctions or other relief.
The Firm contests liability and/or the amount of damages as appropriate in each pending matter. Where available information indicates that it is probable a liability had been incurred at the date of the financial statements and the Firm can reasonably estimate the amount of that loss, the Firm accrues the estimated loss by a charge to income. The Firm’s future legal expenses may fluctuate from period to period, given the current environment regarding government investigations and private litigation affecting global financial services firms, including the Firm.
In many proceedings and investigations, however, it is inherently difficult to determine whether any loss is probable or even possible, or to estimate the amount of any loss. The Firm cannot predict with certainty if, how or when such proceedings or investigations will be resolved or what the eventual settlement, fine, penalty or other relief, if any, may be, particularly for proceedings and investigations where the factual record is being developed or contested or where plaintiffs or government entities seek substantial or indeterminate damages, restitution, disgorgement or penalties. Numerous issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, determination of issues related to class certification and the calculation of damages or other relief, and by addressing novel or unsettled legal questions relevant to the proceedings or investigations in question, before a loss or additional loss or range of loss or additional loss can be reasonably estimated for a proceeding or investigation. Subject to the foregoing, the Firm believes, based on current knowledge and after consultation with counsel, that the outcome of such proceedings and investigations will not have a material adverse effect on the financial condition of the Firm, although the outcome of such proceedings or investigations could be material to the Firm’s operating results and cash flows for a particular period depending on, among other things, the level of the Firm’s revenues or income for such period.
While the Firm has identified below certain proceedings that the Firm believes to be material, individually or collectively, there can be no assurance that additional material losses will not be incurred from claims that have not yet been asserted or are not yet determined to be material.
Residential Mortgage and Credit Crisis Related Matters
On 15 July 2010, China Development Industrial Bank (“CDIB”) filed a complaint against the Firm, styled China Development Industrial Bank v. Morgan Stanley & Co. Incorporated et al., which is pending in the Supreme Court of the State of New York, New York County (“Supreme Court of NY”). The complaint relates to a $275 million CDS referencing the super senior portion of the STACK 2006-1 CDO. The complaint asserts claims for common law fraud, fraudulent inducement and fraudulent concealment and alleges that the Firm misrepresented the risks of the STACK 2006-1 CDO to CDIB, and that the Firm knew that the assets backing the CDO were of poor quality when it entered into the CDS with CDIB. The complaint seeks compensatory damages related to the approximately $228 million that CDIB alleges it has already lost under the CDS, rescission of CDIB’s obligation to pay an additional $12 million, punitive damages, equitable relief, pre- and post-judgment interest, fees and costs. On 28 February 2011, the court denied the Firm’s motion to dismiss the complaint. On 21 December 2018, the court denied the Firm’s motion for summary judgment and granted in part the
−38− Firm’s motion for sanctions related to the spoliation of evidence. On 18 January 2019, CDIB filed a motion to clarify and resettle the portion of the court’s 21 December 2018 order granting spoliation sanctions. On 24 January 2019, CDIB filed a notice of appeal from the court’s 21 December 2018 order, and on 25 January 2019, the Firm filed a notice of appeal from the same order.
On 17 May 2013, plaintiff in IKB International S.A. in Liquidation, et al. v. Morgan Stanley, et al. filed a complaint against the Firm and certain affiliates in the Supreme Court of NY. The complaint alleges that defendants made material misrepresentations and omissions in the sale to plaintiff of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sponsored, underwritten and/ or sold by the Firm to plaintiff was approximately $133 million. The complaint alleges causes of action against the Firm for common law fraud, fraudulent concealment, aiding and abetting fraud, and negligent misrepresentation, and seeks, among other things, compensatory and punitive damages. On 29 October 2014, the court granted in part and denied in part the Firm’s motion to dismiss. All claims regarding four certificates were dismissed. After these dismissals, the remaining amount of certificates allegedly issued by the Firm or sold to plaintiff by the Firm was approximately $116 million. On 11 August 2016, the Appellate Division, First Department (“First Department”) affirmed the trial court’s order denying in part the Firm’s motion to dismiss the complaint.
On 2 July 2013, Deutsche Bank, in its capacity as trustee, became the named plaintiff in Federal Housing Finance Agency, as Conservator for the Federal Home Loan Mortgage Corporation, on behalf of the Trustee of the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC1 (MSAC 2007-NC1) v. Morgan Stanley ABS Capital I Inc., and filed a complaint in the Supreme Court of NY under the caption Deutsche Bank National Trust Company, as Trustee for the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC1 v. Morgan Stanley ABS Capital I, Inc. On 3 February 2014, the plaintiff filed an amended complaint, which asserts claims for breach of contract and breach of the implied covenant of good faith and fair dealing and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $1.25 billion, breached various representations and warranties. The amended complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages, rescission and interest. On 12 April 2016, the court granted in part and denied in part the Firm’s motion to dismiss the amended complaint, dismissing all claims except a single claim alleging failure to notify, regarding which the motion was denied without prejudice. On 9 December 2016, the Firm renewed its motion to dismiss that notification claim. On 17 January 2017, the First Department affirmed the lower court’s 12 April 2016 order. On 13 April 2017, the First Department denied plaintiff’s motion for leave to appeal to the New York Court of Appeals. On 8 March 2018, the trial court denied the Firm’s renewed motion to dismiss the notification claims.
On 8 July 2013, U.S. Bank National Association, in its capacity as trustee, filed a complaint against the Firm styled U.S. Bank National Association, solely in its capacity as Trustee of the Morgan Stanley Mortgage Loan Trust 2007-2AX (MSM 2007-2AX) v. Morgan Stanley Mortgage Capital Holdings LLC, Successor-by-Merger to Morgan Stanley Mortgage Capital Inc. and Green Point Mortgage Funding, Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $650 million, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages and interest. On 24 November 2014, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On 13 August 2018, the Firm filed a motion to renew its motion to dismiss.
On 6 November 2013, Deutsche Bank, in its capacity as trustee, became the named plaintiff in Federal Housing Finance Agency, as Conservator for the Federal Home Loan Mortgage Corporation, on behalf of the Trustee of the Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC3 (MSAC 2007-NC3) v. Morgan Stanley Mortgage Capital Holdings LLC, and filed a complaint in the Supreme Court of NY under the caption Deutsche Bank National Trust Company, solely in its capacity as
−39− Trustee for Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC3 v. Morgan Stanley Mortgage Capital Holdings LLC, as Successor-by-Merger to Morgan Stanley Mortgage Capital Inc. The complaint asserts claims for breach of contract and breach of the implied covenant of good faith and fair dealing and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $1.3 billion, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, unspecified damages, rescission, interest and costs. On 12 April 2016, the court granted the Firm’s motion to dismiss the complaint, and granted the plaintiff the ability to seek to replead certain aspects of the complaint. On 17 January 2017, the First Department affirmed the lower court’s order granting the motion to dismiss the complaint. On 9 January 2017, plaintiff filed a motion to amend its complaint. On 13 April 2017, the First Department denied plaintiff’s motion for leave to appeal to the New York Court of Appeals. On 8 March 2018, the trial court granted plaintiff’s motion to amend its complaint to include failure to notify claims. On 19 March 2018, the Firm filed an answer to plaintiff’s amended complaint.
On 19 September 2014, Financial Guaranty Insurance Company (“FGIC”) filed a complaint against the Firm in the Supreme Court of NY, styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to a securitization issued by Basket of Aggregated Residential NIMS 2007-1 Ltd. The complaint asserts claims for breach of contract and alleges, among other things, that the net interest margin securities (“NIMS”) in the trust breached various representations and warranties. FGIC issued a financial guaranty policy with respect to certain notes that had an original balance of approximately $475 million. The complaint seeks, among other relief, specific performance of the NIMS breach remedy procedures in the transaction documents, unspecified damages, reimbursement of certain payments made pursuant to the transaction documents, attorneys’ fees and interest. On 24 November 2014, the Firm filed a motion to dismiss the complaint, which the court denied on 19 January 2017. On 24 February 2017, the Firm filed a notice of appeal of the denial of its motion to dismiss the complaint and perfected its appeal on 22 November 2017. On 13 September 2018, the court affirmed the lower court’s order denying the Firm’s motion to dismiss the complaint.
On 23 September 2014, FGIC filed a complaint against the Firm in the Supreme Court of NY styled Financial Guaranty Insurance Company v. Morgan Stanley ABS Capital I Inc. et al. relating to the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4. The complaint asserts claims for breach of contract and fraudulent inducement and alleges, among other things, that the loans in the trust breached various representations and warranties and defendants made untrue statements and material omissions to induce FGIC to issue a financial guaranty policy on certain classes of certificates that had an original balance of approximately $876 million. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, compensatory, consequential and punitive damages, attorneys’ fees and interest. On 23 January 2017, the court denied the Firm’s motion to dismiss the complaint. On 24 February 2017, the Firm filed a notice of appeal of the denial of its motion to dismiss the complaint and perfected its appeal on 22 November 2017. On 13 September 2018, the First Department affirmed in part and reversed in part the lower court’s order denying the Firm’s motion to dismiss the complaint. On 20 December 2018, the First Department denied plaintiff’s motion for leave to appeal to the New York Court of Appeals or, in the alternative, for reargument.
On 23 January 2015, Deutsche Bank National Trust Company, in its capacity as trustee, filed a complaint against the Firm styled Deutsche Bank National Trust Company solely in its capacity as Trustee of the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 v. Morgan Stanley Mortgage Capital Holdings LLC as Successor-by-Merger to Morgan Stanley Mortgage Capital Inc., and Morgan Stanley ABS Capital I Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, among other things, that the loans in the trust, which had an original principal balance of approximately $1.05 billion, breached various representations and warranties. The complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction documents, compensatory, consequential, rescissory, equitable and punitive damages,
−40− attorneys’ fees, costs and other related expenses, and interest. On 11 December 2015, the court granted in part and denied in part the Firm’s motion to dismiss the complaint. On 19 October 2018, the court granted the Firm’s motion for leave to amend its answer and to stay the case pending resolution of Deutsche Bank National Trust Company’s appeal to the New York Court of Appeals in another case. On 17 January 2019, the First Department reversed the trial court’s order to the extent that it had granted in part the Firm’s motion to dismiss the complaint.
On 1 April 2016, the California Attorney General’s Office filed an action against the Firm in California state court styled California v. Morgan Stanley, et al., on behalf of California investors, including the California Public Employees’ Retirement System and the California Teachers’ Retirement System. The complaint alleges that the Firm made misrepresentations and omissions regarding RMBS and notes issued by the Cheyne SIV, and asserts violations of the California False Claims Act and other state laws and seeks treble damages, civil penalties, disgorgement, and injunctive relief. On 30 September 2016, the court granted the Firm’s demurrer, with leave to replead. On 21 October 2016, the California Attorney General filed an amended complaint. On 25 January 2017, the court denied the Firm’s demurrer with respect to the amended complaint.
Antitrust Related Matters
The Firm and other financial institutions are responding to a number of governmental investigations and civil litigation matters related to allegations of anticompetitive conduct in various aspects of the financial services industry, including the matters described below.
Beginning in February of 2016, the Firm was named as a defendant in multiple purported antitrust class actions now consolidated into a single proceeding in the United States District Court for the Southern District of New York (“SDNY”) styled In Re: Interest Rate Swaps Antitrust Litigation. Plaintiffs allege, inter alia, that the Firm, together with a number of other financial institution defendants, violated U.S. and New York state antitrust laws from 2008 through December of 2016 in connection with their alleged efforts to prevent the development of electronic exchange-based platforms for interest rates swaps trading. Complaints were filed both on behalf of a purported class of investors who purchased interest rates swaps from defendants, as well as on behalf of two swap execution facilities that allegedly were thwarted by the defendants in their efforts to develop such platforms. The consolidated complaints seek, among other relief, certification of the investor class of plaintiffs and treble damages. On 28 July 2017, the court granted in part and denied in part the defendants’ motion to dismiss the complaints.
In August of 2017, the Firm was named as a defendant in a purported antitrust class action in the United States District Court for the SDNY styled Iowa Public Employees’ Retirement System et al. v. Bank of America Corporation et al. Plaintiffs allege, inter alia, that the Firm, together with a number of other financial institution defendants, violated U.S. antitrust laws and New York state law in connection with their alleged efforts to prevent the development of electronic exchange-based platforms for securities lending. The class action complaint was filed on behalf of a purported class of borrowers and lenders who entered into stock loan transactions with the defendants. The class action complaint seeks, among other relief, certification of the class of plaintiffs and treble damages. On 27 September 2018, the court denied the defendants’ motion to dismiss the class action complaint.
European Matters
On 11 October 2011, an Italian financial institution, Banco Popolare Societá Cooperativa (“Banco Popolare”), filed a civil claim against the Firm in the Milan courts, styled Banco Popolare Societá Cooperativa v Morgan Stanley & Co. International plc & others, related to its purchase of €100 million of bonds issued by Parmalat. The claim asserted by Banco Popolare alleges, among other things, that the Firm was aware of Parmalat’s impending insolvency and conspired with others to deceive Banco Popolare into buying bonds by concealing both Parmalat’s true financial condition and
−41− certain features of the bonds from the market and Banco Popolare. Banco Popolare seeks damages of €76 million (approximately $87 million) plus damages for loss of opportunity and moral damages. The Firm filed its answer on 20 April 2012. On 11 September 2018, the court dismissed in full the claim against the Firm. The plaintiff has until 11 March 2019 to file an appeal.
On 22 June 2017, the public prosecutor for the Court of Accounts for the Republic of Italy filed a claim against the Firm styled Case No. 2012/00406/MNV, which is pending in the Regional Prosecutor’s Office at the Judicial Section of the Court of Auditors for Lazio, Italy. The claim relates to certain derivative transactions between the Republic of Italy and the Firm. The transactions were originally entered into between 1999 and 2005, and were restructured (and certain of the transactions were terminated) in December 2011 and January 2012. The claim alleges, inter alia, that the Firm effectively acted as an agent of the state in connection with these transactions and asserts claims related to, among other things, whether the Ministry of Finance was authorized to enter into these transactions, whether the transactions were appropriate and whether the Firm’s conduct related to the termination of certain transactions was proper. The prosecutor is seeking damages through an administrative process against the Firm for €2.76 billion (approximately $3.2 billion). On 30 March 2018, the Firm filed its defense to the claim. On 15 June 2018, the Court issued a decision declining jurisdiction and dismissing the claim against the Firm. A hearing of the public prosecutor’s appeal was held on 10 January 2019.
In matters styled Case number 15/3637 and Case number 15/4353, the Dutch Tax Authority (“Dutch Authority”) has challenged in the District Court in Amsterdam the prior set-off by the Firm of approximately €124 million (approximately $142 million) plus accrued interest of withholding tax credits against the Firm’s corporation tax liabilities for the tax years 2007 to 2013. The Dutch Authority alleges that the Firm was not entitled to receive the withholding tax credits on the basis, inter alia, that a Firm subsidiary did not hold legal title to certain securities subject to withholding tax on the relevant dates. The Dutch Authority has also alleged that the Firm failed to provide certain information to the Dutch Authority and keep adequate books and records. On 26 April 2018, the District Court in Amsterdam issued a decision dismissing the Dutch Authority’s claims. On 4 June 2018, the Dutch Authority filed an appeal before the Court of Appeal in Amsterdam in matters re-styled Case number 18/00318 and Case number 18/00319. A hearing of the Dutch Authority’s appeal has been scheduled for 26 June 2019.
On 5 October 2017, various institutional investors filed a claim against the Firm and another bank in a matter now styled Case number B-803-18 (previously BS 99-6998/2017), in the City Court of Copenhagen, Denmark concerning their roles as underwriters of the initial public offering (“IPO”) in March 2014 of the Danish company OW Bunker A/S. The claim seeks damages of DKK 534,270,456 (approximately $82 million) plus interest in respect of alleged losses arising from investing in shares in OW Bunker, which entered into bankruptcy in November 2014. Separately, on 29 November 2017, another group of institutional investors joined the Firm and another bank as defendants to pending proceedings in the High Court of Eastern Denmark against various other parties involved in the IPO in a matter styled Case number B-2073-16. The claim brought against the Firm and the other bank has been given its own Case number B-2564-17. The investors claim damages of DKK 767,235,885 (approximately $118 million) plus interest, from the Firm and the other bank on a joint and several basis with the Defendants to these proceedings. Both claims are based on alleged prospectus liability; the second claim also alleges professional liability of banks acting as financial intermediaries. On 8 June 2018, the City Court of Copenhagen, Denmark ordered that the matters now styled Case number B-803-18, B-2073-16 and Case number B-2564-17 be heard together before the High Court of Eastern Denmark. On 29 June 2018, the Firm filed its defense to the matter now styled Case number B-2564-17. On 4 February 2019, the Firm filed its defense to the matter now styled Case number B-803-18.
−42− The following matters were terminated during or following the quarter ended 31 December 2018:
On 20 October 2014, a purported class action complaint was filed against the Firm and other defendants styled Genesee County Employees’ Retirement System v. Bank of America Corporation et al. in the SDNY. The action was later consolidated with four similar actions in SDNY under the lead case styled Alaska Electrical Pension Fund v. Bank of America Corporation et al. A consolidated amended complaint was filed on 2 February 2015 asserting claims for alleged violations of the Sherman Act, breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, and tortious interference with contract. The consolidated amended complaint alleges, among other things, that the defendants engaged in antitrust violations with regards to the process of setting ISDAfix, a financial benchmark and seeks treble damages, injunctive relief, attorneys’ fees and other relief. On 22 June 2018, the parties entered into an agreement to settle the litigation. On 13 November 2018, the court entered a final judgment and order granting final approval of the settlement and dismissing the action as to the Firm and the other remaining defendants.
On 14 December 2012, Royal Park Investments SA/NV filed a complaint against the Firm, certain affiliates, and other defendants in the Supreme Court of NY, styled Royal Park Investments SA/NV v. Merrill Lynch et al. On 24 October 2013, plaintiff filed a new complaint against the Firm in the Supreme Court of NY, styled Royal Park Investments SA/NV v. Morgan Stanley et al., alleging that defendants made material misrepresentations and omissions in the sale to plaintiff of certain mortgage pass-through certificates backed by securitization trusts containing residential mortgage loans. The total amount of certificates allegedly sponsored, underwritten and/or sold by the Firm to plaintiff was approximately $597 million. The complaint raises common law claims of fraud, fraudulent inducement, negligent misrepresentation, and aiding and a betting fraud and seeks, among other things, compensatory and punitive damages. The plaintiff filed an amended complaint on 1 December 2015. On 12 April 2017, the Supreme Court of the State of NY granted the Firm’s motion to dismiss the amended complaint. On 9 October 2018, the Appellate Division, First Department affirmed the lower court’s order dismissing the amended complaint. On 15 January 2019, plaintiff’s motion for leave to appeal to the New York Court of Appeals was denied.
For the quarter ended 31 March 2019:
The information in this section has been excerpted from Morgan Stanley’s Form 10-Q for the quarter ended 31 March 2019. References in this section to the “Firm” mean Morgan Stanley and its consolidated subsidiaries.
Legal Proceedings
The following new matters and developments have occurred since previously reporting certain matters in the Firm’s 2018 Form 10-K. See also the disclosures set forth under “Legal Proceedings” in the 2018 Form 10-K.
Residential Mortgage and Credit Crisis Related Matters
On 15 February 2019, the Firm filed a motion for leave to appeal, or in the alternative, for the re-argument of the First Department’s 17 January 2019 decision in Deutsche Bank National Trust Company solely in its capacity as Trustee of the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 v. Morgan Stanley Mortgage Capital Holdings LLC as Successor-by-Merger to Morgan Stanley Mortgage Capital Inc., and Morgan Stanley ABS Capital I Inc.
On 7 March 2019, in the matter styled China Development Industrial Bank v. Morgan Stanley & Co, Incorporated, et al, the court denied the relief that CDIB sought in a motion to clarify and resettle the portion of the court’s 21 December 2018 order granting spoliation sanctions.
−43− On 4 April 2019, the court denied the Firm’s motion to renew its motion to dismiss in U.S. Bank National Association, solely in its capacity as Trustee of the Morgan Stanley Mortgage Loan Trust 2007-2AX (MSM 2007-2AX) v. Morgan Stanley Mortgage Capital Holdings LLC, Successor-by-Merger to Morgan Stanley Mortgage Capital Inc. and GreenPoint Mortgage Funding, Inc.
On 24 April 2019, the parties in California v. Morgan Stanley, et al., reached an agreement to settle the litigation.
Antitrust Related Matter
Beginning on 25 March 2019, the Firm was named as a defendant in a series of putative class action complaints filed in the Southern District of New York, the first of which is styled Alaska Electrical Pension Fund v. BofA Secs., Inc., et al. Each complaint alleges a conspiracy to fix prices and restrain competition in the market for unsecured bonds issued by the following Government-Sponsored Enterprises: the Federal National Mortgage Associate; the Federal Home Loan Mortgage Corporation; the Federal Farm Credit Banks Funding Corporation; and the Federal Home Loan Banks. The purported class period for each suit is from 1 January 2012 to 1 June 2018. Each complaint raises a claim under Section 1 of the Sherman Act and seeks, among other things, injunctive relief and treble compensatory damages.
European Matters
On 7 March 2019, the Appellate Division of the Court of Accounts for the Republic of Italy issued a decision in the matter styled Case No. 2012/00406/MNV affirming the decision below declining jurisdiction and dismissing the claim against the Firm. On 19 April 2019, the public prosecutor filed an appeal with the Italian Supreme Court seeking to overturn this decision.
On 11 March 2019, the plaintiff in the matter styled Banco Popolare Societá Cooperativa v Morgan Stanley & Co. International plc & others filed an appeal in the Court of Appeal of Milan against the lower Milan court’s decision dated 11 September 2018 dismissing the claim against the Firm.
−44− STATUTORY AND GENERAL INFORMATION ABOUT US AND THE GUARANTOR
STATUTORY CONSENTS
Each issue of structured products will have the benefit of the guarantee.
HAS THE FINANCIAL POSITION OF THE ISSUER OR THE GUARANTOR CHANGED SINCE LAST FINANCIAL YEAR-END?
Save as disclosed in this base listing document, there has been no material adverse change in the issuer’s financial or trading position since the date of our most recently published audited consolidated financial statements that would have a material adverse effect our ability to perform our obligations in respect of the structured products under this base listing document.
Save as disclosed in this base listing document, there has been no material adverse change in the guarantor’s financial or trading position since the date of the most recently published audited consolidated financial statements of the guarantor that would have a material adverse effect on the guarantor’s ability to perform its obligations in the context of the guarantee in respect of the structured products under this base listing document.
IS THE ISSUER OR OUR GUARANTOR SUBJECT TO ANY LITIGATION?
Save as disclosed in this base listing document, we and the guarantor are not aware, to the best of our and the guarantor’s knowledge and belief, of any litigation or claims of material importance relating to the issue of structured products by the issuer hereunder pending or threatened against us or the guarantor
FINANCIAL INFORMATION ABOUT THE AUDITOR OF THE ISSUER AND GUARANTOR
As at the date of this base listing document, each of the issuer’s auditors and the guarantor’s auditors have given and have not withdrawn their written consents to the inclusion of their auditors’ reports on the issuer’s financial statements as of 31 December 2018 and 2017 and for each of the two years ended 31 December 2018 dated 22 March 2019, the issuer’s financial statements as of 31 December 2017 and 2016 and for each of the two years in the period ended 31 December 2017 dated 23 April 2018 and the guarantor’s consolidated financial statements as of 31 December 2018 and 2017 and for each of the three years in the period ended 31 December 2018 dated 26 February 2019 in this document and/or references to their names in the listing documents, in the form and context in which they are included. Their reports were not prepared for incorporation into this base listing document. The auditors do not have any shareholding in us or the guarantor or any of the guarantor’s subsidiaries nor do they have the right (whether legally enforceable or not) to subscribe for or to nominate persons to subscribe for our securities or securities of the guarantor or any of the guarantor’s subsidiaries.
OUR SERVICE OF PROCESS AGENT
We have authorised Morgan Stanley Hong Kong Limited, Level 46, International Commerce Centre, 1 Austin Road West, Kowloon, Hong Kong (marked to the attention of Head of Legal and Compliance) to accept on our behalf and on behalf of the guarantor service of process and any other notices required to be served on either us or the guarantor in Hong Kong.
−45− ANNEX 1
The relevant Conditions will, together with the supplemental provisions contained in the relevant launch announcement and supplemental listing document and subject to completion and amendment, be endorsed on the back of the global warrant certificate or the global CBBC certificate (as applicable). The applicable launch announcement and supplemental listing document in relation to the issue of any series of warrants or CBBCs may specify other terms and conditions which shall, to the extent so specified or to the extent inconsistent with the relevant Conditions, replace or modify the relevant Conditions for the purpose of such series of warrants or CBBCs. Capitalised terms used in the Conditions and not otherwise defined therein shall have the meaning given to them in the relevant launch announcement and supplemental listing document.
−46− TERMS AND CONDITIONS OF THE CASH-SETTLED STOCK WARRANTS
1 Form; Status; Guarantee; Transfer and Title
(A) The Warrants (which expression shall, unless the context otherwise requires, include any further warrants issued pursuant to Condition 12) relating to the Shares of the Company are issued in registered form subject to and with the benefit of the instrument dated 18 July 2019 (the “Instrument”) made by Morgan Stanley Asia Products Limited (the “Issuer”) and the guarantee dated 18 July 2019 (including any supplement or replacement, the “Guarantee”) made by Morgan Stanley (the “Guarantor”).
Copies of the Instrument and the Guarantee are available for inspection at the office of the manager as specified below. The Warrantholders (as hereinafter defined) are entitled to the benefit of, are bound by and are deemed to have notice of, all the provisions of the Instrument and the Guarantee.
(B) The settlement obligation of the Issuer in respect of the Warrants represent general unsecured contractual obligations of the Issuer and of no other person which rank, and will rank, equally among themselves and pari passu with all other present and future unsecured and unsubordinated contractual obligations of the Issuer, except for obligations accorded preference by mandatory provisions of applicable law.
Warrants represent general contractual obligations of the Issuer, and are not, nor is it the intention (expressed, implicit or otherwise) of the Issuer to create by the issue of the Warrants deposit liabilities of the Issuer or a debt obligation of any kind.
In the Guarantee the Guarantor has, subject to the terms therein, unconditionally and irrevocably guaranteed to the Warrantholders the due and punctual settlement in full of all obligations due and owing by the Issuer arising under the issuance of the Warrants after taking account of any set off, combination of accounts, netting or similar arrangement from time to time exercisable by the Issuer against any person to whom obligations are from time to time being owed, when and as due (whether at expiry, by acceleration or otherwise).
(C) Transfers of Warrants may be effected only in Board Lots or integral multiples thereof in the Central Clearing and Settlement System (“CCASS”) in accordance with the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time.
(D) Each person who is for the time being shown in the register kept by or on behalf of the Issuer in Hong Kong as the holder shall be treated by the Issuer and the Guarantor as the absolute owner and holder of the Warrants (which shall be HKSCC Nominees Limited (or its successors) for so long as the Warrants are accepted as eligible securities in CCASS). The expression “Warrantholder” shall be construed accordingly.
(E) Trading in Warrants on The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) shall be suspended prior to the Expiry Date in accordance with the requirements of the Stock Exchange.
−47− 2 Warrant Rights and Exercise Expenses
(A) Every Board Lot entitles the Warrantholder, upon compliance with Condition 4, to payment of the Cash Settlement Amount (as defined in Condition 4(D)).
(B) The Warrantholder will be required to pay all charges which are incurred in respect of the exercise of the Warrants (the “Exercise Expenses”). To effect such payment, an amount equivalent to the Exercise Expenses will be deducted by the Issuer from the Cash Settlement Amount in accordance with Condition 4(B).
3 Automatic Exercise
(A) Any Warrant in respect of which the Cash Settlement Amount which would be payable by the Issuer if exercised on the Expiry Date shall be deemed automatically exercised on the Expiry Date (“Automatic Exercise”).
(B) Any Warrant which has not been automatically exercised in accordance with Condition 3(A) shall expire immediately without value thereafter and all rights of the Warrantholder and obligations of the Issuer with respect to such Warrant shall cease.
(C) In these Conditions, “Business Day” means a day (excluding Saturdays) on which the Stock Exchange is scheduled to open for dealings in Hong Kong and banks are open for business in Hong Kong.
4 Exercise of Warrants
(A) Warrants may only be exercised in Board Lots or integral multiples thereof.
(B) An irrevocable authorisation is deemed to be given to the Issuer to deduct any determined Exercise Expenses from the Cash Settlement Amount. Any Exercise Expenses which have not been determined by the Issuer on the Expiry Date shall be notified as soon as practicable after determination by the Issuer to the Warrantholder and shall be paid by the Warrantholder forthwith in immediately available funds no later than 3 Business Days after the Warrantholder receives notice of any unpaid expenses.
(C) Following the Expiry Date the Issuer will, with effect from the first Business Day following the Expiry Date cancel and destroy the Global Warrant Certificate.
(D) Subject to an Automatic Exercise in accordance with Condition 3(A), the Issuer will as soon as practicable and on a date not later than the Settlement Date in accordance with these Conditions procure payment of the aggregate Cash Settlement Amount (following deduction of determined Exercise Expenses), for all Warrants deemed exercised, electronically through CCASS by crediting the relevant bank account of the Warrantholder as appearing in the register kept by or on behalf of the Issuer.
Subject to adjustment as provided in Condition 5, “Cash Settlement Amount” means an amount payable in the Settlement Currency (such amount to be calculated by the Issuer) equal to:
In the case of a series of Call Warrants:
“Cash Settlement Amount” Entitlement x (Average Price − Exercise Price) x one Board Lot = per Board Lot Number of Warrant(s) per Entitlement
−48− In the case of a series of Put Warrants:
“Cash Settlement Amount” Entitlement x (Exercise Price − Average Price) x one Board Lot = per Board Lot Number of Warrant(s) per Entitlement
“Average Price” shall be the arithmetic mean of the closing prices of one Share (as derived from the Daily Quotation Sheet of the Stock Exchange, subject to any adjustment to such closing prices as may be necessary to reflect any event as contemplated in Condition 5 such as capitalisation, rights issue, distribution or the like) in respect of each Valuation Date.
“CCASS Settlement Day” has the meaning ascribed to the term “Settlement Day” in the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time, subject to such modification and amendment prescribed by HKSCC from time to time.
“Entitlement” means such number of Shares as specified in the relevant Launch Announcement and Supplemental Listing Document, subject to any adjustment in accordance with Condition 5.
“Market Disruption Event” means:
(1) the occurrence or existence on any Valuation Date during the one-half hour period that ends at the close of trading of any suspension of or limitation imposed on trading (by reason of movements in price exceeding limits permitted by the Stock Exchange or otherwise) on the Stock Exchange in (i) the Shares or (ii) any options or futures contracts relating to the Shares if, in any such case, such suspension or limitation is, in the determination of the Issuer, material;
(2) the issuance of the tropical cyclone warning signal number 8 or above or the issuance of a “BLACK” rainstorm signal on any day which either (i) results in the Stock Exchange being closed for trading for the entire day; or (ii) results in the Stock Exchange being closed prior to its regular time for close of trading for the relevant day (for the avoidance of doubt, in the case when the Stock Exchange is scheduled to open for the morning trading session only, closed prior to its regular time for close of trading for the morning session), PROVIDED THAT there shall be no Market Disruption Event solely by reason of the Stock Exchange opening for trading later than its regular time for opening of trading on any day as a result of the tropical cyclone warning signal number 8 or above or the “BLACK” rainstorm signal having been issued; or
(3) a limitation or closure of the Stock Exchange due to any unforeseen circumstances.
“Settlement Currency” means Hong Kong dollars unless otherwise specified in the relevant Launch Announcement and Supplemental Listing Document.
“Settlement Date” means the third CCASS Settlement Day after the later of: (i) the Expiry Date; and (ii) the day on which the Average Price is determined in accordance with these Conditions.
“Valuation Date” means, each of the five Business Days immediately preceding the Expiry Date. If the Issuer determines, in its sole discretion, that a Market Disruption Event has occurred on any Valuation Date, then that Valuation Date shall be postponed until the first succeeding Business Day on which there is no Market Disruption Event irrespective of whether that postponed Valuation Date would fall on a Business Day that already is or is deemed to be a Valuation Date. For the avoidance of doubt, in the event that a Market
−49− Disruption Event has occurred and a Valuation Date is postponed as aforesaid, the closing price of the Shares on the first succeeding Business Day will be used more than once in determining the Average Price, so that in no event shall there be less than five closing prices used to determine the Average Price.
If the postponement of a Valuation Date as aforesaid would result in the Valuation Date falling on or after the Expiry Date, then:
(i) the Business Day immediately preceding the Expiry Date (the “Last Valuation Date”) shall be deemed to be the Valuation Date notwithstanding the Market Disruption Event; and
(ii) the Issuer shall determine the closing price of the Shares on the basis of its good faith estimate of the price that would have prevailed on the Last Valuation Date but for the Market Disruption Event.
Any payment made pursuant to this Condition 4(D) shall be delivered at the risk and expense of the Warrantholder to the Warrantholder as recorded on the register.
(E) If as a result of an event beyond the control of the Issuer (“Settlement Disruption Event”), it is not possible for the Issuer to procure payment electronically through CCASS by crediting the relevant bank account of the Warrantholder on the original Settlement Date, the Issuer shall use its reasonable endeavours to procure payment electronically through CCASS by crediting the relevant bank account of the Warrantholder as soon as reasonably practicable after the original Settlement Date. The Issuer will not be liable to the Warrantholder for any interest in respect of the amount due or any loss or damage that such Warrantholder may suffer as a result of the existence of a Settlement Disruption Event.
(F) These Conditions shall not be construed so as to give rise to any relationship of agency or trust between the Guarantor, the Issuer or its agent or nominee and the Warrantholder and neither the Guarantor, the Issuer nor its agent or nominee shall owe any duty of a fiduciary nature to the Warrantholder.
None of the Issuer or the Guarantor shall have any responsibility for any errors or omissions in the calculation and dissemination of any variables published by a third party and used in any calculation made pursuant to these terms and conditions or in the calculation of the Cash Settlement Amount arising from such errors or omissions.
The Issuer’s obligations to pay the Cash Settlement Amount shall be discharged by payment in accordance with Condition 4(D) above.
5 Adjustments
Adjustments may be made by the Issuer to the terms of the Warrants (including, but not limited to, the Exercise Price and the Entitlement) on the basis of the following provisions:
(A) (i) If and whenever the Company shall, by way of Rights (as defined below), offer new Shares for subscription at a fixed subscription price to the holders of existing Shares pro rata to existing holdings (a “Rights Offer”), the Entitlement and the Exercise Price shall be adjusted to take effect on the Business Day on which the trading in the Shares of the Company becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
−50− The Exercise Price will be adjusted to:
1 Adjusted Exercise Price = xX Adjustment Factor
Where:
1+M “Adjustment Factor” = 1 + (R/S) x M
E: Existing Entitlement immediately prior to the Rights Offer
X: Existing Exercise Price immediately prior to the Rights Offer
S: Cum-Rights Share price, being the closing price of an existing Share, as derived from the Daily Quotation Sheet of the Stock Exchange on the last Business Day on which the Shares are traded on a cum-rights basis
R: Subscription price per new Share specified in the Rights Offer plus an amount equal to any dividends or other benefits foregone to exercise the Right
M: Number of new Shares per existing Share (whether a whole or a fraction) each holder of an existing Share is entitled to subscribe or have
For the purposes of these Conditions, “Rights” means the right(s) attached to each existing Share or needed to acquire one new Share (as the case may be) which are given to a holder of existing Shares to subscribe at a fixed subscription price for new Shares pursuant to the Rights Offer (whether by the exercise of one Right, a part of a Right or an aggregate number of Rights).
(ii) The Adjusted Exercise Price shall be rounded to the nearest 0.001.
(B) (i) If and whenever the Company shall make an issue of Shares credited as fully paid to the holders of Shares generally by way of capitalisation of profits or reserves (other than pursuant to a scrip dividend or similar scheme for the time being operated by the Company or otherwise in lieu of a cash dividend and without any payment or other consideration being made or given by such holders) (a “Bonus Issue”), the Entitlement and the Exercise Price shall be adjusted to take effect on the Business Day on which trading in the Shares of the Company becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Exercise Price will be adjusted to:
1 Adjusted Exercise Price = xX Adjustment Factor
Where:
“Adjustment Factor”=1+N
−51− E: Existing Entitlement immediately prior to the Bonus Issue
X: Existing Exercise Price immediately prior to the Bonus Issue
N: Number of additional Shares (whether a whole or a fraction) received by a holder of existing Shares for each Share held prior to the Bonus Issue
(ii) The Adjusted Exercise Price shall be rounded to the nearest 0.001.
(iii) For the purposes of Conditions 5(A) and 5(B), the Issuer may determine that no adjustment will be made if the adjustment to the Entitlement is one per cent. or less of the Entitlement immediately prior to the adjustment, all as determined by the Issuer.
(C) If and whenever the Company shall subdivide its outstanding share capital into a greater number of shares or consolidate its outstanding share capital into a smaller number of shares, the Entitlement shall be increased and the Exercise Price shall be decreased (in the case of a subdivision) or the Entitlement shall be decreased and the Exercise Price shall be increased (in the case of a consolidation) accordingly, in each case on the day on which the relevant subdivision or consolidation shall have taken effect.
(D) If it is announced that the Company is to or may merge or consolidate with or into any other corporation (including becoming, by agreement or otherwise, a subsidiary of or controlled by any person or corporation) (except where the Company is the surviving corporation in a merger or consolidation) or that it is to or may sell or transfer all or substantially all of its assets, the rights attaching to the Warrants may in the absolute discretion of the Issuer be amended no later than the Business Day preceding the consummation of such merger, consolidation, sale or transfer (each a “Restructuring Event”) (as determined by the Issuer in its absolute discretion).
The rights attaching to the Warrants after the adjustment shall, after such Restructuring Event, relate to the number of shares of the corporation(s) resulting from or surviving such Restructuring Event or other securities (the “Substituted Securities”) and/or cash offered in substitution for the affected Shares, as the case may be, to which the holder of such number of Shares to which the Warrants related immediately before such Restructuring Event would have been entitled upon such Restructuring Event. Thereafter the provisions hereof shall apply to such Substituted Securities, provided that any Substituted Securities may, in the absolute discretion of the Issuer, be deemed to be replaced by an amount in the relevant currency equal to the market value or, if no market value is available, fair value, of such Substituted Securities in each case as determined by the Issuer as soon as practicable after such Restructuring Event is effected.
For the avoidance of doubt, any remaining Shares shall not be affected by this paragraph (D) and, where cash is offered in substitution for Shares or is deemed to replace Substituted Securities as described above, references in these Conditions to the Shares shall include any such cash.
(E) Generally, no adjustment will be made for an ordinary cash dividend (whether or not it is offered with a scrip alternative). For any other forms of cash distribution (each a “Cash Distribution”) announced by the Company, such as a cash bonus, special dividend or extraordinary dividend, no adjustment will be made unless the value of the Cash Distribution accounts for 2 per cent. or more of the Share’s closing price on the day of announcement by the Company.
−52− If and whenever the Company shall make a Cash Distribution credited as fully paid to the holders of Shares generally, the Entitlement and the Exercise Price shall be adjusted to take effect on the Business Day on which trading in the Shares becomes ex-entitlement (each a“Dividend Adjustment Date”) in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Exercise Price will be adjusted to:
1 Adjusted Exercise Price = xX Adjustment Factor
Where:
S−OD “Adjustment Factor” = S−OD−CD
E: Existing Entitlement immediately prior to the relevant Cash Distribution
X: Existing Exercise Price immediately prior to the relevant Cash Distribution
S: Closing price of a Share, as derived from the Daily Quotation Sheet of the Stock Exchange on the Business Day immediately prior to the Dividend Adjustment Date
OD: Amount of ordinary cash dividend per Share, provided that “OD” shall be deemed to be zero if no ordinary cash dividend is announced by the Company or if the ex-entitlement date of the ordinary cash dividend is different from the ex-entitlement date of the relevant Cash Distribution
CD: Amount of the relevant Cash Distribution per Share
The Adjusted Exercise Price shall be rounded to the nearest 0.001.
(F) Without prejudice to and notwithstanding any prior adjustment(s) made pursuant to the applicable Conditions, the Issuer may (but shall not be obliged to) make such other adjustments to the terms and conditions of the Warrants as appropriate where any event (including the events as contemplated in the applicable Conditions) occurs and irrespective of, in substitution for, or in addition to the provisions contemplated in the applicable Conditions, provided that such adjustment is (i) not materially prejudicial to the interests of the Warrantholders generally (without considering the circumstances of any individual Warrantholder or the tax or other consequences of such adjustment in any particular jurisdiction) or (ii) determined by the Issuer in good faith to be appropriate and commercially reasonable.
(G) The Issuer shall determine any adjustment or amendment and its determination shall be conclusive and binding on the Warrantholder save in the case of manifest error. Any such adjustment or amendment shall be set out in a notice, which shall be given to the Warrantholder in accordance with Condition 9 as soon as practicable after the determination.
−53− 6 Purchase by the Issuer
The Issuer and any of its affiliates may purchase Warrants at any time on or after the date of their issue and any Warrants which are so purchased may be surrendered for cancellation or offered from time to time in one or more transactions in the over-the-counter market or otherwise at prevailing market prices or in negotiated transactions, at the discretion of the Issuer or any such affiliate, as the case may be.
7 Global Warrant Certificate
A global warrant certificate (the “Global Warrant Certificate”) representing the Warrants will be deposited within CCASS and registered in the name of HKSCC Nominees Limited (or its successors). The Global Warrant Certificate will not be exchangeable for definitive warrant certificates.
8 Meeting of Warrantholder; Modification
(A) Meetings of Warrantholder. Notices for convening meetings to consider any matter affecting the Warrantholder’s interests will be given to the Warrantholder in accordance with the provisions of Condition 9.
Every question submitted to a meeting of the Warrantholder shall be decided by poll. A meeting may be convened by the Issuer or by the Warrantholder holding not less than 10 percent of the Warrants for the time being remaining unexercised. The quorum at any such meeting for passing an Extraordinary Resolution will be two or more persons (including any nominee appointed by the Warrantholder) holding or representing not less than 25 percent of the Warrants for the time being remaining unexercised, or at any adjourned meeting two or more persons (including any nominee appointed by the Warrantholder) being or representing Warrantholder whatever the number of Warrants so held or represented.
A resolution will be an Extraordinary Resolution when it has been passed at a duly convened meeting by not less than three-quarters of the votes cast by such Warrantholder as, being entitled to do so, vote in person or by proxy.
An Extraordinary Resolution passed at any meeting of the Warrantholder shall be binding on all the holders of the Warrants, whether or not they are present at the meeting.
Resolutions can be passed in writing without a meeting of the Warrantholder being held if passed unanimously.
(B) Modification. The Issuer may, without the consent of the Warrantholders, effect any modification of the terms and conditions of the Warrants or the Instrument which, in the opinion of the Issuer, is (i) not materially prejudicial to the interests of the Warrantholders generally (without considering the circumstances of any individual Warrantholder or the tax or other consequences of such modification in any particular jurisdiction); (ii) of a formal, minor or technical nature; (iii) made to correct a manifest error; or (iv) necessary in order to comply with mandatory provisions of the laws or regulations of Hong Kong. Any such modification shall be binding on the Warrantholders and shall be notified to them by the Issuer as soon as practicable thereafter in accordance with Condition 9.
9 Notices
All notices in English and Chinese to the Warrantholder will be validly given if published on the website of the Hong Kong Exchanges and Clearing Limited.
−54− 10 Liquidation
In the event of a liquidation or dissolution or winding up of the Company or the appointment of a liquidator, receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the undertaking, property or assets of the Company, all unexercised Warrants will lapse and shall cease to be valid for any purpose, in the case of a voluntary liquidation, on the effective date of the resolution and, in the case of an involuntary liquidation or dissolution, on the date of the relevant court order or, in the case of the appointment of a liquidator or receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the undertaking, property or assets, on the date when such appointment is effective but subject (in any such case) to any contrary mandatory requirement of law.
11 Delisting of Company
(A) If at any time the Shares cease to be listed on the Stock Exchange, the Issuer shall give effect to these Conditions in such manner and make such adjustments to the rights attaching to the Warrants as it shall, in its absolute discretion, consider appropriate to ensure, so far as it is reasonably able to do so, that the interests of the Warrantholder generally are not materially prejudiced as a consequence of such delisting (without considering the individual circumstances of the Warrantholder or the tax or other consequences that may result in any particular jurisdiction).
(B) Without prejudice to the generality of Condition 11(A), where the Shares are or, upon the delisting, become, listed on any other stock exchange, these Conditions may, in the absolute discretion of the Issuer, be amended to the extent necessary to allow for the substitution of that other stock exchange in place of the Stock Exchange and the Issuer may, without the consent of the Warrantholder, make such adjustments to the entitlements of the Warrantholder on exercise (including, if appropriate, by converting foreign currency amounts at prevailing market rates into the relevant currency) as it shall consider appropriate in the circumstances.
(C) Any adjustment, amendment or determination made by the Issuer pursuant to this Condition 11 shall be conclusive and binding on the Warrantholder save in the case of manifest error. Notice of any adjustments or amendments shall be given to the Warrantholder in accordance with Condition 9 as soon as practicable after they are determined.
12 Further Issues
The Issuer shall be at liberty from time to time, without the consent of the Warrantholder, to create and issue further warrants, upon such terms as to issue price, commencement of the exercise period and otherwise as the Issuer may determine so as to form a single series with the Warrants.
13 Illegality and Impracticability
The Issuer is entitled to terminate the Warrants if it determines in good faith and in a commercially reasonable manner that, for reasons beyond its control, it has become or it will become illegal or impracticable:
(i) for it to perform its obligations under the Warrants, or for the Guarantor to perform its obligations under the Guarantee, in whole or in part as a result of:
(a) the adoption of, or any change in, any relevant law or regulation (including any tax law); or
−55− (b) the promulgation of, or any change in, the interpretation by any court, tribunal, governmental, administrative, legislative, regulatory or judicial authority or power with competent jurisdiction of any relevant law or regulation (including any tax law),
(each of (a) and (b), a “Change in Law Event”); or
(ii) for it or any of its affiliates to maintain the Issuer’s hedging arrangements with respect to the Warrants due to a Change in Law Event.
Upon the occurrence of a Change in Law Event, the Issuer will, if and to the extent permitted by the applicable law or regulation, pay to each Warrantholder a cash amount that the Issuer determines in good faith and in a commercially reasonable manner to be the fair market value in respect of each Warrant held by such Warrantholder immediately prior to such termination (ignoring such illegality or impracticability) less the cost to the Issuer of unwinding any related hedging arrangement as determined by the Issuer in its sole and absolute discretion. Payment will be made to each Warrantholder in such manner as shall be notified to the Warrantholders in accordance with Condition 9.
14 Good Faith and Commercially Reasonable Manner
Any exercise of discretion by the Issuer under these Conditions will be made in good faith and in a commercially reasonable manner.
15 Governing Law
The Warrants and the Instrument will be governed by and construed in accordance with the laws of the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”). The Issuer and the Warrantholder (by its acquisition of the Warrants) shall be deemed to have submitted for all purposes in connection with the Warrants and the Instrument to the non-exclusive jurisdiction of the courts of Hong Kong.
16 Language
A Chinese translation of these Conditions is available upon request during usual business hours on any weekday (Saturdays, Sundays and holidays excepted) at the offices of the Manager. In the event of any inconsistency between the English version and Chinese translation of these Conditions, the English version shall prevail and be governing.
17 Contracts (Rights of Third Parties) Ordinance
A person who is not a party to the terms and conditions of the Warrants has no right under the Contracts (Rights of Third Parties) Ordinance (Cap. 623 of the Laws of Hong Kong) to enforce or to enjoy the benefit of any term of the Warrants.
Manager
Morgan Stanley Asia Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
−56− TERMS AND CONDITIONS OF THE INDEX WARRANTS
1 Form; Status; Guarantee; Transfer and Title
(A) The Warrants (which expression shall, unless the context otherwise requires, include any further warrants issued pursuant to Condition 10) relating to the Index as published by the Index Sponsor are issued in registered form subject to and with the benefit of the instrument dated 18 July 2019 (the “Instrument”) made by Morgan Stanley Asia Products Limited (the “Issuer”) and the guarantee dated 18 July 2019 (including any supplement or replacement, the “Guarantee”) made by Morgan Stanley (the “Guarantor”).
Copies of the Instrument and the Guarantee are available for inspection at the office of the manager as specified below. The Warrantholders (as hereinafter defined) are entitled to the benefit of, are bound by and are deemed to have notice of, all the provisions of the Instrument and the Guarantee.
(B) The settlement obligation of the Issuer in respect of the Warrants represent general unsecured contractual obligations of the Issuer and of no other person which rank, and will rank, equally among themselves and pari passu with all other present and future unsecured and unsubordinated contractual obligations of the Issuer, except for obligations accorded preference by mandatory provisions of applicable law.
Warrants represent general contractual obligations of the Issuer, and are not, nor is it the intention (expressed, implicit or otherwise) of the Issuer to create by the issue of the Warrants deposit liabilities of the Issuer or a debt obligation of any kind.
In the Guarantee the Guarantor has, subject to the terms therein, unconditionally and irrevocably guaranteed to the Warrantholders the due and punctual settlement in full of all obligations due and owing by the Issuer arising under the issuance of the Warrants after taking account of any set off, combination of accounts, netting or similar arrangement from time to time exercisable by the Issuer against any person to whom obligations are from time to time being owed, when and as due (whether at expiry, by acceleration or otherwise).
(C) Transfers of Warrants may be effected only in Board Lots or integral multiples thereof in the Central Clearing and Settlement System (“CCASS”) in accordance with the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time.
(D) Each person who is for the time being shown in the register kept by or on behalf of the Issuer in Hong Kong as the holder shall be treated by the Issuer and the Guarantor as the absolute owner and holder of the Warrants (which shall be HKSCC Nominees Limited (or its successors) for so long as the Warrants are accepted as eligible securities in CCASS). The expression “Warrantholder” shall be construed accordingly.
(E) Trading in Warrants on The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) shall be suspended prior to the Expiry Date in accordance with the requirements of the Stock Exchange.
−57− 2 Warrant Rights and Exercise Expenses
(A) Every Board Lot entitles the Warrantholder, upon compliance with Condition 4, to payment of the Cash Settlement Amount (as defined in Condition 4(D)).
(B) The Warrantholder will be required to pay all charges which are incurred in respect of the exercise of the Warrants (the “Exercise Expenses”). To effect such payment, an amount equivalent to the Exercise Expenses will be deducted by the Issuer from the Cash Settlement Amount in accordance with Condition 4(B).
3 Automatic Exercise
(A) Any Warrant in respect of which the Cash Settlement Amount which would be payable by the Issuer if exercised on the Expiry Date shall be deemed automatically exercised on the Expiry Date (“Automatic Exercise”).
(B) Any Warrant which has not been automatically exercised in accordance with Condition 3(A) shall expire immediately without value thereafter and all rights of the Warrantholder and obligations of the Issuer with respect to such Warrant shall cease.
(C) In these Conditions, “Business Day” means a day (excluding Saturdays) on which the Stock Exchange is scheduled to open for dealings in Hong Kong and banks are open for business in Hong Kong.
4 Exercise of Warrants
(A) Warrants may only be exercised in Board Lots or integral multiples thereof.
(B) An irrevocable authorisation is deemed to be given to the Issuer to deduct any determined Exercise Expenses from the Cash Settlement Amount. Any Exercise Expenses which have not been determined by the Issuer on the Expiry Date shall be notified as soon as practicable after determination by the Issuer to the Warrantholder and shall be paid by the Warrantholder forthwith in immediately available funds no later than 3 Business Days after the Warrantholder receives notice of any unpaid expenses.
(C) Following the Expiry Date the Issuer will, with effect from the first Business Day following the Expiry Date cancel and destroy the Global Warrant Certificate.
(D) Subject to an Automatic Exercise in accordance with Condition 3(A), the Issuer will as soon as practicable and on a date not later than the Settlement Date in accordance with these Conditions procure payment of the aggregate Cash Settlement Amount (following deduction of determined Exercise Expenses), for all Warrants deemed exercised, electronically through CCASS by crediting the relevant bank account of the Warrantholder as appearing in the register kept by or on behalf of the Issuer.
−58− Subject to adjustment as provided in Condition 5, “Cash Settlement Amount” means an amount payable in the Settlement Currency (such amount to be calculated by the Issuer) equal to:
In the case of a series of Index Call Warrants:
“Cash Settlement Amount” (Closing Level − Strike Level) x one Board Lot x Index Currency Amount = per Board Lot Divisor
In the case of a series of Index Put Warrants:
“Cash Settlement Amount” (Strike Level − Closing Level) x one Board Lot x Index Currency Amount = per Board Lot Divisor
If applicable, such amount will be either (i) converted from the Reference Currency into the Settlement Currency at the Exchange Rate or, as the case may be, (ii) converted into the Interim Currency at the First Exchange Rate and then (if applicable) converted into the Settlement Currency at the Second Exchange Rate.
“CCASS Settlement Day” has the meaning ascribed to the term “Settlement Day” in the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time, subject to such modification and amendment prescribed by HKSCC from time to time.
“Exchange Rate”, if applicable, has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document.
“First Exchange Rate”, if applicable, has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document.
“Market Disruption Event” means:
(1) the occurrence or existence, on the Valuation Date during the one-half hour period that ends at the close of trading on the Index Exchange, of any of:
(i) the suspension of or material limitation on the trading of a material number of constituent securities that comprise the Index; or
(ii) the suspension of or material limitation on the trading of options or futures contracts relating to the Index on any exchange on which such contracts are traded; or
(iii) the imposition of any exchange controls in respect of any currencies involved in determining the Cash Settlement Amount;
for the purpose of paragraph (1), (x) the limitation of the number of hours or days of trading will not constitute a Market Disruption Event if it results from an announced change in the regular business hours of any relevant exchange, and (y) a limitation on trading imposed by reason of the movements in price exceeding the levels permitted by any relevant exchange will constitute a Market Disruption Event; or
−59− (2) where the Index Exchange is the Stock Exchange, the issuance of the tropical cyclone warning signal number 8 or above or the issuance of a “BLACK” rainstorm signal on any day which either (i) results in the Stock Exchange being closed for trading for the entire day; or (ii) results in the Stock Exchange being closed prior to its regular time for close of trading for the relevant day (for the avoidance of doubt, in the case when the Stock Exchange is scheduled to open for the morning trading session only, closed prior to its regular time for close of trading for the morning session), PROVIDED THAT there shall be no Market Disruption Event solely by reason of the Stock Exchange opening for trading later than its regular time for opening of trading on any day as a result of the tropical cyclone warning signal number 8 or above or the “BLACK” rainstorm signal having been issued;
(3) a limitation or closure of the Index Exchange due to any unforeseen circumstances; or
(4) any circumstances beyond the control of the Issuer in which the Closing Level or, if applicable, the Exchange Rate, the First Exchange Rate or the Second Exchange Rate (as the case may be) cannot be determined by the Issuer in the manner set out in these Conditions or in such other manner as the Issuer considers appropriate at such time after taking into account all the relevant circumstances.
“Second Exchange Rate”, if applicable, has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document.
“Settlement Currency” means Hong Kong dollars unless otherwise specified in the relevant Launch Announcement and Supplemental Listing Document.
“Settlement Date” means the third CCASS Settlement Day after the later of: (i) the Expiry Date; and (ii) the day on which the Closing Level is determined in accordance with these Conditions.
“Valuation Date” means the Expiry Date. If the Issuer determines, in its sole discretion, that a Market Disruption Event has occurred on the Valuation Date, then the Issuer shall determine the Closing Level on the basis of its good faith estimate of the Closing Level that would have prevailed on that day but for the occurrence of the Market Disruption Event, provided that the Issuer, if applicable, may, but shall not be obliged to, determine such Closing Level by having regard to the manner in which futures contracts relating to the Index are calculated.
Any payment made pursuant to this Condition 4(D) shall be delivered at the risk and expense of the Warrantholder to the Warrantholder as recorded on the register.
(E) If as a result of an event beyond the control of the Issuer (“Settlement Disruption Event”), it is not possible for the Issuer to procure payment electronically through CCASS by crediting the relevant bank account of the Warrantholder on the original Settlement Date, the Issuer shall use its reasonable endeavours to procure payment electronically through CCASS by crediting the relevant bank account of the Warrantholder as soon as reasonably practicable after the original Settlement Date. The Issuer will not be liable to the Warrantholder for any interest in respect of the amount due or any loss or damage that such Warrantholder may suffer as a result of the existence of a Settlement Disruption Event.
The Issuer’s obligations to pay the Cash Settlement Amount shall be discharged by payment in accordance with Condition 4(D) above.
−60− (F) These Conditions shall not be construed so as to give rise to any relationship of agency or trust between the Guarantor, the Issuer or its agent or nominee and the Warrantholder and neither the Guarantor, the Issuer nor its agent or nominee shall owe any duty of a fiduciary nature to the Warrantholder.
None of the Issuer or the Guarantor shall have any responsibility for any errors or omissions in the calculation and dissemination of any variables published by a third party and used in any calculation made pursuant to these terms and conditions or in the calculation of the Cash Settlement Amount arising from such errors or omissions.
5 Adjustment to the Index
(A) If the Index is (i) not calculated and announced by the Index Sponsor but is calculated and published by a successor to the Index Sponsor (the “Successor Index Sponsor”) acceptable to the Issuer or (ii) replaced by a successor index using, in the determination of the Issuer, the same or a substantially similar formula for and method of calculation as used in the calculation of the Index, then the Index will be deemed to be the index so calculated and announced by the Successor Index Sponsor or that successor index, as the case may be.
(B) If (i) on or prior to a Valuation Date the Index Sponsor or (if applicable) the Successor Index Sponsor makes a material change in the formula for or the method of calculating the Index or in any other way materially modifies the Index (other than a modification prescribed in that formula or method to maintain the Index in the event of changes in constituent stock, contracts or commodities and other routine events), or (ii) on a Valuation Date the Index Sponsor or (if applicable) the Successor Index Sponsor fails to calculate and publish the Index (other than as a result of a Market Disruption Event), then the Issuer shall determine the Closing Level using, in lieu of a published level for the Index, the level for the Index as at that Valuation Date as determined by the Issuer in accordance with the formula for and method of calculating the Index last in effect prior to the change or failure, but using only those securities/commodities that comprised the Index immediately prior to that change or failure (other than those securities that have since ceased to be listed on the relevant exchange).
(C) Without prejudice to and notwithstanding any prior adjustment(s) made pursuant to the applicable Conditions, the Issuer may (but shall not be obliged to) make such other adjustments to the terms and conditions of the Warrants as appropriate where any event (including the events as contemplated in the applicable Conditions) occurs and irrespective of, in substitution for, or in addition to the provisions contemplated in the applicable Conditions, provided that such adjustment is (i) not materially prejudicial to the interests of the Warrantholders generally (without considering the circumstances of any individual Warrantholder or the tax or other consequences of such adjustment in any particular jurisdiction) or (ii) determined by the Issuer in good faith to be appropriate and commercially reasonable.
(D) All determinations made by the Issuer pursuant hereto will be conclusive and binding on the Warrantholders. The Issuer will give, or procure that there is given, notice as soon as practicable of any determinations by publication in accordance with Condition 9.
−61− 6 Purchase by the Issuer
The Issuer and any of its affiliates may purchase Warrants at any time on or after the date of their issue and any Warrants which are so purchased may be surrendered for cancellation or offered from time to time in one or more transactions in the over-the-counter market or otherwise at prevailing market prices or in negotiated transactions, at the discretion of the Issuer or any such affiliate, as the case may be.
7 Global Warrant Certificate
A global warrant certificate (the “Global Warrant Certificate”) representing the Warrants will be deposited within CCASS and registered in the name of HKSCC Nominees Limited (or its successors). The Global Warrant Certificate will not be exchangeable for definitive warrant certificates.
8 Meeting of Warrantholder; Modification
(A) Meetings of Warrantholder. Notices for convening meetings to consider any matter affecting the Warrantholder’s interests will be given to the Warrantholder in accordance with the provisions of Condition 9.
Every question submitted to a meeting of the Warrantholder shall be decided by poll. A meeting may be convened by the Issuer or by the Warrantholder holding not less than 10 percent of the Warrants for the time being remaining unexercised. The quorum at any such meeting for passing an Extraordinary Resolution will be two or more persons (including any nominee appointed by the Warrantholder) holding or representing not less than 25 percent of the Warrants for the time being remaining unexercised, or at any adjourned meeting two or more persons (including any nominee appointed by the Warrantholder) being or representing Warrantholder whatever the number of Warrants so held or represented.
A resolution will be an Extraordinary Resolution when it has been passed at a duly convened meeting by not less than three-quarters of the votes cast by such Warrantholder as, being entitled to do so, vote in person or by proxy.
An Extraordinary Resolution passed at any meeting of the Warrantholder shall be binding on all the holders of the Warrants, whether or not they are present at the meeting.
Resolutions can be passed in writing without a meeting of the Warrantholder being held if passed unanimously.
(B) Modification. The Issuer may, without the consent of the Warrantholders, effect any modification of the terms and conditions of the Warrants or the Instrument which, in the opinion of the Issuer, is (i) not materially prejudicial to the interests of the Warrantholders generally (without considering the circumstances of any individual Warrantholder or the tax or other consequences of such modification in any particular jurisdiction); (ii) of a formal, minor or technical nature; (iii) made to correct a manifest error; or (iv) necessary in order to comply with mandatory provisions of the laws or regulations of Hong Kong. Any such modification shall be binding on the Warrantholders and shall be notified to them by the Issuer as soon as practicable thereafter in accordance with Condition 9.
−62− 9 Notices
All notices in English and Chinese to the Warrantholder will be validly given if published on the website of the Hong Kong Exchanges and Clearing Limited.
10 Further Issues
The Issuer shall be at liberty from time to time, without the consent of the Warrantholder, to create and issue further warrants, upon such terms as to issue price, commencement of the exercise period and otherwise as the Issuer may determine so as to form a single series with the Warrants.
11 Illegality and Impracticability
The Issuer is entitled to terminate the Warrants if it determines in good faith and in a commercially reasonable manner that, for reasons beyond its control, it has become or it will become illegal or impracticable:
(i) for it to perform its obligations under the Warrants, or for the Guarantor to perform its obligations under the Guarantee, in whole or in part as a result of:
(a) the adoption of, or any change in, any relevant law or regulation (including any tax law); or
(b) the promulgation of, or any change in, the interpretation by any court, tribunal, governmental, administrative, legislative, regulatory or judicial authority or power with competent jurisdiction of any relevant law or regulation (including any tax law),
(each of (a) and (b), a “Change in Law Event”); or
(ii) for it or any of its affiliates to maintain the Issuer’s hedging arrangements with respect to the Warrants due to a Change in Law Event.
Upon the occurrence of a Change in Law Event, the Issuer will, if and to the extent permitted by the applicable law or regulation, pay to each Warrantholder a cash amount that the Issuer determines in good faith and in a commercially reasonable manner to be the fair market value in respect of each Warrant held by such Warrantholder immediately prior to such termination (ignoring such illegality or impracticability) less the cost to the Issuer of unwinding any related hedging arrangement as determined by the Issuer in its sole and absolute discretion. Payment will be made to each Warrantholder in such manner as shall be notified to the Warrantholders in accordance with Condition 9.
12 Good Faith and Commercially Reasonable Manner
Any exercise of discretion by the Issuer under these Conditions will be made in good faith and in a commercially reasonable manner.
−63− 13 Governing Law
The Warrants and the Instrument will be governed by and construed in accordance with the laws of the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”). The Issuer and the Warrantholder (by its acquisition of the Warrants) shall be deemed to have submitted for all purposes in connection with the Warrants and the Instrument to the non-exclusive jurisdiction of the courts of Hong Kong.
14 Language
A Chinese translation of these Conditions is available upon request during usual business hours on any weekday (Saturdays, Sundays and holidays excepted) at the offices of the Manager. In the event of any inconsistency between the English version and Chinese translation of these Conditions, the English version shall prevail and be governing.
15 Contracts (Rights of Third Parties) Ordinance
A person who is not a party to the terms and conditions of the Warrants has no right under the Contracts (Rights of Third Parties) Ordinance (Cap. 623 of the Laws of Hong Kong) to enforce or to enjoy the benefit of any term of the Warrants.
Manager
Morgan Stanley Asia Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
−64− TERMS AND CONDITIONS OF THE CASH-SETTLED WARRANTS RELATING TO THE UNITS OF A FUND OR TRUST
1 Form; Status; Guarantee; Transfer and Title
(A) The Warrants (which expression shall, unless the context otherwise requires, include any further warrants issued pursuant to Condition 12) relating to the Units of the Fund or Trust are issued in registered form subject to and with the benefit of the instrument dated 18 July 2019 (the “Instrument”) made by Morgan Stanley Asia Products Limited (the “Issuer”) and the guarantee dated 18 July 2019 (including any supplement or replacement, the “Guarantee”) made by Morgan Stanley (the “Guarantor”).
Copies of the Instrument and the Guarantee are available for inspection at the office of the manager as specified below. The Warrantholders (as hereinafter defined) are entitled to the benefit of, are bound by and are deemed to have notice of, all the provisions of the Instrument and the Guarantee.
(B) The settlement obligation of the Issuer in respect of the Warrants represent general unsecured contractual obligations of the Issuer and of no other person which rank, and will rank, equally among themselves and pari passu with all other present and future unsecured and unsubordinated contractual obligations of the Issuer, except for obligations accorded preference by mandatory provisions of applicable law.
Warrants represent general contractual obligations of the Issuer, and are not, nor is it the intention (expressed, implicit or otherwise) of the Issuer to create by the issue of the Warrants deposit liabilities of the Issuer or a debt obligation of any kind.
In the Guarantee the Guarantor has, subject to the terms therein, unconditionally and irrevocably guaranteed to the Warrantholders the due and punctual settlement in full of all obligations due and owing by the Issuer arising under the issuance of the Warrants after taking account of any set off, combination of accounts, netting or similar arrangement from time to time exercisable by the Issuer against any person to whom obligations are from time to time being owed, when and as due (whether at expiry, by acceleration or otherwise).
(C) Transfers of Warrants may be effected only in Board Lots or integral multiples thereof in the Central Clearing and Settlement System (“CCASS”) in accordance with the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time.
(D) Each person who is for the time being shown in the register kept by or on behalf of the Issuer in Hong Kong as the holder shall be treated by the Issuer and the Guarantor as the absolute owner and holder of the Warrants (which shall be HKSCC Nominees Limited (or its successors) for so long as the Warrants are accepted as eligible securities in CCASS). The expression “Warrantholder” shall be construed accordingly.
(E) Trading in Warrants on The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) shall be suspended prior to the Expiry Date in accordance with the requirements of the Stock Exchange.
−65− 2 Warrant Rights and Exercise Expenses
(A) Every Board Lot entitles the Warrantholder, upon compliance with Condition 4, to payment of the Cash Settlement Amount (as defined in Condition 4(D)).
(B) The Warrantholder will be required to pay all charges which are incurred in respect of the exercise of the Warrants (the “Exercise Expenses”). To effect such payment, an amount equivalent to the Exercise Expenses will be deducted by the Issuer from the Cash Settlement Amount in accordance with Condition 4(B).
3 Automatic Exercise
(A) Any Warrant in respect of which the Cash Settlement Amount which would be payable by the Issuer if exercised on the Expiry Date shall be deemed automatically exercised on the Expiry Date (“Automatic Exercise”).
(B) Any Warrant which has not been automatically exercised in accordance with Condition 3(A) shall expire immediately without value thereafter and all rights of the Warrantholder and obligations of the Issuer with respect to such Warrant shall cease.
(C) In these Conditions, “Business Day” means a day (excluding Saturdays) on which the Stock Exchange is scheduled to open for dealings in Hong Kong and banks are open for business in Hong Kong.
4 Exercise of Warrants
(A) Warrants may only be exercised in Board Lots or integral multiples thereof.
(B) An irrevocable authorisation is deemed to be given to the Issuer to deduct any determined Exercise Expenses from the Cash Settlement Amount. Any Exercise Expenses which have not been determined by the Issuer on the Expiry Date shall be notified as soon as practicable after determination by the Issuer to the Warrantholder and shall be paid by the Warrantholder forthwith in immediately available funds no later than 3 Business Days after the Warrantholder receives notice of any unpaid expenses.
(C) Following the Expiry Date the Issuer will, with effect from the first Business Day following the Expiry Date cancel and destroy the Global Warrant Certificate.
(D) Subject to an Automatic Exercise in accordance with Condition 3(A), the Issuer will as soon as practicable and on a date not later than the Settlement Date in accordance with these Conditions procure payment of the aggregate Cash Settlement Amount (following deduction of determined Exercise Expenses), for all Warrants deemed exercised, electronically through CCASS by crediting the relevant bank account of the Warrantholder as appearing in the register kept by or on behalf of the Issuer.
−66− Subject to adjustment as provided in Condition 5, “Cash Settlement Amount” means an amount payable in the Settlement Currency (such amount to be calculated by the Issuer) equal to:
In the case of a series of Call Warrants:
“Cash Settlement Amount” Entitlement x (Average Price − Exercise Price) x one Board Lot = per Board Lot Number of Warrant(s) per Entitlement
In the case of a series of Put Warrants:
“Cash Settlement Amount” Entitlement x (Exercise Price − Average Price) x one Board Lot = per Board Lot Number of Warrant(s) per Entitlement
“Average Price” shall be the arithmetic mean of the closing prices of one Unit (as derived from the Daily Quotation Sheet of the Stock Exchange, subject to any adjustment to such closing prices as may be necessary to reflect any event as contemplated in Condition 5 such as capitalisation, rights issue, distribution or the like) in respect of each Valuation Date.
“CCASS Settlement Day” has the meaning ascribed to the term “Settlement Day” in the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time, subject to such modification and amendment prescribed by HKSCC from time to time.
“Entitlement” means such number of Units as specified in the relevant Launch Announcement and Supplemental Listing Document, subject to any adjustment in accordance with Condition 5.
“Market Disruption Event” means:
(1) the occurrence or existence on any Valuation Date during the one-half hour period that ends at the close of trading of any suspension of or limitation imposed on trading (by reason of movements in price exceeding limits permitted by the Stock Exchange or otherwise) on the Stock Exchange in (i) the Units or (ii) any options or futures contracts relating to the Units if, in any such case, such suspension or limitation is, in the determination of the Issuer, material;
(2) the issuance of the tropical cyclone warning signal number 8 or above or the issuance of a “BLACK” rainstorm signal on any day which either (i) results in the Stock Exchange being closed for trading for the entire day; or (ii) results in the Stock Exchange being closed prior to its regular time for close of trading for the relevant day (for the avoidance of doubt, in the case when the Stock Exchange is scheduled to open for the morning trading session only, closed prior to its regular time for close of trading for the morning session), PROVIDED THAT there shall be no Market Disruption Event solely by reason of the Stock Exchange opening for trading later than its regular time for opening of trading on any day as a result of the tropical cyclone warning signal number 8 or above or the “BLACK” rainstorm signal having been issued; or
(3) a limitation or closure of the Stock Exchange due to any unforeseen circumstances.
−67− “Settlement Currency” means Hong Kong dollars unless otherwise specified in the relevant Launch Announcement and Supplemental Listing Document.
“Settlement Date” means the third CCASS Settlement Day after the later of: (i) the Expiry Date; and (ii) the day on which the Average Price is determined in accordance with these Conditions.
“Valuation Date” means, each of the five Business Days immediately preceding the Expiry Date. If the Issuer determines, in its sole discretion, that a Market Disruption Event has occurred on any Valuation Date, then that Valuation Date shall be postponed until the first succeeding Business Day on which there is no Market Disruption Event irrespective of whether that postponed Valuation Date would fall on a Business Day that already is or is deemed to be a Valuation Date. For the avoidance of doubt, in the event that a Market Disruption Event has occurred and a Valuation Date is postponed as aforesaid, the closing price of the Units on the first succeeding Business Day will be used more than once in determining the Average Price, so that in no event shall there be less than five closing price used to determine the Average Price.
If the postponement of a Valuation Date as aforesaid would result in the Valuation Date falling on or after the Expiry Date, then:
(i) the Business Day immediately preceding the Expiry Date (the “Last Valuation Date”) shall be deemed to be the Valuation Date notwithstanding the Market Disruption Event; and
(ii) the Issuer shall determine the closing price of the Units on the basis of its good faith estimate of the price that would have prevailed on the Last Valuation Date but for the Market Disruption Event.
Any payment made pursuant to this Condition 4(D) shall be delivered at the risk and expense of the Warrantholder to the Warrantholder as recorded on the register.
(E) If as a result of an event beyond the control of the Issuer (“Settlement Disruption Event”), it is not possible for the Issuer to procure payment electronically through CCASS by crediting the relevant bank account of the Warrantholder on the original Settlement Date, the Issuer shall use its reasonable endeavours to procure payment electronically through CCASS by crediting the relevant bank account of the Warrantholder as soon as reasonably practicable after the original Settlement Date. The Issuer will not be liable to the Warrantholder for any interest in respect of the amount due or any loss or damage that such Warrantholder may suffer as a result of the existence of a Settlement Disruption Event.
(F) These Conditions shall not be construed so as to give rise to any relationship of agency or trust between the Guarantor, the Issuer or its agent or nominee and the Warrantholder and neither the Guarantor, the Issuer nor its agent or nominee shall owe any duty of a fiduciary nature to the Warrantholder.
None of the Issuer or the Guarantor shall have any responsibility for any errors or omissions in the calculation and dissemination of any variables published by a third party and used in any calculation made pursuant to these terms and conditions or in the calculation of the Cash Settlement Amount arising from such errors or omissions.
The Issuer’s obligations to pay the Cash Settlement Amount shall be discharged by payment in accordance with Condition 4(D) above.
−68− 5 Adjustments
Adjustments may be made by the Issuer to the terms of the Warrants (including, but not limited to, the Exercise Price and the Entitlement) on the basis of the following provisions:
(A) (i) If and whenever the Fund or Trust shall, by way of Rights (as defined below), offer new Units for subscription at a fixed subscription price to the holders of existing Units pro rata to existing holdings (a “Rights Offer”), the Entitlement and the Exercise Price shall be adjusted to take effect on the Business Day on which the trading in the Units of the Fund or Trust becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Exercise Price will be adjusted to:
1 Adjusted Exercise Price = xX Adjustment Factor
Where:
1+M “Adjustment Factor” = 1 + (R/S) x M
E: Existing Entitlement immediately prior to the Rights Offer
X: Existing Exercise Price immediately prior to the Rights Offer
S: Cum-Rights Unit price, being the closing price of an existing Unit, as derived from the Daily Quotation Sheet of the Stock Exchange on the last Business Day on which the Units are traded on a cum-rights basis
R: Subscription price per new Unit specified in the Rights Offer plus an amount equal to any distributions or other benefits foregone to exercise the Right
M: Number of new Units per existing Unit (whether a whole or a fraction) each holder of an existing Unit is entitled to subscribe or have
For the purposes of these Conditions, “Rights” means the right(s) attached to each existing Unit or needed to acquire one new Unit (as the case may be) which are given to a holder of existing Units to subscribe at a fixed subscription price for new Units pursuant to the Rights Offer (whether by the exercise of one Right, a part of a Right or an aggregate number of Rights).
(ii) The Adjusted Exercise Price shall be rounded to the nearest 0.001.
−69− (B) (i) If and whenever the Fund or Trust shall make an issue of Units credited as fully paid to the holders of Units generally by way of capitalisation of profits or reserves (other than pursuant to a scrip distribution or similar scheme for the time being operated by the Fund or Trust or otherwise in lieu of a cash distribution and without any payment or other consideration being made or given by such holders) (a “Bonus Issue”), the Entitlement and the Exercise Price shall be adjusted to take effect on the Business Day on which trading in the Units of the Fund or Trust becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Exercise Price will be adjusted to:
1 Adjusted Exercise Price = xX Adjustment Factor
Where:
“Adjustment Factor”=1+N
E: Existing Entitlement immediately prior to the Bonus Issue
X: Existing Exercise Price immediately prior to the Bonus Issue
N: Number of additional Units (whether a whole or a fraction) received by a holder of existing Units for each Unit held prior to the Bonus Issue
(ii) The Adjusted Exercise Price shall be rounded to the nearest 0.001.
(iii) For the purposes of Conditions 5(A) and 5(B), the Issuer may determine that no adjustment will be made if the adjustment to the Entitlement is one per cent. or less of the Entitlement immediately prior to the adjustment, all as determined by the Issuer.
(C) If and whenever the Fund or Trust shall subdivide its units or any class of its outstanding units into a greater number of units or consolidate its outstanding units or any class of it into a smaller number of units, the Entitlement shall be increased and the Exercise Price shall be decreased (in the case of a subdivision) or the Entitlement shall be decreased and the Exercise Price shall be increased (in the case of a consolidation) accordingly, in each case on the day on which the relevant subdivision or consolidation shall have taken effect.
(D) If it is announced that the Fund or Trust is to or may merge or consolidate with or into any other corporation (including becoming, by agreement or otherwise, a subsidiary of or controlled by any person or corporation) (except where the Fund or Trust is the surviving entity in a merger or consolidation) or that it is to or may sell or transfer all or substantially all of its assets, the rights attaching to the Warrants may in the absolute discretion of the Issuer be amended no later than the Business Day preceding the consummation of such merger, consolidation, sale or transfer (each a “Restructuring Event”) (as determined by the Issuer in its absolute discretion).
The rights attaching to the Warrants after the adjustment shall, after such Restructuring Event, relate to the number of units of the trust(s) or fund(s) (as the case may be) resulting from or surviving such Restructuring Event or other securities (the “Substituted
−70− Securities”) and/or cash offered in substitution for the affected Units, as the case may be, to which the holder of such number of Units to which the Warrants related immediately before such Restructuring Event would have been entitled upon such Restructuring Event. Thereafter the provisions hereof shall apply to such Substituted Securities, provided that any Substituted Securities may, in the absolute discretion of the Issuer, be deemed to be replaced by an amount in the relevant currency equal to the market value or, if no market value is available, fair value, of such Substituted Securities in each case as determined by the Issuer as soon as practicable after such Restructuring Event is effected.
For the avoidance of doubt, any remaining Units shall not be affected by this paragraph (D) and, where cash is offered in substitution for Units or is deemed to replace Substituted Securities as described above, references in these Conditions to the Units shall include any such cash.
(E) Generally, no adjustment will be made for an ordinary cash distribution (whether or not it is offered with a scrip alternative). For any other forms of cash distribution (each a “Cash Distribution”) announced by the Fund or Trust, such as a cash bonus, special dividend or extraordinary dividend, no adjustment will be made unless the value of the Cash Distribution accounts for 2 per cent. or more of the Unit’s closing price on the day of announcement by the Fund or Trust.
If and whenever the Fund or Trust shall make a Cash Distribution credited as fully paid to the holders of Units generally, the Entitlement and the Exercise Price shall be adjusted to take effect on the Business Day on which trading in the Units becomes ex-entitlement (each a“Dividend Adjustment Date”) in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Exercise Price will be adjusted to:
1 Adjusted Exercise Price = xX Adjustment Factor
Where:
S−OD “Adjustment Factor” = S−OD−CD
E: Existing Entitlement immediately prior to the relevant Cash Distribution
X: Existing Exercise Price immediately prior to the relevant Cash Distribution
S: Closing price of a Unit, as derived from the Daily Quotation Sheet of the Stock Exchange on the Business Day immediately prior to the Dividend Adjustment Date
OD: Amount of ordinary cash distribution per Unit, provided that “OD” shall be deemed to be zero if no ordinary cash distribution is announced by the Fund or Trust or if the ex-entitlement date of the ordinary cash distribution is different from the ex-entitlement date of the relevant Cash Distribution
CD: Amount of the relevant Cash Distribution per Unit
−71− The Adjusted Exercise Price shall be rounded to the nearest 0.001.
(F) Without prejudice to and notwithstanding any prior adjustment(s) made pursuant to the applicable Conditions, the Issuer may (but shall not be obliged to) make such other adjustments to the terms and conditions of the Warrants as appropriate where any event (including the events as contemplated in the applicable Conditions) occurs and irrespective of, in substitution for, or in addition to the provisions contemplated in the applicable Conditions, provided that such adjustment is (i) not materially prejudicial to the interests of the Warrantholders generally (without considering the circumstances of any individual Warrantholder or the tax or other consequences of such adjustment in any particular jurisdiction) or (ii) determined by the Issuer in good faith to be appropriate and commercially reasonable.
(G) The Issuer shall determine any adjustment or amendment and its determination shall be conclusive and binding on the Warrantholder save in the case of manifest error. Any such adjustment or amendment shall be set out in a notice, which shall be given to the Warrantholder in accordance with Condition 9 as soon as practicable after the determination.
6 Purchase by the Issuer
The Issuer and any of its affiliates may purchase Warrants at any time on or after the date of their issue and any Warrants which are so purchased may be surrendered for cancellation or offered from time to time in one or more transactions in the over-the-counter market or otherwise at prevailing market prices or in negotiated transactions, at the discretion of the Issuer or any such affiliate, as the case may be.
7 Global Warrant Certificate
A global warrant certificate (the “Global Warrant Certificate”) representing the Warrants will be deposited within CCASS and registered in the name of HKSCC Nominees Limited (or its successors). The Global Warrant Certificate will not be exchangeable for definitive warrant certificates.
8 Meeting of Warrantholder; Modification
(A) Meetings of Warrantholder. Notices for convening meetings to consider any matter affecting the Warrantholder’s interests will be given to the Warrantholder in accordance with the provisions of Condition 9.
Every question submitted to a meeting of the Warrantholder shall be decided by poll. A meeting may be convened by the Issuer or by the Warrantholder holding not less than 10 percent of the Warrants for the time being remaining unexercised. The quorum at any such meeting for passing an Extraordinary Resolution will be two or more persons (including any nominee appointed by the Warrantholder) holding or representing not less than 25 percent of the Warrants for the time being remaining unexercised, or at any adjourned meeting two or more persons (including any nominee appointed by the Warrantholder) being or representing Warrantholder whatever the number of Warrants so held or represented.
A resolution will be an Extraordinary Resolution when it has been passed at a duly convened meeting by not less than three-quarters of the votes cast by such Warrantholder as, being entitled to do so, vote in person or by proxy.
An Extraordinary Resolution passed at any meeting of the Warrantholder shall be binding on all the holders of the Warrants, whether or not they are present at the meeting.
−72− Resolutions can be passed in writing without a meeting of the Warrantholder being held if passed unanimously.
(B) Modification. The Issuer may, without the consent of the Warrantholders, effect any modification of the terms and conditions of the Warrants or the Instrument which, in the opinion of the Issuer, is (i) not materially prejudicial to the interests of the Warrantholders generally (without considering the circumstances of any individual Warrantholder or the tax or other consequences of such modification in any particular jurisdiction); (ii) of a formal, minor or technical nature; (iii) made to correct a manifest error; or (iv) necessary in order to comply with mandatory provisions of the laws or regulations of Hong Kong. Any such modification shall be binding on the Warrantholders and shall be notified to them by the Issuer as soon as practicable thereafter in accordance with Condition 9.
9 Notices
All notices in English and Chinese to the Warrantholder will be validly given if published on the website of the Hong Kong Exchanges and Clearing Limited.
10 Termination or Liquidation of the Fund or Trust
In the event of a Termination or the liquidation or dissolution of the trustee of the Fund or Trust (including any successor trustee appointed from time to time) (“Trustee”) (in its capacity as trustee of the Fund or Trust) or the appointment of a liquidator, receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the Trustee’s undertaking, property or assets, all unexercised Warrants will lapse and shall cease to be valid for any purpose. The unexercised Warrants will lapse and shall cease to be valid (i) in the case of a Termination, on the effective date of the Termination; (ii) in the case of a voluntary liquidation, on the effective date of the resolution; (iii) in the case of an involuntary liquidation or dissolution, on the date of the relevant court order; or (iv) in the case of the appointment of a liquidator or receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the Trustee’s undertaking, property or assets, on the date when such appointment is effective but subject (in any such case) to any contrary mandatory requirement of law.
For the purpose of this Condition 10, “Termination” means (i) the Fund or Trust is terminated, or the Trustee or the manager of the Fund or Trust (including any successor manager appointed from time to time) (“Manager”) is required to terminate the Fund or Trust under the trust deed (“Trust Deed”) constituting the Fund or Trust or applicable law, or the termination of the Fund or Trust commences; (ii) the Fund is held or is conceded by the Trustee or the Manager not to have been constituted or to have been imperfectly constituted; (iii) the Trustee ceases to be authorised under the Fund or Trust to hold the property of the Fund or Trust in its name and perform its obligations under the Trust Deed; or (iv) the Fund or Trust ceases to be authorised as an authorised collective investment scheme under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong).
11 Delisting of Fund or Trust
(A) If at any time the Units cease to be listed on the Stock Exchange, the Issuer shall give effect to these Conditions in such manner and make such adjustments to the rights attaching to the Warrants as it shall, in its absolute discretion, consider appropriate to ensure, so far as it is reasonably able to do so, that the interests of the Warrantholder generally are not materially prejudiced as a consequence of such delisting (without considering the individual circumstances of the Warrantholder or the tax or other consequences that may result in any particular jurisdiction).
−73− (B) Without prejudice to the generality of Condition 11(A), where the Units are or, upon the delisting, become, listed on any other stock exchange, these Conditions may, in the absolute discretion of the Issuer, be amended to the extent necessary to allow for the substitution of that other stock exchange in place of the Stock Exchange and the Issuer may, without the consent of the Warrantholder, make such adjustments to the entitlements of the Warrantholder on exercise (including, if appropriate, by converting foreign currency amounts at prevailing market rates into the relevant currency) as it shall consider appropriate in the circumstances.
(C) Any adjustment, amendment or determination made by the Issuer pursuant to this Condition 11 shall be conclusive and binding on the Warrantholder save in the case of manifest error. Notice of any adjustments or amendments shall be given to the Warrantholder in accordance with Condition 9 as soon as practicable after they are determined.
12 Further Issues
The Issuer shall be at liberty from time to time, without the consent of the Warrantholder, to create and issue further warrants, upon such terms as to issue price, commencement of the exercise period and otherwise as the Issuer may determine so as to form a single series with the Warrants.
13 Illegality and Impracticability
The Issuer is entitled to terminate the Warrants if it determines in good faith and in a commercially reasonable manner that, for reasons beyond its control, it has become or it will become illegal or impracticable:
(i) for it to perform its obligations under the Warrants, or for the Guarantor to perform its obligations under the Guarantee, in whole or in part as a result of:
(a) the adoption of, or any change in, any relevant law or regulation (including any tax law); or
(b) the promulgation of, or any change in, the interpretation by any court, tribunal, governmental, administrative, legislative, regulatory or judicial authority or power with competent jurisdiction of any relevant law or regulation (including any tax law),
(each of (a) and (b), a “Change in Law Event”); or
(ii) for it or any of its affiliates to maintain the Issuer’s hedging arrangements with respect to the Warrants due to a Change in Law Event.
Upon the occurrence of a Change in Law Event, the Issuer will, if and to the extent permitted by the applicable law or regulation, pay to each Warrantholder a cash amount that the Issuer determines in good faith and in a commercially reasonable manner to be the fair market value in respect of each Warrant held by such Warrantholder immediately prior to such termination (ignoring such illegality or impracticability) less the cost to the Issuer of unwinding any related hedging arrangement as determined by the Issuer in its sole and absolute discretion. Payment will be made to each Warrantholder in such manner as shall be notified to the Warrantholders in accordance with Condition 9.
−74− 14 Good Faith and Commercially Reasonable Manner
Any exercise of discretion by the Issuer under these Conditions will be made in good faith and in a commercially reasonable manner.
15 Governing Law
The Warrants and the Instrument will be governed by and construed in accordance with the laws of the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”). The Issuer and the Warrantholder (by its acquisition of the Warrants) shall be deemed to have submitted for all purposes in connection with the Warrants and the Instrument to the non-exclusive jurisdiction of the courts of Hong Kong.
16 Language
A Chinese translation of these Conditions is available upon request during usual business hours on any weekday (Saturdays, Sundays and holidays excepted) at the offices of the Manager. In the event of any inconsistency between the English version and Chinese translation of these Conditions, the English version shall prevail and be governing.
17 Contracts (Rights of Third Parties) Ordinance
A person who is not a party to the terms and conditions of the Warrants has no right under the Contracts (Rights of Third Parties) Ordinance (Cap. 623 of the Laws of Hong Kong) to enforce or to enjoy the benefit of any term of the Warrants.
Manager
Morgan Stanley Asia Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
−75− TERMS AND CONDITIONS OF THE CBBCS RELATING TO SINGLE STOCK
1 Form; Status; Guarantee; Transfer and Title
(A) The callable bull/bear contracts or “CBBCs” (which expression shall, unless the context otherwise requires, include any further CBBCs issued pursuant to Condition 11) relating to the Shares of the Company are issued in registered form subject to and with the benefit of the instrument dated 18 July 2019 (the “Instrument”) made by Morgan Stanley Asia Products Limited (the “Issuer”) and the guarantee dated 18 July 2019 (including any supplement or replacement, the “Guarantee”) made by Morgan Stanley (the “Guarantor”).
Copies of the Instrument and the Guarantee are available for inspection at the office of the manager as specified below. The Holders (as hereinafter defined) are entitled to the benefit of, are bound by and are deemed to have notice of, all the provisions of the Instrument and the Guarantee.
(B) The settlement obligations of the Issuer in respect of the CBBCs represent general unsecured contractual obligations of the Issuer and of no other person which rank, and will rank, equally among themselves and pari passu with all other present and future unsecured and unsubordinated contractual obligations of the Issuer, except for obligations accorded preference by mandatory provisions of applicable law.
CBBCs represent general contractual obligations of the Issuer, and are not, nor is it the intention (expressed, implicit or otherwise) of the Issuer to create by the issue of CBBCs deposit liabilities of the Issuer or a debt obligation of any kind.
In the Guarantee, the Guarantor has, subject to the terms therein, unconditionally and irrevocably guaranteed to the Holders the due and punctual settlement in full of all obligations due and owing by the Issuer arising under the issuance of the CBBCs after taking account of any set-off, combination of accounts, netting or similar arrangement from time to time exercisable by the Issuer against any person to whom obligations are from time to time being owed, as and when due (whether at expiry, by acceleration or otherwise).
(C) Transfers of CBBCs may be effected only in Board Lots or integral multiples thereof in the Central Clearing and Settlement System (“CCASS”) in accordance with the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time.
(D) Each person who is for the time being shown in the register kept by or on behalf of the Issuer in Hong Kong as the holder shall be treated by the Issuer and the Guarantor as the absolute owner and holder of the CBBCs (which shall be HKSCC Nominees Limited or another nominee of Hong Kong Securities Clearing Company Limited for so long as the CBBCs are accepted as eligible securities in CCASS). The expression “Holder” shall be construed accordingly.
(E) Trading in CBBCs on The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) shall be suspended after the occurrence of a Mandatory Call Event in accordance with the rules of the Stock Exchange. None of the Stock Exchange, the Issuer, the Guarantor nor any of their affiliates shall have any responsibility towards the Holder for any losses suffered in connection with the determination of a Mandatory Call Event, whether or not such losses are a result of the suspension of trading of the CBBCs, notwithstanding that such suspension may have occurred as a result of an error in the determination of the event.
−76− 2 CBBCs Rights and Exercise Expenses
(A) Every Board Lot of the CBBCs entitles the Holder, upon compliance with Condition 3, to payment of the Cash Settlement Amount.
(B) The Holder will be required to pay the Exercise Expenses in respect of the Mandatory Call Termination or Automatic Exercise of the CBBCs. To effect such payment, an amount equivalent to the Exercise Expenses will be deducted by the Issuer from the Cash Settlement Amount in accordance with Condition 3(D).
(C) An irrevocable authorisation is deemed to be given to the Issuer to deduct any determined Exercise Expenses from the Cash Settlement Amount.
3 Mandatory Call Termination and Automatic Exercise
(A) Upon the occurrence of a Mandatory Call Event, the CBBCs will terminate automatically on the date on which the Mandatory Call Event occurs (“Mandatory Call Termination”) and the Issuer will give notice of the occurrence of the Mandatory Call Event to the Holders in accordance with Condition 8. Trading in the CBBCs will be suspended immediately upon a Mandatory Call Event and all Post MCE Trades will be canceled and will not be recognized by the Stock Exchange or the Issuer.
Whereas:
“Business Day” means a day (excluding Saturdays) on which the Stock Exchange is scheduled to open for dealings in Hong Kong and banks are open for business in Hong Kong;
“CCASS Settlement Day” has the meaning ascribed to the term “Settlement Day” in the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time, subject to such modification and amendment prescribed by HKSCC from time to time;
“Mandatory Call Event” occurs when the Spot Price of the Shares is, at any time during a Trading Day in the Observation Period:
(i) in the case of a series of Bull CBBCs, at or below the Call Price; or
(ii) in the case of a series of Bear CBBCs, at or above the Call Price;
“Observation Period” means the period from the Observation Commencement Date to the Trading Day immediately before the Expiry Date (both dates inclusive);
“Post MCE Trades” has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document, subject to such modification and amendment prescribed by the Stock Exchange from time to time;
“Spot Price” means:
(i) in respect of a continuous trading session of the Stock Exchange, the price per Share concluded by means of automatic order matching on the Stock Exchange as reported in the official real-time dissemination mechanism for the Stock Exchange during such continuous trading session in accordance with the Trading Rules, excluding direct business (as defined in the Trading Rules); and
−77− (ii) in respect of a pre-opening session or a closing auction session (if applicable) of the Stock Exchange, as the case may be, the final Indicative Equilibrium Price (as defined in the Trading Rules) of the Share (if any) calculated at the end of the pre-order matching period of such pre-opening session or closing auction session (if applicable), as the case may be, in accordance with the Trading Rules, excluding direct business (as defined in the Trading Rules),
subject to such modification and amendment prescribed by the Stock Exchange from time to time;
“Trading Day” means any day on which the Stock Exchange is scheduled to open for trading for its regular trading sessions; and
“Trading Rules” means the Rules and Regulations of the Stock Exchange prescribed by the Stock Exchange from time to time.
(B) Any CBBCs with respect to which a Mandatory Call Event has not occurred during the Observation Period shall be deemed automatically exercised on the Expiry Date (“Automatic Exercise”).
(C) Following the date on which the Mandatory Call Event occurs or the Expiry Date, the Issuer will, with effect from the first Business Day following the Settlement Date cancel and destroy the Global CBBC Certificate.
(D) Following a Mandatory Call Termination or an Automatic Exercise in accordance with Conditions 3(A) or 3(B), the Issuer will on a date no later than the Settlement Date in accordance with these Conditions procure payment of the aggregate Cash Settlement Amount (following deduction of any determined Exercise Expenses) for all CBBCs terminated or deemed automatically exercised in favour of the Holder as appearing in the register kept by or on behalf of the Issuer.
Any payment of the Cash Settlement Amount made pursuant to this Condition 3(D) shall be delivered at the risk and expense of the Holder to the Holder as recorded on the register, or such bank, broker or agent in Hong Kong (if any) as directed by the Holder.
Whereas:
“Cash Settlement Amount” means, subject to adjustment as provided in Condition 4, an amount calculated by the Issuer in accordance with the following formula:
(i) if no Mandatory Call Event has occurred:
(a) in the case of a series of Bull CBBCs:
“Cash Settlement Entitlement x (Closing Price − Strike Price) x one Board Lot = Amount” per Board Lot Number of CBBC(s) per Entitlement
(b) in the case of a series of Bear CBBCs:
“Cash Settlement Entitlement x (Strike Price − Closing Price) x one Board Lot = Amount” per Board Lot Number of CBBC(s) per Entitlement
−78− (ii) following a Mandatory Call Event:
(a) in the case of a series of Category R CBBCs, the Residual Value; or
(b) in the case of a series of Category N CBBCs, zero; provided that if the relevant formula above produces an amount that is equal to or less than zero or the Exercise Expenses (if any), then no Cash Settlement Amount shall be payable. The aggregate Cash Settlement Amount payable to a Holder shall be expressed in the Settlement Currency and shall be rounded up to the nearest two decimal places in the Settlement Currency.
“Closing Price” shall be the closing price of one Share (as derived from the Daily Quotation Sheet of the Stock Exchange, subject to any adjustment to such closing price as may be necessary to reflect any event as contemplated in Condition 4 such as capitalisation, rights issue, distribution or the like) on the Valuation Date;
“Entitlement” means such number of Shares as specified in the relevant Launch Announcement and Supplemental Listing Document, subject to any adjustment in accordance with Condition 4;
“Exercise Expenses” means any charges or expenses including any taxes or duties which are incurred in respect of the early termination of the CBBCs upon the occurrence of a Mandatory Call Event or the exercise of the CBBCs at expiry;
“Market Disruption Event” means:
(i) the occurrence or existence on any Trading Day during the one-half hour period that ends at the close of trading of any suspension of or limitation imposed on trading (by reason of movements in price exceeding limits permitted by the Stock Exchange or otherwise) on the Stock Exchange in (a) the Shares; or (b) any options or futures contracts relating to the Shares if, in any such case, such suspension or limitation is, in the determination of the Issuer, material;
(ii) the issuance of the tropical cyclone warning signal number 8 or above or the issuance of a “BLACK” rainstorm signal by the Hong Kong Observatory on any day which (i) results in the Stock Exchange being closed for trading for the entire day; or (ii) results in the Stock Exchange being closed prior to its regular time for close of trading for the relevant day (for the avoidance of doubt, in the case when the Stock Exchange is scheduled to open for the morning trading session only, closed prior to its regular time for close of trading for the morning session), PROVIDED THAT there shall be no Market Disruption Event solely by reason of the Stock Exchange opening for trading later than its regular time for opening of trading on any day as a result of the tropical cyclone warning signal number 8 or above or the “BLACK” rainstorm signal having been issued; or
(iii) a limitation or closure of the Stock Exchange due to any unforeseen circumstances.
“Maximum Trade Price” means the highest Spot Price of the Shares (subject to any adjustment to such Spot Price as may be necessary to reflect any event as contemplated in Condition 4 such as capitalisation, rights issue, distribution or the like) during the MCE Valuation Period;
−79− “MCE Valuation Period” means the period commencing from and including the moment upon which the Mandatory Call Event occurs (the trading session during which the Mandatory Call Event occurs is the “1st Session”) and up to the end of the trading session on the Stock Exchange immediately following the 1st Session (“2nd Session”) unless, in the determination of the Issuer in its good faith, the 2nd Session for any reason (including, without limitation, a Market Disruption Event occurring and subsisting in the 2nd Session) does not contain any continuous period of 1 hour or more than 1 hour during which trading in the Shares is permitted on the Stock Exchange with no limitation imposed, the MCE Valuation Period shall be extended to the end of the subsequent trading session following the 2nd Session during which trading in the Shares is permitted on the Stock Exchange with no limitation imposed for a continuous period of at least 1 hour notwithstanding the existence or continuance of a Market Disruption Event in such postponed trading session, unless the Issuer determines in its good faith that each trading session on each of the four Trading Days immediately following the date on which the Mandatory Call Event occurs does not contain any continuous period of 1 hour or more than 1 hour during which trading in the Shares is permitted on the Stock Exchange with no limitation imposed. In that case:
(i) the period commencing from the 1st Session up to, and including, the last trading session on the Stock Exchange of the fourth Trading Day immediately following the date on which the Mandatory Call Event occurs shall be deemed to be the MCE Valuation Period; and
(ii) the Issuer shall determine the Maximum Trade Price or the Minimum Trade Price (as the case may be) having regard to the then prevailing market conditions, the last reported Spot Price of the Shares and such other factors as the Issuer may determine to be relevant in its good faith.
For the avoidance of doubt, all Spot Prices available throughout the extended MCE Valuation Period shall be taken into account to determine the Maximum Trade Price or the Minimum Trade Price (as the case may be) for the calculation of the Residual Value.
For the purposes of this definition,
(a) the pre-opening session, the morning session and, in the case of half day trading, the closing auction session (if applicable) of the same day; and
(b) the afternoon session and the closing auction session (if applicable) of the same day, shall each be considered as one trading session only;
“Minimum Trade Price” means the lowest Spot Price of the Shares (subject to any adjustment to such Spot Price as may be necessary to reflect any event as contemplated in Condition 4 such as capitalisation, rights issue, distribution or the like) during the MCE Valuation Period;
“Residual Value” means, subject to adjustment as provided in Condition 4:
(i) in the case of a series of Bull CBBCs:
“Residual Value” Entitlement x (Minimum Trade Price − Strike Price) x one Board Lot = per Board Lot Number of CBBC(s) per Entitlement
−80− (ii) in the case of a series of Bear CBBCs:
“Residual Value” Entitlement x (Strike Price − Maximum Trade Price) x one Board Lot = per Board Lot Number of CBBC(s) per Entitlement
“Settlement Currency” means Hong Kong dollars unless otherwise specified in the relevant Launch Announcement and Supplemental Listing Document; and
“Settlement Date” means the third CCASS Settlement Day after (i) the end of the MCE Valuation Period or (ii) the later of: (a) the Expiry Date; and (b) the day on which the Closing Price is determined in accordance with these Conditions (as the case may be).
“Valuation Date” means, the Trading Day immediately preceding the Expiry Date. If the Issuer determines, in its sole discretion, that a Market Disruption Event has occurred on the Valuation Date, then the Valuation Date shall be the first succeeding Trading Day on which the Issuer determines that there is no Market Disruption Event, unless the Issuer determines that there is a Market Disruption Event occurring on each of the four Trading Days immediately following the original date which (but for the Market Disruption Event) would have been the Valuation Date. In that case:
(i) the fourth Trading Day immediately following the original date shall be deemed to be the Valuation Date (regardless of the Market Disruption Event); and
(ii) the Issuer shall determine the Closing Price having regard to the then prevailing market conditions, the last reported trading price of the Shares on the Stock Exchange and such other factors as the Issuer determines to be relevant.
(E) If as a result of an event beyond the control of the Issuer, it is not possible for the Issuer to procure payment electronically through CCASS by crediting the relevant bank account of the Holder on the original Settlement Date (“Settlement Disruption Event”), the Issuer shall use its reasonable endeavours to procure payment electronically through CCASS by crediting the relevant bank account of the Holder as soon as reasonably practicable after the original Settlement Date. The Issuer will not be liable to the Holder for any interest in respect of the amount due or any loss or damage that such Holder may suffer as a result of the existence of a Settlement Disruption Event, nor shall the Issuer be under any circumstances be liable for any acts or defaults of CCASS in relation to the performance of its duties in relation to the CBBCs.
(F) These Conditions shall not be construed so as to give rise to any relationship of agency or trust between the Stock Exchange, the Guarantor, the Issuer or its agent or nominee and the Holder and neither the Stock Exchange, the Guarantor, the Issuer nor its agent or nominee shall owe any duty of a fiduciary nature to the Holder.
None of the Stock Exchange, the Issuer or the Guarantor shall have any responsibility for any errors or omissions in the calculation and determination of any variables published by it or a third party and used in any calculation or determination made pursuant to these terms and conditions (including the determination as the occurrence of the Mandatory Call Event) or in the calculation of the Cash Settlement Amount arising from such errors or omissions.
The Issuer’s obligations to pay the Cash Settlement Amount shall be discharged by payment in accordance with Condition 3(D) above.
−81− 4 Adjustments
Adjustments may be made by the Issuer to the terms of the CBBCs (including, but not limited to (i) the Strike Price, (ii) the Call Price and/or (iii) the Entitlement) on the basis of the following provisions:
(A) (i) If and whenever the Company shall, by way of Rights, offer new Shares for subscription at a fixed subscription price to the holders of existing Shares pro rata to existing holdings (a “Rights Offer”), the Entitlement, the Strike Price and the Call Price shall be adjusted to take effect on the Business Day on which the trading in the Shares of the Company becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Strike Price will be adjusted to:
1 Adjusted Strike Price = xX Adjustment Factor
The Call Price will be adjusted to:
1 Adjusted Call Price = xY Adjustment Factor
Where:
1+M “Adjustment Factor” = 1 + (R/S) x M
E: Existing Entitlement immediately prior to the Rights Offer
X: Existing Strike Price immediately prior to the Rights Offer
Y: Existing Call Price immediately prior to the Rights Offer
S: Cum-Rights Share price, being the closing price of an existing Share, as derived from the Daily Quotation Sheet of the Stock Exchange on the last Business Day on which the Shares are traded on a cum-rights basis
R: Subscription price per new Share specified in the Rights Offer plus an amount equal to any dividends or other benefits foregone to exercise the Right
M: Number of new Shares per existing Share (whether a whole or a fraction) each holder of an existing Share is entitled to subscribe or have
For the purposes of these Conditions, “Rights” means the right(s) attached to each existing Share or needed to acquire one new Share (as the case may be) which are given to a holder of existing Shares to subscribe at a fixed subscription price for new Shares pursuant to the Rights Offer (whether by the exercise of one Right, a part of a Right or an aggregate number of Rights).
−82− (ii) The Adjusted Strike Price and the Adjusted Call Price shall be rounded to the nearest 0.001.
(B) (i) If and whenever the Company shall make an issue of Shares credited as fully paid to the holders of Shares generally by way of capitalisation of profits or reserves (other than pursuant to a scrip dividend or similar scheme for the time being operated by the Company or otherwise in lieu of a cash dividend and without any payment or other consideration being made or given by such holders) (a “Bonus Issue”), the Entitlement, the Strike Price and the Call Price shall be adjusted to take effect on the Business Day on which trading in the Shares of the Company becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Strike Price will be adjusted to:
1 Adjusted Strike Price = xX Adjustment Factor
The Call Price will be adjusted to:
1 Adjusted Call Price = xY Adjustment Factor
Where:
“Adjustment Factor”=1+N
E: Existing Entitlement immediately prior to the Bonus Issue
X: Existing Strike Price immediately prior to the Bonus Issue
Y: Existing Call Price immediately prior to the Bonus Issue
N: Number of additional Shares (whether a whole or a fraction) received by a holder of existing Shares for each Share held prior to the Bonus Issue
(ii) The Adjusted Strike Price and the Adjusted Call Price shall be rounded to the nearest 0.001.
(iii) For the purposes of Conditions 4(A) and 4(B), the Issuer may determine that no adjustment will be made if the adjustment to the Entitlement is one per cent. or less of the Entitlement immediately prior to the adjustment, all as determined by the Issuer.
(C) If and whenever the Company shall subdivide its outstanding share capital into a greater number of shares or consolidate its outstanding share capital into a smaller number of shares, the Entitlement shall be increased and the Strike Price and the Call Price shall be decreased (in the case of a subdivision) or the Entitlement shall be decreased and the Strike Price and the Call Price shall be increased (in the case of a consolidation) accordingly, in each case on the day on which the relevant subdivision or consolidation shall have taken effect.
−83− (D) If it is announced that the Company is to or may merge or consolidate with or into any other corporation (including becoming, by agreement or otherwise, a subsidiary of or controlled by any person or corporation) (except where the Company is the surviving corporation in a merger or consolidation) or that it is to or may sell or transfer all or substantially all of its assets, the rights attaching to the CBBCs may in the absolute discretion of the Issuer be amended no later than the Business Day preceding the consummation of such merger, consolidation, sale or transfer (each a “Restructuring Event”) (as determined by the Issuer in its absolute discretion).
The rights attaching to the CBBCs after the adjustment shall, after such Restructuring Event, relate to the number of shares of the corporation(s) resulting from or surviving such Restructuring Event or other securities (the “Substituted Securities”) and/or cash offered in substitution for the affected Shares, as the case may be, to which the holder of such number of Shares to which the CBBCs related immediately before such Restructuring Event would have been entitled upon such Restructuring Event. Thereafter the provisions hereof shall apply to such Substituted Securities, provided that any Substituted Securities may, in the absolute discretion of the Issuer, be deemed to be replaced by an amount in the relevant currency equal to the market value or, if no market value is available, fair value, of such Substituted Securities in each case as determined by the Issuer as soon as practicable after such Restructuring Event is effected.
For the avoidance of doubt, any remaining Shares shall not be affected by this paragraph (D) and, where cash is offered in substitution for Shares or is deemed to replace Substituted Securities as described above, references in these Conditions to the Shares shall include any such cash.
(E) Generally, no adjustment will be made for an ordinary cash dividend (whether or not it is offered with a scrip alternative). For any other forms of cash distribution (each a “Cash Distribution”) announced by the Company, such as a cash bonus, special dividend or extraordinary dividend, no adjustment will be made unless the value of the Cash Distribution accounts for 2 per cent. or more of the Share’s closing price on the day of announcement by the Company.
If and whenever the Company shall make a Cash Distribution credited as fully paid to the holders of Shares generally, the Entitlement, the Call Price and the Strike Price shall be adjusted to take effect on the Business Day on which trading in the Shares becomes ex-entitlement (each a “Dividend Adjustment Date”) in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Strike Price will be adjusted to:
1 Adjusted Strike Price = xX Adjustment Factor
The Call Price will be adjusted to:
1 Adjusted Call Price = xY Adjustment Factor
−84− Where:
S−OD “Adjustment Factor” = S−OD−CD
E: Existing Entitlement immediately prior to the relevant Cash Distribution
X: Existing Strike Price immediately prior to the relevant Cash Distribution
Y: Existing Call Price immediately prior to the relevant Cash Distribution
S: Closing Price of a Share, as derived from the Daily Quotation Sheet of the Stock Exchange on the Business Day immediately prior to the Dividend Adjustment Date
OD: Amount of ordinary cash dividend per Share, provided that “OD” shall be deemed to be zero if no ordinary cash dividend is announced by the Company or if the ex-entitlement date of the ordinary cash dividend is different from the ex-entitlement date of the relevant Cash Distribution
CD: Amount of the relevant Cash Distribution per Share
The Adjusted Strike Price and the Adjusted Call Price shall be rounded to the nearest 0.001.
(F) Without prejudice to and notwithstanding any prior adjustment(s) made pursuant to the applicable Conditions, the Issuer may (but shall not be obliged to) make such other adjustments to the terms and conditions of the CBBCs as appropriate where any event (including the events as contemplated in the applicable Conditions) occurs and irrespective of, in substitution for, or in addition to the provisions contemplated in the applicable Conditions, provided that such adjustment is (i) not materially prejudicial to the interests of the Holders generally (without considering the circumstances of any individual Holder or the tax or other consequences of such adjustment in any particular jurisdiction) or (ii) determined by the Issuer in good faith to be appropriate and commercially reasonable.
(G) The Issuer shall determine any adjustment or amendment and its determination shall be conclusive and binding on the Holder save in the case of manifest error. Any such adjustment or amendment shall be set out in a notice, which shall be given to the Holder in accordance with Condition 8 as soon as practicable after the determination.
5 Purchase by the Issuer
The Issuer and any of its affiliates may purchase CBBCs at any time on or after the date of their issue and any CBBCs which are so purchased may be surrendered for cancellation or offered from time to time in one or more transactions in the over-the-counter market or otherwise at prevailing market prices or in negotiated transactions, at the discretion of the Issuer or any such affiliate, as the case may be.
6 Global CBBC Certificate
A global callable bull/bear contract certificate (the “Global CBBC Certificate”) representing the CBBCs will be deposited within CCASS and registered in the name of HKSCC Nominees Limited or another nominee of Hong Kong Securities Clearing Company Limited. The Global CBBC Certificate will not be exchangeable for definitive certificates.
−85− 7 Meeting of Holder; Modification
(A) Meetings of Holder. Notices for convening meetings to consider any matter affecting the Holder’s interests will be given to the Holder in accordance with the provisions of Condition 8.
Every question submitted to a meeting of the Holder shall be decided by poll. A meeting may be convened by the Issuer or by the Holder holding not less than 10 per cent. of the CBBCs for the time being remaining unexercised. The quorum at any such meeting for passing an Extraordinary Resolution will be two or more persons (including any nominee appointed by the Holder) holding or representing not less than 25 per cent. of the CBBCs for the time being remaining unexercised, or at any adjourned meeting two or more persons (including any nominee appointed by the Holder) being or representing Holder whatever the number of CBBCs so held or represented.
A resolution will be an Extraordinary Resolution when it has been passed at a duly convened meeting by not less than three-quarters of the votes cast by such Holder as, being entitled to do so, vote in person or by proxy.
An Extraordinary Resolution passed at any meeting of the Holder shall be binding on all the holders of the CBBCs, whether or not they are present at the meeting.
Resolutions can be passed in writing without a meeting of the Holder being held if passed unanimously.
Where the Holder is a clearing house recognised by the Laws of Hong Kong or its nominee(s), it may authorise such person or person(s) as it thinks fit to act as its representative(s) or proxy(ies) at any Holders’ meeting provided that, if more than one person is so authorised, the authorisation or proxy form must specify the number of CBBCs in respect of which each such person is so authorised. Each person so authorised will be entitled to exercise the same powers and right, including the right to vote on a show of hands, on behalf of the recognised clearing house or its nominee(s) as that clearing house or its nominee(s) as if he was an individual Holder of the CBBC.
(B) Modification. The Issuer may, without the consent of the Holders, effect any modification of the terms and conditions of the CBBCs or the Instrument which, in the opinion of the Issuer, is (i) not materially prejudicial to the interests of the Holders generally (without considering the circumstances of any individual Holder or the tax or other consequences of such modification in any particular jurisdiction); (ii) of a formal, minor or technical nature; (iii) made to correct a manifest error; or (iv) necessary in order to comply with mandatory provisions of the laws or regulations of Hong Kong. Any such modification shall be binding on the Holders and shall be notified to them by the Issuer as soon as practicable thereafter in accordance with Condition 8.
8 Notices
All notices in English and Chinese to the Holder will be validly given if published on the website of the Hong Kong Exchanges and Clearing Limited.
−86− 9 Liquidation
In the event of a liquidation or dissolution or winding up of the Company or the appointment of a liquidator, receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the undertaking, property or assets of the Company, all CBBCs will lapse and shall cease to be valid for any purpose, in the case of a voluntary liquidation, on the effective date of the resolution and, in the case of an involuntary liquidation or dissolution, on the date of the relevant court order or, in the case of the appointment of a liquidator or receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the undertaking, property or assets, on the date when such appointment is effective but subject (in any such case) to any contrary mandatory requirement of law.
10 Delisting of Company
(A) If at any time the Shares cease to be listed on the Stock Exchange, the Issuer shall give effect to these Conditions in such manner and make such adjustments to the rights attaching to the CBBCs as it shall, in its absolute discretion, consider appropriate to ensure, so far as it is reasonably able to do so, that the interests of the Holder generally are not materially prejudiced as a consequence of such delisting (without considering the individual circumstances of the Holder or the tax or other consequences that may result in any particular jurisdiction).
(B) Without prejudice to the generality of Condition 10(A), where the Shares are or, upon the delisting, become, listed on any other stock exchange, these Conditions may, in the absolute discretion of the Issuer, be amended to the extent necessary to allow for the substitution of that other stock exchange in place of the Stock Exchange and the Issuer may, without the consent of the Holder, make such adjustments to the entitlements of the Holder on exercise (including, if appropriate, by converting foreign currency amounts at prevailing market rates into the relevant currency) as it shall consider appropriate in the circumstances.
(C) Any such adjustment or amendment and determination made by the Issuer pursuant to this Condition 10 shall be conclusive and binding on the Holder save in the case of manifest error. Notice of any adjustments or amendments shall be given to the Holder in accordance with Condition 8 as soon as practicable after they are determined.
11 Further Issues
The Issuer shall be at liberty from time to time, without the consent of the Holder, to create and issue further callable bull/bear contracts, upon such terms as to issue price and otherwise as the Issuer may determine so as to form a single series with the CBBCs.
12 Illegality and Impracticability
The Issuer is entitled to terminate the CBBCs if it determines in good faith and in a commercially reasonable manner that, for reasons beyond its control, it has become or it will become illegal or impracticable:
(i) for it to perform its obligations under the CBBCs, or for the Guarantor to perform its obligations under the Guarantee, in whole or in part as a result of:
(a) the adoption of, or any change in, any relevant law or regulation (including any tax law); or
−87− (b) the promulgation of, or any change in, the interpretation by any court, tribunal, governmental, administrative, legislative, regulatory or judicial authority or power with competent jurisdiction of any relevant law or regulation (including any tax law),
(each of (a) and (b), a “Change in Law Event”); or
(ii) for it or any of its affiliates to maintain the Issuer’s hedging arrangements with respect to the CBBCs due to a Change in Law Event.
Upon the occurrence of a Change in Law Event, the Issuer will, if and to the extent permitted by the applicable law or regulation, pay to each Holder a cash amount that the Issuer determines in good faith and in a commercially reasonable manner to be the fair market value in respect of each CBBC held by such Holder immediately prior to such termination (ignoring such illegality or impracticability) less the cost to the Issuer of unwinding any related hedging arrangement as determined by the Issuer in its sole and absolute discretion. Payment will be made to each Holder in such manner as shall be notified to the Holders in accordance with Condition 8.
13 Good Faith and Commercially Reasonable Manner
Any exercise of discretion by the Issuer under these Conditions will be made in good faith and in a commercially reasonable manner.
14 Governing Law
The CBBCs and the Instrument will be governed by and construed in accordance with the laws of the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”). The Issuer and the Holder (by its acquisition of the CBBCs) shall be deemed to have submitted for all purposes in connection with the CBBCs and the Instrument to the non-exclusive jurisdiction of the courts of Hong Kong.
15 Language
A Chinese translation of these Conditions is available upon request during usual business hours on any weekday (Saturdays, Sundays and holidays excepted) at the offices of the Manager. In the event of any inconsistency between the English version and Chinese translation of these Conditions, the English version shall prevail and be governing.
16 Contracts (Rights of Third Parties) Ordinance
A person who is not a party to the terms and conditions of the CBBCs has no right under the Contracts (Rights of Third Parties) Ordinance (Cap. 623 of the Laws of Hong Kong) to enforce or to enjoy the benefit of any term of the CBBCs.
Manager
Morgan Stanley Asia Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
−88− TERMS AND CONDITIONS OF THE CBBCS RELATING TO AN INDEX
1 Form; Status; Guarantee; Transfer and Title
(A) The callable bull/bear contracts or “CBBCs” (which expression shall, unless the context otherwise requires, include any further CBBCs issued pursuant to Condition 9) relating to the Index are issued in registered form subject to and with the benefit of the instrument dated 18 July 2019 (the “Instrument”) made by Morgan Stanley Asia Products Limited (the “Issuer”) and the guarantee dated 18 July 2019 (including any supplement or replacement, the “Guarantee”) made by Morgan Stanley (the “Guarantor”).
Copies of the Instrument and the Guarantee are available for inspection at the office of the manager as specified below. The Holders (as hereinafter defined) are entitled to the benefit of, are bound by and are deemed to have notice of, all the provisions of the Instrument and the Guarantee.
(B) The settlement obligations of the Issuer in respect of the CBBCs represent general unsecured contractual obligations of the Issuer and of no other person which rank, and will rank, equally among themselves and pari passu with all other present and future unsecured and unsubordinated contractual obligations of the Issuer, except for obligations accorded preference by mandatory provisions of applicable law.
CBBCs represent general contractual obligations of the Issuer, and are not, nor is it the intention (expressed, implicit or otherwise) of the Issuer to create by the issue of CBBCs deposit liabilities of the Issuer or a debt obligation of any kind.
In the Guarantee, the Guarantor has, subject to the terms therein, unconditionally and irrevocably guaranteed to the Holders the due and punctual settlement in full of all obligations due and owing by the Issuer arising under the issuance of the CBBCs after taking account of any set-off, combination of accounts, netting or similar arrangement from time to time exercisable by the Issuer against any person to whom obligations are from time to time being owed, as and when due (whether at expiry, by acceleration or otherwise).
(C) Transfers of CBBCs may be effected only in Board Lots or integral multiples thereof in the Central Clearing and Settlement System (“CCASS”) in accordance with the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time.
(D) Each person who is for the time being shown in the register kept by or on behalf of the Issuer in Hong Kong as the holder shall be treated by the Issuer and the Guarantor as the absolute owner and holder of the CBBCs (which shall be HKSCC Nominees Limited or another nominee of Hong Kong Securities Clearing Company Limited for so long as the CBBCs are accepted as eligible securities in CCASS). The expression “Holder” shall be construed accordingly.
(E) Trading in CBBCs on The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) shall be suspended after the occurrence of a Mandatory Call Event in accordance with the rules of the Stock Exchange. None of the Stock Exchange, the Issuer, the Guarantor, the Index Sponsor nor any of their affiliates shall have any responsibility towards the Holder for any losses suffered in connection with the determination of a Mandatory Call Event, whether or not such losses are a result of the suspension of trading of the CBBCs, notwithstanding that such suspension may have occurred as a result of an error in the determination of the event.
−89− 2 CBBCs Rights and Exercise Expenses
(A) Every Board Lot of the CBBCs entitles the Holder, upon compliance with Condition 3, to payment of the Cash Settlement Amount.
(B) The Holder will be required to pay the Exercise Expenses in respect of the Mandatory Call Termination or Automatic Exercise of the CBBCs. To effect such payment, an amount equivalent to the Exercise Expenses will be deducted by the Issuer from the Cash Settlement Amount in accordance with Condition 3(D).
(C) An irrevocable authorisation is deemed to be given to the Issuer to deduct any determined Exercise Expenses from the Cash Settlement Amount.
3 Mandatory Call Termination and Automatic Exercise
(A) Upon the occurrence of a Mandatory Call Event, the CBBCs will terminate automatically on the date on which the Mandatory Call Event occurs (“Mandatory Call Termination”) and the Issuer will give notice of the occurrence of the Mandatory Call Event to the Holders in accordance with Condition 8. Trading in the CBBCs will be suspended immediately upon a Mandatory Call Event and all Post MCE Trades will be canceled and will not be recognized by the Stock Exchange or the Issuer.
Whereas:
“Business Day” means a day (excluding Saturdays) on which the Stock Exchange is scheduled to open for dealings in Hong Kong and banks are open for business in Hong Kong;
“CCASS Settlement Day” has the meaning ascribed to the term “Settlement Day” in the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time, subject to such modification and amendment prescribed by HKSCC from time to time;
“Index Business Day” means any day on which the Index Exchange is scheduled to open for trading for its regular trading sessions;
“Mandatory Call Event” occurs when the Spot Level of the Index is, at any time during an Index Business Day in the Observation Period:
(i) in the case of a series of Bull CBBCs, at or below the Call Level; or
(ii) in the case of a series of Bear CBBCs, at or above the Call Level;
“Observation Period” means the period from the Observation Commencement Date to the Trading Day immediately before the Expiry Date (both dates inclusive);
“Post MCE Trades” has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document, subject to such modification and amendment prescribed by the Stock Exchange from time to time;
“Spot Level” means the spot level of the Index as compiled and published by the Index Sponsor; and
“Trading Day” means any day on which the Stock Exchange is scheduled to open for trading for its regular trading sessions.
−90− (B) Any CBBCs with respect to which a Mandatory Call Event has not occurred during the Observation Period shall be deemed automatically exercised on the Expiry Date (“Automatic Exercise”).
(C) Following the date on which the Mandatory Call Event occurs or the Expiry Date, the Issuer will, with effect from the first Business Day following the Settlement Date, cancel and destroy the Global CBBC Certificate.
(D) Following a Mandatory Call Termination or an Automatic Exercise in accordance with Conditions 3(A) or 3(B), the Issuer will as soon as practicable and on a date no later than the Settlement Date in accordance with these Conditions procure payment of the aggregate Cash Settlement Amount, (following deduction of any determined Exercise Expenses) for all CBBCs terminated or deemed automatically exercised in favour of the Holder as appearing in the register kept by or on behalf of the Issuer.
Any payment of the Cash Settlement Amount made pursuant to this Condition 3(D) shall be delivered at the risk and expense of the Holder to the Holder as recorded on the register, or such bank, broker or agent in Hong Kong (if any) as directed by the Holder.
Whereas:
“Cash Settlement Amount” means, subject to adjustment as provided in Condition 4, an amount calculated by the Issuer in accordance with the following formula (and if applicable, either (i) converted from the Reference Currency into the Settlement Currency at the Exchange Rate or, as the case may be, (ii) converted into the Interim Currency at the First Exchange Rate and then (if applicable) converted into the Settlement Currency at the Second Exchange Rate):
(i) if no Mandatory Call Event has occurred:
(a) in the case of a series of Bull CBBCs:
“Cash Settlement Amount” (Closing Level − Strike Level) x one Board Lot x Index Currency Amount = per Board Lot Divisor
(b) in the case of a series of Bear CBBCs:
“Cash Settlement Amount” (Strike Level − Closing Level) x one Board Lot x Index Currency Amount = per Board Lot Divisor
(ii) following a Mandatory Call Event:
(a) in the case of a series of Category R CBBCs, the Residual Value; or
(b) in the case of a series of Category N CBBCs, zero;
provided that if the relevant formula above produces an amount that is equal to or less than zero or the Exercise Expenses (if any), then no Cash Settlement Amount shall be payable. The aggregate Cash Settlement Amount payable to a Holder shall be expressed in the Settlement Currency and shall be rounded up to the nearest two decimal places in the Settlement Currency.
“Closing Level” means the level of the Index specified in the relevant Launch Announcement and Supplemental Listing Document subject to any adjustment in accordance with Condition 4;
−91− “Exchange Rate”, if applicable, has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document.
“Exercise Expenses” means any charges or expenses including any taxes or duties which are incurred in respect of the early termination of the CBBCs upon the occurrence of a Mandatory Call Event or the exercise of the CBBCs at expiry;
“First Exchange Rate”, if applicable, has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document.
“Market Disruption Event” means:
(i) the occurrence or existence, on any Trading Day or Index Business Day during the one-half hour period that ends at the close of trading, of any of:
(1) the suspension of or material limitation on the trading of a material number of constituent securities that comprise the Index; or
(2) the suspension of or material limitation on the trading of options or futures contracts relating to the Index on any exchanges on which such contracts are traded; or
(3) the imposition of any exchange controls in respect of any currencies involved in determining the Cash Settlement Amount.
For the purposes of this definition, (a) the limitation of the number of hours or days of trading will not constitute a Market Disruption Event if it results from an announced change in the regular business hours of any exchange, and (b) a limitation on trading imposed by reason of the movements in price exceeding the levels permitted by any relevant exchange will constitute a Market Disruption Event; or
(ii) where the Index Exchange is the Stock Exchange, the issuance of the tropical cyclone warning signal number 8 or above or the issuance of a “BLACK” rainstorm signal on any day which (i) results in the Stock Exchange being closed for trading for the entire day; or (ii) results in the Stock Exchange being closed prior to its regular time for close of trading for the relevant day (for the avoidance of doubt, in the case when the Stock Exchange is scheduled to open for the morning trading session only, closed prior to its regular time for close of trading for the morning session), PROVIDED THAT there shall be no Market Disruption Event solely by reason of the Stock Exchange opening for trading later than its regular time for opening of trading on any day as a result of the tropical cyclone warning signal number 8 or above or the “BLACK” rainstorm signal having been issued; or
(iii) a limitation or closure of the Index Exchange due to any unforeseen circumstances.
“Maximum Index Level” means the highest Spot Level of the Index during the MCE Valuation Period;
“MCE Valuation Period” means the period commencing from and including the moment upon which the Mandatory Call Event occurs (the trading session during which the Mandatory Call Event occurs is the “1st Session”) and up to the end of the trading session on the Index Exchange immediately following the 1st Session (“2nd Session”) unless, in the determination of the Issuer in its good faith, the 2nd Session for any reason (including, without limitation, a Market Disruption Event occurring and subsisting in the 2nd Session) does not contain any continuous period of 1 hour or more than 1 hour during which Spot Levels are available, the MCE Valuation Period shall be extended to the end of the
−92− subsequent trading session on the Index Exchange following the 2nd Session during which Spot Levels are available for a continuous period of at least 1 hour notwithstanding the existence or continuance of a Market Disruption Event in such postponed trading session, unless the Issuer determines in its good faith that each trading session on each of the four Index Business Days immediately following the date on which the Mandatory Call Event occurs does not contain any continuous period of 1 hour or more than 1 hour during which Spots Levels are available. In that case:
(i) the period commencing from the 1st Session up to, and including, the last trading session of the fourth Index Business Day on the Index Exchange immediately following the date on which the Mandatory Call Event occurs shall be deemed to be the MCE Valuation Period; and
(ii) the Issuer shall determine the Maximum Index Level or the Minimum Index Level (as the case may be) having regard to the then prevailing market conditions, the last reported Spot Level of the Index and such other factors as the Issuer may determine to be relevant in its good faith.
For the avoidance of doubt, all Spot Levels available throughout the extended MCE Valuation Period shall be taken into account to determine the Maximum Index Level or the Minimum Index Level (as the case may be) for the calculation of the Residual Value.
For the purposes of this definition,
(a) the pre-opening session, the morning session and, in the case of half day trading, the closing auction session (if applicable) of the same day; and
(b) the afternoon session and the closing auction session (if applicable) of the same day, shall each be considered as one trading session only;
“Minimum Index Level” means the lowest Spot Level of the Index during the MCE Valuation Period;
“Residual Value” means, subject to adjustment as provided in Condition 4, an amount calculated by the Issuer in accordance with the following formula (and if applicable, either (i) converted from the Reference Currency into the Settlement Currency at the Exchange Rate or, as the case may be, (ii) converted into the Interim Currency at the First Exchange Rate and then (if applicable) converted into the Settlement Currency at the Second Exchange Rate):
(i) in the case of a series of Bull CBBCs:
“Residual Value” (Minimum Index Level − Strike Level) x one Board Lot x Index Currency Amount = per Board Lot Divisor
(ii) in the case of a series of Bear CBBCs:
“Residual Value” (Strike Level − Maximum Index Level) x one Board Lot x Index Currency Amount = per Board Lot Divisor
“Second Exchange Rate”, if applicable, has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document.
“Settlement Currency” means Hong Kong dollars unless otherwise specified in the relevant Launch Announcement and Supplemental Listing Document; and
−93− “Settlement Date” means the third CCASS Settlement Day after (i) the end of the MCE Valuation Period or (ii) the later of: (a) the Expiry Date; and (b) the day on which the Closing Level is determined in accordance with these Conditions (as the case may be).
“Valuation Date” means the Expiry Date. If the Issuer determines, in its sole discretion, that a Market Disruption Event has occurred on the Valuation Date, then the Issuer shall determine the Closing Level on the basis of its good faith estimate of the Closing Level that would have prevailed on that day but for the occurrence of the Market Disruption Event, provided that the Issuer, if applicable, may, but shall not be obliged to, determine such Closing Level by having regard to the manner in which futures contracts relating to the Index are calculated.
(E) If as a result of an event beyond the control of the Issuer, it is not possible for the Issuer to procure payment electronically through CCASS by crediting the relevant bank account of the Holder on the original Settlement Date (“Settlement Disruption Event”), the Issuer shall use its reasonable endeavours to procure payment electronically through CCASS by crediting the relevant bank account of the Holder as soon as reasonably practicable after the original Settlement Date. The Issuer will not be liable to the Holder for any interest in respect of the amount due or any loss or damage that such Holder may suffer as a result of the existence of a Settlement Disruption Event, nor shall the Issuer be under any circumstances be liable for any acts or defaults of CCASS in relation to the performance of its duties in relation to the CBBCs.
(F) These Conditions shall not be construed so as to give rise to any relationship of agency or trust between the Stock Exchange, the Guarantor, the Issuer, the Index Sponsor, or its agent or nominee and the Holder and neither the Stock Exchange, the Guarantor, the Issuer, the Index Sponsor, nor its agent or nominee shall owe any duty of a fiduciary nature to the Holder.
None of the Stock Exchange, the Issuer, the Guarantor or the Index Sponsor shall have any responsibility for any errors or omissions in the calculation and determination of any variables published by it or a third party and used in any calculation or determination made pursuant to these terms and conditions (including the determination as to the occurrence of the Mandatory Call Event) or in the calculation of the Cash Settlement Amount arising from such errors or omissions.
The Issuer’s obligations to pay the Cash Settlement Amount shall be discharged by payment in accordance with Condition 3(D) above.
4 Adjustment to the Index
(A) If the Index is (i) not calculated and announced by the Index Sponsor but is calculated and published by a successor to the Index Sponsor (the “Successor Index Sponsor”) acceptable to the Issuer or (ii) replaced by a successor index using, in the determination of the Issuer, the same or a substantially similar formula for and method of calculation as used in the calculation of the Index, then the Index will be deemed to be the index so calculated and announced by the Successor Index Sponsor or that successor index, as the case may be.
(B) If (i) on or prior to the Valuation Date the Index Sponsor or (if applicable) the Successor Index Sponsor makes a material change in the formula for or the method of calculating the Index or in any other way materially modifies the Index (other than a modification prescribed in that formula or method to maintain the Index in the event of changes in constituent stock, contracts or commodities and other routine events), or (ii) on the Valuation Date the Index Sponsor or (if applicable) the Successor Index Sponsor fails to calculate and publish the Index (other than as a result of a Market Disruption Event), then the Issuer shall determine the Closing Level using, in lieu of the level of the Index
−94− calculated for the purpose of final settlement of the contract specified in the Launch Announcement and Supplemental Listing Document, the level for the Index as at the Valuation Date as determined by the Issuer in accordance with the formula for and method of calculating the Index last in effect prior to the change or failure, but using only those securities/commodities that comprised the Index immediately prior to that change or failure (other than those securities that have since ceased to be listed on the relevant exchange).
(C) Without prejudice to and notwithstanding any prior adjustment(s) made pursuant to the applicable Conditions, the Issuer may (but shall not be obliged to) make such other adjustments to the terms and conditions of the CBBCs as appropriate where any event (including the events as contemplated in the applicable Conditions) occurs and irrespective of, in substitution for, or in addition to the provisions contemplated in the applicable Conditions, provided that such adjustment is (i) not materially prejudicial to the interests of the Holders generally (without considering the circumstances of any individual Holder or the tax or other consequences of such adjustment in any particular jurisdiction) or (ii) determined by the Issuer in good faith to be appropriate and commercially reasonable.
(D) All determinations made by the Issuer pursuant hereto will be conclusive and binding on the Holders. The Issuer will give, or procure that there is given, notice as soon as practicable of any determinations by publication in accordance with Condition 8.
5 Purchase by the Issuer
The Issuer and any of its affiliates may purchase CBBCs at any time on or after the date of their issue and any CBBCs which are so purchased may be surrendered for cancellation or offered from time to time in one or more transactions in the over-the-counter market or otherwise at prevailing market prices or in negotiated transactions, at the discretion of the Issuer or any such affiliate, as the case may be.
6 Global CBBC Certificate
A global callable bull/bear contract certificate (the “Global CBBC Certificate”) representing the CBBCs will be deposited within CCASS and registered in the name of HKSCC Nominees Limited or another nominee of Hong Kong Securities Clearing Company Limited. The Global CBBC Certificate will not be exchangeable for definitive certificates.
7 Meeting of Holder; Modification
(A) Meetings of Holder. Notices for convening meetings to consider any matter affecting the Holder’s interests will be given to the Holder in accordance with the provisions of Condition 8.
Every question submitted to a meeting of the Holder shall be decided by poll. A meeting may be convened by the Issuer or by the Holder holding not less than 10 per cent. of the CBBCs for the time being remaining unexercised. The quorum at any such meeting for passing an Extraordinary Resolution will be two or more persons (including any nominee appointed by the Holder) holding or representing not less than 25 per cent. of the CBBCs for the time being remaining unexercised, or at any adjourned meeting two or more persons (including any nominee appointed by the Holder) being or representing Holder whatever the number of CBBCs so held or represented.
A resolution will be an Extraordinary Resolution when it has been passed at a duly convened meeting by not less than three-quarters of the votes cast by such Holder as, being entitled to do so, vote in person or by proxy.
−95− An Extraordinary Resolution passed at any meeting of the Holder shall be binding on all the holders of the CBBCs, whether or not they are present at the meeting.
Resolutions can be passed in writing without a meeting of the Holder being held if passed unanimously.
Where the Holder is a clearing house recognised by the Laws of Hong Kong or its nominee(s), it may authorise such person or person(s) as it thinks fit to act as its representative(s) or proxy(ies) at any Holders’ meeting provided that, if more than one person is so authorised, the authorisation or proxy form must specify the number of CBBCs in respect of which each such person is so authorised. Each person so authorised will be entitled to exercise the same powers and right, including the right to vote on a show of hands, on behalf of the recognised clearing house or its nominee(s) as that clearing house or its nominee(s) as if he was an individual Holder of the CBBC.
(B) Modification. The Issuer may, without the consent of the Holders, effect any modification of the terms and conditions of the CBBCs or the Instrument which, in the opinion of the Issuer, is (i) not materially prejudicial to the interests of the Holders generally (without considering the circumstances of any individual Holder or the tax or other consequences of such modification in any particular jurisdiction); (ii) of a formal, minor or technical nature; (iii) made to correct a manifest error; or (iv) necessary in order to comply with mandatory provisions of the laws or regulations of Hong Kong. Any such modification shall be binding on the Holders and shall be notified to them by the Issuer as soon as practicable thereafter in accordance with Condition 8.
8 Notices
All notices in English and Chinese to the Holder will be validly given if published on the website of the Hong Kong Exchanges and Clearing Limited.
9 Further Issues
The Issuer shall be at liberty from time to time, without the consent of the Holder, to create and issue further callable bull/bear contracts, upon such terms as to issue price and otherwise as the Issuer may determine so as to form a single series with the CBBCs.
10 Illegality and Impracticability
The Issuer is entitled to terminate the CBBCs if it determines in good faith and in a commercially reasonable manner that, for reasons beyond its control, it has become or it will become illegal or impracticable:
(i) for it to perform its obligations under the CBBCs, or for the Guarantor to perform its obligations under the Guarantee, in whole or in part as a result of:
(a) the adoption of, or any change in, any relevant law or regulation (including any tax law); or
(b) the promulgation of, or any change in, the interpretation by any court, tribunal, governmental, administrative, legislative, regulatory or judicial authority or power with competent jurisdiction of any relevant law or regulation (including any tax law),
(each of (a) and (b), a “Change in Law Event”); or
(ii) for it or any of its affiliates to maintain the Issuer’s hedging arrangements with respect to the CBBCs due to a Change in Law Event.
−96− Upon the occurrence of a Change in Law Event, the Issuer will, if and to the extent permitted by the applicable law or regulation, pay to each Holder a cash amount that the Issuer determines in good faith and in a commercially reasonable manner to be the fair market value in respect of each CBBC held by such Holder immediately prior to such termination (ignoring such illegality or impracticability) less the cost to the Issuer of unwinding any related hedging arrangement as determined by the Issuer in its sole and absolute discretion. Payment will be made to each Holder in such manner as shall be notified to the Holders in accordance with Condition 8.
11 Good Faith and Commercially Reasonable Manner
Any exercise of discretion by the Issuer under these Conditions will be made in good faith and in a commercially reasonable manner.
12 Governing Law
The CBBCs and the Instrument will be governed by and construed in accordance with the laws of the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”). The Issuer and the Holder (by its acquisition of the CBBCs) shall be deemed to have submitted for all purposes in connection with the CBBCs and the Instrument to the non-exclusive jurisdiction of the courts of Hong Kong.
13 Language
A Chinese translation of these Conditions is available upon request during usual business hours on any weekday (Saturdays, Sundays and holidays excepted) at the offices of the Manager. In the event of any inconsistency between the English version and Chinese translation of these Conditions, the English version shall prevail and be governing.
14 Contracts (Rights of Third Parties) Ordinance
A person who is not a party to the terms and conditions of the CBBCs has no right under the Contracts (Rights of Third Parties) Ordinance (Cap. 623 of the Laws of Hong Kong) to enforce or to enjoy the benefit of any term of the CBBCs.
Manager
Morgan Stanley Asia Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
−97− TERMS AND CONDITIONS OF THE CBBCS RELATING TO THE UNITS OF A FUND OR TRUST
1 Form; Status; Guarantee; Transfer and Title
(A) The callable bull/bear contracts or “CBBCs” (which expression shall, unless the context otherwise requires, include any further CBBCs issued pursuant to Condition 11) relating to the Units of the Fund or Trust are issued in registered form subject to and with the benefit of the instrument dated 18 July 2019 (the “Instrument”) made by Morgan Stanley Asia Products Limited (the “Issuer”) and the guarantee dated 18 July 2019 (including any supplement or replacement, the “Guarantee”) made by Morgan Stanley (the “Guarantor”).
Copies of the Instrument and the Guarantee are available for inspection at the office of the manager as specified below. The Holders (as hereinafter defined) are entitled to the benefit of, are bound by and are deemed to have notice of, all the provisions of the Instrument and the Guarantee.
(B) The settlement obligations of the Issuer in respect of the CBBCs represent general unsecured contractual obligations of the Issuer and of no other person which rank, and will rank, equally among themselves and pari passu with all other present and future unsecured and unsubordinated contractual obligations of the Issuer, except for obligations accorded preference by mandatory provisions of applicable law.
CBBCs represent general contractual obligations of the Issuer, and are not, nor is it the intention (expressed, implicit or otherwise) of the Issuer to create by the issue of CBBCs deposit liabilities of the Issuer or a debt obligation of any kind.
In the Guarantee, the Guarantor has, subject to the terms therein, unconditionally and irrevocably guaranteed to the Holders the due and punctual settlement in full of all obligations due and owing by the Issuer arising under the issuance of the CBBCs after taking account of any set-off, combination of accounts, netting or similar arrangement from time to time exercisable by the Issuer against any person to whom obligations are from time to time being owed, as and when due (whether at expiry, by acceleration or otherwise).
(C) Transfers of CBBCs may be effected only in Board Lots or integral multiples thereof in the Central Clearing and Settlement System (“CCASS”) in accordance with the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time.
(D) Each person who is for the time being shown in the register kept by or on behalf of the Issuer in Hong Kong as the holder shall be treated by the Issuer and the Guarantor as the absolute owner and holder of the CBBCs (which shall be HKSCC Nominees Limited or another nominee of Hong Kong Securities Clearing Company Limited for so long as the CBBCs are accepted as eligible securities in CCASS). The expression “Holder” shall be construed accordingly.
(E) Trading in CBBCs on The Stock Exchange of Hong Kong Limited (the “Stock Exchange”) shall be suspended after the occurrence of a Mandatory Call Event in accordance with the rules of the Stock Exchange. None of the Stock Exchange, the Issuer, the Guarantor nor any of their affiliates shall have any responsibility towards the Holder for any losses suffered in connection with the determination of a Mandatory Call Event, whether or not such losses are a result of the suspension of trading of the CBBCs, notwithstanding that such suspension may have occurred as a result of an error in the determination of the event.
−98− 2 CBBCs Rights and Exercise Expenses
(A) Every Board Lot of the CBBCs entitles the Holder, upon compliance with Condition 3, to payment of the Cash Settlement Amount.
(B) The Holder will be required to pay the Exercise Expenses in respect of the Mandatory Call Termination or Automatic Exercise of the CBBCs. To effect such payment, an amount equivalent to the Exercise Expenses will be deducted by the Issuer from the Cash Settlement Amount in accordance with Condition 3(D).
(C) An irrevocable authorisation is deemed to be given to the Issuer to deduct any determined Exercise Expenses from the Cash Settlement Amount.
3 Mandatory Call Termination and Automatic Exercise
(A) Upon the occurrence of a Mandatory Call Event, the CBBCs will terminate automatically on the date on which the Mandatory Call Event occurs (“Mandatory Call Termination”) and the Issuer will give notice of the occurrence of the Mandatory Call Event to the Holders in accordance with Condition 8. Trading in the CBBCs will be suspended immediately upon a Mandatory Call Event and all Post MCE Trades will be canceled and will not be recognized by the Stock Exchange or the Issuer.
Whereas:
“Business Day” means a day (excluding Saturdays) on which the Stock Exchange is scheduled to open for dealings in Hong Kong and banks are open for business in Hong Kong;
“CCASS Settlement Day” has the meaning ascribed to the term “Settlement Day” in the General Rules of CCASS and the CCASS Operational Procedures in effect from time to time, subject to such modification and amendment prescribed by HKSCC from time to time;
“Mandatory Call Event” occurs when the Spot Price of the Units is, at any time during a Trading Day in the Observation Period:
(i) in the case of a series of Bull CBBCs, at or below the Call Price; or
(ii) in the case of a series of Bear CBBCs, at or above the Call Price;
“Observation Period” means the period from the Observation Commencement Date to the Trading Day immediately before the Expiry Date (both dates inclusive);
“Post MCE Trades” has the meaning given to it in the relevant Launch Announcement and Supplemental Listing Document, subject to such modification and amendment prescribed by the Stock Exchange from time to time;
“Spot Price” means:
(i) in respect of a continuous trading session of the Stock Exchange, the price per Unit concluded by means of automatic order matching on the Stock Exchange as reported in the official real-time dissemination mechanism for the Stock Exchange during such continuous trading session in accordance with the Trading Rules, excluding direct business (as defined in the Trading Rules); and
−99− (ii) in respect of a pre-opening session or a closing auction session (if applicable) of the Stock Exchange, as the case may be, the final Indicative Equilibrium Price (as defined in the Trading Rules) of the Share (if any) calculated at the end of the pre-order matching period of such pre-opening session or closing auction session (if applicable), as the case may be, in accordance with the Trading Rules, excluding direct business (as defined in the Trading Rules),
subject to such modification and amendment prescribed by the Stock Exchange from time to time;
“Trading Day” means any day on which the Stock Exchange is scheduled to open for trading for its regular trading sessions; and
“Trading Rules” means the Rules and Regulations of the Stock Exchange prescribed by the Stock Exchange from time to time.
(B) Any CBBCs with respect to which a Mandatory Call Event has not occurred during the Observation Period shall be deemed automatically exercised on the Expiry Date (“Automatic Exercise”).
(C) Following the date on which the Mandatory Call Event occurs or the Expiry Date, the Issuer will, with effect from the first Business Day following the Settlement Date cancel and destroy the Global CBBC Certificate.
(D) Following a Mandatory Call Termination or an Automatic Exercise in accordance with Conditions 3(A) or 3(B), the Issuer will on a date no later than the Settlement Date in accordance with these Conditions procure payment of the aggregate Cash Settlement Amount (following deduction of any determined Exercise Expenses) for all CBBCs terminated or deemed automatically exercised in favour of the Holder as appearing in the register kept by or on behalf of the Issuer.
Any payment of the Cash Settlement Amount made pursuant to this Condition 3(D) shall be delivered at the risk and expense of the Holder to the Holder as recorded on the register, or such bank, broker or agent in Hong Kong (if any) as directed by the Holder.
Whereas:
“Cash Settlement Amount” means, subject to adjustment as provided in Condition 4, an amount calculated by the Issuer in accordance with following formula:
(i) if no Mandatory Call Event has occurred:
(a) in the case of a series of Bull CBBCs:
“Cash Settlement Entitlement x (Closing Price − Strike Price) x one Board Lot = Amount” per Board Lot Number of CBBC(s) per Entitlement
(b) in the case of a series of Bear CBBCs:
“Cash Settlement Entitlement x (Strike Price − Closing Price) x one Board Lot = Amount” per Board Lot Number of CBBC(s) per Entitlement
− 100 − (ii) following a Mandatory Call Event:
(a) in the case of a series of Category R CBBCs, the Residual Value; or
(b) in the case of a series of Category N CBBCs, zero; provided that if the relevant formula above produces an amount that is equal to or less than zero or the Exercise Expenses (if any), then no Cash Settlement Amount shall be payable. The aggregate Cash Settlement Amount payable to a Holder shall be expressed in the Settlement Currency and shall be rounded up to the nearest two decimal places in the Settlement Currency.
“Closing Price” shall be the closing price of one Unit (as derived from the Daily Quotation Sheet of the Stock Exchange, subject to any adjustment to such closing price as may be necessary to reflect any event as contemplated in Condition 4 such as capitalisation, rights issue, distribution or the like) on the Valuation Date;
“Entitlement” means such number of Units as specified in the relevant Launch Announcement and Supplemental Listing Document, subject to any adjustment in accordance with Condition 4;
“Exercise Expenses” means any charges or expenses including any taxes or duties which are incurred in respect of the early termination of the CBBCs upon the occurrence of a Mandatory Call Event or the exercise of the CBBCs at expiry;
“Market Disruption Event” means:
(i) the occurrence or existence on any Trading Day during the one-half hour period that ends at the close of trading of any suspension of or limitation imposed on trading (by reason of movements in price exceeding limits permitted by the Stock Exchange or otherwise) on the Stock Exchange in (a) the Units; or (b) any options or futures contracts relating to the Units if, in any such case, such suspension or limitation is, in the determination of the Issuer, material;
(ii) the issuance of the tropical cyclone warning signal number 8 or above or the issuance of a “BLACK” rainstorm signal by the Hong Kong Observatory on any day which (i) results in the Stock Exchange being closed for trading for the entire day; or (ii) results in the Stock Exchange being closed prior to its regular time for close of trading for the relevant day (for the avoidance of doubt, in the case when the Stock Exchange is scheduled to open for the morning trading session only, closed prior to its regular time for close of trading for the morning session), PROVIDED THAT there shall be no Market Disruption Event solely by reason of the Stock Exchange opening for trading later than its regular time for opening of trading on any day as a result of the tropical cyclone warning signal number 8 or above or the “BLACK” rainstorm signal having been issued; or
(iii) a limitation or closure of the Stock Exchange due to any unforeseen circumstances.
“Maximum Trade Price” means the highest Spot Price of the Unit (subject to any adjustment to such Spot Price as may be necessary to reflect any event as contemplated in Condition 4 such as capitalisation, rights issue, distribution or the like) during the MCE Valuation Period;
− 101 − “MCE Valuation Period” means the period commencing from and including the moment upon which the Mandatory Call Event occurs (the trading session during which the Mandatory Call Event occurs is the “1st Session”) and up to the end of the trading session on the Stock Exchange immediately following the 1st Session (“2nd Session”) unless, in the determination of the Issuer in its good faith, the 2nd Session for any reason (including, without limitation, a Market Disruption Event occurring and subsisting in the 2nd Session) does not contain any continuous period of 1 hour or more than 1 hour during which trading in the Units is permitted on the Stock Exchange with no limitation imposed, the MCE Valuation Period shall be extended to the end of the subsequent trading session following the 2nd Session during which trading in the Units is permitted on the Stock Exchange with no limitation imposed for a continuous period of at least 1 hour notwithstanding the existence or continuance of a Market Disruption Event in such postponed trading session, unless the Issuer determines in its good faith that each trading session on each of the four Trading Days immediately following the date on which the Mandatory Call Event occurs does not contain any continuous period of 1 hour or more than 1 hour during which trading in the Units is permitted on the Stock Exchange with no limitation imposed. In that case:
(i) the period commencing from the 1st Session up to, and including, the last trading session on the Stock Exchange of the fourth Trading Day immediately following the date on which the Mandatory Call Event occurs shall be deemed to be the MCE Valuation Period; and
(ii) the Issuer shall determine the Maximum Trade Price or the Minimum Trade Price (as the case may be) having regard to the then prevailing market conditions, the last reported Spot Price of the Unit and such other factors as the Issuer may determine to be relevant in its good faith.
For the avoidance of doubt, all Spot Prices available throughout the extended MCE Valuation Period shall be taken into account to determine the Maximum Trade Price or the Minimum Trade Price (as the case may be) for the calculation of the Residual Value.
For the purposes of this definition,
(a) the pre-opening session, the morning session and, in the case of half day trading, the closing auction session (if applicable) of the same day; and
(b) the afternoon session and the closing auction session (if applicable) of the same day, shall each be considered as one trading session only;
“Minimum Trade Price” means the lowest Spot Price of the Unit (subject to any adjustment to such Spot Price as may be necessary to reflect any event as contemplated in Condition 4 such as capitalisation, rights issue, distribution or the like) during the MCE Valuation Period;
“Residual Value” means, subject to adjustment as provided in Condition 4:
(a) in the case of a series of Bull CBBCs:
“Residual Value” Entitlement x (Minimum Trade Price − Strike Price) x one Board Lot = per Board Lot Number of CBBC(s) per Entitlement
− 102 − (b) in the case of a series of Bear CBBCs:
“Residual Value” Entitlement x (Strike Price − Maximum Trade Price) x one Board Lot = per Board Lot Number of CBBC(s) per Entitlement
“Settlement Currency” means Hong Kong dollars unless otherwise specified in the relevant Launch Announcement and Supplemental Listing Document;
“Settlement Date” means the third CCASS Settlement Day after (i) the end of the MCE Valuation Period or (ii) the later of: (a) the Expiry Date; and (b) the day on which the Closing Price is determined in accordance with the Conditions (as the case may be); and
“Valuation Date” means, the Trading Day immediately preceding the Expiry Date. If the Issuer determines, in its sole discretion, that a Market Disruption Event has occurred on the Valuation Date, then the Valuation Date shall be the first succeeding Trading Day on which the Issuer determines that there is no Market Disruption Event, unless the Issuer determines that there is a Market Disruption Event occurring on each of the four Trading Days immediately following the original date which (but for the Market Disruption Event) would have been the Valuation Date. In that case:
(i) the fourth Trading Day immediately following the original date shall be deemed to be the Valuation Date (regardless of the Market Disruption Event); and
(ii) the Issuer shall determine the Closing Price having regard to the then prevailing market conditions, the last reported trading price of the Units on the Stock Exchange and such other factors as the Issuer determines to be relevant.
(E) If as a result of an event beyond the control of the Issuer, it is not possible for the Issuer to procure payment electronically through CCASS by crediting the relevant bank account of the Holder on the original Settlement Date (“Settlement Disruption Event”), the Issuer shall use its reasonable endeavours to procure payment electronically through CCASS by crediting the relevant bank account of the Holder as soon as reasonably practicable after the original Settlement Date. The Issuer will not be liable to the Holder for any interest in respect of the amount due or any loss or damage that such Holder may suffer as a result of the existence of a Settlement Disruption Event, nor shall the Issuer be under any circumstances be liable for any acts or defaults of CCASS in relation to the performance of its duties in relation to the CBBCs.
(F) These Conditions shall not be construed so as to give rise to any relationship of agency or trust between the Stock Exchange, the Guarantor, the Issuer or its agent or nominee and the Holder and neither the Stock Exchange, the Guarantor, the Issuer nor its agent or nominee shall owe any duty of a fiduciary nature to the Holder.
None of the Stock Exchange, the Issuer or the Guarantor shall have any responsibility for any errors or omissions in the calculation and determination of any variables published by it or a third party and used in any calculation or determination made pursuant to these terms and conditions (including the determination as the occurrence of the Mandatory Call Event) or in the calculation of the Cash Settlement Amount arising from such errors or omissions.
The Issuer’s obligations to pay the Cash Settlement Amount shall be discharged by payment in accordance with Condition 3(D) above.
− 103 − 4 Adjustments
Adjustments may be made by the Issuer to the terms of the CBBCs (including, but not limited to (i) the Strike Price, (ii) the Call Price and/or (iii) the Entitlement) on the basis of the following provisions:
(A) (i) If and whenever the Fund or Trust shall, by way of Rights, offer new Units for subscription at a fixed subscription price to the holders of existing Units pro rata to existing holdings (a “Rights Offer”), the Entitlement, the Strike Price and the Call Price shall be adjusted to take effect on the Business Day on which the trading in the Units of the Fund or Trust becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
The Strike Price will be adjusted to:
1 Adjusted Strike Price = xX Adjustment Factor
The Call Price will be adjusted to:
1 Adjusted Call Price = xY Adjustment Factor
Where:
1+M “Adjustment Factor” = 1 + (R/S) x M
E: Existing Entitlement immediately prior to the Rights Offer
X: Existing Strike Price immediately prior to the Rights Offer
Y: Existing Call Price immediately prior to the Rights Offer
S: Cum-Rights Unit price, being the closing price of an existing Unit, as derived from the Daily Quotation Sheet of the Stock Exchange on the last Business Day on which the Units are traded on a cum-rights basis
R: Subscription price per new Unit specified in the Rights Offer plus an amount equal to any dividends or other benefits foregone to exercise the Right
M: Number of new Units per existing Unit (whether a whole or a fraction) each holder of an existing Unit is entitled to subscribe or have
For the purposes of these Conditions, “Rights” means the right(s) attached to each existing Unit or needed to acquire one new Unit (as the case may be) which are given to a holder of existing Units to subscribe at a fixed subscription price for new Units pursuant to the Rights Offer (whether by the exercise of one Right, a part of a Right or an aggregate number of Rights).
− 104 − (ii) The Adjusted Strike Price and the Adjusted Call Price shall be rounded to the nearest 0.001.
(B) (i) If and whenever the Fund or Trust shall make an issue of Units credited as fully paid to the holders of Units generally by way of capitalisation of profits or reserves (other than pursuant to a scrip distribution or similar scheme for the time being operated by the Fund or Trust or otherwise in lieu of a cash distribution and without any payment or other consideration being made or given by such holders) (a “Bonus Issue”), the Entitlement, the Strike Price and the Call Price shall be adjusted to take effect on the Business Day on which trading in the Units of the Fund or Trust becomes ex-entitlement in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement =Adjustment Factor x E
The Strike Price will be adjusted to:
1 Adjusted Strike Price = xX Adjustment Factor
The Call Price will be adjusted to:
1 Adjusted Call Price = xY Adjustment Factor
Where:
“Adjustment Factor”=1+N
E: Existing Entitlement immediately prior to the Bonus Issue
X: Existing Strike Price immediately prior to the Bonus Issue
Y: Existing Call Price immediately prior to the Bonus Issue
N: Number of additional Units (whether a whole or a fraction) received by a holder of existing Units for each Unit held prior to the Bonus Issue
(ii) The Adjusted Strike Price and the Adjusted Call Price shall be rounded to the nearest 0.001.
(iii) For the purposes of Conditions 4(A) and 4(B), the Issuer may determine that no adjustment will be made if the adjustment to the Entitlement is one per cent. or less of the Entitlement immediately prior to the adjustment, all as determined by the Issuer.
− 105 − (C) If and whenever the Fund or Trust shall subdivide its Units or any class of its outstanding Units into a greater number of Units or consolidate its outstanding Units or any class of it into a smaller number of Units, the Entitlement shall be increased and the Strike Price and the Call Price shall be decreased (in the case of a subdivision) or the Entitlement shall be decreased and the Strike Price and the Call Price shall be increased (in the case of a consolidation) accordingly, in each case on the day on which the relevant subdivision or consolidation shall have taken effect.
(D) If it is announced that the Fund or Trust is to or may merge or consolidate with or into any other corporation (including becoming, by agreement or otherwise, a subsidiary of or controlled by any person or corporation) (except where the Fund or Trust is the surviving entity in a merger or consolidation) or that it is to or may sell or transfer all or substantially all of its assets, the rights attaching to the CBBCs may in the absolute discretion of the Issuer be amended no later than the Business Day preceding the consummation of such merger, consolidation, sale or transfer (each a “Restructuring Event”).
The rights attaching to the CBBCs after the adjustment shall, after such Restructuring Event, relate to the number of units of the trust(s) or fund(s) resulting from or surviving such Restructuring Event or other securities (the “Substituted Securities”) and/or cash offered in substitution for the affected Units, as the case may be, to which the holder of such number of Units to which the CBBCs related immediately before such Restructuring Event would have been entitled upon such Restructuring Event. Thereafter the provisions hereof shall apply to such Substituted Securities, provided that any Substituted Securities may, in the absolute discretion of the Issuer, be deemed to be replaced by an amount in the relevant currency equal to the market value or, if no market value is available, fair value, of such Substituted Securities in each case as determined by the Issuer as soon as practicable after such Restructuring Event is effected.
For the avoidance of doubt, any remaining Units shall not be affected by this paragraph (D) and, where cash is offered in substitution for Units or is deemed to replace Substituted Securities as described above, references in these Conditions to the Units shall include any such cash.
(E) Generally, no adjustment will be made for an ordinary cash distribution (whether or not it is offered with a scrip alternative). For any other forms of cash distribution (each a “Cash Distribution”) announced by the Fund or Trust, such as a cash bonus, special dividend or extraordinary dividend, no adjustment will be made unless the value of the Cash Distribution accounts for 2 per cent. or more of the Unit’s closing price on the day of announcement by the Fund or Trust.
If and whenever the Fund or Trust shall make a Cash Distribution credited as fully paid to the holders of Units generally, the Entitlement, the Call Price and the Strike Price shall be adjusted to take effect on the Business Day on which trading in the Units becomes ex-entitlement (each a “Dividend Adjustment Date”) in accordance with the following formula:
The Entitlement will be adjusted to:
Adjusted Entitlement = Adjustment Factor x E
− 106 − The Strike Price will be adjusted to:
1 Adjusted Strike Price = xX Adjustment Factor
The Call Price will be adjusted to:
1 Adjusted Call Price = xY Adjustment Factor
Where:
S−OD “Adjustment Factor” = S−OD−CD
E: Existing Entitlement immediately prior to the relevant Cash Distribution
X: Existing Strike Price immediately prior to the relevant Cash Distribution
Y: Existing Call Price immediately prior to the relevant Cash Distribution
S: Closing Price of a Unit, as derived from the Daily Quotation Sheet of the Stock Exchange on the Business Day immediately prior to the Dividend Adjustment Date
OD: Amount of ordinary cash distribution per Unit, provided that “OD” shall be deemed to be zero if no ordinary cash distribution is announced by the Fund or Trust or if the ex-entitlement date of the ordinary cash distribution is different from the ex-entitlement date of the relevant Cash Distribution
CD: Amount of the relevant Cash Distribution per Unit
The Adjusted Strike Price and the Adjusted Call Price shall be rounded to the nearest 0.001.
(F) Without prejudice to and notwithstanding any prior adjustment(s) made pursuant to the applicable Conditions, the Issuer may (but shall not be obliged to) make such other adjustments to the terms and conditions of the CBBCs as appropriate where any event (including the events as contemplated in the applicable Conditions) occurs and irrespective of, in substitution for, or in addition to the provisions contemplated in the applicable Conditions, provided that such adjustment is (i) not materially prejudicial to the interests of the Holders generally (without considering the circumstances of any individual Holder or the tax or other consequences of such adjustment in any particular jurisdiction) or (ii) determined by the Issuer in good faith to be appropriate and commercially reasonable.
(G) The Issuer shall determine any adjustment or amendment and its determination shall be conclusive and binding on the Holder save in the case of manifest error. Any such adjustment or amendment shall be set out in a notice, which shall be given to the Holder in accordance with Condition 8 as soon as practicable after the determination.
5 Purchase by the Issuer
The Issuer and any of its affiliates may purchase CBBCs at any time on or after the date of their issue and any CBBCs which are so purchased may be surrendered for cancellation or offered from time to time in one or more transactions in the over-the-counter market or otherwise at prevailing market prices or in negotiated transactions, at the discretion of the Issuer or any such affiliate, as the case may be.
− 107 − 6 Global CBBC Certificate
A global callable bull/bear contract certificate (the “Global CBBC Certificate”) representing the CBBCs will be deposited within CCASS and registered in the name of HKSCC Nominees Limited or another nominee of Hong Kong Securities Clearing Company Limited. The Global CBBC Certificate will not be exchangeable for definitive certificates.
7 Meeting of Holder; Modification
(A) Meetings of Holder. Notices for convening meetings to consider any matter affecting the Holder’s interests will be given to the Holder in accordance with the provisions of Condition 8.
Every question submitted to a meeting of the Holder shall be decided by poll. A meeting may be convened by the Issuer or by the Holder holding not less than 10 per cent. of the CBBCs for the time being remaining unexercised. The quorum at any such meeting for passing an Extraordinary Resolution will be two or more persons (including any nominee appointed by the Holder) holding or representing not less than 25 per cent. of the CBBCs for the time being remaining unexercised, or at any adjourned meeting two or more persons (including any nominee appointed by the Holder) being or representing Holder whatever the number of CBBCs so held or represented.
A resolution will be an Extraordinary Resolution when it has been passed at a duly convened meeting by not less than three-quarters of the votes cast by such Holder as, being entitled to do so, vote in person or by proxy.
An Extraordinary Resolution passed at any meeting of the Holder shall be binding on all the holders of the CBBCs, whether or not they are present at the meeting.
Resolutions can be passed in writing without a meeting of the Holder being held if passed unanimously.
Where the Holder is a clearing house recognised by the Laws of Hong Kong or its nominee(s), it may authorise such person or person(s) as it thinks fit to act as its representative(s) or proxy(ies) at any Holders’ meeting provided that, if more than one person is so authorised, the authorisation or proxy form must specify the number of CBBCs in respect of which each such person is so authorised. Each person so authorised will be entitled to exercise the same powers and right, including the right to vote on a show of hands, on behalf of the recognised clearing house or its nominee(s) as that clearing house or its nominee(s) as if he was an individual Holder of the CBBC.
(B) Modification. The Issuer may, without the consent of the Holders, effect any modification of the terms and conditions of the CBBCs or the Instrument which, in the opinion of the Issuer, is (i) not materially prejudicial to the interests of the Holders generally (without considering the circumstances of any individual Holder or the tax or other consequences of such modification in any particular jurisdiction); (ii) of a formal, minor or technical nature; (iii) made to correct a manifest error; or (iv) necessary in order to comply with mandatory provisions of the laws or regulations of Hong Kong. Any such modification shall be binding on the Holders and shall be notified to them by the Issuer as soon as practicable thereafter in accordance with Condition 8.
8 Notices
All notices in English and Chinese to the Holder will be validly given if published on the website of the Hong Kong Exchanges and Clearing Limited.
− 108 − 9 Termination or Liquidation of the Fund or Trust
In the event of a Termination or the liquidation or dissolution of the trustee of the Fund or Trust (including any successor trustee appointed from time to time) (“Trustee”) (in its capacity as trustee of the Fund or Trust) or the appointment of a liquidator, receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the Trustee’s undertaking, property or assets, all unexercised CBBCs will lapse and shall cease to be valid for any purpose. The unexercised CBBCs will lapse and shall cease to be valid (i) in the case of a Termination, on the effective date of the Termination; (ii) in the case of a voluntary liquidation, on the effective date of the resolution; (iii) in the case of an involuntary liquidation or dissolution, on the date of the relevant court order; or (iv) in the case of the appointment of a liquidator or receiver or administrator or analogous person under applicable law in respect of the whole or substantially the whole of the Trustee’s undertaking, property or assets, on the date when such appointment is effective but subject (in any such case) to any contrary mandatory requirement of law.
For the purpose of this Condition 9, “Termination” means (i) the Fund or Trust is terminated, or the Trustee or the manager of the Fund or Trust (including any successor manager appointed from time to time) (“Manager”) is required to terminate the Fund or Trust under the trust deed (“Trust Deed”) constituting the Fund or Trust or applicable law, or the termination of the Fund or Trust commences; (ii) the Fund or Trust is held or is conceded by the Trustee or the Manager not to have been constituted or to have been imperfectly constituted; (iii) the Trustee ceases to be authorised under the Fund or Trust to hold the property of the Fund or Trust in its name and perform its obligations under the Trust Deed; or (iv) the Fund or Trust ceases to be authorised as an authorised collective investment scheme under the Securities and Futures Ordinance (Cap. 571 of the Laws of Hong Kong).
10 Delisting of Fund or Trust
(A) If at any time the Units cease to be listed on the Stock Exchange, the Issuer shall give effect to these Conditions in such manner and make such adjustments to the rights attaching to the CBBCs as it shall, in its absolute discretion, consider appropriate to ensure, so far as it is reasonably able to do so, that the interests of the Holders generally are not materially prejudiced as a consequence of such delisting (without considering the individual circumstances of the Holders or the tax or other consequences that may result in any particular jurisdiction).
(B) Without prejudice to the generality of Condition 10(A), where the Units are or, upon the delisting, become, listed on any other stock exchange, these Conditions may, in the absolute discretion of the Issuer, be amended to the extent necessary to allow for the substitution of that other stock exchange in place of the Stock Exchange and the Issuer may, without the consent of the Holder, make such adjustments to the entitlements of the Holders on exercise (including, if appropriate, by converting foreign currency amounts at prevailing market rates into the relevant currency) as it shall consider appropriate in the circumstances.
(C) Any adjustment, amendment or determination made by the Issuer pursuant to this Condition 10 shall be conclusive and binding on the Holders save in the case of manifest error. Notice of any adjustments or amendments shall be given to the Holders in accordance with Condition 8 as soon as practicable after they are determined.
11 Further Issues
The Issuer shall be at liberty from time to time, without the consent of the Holder, to create and issue further callable bull/bear contracts, upon such terms as to issue price and otherwise as the Issuer may determine so as to form a single series with the CBBCs.
− 109 − 12 Illegality and Impracticability
The Issuer is entitled to terminate the CBBCs if it determines in good faith and in a commercially reasonable manner that, for reasons beyond its control, it has become or it will become illegal or impracticable:
(i) for it to perform its obligations under the CBBCs, or for the Guarantor to perform its obligations under the Guarantee, in whole or in part as a result of:
(a) the adoption of, or any change in, any relevant law or regulation (including any tax law); or
(b) the promulgation of, or any change in, the interpretation by any court, tribunal, governmental, administrative, legislative, regulatory or judicial authority or power with competent jurisdiction of any relevant law or regulation (including any tax law),
(each of (a) and (b), a “Change in Law Event”); or
(ii) for it or any of its affiliates to maintain the Issuer’s hedging arrangements with respect to the CBBCs due to a Change in Law Event.
Upon the occurrence of a Change in Law Event, the Issuer will, if and to the extent permitted by the applicable law or regulation, pay to each Holder a cash amount that the Issuer determines in good faith and in a commercially reasonable manner to be the fair market value in respect of each CBBC held by such Holder immediately prior to such termination (ignoring such illegality or impracticability) less the cost to the Issuer of unwinding any related hedging arrangement as determined by the Issuer in its sole and absolute discretion. Payment will be made to each Holder in such manner as shall be notified to the Holders in accordance with Condition 8.
13 Good Faith and Commercially Reasonable Manner
Any exercise of discretion by the Issuer under these Conditions will be made in good faith and in a commercially reasonable manner.
14 Governing Law
The CBBCs and the Instrument will be governed by and construed in accordance with the laws of the Hong Kong Special Administrative Region of the People’s Republic of China (“Hong Kong”). The Issuer and the Holder (by its acquisition of the CBBCs) shall be deemed to have submitted for all purposes in connection with the CBBCs and the Instrument to the non-exclusive jurisdiction of the courts of Hong Kong.
15 Language
A Chinese translation of these Conditions is available upon request during usual business hours on any weekday (Saturdays, Sundays and holidays excepted) at the offices of the Manager. In the event of any inconsistency between the English version and Chinese translation of these Conditions, the English version shall prevail and be governing.
−110− 16 Contracts (Rights of Third Parties) Ordinance
A person who is not a party to the terms and conditions of the CBBCs has no right under the Contracts (Rights of Third Parties) Ordinance (Cap. 623 of the Laws of Hong Kong) to enforce or to enjoy the benefit of any term of the CBBCs.
Manager
Morgan Stanley Asia Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
− 111 − ANNEX 2
FORM OF GUARANTEE
GUARANTEE
THIS GUARANTEE is made by way of deed poll on 18 July 2019 by Morgan Stanley a corporation duly organized under the laws of the State of Delaware (the “Guarantor”).
WHEREAS:
A) Morgan Stanley Asia Products Limited (the “Issuer”) may determine to issue from time to time various series of warrants (the “Warrants”) and callable bull/bear contracts (the “CBBCs”) pursuant to an instrument by way of deed poll dated 18 July 2019 for each series of Warrants and CBBCs (the “Instrument”). The Warrants and the CBBCs shall together be referred to as the “Structured Products” in this Guarantee.
B) The Guarantor has determined to execute this Guarantee of the Issuer’s obligations (the “Obligations”) in respect of the Structured Products issued pursuant to a base listing document dated 18 July 2019 (as amended and/or restated and/or supplemented from time to time), as a primary obligor and not merely as surety, for the benefit of the holders for the time being of the Structured Products (each, a “Holder”).
C) Terms defined in the Instrument shall bear the same meaning in this Guarantee.
THE GUARANTOR hereby agrees as follows:
1. For value received, the Guarantor hereby unconditionally and irrevocably, subject to the provisions of paragraph 3 and 4 hereof, guarantees to each and every Holder the due and punctual payment and performance when due and owing of the Obligations in accordance with the terms and conditions of the Structured Products, and the Guarantor hereby agrees to (i) cause any such payment to be made promptly when and as the same shall become due and payable; and (ii) cause any such performance to be discharged promptly when and as the same shall become due, as if such payment was made or, as the case may be, performance was discharged, by the Issuer in accordance with the Conditions.
2. The Guarantor hereby waives notice of acceptance of this Guarantee and notice of the Obligations, and waives presentment, demand for payment, protest, notice of dishonour or non-payment of the Obligations. The Guarantor waives any right it may have of first requiring the Holder (or any trustee or agent on its behalf) to proceed against or enforce any other rights or security or claim payment from any person before claiming from the Guarantor under this Guarantee. This waiver applies irrespective of any law or any provision of this Guarantee to the contrary.
3. The obligations of the Guarantor will not be impaired or released by: (1) any change in the terms of the Obligations; (2) the taking or failure to take any action of any kind in respect of any security for the Obligations; (3) the exercising or refraining from exercising any rights against the Issuer or others in respect of the Obligations; or (4) any compromise or subordination of the Obligations, including any security therefor.
4. The Guarantee shall continue in full force and effect unless revoked by the Guarantor by giving written notice of termination to the Issuer. Notwithstanding any such termination, this Guarantee shall continue in full force and effect with respect to the Obligations which have been incurred prior to such termination until all such Obligations have been satisfied in full.
−112− 5. The Guarantor further agrees that this Guarantee will continue to be effective or be reinstated, as the case may be, if at any time payment, or any part thereof, of any of the Obligations, or interest thereon is rescinded or must otherwise be restored or returned by the Holder upon the liquidation, bankruptcy, insolvency, dissolution or reorganization of the Issuer.
6. This Guarantee shall continue to be effective if the Issuer merges or consolidates with or into, or transfers all or substantially all of its assets to, another entity, loses its separate legal identity, is liquidated or ceases to exist.
7. The Guarantor’s obligations under this Guarantee are absolute and unconditional and shall not be affected by the validity, regularity or enforceability of any Structured Products, Obligation or any instrument evidencing any Obligation, or by the validity, enforceability, perfection or existence of any collateral therefor or by any other circumstance relating to any Obligation which might otherwise constitute a legal or equitable discharge of or defense of a guarantor or surety, provided that the Guarantor may interpose any counterclaim or setoff which the Issuer is or would have been entitled to interpose and that the Guarantor may interpose any defense which the Issuer is or would have been entitled to interpose.
8. Notwithstanding paragraph 1 hereof, the Guarantor may perform any of its duties and obligations under this Guarantee through any of its affiliates, provided that the Guarantor shall remain liable in accordance with the terms of this Guarantee for all such duties and obligations performed through such affiliate.
The Guarantor has appointed Morgan Stanley Hong Kong Limited, Level 46 International Commerce Centre, 1 Austin Road West, Kowloon, Hong Kong as its agent for service of process in Hong Kong.
THE GUARANTEE SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH HONG KONG LAW WITHOUT GIVING EFFECT TO PRINCIPLES OF CONFLICTS OF LAW.
THE GUARANTOR IRREVOCABLY AGREES THAT THE COURTS OF HONG KONG ARE TO HAVE EXCLUSIVE JURISDICTION TO SETTLE ANY DISPUTES ARISING FROM OR RELATING TO THIS GUARANTEE.
IN WITNESS whereof this Guarantee has been executed by the Guarantor as a deed poll and delivered on the date specified at the beginning of this Guarantee.
MORGAN STANLEY
By: Authorized Officer
−113− ANNEX 3
PURCHASE AND SALE
General
No action has been or will be taken by the Issuer or the Guarantor that would permit a public offering (other than Hong Kong) of any series of structured products or possession or distribution of any offering material in relation to any structured products in any jurisdiction where action for that purpose is required. No offers, sales, re-sales, transfers or deliveries of any structured products, or distribution of any offering material relating to structured products, may be made in or from any jurisdiction except in circumstances which will result in compliance with any applicable laws and regulations and will not impose any obligations on the Issuer or the Guarantor.
United States of America
The structured products and the Guarantee have not been and will not be registered under the Securities Act. Trading in the structured products has not been and will not be approved by the U.S. Securities and Exchange Commission or any state securities commission or on an exchange or board of trade or otherwise by the United States Commodity Futures Trading Commission under the United States Commodity Exchange Act. The structured products may not be offered or sold within the United States or to, or for the account or benefit of, U.S. persons at any time. In addition, hedging transactions involving the structured products may not be conducted other than in compliance with the Securities Act. The Issuer will not offer, or sell the structured products at any time within the United States or to, or for the account or benefit of, U.S. persons. Each person, including any dealer, who purchases structured products, whether in an offering, in the secondary market or otherwise, is deemed to have represented to and agreed with the Issuer not to offer, or sell the structured products at any time within the United States or to, or for the account or benefit of, U.S. persons. Each distributor, if any, will have sent to each dealer to which it sells structured products a confirmation or other notice describing the restrictions on sales and offers of structured products within the United States or to, or for the account or benefit of, U.S. persons. As used in this paragraph “United States” means the United States of America, its territories or possessions, any state of the United States, the District of Columbia or any other enclave of the United States government, its agencies or instrumentalities, and “U.S. person” means (i) any person who is a U.S. person as defined in Regulation S under the Securities Act or (ii) any person or entity other than one of the following:
(i) a natural person who is not a resident of the United States;
(ii) a partnership, corporation or other entity, other than an entity organised principally for passive investment, organised under the laws of a jurisdiction other than the United States and which has its principal place of business in a jurisdiction other than the United States;
(iii) an estate or trust, the income of which is not subject to United States income tax regardless of source;
(iv) an entity organised principally for passive investment such as a pool, investment company or other similar entity, provided that units of participation in the entity held by U.S. persons represent in the aggregate less than 10% of the beneficial interest in the entity, and that such entity was not formed principally for the purpose of facilitating investment by U.S. persons; or
−114− (v) a pension plan for the employees, officers or principals of an entity organised and with its principal place of business outside the United States.
In addition, unless otherwise specified in the Launch Announcement and Supplemental Listing Document relating to a series of structured products, each purchaser (or transferee) and any person directing such purchase (or transfer) will represent and warrant, or will be deemed to have represented and warranted, on each day from the date on which the purchaser (or transferee) acquires the structured products through and including the date on which the purchaser (or transferee) disposes of its interest in the structured products, that the purchaser (or transferee) is not an “employee benefit plan” (as defined in Section 3(3) of Title I of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”)) that is subject to the fiduciary responsibility provisions of ERISA, a “plan” that is subject to Section 4975 of the Internal Revenue Code of 1986, as amended (the “Code”), any entity whose underlying assets include “plan assets” by reason of any such employee plan’s or plan’s investment in the entity, or a governmental, church, non-U.S. or other plan that is subject to any law or regulation that is substantially similar to the provisions of Section 406 of ERISA or Section 4975 of the Code.
No ownership by U.S. Persons
The structured products and the Guarantee may not be legally or beneficially owned by U.S. Persons at any time. Each holder and each beneficial owner of a structured product hereby represents, as a condition to purchasing or owning the structured product or any beneficial interest therein, that neither it nor any person for whose account or benefit the structured products are being purchased is located in the United States, is a U.S. Person or was solicited to purchase the structured products while present in the United States. Each holder and each beneficial owner of a structured product hereby agrees not to offer, sell or deliver any of the structured products at any time, directly or indirectly in the United States or to any U.S. Person.
European Economic Area
Each dealer represents and agrees, and each further dealer appointed in respect of the structured products will be required to represent and agree that, it has not offered, sold or otherwise made available and will not offer, sell, or otherwise make available any structured products which are the subject of the offering as contemplated by this Base Listing Document to any retail investor in the European Economic Area. For the purposes of this provision:
(a) the expression “retail investor” means a person who is one (or more) of the following:
i. a retail client as defined in point (11) of Article 4(1) of Directive 2014/65/EU (as amended, “MiFID II”); or
ii. a customer within the meaning of Directive 2016/97/EU (as amended, the Insurance Distribution Directive), where that customer would not qualify as a professional client as defined in point (10) of Article 4(1) of MiFID II; or
iii. not a qualified investor as defined in Directive 2003/71/EC (as amended, including by Directive 2010/73/EU, the Prospectus Directive); and
(b) the expression “offer” includes the communication in any form and by any means of sufficient information on the terms of the offer and the structured products to be offered so as to enable an investor to decide to purchase or subscribe the structured products.
−115− United Kingdom
Each dealer represents and agrees, and each further dealer appointed in respect of the structured products will be required to represent and agree, that:
(a) in respect to structured products having a maturity of less than one year: (i) it is a person whose ordinary activities involve it in acquiring, holding, managing or disposing of investments (as principal or agent) for the purposes of its business; and (ii) it has not offered or sold and will not offer or sell any structured products other than to persons whose ordinary activities involve them in acquiring, holding, managing or disposing of investments (as principal or agent) for the purposes of their businesses or who it is reasonable to expect will acquire, hold, manage or dispose of investments (as principal or agent) for the purposes of their businesses where the issue of the structured products would otherwise constitute a contravention of Section 19 of Financial Services and Markets Act, as amended (the “FSMA”) by the Issuer;
(b) it has only communicated or caused to be communicated and will only communicate or cause to be communicated an invitation or inducement to engage in investment activity (within the meaning of Section 21 of the FSMA) received by it in connection with the issue or sale of any structured products in circumstances in which Section 21(1) of the FSMA does not apply to the Issuer or the Guarantor; and
(c) it has complied and will comply with all applicable provisions of the FSMA with respect to anything done by it in relation to any structured products in, from or otherwise involving the United Kingdom.
People’s Republic of China
Neither the Base Listing Document nor any launch announcement and supplemental listing document (including any addendum thereto) in connection with the structured products has been or will be registered, circulated, published or distributed in the People’s Republic of China (excluding the Hong Kong Special Administrative Region, the Macau Special Administrative Region and the Taiwan area) (the “PRC”). Accordingly, the structured products may not be offered or sold or delivered, or offered or sold or delivered to any person for reoffering or resale or redelivery, in any such case directly or indirectly (i) by means of any advertisement, invitation, document or activity which is directed at, or the contents of which are likely to be accessed or read by, the public in the PRC or (ii) to any person within the PRC other than permitted by and in full compliance with the relevant laws and regulations of the PRC.
Japan
The structured products have not been and will not be registered under the Financial Instruments and Exchange Acts of Japan (Law No. 25 of 1948, as amended, the “Financial Instruments and Exchange Act”). Accordingly, the structured products may not be, each dealer has agreed and each further dealer to be appointed in respect of the structured products will be required to agree that it will not offer or sell any structured products, directly or indirectly, offered or sold in Japan or to, or for the benefit of, any resident of Japan (which term as used herein means any person resident in Japan, including any corporation or other entity organised under the laws of Japan) or to others for re-offering or re-sale, directly or indirectly, in Japan or to, or for the benefit of, any resident of Japan except pursuant to an exemption from the registration requirements of, and otherwise in compliance with, the Financial Instruments and Exchange Act and any other applicable laws, regulations and ministerial guidelines of Japan.
−116− Additional
The offer and sale of structured products will also be subject to such other restrictions and requirements as may be set out in the relevant launch announcement and supplemental listing document.
Persons interested in acquiring structured products should inform themselves and obtain appropriate professional advice as to (i) the legal requirements within the countries of their nationality, residence, ordinary residence or domicile for such acquisition; (ii) any foreign exchange restrictions or exchange control requirements which they might encounter on the acquisition of structured products or their redemption; or (iii) the acquisition, holding or disposal of structured products.
−117− ANNEX 4
A BRIEF GUIDE TO CREDIT RATINGS
Information set out in this Annex 4 is based on, extracted or reproduced from the website of S&P at https://www.spratings.com/en_US/home and the website of Moody’s at https://www.moodys.com as at the day immediately preceding the date of this base listing document. Information appearing on those websites does not form part of this base listing document, and we accept no responsibility for the accuracy or completeness of the information appearing on those websites, except that we have accurately extracted and reproduced such information in this Annex 4 and take responsibility for such extraction and reproduction. We have not separately verified such information. There can be no assurance that such information will not be revised by the relevant rating agency in the future and we have no responsibility to notify you of such change. If you are unsure about any information provided in this Annex 4 and/or what a credit rating means, you should seek independent professional advice.
What is a credit rating?
A credit rating is a forward looking opinion by a credit rating agency of a company’s overall ability to meet its financial obligations. The focus is on the company’s capacity to pay its debts as they become due. The rating does not necessarily apply to any specific obligation.
What do the credit ratings mean?
Below are guidelines issued by S&P and Moody’s on what each of their investment-grade ratings means.
S&P long-term issuer credit ratings
AAA
An obligor rated ‘AAA’ has extremely strong capacity to meet its financial commitments. ‘AAA’ is the highest issuer credit rating assigned by S&P.
AA
An obligor rated ‘AA’ has very strong capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.
A
An obligor rated ‘A’ has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.
BBB
An obligor rated ‘BBB’ has adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to weaken the obligor’s capacity to meet its financial commitments.
Plus (+) or minus (-)
The above ratings (except for ‘AAA’) may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories.
−118− Please refer to https://www.standardandpoors.com/en_US/web/guest/article/-/view/sourceId/504352 for further details.
Moody’s long-term ratings definitions
Aaa
Obligations rated Aaa are judged to be of the highest quality, subject to the lowest level of credit risk.
Aa
Obligations rated Aa are judged to be of high quality and are subject to very low credit risk.
A
Obligations rated A are judged to be upper-medium grade and are subject to low credit risk.
Baa
Obligations rated Baa are judged to be medium-grade and subject to moderate credit risk and as such may possess certain speculative characteristics.
Modifiers “1”, “2” and “3”
Moody’s appends numerical modifiers 1, 2 and 3 to each of the above generic rating classifications (except for Aaa). The modifier 1 indicates that the obligation ranks in the higher end of its generic rating category; the modifier 2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the lower end of that generic rating category.
Please refer to https://www.moodys.com/ratings-process/Ratings-Definitions/002002 for further details.
Rating Outlooks
A rating outlook indicates the potential direction of a long-term credit rating over the intermediate term (for example, this is typically six to twenty-four months for S&P). A rating outlook issued by S&P or Moody’s will usually indicate whether the potential direction is likely to be “positive”, “negative”, “stable” or “developing”. Please refer to the abovementioned websites of the relevant credit rating agencies for further details regarding rating outlooks published by the relevant credit rating agencies.
−119− ANNEX 5
ISSUER’S FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED 31 DECEMBER 2017
This information in this Annex 5 is our financial statements as of 31 December 2017 and 2016 and for each of the two years in the period ended 31 December 2017. References to page numbers in this Annex 5 are to the pages in our financial statement and not to the pages in this document.
− 120 − − 121 − − 122 − − 123 − − 124 − − 125 − − 126 − − 127 − − 128 − − 129 − − 130 − − 131 − − 132 − − 133 − − 134 − − 135 − − 136 − − 137 − − 138 − − 139 − − 140 − − 141 − − 142 − − 143 − − 144 − − 145 − − 146 − − 147 − − 148 − − 149 − − 150 − − 151 − − 152 − − 153 − − 154 − − 155 − − 156 − − 157 − − 158 − − 159 − − 160 − − 161 − − 162 − − 163 − − 164 − − 165 − − 166 − − 167 − − 168 − − 169 − − 170 − − 171 − − 172 − − 173 − ANNEX 6
ISSUER’S FINANCIAL STATEMENTS FOR EACH OF THE TWO YEARS IN THE PERIOD ENDED 31 DECEMBER 2018
This information in this Annex 6 is our financial statements as of 31 December 2018 and 2017 and for each of the two years in the period ended 31 December 2018. References to page numbers in this Annex 6 are to the pages in our financial statement and not to the pages in this document.
− 174 − − 175 − − 176 − − 177 − − 178 − − 179 − − 180 − − 181 − − 182 − − 183 − − 184 − − 185 − − 186 − − 187 − − 188 − − 189 − − 190 − − 191 − − 192 − − 193 − − 194 − − 195 − − 196 − − 197 − − 198 − − 199 − − 200 − − 201 − − 202 − − 203 − − 204 − − 205 − − 206 − − 207 − − 208 − − 209 − − 210 − − 211 − − 212 − − 213 − − 214 − − 215 − − 216 − − 217 − − 218 − − 219 − − 220 − − 221 − − 222 − − 223 − − 224 − − 225 − − 226 − − 227 − − 228 − − 229 − − 230 − − 231 − − 232 − ANNEX 7
GUARANTOR’S CONSOLIDATED FINANCIAL STATEMENTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED 31 DECEMBER 2018
This information in this Annex 7 is the guarantor’s consolidated financial statements as of 31 December 2018 and 2017 and for each of the three years in the period ended 31 December 2018. References to page numbers in this Annex 7 are to the pages in the guarantor’s consolidated financial statement and not to the pages in this document.
− 233 − UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the year ended December 31, 2018 Commission File Number 1-11758
(Exact name of Registrant as specified in its charter)
Delaware 1585 Broadway 36-3145972 (212) 761-4000 (State or other jurisdiction of New York, NY 10036 (I.R.S. Employer Identification No.) (Registrant’s telephone number, incorporation or organization) (Address of principal executive offices, including area code) including zip code)
Securities registered pursuant to Section 12(b) of the Act: Name of exchange on Title of each class which registered Common Stock, $0.01 par value ...... NewYork Stock Exchange Depositary Shares, each representing 1/1,000th interest in a share of Floating Rate Non-Cumulative Preferred Stock, Series A, $0.01 par value ...... NewYork Stock Exchange Depositary Shares, each representing 1/1,000th interest in a share of Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series E, $0.01 par value ...... NewYork Stock Exchange Depositary Shares, each representing 1/1,000th interest in a share of Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series F, $0.01 par value ...... NewYork Stock Exchange Depositary Shares, each representing 1/1,000th interest in a share of 6.625% Non-Cumulative Preferred Stock, Series G, $0.01 par value ...... NewYork Stock Exchange Depositary Shares, each representing 1/1,000th interest in a share of Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series I, $0.01 par value ...... NewYork Stock Exchange Depositary Shares, each representing 1/1,000th interest in a share of Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series K, $0.01 par value ...... NewYork Stock Exchange Global Medium-Term Notes, Series A, Fixed Rate Step-Up Senior Notes Due 2026 of Morgan Stanley Finance LLC (and Registrant’s guarantee with respect thereto) ...... NewYork Stock Exchange Market Vectors ETNs due March 31, 2020 (two issuances); Market Vectors ETNs due April 30, 2020 (two issuances) ...... NYSE Arca, Inc. Morgan Stanley Cushing® MLP High Income Index ETNs due March 21, 2031 ...... NYSE Arca, Inc.
Indicate by check mark if Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES È NO ‘
Indicate by check mark if Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. YES ‘ NO È
Indicate by check mark whether Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES È NO ‘
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files). YES È NO ‘
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. È
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer È Accelerated Filer ‘ Non-Accelerated Filer ‘ Smaller reporting company ‘ Emerging growth company ‘
If an emerging growth company, indicate by check mark if the Registrant has elected not to use the extended transition period for complying with any new or revised finan- cial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ‘
Indicate by check mark whether Registrant is a shell company (as defined in Exchange Act Rule 12b-2). YES ‘ NO È
As of June 30, 2018, the aggregate market value of the common stock of Registrant held by non-affiliates of Registrant was approximately $79,320,949,858. This calculation does not reflect a determination that persons are affiliates for any other purposes.
As of January 31, 2019, there were 1,708,787,567 shares of Registrant’s common stock, $0.01 par value, outstanding.
Documents Incorporated by Reference: Portions of Registrant’s definitive proxy statement for its 2018 annual meeting of shareholders are incorporated by reference in Part III of this Form 10-K.
− 234 − ANNUAL REPORT ON FORM 10-K for the year ended December 31, 2018 Table of Contents Part Item Page Business I1 1 Overview 1 Business Segments 1 Competition 1 Supervision and Regulation 2 Executive Officers of Morgan Stanley 10 Risk Factors 1A 11 Selected Financial Data 624 Management’s Discussion and Analysis of Financial Condition and Results of Operations II 7 25 Introduction 25 Executive Summary 26 Business Segments 31 Supplemental Financial Information and Disclosures 45 Accounting Development Updates 46 Critical Accounting Policies 47 Liquidity and Capital Resources 49 Balance Sheet 49 Regulatory Requirements 55 Quantitative and Qualitative Disclosures about Risk 7A 64 Risk Management 64 Market Risk 67 Credit Risk 71 Country and Other Risks 77 Financial Statements and Supplementary Data 883 Report of Independent Registered Public Accounting Firm 83 Consolidated Income Statements 84 Consolidated Comprehensive Income Statements 85 Consolidated Balance Sheets 86 Consolidated Statements of Changes in Total Equity 87 Consolidated Cash Flow Statements 88 Notes to Consolidated Financial Statements 89 1. Introduction and Basis of Presentation 89 2. Significant Accounting Policies 90 3. Fair Values 101 4. Derivative Instruments and Hedging Activities 112 5. Investment Securities 117 6. Collateralized Transactions 119 7. Loans, Lending Commitments and Allowance for Credit Losses 122
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− 235 − Table of Contents Part Item Page 8. Equity Method Investments 125 9. Goodwill and Intangible Assets 125 10. Deposits 126 11. Borrowings and Other Secured Financings 126 12. Commitments, Guarantees and Contingencies 128 13. Variable Interest Entities and Securitization Activities 133 14. Regulatory Requirements 138 15. Total Equity 140 16. Earnings per Common Share 143 17. Interest Income and Interest Expense 144 18. Deferred Compensation Plans 144 19. Employee Benefit Plans 146 20. Income Taxes 149 21. Segment, Geographic and Revenue Information 151 22. Parent Company 155 23. Quarterly Results (Unaudited) 158 24. Subsequent Events 159 Financial Data Supplement (Unaudited) 160 Glossary of Common Acronyms 164 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 9 166 Controls and Procedures 9A 166 Other Information 9B 168 Unresolved Staff Comments I 1B 168 Properties 2 168 Legal Proceedings 3 169 Mine Safety Disclosures 4 173 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities II 5 174 Directors, Executive Officers and Corporate Governance III 10 176 Executive Compensation 11 176 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 12 176 Certain Relationships and Related Transactions and Director Independence 13 177 Principal Accountant Fees and Services 14 177 Exhibits and Financial Statement Schedules IV 15 177 Form 10-K Summary 16 177 Exhibit Index E-1 Signatures S-1
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− 236 − Forward-Looking Statements
We have included in or incorporated by reference into this report, and from time to time may make in our public filings, press releases or other public statements, certain statements, including (without limitation) those under “Legal Proceedings”, “Manage- ment’s Discussion and Analysis of Financial Condition and Results of Operations” and “Quantitative and Qualitative Disclosures about Risk” that may constitute “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. In addition, our management may make forward-looking statements to analysts, inves- tors, representatives of the media and others. These forward-looking statements are not historical facts and represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and beyond our control.
The nature of our business makes predicting the future trends of our revenues, expenses, and net income difficult. The risks and uncertainties involved in our businesses could affect the matters referred to in such statements, and it is possible that our actual results may differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Important factors that could cause actual results to differ from those in the forward-looking statements include (without limitation):
• the effect of market conditions, particularly in the global equity, fixed income, currency, credit and commodities markets, including corporate and mortgage (commercial and residential) lending and commercial real estate markets and energy markets; • the level of individual investor participation in the global markets as well as the level of client assets; • the flow of investment capital into or from assets under management or supervision; • the level and volatility of equity, fixed income and commodity prices, interest rates, inflation and currency values and other market indices; • the availability and cost of both credit and capital as well as the credit ratings assigned to our unsecured short-term and long- term debt; • technological changes instituted by us, our competitors or counterparties and technological risks, business continuity and related operational risks, including breaches or other disruptions of our or a third party’s (or third parties thereof) operations or systems; • risk associated with cybersecurity threats, including data protection and cybersecurity risk management; • our ability to manage effectively our capital and liquidity, including approval of our capital plans by our banking regulators; • the impact of current, pending and future legislation (including with respect to the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) or changes thereto, regulation (including capital, leverage, funding, liquidity and recovery and resolution requirements and our ability to address such requirements), policies including fiscal and mone- tary policies established by central banks and financial regulators; • changes to global trade policies and tariffs, government debt ceilings and funding, reforms of LIBOR, EURIBOR and other indices, and other legal and regulatory actions in the U.S. and worldwide; • changes in tax laws and regulations globally, including the interpretation and application of the U.S. Tax Cuts and Jobs Act (“Tax Act”); • the effectiveness of our risk management processes; • our ability to effectively respond to an economic downturn, or other market disruptions; • the effect of economic and political conditions and geopolitical events, including, for example, the U.K.’s anticipated with- drawal from the E.U. and a government shutdown in the United States; • the actions and initiatives of current and potential competitors as well as governments, central banks, regulators and self- regulatory organizations; • our ability to provide innovative products and services and execute our strategic objectives; • sovereign risk; • the performance and results of our acquisitions, divestitures, joint ventures, strategic alliances or other strategic arrangements; • investor, consumer and business sentiment and confidence in the financial markets; • our reputation and the general perception of the financial services industry; • natural disasters, pandemics and acts of war or terrorism; and • other risks and uncertainties detailed under “Business—Competition” and “Business—Supervision and Regulation”, “Risk Factors” and elsewhere throughout this report.
Accordingly, you are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date on which they are made. We undertake no obligation to update publicly or revise any forward-looking statements to reflect the impact of circumstances or events that arise after the dates they are made, whether as a result of new information, future events or otherwise except as required by applicable law. You should, however, consult further disclosures we may make in future filings of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and any amendments thereto or in future press releases or other public statements.
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− 237 − Available Information
We file annual, quarterly and current reports, proxy statements and other information with the SEC. The SEC maintains an internet site, www.sec.gov, that contains annual, quarterly and current reports, proxy and information statements and other infor- mation that issuers file electronically with the SEC. Our electronic SEC filings are available to the public at the SEC’s internet site.
Our internet site is www.morganstanley.com. You can access our Investor Relations webpage at www.morganstanley.com/ about-us-ir. We make available free of charge, on or through our Investor Relations webpage, our Proxy Statements, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934, as amended (“Exchange Act”), as soon as reasonably practi- cable after such material is electronically filed with, or furnished to, the SEC. We also make available, through our Investor Rela- tions webpage, via a link to the SEC’s internet site, statements of beneficial ownership of our equity securities filed by our direc- tors, officers, 10% or greater shareholders and others under Section 16 of the Exchange Act.
You can access information about our corporate governance at www.morganstanley.com/about-us-governance. Our Corpo- rate Governance webpage includes:
• Amended and Restated Certificate of Incorporation; • Amended and Restated Bylaws; • Charters for our Audit Committee, Compensation, Management Development and Succession Committee, Nominating and Governance Committee, Operations and Technology Committee, and Risk Committee; • Corporate Governance Policies; • Policy Regarding Corporate Political Activities; • Policy Regarding Shareholder Rights Plan; • Equity Ownership Commitment; • Code of Ethics and Business Conduct; • Code of Conduct; • Integrity Hotline Information; and • Environmental and Social Policies.
Our Code of Ethics and Business Conduct applies to all directors, officers and employees, including our Chief Executive Officer, Chief Financial Officer and Deputy Chief Financial Officer. We will post any amendments to the Code of Ethics and Business Conduct and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange LLC (“NYSE”) on our internet site. You can request a copy of these documents, excluding exhibits, at no cost, by contacting Investor Relations, 1585 Broadway, New York, NY 10036 (212-761-4000). The information on our internet site is not incorporated by reference into this report.
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− 238 − Business presents, among other things, technological, risk manage- ment, regulatory and other infrastructure challenges that Overview require effective resource allocation in order for us to remain competitive. Our competitive position depends on our reputa- We are a global financial services firm that, through our tion and the quality and consistency of our long-term invest- subsidiaries and affiliates, advises, and originates, trades, ment performance. Our ability to sustain or improve our manages and distributes capital for, governments, institutions competitive position also depends substantially on our ability and individuals. We were originally incorporated under the to continue to attract and retain highly qualified employees laws of the State of Delaware in 1981, and our predecessor while managing compensation and other costs. We compete companies date back to 1924. We are an FHC regulated by with commercial banks, brokerage firms, insurance compa- the Board of Governors of the Federal Reserve System nies, exchanges, electronic trading and clearing platforms, (“Federal Reserve”) under the Bank Holding Company Act of financial data repositories, sponsors of mutual funds, hedge 1956, as amended (“BHC Act”). We conduct our business funds and private equity funds, energy companies, financial from our headquarters in and around New York City, our technology firms and other companies offering financial or regional offices and branches throughout the U.S. and our ancillary services in the U.S., globally and digitally or principal offices in London, Tokyo, Hong Kong and other through the internet. In addition, restrictive laws and regula- world financial centers. As of December 31, 2018, we had tions applicable to certain U.S. financial services institutions, 60,348 employees worldwide. Unless the context otherwise such as Morgan Stanley, which may prohibit us from requires, the terms “Morgan Stanley,” the “Firm,” “us,” “we,” engaging in certain transactions and impose more stringent and “our” mean Morgan Stanley (the “Parent Company”) capital and liquidity requirements, can put us at a competitive together with its consolidated subsidiaries. We define the disadvantage to competitors in certain businesses not subject following as part of our consolidated financial statements to these same requirements. See also “Supervision and Regu- (“financial statements”): consolidated income statements lation” herein and “Risk Factors.” (“income statements”), consolidated balance sheets (“balance sheets”), and consolidated cash flow statements (“cash flow Institutional Securities and Wealth Management statements”). See the “Glossary of Common Acronyms” for the definition of certain acronyms used throughout the 2018 Our competitive position for our Institutional Securities and Form 10-K. Wealth Management business segments depends on innova- tion, execution capability and relative pricing. We compete Financial information concerning us, our business segments directly in the U.S. and globally with other securities and and geographic regions for each of the 12 months ended financial services firms and broker-dealers and with others on December 31, 2018, December 31, 2017 and December 31, a regional or product basis. Additionally, there is increased 2016 is included in the financial statements and the notes competition driven by established firms as well as the emer- thereto and in “Financial Statements and Supplementary gence of new firms and business models (including innova- Data.” tive uses of technology) competing for the same clients and Business Segments assets or offering similar products and services.
We are a global financial services firm that maintains signifi- Our ability to access capital at competitive rates (which is cant market positions in each of our business segments— generally impacted by our credit ratings), to commit and to Institutional Securities, Wealth Management and Investment deploy capital efficiently, particularly in our capital-intensive Management. Through our subsidiaries and affiliates, we underwriting and sales, trading, financing and market-making provide a wide variety of products and services to a large and activities, also affects our competitive position. Corporate diversified group of clients and customers, including corpora- clients may request that we provide loans or lending commit- tions, governments, financial institutions and individuals. ments in connection with certain investment banking activ- Additional information related to our business segments, ities and such requests are expected to continue. respective clients, and products and services provided is It is possible that competition may become even more intense included under “Management’s Discussion and Analysis of as we continue to compete with financial or other institutions Financial Condition and Results of Operations.” that may be larger, or better capitalized, or may have a Competition stronger local presence and longer operating history in certain geographies or products. Many of these firms have the ability All aspects of our businesses are highly competitive, and we to offer a wide range of products and services, and on expect them to remain so. We compete in the U.S. and glob- different platforms, that may enhance their competitive posi- ally for clients, market share and human talent. Operating tion and could result in pricing pressure on our businesses. In within the financial services industry on a global basis addition, our business is subject to extensive regulation in the
1 December 2018 Form 10-K
− 239 − U.S. and abroad, while certain of our competitors may be although it remains difficult to predict the exact impact these subject to less stringent legal and regulatory regimes than us, changes will have on our business, financial condition, results thereby putting us at a competitive disadvantage. of operations and cash flows for a particular future period and we expect to remain subject to extensive supervision and We continue to experience intense price competition in some regulation. of our businesses. In particular, the ability to execute securi- ties trades electronically on exchanges and through other Financial Holding Company automated trading markets has increased the pressure on trading commissions and comparable fees. The trend toward Consolidated Supervision. We have operated as a BHC and direct access to automated, electronic markets will likely FHC under the BHC Act since September 2008. As a BHC, increase as additional trading moves to more automated plat- we are subject to comprehensive consolidated supervision, forms. It is also possible that we will experience competitive regulation and examination by the Federal Reserve. The pressures in these and other areas in the future as some of our Federal Reserve has heightened authority to examine, competitors seek to obtain market share by reducing prices prescribe regulations and take action with respect to all of our (in the form of commissions or pricing). subsidiaries. In particular, we are, or will become, subject to (among other things): significantly revised and expanded Investment Management regulation and supervision; intensive scrutiny of our busi- nesses and plans for expansion of those businesses; limita- Our ability to compete successfully in the asset management tions on activities; a systemic risk regime that imposes industry is affected by several factors, including our reputa- heightened capital and liquidity requirements; restrictions on tion, investment objectives, quality of investment profes- activities and investments imposed by a section of the BHC sionals, performance of investment strategies or product Act added by the Dodd-Frank Act referred to as the “Volcker offerings relative to peers and appropriate benchmark indices, Rule”; and comprehensive derivatives regulation. In addition, advertising and sales promotion efforts, fee levels, the effec- the Consumer Financial Protection Bureau has primary rule- tiveness of and access to distribution channels and investment making, enforcement and examination authority over us and pipelines, and the types and quality of products offered. Our our subsidiaries with respect to federal consumer protection investment products, including alternative investment prod- laws, to the extent applicable. ucts, may compete with investments offered by other invest- ment managers with passive investment products or who may Scope of Permitted Activities. The BHC Act limits the be subject to less stringent legal and regulatory regimes than activities of BHCs and FHCs and grants the Federal Reserve us. authority to limit our ability to conduct activities. We must obtain the Federal Reserve’s approval before engaging in Supervision and Regulation certain banking and other financial activities both in the U.S. and internationally. As a major financial services firm, we are subject to exten- sive regulation by U.S. federal and state regulatory agencies The BHC Act grandfathers “activities related to the trading, and securities exchanges and by regulators and exchanges in sale or investment in commodities and underlying physical each of the major markets where we conduct our business. properties,” provided that we were engaged in “any of such Legislative and regulatory responses to the 2007-2008 finan- activities as of September 30, 1997 in the U.S.” and provided cial crisis, both in the U.S. and worldwide, have resulted in that certain other conditions that are within our reasonable major changes to the way we are regulated and conduct our control are satisfied. We currently engage in our commodities business. These laws and regulations include: the Dodd-Frank activities pursuant to the BHC Act grandfather exemption as Act; risk-based capital, leverage and liquidity standards well as other authorities under the BHC Act. adopted or being developed by the Basel Committee on Banking Supervision (“Basel Committee”), including Basel Activities Restrictions under the Volcker Rule. The Volcker III, and the national implementation of those standards; Rule prohibits “banking entities,” including us and our affili- capital planning and stress testing requirements; and new ates, from engaging in certain “proprietary trading” activities, recovery and resolution regimes in the U.S. and other juris- as defined in the Volcker Rule, subject to exemptions for dictions. Some areas of post-financial crisis regulation are underwriting, market-making-related activities, risk- still subject to final rulemaking or transition periods. mitigating hedging and certain other activities. The Volcker Rule also prohibits certain investments and relationships by We continue to monitor the changing political, tax and regu- banking entities with “covered funds,” with a number of latory environment; it is likely that there will be further exemptions and exclusions. Banking entities were required to changes in the way major financial institutions are regulated bring all of their activities and investments into conformance in both the U.S. and other markets in which we operate, with the Volcker Rule by July 21, 2015, subject to certain
December 2018 Form 10-K 2
− 240 − extensions. In June 2017, the Federal Reserve approved our “Swaps Entities”) or registered as broker-dealers or futures application for a five-year extension of the transition period commission merchants. Specific regulatory capital require- to conform investments in certain legacy covered funds that ments vary by regulated subsidiary, and in many cases these are also illiquid funds. The approval covers essentially all of standards are not yet established or are subject to ongoing our non-conforming investments in, and relationships with, rulemakings that could substantially modify requirements. legacy covered funds subject to the Volcker Rule. The Volcker Rule also requires that deductions be made from a For more information about the specific capital requirements BHC’s Tier 1 capital for permissible investments in covered applicable to us and our U.S. Bank Subsidiaries, see funds. In addition, the Volcker Rule requires banking entities “Management’s Discussion and Analysis of Financial Condi- to have comprehensive compliance programs reasonably tion and Results of Operations—Liquidity and Capital designed to ensure and monitor compliance with the Volcker Resources—Regulatory Requirements.” Rule. Capital Planning, Stress Tests and Capital The federal financial regulatory agencies responsible for the Distributions. Pursuant to the Dodd-Frank Act, the Federal Volcker Rule’s implementing regulations have proposed, but Reserve has adopted capital planning and stress test require- have not yet finalized, revisions to certain elements of those ments for large BHCs, including Morgan Stanley. For more regulations. The proposed changes focus on proprietary information about the capital planning and stress test require- trading and certain requirements imposed in connection with ments, including proposed changes to those requirements that permitted market making, underwriting and risk-mitigating would integrate them with certain ongoing regulatory capital hedging activities. The impact of this proposal on us will not requirements, see “Management’s Discussion and Analysis of be known with certainty until final rules are issued. Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Requirements” and Capital Standards. The Federal Reserve establishes capital “Management’s Discussion and Analysis of Financial Condi- requirements, including well-capitalized standards, for large tion and Results of Operations—Regulatory Developments— BHCs and evaluates our compliance with such requirements. Proposed Stress Buffer Requirements.” The OCC establishes similar capital requirements and stan- dards for Morgan Stanley Bank, N.A. (“MSBNA”) and In addition to capital planning requirements, the Federal Morgan Stanley Private Bank, National Association Reserve, the OCC and the FDIC have the authority to prohibit (“MSPBNA”) (collectively, our “U.S. Bank Subsidiaries”). or to limit the payment of dividends by the banking organiza- tions they supervise, including us and our U.S. Bank Subsidi- Regulatory Capital Framework. The regulatory capital aries, if, in the banking regulator’s opinion, payment of a requirements for us and our U.S. Bank Subsidiaries are dividend would constitute an unsafe or unsound practice in largely based on the Basel III capital standards established by light of the financial condition of the banking organization. the Basel Committee, as supplemented by certain provisions All of these policies and other requirements could affect our of the Dodd-Frank Act. We are subject to various risk-based ability to pay dividends and/or repurchase stock, or require us capital requirements with various transition provisions, to provide capital assistance to our U.S. Bank Subsidiaries measured against our Common Equity Tier 1 capital, Tier 1 under circumstances which we would not otherwise decide to capital and Total capital bases, leverage-based capital do so. requirements, including the SLR, and additional capital buffers above generally applicable minimum standards for Liquidity Standards. In addition to capital regulations, the BHCs. U.S. banking agencies and the Basel Committee have adopted, or are in the process of adopting, liquidity standards. We and The Basel Committee has published a comprehensive set of our U.S. Bank Subsidiaries are subject to the U.S. banking revisions to its Basel III Framework. The revised require- agencies’ LCR requirements, which generally follow Basel ments are expected to take effect starting January 2022, Committee standards. Similarly, if the proposed NSFR require- subject to U.S. banking agencies issuing implementation ments are adopted by the U.S. banking agencies, we and our proposals. The impact on us of any revisions to the Basel U.S. Bank Subsidiaries will become subject to NSFR require- Committee’s capital standards is uncertain and depends on ments, which generally follow Basel Committee standards. future rulemakings by the U.S. banking agencies. In addition to the LCR and NSFR, we and many of our regu- Regulated Subsidiaries. In addition, many of our regulated lated subsidiaries, including those registered as Swaps Enti- subsidiaries are, or are expected to be in the future, subject to ties with the CFTC or SEC, are, or are expected to be in the regulatory capital requirements, including regulated subsidi- future, subject to other liquidity standards, including liquidity aries registered as “swap dealers” with the CFTC or stress-testing and associated liquidity reserve requirements. “security-based swap dealers” with the SEC (collectively,
3 December 2018 Form 10-K
− 241 − For more information, see “Management’s Discussion and Resolution and Recovery Planning. Pursuant to the Dodd-Frank Analysis of Financial Condition and Results of Operations— Act, we are required to periodically submit to the Federal Liquidity and Capital Resources—Regulatory Liquidity Reserve and the FDIC a resolution plan that describes our Framework.” strategy for a rapid and orderly resolution under the U.S. Bank- ruptcy Code in the event of our material financial distress or Systemic Risk Regime. The Dodd-Frank Act, as amended by failure. Our preferred resolution strategy, which is set out in our the Economic Growth, Regulatory Relief and Consumer Protec- 2017 resolution plan, is an SPOE strategy. An SPOE strategy tion Act (“EGRRCPA”), establishes a systemic risk regime to generally contemplates the provision of additional capital and which certain large BHCs, including Morgan Stanley, are liquidity by the Parent Company to certain of its subsidiaries so subject. Under rules issued by the Federal Reserve to implement that such subsidiaries have the resources necessary to implement certain requirements of the Dodd-Frank Act’s enhanced pruden- the resolution strategy after the Parent Company has filed for tial standards, such large BHCs must conduct internal liquidity bankruptcy. stress tests, maintain unencumbered highly liquid assets to meet projected net cash outflows for 30 days over the range of Certain of our domestic and foreign subsidiaries are also liquidity stress scenarios used in internal stress tests, and comply subject to resolution and recovery planning requirements in with various liquidity risk management requirements. These the jurisdictions in which they operate. For example the FDIC large BHCs also must comply with a range of risk management requires certain insured depository institutions (“IDIs”), and corporate governance requirements. including our U.S. Bank Subsidiaries, to submit an annual resolution plan that describes the IDI’s strategy for a rapid The Federal Reserve has adopted a framework to impose and orderly resolution in the event of material financial single-counterparty credit limits (“SCCL”) for large banking distress or failure of the IDI (an “IDI plan”). organizations. U.S. G-SIBs, including us, are subject to a limit of 15% of Tier 1 capital for aggregate net credit expo- Further, we are required to submit an annual recovery plan to sures to any “major counterparty” (defined to include other the Federal Reserve that outlines the steps that management U.S. G-SIBs, foreign G-SIBs, and nonbank systemically could take over time to generate or conserve financial important financial institutions supervised by the Federal resources in times of prolonged financial stress. Reserve). In addition, we are subject to a limit of 25% of Tier 1 capital for aggregate net credit exposures to any other unaf- In December 2018, the OCC finalized revisions to its filiated counterparty. We must comply with the SCCL frame- recovery planning guidelines for national banks and certain work beginning on January 1, 2020. other institutions that increase the threshold at which the guidelines apply from $50 billion to $250 billion in total The Federal Reserve has proposed rules that would create a consolidated assets. As a result, our U.S. Bank Subsidiaries new early remediation framework to address financial are no longer required to prepare recovery plans. distress or material management weaknesses. The Federal Reserve also has the ability to establish additional prudential In addition, certain financial companies, including BHCs standards, including those regarding contingent capital, such as the Firm and certain of its covered subsidiaries, can enhanced public disclosures and limits on short-term debt, be subjected to a resolution proceeding under the orderly including off-balance sheet exposures. See “Management’s liquidation authority in Title II of the Dodd-Frank Act with Discussion and Analysis of Financial Condition and Results the FDIC being appointed as receiver, provided that certain of Operations—Liquidity and Capital Resources—Regulatory procedures are met, including certain extraordinary financial Requirements—Total Loss-Absorbing Capacity and Long- distress and systemic risk determinations by the U.S. Trea- Term Debt Requirement.” sury Secretary in consultation with the U.S. President. The orderly liquidation authority rulemaking is proceeding in Under the systemic risk regime, if the Federal Reserve or the stages, with some regulations now finalized and others not Financial Stability Oversight Council determines that a BHC yet proposed. If we were subject to the orderly liquidation with $250 billion or more in consolidated assets poses a authority, the FDIC would have considerable powers, “grave threat” to U.S. financial stability, the institution may including: the power to remove directors and officers respon- be, among other things, restricted in its ability to merge or sible for our failure and to appoint new directors and officers; offer financial products and/or required to terminate activities the power to assign our assets and liabilities to a third party or and dispose of assets. bridge financial company without the need for creditor consent or prior court review; the ability to differentiate See also “Capital Standards” and “Liquidity Standards” among our creditors, including by treating certain creditors herein and “Resolution and Recovery Planning” below. within the same class better than others, subject to a minimum recovery right on the part of disfavored creditors to receive at least what they would have received in bankruptcy
December 2018 Form 10-K 4
− 242 − liquidation; and broad powers to administer the claims Our businesses are also subject to privacy and data protection process to determine distributions from the assets of the information security legal requirements concerning the use and receivership. The FDIC has been developing an SPOE protection of certain personal information. For example, the strategy that could be used to implement the orderly liquida- General Data Protection Regulation (“GDPR”) became effective tion authority. in the E.U. on May 25, 2018 as a replacement for the E.U. Data Protection Directive. The GDPR imposes mandatory breach Regulators have also taken and proposed various actions to notification obligations, including significant fines for noncom- facilitate an SPOE strategy under the U.S. Bankruptcy Code, pliance, enhanced governance and accountability requirements the orderly liquidation authority or other resolution regimes. and has extraterritorial impact. In addition, other jurisdictions have adopted or are proposing GDPR or similar standards, such For example, the Federal Reserve has established rules that as California, Australia, Singapore, Japan, Colombia, Argentina, impose contractual requirements on certain qualified financial India, Turkey, Hong Kong, Brazil, Russia and Switzerland. contracts (“covered QFCs”) to which U.S. G-SIBs, including us, and their subsidiaries are parties. The OCC has also estab- Protection of Client Information lished rules that impose substantively identical requirements on national banks that are subsidiaries of U.S. G-SIBs, Many aspects of our businesses are subject to legal require- including our U.S. Bank Subsidiaries, as well as certain other ments concerning the use and protection of certain customer institutions (together with the entities covered by the Federal information. These include those adopted pursuant to the Reserve’s rules, the “covered entities”). Under these rules, Gramm-Leach-Bliley Act and the Fair and Accurate Credit covered QFCs must expressly provide that transfer restric- Transactions Act of 2003 in the U.S., the GDPR and various tions and default rights against covered entities are limited to laws in Asia, including the Japanese Personal Information the same extent as they would be under the Federal Deposit Protection Law, the Hong Kong Personal Data (Protection) Insurance Act and Title II of the Dodd-Frank Act and their Ordinance and the Australian Privacy Act. We have adopted implementing regulations. In addition, covered QFCs may measures designed to comply with these and related appli- not, among other things, permit the exercise of any cross- cable requirements in all relevant jurisdictions. default right against covered entities based on an affiliate’s entry into insolvency, resolution or similar proceedings, U.S. Bank Subsidiaries subject to certain creditor protections. There is a phased-in U.S. Bank Subsidiaries. MSBNA, primarily a wholesale compliance schedule based on counterparty type, and the first commercial bank, offers commercial lending and certain retail compliance date was January 1, 2019. securities-based lending services in addition to deposit prod- For more information about our resolution plan-related ucts, and also conducts certain foreign exchange activities. submissions and associated regulatory actions, see “Risk MSPBNA offers certain mortgage and other secured lending Factors—Legal, Regulatory and Compliance Risk”, products, including retail securities-based lending products, “Management’s Discussion and Analysis of Financial Condi- primarily for customers of our affiliate retail broker-dealer, tion and Results of Operations—Regulatory Requirements— Morgan Stanley Smith Barney LLC (“MSSB LLC”). Total Loss-Absorbing Capacity, Long-Term Debt and Clean MSPBNA also offers certain deposit products and prime Holding Company Requirements” and “Management’s brokerage custody services. Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Regulatory Both MSBNA and MSPBNA are FDIC-insured national Requirements—Resolution and Recovery Planning.” banks subject to supervision, regulation and examination by the OCC. They are both subject to the OCC’s risk governance Cyber and Information Security Risk Management guidelines, which establish heightened standards for a large As a general matter, the financial services industry faces national bank’s risk governance framework and the oversight increased global regulatory focus regarding cyber and infor- of that framework by the bank’s board of directors. mation security risk management practices. Many aspects of Prompt Corrective Action. The Federal Deposit Insurance our businesses are subject to cybersecurity legal and regula- Corporation Improvement Act of 1991 provides a framework tory requirements enacted by U.S. federal and state govern- for regulation of depository institutions and their affiliates, ments and other non-U.S. jurisdictions in the Americas, including parent holding companies, by their federal banking Europe, the Middle East, Africa and Asia. These laws are regulators. Among other things, it requires the relevant aimed at codifying basic cybersecurity protections and federal banking regulator to take prompt corrective action mandating data breach notification requirements.
5 December 2018 Form 10-K
− 243 − with respect to a depository institution if that institution does Columbia, Puerto Rico and the U.S. Virgin Islands, and are not meet certain capital adequacy standards. These regula- members of various self-regulatory organizations, including tions generally apply only to insured banks and thrifts such as FINRA, and various securities exchanges and clearing orga- MSBNA or MSPBNA and not to their parent holding compa- nizations. Broker-dealers are subject to laws and regulations nies. The Federal Reserve is, however, separately authorized covering all aspects of the securities business, including sales to take appropriate action at the holding company level, and trading practices, securities offerings, publication of subject to certain limitations. Under the systemic risk regime, research reports, use of customers’ funds and securities, as described above, we also would become subject to an early capital structure, risk management controls in connection remediation protocol in the event of financial distress. In with market access, recordkeeping and retention, and the addition, BHCs, such as Morgan Stanley, are required to conduct of their directors, officers, representatives and other serve as a source of strength to their U.S. bank subsidiaries associated persons. Broker-dealers are also regulated by secu- and commit resources to support these subsidiaries in the rities administrators in those states where they do business. event such subsidiaries are in financial distress. Violations of the laws and regulations governing a broker- dealer’s actions could result in censures, fines, the issuance of Transactions with Affiliates. Our U.S. Bank Subsidiaries are cease-and-desist orders, revocation of licenses or registra- subject to Sections 23A and 23B of the Federal Reserve Act, tions, the suspension or expulsion from the securities industry which impose restrictions on “covered transactions” with any of such broker-dealer or its officers or employees, or other affiliates. Covered transactions include any extension of similar consequences by both federal and state securities credit to, purchase of assets from, and certain other transac- administrators. Our broker-dealer subsidiaries are also tions by insured banks with an affiliate. These restrictions members of the Securities Investor Protection Corporation, limit the total amount of credit exposure that our U.S. Bank which provides certain protections for customers of broker- Subsidiaries may have to any one affiliate and to all affiliates. dealers against losses in the event of the insolvency of a Sections 23A and 23B also set collateral requirements and broker-dealer. require all such transactions to be made on market terms. Derivatives, securities borrowing and securities lending trans- MSSB LLC is also a registered investment adviser with the actions between our U.S. Bank Subsidiaries and their affili- SEC. MSSB LLC’s relationship with its investment advisory ates are subject to these restrictions. The Federal Reserve has clients is subject to the fiduciary and other obligations indicated that it will propose a rulemaking to implement imposed on investment advisers under the Investment changes to these restrictions made by the Dodd-Frank Act. Advisers Act of 1940, and the rules and regulations promul- gated thereunder as well as various state securities laws. In addition, the Volcker Rule generally prohibits covered These laws and regulations generally grant the SEC and other transactions between (i) us or any of our affiliates and supervisory bodies broad administrative powers to address (ii) covered funds for which we or any of our affiliates serve non-compliance, including the power to restrict or limit as the investment manager, investment adviser, commodity MSSB LLC from carrying on its investment advisory and trading advisor or sponsor, or other covered funds organized other asset management activities. Other sanctions that may and offered by us or any of our affiliates pursuant to specific be imposed include the suspension of individual employees, exemptions in the Volcker Rule. See also “Financial Holding limitations on engaging in certain activities for specified Company—Activities Restriction under the Volcker Rule” periods of time or for specified types of clients, the revoca- above. tion of registrations, other censures and significant fines. FDIC Regulation. An FDIC-insured depository institution The Firm is subject to various regulations that affect broker- is generally liable for any loss incurred or expected to be dealer sales practices and customer relationships. For incurred by the FDIC in connection with the failure of an example, under the Dodd-Frank Act, the SEC is authorized to insured depository institution under common control by the impose a fiduciary duty rule applicable to broker-dealers same BHC. As commonly controlled FDIC-insured deposi- when providing personalized investment advice about securi- tory institutions, each of MSBNA and MSPBNA could be ties to retail customers. The SEC released for public comment responsible for any loss to the FDIC from the failure of the a package of proposed rulemaking on the standards of other. In addition, both institutions are exposed to changes in conduct and required disclosures for broker-dealers and the cost of FDIC insurance. investment advisers. One of the proposals, entitled “Regula- Institutional Securities and Wealth Management tion Best Interest,” would require broker-dealers to act in the “best interest” of retail customers at the time a recommenda- Broker-Dealer and Investment Adviser Regulation. Our tion is made without placing the financial or other interests of primary U.S. broker-dealer subsidiaries, Morgan Stanley & the broker-dealer ahead of the interest of the retail customer. Co. LLC (“MS&Co.”) and MSSB LLC, are registered broker- Additionally, the SEC proposed a new requirement for both dealers with the SEC and in all 50 states, the District of broker-dealers and investment advisers to provide a brief
December 2018 Form 10-K 6
− 244 − relationship summary to retail investors with information Our commodities activities are subject to extensive and intended to clarify the relationship between the parties. The evolving energy, commodities, environmental, health and SEC issued a proposed interpretation regarding the fiduciary safety, and other governmental laws and regulations in the duty that investment advisers owe their clients. None of these U.S. and abroad. Intensified scrutiny of certain energy proposals have yet been finalized. markets by U.S. federal, state and local authorities in the U.S. and abroad and by the public has resulted in increased regula- Margin lending by broker-dealers is regulated by the Federal tory and legal enforcement and remedial proceedings Reserve’s restrictions on lending in connection with customer involving companies conducting the activities in which we and proprietary purchases and short sales of securities, as are engaged. well as securities borrowing and lending activities. Broker- dealers are also subject to maintenance and other margin Derivatives Regulation. Under the U.S. regulatory regime requirements imposed under FINRA and other self-regulatory for “swaps” and “security-based swaps” (collectively, organization rules. In many cases, our broker-dealer subsidi- “Swaps”) implemented pursuant to the Dodd-Frank Act, we aries’ margin policies are more stringent than these rules. are subject to regulations including, among others, public and regulatory reporting, central clearing and mandatory trading As registered U.S. broker-dealers, certain of our subsidiaries on regulated exchanges or execution facilities for certain are subject to the SEC’s net capital rule and the net capital types of Swaps. The CFTC has completed the majority of its requirements of various exchanges, other regulatory author- regulations in this area, most of which are in effect. The SEC ities and self-regulatory organizations. These rules are gener- has also finalized many of its Swaps regulations, although a ally designed to measure the broker-dealer subsidiary’s significant number are not yet in effect. The Dodd-Frank Act general financial integrity and/or liquidity and require that at also requires the registration of “swap dealers” with the least a minimum amount of net and/or liquid assets be main- CFTC and “security-based swap dealers” with the SEC. tained by the subsidiary. See also “Financial Holding Certain of our subsidiaries have registered with the CFTC as Company—Consolidated Supervision” and “Financial swap dealers and will in the future be required to register with Holding Company—Liquidity Standards” above. Rules of the SEC as security-based swap dealers. Such Swaps Entities FINRA and other self-regulatory organizations also impose are or will be subject to a comprehensive regulatory regime limitations and requirements on the transfer of member with new obligations for the Swaps activities for which they organizations’ assets. are registered, including capital requirements, margin require- ments for uncleared Swaps and comprehensive business Research. Research-related regulations have been imple- conduct rules. Each of the CFTC and SEC have proposed mented in many jurisdictions, including in the U.S., where rules to impose capital standards on Swaps Entities subject to FINRA has adopted rules that cover research relating to both its respective jurisdiction, which include our subsidiaries, but equity and debt securities. In addition, European regulators these rules have not yet been finalized. have introduced new requirements in the Markets in Financial Instruments Directive II (“MiFID II”) relating to the The specific parameters of some of these requirements for unbundling of research services and execution services. Both Swaps have been and continue to be developed through the U.S. and non-U.S. regulators continue to focus on research CFTC, SEC and bank regulator rulemakings. In 2015, the conflicts of interest and may impose additional regulations. federal banking regulators and the CFTC separately issued final rules establishing uncleared swap margin requirements Regulation of Futures Activities and Certain Commodities for Swaps Entities subject to their respective regulation, Activities. MS&Co., as a futures commission merchant, and including MSBNA, Morgan Stanley Capital Services LLC MSSB LLC, as an introducing broker, are subject to net and Morgan Stanley & Co. International plc (“MSIP”), capital requirements of, and certain of their activities are respectively. The variation margin requirements under these regulated by, the CFTC, the NFA, CME Group, and various rules were effective as of March 1, 2017. The rules phase-in commodity futures exchanges. MS&Co. and MSSB LLC and initial margin requirements from September 1, 2016 through certain of their affiliates are registered members of the NFA September 1, 2020, depending on the level of OTC deriva- in various capacities. Rules and regulations of the CFTC, tives activity of the swap dealer and the relevant counter- NFA and commodity futures exchanges address obligations party. Margin rules with the same or similar compliance dates related to, among other things, customer protections, the have been adopted or are in the process of being finalized by segregation of customer funds and the holding of secured regulators outside the U.S., and certain of our subsidiaries amounts, the use by futures commission merchants of may be subject to such rules. customer funds, recordkeeping and reporting obligations of futures commission merchants and introducing brokers, risk Although important areas within the global derivatives regula- disclosure, risk management and discretionary trading. tory framework have been finalized in recent years, additional
7 December 2018 Form 10-K
− 245 − changes are expected. For example, in November 2018, the commodity exchanges could result in remedial actions, CFTC proposed revisions to the rules governing swap execu- including fines, registration restrictions or terminations, tion facilities. As the derivatives regulatory framework trading prohibitions or revocations of commodity exchange evolves, we expect to continue to face increased costs and memberships. See also “Institutional Securities and Wealth regulatory oversight. Complying with registration and other Management—Broker-Dealer and Investment Adviser regulatory requirements has required, and is expected to Regulation,” “Institutional Securities and Wealth Manage- require in the future, systems and other changes. Compliance ment—Regulation of Futures Activities and Certain with Swaps-related regulatory capital requirements may also Commodities Activities,” and “Institutional Securities and require us to devote more capital to our Swaps business. Wealth Management—Derivatives Regulation” above and “Non-U.S. Regulation,” below for a discussion of other regu- Our Institutional Securities and Wealth Management business lations that impact our Investment Management business segment activities are also regulated in jurisdictions outside activities, including MiFID II. the U.S. See “Non-U.S. Regulation” herein. Our Investment Management business activities are also Investment Management regulated outside the U.S. For example, the U.K. Financial Conduct Authority (“FCA”) is the primary regulator of our Many of the subsidiaries engaged in our asset management business in the U.K.; the Financial Services Agency regulates activities are registered as investment advisers with the SEC. our business in Japan; the Securities and Futures Commission Many aspects of our asset management activities are also of Hong Kong regulates our business in Hong Kong; and the subject to federal and state laws and regulations primarily Monetary Authority of Singapore regulates our business in intended to benefit the investor or client. These laws and Singapore. See also “Non-U.S. Regulation” herein. regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or Non-U.S. Regulation restrict us from carrying on our asset management activities in the event that we fail to comply with such laws and regula- All of our businesses are regulated extensively by non-U.S. tions. Sanctions that may be imposed for such failure include regulators, including governments, securities exchanges, the suspension of individual employees, limitations on our commodity exchanges, self-regulatory organizations, central engaging in various asset management activities for specified banks and regulatory bodies, especially in those jurisdictions periods of time or specified types of clients, the revocation of in which we maintain an office. Certain regulators have registrations, other censures and significant fines. In order to prudential, conduct and other authority over us or our subsidi- facilitate our asset management business, a U.S. broker- aries, as well as powers to limit or restrict us from engaging dealer subsidiary of ours, Morgan Stanley Distribution, Inc., in certain businesses or to conduct administrative proceedings acts as distributor to the Morgan Stanley mutual funds and as that can result in censures, fines, the issuance of placement agent to certain private investment funds managed cease-and-desist orders, or the suspension or expulsion of a by our Investment Management business segment. regulated entity or its affiliates.
Our asset management activities are subject to certain addi- Some of our subsidiaries are regulated as broker-dealers and tional laws and regulations, including, but not limited to, addi- other regulated entity types under the laws of the jurisdictions tional reporting and recordkeeping requirements (including in which they operate. Subsidiaries engaged in banking and with respect to clients that are private funds) and restrictions on trust activities outside the U.S. are regulated by various sponsoring or investing in, or maintaining certain other rela- government agencies in the particular jurisdiction where they tionships with, “covered funds,” as defined in the Volcker are chartered, incorporated and/or conduct their business Rule, subject to certain limited exemptions. Many of these activity. For instance, the PRA, the FCA and several securi- requirements have increased the expenses associated with our ties and futures exchanges in the U.K., including the London asset management activities and/or reduced the investment Stock Exchange and ICE Futures Europe, regulate our activ- returns we are able to generate for us and our asset manage- ities in the U.K.; the Bundesanstalt für Finanzdienstleistung- ment clients. See also “Financial Holding Company— saufsicht (the Federal Financial Supervisory Authority) and Activities Restrictions under the Volcker Rule.” the Deutsche Börse AG regulate our activities in the Federal Republic of Germany; the Financial Services Agency, the In addition, certain of our affiliates are registered as Bank of Japan, the Japan Securities Dealers Association and commodity trading advisors and/or commodity pool opera- several Japanese securities and futures exchanges and minis- tors, or are operating under certain exemptions from such tries regulate our activities in Japan; the Securities and registration pursuant to CFTC rules and other guidance, and Futures Commission of Hong Kong, the Hong Kong Mone- have certain responsibilities with respect to each pool they tary Authority and the Hong Kong Exchanges and Clearing advise. Violations of the rules of the CFTC, the NFA or the Limited regulate our operations in Hong Kong; and the
December 2018 Form 10-K 8
− 246 − Monetary Authority of Singapore and the Singapore writing down certain unsecured liabilities or converting Exchange Limited regulate our business in Singapore. certain unsecured liabilities into equity.
Our largest non-U.S. entity, MSIP, is subject to extensive Regulators in the U.K., E.U. and other major jurisdictions have regulation and supervision by the PRA, which has broad legal also finalized other regulatory standards applicable to certain of authority to establish prudential and other standards appli- our subsidiaries that operate in those jurisdictions. For instance, cable to MSIP that seek to ensure its safety and soundness the European Market Infrastructure Regulation introduced new and to minimize adverse effects on the stability of the U.K. requirements regarding the central clearing and reporting of financial system. MSIP is also regulated and supervised by derivatives, as well as margin requirements for uncleared deriv- the FCA with respect to business conduct matters. atives. MiFID II, which took effect on January 3, 2018, intro- duced comprehensive and new trading and market infrastruc- Non-U.S. policymakers and regulators, including the ture reforms in the E.U., including new trading venues, European Commission and European Supervisory Authorities enhancements to pre- and post-trading transparency, and addi- (among others, the European Banking Authority and the tional investor protection requirements, among others. We have European Securities and Markets Authority), continue to had to make extensive changes to our operations, including propose and adopt numerous reforms, including those that systems and controls in order to comply with MiFID II. may further impact the structure of banks or subject us to new prudential requirements, and to formulate regulatory stan- Financial Crimes Program dards and measures that will be of relevance and importance to our European operations. Our Financial Crimes program is coordinated on an enterprise- wide basis and supports our financial crime prevention efforts In November 2016, the European Commission published a across all regions and business units with responsibility for package of proposals including various risk reduction governance, oversight and execution of our AML, economic measures. These include proposed amendments to the Capital sanctions (“Sanctions”) and anti-corruption programs. Requirements Directive and Regulation providing updates to risk-based capital, liquidity, leverage and other prudential stan- In the U.S., the Bank Secrecy Act, as amended by the USA dards on a consolidated basis, consistent with final Basel stan- PATRIOT Act of 2001, imposes significant obligations on dards. In addition, the proposals would require certain large, financial institutions to detect and deter money laundering non-E.U. financial groups with two or more institutions estab- and terrorist financing activity, including requiring banks, lished in the E.U. to establish an E.U. IHC. The proposals BHCs and their subsidiaries, broker-dealers, futures commis- would require E.U. banks and broker-dealers to be held below sion merchants, introducing brokers and mutual funds to the E.U. IHC; until more specific regulations are proposed, it implement AML programs, verify the identity of customers remains unclear which other E.U. entities would need to be that maintain accounts, and monitor and report suspicious held beneath the E.U. IHC. The E.U. IHC would be subject to activity to appropriate law enforcement or regulatory author- direct supervision and authorization by the European Central ities. Outside the U.S., applicable laws, rules and regulations Bank or the relevant national E.U. regulator. Further amend- similarly require designated types of financial institutions to ments were also proposed to the E.U. bank recovery and reso- implement AML programs. lution regime under the E.U. Bank Recovery and Resolution Directive (“BRRD”). It is expected that the proposals will be We have implemented policies, procedures and internal adopted in early 2019, however their final form, as well as the controls that are designed to comply with all applicable AML date of their adoption, is not yet certain. laws and regulations. Regarding Sanctions, we have imple- mented policies, procedures and internal controls that are The amendments to the BRRD build on previous proposals designed to comply with the regulations and economic sanc- by regulators in the U.K., E.U. and other major jurisdictions tions programs administered by the U.S. Treasury’s Office of to finalize recovery and resolution planning frameworks and Foreign Assets Control (“OFAC”), which target foreign related regulatory requirements that will apply to certain of countries, entities and individuals based on external threats to our subsidiaries that operate in those jurisdictions. For U.S. foreign policy, national security or economic interests, instance, the BRRD established a recovery and resolution and to comply, as applicable, with similar sanctions programs framework for E.U. credit institutions and investment firms, imposed by foreign governments or global or regional multi- including MSIP. In addition, certain jurisdictions, including lateral organizations such as the United Nations Security the U.K. and other E.U. jurisdictions, have implemented, or Council and the E.U. Council. are in the process of implementing, changes to resolution regimes to provide resolution authorities with the ability to We are also subject to applicable anti-corruption laws, such as recapitalize a failing entity organized in such jurisdictions by the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, in the jurisdictions in which we operate. Anti-corruption
9 December 2018 Form 10-K
− 247 − laws generally prohibit offering, promising, giving or autho- Keishi Hotsuki (56). Executive Vice President (since May rizing others to give anything of value, either directly or indi- 2014) and Chief Risk Officer of Morgan Stanley (since May rectly, to a government official or private party in order to 2011). Interim Chief Risk Officer (January 2011 to May 2011) influence official action or otherwise gain an unfair business and Head of Market Risk Department (March 2008 to April advantage, such as to obtain or retain business. We have imple- 2014). Director of Mitsubishi UFJ Morgan Stanley Securities mented policies, procedures and internal controls that are Co., Ltd. (since May 2010). Global Head of Market Risk designed to comply with such laws, rules and regulations. Management at Merrill Lynch (June 2005 to September 2007).
Executive Officers of Morgan Stanley Colm Kelleher (61). President of Morgan Stanley (since January 2016). Executive Vice President (October 2007 to The executive officers of Morgan Stanley and their age and January 2016). President of Institutional Securities (January titles as of February 26, 2019 are set forth below. Business 2013 to January 2016). Head of International (January 2011 experience is provided in accordance with SEC rules. to January 2016). Co-President of Institutional Securities (January 2010 to December 2012). Chief Financial Officer Jeffrey S. Brodsky (54). Executive Vice President and and Co-Head of Strategic Planning (October 2007 to Chief Human Resources Officer of Morgan Stanley (since December 2009). Head of Global Capital Markets (February January 2016). Vice President and Global Head of Human 2006 to October 2007). Co-Head of Fixed Income Europe Resources (January 2011 to December 2015). Co-Head of (May 2004 to February 2006). Director of Norfolk Southern Human Resources (January 2010 to December 2011). Head Corporation (since January 2019). of Morgan Stanley Smith Barney Human Resources (June 2009 to January 2010). Jonathan M. Pruzan (50). Executive Vice President and Chief Financial Officer of Morgan Stanley (since May 2015) James P. Gorman (60). Chairman of the Board of Direc- and Head of Corporate Strategy (since December 2016). tors and Chief Executive Officer of Morgan Stanley (since Co-Head of Global Financial Institutions Group (January January 2012). President and Chief Executive Officer 2010 to April 2015). Co-Head of North American Financial (January 2010 to December 2011) and member of the Board Institutions Group M&A (September 2007 to December of Directors (since January 2010). Co-President (December 2009). Head of the U.S. Bank Group (April 2005 to August 2007 to December 2009) and Co-Head of Strategic Planning 2007). (October 2007 to December 2009). President and Chief Oper- ating Officer of Wealth Management (February 2006 to April Daniel A. Simkowitz (53). Head of Investment Manage- 2008). ment of Morgan Stanley (since October 2015). Co-Head of Global Capital Markets (March 2013 to September 2015). Eric F. Grossman (52). Executive Vice President and Chairman of Global Capital Markets (November 2009 to Chief Legal Officer of Morgan Stanley (since January 2012). March 2013). Managing Director in Global Capital Markets Global Head of Legal (September 2010 to January 2012). (December 2000 to November 2009). Global Head of Litigation (January 2006 to September 2010) and General Counsel of the Americas (May 2009 to September 2010). General Counsel of Wealth Management (November 2008 to September 2010). Partner at the law firm of Davis Polk & Wardwell LLP (June 2001 to December 2005).
December 2018 Form 10-K 10
− 248 − Risk Factors income or other investment alternatives, which could nega- tively impact our Investment Management business segment. For a discussion of the risks and uncertainties that may affect our future results and strategic objectives, see “Forward- The value of our financial instruments may be materially Looking Statements” immediately preceding “Business” and affected by market fluctuations. Market volatility, illiquid “Return on Equity and Tangible Common Equity Targets” market conditions and disruptions in the credit markets may under “Management’s Discussion and Analysis of Financial make it extremely difficult to value and monetize certain of Condition and Results of Operations.” our financial instruments, particularly during periods of market displacement. Subsequent valuations in future Market Risk periods, in light of factors then prevailing, may result in significant changes in the values of these instruments and Market risk refers to the risk that a change in the level of one may adversely impact historical or prospective fees and or more market prices, rates, indices, volatilities, correlations performance-based fees (also known as incentive fees, which or other market factors, such as market liquidity, will result in include carried interest) in respect of certain businesses. In losses for a position or portfolio owned by us. For more infor- addition, at the time of any sales and settlements of these mation on how we monitor and manage market risk, see financial instruments, the price we ultimately realize will “Quantitative and Qualitative Disclosures about Risk—Risk depend on the demand and liquidity in the market at that time Management—Market Risk.” and may be materially lower than their current fair value. Any of these factors could cause a decline in the value of our Our results of operations may be materially affected by financial instruments, which may have an adverse effect on market fluctuations and by global and economic conditions our results of operations in future periods. and other factors, including changes in asset values. In addition, financial markets are susceptible to severe events Our results of operations have been in the past and may, in evidenced by rapid depreciation in asset values accompanied the future, be materially affected by market fluctuations due by a reduction in asset liquidity. Under these extreme condi- to global financial markets, economic conditions, changes to tions, hedging and other risk management strategies may not the global trade policies and tariffs and other factors, be as effective at mitigating trading losses as they would be including the level and volatility of equity, fixed income and under more normal market conditions. Moreover, under these commodity prices, the level and term structure of interest conditions, market participants are particularly exposed to rates, inflation and currency values, and the level of other trading strategies employed by many market participants market indices. simultaneously and on a large scale. Our risk management The results of our Institutional Securities business segment, and monitoring processes seek to quantify and mitigate risk particularly results relating to our involvement in primary and to more extreme market moves. However, severe market secondary markets for all types of financial products, are events have historically been difficult to predict and we could subject to substantial market fluctuations due to a variety of realize significant losses if extreme market events were to factors that we cannot control or predict with great certainty. occur. These fluctuations impact results by causing variations in Holding large and concentrated positions may expose us to business flows and activity and in the fair value of securities losses. and other financial products. Fluctuations also occur due to the level of global market activity, which, among other Concentration of risk may reduce revenues or result in losses things, affects the size, number and timing of investment in our market-making, investing, block trading, underwriting banking client assignments and transactions and the realiza- and lending businesses in the event of unfavorable market tion of returns from our principal investments. movements, or when market conditions are more favorable for our competitors. We commit substantial amounts of During periods of unfavorable market or economic condi- capital to these businesses, which often results in our taking tions, the level of individual investor participation in the large positions in the securities of, or making large loans to, a global markets, as well as the level of client assets, may also particular issuer or issuers in a particular industry, country or decrease, which would negatively impact the results of our region. For further information regarding our country risk Wealth Management business segment. exposure, see also “Quantitative and Qualitative Disclosures In addition, fluctuations in global market activity could impact about Risk—Risk Management—Credit Risk—Country Risk the flow of investment capital into or from AUM and the way Exposure.” customers allocate capital among money market, equity, fixed
11 December 2018 Form 10-K
− 249 − Credit Risk This is sometimes referred to as “systemic risk” and may adversely affect financial intermediaries, such as clearing Credit risk refers to the risk of loss arising when a borrower, houses, clearing agencies, exchanges, banks and securities counterparty or issuer does not meet its financial obligations firms, with which we interact on a daily basis and, therefore, to us. For more information on how we monitor and manage could adversely affect us. See also “Systemic Risk Regime” credit risk, see “Quantitative and Qualitative Disclosures under “Business—Supervision and Regulation—Financial about Risk—Risk Management—Credit Risk.” Holding Company.”
We are exposed to the risk that third parties that are Operational Risk indebted to us will not perform their obligations. Operational risk refers to the risk of loss, or of damage to our We incur significant credit risk exposure through our Institu- reputation, resulting from inadequate or failed processes or tional Securities business segment. This risk may arise from a systems, from human factors or from external events (e.g., variety of business activities, including, but not limited to: fraud, theft, legal and compliance risks, cyber attacks or extending credit to clients through various lending commit- damage to physical assets). We may incur operational risk ments; entering into swap or other derivative contracts under across the full scope of our business activities, including which counterparties have obligations to make payments to revenue-generating activities (e.g., sales and trading) and us; providing short- or long-term funding that is secured by support and control groups (e.g., information technology and physical or financial collateral whose value may at times be trade processing). Legal, regulatory and compliance risk is insufficient to fully cover the loan repayment amount; posting margin and/or collateral and other commitments to clearing included in the scope of operational risk and is discussed houses, clearing agencies, exchanges, banks, securities firms below under “Legal, Regulatory and Compliance Risk.” For and other financial counterparties; and investing and trading more information on how we monitor and manage opera- in securities and loan pools, whereby the value of these assets tional risk, see “Quantitative and Qualitative Disclosures may fluctuate based on realized or expected defaults on the about Risk—Risk Management—Operational Risk.” underlying obligations or loans. We are subject to operational risks, including a failure, We also incur credit risk in our Wealth Management business breach or other disruption of our operations or security segment lending to mainly individual investors, including, systems or those of our third parties (or third parties but not limited to, margin- and securities-based loans collat- thereof), which could adversely affect our businesses or eralized by securities, residential mortgage loans and reputation. HELOCs. Our businesses are highly dependent on our ability to process While we believe current valuations and reserves adequately and report, on a daily basis, a large number of transactions address our perceived levels of risk, adverse economic condi- across numerous and diverse markets in many currencies. We tions may negatively impact our clients and our credit expo- may introduce new products or services or change processes sures. In addition, as a clearing member of several central or reporting, including in connection with new regulatory counterparties, we finance our customer positions and could requirements, resulting in new operational risk that we may be held responsible for the defaults or misconduct of our not fully appreciate or identify. customers. Although we regularly review our credit expo- sures, default risk may arise from events or circumstances The trend toward direct access to automated, electronic markets and the move to more automated trading platforms that are difficult to detect or foresee. has resulted in the use of increasingly complex technology A default by a large financial institution could adversely that relies on the continued effectiveness of the programming affect financial markets. code and integrity of the data to process the trades. We rely on the ability of our employees, consultants, our internal The commercial soundness of many financial institutions systems and systems at technology centers maintained by may be closely interrelated as a result of credit, trading, unaffiliated third parties to operate our different businesses clearing or other relationships among the institutions. and process a high volume of transactions. Additionally, we are subject to complex and evolving laws and regulations Increased centralization of trading activities through partic- governing cybersecurity, privacy and data protection, which ular clearing houses, central agents or exchanges as required may differ and potentially conflict, in various jurisdictions. by provisions of the Dodd-Frank Act may increase our concentration of risk with respect to these entities. As a As a major participant in the global capital markets, we face result, concerns about, or a default or threatened default by, the risk of incorrect valuation or risk management of our one institution could lead to significant market-wide liquidity trading positions due to flaws in data, models, electronic and credit problems, losses or defaults by other institutions. trading systems or processes or due to fraud or cyber attack.
December 2018 Form 10-K 12
− 250 − We also face the risk of operational failure or termination of may be in conflict with one another, or courts and regulators any of the clearing agents, exchanges, clearing houses or may interpret them in ways that we had not anticipated or that other financial intermediaries we use to facilitate our lending, adversely affect our business. securities and derivatives transactions. In the event of a breakdown or improper operation of our or a direct or indirect Cybersecurity risks for financial institutions have signifi- third party’s systems (or third parties thereof) or processes or cantly increased in recent years in part because of the prolif- improper or unauthorized action by third parties, including eration of new technologies, the use of the internet and consultants and subcontractors or our employees, we could mobile telecommunications technologies to conduct financial suffer financial loss, an impairment to our liquidity position, transactions, and the increased sophistication and activities of a disruption of our businesses, regulatory sanctions or organized crime, hackers, terrorists and other external damage to our reputation. In addition, the interconnectivity of extremist parties, including foreign state actors, in some multiple financial institutions with central agents, exchanges circumstances as a means to promote political ends. In addi- and clearing houses, and the increased importance of these tion to the growing sophistication of certain parties, the entities, increases the risk that an operational failure at one commoditization of cyber tools which are able to be weapon- institution or entity may cause an industry-wide operational ized by less sophisticated actors has led to an increase in the failure that could materially impact our ability to conduct exploitation of technological vulnerabilities. Any of these business. Furthermore, the concentration of company and parties may also attempt to fraudulently induce employees, personal information held by a handful of third parties customers, clients, vendors or other third parties or users of increases the risk that a breach at a key third party may cause our systems to disclose sensitive information in order to gain an industry-wide data breach that could significantly increase access to our data or that of our employees or clients. Cyber- the cost and risk of conducting business. security risks may also derive from human error, fraud or malice on the part of our employees or third parties, including Despite the business contingency and security response third party providers, or may result from accidental techno- plans we have in place, there can be no assurance that such logical failure. In addition, third parties with whom we do plans fully mitigate all potential risks to us. Our ability to business, their service providers, as well as other third parties conduct business may be adversely affected by a disruption with whom our customers do business, may also be sources in the infrastructure that supports our business and the of cybersecurity risks, particularly where activities of communities where we are located, which are concentrated customers are beyond our security and control systems. There in the New York metropolitan area, London, Hong Kong is no guarantee that the measures we take will provide abso- and Tokyo, as well as Mumbai, Budapest, Glasgow and lute security or recoverability given the techniques used in Baltimore. This may include a disruption involving physical cyber attacks are complex and frequently change, and may site access, cybersecurity incidents, terrorist activities, not be able to be anticipated. disease pandemics, catastrophic events, natural disasters, extreme weather events, electrical outage, environmental Like other financial services firms, the Firm and its third hazard, computer servers, communications or other services party providers continue to be the subject of unauthorized we use, our employees or third parties with whom we access attacks, mishandling or misuse of information, conduct business. computer viruses or malware, cyber attacks designed to obtain confidential information, destroy data, disrupt or Although we employ backup systems for our data, those degrade service, sabotage systems or cause other damage, backup systems may be unavailable following a disruption, denial of service attacks, data breaches and other events. the affected data may not have been backed up or may not be There can be no assurance that such unauthorized access, recoverable from the backup, or the backup data may be mishandling or misuse of information, or cyber incidents will costly to recover, which could adversely affect our business. not occur in the future, and they could occur more frequently A cyber attack, information or security breach or a and on a more significant scale. technology failure could adversely affect our ability to conduct our business, manage our exposure to risk or result A cyber attack, information or security breach or a technology in disclosure or misuse of confidential or proprietary failure of ours or of a third party could jeopardize our or our information and otherwise adversely impact our results of clients’, employees’, partners’, vendors’ or counterparties’ operations, liquidity and financial condition, as well as personal, confidential, proprietary or other information cause reputational harm. processed and stored in, and transmitted through, our and our third parties’ computer systems. Furthermore, such events could We maintain a significant amount of personal information on cause interruptions or malfunctions in our, our clients’, employ- our customers, clients, employees and certain counterparties ees’, partners’, vendors’, counterparties’ or third parties’ opera- that we are required to protect under various state, federal and tions, as well as the unauthorized release, gathering, monitoring, international data protection and privacy laws. These laws misuse, loss or destruction of confidential, proprietary and other
13 December 2018 Form 10-K
− 251 − information of ours, our employees, our customers or of other Capital Resources” and “Quantitative and Qualitative Disclo- third parties. Any of these events could result in reputational sures about Risk—Risk Management—Liquidity Risk.” damage with our clients and the market, client dissatisfaction, additional costs to us to maintain and update our operational and Liquidity is essential to our businesses and we rely on security systems and infrastructure, regulatory investigations, external sources to finance a significant portion of our litigation or enforcement, or regulatory fines or penalties, any of operations. which could adversely affect our business, financial condition or results of operations. Liquidity is essential to our businesses. Our liquidity could be negatively affected by our inability to raise funding in the Given our global footprint and the high volume of transac- long-term or short-term debt capital markets or our inability tions we process, the large number of clients, partners, to access the secured lending markets. Factors that we cannot vendors and counterparties with which we do business, and control, such as disruption of the financial markets or nega- the increasing sophistication of cyber attacks, a cyber attack, tive views about the financial services industry generally, information or security breach could occur and persist for an including concerns regarding fiscal matters in the U.S. and extended period of time without detection. We expect that other geographic areas, could impair our ability to raise any investigation of a cyber attack would be inherently funding. unpredictable and that it would take time before the comple- tion of any investigation and before there is availability of In addition, our ability to raise funding could be impaired if full and reliable information. During such time we would not investors or lenders develop a negative perception of our necessarily know the extent of the harm or how best to reme- long-term or short-term financial prospects due to factors diate it, and certain errors or actions could be repeated or such as an incurrence of large trading losses, a downgrade by compounded before they are discovered and remediated, all the rating agencies, a decline in the level of our business or any of which would further increase the costs and conse- activity, if regulatory authorities take significant action quences of a cyber attack. against us or our industry, or we discover significant employee misconduct or illegal activity. While many of our agreements with partners and third party vendors include indemnification provisions, we may not be If we are unable to raise funding using the methods described able to recover sufficiently, or at all, under such provisions to above, we would likely need to finance or liquidate unencum- adequately offset any losses we may incur. In addition, bered assets, such as our investment portfolios or trading although we maintain insurance coverage that may, subject to assets, to meet maturing liabilities. We may be unable to sell policy terms and conditions, cover certain aspects of cyber some of our assets or we may have to sell assets at a discount and information security risks, such insurance coverage may to market value, either of which could adversely affect our be insufficient to cover all losses. results of operations, cash flows and financial condition.
The cost of managing cyber and information security risks Our borrowing costs and access to the debt capital markets and attacks along with complying with new and increasingly depend on our credit ratings. expansive regulatory requirements could adversely affect our results of operations and business. The cost and availability of unsecured financing generally are impacted by our long-term and short-term credit ratings. The Liquidity Risk rating agencies continue to monitor certain issuer specific factors that are important to the determination of our credit Liquidity risk refers to the risk that we will be unable to ratings, including governance, the level and quality of earn- finance our operations due to a loss of access to the capital ings, capital adequacy, liquidity and funding, risk appetite markets or difficulty in liquidating our assets. Liquidity risk and management, asset quality, strategic direction, and busi- also encompasses our ability (or perceived ability) to meet ness mix. Additionally, the rating agencies will look at other our financial obligations without experiencing significant industry-wide factors such as regulatory or legislative business disruption or reputational damage that may threaten changes, macro-economic environment, and perceived levels our viability as a going concern. Liquidity risk also encom- of third party support, and it is possible that they could down- passes the associated funding risks triggered by the market or grade our ratings and those of similar institutions. idiosyncratic stress events that may negatively affect our liquidity and may impact our ability to raise new funding. For Our credit ratings also can have a significant impact on more information on how we monitor and manage liquidity certain trading revenues, particularly in those businesses risk, see “Management’s Discussion and Analysis of Finan- where longer term counterparty performance is a key consid- cial Condition and Results of Operations—Liquidity and eration, such as OTC and other derivative transactions,
December 2018 Form 10-K 14
− 252 − including credit derivatives and interest rate swaps. In secured lending markets, has in the past been, and could in connection with certain OTC trading agreements and certain the future be, adversely affected by conditions in the U.S. and other agreements associated with our Institutional Securities international markets and economies. business segment, we may be required to provide additional collateral to, or immediately settle any outstanding liability In particular, our cost and availability of funding in the past balance with, certain counterparties in the event of a credit have been, and may in the future be, adversely affected by ratings downgrade. illiquid credit markets and wider credit spreads. Significant turbulence in the U.S., the E.U. and other international Termination of our trading and other agreements could cause markets and economies could adversely affect our liquidity us to sustain losses and impair our liquidity by requiring us to and financial condition and the willingness of certain counter- find other sources of financing or to make significant cash parties and customers to do business with us. payments or securities movements. The additional collateral or termination payments which may occur in the event of a Legal, Regulatory and Compliance Risk future credit rating downgrade vary by contract and can be based on ratings by either or both of Moody’s Investors Legal, regulatory and compliance risk includes the risk of Service, Inc. and S&P Global Ratings. See also “Manage- legal or regulatory sanctions, material financial loss including fines, penalties, judgments, damages and/or settlements, or ment’s Discussion and Analysis of Financial Condition and loss to reputation we may suffer as a result of our failure to Results of Operations—Liquidity and Capital Resources— comply with laws, regulations, rules, related self-regulatory Credit Ratings—Incremental Collateral or Terminating organization standards and codes of conduct applicable to our Payments upon Potential Future Rating Downgrade.” business activities. This risk also includes contractual and commercial risk, such as the risk that a counterparty’s perfor- We are a holding company and depend on payments from mance obligations will be unenforceable. It also includes our subsidiaries. compliance with AML, anti-corruption and terrorist financing The Parent Company has no operations and depends on divi- rules and regulations. For more information on how we dends, distributions and other payments from its subsidiaries monitor and manage legal, regulatory and compliance risk, to fund dividend payments and to fund all payments on its see “Quantitative and Qualitative Disclosures about Risk— obligations, including debt obligations. Regulatory, tax Risk Management—Legal and Compliance Risk.” restrictions or elections and other legal restrictions may limit The financial services industry is subject to extensive our ability to transfer funds freely, either to or from our regulation, and changes in regulation will impact our business. subsidiaries. In particular, many of our subsidiaries, including our bank and broker-dealer subsidiaries, are subject to laws, Like other major financial services firms, we are subject to regulations and self-regulatory organization rules that limit, extensive regulation by U.S. federal and state regulatory as well as authorize regulatory bodies to block or reduce, the agencies and securities exchanges and by regulators and flow of funds to the Parent Company, or that prohibit such transfers or dividends altogether in certain circumstances, exchanges in each of the major markets where we conduct including steps to “ring fence” entities by regulators outside our business. These laws and regulations significantly affect of the U.S. to protect clients and creditors of such entities in the way we do business and can restrict the scope of our the event of financial difficulties involving such entities. existing businesses and limit our ability to expand our product offerings and pursue certain investments. These laws, regulations and rules may hinder our ability to access funds that we may need to make payments on our obli- The regulation of major financial firms, including the Firm, as gations. Furthermore, as a BHC, we may become subject to a well as of the markets in which we operate, is extensive and prohibition or to limitations on our ability to pay dividends. subject to ongoing change. We are, or will become, subject to The Federal Reserve, the OCC, and the FDIC have the (among other things) wide-ranging regulation and supervision, authority, and under certain circumstances the duty, to intensive scrutiny of our businesses and any plans for expan- prohibit or to limit the payment of dividends by the banking sion of those businesses, limitations on new activities, a organizations they supervise, including us and our U.S. Bank systemic risk regime that imposes heightened capital and Subsidiaries. liquidity and funding requirements and other enhanced pruden- tial standards, resolution regimes and resolution planning Our liquidity and financial condition have in the past been, requirements, requirements for maintaining minimum amounts and in the future could be, adversely affected by U.S. and of TLAC and external long-term debt, restrictions on activities international markets and economic conditions. and investments imposed by the Volcker Rule, comprehensive derivatives regulation, market structure regulation, tax regula- Our ability to raise funding in the long-term or short-term tions, antitrust laws, trade and transaction reporting obligations, debt capital markets or the equity markets, or to access and broadened fiduciary obligations.
15 December 2018 Form 10-K
− 253 − In some areas, regulatory standards are subject to final rule- has proposed an SPOE strategy through which it may apply making or transition periods or may otherwise be revised in its orderly liquidation authority powers, we believe that the whole or in part. Ongoing implementation of, or changes in, application of an SPOE strategy is the reasonably likely laws and regulations could materially impact the profitability outcome if either our resolution plan were implemented or a of our businesses and the value of assets we hold, expose us resolution proceeding were commenced under the orderly to additional costs, require changes to business practices or liquidation authority. An SPOE strategy generally contem- force us to discontinue businesses, adversely affect our ability plates the provision of additional capital and liquidity by the to pay dividends and repurchase our stock or require us to Parent Company to certain of its subsidiaries so that such raise capital, including in ways that may adversely impact our subsidiaries have the resources necessary to implement the shareholders or creditors. resolution strategy, and the Parent Company has entered into a secured amended and restated support agreement with its In addition, regulatory requirements that are being imposed material entities, as defined in our 2017 resolution plan, by foreign policymakers and regulators may be inconsistent pursuant to which it would provide such capital and liquidity. or conflict with regulations that we are subject to in the U.S. and may adversely affect us. We expect legal and regulatory Under the secured amended and restated support agreement, requirements to be subject to ongoing change for the foresee- upon the occurrence of a resolution scenario, including one in able future, which may result in significant new costs to which an SPOE strategy is used, the Parent Company will be comply with new or revised requirements as well as to obligated to contribute or loan on a subordinated basis all of monitor for compliance on an ongoing basis. its contributable material assets, other than shares in subsidi- aries of the Parent Company and certain intercompany The application of regulatory requirements and strategies in payables, to provide capital and liquidity, as applicable, to the U.S. or other jurisdictions to facilitate the orderly our material entities. The obligations of the Parent Company resolution of large financial institutions may pose a greater under the secured amended and restated support agreement risk of loss for our security holders, and subject us to other are in most cases secured on a senior basis by the assets of the restrictions. Parent Company (other than shares in subsidiaries of the Parent Company). As a result, claims of our material entities Pursuant to the Dodd-Frank Act, we are required to periodi- against the assets of the Parent Company (other than shares in cally submit to the Federal Reserve and the FDIC a resolution subsidiaries of the Parent Company) are effectively senior to plan that describes our strategy for a rapid and orderly resolu- unsecured obligations of the Parent Company. Such unse- tion under the U.S. Bankruptcy Code in the event of material cured obligations are at risk of absorbing losses of the Parent financial distress or failure. If the Federal Reserve and the Company and its subsidiaries. FDIC were to jointly determine that our resolution plan submission was not credible or would not facilitate an orderly In further development of our SPOE strategy, we have resolution, and if we were unable to address any deficiencies created a wholly owned, direct subsidiary of the Parent identified by the regulators, we or any of our subsidiaries may Company, MS Holdings LLC (“Funding IHC”), to serve as a be subject to more stringent capital, leverage, or liquidity resolution funding vehicle. We expect that, prior to the requirements or restrictions on our growth, activities, or oper- submission of our 2019 resolution plan by July 1, 2019, the ations, or after a two-year period, we may be required to Parent Company will contribute certain of its assets to the divest assets or operations. Funding IHC and enter into an updated secured amended and restated support agreement with the Funding IHC as well as In addition, provided that certain procedures are met, we can certain other subsidiaries to facilitate the execution of our be subject to a resolution proceeding under the orderly liqui- SPOE strategy. Similar to the existing secured amended and dation authority under Title II of the Dodd-Frank Act with the restated support agreement, the updated secured amended and FDIC being appointed as receiver. The FDIC’s power under restated support agreement will obligate the Parent Company the orderly liquidation authority to disregard the priority of to transfer capital and liquidity, as revised, to the Funding creditor claims and treat similarly situated creditors differ- IHC, and that the Parent Company and/or the Funding IHC ently in certain circumstances, subject to certain limitations, will recapitalize and provide liquidity to material entities in could adversely impact holders of our unsecured debt. See the event of our material financial distress or failure. “Business—Supervision and Regulation” and “Manage- ment’s Discussion and Analysis of Financial Condition and Although an SPOE strategy, whether applied pursuant to our Results of Operations—Liquidity and Capital Resources— resolution plan or in a resolution proceeding under the orderly Regulatory Requirements.” liquidation authority, is intended to result in better outcomes for creditors overall, there is no guarantee that the application Further, because both our resolution plan contemplates an of an SPOE strategy, including the provision of support to the SPOE strategy under the U.S. Bankruptcy Code and the FDIC Parent Company’s material entities pursuant to the secured
December 2018 Form 10-K 16
− 254 − amended and restated support agreement, will not result in Finally, the Federal Reserve may change regulatory capital greater losses for holders of our securities compared to a standards to impose higher requirements that restrict our ability different resolution strategy for us. to take capital actions or may modify or impose other regula- tory standards that increase our operating expenses and reduce Regulators have taken and proposed various actions to facili- our ability to take capital actions. tate an SPOE strategy under the U.S. Bankruptcy Code, the orderly liquidation authority or other resolution regimes. For The financial services industry faces substantial litigation example, the Federal Reserve requires top-tier BHCs of U.S. and is subject to extensive regulatory and law enforcement G-SIBs, including Morgan Stanley, to maintain minimum investigations, and we may face damage to our reputation amounts of equity and eligible long-term debt TLAC in order and legal liability. to ensure that such institutions have enough loss-absorbing resources at the point of failure to be recapitalized through As a global financial services firm, we face the risk of inves- the conversion of debt to equity or otherwise by imposing tigations and proceedings by governmental and self- losses on eligible TLAC where the SPOE strategy is used. regulatory organizations in all countries in which we conduct The combined implication of the SPOE resolution strategy our business. Investigations and proceedings initiated by and the TLAC requirement is that our losses will be imposed these authorities may result in adverse judgments, settle- on the holders of eligible long-term debt and other forms of ments, fines, penalties, injunctions or other relief. In addition eligible TLAC issued by the Parent Company before any to the monetary consequences, these measures could, for losses are imposed on the holders of the debt securities of our example, impact our ability to engage in, or impose limita- operating subsidiaries or before putting U.S. taxpayers at risk. tions on, certain of our businesses.
In addition, certain jurisdictions, including the U.K. and other These investigations and proceedings, as well as the amount E.U. jurisdictions, have implemented, or are in the process of of penalties and fines sought, continue to impact the financial implementing, changes to resolution regimes to provide reso- services industry and certain U.S. and international govern- lution authorities with the ability to recapitalize a failing mental entities have brought criminal actions against, or have entity organized in such jurisdiction by writing down certain sought criminal convictions, pleas or deferred prosecution unsecured liabilities or converting certain unsecured liabil- agreements from, financial institutions. Significant regulatory ities into equity. Such “bail-in” powers are intended to enable or law enforcement action against us could materially the recapitalization of a failing institution by allocating losses adversely affect our business, financial condition or results of to its shareholders and unsecured creditors. Non-U.S. regula- operations or cause us significant reputational harm, which tors are also considering requirements that certain subsidi- could seriously harm our business. aries of large financial institutions maintain minimum amounts of TLAC that would pass losses up from the subsidi- The Dodd-Frank Act also provides compensation to whistle- aries to the Parent Company and, ultimately, to security blowers who present the SEC or CFTC with information holders of the Parent Company in the event of failure. related to securities or commodities law violations that leads to a successful enforcement action. As a result of this We may be prevented from paying dividends or taking other compensation, it is possible we could face an increased capital actions because of regulatory constraints or revised number of investigations by the SEC or CFTC. regulatory capital standards. We have been named, from time to time, as a defendant in We are subject to comprehensive consolidated supervision, various legal actions, including arbitrations, class actions and regulation and examination by the Federal Reserve, which other litigation, as well as investigations or proceedings requires us to submit, on an annual basis, a capital plan brought by regulatory agencies, arising in connection with describing proposed dividend payments to shareholders, our activities as a global diversified financial services institu- proposed repurchases of our outstanding securities and other tion. Certain of the actual or threatened legal or regulatory proposed capital actions that we intend to take. The Federal actions include claims for substantial compensatory and/or Reserve may object to, or otherwise require us to modify, punitive damages, claims for indeterminate amounts of such plan, or may object or require modifications to a resub- damages, or may result in penalties, fines, or other results mitted capital plan, any of which would adversely affect adverse to us. shareholders. In some cases, the issuers that would otherwise be the In addition, beyond review of the plan, the Federal Reserve primary defendants in such cases are bankrupt or are in finan- may impose other restrictions or conditions on us that prevent cial distress. In other cases, including antitrust litigation, we us from paying or increasing dividends, repurchasing securities may be subject to claims for joint and several liability with or taking other capital actions that would benefit shareholders. other defendants for treble damages or other relief related to
17 December 2018 Form 10-K
− 255 − alleged conspiracies involving other institutions. Like any involving storage and transportation, adopting appropriate poli- large corporation, we are also subject to risk from potential cies and procedures, and implementing emergency response employee misconduct, including non-compliance with poli- programs, these actions may not prove adequate to address cies and improper use or disclosure of confidential informa- every contingency. In addition, insurance covering some of tion, or improper sales practices or conduct. these risks may not be available, and the proceeds, if any, from insurance recovery may not be adequate to cover liabilities We may be responsible for representations and warranties with respect to particular incidents. As a result, our financial associated with residential and commercial real estate loans condition, results of operations and cash flows may be and may incur losses in excess of our reserves. adversely affected by these events.
We originate loans secured by commercial and residential During the past several years, intensified scrutiny of certain properties. Further, we securitize and trade in a wide range of energy markets by federal, state and local authorities in the commercial and residential real estate and real estate-related U.S. and abroad and by the public has resulted in increased whole loans, mortgages and other real estate and commercial regulatory and legal enforcement, litigation and remedial assets and products, including residential and CMBS. In proceedings involving companies conducting the activities in connection with these activities, we have provided, or other- which we are engaged. In addition, enhanced regulation of wise agreed to be responsible for, certain representations and OTC derivatives markets in the U.S. and the E.U., as well as warranties. Under certain circumstances, we may be required similar legislation proposed or adopted elsewhere, will to repurchase such assets or make other payments related to impose significant costs and requirements on our commod- such assets if such representations and warranties were ities derivatives activities. breached. We have also made representations and warranties in connection with our role as an originator of certain commercial We may incur substantial costs or loss of revenue in mortgage loans that we securitized in CMBS. For additional complying with current or future laws and regulations and our information, see also Note 12 to the financial statements. overall businesses and reputation may be adversely affected by the current legal environment. In addition, failure to We currently have several legal proceedings related to claims comply with these laws and regulations may result in for alleged breaches of representations and warranties. If substantial civil and criminal fines and penalties. there are decisions adverse to us in those legal proceedings, we may incur losses substantially in excess of our reserves. In A failure to address conflicts of interest appropriately could addition, our reserves are based, in part, on certain factual and adversely affect our businesses and reputation. legal assumptions. If those assumptions are incorrect and need to be revised, we may need to adjust our reserves As a global financial services firm that provides products and substantially. services to a large and diversified group of clients, including corporations, governments, financial institutions and individ- Our commodities activities and investments subject us to uals, we face potential conflicts of interest in the normal extensive regulation, and environmental risks and course of business. For example, potential conflicts can occur regulation that may expose us to significant costs and when there is a divergence of interests between us and a liabilities. client, among clients, between an employee on the one hand and us or a client on the other, or situations in which we may In connection with the commodities activities in our Institu- be a creditor of a client. tional Securities business segment, we execute transactions involving the storage, transportation and market-making of We have policies, procedures and controls that are designed several commodities, including metals, natural gas, electric to identify and address potential conflicts of interest, and we power, environmental attributes and other commodity prod- utilize various measures, such as the use of disclosure, to ucts. In addition, we are an electricity power marketer in the manage these potential conflicts. However, identifying and U.S. and own a minority interest in Heidmar Holdings LLC, mitigating potential conflicts of interest can be complex and which owns a group of companies that provide international challenging and can become the focus of media and regula- marine transportation and U.S. marine logistics services. tory scrutiny. Indeed, actions that merely appear to create a These activities subject us to extensive energy, commodities, conflict can put our reputation at risk even if the likelihood of environmental, health and safety and other governmental an actual conflict has been mitigated. It is possible that poten- laws and regulations. tial conflicts could give rise to litigation or enforcement actions, which may lead to our clients being less willing to Although we have attempted to mitigate our environmental enter into transactions in which a conflict may occur and risks by, among other measures, limiting the scope of activities could adversely affect our businesses and reputation.
December 2018 Form 10-K 18
− 256 − Our regulators have the ability to scrutinize our activities for Risk Management potential conflicts of interest, including through detailed examinations of specific transactions. For example, our status Our risk management strategies, models and processes may as a BHC supervised by the Federal Reserve subjects us to not be fully effective in mitigating our risk exposures in all direct Federal Reserve scrutiny with respect to transactions market environments or against all types of risk. between our U.S. Bank Subsidiaries and their affiliates. Further, the Volcker Rule subjects us to regulatory scrutiny We have devoted significant resources to develop our risk regarding certain transactions between us and our clients. management capabilities and expect to continue to do so in the future. Nonetheless, our risk management strategies, Uncertainties and ambiguities as to the interpretation and models and processes, including our use of various risk application of the Tax Cuts and Jobs Act could adversely models for assessing market exposures and hedging strat- affect us. egies, stress testing and other analysis, may not be fully effec- tive in mitigating our risk exposure in all market environ- The Tax Act, enacted on December 22, 2017, significantly ments or against all types of risk, including risks that are revised U.S. corporate income tax law by reducing the corpo- unidentified or unanticipated. rate income tax rate to 21%, partially or wholly eliminating tax deductions for certain expenses and implementing a As our businesses change and grow, and the markets in which modified territorial tax system. The modified territorial tax we operate evolve, our risk management strategies, models system includes a one-time transition tax on deemed repatri- and processes may not always adapt with those changes. ated earnings of non-U.S. subsidiaries and also imposes a Some of our methods of managing risk are based upon our minimum tax on GILTI and an alternative BEAT on U.S. use of observed historical market behavior and management’s corporations with operations outside of the U.S. See also judgment. As a result, these methods may not predict future “Management’s Discussion and Analysis of Financial Condi- risk exposures, which could be significantly greater than the tion and Results of Operations—Supplemental Financial historical measures indicate. Information and Disclosures—Income Tax Matters.” In addition, many models we use are based on assumptions or The U.S. Treasury Department has issued proposed regula- inputs regarding correlations among prices of various asset tions on certain provisions in the Tax Act, some of which are classes or other market indicators and therefore cannot antici- not yet finalized and are therefore subject to change. In addi- pate sudden, unanticipated or unidentified market or tion, there continue to be a number of uncertainties and ambi- economic movements, which could cause us to incur losses. guities as to the interpretation and application of many of the provisions in the Tax Act, including the provisions relating to Management of market, credit, liquidity, operational, model, the modified territorial tax system, GILTI, and the BEAT. In legal, regulatory and compliance risks requires, among other the absence of further guidance on these issues, we use what things, policies and procedures to record properly and verify we believe are reasonable interpretations and assumptions in a large number of transactions and events, and these policies applying the Tax Act for purposes of determining our tax and procedures may not be fully effective. Our trading risk balances and results of operations, which may change as we management strategies and techniques also seek to balance receive additional clarification and implementation guidance our ability to profit from trading positions with our exposure and as the interpretation of the Tax Act evolves over time. to potential losses. We expect that the U.S. Treasury Department will continue to While we employ a broad and diversified set of risk moni- issue additional guidance on the application of various provi- toring and risk mitigation techniques, those techniques and sions in the Tax Act. It is possible that such additional guid- the judgments that accompany their application cannot antici- ance or positions taken by the IRS in an audit could differ pate every economic and financial outcome or the timing of from the interpretations and assumptions that we previously such outcomes. For example, to the extent that our trading or made, which could have a material adverse effect on our investing activities involve less liquid trading markets or are results of operations and financial condition. otherwise subject to restrictions on sales or hedging, we may not be able to reduce our positions and therefore reduce our risk associated with such positions. We may, therefore, incur losses in the course of our trading or investing activities. For more information on how we monitor and manage market and certain other risks and related strategies, models and processes, see “Quantitative and Qualitative Disclosures about Risk—Risk Management—Market Risk.”
19 December 2018 Form 10-K
− 257 − Expected replacement of London Interbank Offered Rate • Result in disputes, litigation or other actions with counter- and replacement or reform of other interest rates could parties regarding the interpretation and enforceability of adversely affect our business, financial condition and provisions in IBOR-based products such as fallback results of operations. language or other related provisions, including in the case of fallbacks to the alternative reference rates, any Central banks around the world, including the Federal Reserve, economic, legal, operational or other impact resulting from have commissioned working groups of market participants and the fundamental differences between the IBORs and the official sector representatives with the goal of finding suitable various alternative reference rates; replacements for LIBOR and replacements or reforms of other interest rate benchmarks, such as EURIBOR and EONIA • Require the transition and/or development of appropriate (collectively, the “IBORs”). It is expected that a transition away systems and analytics to effectively transition our risk from the widespread use of such rates to alternative rates based management processes from IBOR-based products to those on observable market transactions and other potential interest based on one or more alternative reference rates in a timely rate benchmark reforms will occur over the course of the next manner, including by quantifying value and risk for various few years. For example, the FCA, which regulates LIBOR, has alternative reference rates, which may prove challenging given announced that it has commitments from panel banks to the limited history of the proposed alternative reference rates; continue to contribute to LIBOR through the end of 2021, but and that it will not use its powers to compel contributions beyond such date. Accordingly, there is considerable uncertainty • Cause us to incur additional costs in relation to any of the regarding the publication of LIBOR beyond 2021. above factors.
On April 3, 2018, the Federal Reserve Bank of New York Depending on several factors including those set forth above, our commenced publication of three reference rates based on over- business, financial condition and results of operations could be night U.S. Treasury repurchase agreement transactions, materially adversely impacted by the market transition or reform including the Secured Overnight Financing Rate, which has been of certain benchmarks. Other factors include the pace of the recommended as an alternative to U.S. dollar LIBOR by the transition to replacement or reformed rates, the specific terms Alternative Reference Rates Committee. Further, the Bank of and parameters for and market acceptance of any alternative England is publishing a reformed Sterling Overnight Index reference rate, prices of and the liquidity of trading markets for Average, comprised of a broader set of overnight Sterling money products based on alternative reference rates, and our ability to market transactions, which has been selected by the Working transition and develop appropriate systems and analytics for one Group on Sterling Risk-Free Reference Rates as the alternative or more alternative reference rates. rate to Sterling LIBOR. Central bank-sponsored committees in other jurisdictions, including Europe, Japan and Switzerland, Competitive Environment have, or are expected to, select alternative reference rates We face strong competition from other financial services denominated in other currencies. firms, which could lead to pricing pressures that could The market transition away from IBORs to alternative refer- materially adversely affect our revenue and profitability. ence rates is complex and could have a range of adverse The financial services industry and all aspects of our businesses impacts on our business, financial condition and results of are intensely competitive, and we expect them to remain so. We operations. In particular, any such transition or reform could: compete with commercial banks, brokerage firms, insurance • Adversely impact the pricing, liquidity, value of, return on companies, exchanges, electronic trading and clearing platforms, and trading for a broad array of financial products, financial data repositories, sponsors of mutual funds, hedge including any IBOR-linked securities, loans and derivatives funds, energy companies, financial technology firms and other that are included in our financial assets and liabilities; companies offering financial or ancillary services in the U.S., globally and digitally or through the internet. We compete on the • Require extensive changes to documentation that governs basis of several factors, including transaction execution, capital or references IBOR or IBOR-based products, including, for or access to capital, products and services, innovation, tech- example, pursuant to time-consuming renegotiations of nology, reputation, risk appetite and price. existing documentation to modify the terms of outstanding securities and related hedging transactions; Over time, certain sectors of the financial services industry have become more concentrated, as institutions involved in a • Result in inquiries or other actions from regulators in broad range of financial services have left businesses, been respect of our preparation and readiness for the replace- acquired by or merged into other firms, or have declared ment of IBOR with one or more alternative reference rates; bankruptcy. Such changes could result in our remaining
December 2018 Form 10-K 20
− 258 − competitors gaining greater capital and other resources, such International Risk as the ability to offer a broader range of products and services and geographic diversity, or new competitors may emerge. We are subject to numerous political, economic, legal, tax, operational, franchise and other risks as a result of our We have experienced and may continue to experience pricing international operations which could adversely impact our pressures as a result of these factors and as some of our competi- businesses in many ways. tors seek to obtain market share by reducing prices or providing more favorable terms of business. In addition, certain of our We are subject to political, economic, legal, tax, operational, competitors may be subject to different, and, in some cases, less franchise and other risks that are inherent in operating in stringent, legal and regulatory regimes, than we are, thereby many countries, including risks of possible nationalization, putting us at a competitive disadvantage. Some new competitors expropriation, price controls, capital controls, exchange in the financial technology sector have sought to target existing controls, increased taxes and levies, and other restrictive segments of our businesses that could be susceptible to disrup- governmental actions, as well as the outbreak of hostilities or tion by innovative or less regulated business models. For more political and governmental instability. In many countries, the information regarding the competitive environment in which we laws and regulations applicable to the securities and financial operate, see “Business—Competition” and “Business— services industries are uncertain and evolving, and it may be Supervision and Regulation.” difficult for us to determine the exact requirements of local laws in every market. Automated trading markets may adversely affect our business and may increase competition. Our inability to remain in compliance with local laws in a partic- ular market could have a significant and negative effect not only We have experienced intense price competition in some of on our business in that market but also on our reputation gener- our businesses in recent years. In particular, the ability to ally. We are also subject to the risk that transactions we structure execute securities, derivatives and other financial instrument might not be legally enforceable in all cases. trades electronically on exchanges, swap execution facilities, and other automated trading platforms has increased the pres- Various emerging market countries have experienced severe sure on bid-offer spreads, commissions, markups or compa- political, economic or financial disruptions, including significant rable fees. The trend toward direct access to automated, elec- devaluations of their currencies, defaults or potential defaults on tronic markets will likely continue and will likely increase as sovereign debt, capital and currency exchange controls, high additional markets move to more automated trading plat- rates of inflation and low or negative growth rates in their forms. We have experienced and it is likely that we will economies. Crime and corruption, as well as issues of security continue to experience competitive pressures in these and and personal safety, also exist in certain of these countries. These other areas in the future as some of our competitors may seek conditions could adversely impact our businesses and increase to obtain market share by reducing bid-offer spreads, volatility in financial markets generally. commissions, markups or comparable fees. The emergence of a disease pandemic or other widespread Our ability to retain and attract qualified employees is health emergency, or concerns over the possibility of such an critical to the success of our business and the failure to do emergency as well as natural disasters, terrorist activities or so may materially adversely affect our performance. military actions, could create economic and financial disrup- tions in emerging markets and other areas throughout the Our people are our most important resource and competition for world, and could lead to operational difficulties (including qualified employees is intense. If we are unable to continue to travel limitations) that could impair our ability to manage our attract and retain highly qualified employees, or do so at levels businesses around the world. or in forms necessary to maintain our competitive position, or if compensation costs required to attract and retain employees As a U.S. company, we are required to comply with the become more expensive, our performance, including our economic sanctions and embargo programs administered by competitive position, could be materially adversely affected. OFAC and similar multi-national bodies and governmental agencies worldwide, as well as applicable anti-corruption laws in The financial industry has experienced and may continue to the jurisdictions in which we operate, such as the U.S. Foreign experience more stringent regulation of employee compensa- Corrupt Practices Act and the U.K. Bribery Act. A violation of a tion, including limitations relating to incentive-based sanction, embargo program, or anti-corruption law could subject compensation, clawback requirements and special taxation, us, and individual employees, to a regulatory enforcement action which could have an adverse effect on our ability to hire or as well as significant civil and criminal penalties. retain the most qualified employees.
21 December 2018 Form 10-K
− 259 − The U.K.’s anticipated withdrawal from the E.U. could In order to prepare for this risk, we are taking steps to make adversely affect us. changes to our European operations in an effort to ensure that we can continue to provide cross-border banking and invest- It is difficult to predict the future of the U.K.’s relationship ment and other services in E.U. Member States without the with the E.U., the uncertainty of which may increase the vola- need for separate regulatory authorizations in each member tility in the global financial markets in the short- and state. See also “Management’s Discussion and Analysis of medium-term and may negatively disrupt regional and global Financial Condition and Results of Operations—Liquidity financial markets. Additionally, depending on the outcome, and Capital Resources—Regulatory Requirements— such uncertainty may adversely affect the manner in which Regulatory Developments.” However, as a result of the polit- we operate certain of our businesses in Europe. ical uncertainty described above, it is currently unclear what the final post-Brexit structure of our European operations will On June 23, 2016, the U.K. electorate voted to leave the E.U. be. Given the potential negative disruption to regional and On March 29, 2017, the U.K. invoked Article 50 of the global financial markets, and depending on the extent to Lisbon Treaty, which triggered a two-year period, subject to which we may be required to make material changes to our extension (which would need the unanimous approval of the European operations beyond those currently planned, our E.U. Member States), during which the U.K. government results of operations and business prospects could be nega- negotiated a form of withdrawal agreement with the E.U. tively affected. Absent any changes to this time schedule, the U.K. is expected to leave the E.U. by March 29, 2019. The proposed Acquisition, Divestiture and Joint Venture Risk withdrawal agreement includes a transition period until December 2020 and provides that the U.K. will leave the We may be unable to fully capture the expected value from E.U. single market and will seek a phased period of imple- acquisitions, divestitures, joint ventures, minority stakes or mentation for a new U.K.-E.U. relationship that may cover strategic alliances. the legal and regulatory framework applicable to financial institutions with significant operations in Europe, such as the In connection with past or future acquisitions, divestitures, Firm. joint ventures, minority stakes or strategic alliances (including with MUFG), we face numerous risks and uncer- The withdrawal agreement was rejected by the U.K. Parlia- tainties combining, transferring, separating or integrating the ment on January 15, 2019, and the U.K. Government is in the relevant businesses and systems, including the need to process of negotiating changes to the withdrawal agreement combine or separate accounting and data processing systems that would be acceptable to the U.K. Parliament and the E.U. and management controls and to integrate relationships with As a result, the terms and conditions of the anticipated with- clients, trading counterparties and business partners. In the drawal from the E.U. remain uncertain. case of joint ventures and minority stakes, we are subject to additional risks and uncertainties because we may be depen- The ongoing political uncertainty in relation to the proposed dent upon, and subject to liability, losses or reputational withdrawal agreement in the U.K. means there is a risk that damage relating to systems, controls and personnel that are these arrangements may not be ready for implementation by not under our control. March 29, 2019 or that there will be no transition period. Potential effects of the U.K. exit from the E.U. and potential In addition, conflicts or disagreements between us and any of mitigation actions may vary considerably depending on the our joint venture partners may negatively impact the benefits timing of withdrawal, the nature of any transition, implemen- to be achieved by the relevant joint venture. tation or successor arrangements, and the future trading arrangements between the U.K. and the E.U. There is no assurance that any of our acquisitions or divesti- tures will be successfully integrated or disaggregated or yield If the withdrawal agreement (or any alternative agreement) is all of the positive benefits anticipated. If we are not able to not agreed and as a result no transition period applies, our integrate or disaggregate successfully our past and future U.K. licensed entities may be unable to rely on E.U. pass- acquisitions or dispositions, there is a risk that our results of porting rights to provide services in a number of E.U. juris- operations, financial condition and cash flows may be materi- dictions beginning March 29, 2019, absent further regulatory ally and adversely affected. relief. Even if a transition period is agreed, our U.K. licensed entities may lose their rights to provide services in a number Certain of our business initiatives, including expansions of of E.U. jurisdictions after such transition period unless the existing businesses, may bring us into contact, directly or new U.K.-E.U. relationship provides for such rights. indirectly, with individuals and entities that are not within our traditional client and counterparty base and may expose us to new asset classes and new markets. These business activities
December 2018 Form 10-K 22
− 260 − expose us to new and enhanced risks, greater regulatory scru- tiny of these activities, increased credit-related, sovereign and operational risks, and reputational concerns regarding the manner in which these assets are being operated or held.
For more information regarding the regulatory environment in which we operate, see also “Business—Supervision and Regulation.”
23 December 2018 Form 10-K
− 261 − Selected Financial Data
Income Statement Data Operating Data
$ in millions 2018 2017 2016 2015 2014 2018 2017 2016 2015 2014 Revenues ROE2, 3 11.8% 8.0% 8.0% 8.5% 4.8% 1 Total non-interest revenues $ 36,301 $ 34,645 $ 30,933 $ 32,062 $ 32,540 ROTCE2, 3 13.5% 9.2% 9.3% 9.9% 5.7% Interest income 13,892 8,997 7,016 5,835 5,413 Interest expense 10,086 5,697 3,318 2,742 3,678 Common Share-Related Data Net interest 3,806 3,300 3,698 3,093 1,735 Net revenues 40,107 37,945 34,631 35,155 34,275 2018 2017 2016 2015 2014 Non-interest expenses Per common share Compensation and benefits 17,632 17,166 15,878 16,016 17,824 Earnings (basic)4 $ 4.81 $ 3.14 $ 2.98 $ 2.97 $ 1.64 Non-compensation expenses1 11,238 10,376 9,905 10,644 12,860 Earnings (diluted)4 4.73 3.07 2.92 2.90 1.60 Total non-interest expenses 28,870 27,542 25,783 26,660 30,684 Book value5 42.20 38.52 36.99 35.24 33.25 Income from continuing operations Tangible book value3, 5 36.99 33.46 31.98 30.26 28.26 before income taxes 11,237 10,403 8,848 8,495 3,591 Dividends declared 1.10 0.90 0.70 0.55 0.35 Provision for (benefit from) income Common shares outstanding taxes 2,350 4,168 2,726 2,200 (90) in millions Income from continuing operations 8,887 6,235 6,122 6,295 3,681 At December 31 1,700 1,788 1,852 1,920 1,951 Income (loss) from discontinued Annual average: operations, net of income taxes (4) (19) 1 (16) (14) Basic 1,708 1,780 1,849 1,909 1,924 Net income $ 8,883 $ 6,216 $ 6,123 $ 6,279 $ 3,667 Diluted 1,738 1,821 1,887 1,953 1,971 Net income applicable to noncontrolling interests 135 105 144 152 200 Net income applicable to Balance Sheet Data Morgan Stanley $ 8,748 $ 6,111 $ 5,979 $ 6,127 $ 3,467 Preferred stock dividends and $ in millions 2018 2017 2016 2015 2014 other 526 523 471 456 315 GLR6 $ 249,735 $ 192,660 $ 202,297 $ 203,264 $ 193,169 Earnings applicable to Loans7 115,579 104,126 94,248 85,759 66,577 Morgan Stanley Total assets 853,531 851,733 814,949 787,465 801,510 common shareholders $ 8,222 $ 5,588 $ 5,508 $ 5,671 $ 3,152 Deposits 187,820 159,436 155,863 156,034 133,544 Amounts applicable to Morgan Stanley Borrowings 192,582 165,716 155,941 155,033 Income from continuing operations $ 8,752 $ 6,130 $ 5,978 $ 6,143 $ 3,481 189,662 Income (loss) from discontinued Morgan Stanley shareholders’ equity 77,391 76,050 75,182 70,900 operations (4) (19) 1 (16) (14) 80,246 Common shareholders’ equity 68,871 68,530 67,662 64,880 Net income applicable to 71,726 Morgan Stanley $ 8,748 $ 6,111 $ 5,979 $ 6,127 $ 3,467 Tangible common shareholders’ equity3 Effective income tax rate from 62,879 59,829 59,234 58,098 55,137 continuing operations 20.9% 40.1% 30.8% 25.9% (2.5)% 1. Effective January 1, 2018, the Firm adopted new accounting guidance related to Revenue from Contracts with Customers, which, among other things, requires a gross presentation of certain costs that were previously netted against net revenues. Prior periods have not been restated pursuant to this guidance. Refer to note 21 to the financial statements for further information on the full impact of adoption of this new accounting guidance. 2. The calculation of ROE and ROTCE equal net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity and average tangible common equity, respectively. 3. Represents a non-GAAP measure. See “Executive Summary—Selected Non-GAAP Financial Information.” 4. For the calculation of basic and diluted earnings (loss) per common share, see Note 16 to the financial statements. 5. Book value per common share and tangible book value per common share equal common shareholders’ equity and tangible common shareholders’ equity, respectively, divided by common shares outstanding. 6. For a discussion of the GLR, see “Liquidity and Capital Resources—Liquidity Risk Management Framework—Global Liquidity Reserve” herein. 7. Amounts include loans held for investment (net of allowance) and loans held for sale but exclude loans at fair value, which are included in Trading assets in the balance sheets (see Note 7 to the financial statements).
December 2018 Form 10-K 24
− 262 − Management’s Discussion and Analysis of Financial Condition and Results of Operations Introduction
Morgan Stanley is a global financial services firm that main- Wealth Management provides a comprehensive array of tains significant market positions in each of its business financial services and solutions to individual investors and segments—Institutional Securities, Wealth Management and small to medium-sized businesses and institutions covering Investment Management. Morgan Stanley, through its subsid- brokerage and investment advisory services; financial and iaries and affiliates, provides a wide variety of products and wealth planning services; annuity and insurance products; services to a large and diversified group of clients and securities-based lending, residential real estate loans and customers, including corporations, governments, financial other lending products; banking and retirement plan institutions and individuals. Unless the context otherwise services. requires, the terms “Morgan Stanley,” “Firm,” “us,” “we” or “our” mean Morgan Stanley (the “Parent Company”) together Investment Management provides a broad range of invest- with its consolidated subsidiaries. We define the following as ment strategies and products that span geographies, asset part of our consolidated financial statements (“financial classes, and public and private markets to a diverse group statements”): consolidated income statements (“income of clients across institutional and intermediary channels. statements”), consolidated balance sheets (“balance sheets”) Strategies and products include equity, fixed income, and consolidated cash flow statements (“cash flow liquidity and alternative/other products. Institutional clients statements”). See the “Glossary of Common Acronyms” for include defined benefit/defined contribution plans, founda- the definition of certain acronyms used throughout the 2018 tions, endowments, government entities, sovereign wealth Form 10-K. funds, insurance companies, third-party fund sponsors and corporations. Individual clients are served through A description of the clients and principal products and intermediaries, including affiliated and non-affiliated services of each of our business segments is as follows: distributors.
Institutional Securities provides investment banking, sales The results of operations in the past have been, and in the and trading, lending and other services to corporations, future may continue to be, materially affected by competi- governments, financial institutions, and high to ultra-high tion; risk factors; and legislative, legal and regulatory devel- net worth clients. Investment banking services consist of opments; as well as other factors. These factors also may capital raising and financial advisory services, including have an adverse impact on our ability to achieve our strategic services relating to the underwriting of debt, equity and objectives. Additionally, the discussion of our results of oper- other securities, as well as advice on mergers and acquisi- ations herein may contain forward-looking statements. These tions, restructurings, real estate and project finance. Sales statements, which reflect management’s beliefs and expecta- and trading services include sales, financing, prime tions, are subject to risks and uncertainties that may cause brokerage and market-making activities in equity and fixed actual results to differ materially. For a discussion of the risks income products, including foreign exchange and commod- and uncertainties that may affect our future results, see ities. Lending activities include originating corporate loans, “Forward-Looking Statements,” “Business—Competition,” commercial mortgage lending, asset-backed lending, and “Business—Supervision and Regulation,” “Risk Factors” and financing extended to sales and trading customers. Other “Liquidity and Capital Resources—Regulatory Require- activities include investments and research. ments” herein.
25 December 2018 Form 10-K
− 263 − Management’s Discussion and Analysis Executive Summary
Overview of Financial Results
Consolidated Results Net Income Applicable to Morgan Stanley and Diluted EPS on a U.S. GAAP and Adjusted Basis Net Revenues1 ($ in millions) $ in millions, except per share data 2018 2017 2016 Net income applicable to Morgan Stanley U.S. GAAP $ 8,748 $ 6,111 $ 5,979 6% Adjusted—Non-GAAP3 8,545 7,079 5,911 Earnings per diluted common share 10% U.S. GAAP2 $ 4.73 $ 3.07 $ 2.92 $40,107 Adjusted—Non-GAAP3 4.61 3.60 2.88 $37,945 1. Effective January 1, 2018, the Firm adopted new accounting guidance $34,631 related to Revenue from Contracts with Customers, which among other things, requires a gross presentation of certain costs that were previously netted against net revenues. Prior periods have not been restated pursuant 2016 ∆∆2017 2018 to this guidance. Refer to note 21 to the financial statements for further infor- mation on the full impact of adoption of this new accounting guidance. Net Income Applicable to Morgan Stanley 2. For the calculation of basic and diluted EPS, see Note 16 to the financial ($ in millions) statements. 3. Represents a non-GAAP measure, see “Selected non-GAAP Financial Infor- mation” herein. Adjusted amounts exclude intermittent net discrete tax provi- sions (benefits). Beginning in 2017, income tax consequences associated 43% with employee share-based awards are recognized in Provision for income taxes in the income statements but are excluded from the intermittent net discrete tax provisions (benefits) adjustment as we anticipate conversion 2% activity each year. For further information on the net discrete tax provisions $8,748 (benefits), see “Supplemental Financial Information and Disclosures— Income Tax Matters” herein. $5,979 $6,111 2018 Compared with 2017
2016 ∆ 2017 ∆ 2018 • We reported net revenues of $40,107 million in 2018 compared with $37,945 million in 2017. For 2018, net Earnings per Common Share2 income applicable to Morgan Stanley was $8,748 million, or $4.73 per diluted common share, compared with $6,111 million, or $3.07 per diluted common share, in 2017.
• Results for 2018 include intermittent net discrete tax bene- fits of $203 million, or $0.12 per diluted common share, $4.81 $4.73 primarily associated with the remeasurement of reserves $2.98 $2.92 $3.14 $3.07 and related interest due to the resolution of multi- jurisdiction tax examinations. In addition, the effective tax rate in 2018 is lower than in 2017, primarily as a result of 2016 2017 2018 the enactment of the Tax Cuts and Jobs Act (“Tax Act”). Basic EPS Diluted EPS • Results for 2017 included an intermittent net discrete tax provision of $968 million, or $0.53 per diluted common share, primarily related to the impact of the Tax Act, partially offset by net discrete tax benefits related to the remeasurement of reserves and related interest due to new information regarding the status of multi-year IRS tax examinations. For a discussion of the Tax Act and the net discrete tax benefits, see “Supplemental Financial Informa- tion and Disclosures—Income Tax Matters” herein.
December 2018 Form 10-K 26
− 264 − Management’s Discussion and Analysis
• Excluding the intermittent net discrete tax items, net 2018 Compared with 2017 income applicable to Morgan Stanley was $8,545 million, or $4.61 per diluted common share, compared with • Compensation and benefits expenses of $17,632 million in $7,079 million, or $3.60 per diluted common share, in 2017 2018 increased 3% from $17,166 million in 2017. The (see “Selected Non-GAAP Financial Information” herein). 2018 results reflected increases in discretionary incentive compensation mainly driven by higher revenues and a 2017 compared with 2016 reduction in the portion of discretionary incentive compen- sation subject to deferral (“compensation deferral • We reported net revenues of $37,945 million in 2017 modification”), as well as salaries across all business compared with $34,631 million in 2016. For 2017, net segments, the formulaic payout to Wealth Management income applicable to Morgan Stanley was $6,111 million, or representatives, and amortization of deferred cash and $3.07 per diluted common share, compared with equity awards. These increases were partially offset by a $5,979 million, or $2.92 per diluted common share, in 2016. decrease in the fair value of investments to which certain • Refer to the 2018 compared with 2017 commentary above deferred compensation plans are referenced. for the 2017 intermittent net discrete tax impact. Results for 2016 included intermittent net discrete tax benefits of • Non-compensation expenses were $11,238 million in 2018 $68 million, or $0.04 per diluted common share, primarily compared with $10,376 million in 2017, representing an related to the remeasurement of reserves and related 8% increase. This increase was primarily a result of higher interest due to new information regarding the status of volume-related expenses, the gross presentation of certain multi-year IRS tax examinations, partially offset by adjust- expenses due to the adoption of the accounting update ments for other tax matters. Revenue from Contracts with Customers (see Notes 2 and 21 to the financial statements for further information) and • Excluding the intermittent net discrete tax items, net increased investment in technology, partially offset by income applicable to Morgan Stanley was $7,079 million, lower litigation expenses. or $3.60 per diluted common share, in 2017 compared with $5,911 million, or $2.88 per diluted common share, in 2016 2017 Compared with 2016 (see “Selected Non-GAAP Financial Information” herein). • Compensation and benefits expenses of $17,166 million in Non-interest Expenses1, 2 ($ in millions) 2017 increased 8% from $15,878 million in 2016. The 2017 results reflected increases in the formulaic payout to $28,870 $27,542 5% Wealth Management representatives linked to higher reve- $25,783 7% nues, the fair value of investments to which certain deferred compensation plans are referenced, discretionary $11,238 $10,376 8% 39% incentive compensation mainly driven by higher revenues $9,905 38% 5% 38% and deferred compensation associated with carried interest in the Investment Management business segment.
• Non-compensation expenses were $10,376 million in 2017 $17,632 61% compared with $9,905 million in 2016, representing a 5% increase. This increase was primarily a result of higher $17,166 $15,878 3% 8% 62% volume-related expenses and litigation costs. 62%
2016 ΔΔ2017 2018
Compensation and benefits expenses Non-compensation expenses
1. The percentages on the bars in the chart represent the contribution of compensation and benefits expenses and non-compensation expenses to the total. 2. Effective January 1, 2018, the Firm adopted new accounting guidance related to Revenue from Contracts with Customers, which among other things, requires a gross presentation of certain costs that were previously netted against net revenues. Prior periods have not been restated pursuant to this guidance. Refer to note 21 to the financial statements for further information on the full impact of adoption of this new accounting guidance.
27 December 2018 Form 10-K
− 265 − Management’s Discussion and Analysis
Business Segment Results 2018 Compared with 2017
Net Revenues by Segment1, 2, 3 • Institutional Securities net revenues of $20,582 million in ($ in millions) 2018 increased 9% from 2017, primarily reflecting higher $40,107 revenues from both sales and trading and Investment $37,945 6% $2,746, 7% banking. $34,631 $2,586, 7% 22% $2,112, 6% • Wealth Management net revenues of $17,242 million in $17,242 2018 increased 2% from 2017, primarily reflecting growth $16,836 2% 43% in Asset management revenues, partially offset by reduced $15,350 10% 44% 44% Trading revenues.
• Investment Management net revenues of $2,746 million in 2018 increased 6% from 2017, primarily reflecting higher
$20,582 Asset management revenues, partially offset by lower $18,813 $17,459 51% investment gains. 50% 8% 50% 9% 2017 Compared with 2016
2016 Δ 2017 Δ 2018 • Institutional Securities net revenues of $18,813 million in Institutional Securities Wealth Management Investment Management 2017 increased 8% from 2016, primarily reflecting higher revenues from Investment banking. Net Income Applicable to Morgan Stanley by Segment1, 4 ($ in millions) • Wealth Management net revenues of $16,836 million in $8,748 2017 increased 10% from 2016, primarily reflecting growth $376, 4% in Asset management revenues and Net interest income.
53% $3,472 • Investment Management net revenues of $2,586 million in 40% $5,979 $6,111 2017 increased 22% from 2016, primarily reflecting higher $225, 4% 9% $246, 4% revenues from Investments and Asset management. 49% $2,104 $2,325 11% 1, 2 35% 38% Net Revenues by Region ($ in millions)
$40,107 $4,906 $37,945 56% $4,714 $3,649 (3)% $3,536 39% $34,631 $4,414 7% 12% 61% 58% 12% $4,150 6% $6,092 12% $5,714 7% 15% 15% $4,994 14% 14% 2016ΔΔ 2017 2018
Institutional Securities Wealth Management Investment Management
1. The percentages on the bars in the charts represent the contribution of 5% $29,301 each business segment to the total. Amounts do not necessarily total to 9% $27,817 $25,487 73% 73% 100% due to intersegment eliminations, where applicable. 74% 2. The total amount of Net Revenues by Segment includes intersegment eliminations of $(463) million in 2018, $(290) million in 2017 and $(290) million in 2016. 3. Effective January 1, 2018, the Firm adopted new accounting guidance related to Revenues from Contracts with Customers, which had the effect of increasing the revenues reported in the Institutional Securities 2016 ΔΔ2017 2018 and Investment Management business segments. For further informa- Americas EMEA Asia-Pacific tion, see “Business Segments––Institutional Securities” and “Business Segments—Investment Management.” 4. The total amount of Net Income Applicable to Morgan Stanley by 1. For a discussion of how the geographic breakdown for net revenues is Segment includes intersegment eliminations of $(6) million in 2018, determined, see Note 21 to the financial statements. $4 million in 2017 and $1 million in 2016. 2. The percentages on the bars in the charts represent the contribution of each region to the total.
December 2018 Form 10-K 28
− 266 − Management’s Discussion and Analysis
Selected Financial Information and Other Statistical Data These measures are not in accordance with, or a substitute
$ in millions 2018 2017 2016 for, U.S. GAAP and may be different from or inconsistent with non-GAAP financial measures used by other companies. Expense efficiency ratio1 72.0% 72.6% 74.5% Whenever we refer to a non-GAAP financial measure, we ROE2 11.8% 8.0% 8.0% will also generally define it or present the most directly Adjusted ROE2, 3 11.5% 9.4% 7.9% comparable financial measure calculated and presented in ROTCE2 13.5% 9.2% 9.3% accordance with U.S. GAAP, along with a reconciliation of Adjusted ROTCE2, 3 13.2% 10.8% 9.1% the differences between the U.S. GAAP financial measure Worldwide employees 60,348 57,633 55,311 and the non-GAAP financial measure. At At December 31, December 31, The principal non-GAAP financial measures presented in this 2018 2017 document are set forth below. Capital ratios4 Common Equity Tier 1 capital 16.9% 16.5% Reconciliations from U.S. GAAP to Non-GAAP Consolidated Financial Measures Tier 1 capital 19.2% 18.9% Total capital 21.8% 21.7% $ in millions, except per share data 2018 2017 2016 Tier 1 leverage 8.4% 8.3% Net income applicable to Morgan Stanley $ 8,748 $ 6,111 $ 5,979 SLR5 6.5% 6.5% Impact of adjustments (203) 968 (68) 1. The expense efficiency ratio represents total non-interest expense as a Adjusted net income applicable to percentage of net revenues. Morgan Stanley—non-GAAP1 $ 8,545 $ 7,079 $ 5,911 2. Represents a non-GAAP measure. See “Selected Non-GAAP Financial Earnings per diluted common Information” herein. share $ 4.73 $ 3.07 $ 2.92 3. Adjusted amounts exclude intermittent net discrete tax provisions (bene- fits). Beginning in 2017, income tax consequences associated with Impact of adjustments (0.12) 0.53 (0.04) employee share-based awards are recognized in Provision for income Adjusted earnings per diluted taxes in the income statements but are excluded from the intermittent common share —non-GAAP1 $ 4.61 $ 3.60 $ 2.88 net discrete tax provisions (benefits) adjustment as we anticipate conversion activity each year. For further information on the net discrete Effective income tax rate 20.9% 40.1% 30.8% tax provisions (benefits), see “Supplemental Financial Information and Impact of adjustments 1.8% (9.3)% 0.8% Disclosures—Income Tax Matters” herein. Adjusted effective income tax 4. Beginning in 2018, our risk-based capital ratios are based on the Stan- rate—non-GAAP1 22.7% 30.8% 31.6% dardized Approach fully phased-in rules. At December 31, 2017, our risk-based capital ratios were based on the Standardized Approach transitional rules. For a discussion of our regulatory capital ratios, see At At December 31, December 31, “Liquidity and Capital Resources—Regulatory Requirements” herein. $ in millions 2018 2017 5. The SLR became effective as a capital standard on January 1, 2018; the SLR for 2017 was a non-GAAP pro-forma estimate. For a discussion Tangible equity of the SLR, see “Liquidity and Capital Resources—Regulatory Require- U.S. GAAP ments” herein. Morgan Stanley shareholders’ equity $ 80,246 $ 77,391 Less: Goodwill and net intangible assets (8,847) (9,042) Selected Non-GAAP Financial Information Tangible Morgan Stanley shareholders’ equity—non-GAAP $ 71,399 $ 68,349 We prepare our financial statements using U.S. GAAP. From U.S. GAAP time to time, we may disclose certain “non-GAAP financial Common equity $ 71,726 $ 68,871 measures” in this document or in the course of our earnings Less: Goodwill and net intangible assets (8,847) (9,042) releases, earnings and other conference calls, financial Tangible common equity—non-GAAP $ 62,879 $ 59,829 presentations, Definitive Proxy Statement and otherwise. A “non-GAAP financial measure” excludes, or includes, amounts from the most directly comparable measure calcu- lated and presented in accordance with U.S. GAAP. We consider the non-GAAP financial measures we disclose to be useful to us, investors and analysts by providing further trans- parency about, or an alternate means of assessing, our finan- cial condition, operating results, prospective regulatory capital requirements or capital adequacy.
29 December 2018 Form 10-K
− 267 − Management’s Discussion and Analysis
Average Monthly Balance Twelve Months Ended Non-GAAP Financial Measures by Business Segment December 31, $ in billions 2018 2017 2016 $ in millions 2018 2017 2016 Pre-tax margin4 Tangible equity Institutional Securities 30% 30% 29% U.S. GAAP Wealth Management 26% 26% 22% Morgan Stanley shareholders’ equity $ 78,497 $ 78,230 $ 76,390 Investment Management 17% 18% 14% Junior subordinated debentures issued to capital trusts — — 1,753 Consolidated 28% 27% 26% Less: Goodwill and net intangible assets (8,985) (9,158) (9,410) Average common equity5 Tangible Morgan Stanley Institutional Securities $ 40.8 $ 40.2 $ 43.2 shareholders’ equity—non-GAAP $ 69,512 $ 69,072 $ 68,733 Wealth Management 16.8 17.2 15.3 U.S. GAAP Investment Management 2.6 2.4 2.8 Common equity $ 69,977 $ 69,787 $ 68,870 Parent 9.8 10.0 7.6 Less: Goodwill and net intangible assets (8,985) (9,158) (9,410) Consolidated average Tangible common equity—non-GAAP $ 60,992 $ 60,629 $ 59,460 common equity $ 70.0 $ 69.8 $ 68.9 Average tangible common equity5 Consolidated Non-GAAP Financial Measures Institutional Securities $ 40.1 $ 39.6 $ 42.6 Wealth Management 9.2 9.3 7.1 $ in billions 2018 2017 2016 Investment Management 1.7 1.6 2.0 Average common equity Unadjusted $ 70.0 $ 69.8 $ 68.9 Parent 10.0 10.1 7.8 Adjusted1 69.9 69.9 68.9 Consolidated average tangible common equity $ 61.0 $ 60.6 $ 59.5 ROE2 2, 6 Unadjusted 11.8% 8.0% 8.0% ROE Institutional Securities 11.0% 7.8% 7.6% Adjusted1, 3 11.5% 9.4% 7.9% Wealth Management 20.0% 12.9% 13.3% Average tangible common equity Investment Management 14.2% 10.1% 7.7% Unadjusted $ 61.0 $ 60.6 $ 59.5 Consolidated 11.8% 8.0% 8.0% Adjusted1 60.9 60.7 59.5 ROTCE2, 6 2 ROTCE Institutional Securities 11.2% 7.9% 7.7% Unadjusted 13.5% 9.2% 9.3% Wealth Management 36.6% 23.8% 28.5% Adjusted1, 3 13.2% 10.8% 9.1% Investment Management 22.2% 14.8% 10.7% Consolidated 13.5% 9.2% 9.3%
1. Adjusted amounts exclude intermittent net discrete tax provisions (benefits). Beginning in 2017, income tax consequences associated with employee share-based awards are recognized in Provision for income taxes in the income statements but are excluded from the intermittent net discrete tax provisions (benefits) adjustment as we anticipate conversion activity each year. For further information on the net discrete tax provisions (benefits), see “Supplemental Financial Information and Disclosures—Income Tax Matters” herein. 2. ROE and ROTCE equal net income applicable to Morgan Stanley less preferred dividends as a percentage of average common equity and average tangible common equity, on a consolidated basis as indicated. When excluding intermittent net discrete tax provisions (benefits), both the numer- ator and average denominator are adjusted. 3. The calculations used in determining our “ROE and ROTCE Targets” referred to in the following section are the Adjusted ROE and Adjusted ROTCE amounts shown in this table. 4. Pre-tax margin represents income from continuing operations before income taxes as a percentage of net revenues. 5. Average common equity and average tangible common equity for each busi- ness segment are determined using our Required Capital framework (see “Liquidity and Capital Resources—Regulatory Requirements—Attribution of Average Common Equity According to the Required Capital Framework” herein). 6. The calculation of the ROE and ROTCE by segment uses the net income applicable to Morgan Stanley by segment less preferred dividends allocated to each segment as a percentage of average common equity and average tangible common equity, respectively, allocated to each segment.
December 2018 Form 10-K 30
− 268 − Management’s Discussion and Analysis
Return on Equity and Tangible Common Equity Targets from the purchase and sale transactions will include any spreads between bids and offers. Certain fees received on loans We have established an ROE Target of 10% to 13% and an carried at fair value and dividends from equity securities are ROTCE Target of 11.5% to 14.5%. Excluding the impact of also recorded in Trading revenues since they relate to positions intermittent net discrete tax items, we generated an 11.5% carried at fair value. ROE and a 13.2% ROTCE for 2018. As a market maker, we stand ready to buy, sell or otherwise Our ROE and ROTCE Targets are forward-looking state- transact with customers under a variety of market conditions ments that may be materially affected by many factors, and to provide firm or indicative prices in response to including, among other things: macroeconomic and market customer requests. Our liquidity obligations can be explicit in conditions; legislative and regulatory developments; industry some cases, and in others, customers expect us to be willing trading and investment banking volumes; equity market to transact with them. In order to most effectively fulfill our levels; interest rate environment; outsized legal expenses or market-making function, we engage in activities across all of penalties and the ability to maintain a reduced level of our trading businesses that include, but are not limited to: expenses; and capital levels. See “Forward-Looking State- ments” and “Risk Factors” for additional information. (i) taking positions in anticipation of, and in response to, customer demand to buy or sell and—depending on the For non-GAAP measures (ROE and ROTCE), see “Selected liquidity of the relevant market and the size of the posi- Non-GAAP Financial Information” herein. For information tion—to hold those positions for a period of time; on the impact of intermittent net discrete tax items, see (ii) building, maintaining and rebalancing inventory through “Supplemental Financial Information and Disclosures— trades with other market participants; Income Tax Matters” herein. (iii) managing and assuming basis risk (risk associated with imperfect hedging) between customized customer risks Business Segments and the standardized products available in the market to hedge those risks; Substantially all of our operating revenues and operating expenses are directly attributable to our business segments. (iv) trading in the market to remain current on pricing and Certain revenues and expenses have been allocated to each trends; and business segment, generally in proportion to its respective net (v) engaging in other activities to provide efficiency and revenues, non-interest expenses or other relevant measures. liquidity for markets.
As a result of treating certain intersegment transactions as Interest income and expense are also impacted by market- transactions with external parties, we include an Intersegment making activities, as debt securities held by us earn interest Eliminations category to reconcile the business segment and securities are loaned, borrowed, sold with agreements to results to our consolidated results. See Note 21 to the finan- repurchase and purchased with agreements to resell. cial statements for further information. We invest in investments or other financial instruments to Net Revenues economically hedge our obligations under certain deferred compensation plans. Changes in the value of such invest- Investment Banking. Investment banking revenues are ments are recorded in either Trading revenues or Investments composed of fees from advisory services and revenues from revenues. Expenses associated with the related deferred the underwriting of securities offerings and syndication of compensation plans are recorded in Compensation and bene- loans, net of syndication expenses. fits. See “Compensation Expense” herein for more details.
Trading. Trading revenues include revenues from customers’ Investments. Our investments are generally held for long- purchases and sales of financial instruments in which we act as term appreciation, for hedging purposes, or as part of offering a market maker, as well as gains and losses on our related posi- related products or services. tions and other positions carried at fair value. Trading revenues include the realized gains and losses from sales of cash instru- Typically, there are no fee revenues from these investments. ments and derivative settlements, unrealized gains and losses The revenues recorded are the result of realized gains and from ongoing fair value changes of our positions related to losses from sales and unrealized gains and losses from market-making activities, and gains and losses related to ongoing fair value changes of our positions, as well as from investments associated with certain employee deferred investments associated with certain employee deferred compensation plans and other positions carried at fair value. In compensation and co-investment plans. Estimates of the fair many markets, the realized and unrealized gains and losses value of the investments may involve significant judgment
31 December 2018 Form 10-K
− 269 − Management’s Discussion and Analysis and may fluctuate significantly over time in light of business, aggregate revenues and costs associated with each transaction market, economic and financial conditions generally or in or series of transactions. This review includes, among other relation to specific transactions. things, an assessment of the potential gain or loss associated with a transaction, including any associated commissions and Certain investments are subject to sales restrictions or are fees, dividends, the interest income or expense associated with required to be held in order to carry out related activities. financing or hedging our positions and other related expenses.
Commissions and Fees. Commission and fee revenues Following is a description of the sales and trading activities primarily arise from agency transactions in listed and OTC within our equities and fixed income businesses, as well as equity securities, services related to sales and trading activ- how their results impact the income statement line items. ities, and sales of mutual funds, futures, insurance products and options. Commissions received for purchasing and Equities—Financing. We provide financing and prime selling listed equity securities and options are recorded in brokerage services to our clients active in the equity markets Commissions and fees. Other cash and derivative instruments through a variety of products, including margin lending, secu- typically do not have fees associated with them, and fees for rities lending and swaps. Results from this business are any related services are recorded in Commissions and fees. largely driven by the difference between financing income earned and financing costs incurred, which are reflected in Asset Management. Asset management revenues include Net interest for securities and equity lending products and in fees associated with the management and supervision of Trading revenues for derivative products. assets, account services and administration, performance- based fees relating to certain funds, separately managed Equities—Execution services. A significant portion of the accounts, shareholder servicing and the distribution of certain results for this business is generated by commissions and fees open-ended mutual funds. from executing and clearing client transactions on major stock and derivative exchanges, as well as from OTC transac- Net Interest. Interest income and Interest expense are func- tions. We make markets for our clients in equity-related secu- tions of the level and mix of total assets and liabilities, rities and derivative products, including providing liquidity including Trading assets and Trading liabilities, Investment and hedging products. Market making also generates gains securities (which include AFS and HTM securities), Securi- and losses on inventory positions, which are reflected in ties borrowed or purchased under agreements to resell, Secu- Trading revenues. rities loaned or sold under agreements to repurchase, Loans, Deposits and Borrowings. In addition, Net interest is a func- Fixed income—Within fixed income, we make markets in tion of trading strategies, customer activity in the prime order to facilitate client activity as part of the following prod- brokerage business, and the prevailing level, term structure ucts and services: and volatility of interest rates. • Global macro products. We make markets for our clients in Other. Other revenues include revenues from equity method interest rate, foreign exchange and emerging market prod- investments, realized gains and losses on AFS securities, ucts, including exchange-traded and OTC securities and gains and losses on loan commitments and loans held for sale, derivative instruments. The results of this market-making provision for loan losses, and other miscellaneous revenues. activity are primarily driven by gains and losses from buying and selling positions to stand ready for and satisfy Net Revenues by Segment client demand and are recorded in Trading revenues.
Institutional Securities • Credit products. We make markets in credit-sensitive prod- ucts, such as corporate bonds and mortgage securities and Net revenues are composed of Investment banking revenues, other securitized products, and related derivative instruments. sales and trading net revenues, Investments and Other revenues. The values of positions in this business are sensitive to changes in credit spreads and interest rates, which result in For information about the composition of Investment banking gains and losses reflected in Trading revenues. We undertake revenues, see “Net Revenues” herein. lending activities, which include commercial mortgage lending, asset-backed lending and financing extended to Sales and trading net revenues are composed of Trading reve- customers. Due to the amount and type of the interest-bearing nues, Commissions and fees, Asset management revenues and securities and loans making up this business, a significant Net interest. In assessing the profitability of our sales and portion of the results is also reflected in Net interest revenues. trading activities, we view these net revenues in the aggregate. Decisions relating to trading are based on an overall review of
December 2018 Form 10-K 32
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• Commodities products and Other. We make markets in Other revenues include revenues from realized gains and various commodity products related primarily to electricity, losses on AFS securities, provision for loan losses, referral natural gas, oil and precious metals, with the results fees and other miscellaneous revenues. primarily reflected in Trading revenues. Other activities primarily include results from the centralized management Investment Management of our fixed income derivative counterparty exposures, which are primarily recorded in Trading revenues. Net revenues are composed of Investments and Asset management revenues. Other sales and trading revenues include impacts from certain central treasury functions, such as liquidity costs and gains Investments revenues are primarily derived from investments (losses) on economic hedges related to certain borrowings, as made as part of our product offerings. In certain cases these well as certain activities associated with corporate lending. investments are subject to sales restrictions. In addition to the gains and losses discussed previously, Investments revenues For information about revenues from Investments, see “Net for Investment Management also contain performance fees Revenues” herein. from fund management activities in the form of carried interest, a portion of which is subject to reversal. Addition- Other revenues include revenues from equity method invest- ally, there are certain sponsored Investment Management ments, gains and losses on held for sale loans and lending funds consolidated by us where revenues are primarily related commitments, fees earned in association with lending activities, to holders of noncontrolling interests. provision for loan losses and other miscellaneous revenues. Asset management revenues include revenues from invest- Wealth Management ment management services we provide to investment vehicles pursuant to various contractual arrangements. We receive Net revenues are composed of Transactional, Asset manage- fees primarily based upon mutual fund daily average net ment, Net interest and Other revenues. assets or based on monthly or quarterly invested equity for other vehicles. Performance-based fees, not in the form of Transactional revenues include Investment banking, Trading, carried interest, are earned on certain products as a and Commissions and fees. Investment banking revenues percentage of appreciation earned by those products and, in include revenues from the distribution of equity and fixed certain cases, are based upon the achievement of performance income securities, including initial public offerings, criteria. These fees are generally recognized annually. secondary offerings, closed-end funds and unit trusts. Trading revenues primarily include revenues from customers’ Compensation Expense purchases and sales of fixed income financial instruments, in which we act as principal, and gains and losses associated Compensation and benefits expense includes accruals for with certain employee deferred compensation plans. Reve- base salaries and fixed allowances, formulaic programs, nues from Commissions and fees primarily arise from agency discretionary incentive compensation, amortization of transactions in listed and OTC equity securities and sales of deferred cash and equity awards, changes in the fair value of mutual funds, futures, insurance products and options. investments to which certain deferred compensation plans are referenced, carried interest, severance costs, and other items Asset management revenues primarily consist of revenues such as health and welfare benefits. from individual and institutional investors electing a fee-based pricing arrangement. Wealth Management also The factors that drive compensation for our employees vary receives mutual fund distribution fees, which are based on from quarter to quarter, from segment to segment and within either the average daily fund net asset balances or average a segment. For certain revenue-producing employees in the daily aggregate net fund sales and are affected by changes in Wealth Management and Investment Management business the overall level and mix of AUM. segments, compensation is largely paid on the basis of formu- laic payouts that link employee compensation to revenues. Net interest income includes interest on lending activities, Compensation for most other employees, including revenue- interest on AFS and HTM securities, interest related to producing employees in the Institutional Securities business Deposits and other net interest. Interest income and Interest segment, may also include incentive compensation that is expense are functions of the level and mix of total assets and determined following the assessment of the Firm’s, business liabilities. Net interest is driven by securities-based lending, unit’s and individual’s performance. Compensation for our mortgage lending, margin loans, brokerage sweep deposits, remaining employees is largely fixed in nature (i.e., base time deposits and other funding sources. salary and benefits).
33 December 2018 Form 10-K
− 271 − Management’s Discussion and Analysis
Compensation expense for deferred cash-based compensation Income Taxes plans is calculated based on the notional value of the award granted, adjusted for upward and downward changes in fair The income tax provision for our business segments is gener- value of the referenced investment, and is recognized ratably ally determined based on the revenues, expenses and activ- over the prescribed vesting period for the award. However, ities directly attributable to each business segment. Certain there may be a timing difference between the immediate items have been allocated to each business segment, generally revenue recognition of gains and losses on our investments in proportion to its respective net revenues or other relevant and the deferred recognition of the related compensation measures. expense over the vesting period.
December 2018 Form 10-K 34
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Institutional Securities Investment Banking
Income Statement Information Investment Banking Revenues
% Change % Change $ in millions 2018 2017 2016 2018 2017 $ in millions 2018 2017 2016 2018 2017 Revenues Advisory $ 2,436 $ 2,077 $ 2,220 17% (6)% Investment banking $ 6,088 $ 5,537 $ 4,476 10% 24% Underwriting: Trading 11,191 10,295 9,387 9% 10% Equity 1,726 1,484 887 16% 67% Investments 182 368 147 (51)% 150% Fixed income 1,926 1,976 1,369 (3)% 44% Commissions and fees 2,671 2,433 2,456 10% (1)% Total underwriting 3,652 3,460 2,256 6% 53% Asset management 421 359 293 17% 23% Total Investment banking $ 6,088 $ 5,537 $ 4,476 10% 24% Other 535 630 535 (15)% 18% Total non-interest revenues 21,088 19,622 17,294 7% 13% Investment Banking Volumes Interest income 9,271 5,377 4,005 72% 34% $ in billions 2018 2017 2016 Interest expense 9,777 6,186 3,840 58% 61% Completed mergers and acquisitions1 $ 1,098 $ 749 $ 1,023 Net interest (506) (809) 165 37% N/M Equity and equity-related offerings2, 3 64 65 45 Net revenues 20,582 18,813 17,459 9% 8% Fixed income offerings2, 4 223 268 236 Compensation and benefits 6,958 6,625 6,275 5% 6% Source: Thomson Reuters, data as of January 2, 2019. Transaction Non-compensation expenses 7,364 6,544 6,061 13% 8% volumes may not be indicative of net revenues in a given period. In addi- Total non-interest tion, transaction volumes for prior periods may vary from amounts previ- expenses 14,322 13,169 12,336 9% 7% ously reported due to the subsequent withdrawal or change in the value of a transaction. Income from continuing operations before 1. Includes transactions of $100 million or more. Based on full credit to income taxes 6,260 5,644 5,123 11% 10% each of the advisors in a transaction. 2. Based on full credit for single book managers and equal credit for joint Provision for income taxes 1,230 1,993 1,318 (38)% 51% book managers. Income from continuing 3. Includes Rule 144A issuances and registered public offerings of operations 5,030 3,651 3,805 38% (4)% common stock and convertible securities and rights offerings. 4. Includes Rule 144A and publicly registered issuances, non-convertible Income (loss) from preferred stock, mortgage-backed and asset-backed securities, and discontinued operations, taxable municipal debt. Excludes leveraged loans and self-led issuances. net of income taxes (6) (19) (1) 68% N/M Net income 5,024 3,632 3,804 38% (5)% 2018 Compared with 2017 Net income applicable to noncontrolling interests 118 96 155 23% (38)% Investment banking revenues of $6,088 million in 2018 Net income applicable to increased 10% from 2017. The adoption of the accounting Morgan Stanley $ 4,906 $ 3,536 $ 3,649 39% (3)% update Revenue from Contracts with Customers had the effect of increasing the revenues reported in investment banking by approximately $283 million in 2018 compared with 2017 (see Notes 2 and 21 to the financial statements for further infor- mation). The drivers of the increase in our Investment banking revenues, other than the effect of the above accounting update, were:
• Advisory revenues increased primarily as a result of higher volumes of completed M&A activity (see Investment Banking Volumes table), partially offset by lower fee realizations.
• Equity underwriting revenues increased as a result of higher fee realizations. Revenues increased in IPOs and convertible offerings, partially offset by lower revenues from secondary block share trades.
35 December 2018 Form 10-K
− 273 − Management’s Discussion and Analysis
• Fixed income underwriting revenues decreased primarily as Sales and Trading Revenues—Equity and Fixed Income a result of lower volumes, partially offset by the effect of 2018 higher fee realizations. Revenues decreased in bond under- Net writing fees, partially offset by higher loan fees. $ in millions Trading Fees1 Interest2 Total Financing $ 4,841 $ 394 $ (661) $ 4,574 2017 Compared with 2016 Execution services 2,362 2,376 (336) 4,402 Total Equity $ 7,203 $ 2,770 $ (997) $ 8,976 Investment banking revenues of $5,537 million in 2017 Total Fixed income $ 4,793 $ 322 $ (110) $ 5,005 increased 24% from 2016 due to higher underwriting reve- nues, partially offset by lower advisory revenues. 2017 Net • Advisory revenues decreased reflecting the lower volumes $ in millions Trading Fees1 Interest2 Total of completed M&A (see Investment Banking Volumes Financing $ 4,140 $ 363 $ (762) $ 3,741 table), partially offset by the positive impact of higher fee Execution services 2,294 2,191 (244) 4,241 realizations. Total Equity $ 6,434 $ 2,554 $ (1,006) $ 7,982 • Equity underwriting revenues increased as a result of Total Fixed income $ 4,453 $ 238 $ 237 $ 4,928 higher global market volumes in both follow-on and initial public offerings (see Investment Banking Volumes table) 2016 combined with a higher share of fees. Net $ in millions Trading Fees1 Interest2 Total • Fixed income underwriting revenues increased due to Financing $ 3,668 $ 347 $ (283) $ 3,732 higher bond fees and non-investment grade loan fees. Execution services 2,231 2,241 (167) 4,305 Total Equity $ 5,899 $ 2,588 $ (450) $ 8,037 Sales and Trading Net Revenues Total Fixed income $ 4,115 $ 162 $ 840 $ 5,117 By Income Statement Line Item 1. Includes Commissions and fees and Asset management revenues. % Change 2. Includes funding costs, which are allocated to the businesses based on $ in millions 2018 2017 2016 2018 2017 funding usage. Trading $ 11,191 $ 10,295 $ 9,387 9% 10% Commissions and fees 2,671 2,433 2,456 10% (1)% As discussed in “Net Revenues by Segment” herein, we Asset management 421 359 293 17% 23% manage each of the sales and trading businesses based on its Net interest (506) (809) 165 37% N/M aggregate net revenues, which are composed of the income Total $ 13,777 $ 12,278 $ 12,301 12% N/M statement line items quantified in the previous table. Trading revenues are affected by a variety of market dynamics, By Business including volumes, bid-offer spreads and inventory prices, as well as impacts from hedging activity, which are interrelated. % Change We provide qualitative commentary in the discussion of $ in millions 2018 2017 2016 2018 2017 results that follow on the key drivers of period-over-period Equity $ 8,976 $ 7,982 $ 8,037 12% (1)% variances, as the quantitative impact of the various market Fixed income 5,005 4,928 5,117 2% (4)% dynamics typically cannot be disaggregated. Other (204) (632) (853) 68% 26% Total $ 13,777 $ 12,278 $ 12,301 12% N/M For additional information on total Trading revenues, see the table “Trading Revenues by Product Type” in Note 21 to the financial statements.
2018 Compared with 2017
Equity
Equity sales and trading net revenues of $8,976 million in 2018 increased 12% from 2017, reflecting higher results in both our financing and execution services businesses.
• Financing increased from 2017, primarily due to higher average client balances and changes in client balance mix, which resulted in increased Trading and Net interest revenues.
December 2018 Form 10-K 36
− 274 − Management’s Discussion and Analysis
• Execution services increased from 2017, primarily interest revenues from higher net interest costs, reflecting reflecting higher Commissions and fees due to higher client the business’ increased portion of GLR requirements and a activity in cash equities products. Trading revenues shift in the mix of financing transactions. increased due to effective inventory management in deriva- tives products. Net interest revenues declined due to • Execution services decreased from 2016, primarily increased funding costs. reflecting lower results in derivative products mainly driven by lower corporate activity and volatility, partially Fixed Income offset by higher gains on cash equity products recorded in Trading revenues. Fixed income net revenues of $5,005 million in 2018 were 2% higher than in 2017, primarily driven by higher results in Fixed Income commodities products and other, partially offset by lower results in credit products. Fixed income net revenues of $4,928 million in 2017 were 4% lower than in 2016, driven by lower results in global • Global macro products revenues remained relatively macro products, partially offset by higher results in credit unchanged as revenues from higher client activity in products, and commodities products and other. foreign exchange products were offset by unfavorable inventory management results in both rates and foreign • Global macro products decreased primarily due to the lack exchange products. These results were driven by significant of a constructive market environment, inventory posi- movements in interest rates in the fourth quarter of 2018 tioning, and lower client activity reflected in both Trading with a breakdown of historical correlations, which and Net interest. increased basis risk in the portfolio. Net interest revenues declined due to increased funding costs. • Credit products increased primarily due to the absence of losses driven by a widening spread environment in 2016 • Credit products Trading revenues decreased in both corpo- and increased securitization activity reflected in Trading rate credit and securitized products, driven by significant revenues, partially offset by reduced Net interest revenues. credit spread widening in the fourth quarter of 2018, Net interest revenues decreased as a result of a lower level partially offset by growth in lending products. of interest realized in securitized products and lower net interest spreads, partially offset by increased lending • Commodities products and Other Trading revenues activity. increased primarily due to increased Commodities client flow and structured transactions, as well as positive results • Commodities products and Other increased primarily due to from a reduction in derivative counterparty credit risk. higher revenues in other lending and OTC client clearing.
Other Other
• Other sales and trading net losses of $204 million in 2018 • Other sales and trading net losses of $632 million in 2017 decreased from 2017, primarily due to improved results decreased from 2016, primarily reflecting lower losses from hedge accounting applied to our long-term borrow- associated with corporate loan hedging activity and ings, lower net funding costs reflecting changes in the increases in the fair value of investments to which certain balance sheet and lower losses associated with corporate deferred compensation plans are referenced, partially offset loan hedging activity, partially offset by a decrease in the by higher funding costs. fair value of investments to which certain deferred compen- sation plans are referenced. Investments, Other Revenues, Non-interest Expenses, and Income Tax Items 2017 Compared with 2016 2018 Compared with 2017 Equity Investments Equity sales and trading net revenues of $7,982 million in 2017 decreased 1% from 2016, reflecting lower results in • Net investment gains of $182 million in 2018 decreased from execution services. 2017 as a result of lower gains on business-related invest- ments, losses due to the market deterioration of a publicly • Financing remained relatively unchanged from 2016. The traded investment subject to sale restrictions and lower results results reflected higher client activity in equity swaps from real estate limited partnership investments. reflected in Trading revenues, offset by a decline in Net
37 December 2018 Form 10-K
− 275 − Management’s Discussion and Analysis
Other Revenues Non-interest Expenses
• Other revenues of $535 million in 2018 decreased from Non-interest expenses of $13,169 million in 2017 increased 2017, primarily reflecting mark-to-market losses on from 2016, primarily reflecting a 6% increase in Compensa- held-for-sale corporate loans compared with gains in 2017, tion and benefits expenses and an 8% increase in partially offset by higher loan fee revenues, the recovery in Non-compensation expenses in 2017. 2018 of an energy industry loan charged off in 2017 and improved results from other equity method investments. • Compensation and benefits expenses increased in 2017, primarily due to increases in the fair value of investments Non-interest Expenses to which certain deferred compensation plans are refer- enced, and discretionary incentive compensation driven Non-interest expenses of $14,322 million in 2018 increased mainly by higher revenues. from 2017, primarily reflecting a 5% increase in Compensa- tion and benefits expenses and a 13% increase in • Non-compensation expenses increased in 2017, primarily Non-compensation expenses in 2018. due to higher volume-related expenses and litigation costs related to legacy RMBS matters. • Compensation and benefits expenses increased in 2018, primarily due to increases in discretionary incentive Income Tax Items compensation driven by higher revenues and the compen- sation deferral modification, as well as salaries and amorti- The effective tax rate in 2018 is lower compared with 2017, zation of deferred cash and equity awards, partially offset primarily as a result of the enactment of the Tax Act. For a by a decrease in the fair value of investments to which discussion of the Tax Act and other discrete items, see “Supple- certain deferred compensation plans are referenced. mental Financial Information and Disclosures—Income Tax Matters” herein and Note 20 to the financial statements. In 2018, • Non-compensation expenses increased in 2018, primarily we recognized in Provision for income taxes an intermittent net due to higher volume-related expenses and the gross discrete tax benefit of $182 million, primarily associated with the presentation of certain expenses due to the adoption of the remeasurement of reserves and related interest due to the resolu- accounting update Revenue from Contracts with Customers tion of multi-jurisdiction tax examinations. (see Notes 2 and 21 to the financial statements for further information), partially offset by lower litigation expenses In 2017, we recognized in Provision for income taxes an and the reversal of a portion of previously recorded provi- intermittent net discrete tax provision of $471 million. This sions related to U.K. VAT matters. net discrete tax provision included an approximate $705 million impact from the Tax Act, partially offset by net 2017 Compared with 2016 discrete tax benefits primarily associated with the remeasure- ment of reserves and related interest due to new information Investments regarding the status of multi-year IRS tax examinations.
• Net investment gains of $368 million in 2017 increased In 2016, we recognized in Provision for income taxes inter- from 2016 as a result of higher gains on business-related mittent net discrete tax benefits of $83 million. These net and real estate limited partnership investments. In addition, discrete tax benefits were primarily related to the remeasure- in 2017, we recorded gains on investments to which certain ment of reserves and related interest due to new information deferred compensation plans are referenced compared with regarding the status of multi-year IRS tax examinations, losses in 2016. partially offset by adjustments for other tax matters.
Other Revenues
• Other revenues of $630 million in 2017 increased from 2016, primarily reflecting a decrease in the provision on loans held for investment and higher results from other investments, partially offset by lower mark-to-market gains on loans held for sale.
December 2018 Form 10-K 38
− 276 − Management’s Discussion and Analysis Wealth Management
Income Statement Information Financial Information and Statistical Data
% Change At At December 31, December 31, $ in millions 2018 2017 20161 2018 2017 $ in billions, except employee data 2018 2017 Revenues Client assets $ 2,303 $ 2,373 Investment banking $ 475 $ 533 $ 484 (11)% 10% Fee-based client assets1 $ 1,046 $ 1,045 Trading 279 848 861 (67)% (2)% Fee-based client assets as a Investments 1 3—(67)% N/M percentage of total client assets 45% 44% Commissions and fees 1,804 1,737 1,745 4% —% Client liabilities2 $83$80 Asset management 10,158 9,342 8,454 9% 11% Investment securities portfolio $ 68.6 $ 59.2 Other 248 268 277 (7)% (3)% Loans and lending commitments $ 82.9 $ 77.3 Total non-interest revenues 12,965 12,731 11,821 2% 8% Wealth Management representatives 15,694 15,712 Interest income 5,498 4,591 3,888 20% 18% 2018 2017 2016 Interest expense 1,221 486 359 151% 35% Per representative: Net interest 4,277 4,105 3,529 4% 16% Revenues ($ in thousands)3 $ 1,100 $ 1,068 $ 968 Net revenues 17,242 16,836 15,350 2% 10% Client assets ($ in millions)4 $ 147 $ 151 $ 133 Compensation and benefits 9,507 9,360 8,666 2% 8% Fee-based asset flows ($ in billions)5 $ 65.9 $ 75.4 $ 48.5 Non-compensation expenses 3,214 3,177 3,247 1% (2)% Total non-interest 1. Fee-based client assets represent the amount of assets in client expenses 12,721 12,537 11,913 1% 5% accounts where the basis of payment for services is a fee calculated on Income from continuing those assets. operations before income 2. Client liabilities include securities-based and tailored lending, residential real estate loans and margin lending. taxes 4,521 4,299 3,437 5% 25% 3. Revenues per representative equal Wealth Management’s net revenues Provision for income taxes 1,049 1,974 1,333 (47)% 48% divided by the average representative headcount. Net income applicable to 4. Client assets per representative equal total period-end client assets Morgan Stanley $ 3,472 $ 2,325 $ 2,104 49% 11% divided by period-end representative headcount. 5. Fee-based asset flows include net new fee-based assets, net account transfers, dividends, interest and client fees and exclude institutional 1. Effective July 1, 2016, the Institutional Securities and Wealth Manage- cash management-related activity. ment business segments entered into an agreement, whereby Institu- tional Securities assumed management of Wealth Management’s fixed Transactional Revenues income client-driven trading activities and employees. Institutional Secu- rities now pays fees to Wealth Management based on distribution % Change activity (collectively, the “Fixed Income Integration”). Results prior to the $ in millions 2018 2017 2016 2018 2017 Fixed Income Integration have not been recast for this new interseg- ment agreement due to immateriality. Investment banking $ 475 $ 533 $ 484 (11)% 10% Trading 279 848 861 (67)% (2)% Commissions and fees 1,804 1,737 1,745 4% —% Total $ 2,558 $ 3,118 $ 3,090 (18)% 1% Transactional revenues as a % of Net revenues 15% 19% 20%
39 December 2018 Form 10-K
− 277 − Management’s Discussion and Analysis
2018 Compared with 2017 Non-interest Expenses
Net Revenues Non-interest expenses of $12,721 million in 2018 increased 1% compared with 2017 primarily as a result of higher Transactional Revenues Compensation and benefits expenses.
Transactional revenues of $2,558 million in 2018 decreased • Compensation and benefits expenses increased in 2018 18% from 2017 as a result of lower Trading revenues and primarily due to the formulaic payout to Wealth Manage- Investment banking fees, partially offset by higher Commis- ment representatives linked to higher revenues and sions and fees. increases in salaries, partially offset by a decrease in the fair value of investments to which certain deferred compen- • Investment banking revenues decreased in 2018, primarily sation plans are referenced. due to lower revenues from structured product and equity issuances. • Non-compensation expenses were relatively unchanged in 2018, with increased investment in technology offset by a • Trading revenues decreased in 2018, primarily due to decrease in consulting and litigation expenses. losses related to investments associated with certain employee deferred compensation plans compared with 2017 Compared with 2016 gains in 2017, and lower fixed income fee revenues driven by product mix. Net Revenues
• Commissions and fees increased in 2018 compared with Transactional Revenues 2017 primarily as a result of increased client transactions in alternative products, options and futures, partially offset by Transactional revenues of $3,118 million in 2017 were rela- reduced activity in mutual funds. tively unchanged from 2016, as increased Investment banking revenues were offset by decreased Trading revenues. Asset Management • Investment banking revenues increased in 2017, primarily Asset management revenues of $10,158 million in 2018 due to higher revenues from structured products and equity increased 9% compared with 2017, primarily due to the effect syndicate activities, partially offset by lower preferred of higher fee-based client assets levels in 2018 on the dates stock syndicate activity. on which billings were calculated, generally the beginning of each calendar quarter. Beginning of quarter fee-based client • Trading revenues decreased in 2017, primarily due to lower assets increased in 2018 due to market appreciation and net revenues related to the Fixed Income Integration and lower positive flows, but the effect on revenues was partially offset client activity in fixed income products, partially offset by by lower average fee rates across all account types. gains on investments to which certain deferred compensa- tion plans are referenced. See “Fee-Based Client Assets Rollforwards” herein. • Commissions and fees were relatively unchanged in 2017 Net Interest compared with 2016.
Net interest of $4,277 million in 2018 increased 4% Asset Management compared with 2017, primarily as a result of higher loan interest rates and balances, partially offset by the effect of Asset management revenues of $9,342 million in 2017 higher interest rates on Deposits due to changes in our increased 11% compared with 2016, primarily due to market funding mix. appreciation and net positive flows. These increases were partially offset by decreases in average fee rates across all Other account types.
Other revenues of $248 million in 2018 decreased 7% See “Fee-Based Client Assets Rollforwards” herein. compared with 2017, primarily due to lower realized gains from the AFS securities portfolio. Net Interest
Net interest of $4,105 million in 2017 increased 16% compared with 2016, primarily due to higher loan balances and higher interest rates, partially offset by higher interest expense on deposits.
December 2018 Form 10-K 40
− 278 − Management’s Discussion and Analysis
Other Fee-Based Client Assets Rollforwards
Other revenues of $268 million in 2017 decreased 3% At At December 31, Market December 31, compared with 2016, primarily due to lower realized gains $ in billions 2017 Inflows Outflows Impact 2018 from the AFS securities portfolio. Separately managed1 $ 252 $ 40 $ (18) $ 5 $ 279 Unified managed 250 46 (31) (25) 240 Non-interest Expenses Mutual fund advisory 21 2 (3) (3) 17 Non-interest expenses of $12,537 million in 2017 increased Advisor 149 29 (28) (13) 137 5% compared with 2016 due to higher Compensation and Portfolio manager 353 71 (42) (29) 353 benefits expenses, partially offset by a decrease in Subtotal $ 1,025 $ 188 $ (122) $ (65) $ 1,026 Non-compensation expenses. Cash management 20 16 (16) — 20 Total fee-based • Compensation and benefits expenses increased in 2017, client assets $ 1,045 $ 204 $ (138) $ (65) $ 1,046 primarily due to the formulaic payout to Wealth Manage- At At ment representatives linked to higher revenues, and due to December 31, Market December 31, increases in the fair value of investments to which certain $ in billions 2016 Inflows Outflows Impact 2017 deferred compensation plans are referenced. Separately managed1 $ 222 $ 39 $ (21) $ 12 $ 252 Unified managed 204 47 (30) 29 250 • Non-compensation expenses decreased in 2017, primarily Mutual fund advisory 21 2 (4) 2 21 due to the absence of a $70 million provision recorded in Advisor 125 34 (25) 15 149 2016 related to certain brokerage service reporting activ- Portfolio manager 285 74 (41) 35 353 ities and lower litigation and information processing costs, Subtotal $ 857 $ 196 $ (121) $ 93 $ 1,025 partially offset by higher consulting fees related to strategic Cash management 20 13 (13) — 20 initiatives and higher FDIC insurance expenses. Total fee-based client assets $ 877 $ 209 $ (134) $ 93 $ 1,045 Income Tax Items At At December 31, Market December 31, The effective tax rate in 2018 is lower compared with 2017, $ in billions 2015 Inflows Outflows Impact 2016 primarily as a result of the enactment of the Tax Act. For a Separately managed1, 2 $ 283 $ 33 $ (97) $ 3 $ 222 discussion of the Tax Act, see “Supplemental Financial Infor- Unified managed2 105 107 (17) 9 204 mation and Disclosures—Income Tax Matters” herein. Mutual fund advisory 25 2 (6) — 21 Advisor 115 31 (26) 5 125 In 2017, we recognized in Provision for income taxes an Portfolio manager 252 63 (41) 11 285 intermittent net discrete tax provision of $411 million, which Subtotal $ 780 $ 236 $ (187) $ 28 $ 857 included approximately $402 million related to the enactment Cash management 15 14 (9) — 20 of the Tax Act. Total fee-based client assets $ 795 $ 250 $ (196) $ 28 $ 877 Fee-Based Client Assets
Wealth Management earns fees based on a contractual percentage of fee-based client assets related to certain account types that we offer. These fees, which we record in the Asset management line on our income statement, are earned based on the client assets in the specific account types in which the client participates and are generally not driven by asset class. For most account types, fees are billed in the first month of each quarter based on the related client assets as of the beginning of the quarter. Across the account types, fees will vary based on both the distinct services provided within each account type and on the level of household assets under supervision in Wealth Management.
41 December 2018 Form 10-K
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Average Fee Rates • Unified managed—accounts that provide the client with the ability to combine separately managed accounts, mutual Fee rate in bps 2018 2017 20163 funds and exchange-traded funds all in one aggregate 2 Separately managed 16 17 34 account. Investment decisions and discretionary authority Unified managed2 97 99 107 may be exercised by the client, financial advisor or port- Mutual fund advisory 119 120 121 folio manager. Advisor 84 86 88 Portfolio manager 95 97 101 • Mutual fund advisory—accounts that give the client the Subtotal 76 77 79 ability to systematically allocate assets across a wide range Cash management 6 66 of mutual funds. Investment decisions are made by the Total fee-based client assets 74 76 77 client. • Advisor—accounts where the investment decisions must be 1. Includes non-custody account values reflecting prior quarter-end balances due to a lag in the reporting of asset values by third-party approved by the client and the financial advisor must custodians. obtain approval each time a change is made to the account 2. A shift in client assets of approximately $66 billion in the fourth quarter or its investments. of 2016 from separately managed accounts to unified managed accounts resulted in a lower average fee rate for those platforms but did • Portfolio manager—accounts where a financial advisor has not impact the average fee rate for total fee-based client assets. 3. Certain data enhancements made in the first quarter of 2017 resulted in discretion (contractually approved by the client) to make a modification to the fee rate calculations. 2016 has been restated to ongoing investment decisions without the client’s approval reflect the revised calculations. for each individual change.
• Inflows—include new accounts, account transfers, deposits, • Cash management—accounts where the financial advisor dividends and interest. provides discretionary cash management services to institu- tional clients, whereby securities or proceeds are invested • Outflows—include closed or terminated accounts, account and reinvested in accordance with the client’s investment transfers, withdrawals and client fees. criteria. Generally, the portfolio will be invested in short- term fixed income and cash equivalent investments. • Market impact—includes realized and unrealized gains and losses on portfolio investments.
• Separately managed—accounts by which third-party and affiliated asset managers are engaged to manage clients’ assets with investment decisions made by the asset manager. Only one third-party asset manager strategy can be held per account.
December 2018 Form 10-K 42
− 280 − Management’s Discussion and Analysis Investment Management Other
Income Statement Information Other losses of $30 million in 2018 and $37 million in 2017 % Change primarily reflect an impairment of an equity method invest- $ in millions 2018 2017 2016 2018 2017 ment in a third-party asset manager in both years. Revenues Trading $25$ (22)$ (2) N/M N/M Non-interest Expenses Investments 254 449 13 (43)% N/M Commissions and fees — —3—% (100)% Non-interest expenses of $2,282 million in 2018 increased Asset management 2,468 2,196 2,063 12% 6% 7% compared with 2017, primarily due to higher Other (30) (37) 31 19% N/M Non-compensation expenses. Total non-interest revenues 2,717 2,586 2,108 5% 23% Interest income 57 45N/M (20)% • Compensation and benefits expenses decreased in 2018 Interest expense 28 41N/M N/M primarily due to decreases in the fair value of investments Net interest 29 —4N/M (100)% to which certain deferred compensation plans are refer- Net revenues 2,746 2,586 2,112 6% 22% enced and deferred compensation associated with carried Compensation and benefits 1,167 1,181 937 (1)% 26% interest, partially offset by increases in salaries and the Non-compensation expenses 1,115 949 888 17% 7% compensation deferral modification. Total non-interest expenses 2,282 2,130 1,825 7% 17% • Non-compensation expenses increased in 2018, primarily Income from continuing as a result of the gross presentation of $78 million of distri- operations before income bution fees due to the adoption of the accounting update taxes 464 456 287 2% 59% Revenue from Contracts with Customers and higher fee Provision for income taxes 73 201 75 (64)% 168% sharing on increased average AUM balances (see “Asset Income from continuing operations 391 255 212 53% 20% Management” above). Income from discontinued operations, net of income 2017 Compared with 2016 taxes 2 —2N/M (100)% Net income 393 255 214 54% 19% Net Revenues Net income applicable to noncontrolling interests 17 9 (11) 89% 182% Investments Net income applicable to Morgan Stanley $ 376 $ 246 $ 225 53% 9% Investments gains of $449 million in 2017 compared with $13 million in 2016 reflected higher carried interest and 2018 Compared with 2017 performance gains in all asset classes.
Net Revenues Asset Management
Investments Asset management revenues of $2,196 million increased 6% compared with 2016, primarily as a result of higher average Investments gains of $254 million in 2018 compared with AUM across all asset classes. This increase was partially $449 million in 2017 reflect lower carried interest in certain offset by lower effective fee rates in Alternative/Other due to infrastructure and Asia private equity funds and losses on a shift in product mix and the absence of fees recognized in seed investments in certain Alternative/Other products. 2016 related to the completion of certain fund raisings.
Asset Management See “Average AUM” herein.
Asset management revenues of $2,468 million increased 12% Other compared with 2017, primarily as a result of higher average long-term AUM. See “AUM Rollforwards” herein. Other losses of $37 million were recognized in 2017 compared with other revenues of $31 million in 2016, In addition, the adoption of the accounting update Revenue primarily as a result of an impairment of an equity method from Contracts with Customers had the effect of increasing investment in a third-party asset manager. Asset management revenues due to the gross presentation of distribution fees (approximately $78 million in 2018). See Notes 2 and 21 to the financial statements for further details.
43 December 2018 Form 10-K
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At At Non-interest Expenses December 31, Market December 31, $ in billions 2015 Inflows Outflows Impact Other 2016 Non-interest expenses of $2,130 million in 2017 increased Equity $ 83 $ 19 $ (24)$ 1 $ — $ 79 17% compared with 2016. Fixed income 60 25 (26) 2 (1) 60 Alternative/ Other 114 27 (27) 4 (3) 115 • Compensation and benefits expenses increased in 2017 due Long-term AUM to higher incentive compensation, increases in deferred subtotal 257 71 (77) 7 (4) 254 compensation associated with carried interest, and Liquidity 149 1,325 (1,310) — (1) 163 increases in the fair value of investments to which certain Total AUM $ 406 $ 1,396 $ (1,387)$ 7 $ (5)$ 417 deferred compensation plans are referenced. Shares of minority stake assets 8 8
• Non-compensation expenses increased in 2017, primarily 1. Included in Liquidity products outflows in 2018 is $18 billion related to the due to higher brokerage, clearing and exchange fees. redesign of our brokerage sweep deposits program. See “Liquidity and Capital Resources—Unsecured Financing” herein for more information. Income Tax Items Average AUM The effective tax rate in 2018, which is inclusive of an inter- $ in billions 2018 2017 2016 mittent net discrete tax benefit of $21 million, is lower Equity $ 111 $93$81 compared with 2017, primarily as a result of the enactment of Fixed income 71 66 61 the Tax Act. For a discussion of the Tax Act, see “Supple- Alternative/Other 131 122 115 mental Financial Information and Disclosures—Income Tax Long-term AUM subtotal 313 281 257 Matters” herein. Liquidity 158 157 151 Total AUM $ 471 $ 438 $ 408 In 2017, we recognized in Provision for income taxes an Shares of minority intermittent net discrete tax provision of $86 million, which stake assets 7 78 included approximately $94 million related to the enactment of the Tax Act. Average Fee Rate
Fee rate in bps 2018 2017 2016 Assets Under Management or Supervision Equity 76 73 72 AUM Rollforwards Fixed income 33 33 32 Alternative/Other 66 70 75 At At December 31, Market December 31, Long-term AUM 62 62 64 $ in billions 2017 Inflows Outflows Impact Other 2018 Equity $ 105 $ 38 $ (32)$ (8)$ — $ 103 Liquidity 17 17 18 Fixed income 73 25 (27) (2) (1) 68 Total AUM 47 46 47 Alternative/ Other 128 22 (19) (1) (2) 128 • Inflows—represent investments or commitments from new Long-term AUM subtotal 306 85 (78) (11) (3) 299 and existing clients in new or existing investment products, Liquidity1 176 1,351 (1,362) 2 (3) 164 including reinvestments of client dividends and increases in Total AUM $ 482 $ 1,436 $ (1,440)$ (9)$ (6) $ 463 invested capital. Inflows exclude the impact of exchanges, Shares of minority whereby a client changes positions within the same asset stake assets 7 7 class. At At December 31, Market December 31, $ in billions 2016 Inflows Outflows Impact Other 2017 • Outflows—represent redemptions from clients’ funds, tran- Equity $ 79 $ 23 $ (21)$ 23 $ 1 $ 105 sition of funds from the committed capital period to the Fixed income 60 27 (21) 4 3 73 invested capital period and decreases in invested capital. Alternative/ Outflows exclude the impact of exchanges, whereby a Other 115 24 (18) 8 (1) 128 client changes positions within the same asset class. Long-term AUM subtotal 254 74 (60) 35 3 306 Liquidity 163 1,239 (1,227) 1 — 176 • Market impact—includes realized and unrealized gains and Total AUM $ 417 $ 1,313 $ (1,287)$ 36 $ 3 $ 482 losses on portfolio investments. This excludes any funds Shares of minority where market impact does not impact management fees. stake assets 87 • Other—contains both distributions and foreign currency impact for all periods and the impact of the Mesa West Capital, LLC acquisition in 2018. Distributions represent decreases in invested capital due to returns of capital after
December 2018 Form 10-K 44
− 282 − Management’s Discussion and Analysis
the investment period of a fund. It also includes fund divi- factors. The Tax Act, enacted on December 22, 2017, signifi- dends that the client has not reinvested. Foreign currency cantly revised U.S. corporate income tax law by reducing the impact reflects foreign currency changes for non-U.S. corporate income tax rate to 21%, partially or wholly elimi- dollar denominated funds. nating tax deductions for certain expenses and implementing a modified territorial tax system. The modified territorial tax • Alternative/Other—includes products in fund of funds, real system includes a one-time transition tax on deemed repatri- assets, private equity and credit strategies, as well as multi- ated earnings of non-U.S. subsidiaries and also imposes a asset portfolios. minimum tax on GILTI and an alternative BEAT on U.S. corporations with operations outside of the U.S. The U.S. Trea- • Shares of minority stake assets—represent the Investment sury Department has issued proposed regulations and guidance Management business segment’s proportional share of on certain provisions in the Tax Act during 2018, although assets managed by third-party asset managers in which we some of these regulations have not yet been finalized, and are, hold investments accounted for under the equity method. therefore, still subject to change. Our income tax estimates may • Average fee rate—based on Asset management revenues, change as additional clarification and implementation guidance net of waivers. It excludes performance-based fees and continue to be received from the U.S. Treasury Department and other non-management fees. For certain non-U.S. funds, it as the interpretation of the Tax Act evolves over time. includes the portion of advisory fees that the advisor collects on behalf of third-party distributors. The payment 2017 of those fees to the distributor is included in The effective tax rate from continuing operations for 2017 Non-compensation expenses in the income statements. included an intermittent net discrete tax provision of Supplemental Financial Information and $968 million, primarily related to the impact of the Tax Act, partially offset by net discrete tax benefits primarily associ- Disclosures ated with the remeasurement of reserves and related interest Income Tax Matters due to new information regarding the status of multi-year IRS tax examinations. Effective Tax Rate from Continuing Operations We recorded an approximate $1.2 billion net discrete tax $ in millions 2018 2017 2016 provision as a result of the enactment of the Tax Act, U.S. GAAP 20.9% 40.1% 30.8% primarily from the remeasurement of certain deferred tax Adjusted effective income tax rate—non-GAAP1 22.7% 30.8% 31.6% assets using the lower enacted corporate tax rate. This provi- Net discrete tax provisions/(benefits) sion incorporated the best available information as of the Recurring2 $ (165) $ (155) $ — enactment date, as well as assumptions made based upon our Intermittent3 $ (203) $ 968 $ (68) interpretation of the Tax Act.
1. Adjusted effective income tax rate is a non-GAAP measure that excludes intermit- 2016 tent net discrete tax provisions (benefits). For further information on non-GAAP measures, see “Selected Non-GAAP Financial Information” herein. 2. Beginning in 2017, with the adoption of the accounting update Improvements to The effective tax rate from continuing operations for 2016 Employee Share-Based Payment Accounting, the income tax consequences asso- ciated with employee share-based awards are recognized in Provision for income included intermittent net discrete tax benefits of $68 million, taxes in the income statements. We consider these employee share-based award primarily related to the remeasurement of reserves and related related provisions (benefits) to be recurring-type (“Recurring”) discrete tax items, as interest due to new information regarding the status of multi- we anticipate some level of conversion activity each year. Accordingly, these Recurring discrete tax provisions (benefits) are excluded from the intermittent net year IRS tax examinations, partially offset by adjustments for discrete tax provisions (benefits) adjustment. other tax matters. 3. Includes all tax provisions (benefits) that have been determined to be discrete, other than Recurring items as defined above. U.S. Bank Subsidiaries 2018 Our U.S. bank subsidiaries, Morgan Stanley Bank N.A. The effective tax rate from continuing operations for 2018 (“MSBNA”) and Morgan Stanley Private Bank, National includes intermittent net discrete tax benefits of $203 million, Association (“MSPBNA”) (collectively, “U.S. Bank Subsidi- primarily associated with the remeasurement of reserves and aries”) accept deposit accounts, provide loans to a variety of related interest due to the resolution of multi-jurisdiction tax customers, from large corporate and institutional clients to examinations. high net worth individuals, and invest in securities. The lending activities in the Institutional Securities business The effective tax rate reflects our current assumptions, esti- segment primarily include loans and lending commitments to mates and interpretations related to the Tax Act and other corporate clients. The lending activities in the Wealth
45 December 2018 Form 10-K
− 283 − Management’s Discussion and Analysis
Management business segment primarily include securities- • Leases. This accounting update requires lessees to recog- based lending, which allows clients to borrow money against nize all leases with terms exceeding one year in the balance the value of qualifying securities, and residential real estate sheet, which results in the recognition of a right of use asset loans. and corresponding lease liability, including for those leases that we currently classify as operating leases. The We expect our lending activities to continue to grow through accounting for leases where we are the lessor is largely further market penetration of our client base. For a further unchanged. discussion of our credit risks, see “Quantitative and Qualita- tive Disclosures about Risk—Credit Risk.” For a further The right of use asset and lease liability were initially discussion about loans and lending commitments, see Notes 7 measured using the present value of the remaining rental and 12 to the financial statements. payments. We adopted this accounting update through a cumulative-effect adjustment to retained earnings. U.S. Bank Subsidiaries’ Supplemental Financial Information1 At At At transition on January 1, 2019, the adoption of this stan- December 31, December 31, $ in billions 2018 2017 dard resulted in a balance sheet gross-up of approximately Assets $ 216.9 $ 185.3 $4 billion reflected in Other assets and Other liabilities and accrued expenses. In addition, previously deferred gains Investment securities portfolio: from sale-leaseback transactions of approximately Investment securities—AFS 45.5 42.0 $60 million were recognized directly into retained earnings. Investment securities—HTM 23.7 17.5 Prior period amounts were not restated. Total investment securities $ 69.2 $ 59.5 Deposits2 $ 187.1 $ 159.1 The following accounting update is currently being evaluated to determine the potential impact of adoption: Wealth Management Securities-based lending and other loans3 $ 44.7 $ 41.2 • Financial Instruments–Credit Losses. This accounting Residential real estate loans 27.5 26.7 update impacts the impairment model for certain financial Total $ 72.2 $ 67.9 assets measured at amortized cost by requiring a CECL methodology to estimate expected credit losses over the Institutional Securities entire life of the financial asset, recorded at inception or Corporate loans $ 30.9 $ 24.2 purchase. CECL will replace the loss model currently Wholesale real estate loans 10.5 12.2 applicable to loans held for investment, HTM securities Total $ 41.4 $ 36.4 and other receivables carried at amortized cost, such as employee loans. 1. Amounts exclude transactions between the bank subsidiaries, as well as deposits from the Parent Company and affiliates. 2. For further information on deposits, see “Liquidity and Capital The update also eliminates the concept of other-than- Resources—Funding Management—Unsecured Financing” herein. temporary impairment for AFS securities. Impairments on 3. Other loans primarily include tailored lending. AFS securities will be required to be recognized in earn- ings through an allowance when the fair value is less than Accounting Development Updates amortized cost and a credit loss exists or the securities are expected to be sold before recovery of amortized cost. The Financial Accounting Standards Board has issued certain accounting updates that apply to us. Accounting updates not Under the update, there may be an ability to determine listed below were assessed and determined to be either not there are no expected credit losses in certain circumstances, applicable or are not expected to have a significant impact on e.g., based on collateral arrangements for lending and our financial statements. financing transactions or based on the credit quality of the borrower or issuer. The following accounting updates were adopted on January 1, 2019: Based on preliminary estimates, we expect the impact from the adoption of this standard will primarily result from the • Derivatives and Hedging (ASU 2018-16). The amendments employee loans, wholesale real estate, corporate and resi- in this update permit use of the OIS rate based on the dential real estate portfolios. The models we expect to use Secured Overnight Financing Rate as a U.S. benchmark for these portfolios are in the process of being tested. This interest rate for hedge accounting purposes. We adopted update is effective as of January 1, 2020. this update on a prospective basis for qualifying new or redesignated hedging relationships; this update does not impact our existing hedges.
December 2018 Form 10-K 46
− 284 − Management’s Discussion and Analysis Critical Accounting Policies In periods of market disruption, the observability of prices and inputs may be reduced for many instruments, which Our financial statements are prepared in accordance with U.S. could cause an instrument to be recategorized from Level 1 to GAAP, which requires us to make estimates and assumptions Level 2 or from Level 2 to Level 3. In addition, a downturn in (see Note 1 to the financial statements). We believe that of market conditions could lead to declines in the valuation of our significant accounting policies (see Note 2 to the finan- many instruments. For further information on the definition cial statements), the following policies involve a higher of fair value, Level 1, Level 2, Level 3 and related valuation degree of judgment and complexity. techniques, and quantitative information about and sensitivity of significant unobservable inputs used in Level 3 fair value Fair Value measurements, see Notes 2 and 3 to the financial statements.
Financial Instruments Measured at Fair Value Where appropriate, valuation adjustments are made to account for various factors such as liquidity risk (bid-ask A significant number of our financial instruments are carried adjustments), credit quality, model uncertainty and concentra- at fair value. We make estimates regarding the valuation of tion risk in order to arrive at fair value. For a further discus- assets and liabilities measured at fair value in preparing the sion of valuation adjustments that we apply, see Note 2 to the financial statements. These assets and liabilities include, but financial statements. are not limited to: Assets and Liabilities Measured at Fair Value on a • Trading assets and Trading liabilities; Non-recurring Basis
• Investment Securities—AFS securities; Certain of our assets and liabilities are measured at fair value on a non-recurring basis, primarily relating to loans, other • Certain Securities purchased under agreements to resell; investments, premises, equipment and software costs, intan- • Certain Deposits, primarily structured certificates of gible assets, other assets, and other liabilities and accrued deposits; expenses. We incur losses or gains for any adjustments of these assets to fair value. A downturn in market conditions • Certain Securities sold under agreements to repurchase; could result in impairment charges in future periods.
• Certain Other secured financings; and For assets and liabilities measured at fair value on a non-recurring basis, fair value is determined by using various • Certain Borrowings, primarily structured notes. valuation approaches. The same hierarchy as described above, which maximizes the use of observable inputs and Fair value is defined as the price that would be received to minimizes the use of unobservable inputs by generally sell an asset or paid to transfer a liability (i.e., the exit price) requiring that the observable inputs be used when available, in an orderly transaction between market participants at the is used in measuring fair value for these items. measurement date. See Note 3 to the financial statements for further information In determining fair value, we use various valuation on assets and liabilities that are measured at fair value on a approaches. A hierarchy for inputs is used in measuring fair non-recurring basis. value that maximizes the use of observable prices and inputs and minimizes the use of unobservable prices and inputs by Goodwill and Intangible Assets requiring that the relevant observable inputs be used when available. The hierarchy is broken down into three levels, Goodwill wherein Level 1 represents quoted prices in active markets, Level 2 represents valuations based on quoted prices in Evaluating goodwill for impairment requires management to markets that are not active or for which all significant inputs make significant judgments. Goodwill impairment tests are are observable, and Level 3 consists of valuation techniques performed at the reporting unit level, which is generally at the that incorporate significant unobservable inputs and, there- level of or one level below our business segments. Goodwill fore, require the greatest use of judgment. no longer retains its association with a particular acquisition once it has been assigned to a reporting unit. As such, all the activities of a reporting unit, whether acquired or organically developed, are available to support the value of the goodwill.
47 December 2018 Form 10-K
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We test goodwill for impairment on an annual basis as of Legal and Regulatory Contingencies July 1 and on an interim basis when certain events or circum- stances exist. In the normal course of business, we have been named, from time to time, as a defendant in various legal actions, including For both the annual and interim tests, we have the option to arbitrations, class actions and other litigation, arising in either (i) perform a quantitative impairment test or (ii) first connection with our activities as a global diversified financial perform a qualitative assessment to determine whether it is services institution. more likely than not that the fair value of a reporting unit is less than its carrying amount, in which case the quantitative Certain of the actual or threatened legal actions include test would be performed. claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages. In some When performing a quantitative impairment test, we compare cases, the entities that would otherwise be the primary defen- the fair value of a reporting unit with its carrying amount, dants in such cases are bankrupt or in financial distress. including goodwill. If the fair value of the reporting unit is less than its carrying amount, the goodwill impairment loss is We are also involved, from time to time, in other reviews, equal to the excess of the carrying value over the fair value, investigations and proceedings (both formal and informal) by limited by the carrying amount of goodwill allocated to that governmental and self-regulatory agencies regarding our reporting unit. business and involving, among other matters, sales and trading activities, wealth and investment management The estimated fair value of the reporting units is derived services, financial products or offerings sponsored, under- based on valuation techniques we believe market participants written or sold by us, and accounting and operational matters, would use for each of the reporting units. The estimated fair certain of which may result in adverse judgments, settle- value is generally determined by utilizing a discounted cash ments, fines, penalties, injunctions or other relief. flow methodology or methodologies that incorporate price-to-book and price-to-earnings multiples of certain Accruals for litigation and regulatory proceedings are gener- comparable companies. At each annual goodwill impairment ally determined on a case-by-case basis. Where available testing date, each of our reporting units with goodwill had a information indicates that it is probable a liability had been fair value that was substantially in excess of its carrying incurred at the date of the financial statements and we can value. reasonably estimate the amount of that loss, we accrue the estimated loss by a charge to income. In many proceedings, Intangible Assets however, it is inherently difficult to determine whether any loss is probable or even possible or to estimate the amount of Amortizable intangible assets are amortized over their esti- any loss. mated useful lives and are reviewed for impairment on an interim basis when certain events or circumstances exist. An For certain legal proceedings and investigations, we can esti- impairment exists when the carrying amount of the intangible mate possible losses, additional losses, ranges of loss or asset exceeds its fair value. An impairment loss will be recog- ranges of additional loss in excess of amounts accrued. For nized if the carrying amount of the intangible asset is not certain other legal proceedings and investigations, we cannot recoverable and exceeds its fair value. The carrying amount reasonably estimate such losses, particularly for proceedings of the intangible asset is not recoverable if it exceeds the sum and investigations where the factual record is being devel- of the expected undiscounted cash flows. oped or contested or where plaintiffs or government entities seek substantial or indeterminate damages, restitution, For both goodwill and intangible assets, to the extent an disgorgement or penalties. impairment loss is recognized, the loss establishes the new cost basis of the asset. Subsequent reversal of impairment Numerous issues may need to be resolved before a loss or losses is not permitted. For amortizable intangible assets, the additional loss or range of loss or additional range of loss can new cost basis is amortized over the remaining useful life of be reasonably estimated for a proceeding or investigation, that asset. Adverse market or economic events could result in including through potentially lengthy discovery and determi- impairment charges in future periods. nation of important factual matters, determination of issues related to class certification and the calculation of damages or See Notes 2, 3 and 9 to the financial statements for additional other relief, and addressing novel or unsettled legal questions information about goodwill and intangible assets. relevant to the proceedings or investigations in question.
December 2018 Form 10-K 48
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Significant judgment is required in deciding when and if to Once the deferred tax asset balances have been determined, make these accruals, and the actual cost of a legal claim or we may record a valuation allowance against the deferred tax regulatory fine/penalty may ultimately be materially different asset balances to reflect the amount we estimate is more from the recorded accruals. likely than not to be realized at a future date. Both current and deferred income taxes may reflect adjustments related to our See Note 12 to the financial statements for additional infor- unrecognized tax benefits. mation on legal proceedings. Significant judgment is required in estimating the consoli- Income Taxes dated provision for (benefit from) income taxes, current and deferred tax balances (including valuation allowance, if any), We are subject to the income and indirect tax laws of the accrued interest or penalties and uncertain tax positions. U.S., its states and municipalities and those of the foreign Revisions in estimates and/or the actual costs of a tax assess- jurisdictions in which we have significant business opera- ment may ultimately be materially different from the tions. These tax laws are complex and subject to different recorded accruals and unrecognized tax benefits, if any. interpretations by the taxpayer and the relevant governmental taxing authorities. We must make judgments and interpreta- See Note 2 to the financial statements for additional informa- tions about the application of these inherently complex tax tion on our significant assumptions, judgments and interpreta- laws when determining the provision for income taxes and tions associated with the accounting for income taxes and the expense for indirect taxes and must also make estimates Note 20 to the financial statements for additional information about when certain items affect taxable income in the various on our tax examinations. tax jurisdictions.
Disputes over interpretations of the tax laws may be settled Liquidity and Capital Resources with the taxing authority upon examination or audit. We peri- Senior management, with oversight by the Asset/Liability odically evaluate the likelihood of assessments in each taxing Management Committee and the Board of Directors jurisdiction resulting from current and subsequent years’ (“Board”), establishes and maintains our liquidity and capital examinations, and unrecognized tax benefits related to poten- policies. Through various risk and control committees, senior tial losses that may arise from tax audits are established in management reviews business performance relative to these accordance with the relevant accounting guidance. Once policies, monitors the availability of alternative sources of established, unrecognized tax benefits are adjusted when financing, and oversees the liquidity, interest rate and there is more information available or when an event occurs currency sensitivity of our asset and liability position. The requiring a change. Treasury department, Firm Risk Committee, Asset/Liability Management Committee, and other committees and control Our provision for income taxes is composed of current and groups assist in evaluating, monitoring and controlling the deferred taxes. Current income taxes approximate taxes to be impact that our business activities have on our balance sheet, paid or refunded for the current period. Deferred income liquidity and capital structure. Liquidity and capital matters taxes reflect the net tax effects of temporary differences are reported regularly to the Board and the Risk Committee between the financial reporting and tax bases of assets and of the Board. liabilities and are measured using the applicable enacted tax rates and laws that will be in effect when such differences are expected to reverse. Balance Sheet
Our deferred tax balances may also include deferred assets We monitor and evaluate the composition and size of our related to tax attribute carryforwards, such as net operating balance sheet on a regular basis. Our balance sheet manage- losses and tax credits that will be realized through reduction ment process includes quarterly planning, business-specific of future tax liabilities and, in some cases, are subject to expi- thresholds, monitoring of business-specific usage versus key ration if not utilized within certain periods. We perform performance metrics and new business impact assessments. regular reviews to ascertain whether deferred tax assets are realizable. These reviews include management’s estimates We establish balance sheet thresholds at the consolidated and and assumptions regarding future taxable income and incor- business segment levels. We monitor balance sheet utilization porate various tax planning strategies, including strategies and review variances resulting from business activity and that may be available to tax attribute carryforwards before market fluctuations. On a regular basis, we review current they expire. performance versus established thresholds and assess the need to re-allocate our balance sheet based on business unit needs. We also monitor key metrics, including asset and liability size and capital usage.
49 December 2018 Form 10-K
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Total Assets by Business Segment Liquidity Risk Management Framework
At December 31, 2018 $ in millions IS WM IM Total The primary goal of our Liquidity Risk Management Framework Assets is to ensure that we have access to adequate funding across a Cash and cash equivalents1 $ 69,526 $ 17,621 $ 49 $ 87,196 wide range of market conditions and time horizons. The frame- Trading assets at fair value 263,870 60 2,369 266,299 work is designed to enable us to fulfill our financial obligations Investment securities 23,273 68,559 — 91,832 and support the execution of our business strategies. Securities purchased under agreements to resell 80,660 17,862 — 98,522 The following principles guide our Liquidity Risk Manage- Securities borrowed 116,207 106 — 116,313 ment Framework: Customer and other • Sufficient liquid assets should be maintained to cover receivables 35,777 16,865 656 53,298 maturing liabilities and other planned and contingent Loans, net of allowance2 43,380 72,194 5 115,579 outflows; Other assets3 13,734 9,125 1,633 24,492 Total assets $ 646,427 $ 202,392 $ 4,712 $ 853,531 • Maturity profile of assets and liabilities should be aligned, with limited reliance on short-term funding; At December 31, 2017 $ in millions IS WM IM Total • Source, counterparty, currency, region and term of funding Assets should be diversified; and Cash and cash equivalents1 $ 63,597 $ 16,733 $ 65 $ 80,395 • Liquidity Stress Tests should anticipate, and account for, Trading assets at fair value 295,678 59 2,545 298,282 periods of limited access to funding. Investment securities 19,556 59,246 — 78,802 Securities purchased under The core components of our Liquidity Risk Management agreements to resell 74,732 9,526 — 84,258 Framework are the Required Liquidity Framework, Liquidity Securities borrowed 123,776 234 — 124,010 Stress Tests and the GLR, which support our target liquidity Customer and other profile. receivables 36,803 18,763 621 56,187 Loans, net of allowance2 36,269 67,852 5 104,126 Required Liquidity Framework Other assets3 14,563 9,596 1,514 25,673 Total assets $ 664,974 $ 182,009 $ 4,750 $ 851,733 Our Required Liquidity Framework establishes the amount of liquidity we must hold in both normal and stressed environ- IS—Institutional Securities WM—Wealth Management ments to ensure that our financial condition and overall sound- IM—Investment Management ness are not adversely affected by an inability (or perceived 1. Cash and cash equivalents includes Cash and due from banks, Interest bearing inability) to meet our financial obligations in a timely manner. deposits with banks and Restricted cash. 2. Amounts include loans held for investment (net of allowance) and loans held for The Required Liquidity Framework considers the most sale but exclude loans at fair value, which are included in Trading assets in the constraining liquidity requirement to satisfy all regulatory and balance sheets (see Note 7 to the financial statements). 3. Other assets primarily includes Goodwill, Intangible assets, premises, equipment, internal limits at a consolidated and legal entity level. software, other investments and deferred tax assets. Liquidity Stress Tests A substantial portion of total assets consists of liquid market- able securities and short-term receivables arising principally We use Liquidity Stress Tests to model external and intercom- from sales and trading activities in the Institutional Securities pany liquidity flows across multiple scenarios and a range of business segment. Total assets of $853.5 billion at time horizons. These scenarios contain various combinations of December 31, 2018 were relatively unchanged compared idiosyncratic and systemic stress events of different severity with $851.7 billion at December 31, 2017. In 2018, Loans and duration. The methodology, implementation, production increased in the Institutional Securities and Wealth Manage- and analysis of our Liquidity Stress Tests are important ment business segments; deposit growth in the Wealth components of the Required Liquidity Framework. Management business segment led to increases in Investment securities and Securities purchased under agreements to The assumptions used by us in our various Liquidity Stress resell; Trading assets within the Institutional Securities busi- Test scenarios include, but are not limited to, the following: ness segment declined due to reductions in Equities inven- • No government support; tory, which resulted in greater liquidity, as reflected by increases in Cash and cash equivalents and Securities • No access to equity and unsecured debt markets; purchased under agreements to resell; and Securities • Repayment of all unsecured debt maturing within the stress borrowed within the Institutional Securities business segment horizon; decreased due to lower client balances and Trading liabilities.
December 2018 Form 10-K 50
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• Higher haircuts for and significantly lower availability of from trading assets, investment securities and securities secured funding; received as collateral.
• Additional collateral that would be required by trading GLR by Type of Investment counterparties, certain exchanges and clearing organiza- At At tions related to credit rating downgrades; December 31, December 31, $ in millions 2018 2017 • Additional collateral that would be required due to collateral Cash deposits with banks1 $ 10,441 $ 7,167 substitutions, collateral disputes and uncalled collateral; Cash deposits with central banks1 36,109 33,791 • Discretionary unsecured debt buybacks; Unencumbered highly liquid securities: U.S. government obligations 119,138 73,422 • Drawdowns on lending commitments provided to third U.S. agency and agency mortgage- parties; and backed securities 41,473 55,750 • Client cash withdrawals and reduction in customer short Non-U.S. sovereign obligations2 39,869 19,424 positions that fund long positions. Other investment grade securities 2,705 3,106 Total $ 249,735 $ 192,660 Liquidity Stress Tests are produced and results are reported at 1. Included in Cash and due from banks and Interest bearing deposits with banks in different levels, including major operating subsidiaries and the balance sheets. major currencies, to capture specific cash requirements and 2. Primarily composed of unencumbered Japanese, U.K., German, Brazilian and cash availability across the Firm, including a limited number French government obligations. of asset sales in a stressed environment. The Liquidity Stress GLR Managed by Bank and Non-Bank Legal Entities Tests assume that subsidiaries will use their own liquidity At At Average Daily Balance first to fund their obligations before drawing liquidity from December 31, December 31, Three Months Ended the Parent Company and that the Parent Company will $ in millions 2018 2017 December 31, 2018 support its subsidiaries and will not have access to subsidiar- Bank legal entities ies’ liquidity reserves. In addition to the assumptions under- Domestic $ 88,809 $ 70,364 $ 79,824 pinning the Liquidity Stress Tests, we take into consideration Foreign 4,896 4,756 4,691 settlement risk related to intraday settlement and clearing of Total Bank legal entities 93,705 75,120 84,515 securities and financing activities. Non-Bank legal entities Domestic: At December 31, 2018 and December 31, 2017, Parent Company 64,262 41,642 62,315 we maintained sufficient liquidity to meet current and contin- Non-Parent Company 40,936 35,264 36,501 gent funding obligations as modeled in our Liquidity Stress Total Domestic 105,198 76,906 98,816 Tests. Foreign 50,832 40,634 57,957 Total Non-Bank legal entities 156,030 117,540 156,773 Global Liquidity Reserve Total $ 249,735 $ 192,660 $ 241,288 We maintain sufficient liquidity reserves to cover daily funding needs and to meet strategic liquidity targets sized by Regulatory Liquidity Framework the Required Liquidity Framework and Liquidity Stress Tests. The size of the GLR is actively managed by us consid- Liquidity Coverage Ratio ering the following components: unsecured debt maturity We and our U.S. Bank Subsidiaries are subject to LCR require- profile; balance sheet size and composition; funding needs in ments, including a requirement to calculate each entity’s LCR a stressed environment, inclusive of contingent cash on each business day. The requirements are designed to ensure outflows; legal entity, regional and segment liquidity require- that banking organizations have sufficient HQLA to cover net ments; regulatory requirements; and collateral requirements. cash outflows arising from significant stress over 30 calendar In addition, our GLR includes a discretionary surplus based days, thus promoting the short-term resilience of the liquidity on risk tolerance and is subject to change depending on risk profile of banking organizations. market and Firm-specific events. The GLR is held within the Parent Company and its major operating subsidiaries. The GLR consists of cash and unencumbered securities sourced
51 December 2018 Form 10-K
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The regulatory definition of HQLA is substantially the same potential impact of the proposal, which is subject to further as our GLR. GLR includes cash placed at institutions other rulemaking procedures. Our preliminary estimates, based on than central banks that is considered an inflow for LCR the current proposal, indicate that actions will be necessary to purposes. HQLA includes a portion of cash placed at central meet the requirement, which we would expect to accomplish banks, certain unencumbered investment grade corporate by the effective date of any final rule. Our preliminary esti- bonds and publicly traded common equities, which do not mates are subject to risks and uncertainties that may cause meet the definition of our GLR. actual results based on the final rule to differ materially from estimates. For a discussion of risks and uncertainties that may Based on our daily calculations, we and our U.S. Bank affect our future results, see “Risk Factors.” Subsidiaries are compliant with the minimum required LCR of 100%. Funding Management
HQLA by Type of Asset and LCR We manage our funding in a manner that reduces the risk of disruption to our operations. We pursue a strategy of diversi- Average Daily Balance Three Months Ended fication of secured and unsecured funding sources (by December 31, September 30, product, investor and region) and attempt to ensure that the $ in millions 2018 2018 tenor of our liabilities equals or exceeds the expected holding HQLA period of the assets being financed. Cash deposits with central banks $ 44,225 $ 48,962 Securities1 150,792 140,060 We fund our balance sheet on a global basis through diverse Total $ 195,017 $ 189,022 sources. These sources include our equity capital, borrow- LCR 145% 135% ings, securities sold under agreements to repurchase, securi-
1. Primarily includes U.S. Treasuries, U.S. agency mortgage-backed securities, sover- ties lending, deposits, letters of credit and lines of credit. We eign bonds and investment grade corporate bonds. have active financing programs for both standard and struc- tured products targeting global investors and currencies. The increase in the LCR in the quarter ended December 31, 2018 is due to increased HQLA consistent with higher Secured Financing liquidity levels, and a reduction in net outflows (i.e., the The liquid nature of the marketable securities and short-term denominator of the ratio), primarily driven by lower secured receivables arising principally from sales and trading activ- funding and lending commitment outflows. ities in the Institutional Securities business segment provides The Firm’s calculations are based on our current under- us with flexibility in managing the composition and size of standing of the LCR and other factors, which may be subject our balance sheet. Our goal is to achieve an optimal mix of to change as we receive additional clarification and imple- durable secured and unsecured financing. Secured financing mentation guidance from regulators and as the interpretation investors principally focus on the quality of the eligible of the LCR evolves over time. collateral posted. Accordingly, we actively manage our secured financings based on the quality of the assets being Net Stable Funding Ratio funded.
The objective of the NSFR is to reduce funding risk over a We have established longer tenor secured funding require- one-year horizon by requiring banking organizations to fund ments for less liquid asset classes, for which funding may be their activities with sufficiently stable sources of funding in at risk in the event of a market disruption. We define highly order to mitigate the risk of future funding stress. liquid assets as government-issued or government-guaranteed securities with a high degree of fundability and less liquid The Basel Committee on Banking Supervision (“Basel assets as those that do not meet these criteria. Committee”) has previously finalized the NSFR framework. In May 2016, the U.S. banking agencies issued a proposal to To further minimize the refinancing risk of secured financing implement the NSFR in the U.S. The proposal would require for less liquid assets, we have established concentration limits a covered company to maintain an amount of available stable to diversify our investor base and reduce the amount of funding, which is measured with reference to sources of monthly maturities for secured financing of less liquid assets. funding, including deposit and debt liabilities, that is no less Furthermore, we obtain term secured funding liabilities in than the amount of its required stable funding, which is excess of less liquid inventory as an additional risk mitigant measured by applying standardized weightings to its assets, to replace maturing trades in the event that secured financing derivatives exposures and certain other items. markets, or our ability to access them, become limited. As a component of the Liquidity Risk Management Framework, If adopted as proposed, the requirements would apply to us we hold a portion of our GLR against the potential disruption and our U.S. Bank Subsidiaries. We continue to evaluate the to our secured financing capabilities.
December 2018 Form 10-K 52
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We generally maintain a pool of liquid and easily fundable our interest rate and structured borrowings risk profile (see securities, which takes into account HQLA classifications Note 4 to the financial statements). consistent with LCR definitions, and other regulatory require- ments, and provides a valuable future source of liquidity. Deposits At At Collateralized Financing Transactions December 31, December 31, $ in millions 2018 2017 At At December 31, December 31, Savings and demand deposits: $ in millions 2018 2017 Brokerage sweep deposits1 $ 141,255 $ 135,946 Securities purchased under agreements to resell and Securities borrowed $ 214,835 $ 208,268 Savings and other 13,642 8,541 Securities sold under agreements to Total Savings and demand deposits 154,897 144,487 repurchase and Securities loaned $ 61,667 $ 70,016 Time deposits 32,923 14,949 Securities received as collateral1 $ 7,668 $ 13,749 Total $ 187,820 $ 159,436 Average Daily Balance Three Months Ended 1. Amounts represent balances swept from client brokerage accounts. December 31, December 31, $ in millions 2018 2017 Deposits are primarily sourced from our Wealth Management Securities purchased under agreements clients and are considered to have stable, low-cost funding to resell and Securities borrowed $ 213,974 $ 214,343 characteristics. Total deposits at December 31, 2018 Securities sold under agreements to repurchase and Securities loaned $ 57,677 $ 66,879 increased compared with December 31, 2017, driven by increases in Time deposits, which primarily consist of 1. Securities received as collateral are included in Trading assets in the balance sheets. brokered certificates of deposit with fixed interest rates and maturity dates. The increase in Brokerage sweep deposits See Notes 2 and 6 to the financial statements for more details reflects the redesign of our brokerage sweep deposit program on collateralized financing transactions. in 2018, resulting in inflows of approximately $18 billion, partially offset by client deployment of cash into investments In addition to the collateralized financing transactions shown in throughout the year. The increase in Savings and other the previous table, we engage in financing transactions collat- deposits was driven by promotional client offerings. eralized by customer-owned securities, which are segregated in accordance with regulatory requirements. Receivables under The inflows related to the redesign of our brokerage sweep these financing transactions, primarily margin loans, are deposit program corresponded with outflows from Liquidity included in Customer and other receivables in the balance products AUM in the Investment Management business sheets, and payables under these financing transactions, segment (see “Business Segments—Investment Manage- primarily to prime brokerage customers, are included in ment—Assets Under Management or Supervision” for more Customer and other payables in the balance sheets. Our risk information). exposure on these transactions is mitigated by collateral main- 1 tenance policies that limit our credit exposure to customers and Borrowings by Remaining Maturity at December 31, 2018 liquidity reserves held against this risk exposure. Parent $ in millions Company Subsidiaries Total Unsecured Financing Original maturities of one year or less $ — $ 1,545 $ 1,545 We view deposits and borrowings as stable sources of Original maturities greater than one year funding for unencumbered securities and non-security assets. 2019 $ 19,849 $ 4,845 $ 24,694 Our unsecured financings include structured borrowings, 2020 18,575 2,705 21,280 which are primarily composed of: instruments whose 2021 21,208 3,434 24,642 payments and redemption values are linked to the perfor- 2022 14,969 1,816 16,785 mance of a specific index, a basket of stocks, a specific equity 2023 11,553 2,385 13,938 security, a commodity, a credit exposure or basket of credit exposures; and instruments with various interest-rate-related Thereafter 70,093 16,685 86,778 features, including step-ups, step-downs and zero coupons. Total $156,247 $ 31,870 $188,117 When appropriate, we may use derivative products to conduct Total Borrowings $156,247 $ 33,415 $189,662 asset and liability management and to make adjustments to 1. Original maturity in the table is generally based on contractual final maturity. For borrowings with put options, remaining maturity represents the earliest put date.
53 December 2018 Form 10-K
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Borrowings of $189,662 million as of December 31, 2018 Parent Company and MSBNA Senior Unsecured Ratings at remained relatively unchanged compared with $192,582 million February 21, 2019 at December 31, 2017. Parent Company Short-Term Long-Term Rating We believe that accessing debt investors through multiple Debt Debt Outlook distribution channels helps provide consistent access to the DBRS, Inc. R-1 (middle) A (high) Stable unsecured markets. In addition, the issuance of borrowings Fitch Ratings, Inc. F1 A Stable with original maturities greater than one year allows us to Moody’s Investors Service, Inc. P-2 A3 Stable reduce reliance on short-term credit sensitive instruments. Rating and Investment Information, Inc. a-1 A- Positive Borrowings with original maturities greater than one year are S&P Global Ratings A-2 BBB+ Stable generally managed to achieve staggered maturities, thereby mitigating refinancing risk, and to maximize investor diversi- MSBNA fication through sales to global institutional and retail clients Short-Term Long-Term Rating across regions, currencies and product types. Debt Debt Outlook Fitch Ratings, Inc. F1 A+ Stable The availability and cost of financing to us can vary Moody’s Investors Service, Inc. P-1 A1 Stable depending on market conditions, the volume of certain S&P Global Ratings A-1 A+ Stable trading and lending activities, our credit ratings and the overall availability of credit. We also engage in, and may Incremental Collateral or Terminating Payments continue to engage in, repurchases of our borrowings in the ordinary course of business. In connection with certain OTC derivatives and certain other agreements where we are a liquidity provider to certain For further information on Borrowings, see Note 11 to the financing vehicles associated with the Institutional Securities financial statements. business segment, we may be required to provide additional collateral, immediately settle any outstanding liability Credit Ratings balances with certain counterparties or pledge additional collateral to certain clearing organizations in the event of a We rely on external sources to finance a significant portion of future credit rating downgrade irrespective of whether we are our daily operations. The cost and availability of financing in a net asset or net liability position. See Note 4 to the finan- generally are impacted by our credit ratings, among other cial statements for additional information on OTC derivatives things. In addition, our credit ratings can have an impact on that contain such contingent features. certain trading revenues, particularly in those businesses where longer-term counterparty performance is a key consideration, While certain aspects of a credit rating downgrade are quanti- such as OTC derivative transactions, including credit deriva- fiable pursuant to contractual provisions, the impact it would tives and interest rate swaps. When determining credit ratings, have on our business and results of operations in future rating agencies consider company-specific factors, other periods is inherently uncertain and would depend on a industry factors such as regulatory or legislative changes and number of interrelated factors, including, among other things, the macroeconomic environment, among other things. the magnitude of the downgrade, the rating relative to peers, the rating assigned by the relevant agency pre-downgrade, Our credit ratings do not include any uplift from perceived individual client behavior and future mitigating actions we government support from any rating agency given the signifi- might take. The liquidity impact of additional collateral cant progress of U.S. financial reform legislation and regula- requirements is included in our Liquidity Stress Tests. tions. Some rating agencies have stated that they currently incorporate various degrees of credit rating uplift from Capital Management non-governmental third-party sources of potential support. We view capital as an important source of financial strength and actively manage our consolidated capital position based upon, among other things, business opportunities, risks, capital availability and rates of return together with internal capital policies, regulatory requirements and rating agency guidelines. In the future, we may expand or contract our capital base to address the changing needs of our businesses.
December 2018 Form 10-K 54
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Common Stock Contractual Obligations $ in millions 2018 2017 At December 31, 2018 Repurchases of common stock under Payments Due in: our Share Repurchase Program $ 4,860 $ 3,750 $ in millions 2019 2020-2021 2022-2023 Thereafter Total Borrowings1 From time to time we repurchase our outstanding common $ 24,694 $ 45,922 $ 30,723 $ 86,778 $ 188,117 Other secured stock as part of our share repurchase program. On April 18, financings1 5,900 600 112 160 6,772 2018, we entered into a sales plan with Mitsubishi UFJ Finan- Contractual interest cial Group, Inc. (“MUFG”), whereby MUFG sells shares of payments2 4,895 7,606 5,565 15,842 33,908 the Firm’s common stock to us as part of our share repur- Time deposits— chase program. The sales plan is only intended to maintain principal and interest MUFG’s ownership percentage below 24.9% in order to payments 17,351 12,830 2,791 191 33,163 Operating leases— comply with MUFG’s passivity commitments to the Board of premises3 677 1,259 1,062 2,639 5,637 Governors of the Federal Reserve System (“Federal Purchase obligations 724 614 177 153 1,668 Reserve”) and has no impact on the strategic alliance between Total4 $ 54,241 $ 68,831 $ 40,430 $ 105,763 $ 269,265 MUFG and us, including our joint ventures in Japan. For a description of our share repurchase program, see “Market for 1. Amounts presented for Borrowings and Other secured financings are financings Registrant’s Common Equity, Related Stockholder Matters with original maturities greater than one year. For further information on Borrowings and Other secured financings, see Note 11 to the financial statements. and Issuer Purchases of Equity Securities.” 2. Amounts represent estimated future contractual interest payments related to unse- cured borrowings with original maturities greater than one year based on applicable For a description of our capital plan, see “Liquidity and interest rates at December 31, 2018. Capital Resources—Regulatory Requirements—Capital Plans 3. For further information on operating leases covering premises and equipment, see Note 12 to the financial statements. and Stress Tests.” 4. Amounts exclude unrecognized tax benefits, as the timing and amount of future Common Stock Dividend Announcement cash payments are not determinable at this time (see Note 20 to the financial state- ments for further information). Announcement date January 17, 2019 Amount per share $0.30 In the normal course of business, we enter into various Date paid February 15, 2019 contractual obligations that may require future cash payments. Shareholders of record as of January 31, 2019 Purchase obligations for goods and services include payments Preferred Stock Dividend Announcement for, among other things, consulting, outsourcing, computer and telecommunications maintenance agreements, and certain Announcement date December 17, 2018 transmission, transportation and storage contracts related to Date paid January 15, 2019 the commodities business. Purchase obligations at Shareholders of record as of December 31, 2018 December 31, 2018 reflect the minimum contractual obliga- For additional information on common and preferred stock, tion under legally enforceable contracts with contract terms see Note 15 to the financial statements. that are both fixed and determinable. Off-Balance Sheet Arrangements and Contractual Obligations Regulatory Requirements Off-Balance Sheet Arrangements Regulatory Capital Framework We enter into various off-balance sheet arrangements, including through unconsolidated SPEs and lending-related We are an FHC under the Bank Holding Company Act of financial instruments (e.g., guarantees and commitments), 1956, as amended (“BHC Act”), and are subject to the regula- primarily in connection with the Institutional Securities and tion and oversight of the Federal Reserve. The Federal Investment Management business segments. Reserve establishes capital requirements for us, including “well-capitalized” standards, and evaluates our compliance We utilize SPEs primarily in connection with securitization with such capital requirements. The OCC establishes similar activities. For information on our securitization activities, see capital requirements and standards for our U.S. Bank Subsidi- Note 13 to the financial statements. aries. For us to remain an FHC, we must remain well- For information on our commitments, obligations under capitalized in accordance with standards established by the certain guarantee arrangements and indemnities, see Note 12 Federal Reserve and our U.S. Bank Subsidiaries must remain to the financial statements. For further information on our well-capitalized in accordance with standards established by lending commitments, see “Quantitative and Qualitative the OCC. For additional information on regulatory capital Disclosures about Risk—Credit Risk—Lending Activities requirements for our U.S. Bank Subsidiaries, see Note 14 to Included in Loans and Trading Assets.” the financial statements.
55 December 2018 Form 10-K
− 293 − Management’s Discussion and Analysis
Regulatory capital requirements established by the Federal For a further discussion of our credit, market and operational Reserve are largely based on the Basel III capital standards risks, see “Quantitative and Qualitative Disclosures about established by the Basel Committee and also implement Risk.” certain provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”). Our risk-based capital ratios for purposes of determining regulatory compliance are the lower of the capital ratios Regulatory Capital Requirements computed under (i) the standardized approaches for calcu- lating credit risk and market risk RWA (“Standardized We are required to maintain minimum risk-based and leverage- Approach”) and (ii) the applicable advanced approaches for based capital ratios under regulatory capital requirements. calculating credit risk, market risk and operational risk RWA (“Advanced Approach”). The credit risk RWA calculations Risk-Based Regulatory Capital. Minimum risk-based capital between the two approaches differ in that the Standardized ratio requirements apply to Common Equity Tier 1 capital, Approach requires calculation of RWA using prescribed risk Tier 1 capital and Total capital (which includes Tier 2 weights, whereas the Advanced Approach utilizes models to capital). Certain adjustments to and deductions from capital calculate exposure amounts and risk weights. At are required for purposes of determining these ratios, such as December 31, 2018, our ratios for determining regulatory goodwill, intangible assets, certain deferred tax assets, other compliance are based on the Standardized Approach rules, amounts in AOCI and investments in the capital instruments while at December 31, 2017, the ratios were based on the of unconsolidated financial institutions. Standardized Approach transitional rules. Effective January 1, 2019, Common Equity Tier 1 capital, In addition to the minimum risk-based capital ratio require- Tier 1 capital and Total capital requirements, inclusive of ments, we are subject to the following buffers in 2019: buffers, increase to 10.0%, 11.5% and 13.5%, respectively. • A greater than 2.5% Common Equity Tier 1 capital conser- See “Total Loss-Absorbing Capacity, Long-Term Debt and vation buffer; Clean Holding Company Requirements” herein for additional capital requirements effective January 1, 2019. • The Common Equity Tier 1 G-SIB capital surcharge, currently at 3%; and Leverage-Based Regulatory Capital. Minimum leverage-based capital requirements include a Tier 1 leverage ratio and an • Up to a 2.5% Common Equity Tier 1 CCyB, currently set SLR. The SLR became effective as a capital standard on by U.S. banking agencies at zero. January 1, 2018. We are required to maintain a Tier 1 SLR of 3%, as well as an enhanced SLR capital buffer of at least 2% In 2018 and 2017, each of the buffers was 75% and 50%, (for a total of at least 5%) in order to avoid potential limitations respectively, of the fully phased-in 2019 requirement noted on capital distributions, including dividends and stock repur- above. Failure to maintain the buffers would result in restric- chases, and discretionary bonus payments to executive officers. tions on our ability to make capital distributions, including the payment of dividends and the repurchase of stock, and to Regulatory Capital Ratios pay discretionary bonuses to executive officers. For a further At December 31, 2018 discussion of the G-SIB capital surcharge, see “G-SIB Capital Required Fully Phased-In Surcharge” herein. $ in millions Ratio Standardized Advanced Risk-based capital Risk-Weighted Assets. RWA reflects both our on- and Common Equity Tier 1 capital $ 62,086 $ 62,086 off-balance sheet risk, as well as capital charges attributable Tier 1 capital 70,619 70,619 to the risk of loss arising from the following: Total capital 80,052 79,814 Total RWA 367,309 363,054 • Credit risk: The failure of a borrower, counterparty or Common Equity Tier 1 capital ratio 8.6% 16.9% 17.1% issuer to meet its financial obligations to us; Tier 1 capital ratio 10.1% 19.2% 19.5% Total capital ratio 12.1% 21.8% 22.0% • Market risk: Adverse changes in the level of one or more Leverage-based capital market prices, rates, indices, volatilities, correlations or Adjusted average assets1 $ 843,074 N/A other market factors, such as market liquidity; and Tier 1 leverage ratio 4.0% 8.4% N/A Supplementary leverage exposure2 N/A $ 1,092,672 • Operational risk: Inadequate or failed processes or systems, SLR 5.0% N/A 6.5% from human factors or from external events (e.g., fraud, theft, legal and compliance risks, cyber attacks or damage to physical assets).
December 2018 Form 10-K 56
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At December 31, 2017 Fully Phased-In Regulatory Capital Pro Forma Fully Transitional3 Phased-In Required At At $ in millions Ratio Standardized Advanced Standardized Advanced December 31, December 31, Risk-based capital $ in millions 2018 20171 Change Common Equity Common Equity Tier 1 capital Tier 1 capital $ 61,134 $ 61,134 $ 60,564 $ 60,564 Common stock and surplus $ 9,843 $ 14,354 $ (4,511) Tier 1 capital 69,938 69,938 69,120 69,120 Retained earnings 64,175 57,577 6,598 Total capital 80,275 80,046 79,470 79,240 AOCI (2,292) (3,060) 768 Total RWA 369,578 350,212 377,241 358,324 Regulatory adjustments and deductions: Common Equity Net goodwill (6,661) (6,599) (62) Tier 1 capital ratio 7.3% 16.5% 17.5% 16.1% 16.9% Net intangible assets (other than Tier 1 capital ratio 8.8% 18.9% 20.0% 18.3% 19.3% goodwill and mortgage servicing Total capital ratio 10.8% 21.7% 22.9% 21.1% 22.1% assets) (2,158) (2,446) 288 Leverage-based capital Other adjustments and deductions2 (821) 738 (1,559) Adjusted average assets1 $ 842,270 N/A $ 841,756 N/A Total Common Equity Tier 1 capital $ 62,086 $ 60,564 $ 1,522 Tier 1 leverage ratio 4.0% 8.3% N/A 8.2% N/A Additional Tier 1 capital Preferred stock $ 8,520 $ 8,520 $— Supplementary leverage exposure2 N/A $ 1,082,683 N/A $ 1,082,170 Noncontrolling interests 454 415 39 Pro forma SLR 5.0% N/A 6.5% N/A 6.4% Other adjustments and deductions — (23) 23 Additional Tier 1 capital $ 8,974 $ 8,912 $62 1. Adjusted average assets represents the denominator of the Tier 1 leverage ratio Deduction for investments in covered and is composed of the average daily balance of consolidated on-balance sheet funds (441) (356) (85) assets under U.S. GAAP during the quarters ended December 31, 2018 and December 31, 2017, adjusted for disallowed goodwill, intangible assets, certain Total Tier 1 capital $ 70,619 $ 69,120 $ 1,499 deferred tax assets, certain investments in the capital instruments of unconsoli- Standardized Tier 2 capital dated financial institutions and other capital deductions. Subordinated debt $ 8,923 $ 9,839 $ (916) 2. Supplementary leverage exposure is the sum of Adjusted average assets used in the Tier 1 leverage ratio and other adjustments, primarily (i) potential future expo- Noncontrolling interests 107 98 9 sure for derivative exposures, gross-up for cash collateral netting where qualifying Eligible allowance for credit losses 440 423 17 criteria are not met, and the effective notional principal amount of sold credit protec- tion offset by qualifying purchased credit protection; (ii) the counterparty credit risk Other adjustments and deductions (37) (10) (27) for repo-style transactions; and (iii) the credit equivalent amount for off-balance Total Standardized Tier 2 capital $ 9,433 $ 10,350 $ (917) sheet exposures. Total Standardized capital $ 80,052 $ 79,470 $ 582 3. Regulatory compliance at December 31, 2017 was determined based on capital ratios calculated under transitional rules. Advanced Tier 2 capital Subordinated debt $ 8,923 $ 9,839 $ (916) At December 31, 2017, the pro forma fully phased-in esti- Noncontrolling interests 107 98 9 mated amounts and the pro forma estimated SLR utilized Eligible credit reserves 202 193 9 fully phased-in Tier 1 capital, including the fully phased-in Other adjustments and deductions (37) (10) (27) Tier 1 capital deductions that applied beginning January 1, Total Advanced Tier 2 capital $ 9,195 $ 10,120 $ (925) 2018. These pro forma fully phased-in estimates were non- Total Advanced capital $ 79,814 $ 79,240 $ 574 GAAP financial measures as the related capital rules were not yet effective at December 31, 2017. These estimates were 1. The pro forma fully phased-in estimates as of December 31, 2017 are non-GAAP financial measures as the related capital rules were not yet effective at based on our understanding of the capital rules and other December 31, 2017. 2. Other adjustments and deductions used in the calculation of Common Equity Tier 1 factors at the time. capital include credit spread premium over risk-free rate for derivative liabilities, net deferred tax assets, net after-tax DVA and adjustments related to AOCI. Regulatory compliance was determined based on capital ratios, including regulatory capital and RWA, calculated under the transitional rules until December 31, 2017. The regulatory capital analyses in the following tables are presented using pro forma fully phased-in estimates as of December 31, 2017, which are on an equivalent basis to amounts calculated as of December 31, 2018.
57 December 2018 Form 10-K
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Fully Phased-In RWA Rollforward due to reduced exposures in mortgage-backed securities and
20181 collateralized loan obligations. $ in millions Standardized Advanced Credit risk RWA The decrease in operational risk RWA under the Advanced Balance at December 31, 20172 $ 301,946 $ 170,754 Approach in 2018 reflects a continued reduction in the Change related to the following items: frequency and magnitude of internal losses utilized in the Derivatives (1,589) 661 operational risk capital model related to litigation and execu- Securities financing transactions (5,492) 2,384 tion and processing, partially offset by an increase associated Securitizations 2,859 2,974 with a risk scenario update. Investment securities 83 7,449 Commitments, guarantees and loans 11,302 10,117 G-SIB Capital Surcharge Cash 1,728 1,409 Equity investments (3,441) (3,657) We and other U.S. G-SIBs are subject to a risk-based capital Other credit risk3 (1,865) (1,496) surcharge. A G-SIB must calculate its G-SIB capital surcharge Total change in credit risk RWA $ 3,585 $ 19,841 under two methods and use the higher of the two surcharges. Balance at December 31, 2018 $ 305,531 $ 190,595 The first method considers the G-SIB’s size, interconnected- Market risk RWA ness, cross-jurisdictional activity, substitutability and Balance at December 31, 20172 $ 75,295 $ 74,907 complexity, which is generally consistent with the method- Change related to the following items: ology developed by the Basel Committee (“Method 1”). The Regulatory VaR 1,342 1,342 second method uses similar inputs but replaces substitutability Regulatory stressed VaR (2,908) (2,908) with the use of short-term wholesale funding (“Method 2”) and Incremental risk charge 1,425 1,425 generally results in higher surcharges than the first method. Comprehensive risk measure (2,508) (2,041) The G-SIB capital surcharge must be satisfied using Common Specific risk: Equity Tier 1 capital and functions as an extension of the Non-securitizations (5,616) (5,616) capital conservation buffer. As of January 1, 2019, our current Securitizations (5,252) (5,252) fully phased-in G-SIB surcharge is 3%. In 2018 and 2017, the Total change in market risk RWA $ (13,517) $ (13,050) phase-in amount was 75% and 50%, respectively, of the appli- Balance at December 31, 2018 $ 61,778 $ 61,857 cable surcharge (see “Risk-Based Regulatory Capital” herein). Operational risk RWA Balance at December 31, 20172 N/A $ 112,663 Change in operational risk RWA N/A (2,061) Total Loss-Absorbing Capacity, Long-Term Debt and Balance at December 31, 2018 N/A $ 110,602 Clean Holding Company Requirements Total RWA $ 367,309 $ 363,054 The Federal Reserve has established external TLAC, long-
Regulatory VaR—VaR for regulatory capital requirements term debt (“LTD”) and clean holding company requirements 1. The RWA for each category reflects both on- and off-balance sheet exposures, for top-tier BHCs of U.S. G-SIBs (“covered BHCs”), where appropriate. 2. The pro forma fully phased-in estimates as of December 31, 2017 are non-GAAP including the Parent Company. These requirements include financial measures as the related capital rules were not yet effective at various definitions and restrictions, such as requiring eligible December 31, 2017. 3. Amount reflects assets not in a defined category, non-material portfolios of expo- LTD to be issued by the covered BHC and be unsecured, sures and unsettled transactions, as applicable. have a maturity of one year or more from the date of issuance and not have certain derivative-linked features typically asso- Credit risk RWA increased in 2018 under the Standardized ciated with certain types of structured notes. We are in and Advanced Approaches primarily due to increased corpo- compliance with all relevant TLAC requirements as of the rate lending exposures within the Institutional Securities busi- compliance date of January 1, 2019. ness segment. Under the Standardized Approach, this increase was partially offset by a reduction in RWA for Secu- The main purpose of the Federal Reserve’s minimum external rities financing transactions due to a decline in the market TLAC and LTD requirements is to ensure that covered BHCs, value of associated securities. Under the Advanced Approach, including the Parent Company, will have enough loss- Credit risk RWA also increased in 2018 for Investment secu- absorbing resources at the point of failure to be recapitalized rities driven by model revisions that increased the risk through the conversion of eligible LTD to equity or otherwise weighting for certain counterparty types. by imposing losses on eligible LTD or other forms of TLAC where an SPOE resolution strategy is used (see “Business— Market risk RWA decreased in 2018 under the Standardized Supervision and Regulation—Financial Holding Company— and Advanced Approaches primarily due to a decrease in Resolution and Recovery Planning” and “Risk Factors— non-securitization-specific risk charges mainly as a result of Legal, Regulatory and Compliance Risk”). reduced exposures in equity derivatives and bonds. In addi- tion, securitization-specific risk charges decreased primarily
December 2018 Form 10-K 58
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Under the final rule, a covered BHC is required to maintain rate forward-looking projections of revenues and losses to minimum external TLAC equal to the greater of (i) 18% of monitor and maintain our internal capital adequacy. total RWA and (ii) 7.5% of its total leverage exposure (the denominator of its SLR). In addition, covered BHCs must The capital plan must include a description of all planned meet a separate external LTD requirement equal to the greater capital actions over a nine-quarter planning horizon, of (i) total RWA multiplied by the sum of 6% plus the higher including any issuance or redemption of a debt or equity of the Method 1 and Method 2 G-SIB capital surcharge appli- capital instrument, any capital distribution (i.e., payments of cable to the Parent Company, and (ii) 4.5% of its total dividends or stock repurchases) and any similar action that leverage exposure. the Federal Reserve determines could impact our consoli- dated capital. The capital plan must include a discussion of In addition, the final rule imposes TLAC buffer requirements how we will maintain capital above the minimum regulatory on top of both the risk-based and leverage-exposure-based capital ratios, including the requirements that are phased in external TLAC minimum requirements. The risk-based over the planning horizon, and serve as a source of strength to TLAC buffer is equal to the sum of 2.5%, the covered BHC’s our U.S. Bank Subsidiaries under supervisory stress Method 1 G-SIB surcharge and the CCyB, if any, as a scenarios. In addition, the Federal Reserve has issued guid- percentage of total RWA. The leverage-exposure-based ance setting out its heightened expectations for capital plan- TLAC buffer is equal to 2% of the covered BHC’s total ning practices at certain large financial institutions, including leverage exposure. Failure to maintain the TLAC buffers us. would result in restrictions on capital distributions and discre- The capital plan rule requires that large BHCs receive no tionary bonus payments to executive officers. objection from the Federal Reserve before making a capital distribution. In addition, even with an approved capital plan, The final rule provides permanent grandfathering for debt the BHC must seek the approval of the Federal Reserve instruments issued prior to December 31, 2016 that would be before making a capital distribution if, among other reasons, eligible LTD but for having impermissible acceleration the BHC would not meet its regulatory capital requirements clauses or being governed by foreign law. after making the proposed capital distribution. A BHC’s Furthermore, under the clean holding company requirements ability to make capital distributions (other than scheduled of the final rule, a covered BHC is prohibited from incurring payments on Additional Tier 1 and Tier 2 capital instruments) any external short-term debt or certain other liabilities, is also limited if its net capital issuances are less than the regardless of whether the liabilities are fully secured or other- amount indicated in its capital plan. wise senior to eligible LTD, or entering into certain other In addition, we are currently required to conduct semiannual prohibited transactions. Certain other external liabilities, company-run stress tests and are subject to an annual Dodd- including structured notes, are subject to a cap equal to 5% of Frank Act supervisory stress test conducted by the Federal the covered BHC’s outstanding external TLAC amount. Reserve. The EGRRCPA modifies certain aspects of these stress-testing requirements, reducing the number of scenarios The Federal Reserve has proposed modifications to the in the Federal Reserve’s supervisory stress test from three to enhanced SLR that would also make corresponding changes two and modifying our obligation to perform company-run to the calibration of the TLAC leverage-based requirements, stress-tests from semiannually to annually. The Federal as well as certain other technical changes to the TLAC rule. Reserve has issued proposed rulemakings to implement these For a further discussion of the enhanced SLR, see “Regula- modifications and is currently considering making further tory Developments—Proposed Modifications to the changes to its capital planning and stress testing require- Enhanced SLR and to the SLR Applicable to Our U.S. Bank ments. See “Regulatory Developments” herein. Subsidiaries” herein. Prior to the enactment of the EGRRCPA, each of our U.S. Capital Plans and Stress Tests Bank Subsidiaries was also required to conduct an annual stress test. MSBNA and MSPBNA submitted their 2018 Pursuant to the Dodd-Frank Act, the Federal Reserve has annual company-run stress tests to the OCC on April 5, 2018 adopted capital planning and stress test requirements for large and published a summary of their stress test results on BHCs, including us, which form part of the Federal Reserve’s June 21, 2018. The EGRRCPA eliminated the statutory annual CCAR framework. requirement to conduct company-run stress-tests for banks with less than $250 billion of total assets, which includes both We must submit an annual capital plan to the Federal of our U.S. Bank Subsidiaries. Reserve, taking into account the results of separate stress tests designed by us and the Federal Reserve, so that the Federal We submitted our 2018 Capital Plan (“Capital Plan”) and Reserve may assess our systems and processes that incorpo- company-run stress test results to the Federal Reserve on
59 December 2018 Form 10-K
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April 5, 2018. On June 21, 2018, the Federal Reserve difference between our total average common equity and the published summary results of the Dodd-Frank Act supervi- sum of the average common equity amounts allocated to our sory stress tests of each large BHC, including us. On June 28, business segments as Parent common equity. We generally 2018, the Federal Reserve published summary results of hold Parent common equity for prospective regulatory CCAR, and we received a conditional non-objection to our requirements, organic growth, acquisitions and other capital Capital Plan, where the only condition was that our capital needs. distributions not exceed the greater of the actual distributions we made over the previous four calendar quarters or the The estimation and attribution of common equity to the busi- annualized average of actual distributions over the previous ness segments are based on the fully phased-in regulatory eight calendar quarters. capital rules. The amount of capital allocated to the business segments is generally set at the beginning of each year and Our 2018 Capital Plan includes the repurchase of up to remains fixed throughout the year until the next annual reset $4.7 billion of outstanding common stock for the period unless a significant business change occurs (e.g., acquisition beginning July 1, 2018 through June 30, 2019 and an increase or disposition). Differences between available and Required in our quarterly common stock dividend to $0.30 per share, Capital are attributed to Parent common equity during the beginning with the common stock dividend announced on year. July 18, 2018. The total amount of expected 2018 capital distributions is consistent with the $6.8 billion of actual divi- The Required Capital framework is expected to evolve over dends and gross share repurchases included in our 2017 time in response to changes in the business and regulatory Capital Plan. We disclosed a summary of the results of our environment, for example, to incorporate changes in stress company-run stress tests on June 21, 2018 on our Investor testing or enhancements to modeling techniques. We will Relations webpage. In addition, we submitted the results of continue to evaluate the framework with respect to the impact our mid-cycle company-run stress test to the Federal Reserve of future regulatory requirements, as appropriate. and on October 22, 2018 disclosed a summary of the results Average Common Equity Attribution1 on our Investor Relations webpage. $ in billions 2018 2017 2016 For the 2019 capital planning and stress test cycle, we are Institutional Securities $ 40.8 $ 40.2 $ 43.2 required to submit our capital plan and company-run stress Wealth Management 16.8 17.2 15.3 test results to the Federal Reserve by April 5, 2019. The Investment Management 2.6 2.4 2.8 Federal Reserve is expected to publish summary results of the Parent 9.8 10.0 7.6 CCAR and Dodd-Frank Act supervisory stress tests of each Total $ 70.0 $ 69.8 $ 68.9 large BHC, including us, by June 30, 2019. We are required to disclose a summary of the results of 1. Average common equity is a non-GAAP financial measure. See “Selected our company-run stress tests within 15 days of the date the Non-GAAP Financial Information” herein. Federal Reserve discloses the results of the supervisory stress tests. In addition, we must submit the results of Resolution and Recovery Planning our mid-cycle company-run stress test to the Federal Reserve by October 5, 2019 and disclose a summary of the results Pursuant to the Dodd-Frank Act, we are required to periodi- between October 5, 2019 and November 4, 2019. cally submit to the Federal Reserve and the FDIC a resolution plan that describes our strategy for a rapid and orderly resolu- Attribution of Average Common Equity According to the tion under the U.S. Bankruptcy Code in the event of our Required Capital Framework material financial distress or failure.
Our required capital (“Required Capital”) estimation is based Our preferred resolution strategy, which is set out in our 2017 on the Required Capital framework, an internal capital resolution plan, is an SPOE strategy. The Parent Company adequacy measure. Common equity attribution to the busi- has amended and restated its secured support agreement with ness segments is based on capital usage calculated under the its material entities, as defined in our 2017 resolution plan. Required Capital framework, as well as each business Under the secured amended and restated support agreement, segment’s relative contribution to our total Required Capital. upon the occurrence of a resolution scenario, the Parent Company would be obligated to contribute or loan on a The Required Capital framework is a risk-based and leverage subordinated basis all of its contributable material assets, use-of-capital measure, which is compared with our regula- other than shares in subsidiaries of the Parent Company and tory capital to ensure that we maintain an amount of going certain intercompany receivables, to provide capital and concern capital after absorbing potential losses from stress liquidity, as applicable, to our material entities. events, where applicable, at a point in time. We define the
December 2018 Form 10-K 60
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The obligations of the Parent Company under the secured stress test measurement period plus the sum of the ratios of amended and restated support agreement are in most cases the dollar amount of our planned common stock dividends to secured on a senior basis by the assets of the Parent Company our projected RWA for each of the fourth through seventh (other than shares in subsidiaries of the Parent Company). As quarters of the supervisory stress test projection period and a result, claims of our material entities against the assets of (ii) 2.5%. Regulatory capital requirements under the Stan- the Parent Company (other than shares in subsidiaries of the dardized Approach would include the stress capital buffer, as Parent Company) are effectively senior to unsecured obliga- summarized above, as well as our Common Equity Tier 1 tions of the Parent Company. G-SIB capital surcharge and any applicable Common Equity Tier 1 CCyB. In further development of our SPOE strategy, we have created a wholly owned, direct subsidiary of the Parent Like the stress capital buffer, the stress leverage buffer would Company, MS Holdings LLC (the “Funding IHC”), to serve be calculated based on the results of our annual supervisory as a resolution funding vehicle. We expect that, prior to the stress tests. The stress leverage buffer would equal the submission of our 2019 resolution plan by July 1, 2019, the maximum decline in our Tier 1 leverage ratio under the Parent Company will contribute certain of its assets to the severely adverse scenario, plus the sum of the ratios of the Funding IHC and enter into an updated secured amended and dollar amount of our planned common stock dividends to our restated support agreement with the Funding IHC as well as projected leverage ratio denominator for each of the fourth certain other subsidiaries to facilitate the execution of our through seventh quarters of the supervisory stress test projec- SPOE strategy. Similar to the existing secured amended and tion period. No floor would be established for the stress restated support agreement, the updated secured amended and leverage buffer, which would apply in addition to the current restated support agreement will obligate the Parent Company minimum Tier 1 leverage ratio of 4%. to transfer capital and liquidity, as revised, to the Funding IHC, and that the Parent Company and/or the Funding IHC The proposal would make related changes to capital planning will recapitalize and provide liquidity to material entities in and stress testing processes for BHCs subject to the Stress the event of our material financial distress or failure. Buffer Requirements. In particular, for purposes of deter- mining the size of Stress Buffer Requirements, the proposal For more information about resolution and recovery planning would include only projected capital actions to planned requirements and our activities in these areas, including the common stock dividends in the fourth through seventh quar- implications of such activities in a resolution scenario, see ters of the stress test projection period and would assume that “Business—Supervision and Regulation—Financial Holding BHCs maintain a constant level of assets and RWA Company—Resolution and Recovery Planning” and “Risk throughout the supervisory stress test projection period. Factors—Legal, Regulatory and Compliance Risk.” The proposal does not change regulatory capital requirements Regulatory Developments under the Advanced Approach or the SLR, although the Federal Reserve and the OCC have separately proposed to Proposed Stress Buffer Requirements modify the enhanced SLR requirements, as summarized below. If the proposal is adopted in its current form, limita- In April 2018, the Federal Reserve issued a proposal to inte- tions on capital distributions and discretionary bonus grate its annual capital planning and stress testing require- payments to executive officers would be determined by the ments with existing applicable regulatory capital require- most stringent limitation, if any, as determined under Stan- ments. The proposal, which would apply to certain BHCs, dardized Approach risk-based capital requirements or the Tier including us, would introduce a stress capital buffer and a 1 leverage ratio, inclusive of Stress Buffer Requirements, or stress leverage buffer (collectively, “Stress Buffer Require- the Advanced Approach or SLR or TLAC requirements, ments”) and related changes to the capital planning and stress inclusive of applicable buffers. testing processes. Under the proposal, Stress Buffer Require- ments would apply only with respect to Standardized While the proposal included an intended effective date of Approach risk-based capital requirements and Tier 1 leverage October 1, 2019, the Federal Reserve has not yet taken action regulatory capital requirements. to finalize or implement Stress Buffer Requirements.
Under Standardized Approach risk-based capital require- Proposed Modifications to the Enhanced SLR and to the ments, the stress capital buffer would replace the existing SLR Applicable to Our U.S. Bank Subsidiaries Common Equity Tier 1 capital conservation buffer, which is 2.5% as of January 1, 2019. The Standardized Approach The Federal Reserve has proposed modifications to the stress capital buffer would equal the greater of (i) the enhanced SLR that would replace the current 2% enhanced maximum decline in our Common Equity Tier 1 capital ratio SLR buffer applicable to U.S. G-SIBs, including us, with a under the severely adverse scenario over the supervisory leverage buffer equal to 50% of our G-SIB capital surcharge.
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Under the proposal, our enhanced SLR buffer would become RWA for trade exposures, in single counterparty credit limits 1.5%, for a total enhanced SLR requirement of 4.5%, applicable to us, and in bank lending limits applicable to our assuming that our G-SIB capital surcharge remains the same U.S. Bank Subsidiaries. The proposal would require us and when the proposal becomes effective. our U.S. Bank Subsidiaries to implement SA-CCR by July 1, 2020, with early adoption permitted after the rule is finalized. The Federal Reserve and the OCC have also proposed to modify the well-capitalized SLR standard applicable to our Other Matters U.S. Bank Subsidiaries. The requirement would change from the current 6% to 3% plus 50% of our G-SIB capital U.K. Withdrawal from the E.U. surcharge, for a total well-capitalized SLR requirement of 4.5% for our U.S. Bank Subsidiaries, assuming that our Following the U.K. electorate vote to leave the E.U., the U.K. G-SIB capital surcharge remains the same when the proposal invoked Article 50 of the Lisbon Treaty on March 29, 2017, becomes effective. which triggered a two-year period, subject to extension (which would need the unanimous approval of the E.U. Regulatory Capital and Stress Testing Developments Member States), during which the U.K. government negoti- Related to Implementation of the Current Expected Credit ated a form of withdrawal agreement with the E.U. The with- Losses Methodology drawal agreement was rejected by the U.K. Parliament on January 15, 2019, and the U.K. government is in the process In December 2018, the U.S. banking agencies finalized revi- of negotiating changes to the withdrawal agreement that sions to the regulatory capital framework applicable to would be acceptable to the U.K. Parliament and the E.U. banking organizations, including us and our U.S. Bank Subsidiaries, to address the new accounting standard for We are continuing to prepare our European operations credit losses, known as a CECL methodology that will be regardless of whether or not a withdrawal or transition agree- effective January 1, 2020. For a further discussion of CECL, ment is reached. For example, we are taking steps to make see “Accounting Development Updates—Financial Instru- changes to our European operations in an effort to ensure that ments—Credit Losses.” we can continue to provide cross-border banking and invest- ment and other services in E.U. Member States without the The revisions modify the regulatory capital rules to identify need for separate regulatory authorizations in each member which credit loss allowances under the new accounting stan- state through the use of E.U. “passporting” arrangements, dard are eligible for inclusion in regulatory capital and which allow for such cross-border activity. In the event that provide banking organizations the option to phase in, over a our U.K. licensed entities are unable to rely on E.U. pass- three-year period, the adverse effects on regulatory capital porting rights to provide services, we will adjust our opera- that may result from the adoption of the new accounting stan- tions in Europe to be able to carry out activities from within dard. A banking organization that has adopted a CECL meth- the E.U. These changes will include use of: a new licensed odology must include the provision for credit losses begin- investment firm, Morgan Stanley Europe S.E., based in ning in the 2020 stress test cycle. Germany, which will passport throughout the E.U. and serve E.U.-based clients where required; our existing German In addition, the Federal Reserve issued a statement that it will licensed bank, Morgan Stanley Bank AG, which will provide maintain the current framework for calculating allowances on licensable banking activities where required; new licensed loans in the supervisory stress test through the 2021 cycle. entities based in Ireland for licensable asset management activities; as well as branches of the previously noted entities Proposed Standardized Approach for Counterparty Credit in the E.U. and our existing regulated operations in France Risk and Spain. We are continuing to build out the capabilities of these entities, including engagement with clients and local The U.S. banking agencies have issued a proposal to incorpo- regulators. We also expect to add personnel to certain of our rate the standardized approach for counterparty credit risk existing offices in the E.U. (“SA-CCR”), a new derivatives counterparty exposure meth- odology, into the regulatory capital framework and related However, given the present political uncertainty, it is regulatory standards. As proposed, SA-CCR would replace currently unclear what the final post-Brexit structure of our the current exposure method, on a mandatory basis, in our European operations will be. For a further discussion of the and our U.S. Bank Subsidiaries’ Standardized Approach potential impact of the U.K.’s withdrawal from the E.U. on RWA, central counterparty default fund contributions and, in our operations, see “Risk Factors—International Risk”. For modified form, in Supplementary Leverage Ratio exposure further information regarding our exposure to the U.K., see calculations. SA-CCR would be available as an alternative in also “Quantitative and Qualitative Disclosures about Risk— our and our U.S. Bank Subsidiaries’ Advanced Approach Credit Risk—Country Risk Exposure.”
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Expected Replacement of London Interbank Offered Rate and Replacement or Reform of Other Interest Rates
Central banks around the world, including the Federal Reserve, have commissioned working groups of market participants and official sector representatives with the goal of finding suitable replacements for LIBOR and replacements or reforms of other interest rate benchmarks, such as EURIBOR and EONIA (collectively, the “IBORs”). It is expected that a transition away from the widespread use of such rates to alternative reference rates selected by these central bank committees and working groups and other poten- tial interest rate benchmark reforms, will occur over the course of the next few years. Although the full impact of such reforms and actions, together with any transition away from the IBORs, including the potential or actual discontinuance of any IBOR publication, remains unclear, we are preparing to transition from the IBORs to these alternative reference rates.
Our transition plan includes a number of key steps, including continued engagement with central bank and industry working groups and regulators, active client engagement, internal operational readiness, and risk management, among other things, to promote the transition to alternative reference rates.
There remain, however, a number of unknown factors regarding the transition from the IBORs and/or interest rate benchmark reforms that could impact our business, including, for example, the pace of the transition to replacement or reformed rates, the specific terms and parameters for and market acceptance of the alternative reference rates, prices of and the liquidity of trading markets for products based on the alternative reference rates, and our ability to transition to and develop appropriate systems and analytics for one or more alternative reference rates. For a further discussion of the various risks we face in connection with the expected replacement of the IBORs and/or reform of interest rate benchmarks on our operations, see “Risk Factors—Legal, Regulatory and Compliance Risk.”
63 December 2018 Form 10-K
− 301 − Quantitative and Qualitative Disclosures about Risk Risk Management thorough and frequent communication and the appropriate escalation of risk matters. The fast-paced, complex and Overview constantly evolving nature of global financial markets requires us to maintain a risk management culture that is inci- Risk is an inherent part of our businesses and activities. We sive, knowledgeable about specialized products and markets, believe effective risk management is vital to the success of and subject to ongoing review and enhancement. our business activities. Accordingly, we have an Enterprise Risk Management (“ERM”) framework to integrate the Our risk appetite defines the types of risk that the Firm is diverse roles of risk management into a holistic enterprise willing to accept in pursuit of our strategic objectives and structure and to facilitate the incorporation of risk assessment business plan, taking into account the interest of clients and into decision-making processes across the Firm. fiduciary duties to shareholders, as well as capital and other regulatory requirements. This risk appetite is embedded in We have policies and procedures in place to identify, our risk culture and linked to our short-term and long-term measure, monitor, advise, challenge and control the principal strategic, capital and financial plans, as well as compensation risks involved in the activities of the Institutional Securities, programs. This risk appetite and the related Board-level risk Wealth Management and Investment Management business limits and risk tolerance statements are reviewed and segments, as well as at the Parent Company level. The prin- approved by the Risk Committee of the Board (“BRC”) and cipal risks involved in our business activities include market the Board on at least an annual basis. (including non-trading interest rate risk), credit, operational, model, compliance, cybersecurity, liquidity, strategic, reputa- Risk Governance Structure tional and conduct risk. Strategic risk is integrated into our business planning, embedded in the evaluation of all principal Risk management at the Firm requires independent Firm- risks and overseen by the Board. level oversight, accountability of our business divisions, and effective communication of risk matters across the Firm, to The cornerstone of our risk management philosophy is the senior management and ultimately to the Board. Our risk pursuit of risk-adjusted returns through prudent risk taking governance structure is set forth in the chart below and also that protects our capital base and franchise. This philosophy includes risk managers, committees, and groups within and is implemented through the ERM framework. Five key prin- across the business segments and operating legal entities. The ciples underlie this philosophy: integrity, comprehensiveness, ERM framework, composed of independent but complemen- independence, accountability and transparency. To help tary entities, facilitates efficient and comprehensive supervi- ensure the efficacy of risk management, which is an essential sion of our risk exposures and processes. component of our reputation, senior management requires
Morgan Stanley Board
Operations and Technology Committee Risk Committee Audit Committee
Firm Risk Committee
Chief Executive Officer Chief Compliance Officer Chief Risk Officer Other Committees Internal Audit Chief Financial Officer Chief Legal Officer Business/Control Senior Management • CCAR Global Audit • RRP Director Governance Process Review Subcommittee • Strategic Transactions
Functional Risk and Control Committees
• Firm Credit Risk • Firm Franchise • Model Oversight • Commitment and Underwriting1 • Asset/Liability Management • Operational Risk Oversight • Culture, Values and Conduct • Global Legal Entity Oversight and Governance • Global Compliance • Technology Governance • Enterprise Regulatory Oversight • Segment Risk2
1. Committees include the Capital Commitment Committee, Global Large Loan Committee, Equity Underwriting Committee, Leveraged Finance Underwriting Committee and Municipal Capital Commitment Committee. 2. Committees include the Securities Risk Committee, Wealth Management Risk Committee and Investment Management Risk Committee.
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Morgan Stanley Board of Directors Operations and Technology Committee of the Board
The Board has oversight of the ERM framework and is The BOTC oversees our operations and technology strategy, responsible for helping to ensure that our risks are managed including trends that may affect such strategy; reviews the in a sound manner. The Board has authorized the committees operations and technology budget and significant expendi- within the ERM framework to help facilitate our risk over- tures and investments in support of such strategy; reviews the sight responsibilities. As set forth in our Corporate Gover- operations and technology metrics; oversees risk management nance Policies, the Board also oversees, and receives reports and risk assessment guidelines and policies regarding opera- on, our financial performance, strategy and business plans, as tions and technology risk; reviews the major operations and well as our practices and procedures relating to reputational technology risk exposures of the Firm, including information and franchise risk, and culture, values and conduct. security and cybersecurity risks, and the steps management has taken to monitor and control such exposures; and over- Risk Committee of the Board sees our business continuity planning. The BOTC reports to the entire Board on a regular basis. The BRC assists the Board in its oversight of the ERM frame- work; oversees major risk exposures of the Firm, including Firm Risk Committee market, credit, operational, model, liquidity, and reputational risk, against established risk measurement methodologies and The Board has also authorized the Firm Risk Committee the steps management has taken to monitor and control such (“FRC”), a management committee appointed and chaired by exposures; oversees our risk appetite statement, including risk the Chief Executive Officer, which includes the most senior limits and tolerances; reviews capital, liquidity and funding officers of the Firm, including the Chief Risk Officer, Chief strategy and related guidelines and policies; reviews the Financial Officer and Chief Legal Officer, to help oversee the contingency funding plan and internal capital adequacy ERM framework. The FRC’s responsibilities include over- assessment process and capital plan; oversees our significant sight of our risk management principles, procedures and risk management and risk assessment guidelines and policies; limits and the monitoring of capital levels and material oversees the performance of the Chief Risk Officer; reviews market, credit, operational, model, liquidity, legal, compli- reports from our Strategic Transactions Committee, CCAR ance and reputational risk matters, and other risks, as appro- Committee, and Resolution and Recovery Planning (“RRP”) priate, and the steps management has taken to monitor and Committee; reviews new product risk, emerging risks and manage such risks. The FRC also establishes and communi- regulatory matters; and reviews the Internal Audit reports on cates risk tolerance, including aggregate Firm limits and the assessment of the risk management, liquidity and capital tolerances, as appropriate. The Governance Process Review functions. The BRC reports to the entire Board on a regular Subcommittee of the FRC oversees governance and process basis, and coordinates with other Board committees with issues on behalf of the FRC. The FRC reports to the entire respect to oversight of risk management and risk assessment Board, the BAC, the BOTC and the BRC through the Chief guidelines. Risk Officer, Chief Financial Officer and Chief Legal Officer. Audit Committee of the Board Functional Risk and Control Committees The BAC oversees the integrity of our financial statements, compliance with legal and regulatory requirements and Functional risk and control committees and other committees system of internal controls; oversees risk management and within the ERM framework facilitate efficient and compre- risk assessment guidelines in coordination with the Board, hensive supervision of our risk exposures and processes. BRC and Operations and Technology Committee of the Board (“BOTC”) and reviews the major legal and compliance Each business segment has a risk committee that is respon- risk exposures of the Firm and the steps management has sible for helping to ensure that the business segment, as appli- taken to monitor and control such exposures; selects, deter- cable, adheres to established limits for market, credit, opera- mines the fees, evaluates and, when appropriate, replaces the tional and other risks; implements risk measurement, moni- independent auditor; oversees the qualifications, indepen- toring, and management policies, procedures, controls and dence and performance of our independent auditor, and systems that are consistent with the risk framework estab- pre-approves audit and permitted non-audit services; oversees lished by the FRC; and reviews, on a periodic basis, our the performance of our Global Audit Director; and, after aggregate risk exposures, risk exception experience, and the review, recommends to the Board the acceptance and inclu- efficacy of our risk identification, measurement, monitoring sion of the annual audited financial statements in the Firm’s and management policies and procedures, and related Annual Report on Form 10-K. The BAC reports to the entire controls. Board on a regular basis.
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Chief Risk Officer our control environment and risk management processes using a risk-based audit coverage model and audit execution The Chief Risk Officer, who is independent of business units, methodology developed from professional auditing standards. reports to the BRC and the Chief Executive Officer. The The Internal Audit Department also reviews and tests our Chief Risk Officer oversees compliance with our risk limits; compliance with internal guidelines set for risk management approves exceptions to our risk limits; independently reviews and risk monitoring, as well as external rules and regulations material market, credit, liquidity, model and operational risks; governing the industry. It effects these responsibilities and reviews results of risk management processes with the through periodic reviews (with specified minimum Board, the BRC and the BAC, as appropriate. The Chief Risk frequency) of our processes, activities, products or informa- Officer also coordinates with the Chief Financial Officer tion systems; targeted reviews of specific controls and activ- regarding capital and liquidity management and works with ities; pre-implementation or initiative reviews of new or the Compensation, Management Development and Succes- significantly changed processes, activities, products or infor- sion Committee of the Board to help ensure that the structure mation systems; and special investigations and retrospective and design of incentive compensation arrangements do not reviews required as a result of internal factors or regulatory encourage unnecessary and excessive risk taking. requests. In addition to regular reports to the BAC, the Global Audit Director, who reports functionally to the BAC and Independent Risk Management Functions administratively to the Chief Executive Officer, periodically reports to the BRC and BOTC on risk-related control issues. The risk management functions (Market Risk, Credit Risk, Operational Risk, Model Risk and Liquidity Risk Manage- Culture, Values and Conduct of Employees ment departments) are independent of our business units and report to the Chief Risk Officer. These functions assist senior Employees of the Firm are accountable for conducting them- management and the FRC in monitoring and controlling our selves in accordance with our core values: Putting Clients risk through a number of control processes. Each function First, Doing the Right Thing, Leading with Exceptional Ideas maintains its own risk governance structure with specified and Giving Back. We are committed to reinforcing and individuals and committees responsible for aspects of confirming adherence to the core values through our gover- managing risk. Further discussion about the responsibilities nance framework, tone from the top, management oversight, of the risk management functions may be found under risk management and controls, and three lines of defense “Market Risk,” “Credit Risk,” “Operational Risk,” “Model structure (business, control functions such as Risk Manage- Risk” and “Liquidity Risk.” ment and Compliance, and Internal Audit).
Support and Control Groups The Board is responsible for overseeing the Firm’s practices and procedures relating to culture, values and conduct, as set Our support and control groups include the Legal and forth in the Firm’s Corporate Governance Policies. Our Compliance Division, the Finance Division, the Operations Culture, Values and Conduct Committee is the senior Division, the Technology and Data Division, the Human management committee that oversees the Firm-wide culture, Resources Department and Corporate Services. Our support values and conduct program. A fundamental building block and control groups coordinate with the business segment of this program is the Firm’s Code of Conduct, which estab- control groups to review the risk monitoring and risk lishes standards for employee conduct that further reinforce management policies and procedures relating to, among other the Firm’s commitment to integrity and ethical things, controls over financial reporting and disclosure; each conduct. Every new hire and every employee annually must business segment’s market, credit and operational risk certify to their understanding of and adherence to the Code of profile; liquidity risks; model risks; sales practices; reputa- Conduct. The Firm’s Global Conduct Risk Management tional, legal enforceability, compliance, conduct and regula- Policy also sets out a consistent global framework for tory risk; and technological risks. Participation by the senior managing Conduct Risk (i.e., the risk arising from miscon- officers of the Firm and business segment control groups duct by employees or contingent workers) and Conduct Risk helps ensure that risk policies and procedures, exceptions to incidents at the Firm. risk limits, new products and business ventures, and transac- tions with risk elements undergo thorough review. The employee annual performance review process includes evaluation of employee conduct related to risk management Internal Audit Department practices and the Firm’s expectations. We also have several mutually reinforcing processes to identify employee conduct The Internal Audit Department provides independent risk and that may have an impact on employment status, current year control assessment. The Internal Audit Department provides compensation and/or prior year compensation. For example, an independent assessment of the design and effectiveness of the Global Incentive Compensation Discretion Policy sets
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− 304 − Risk Disclosures forth standards for managers when making annual compensa- to events in the markets in which we operate and certain other tion decisions and specifically provides that managers must factors described in the following paragraphs. consider whether their employees effectively managed and/or supervised risk control practices during the performance year. Management committees from control functions periodically Market Risk meet to discuss employees whose conduct is not in line with Market risk refers to the risk that a change in the level of one our expectations. These results are incorporated into identi- or more market prices, rates, indices, volatilities, correlations fied employees’ performance reviews and compensation and or other market factors, such as market liquidity, will result in promotion decisions. losses for a position or portfolio. Generally, we incur market risk as a result of trading, investing and client facilitation The Firm’s clawback and cancellation provisions apply to activities, principally within the Institutional Securities busi- deferred incentive compensation and cover a broad scope of ness segment where the substantial majority of our VaR for employee conduct, including any act or omission (including market risk exposures is generated. In addition, we incur with respect to direct supervisory responsibilities) that consti- non-trading market risk within the Wealth Management and tutes a breach of obligation to the Firm or causes a restate- Investment Management business segments. The Wealth ment of the Firm’s financial results, constitutes a violation of Management business segment primarily incurs non-trading the Firm’s global risk management principles, policies and market risk from lending and deposit-taking activities. The standards, or causes a loss of revenue associated with a posi- Investment Management business segment primarily incurs tion on which the employee was paid and the employee oper- non-trading market risk from capital investments in alterna- ated outside of internal control policies. tive and other funds.
Risk Limits Framework Market risk includes non-trading interest rate risk. Non-trading interest rate risk in the banking book (amounts Risk limits and quantitative metrics provide the basis for classified for regulatory capital purposes under the banking monitoring risk taking activity and avoiding outsized risk book regime) refers to the exposure that a change in interest taking. Our risk-taking capacity is sized through the Firm’s rates will result in prospective earnings changes for assets capital planning process where losses are estimated under the and liabilities in the banking book. Firm’s BHC Severely Adverse stress testing scenario. We also maintain a comprehensive suite of risk limits and quanti- Sound market risk management is an integral part of our tative metrics to support and implement our risk appetite culture. The various business units and trading desks are statement. Our risk limits support linkages between the responsible for ensuring that market risk exposures are well- overall risk appetite, which is reviewed by the Board, and managed and prudent. The control groups help ensure that more granular risk-taking decisions and activities. these risks are measured and closely monitored and are made transparent to senior management. The Market Risk Depart- Risk limits, once established, are reviewed and updated on at ment is responsible for ensuring transparency of material least an annual basis, with more frequent updates as neces- market risks, monitoring compliance with established limits sary. Board-level risk limits address the most important Firm- and escalating risk concentrations to appropriate senior wide aggregations of risk, including, but not limited to, management. stressed market, credit and liquidity risks. Additional risk limits approved by the FRC address more specific types of To execute these responsibilities, the Market Risk Depart- risk and are bound by the higher-level Board risk limits. ment monitors our risk against limits on aggregate risk expo- sures, performs a variety of risk analyses, routinely reports Risk Management Process risk summaries, and maintains our VaR and scenario analysis systems. Market risk is also monitored through various In subsequent sections we discuss our risk management poli- measures: by use of statistics (including VaR and related cies and procedures for our primary risks. This discussion analytical measures); by measures of position sensitivity; and primarily focuses on our Institutional Securities trading activ- through routine stress testing, which measures the impact on ities and corporate lending and related activities. We believe the value of existing portfolios of specified changes in market that these activities generate a substantial portion of our factors and scenarios designed by the Market Risk Depart- primary risks. These sections and the estimated amounts of ment in collaboration with the business units. The material our risk exposure generated by our statistical analyses are risks identified by these processes are summarized in reports forward-looking statements. However, the analyses used to produced by the Market Risk Department that are circulated assess such risks are not predictions of future events, and to and discussed with senior management, the FRC, the BRC actual results may vary significantly from such analyses due and the Board.
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Trading Risks activities may not always provide effective mitigation against trading losses due to differences in the terms, specific charac- Primary Market Risk Exposures and Market Risk teristics or other basis risks that may exist between the hedge Management instrument and the risk exposure that is being hedged.
During 2018, we had exposures to a wide range of interest We manage the market risk associated with our trading activ- rates, equity prices, foreign exchange rates and commodity ities on a Firm-wide basis, on a worldwide trading division prices—and the associated implied volatilities and spreads— level and on an individual product basis. We manage and related to the global markets in which we conduct our trading monitor our market risk exposures in such a way as to main- activities. tain a portfolio that we believe is well-diversified in the aggregate with respect to market risk factors and that reflects We are exposed to interest rate and credit spread risk as a our aggregate risk tolerance as established by our senior result of our market-making activities and other trading in management. interest rate-sensitive financial instruments (e.g., risk arising from changes in the level or implied volatility of interest Aggregate market risk limits have been approved for the Firm rates, the timing of mortgage prepayments, the shape of the across all divisions worldwide. Additional market risk limits yield curve and credit spreads). The activities from which are assigned to trading desks and, as appropriate, products those exposures arise and the markets in which we are active and regions. Trading division risk managers, desk risk include, but are not limited to, the following: derivatives, and managers, traders and the Market Risk Department monitor corporate and government debt across both developed and market risk measures against limits in accordance with poli- emerging markets and asset-backed debt, including mortgage- cies set by our senior management. related securities. Value-at-Risk We are exposed to equity price and implied volatility risk as a result of making markets in equity securities and derivatives The statistical technique known as VaR is one of the tools we and maintaining other positions, including positions in use to measure, monitor and review the market risk exposures non-public entities. Positions in non-public entities may of our trading portfolios. The Market Risk Department calcu- include, but are not limited to, exposures to private equity, lates and distributes daily VaR-based risk measures to various venture capital, private partnerships, real estate funds and levels of management. other funds. Such positions are less liquid, have longer investment horizons and are more difficult to hedge than We estimate VaR using a model based on volatility-adjusted listed equities. historical simulation for general market risk factors and Monte Carlo simulation for name-specific risk in corporate We are exposed to foreign exchange rate and implied vola- shares, bonds, loans and related derivatives. The model tility risk as a result of making markets in foreign currencies constructs a distribution of hypothetical daily changes in the and foreign currency derivatives, from maintaining foreign value of trading portfolios based on historical observation of exchange positions and from holding non-U.S. dollar- daily changes in key market indices or other market risk denominated financial instruments. factors, and information on the sensitivity of the portfolio values to these market risk factor changes. We are exposed to commodity price and implied volatility risk as a result of market-making activities in commodity Our VaR model uses four years of historical data with a vola- products related primarily to electricity, natural gas, oil and tility adjustment to reflect current market conditions. VaR for precious metals. Commodity exposures are subject to periods risk management purposes (“Management VaR”) is of high price volatility as a result of changes in supply and computed at a 95% level of confidence over a one-day time demand. These changes can be caused by weather conditions; horizon, which is a useful indicator of possible trading losses physical production and transportation; or geopolitical and resulting from adverse daily market moves. The 95%/one-day other events that affect the available supply and level of VaR corresponds to the unrealized loss in portfolio value that, demand for these commodities. based on historically observed market risk factor movements, would have been exceeded with a frequency of 5%, or five We manage our trading positions by employing a variety of times in every 100 trading days, if the portfolio were held risk mitigation strategies. These strategies include diversifica- constant for one day. tion of risk exposures and hedging. Hedging activities consist of the purchase or sale of positions in related securities and Our VaR model generally takes into account linear and financial instruments, including a variety of derivative prod- non-linear exposures to equity and commodity price risk, ucts (e.g., futures, forwards, swaps and options). Hedging interest rate risk, credit spread risk and foreign exchange
December 2018 Form 10-K 68
− 306 − Risk Disclosures rates. The model also takes into account linear exposures to monitor and manage risk. There can be no assurance that our implied volatility risks for all asset classes and non-linear actual losses on a particular day will not exceed the VaR exposures to implied volatility risks for equity, commodity amounts indicated in the following tables and paragraphs or and foreign exchange referenced products. The VaR model that such losses will not occur more than five times in 100 also captures certain implied correlation risks associated with trading days for a 95%/one-day VaR. VaR does not predict portfolio credit derivatives, as well as certain basis risks (e.g., the magnitude of losses that, should they occur, may be corporate debt and related credit derivatives). significantly greater than the VaR amount.
We use VaR as one of a range of risk management tools. VaR statistics are not readily comparable across firms Among their benefits, VaR models permit estimation of a because of differences in the firms’ portfolios, modeling portfolio’s aggregate market risk exposure, incorporating a assumptions and methodologies. These differences can result range of varied market risks and portfolio assets. One key in materially different VaR estimates across firms for similar element of the VaR model is that it reflects risk reduction due portfolios. The impact of such differences varies depending to portfolio diversification or hedging activities. However, on the factor history assumptions, the frequency with which VaR has various limitations, which include, but are not the factor history is updated and the confidence level. As a limited to: use of historical changes in market risk factors, result, VaR statistics are more useful when interpreted as which may not be accurate predictors of future market condi- indicators of trends in a firm’s risk profile rather than as an tions and may not fully incorporate the risk of extreme absolute measure of risk to be compared across firms. market events that are outsized relative to observed historical market behavior or reflect the historical distribution of results Our regulators have approved the same VaR model we use for beyond the 95% confidence interval; and reporting of losses risk management purposes for use in regulatory calculations. in a single day, which does not reflect the risk of positions that cannot be liquidated or hedged in one day. A small The portfolio of positions used for Management VaR differs proportion of market risk generated by trading positions is from that used for Regulatory VaR. Management VaR not included in VaR. contains certain positions that are excluded from Regulatory VaR. Examples include counterparty CVA and related The modeling of the risk characteristics of some positions hedges, as well as loans that are carried at fair value and asso- relies on approximations that, under certain circumstances, ciated hedges. could produce significantly different results from those produced using more precise measures. VaR is most appro- The following table presents the Management VaR for the priate as a risk measure for trading positions in liquid finan- Trading portfolio, on a period-end, annual average, and cial markets and will understate the risk associated with annual high and low basis. To further enhance the transpar- severe events, such as periods of extreme illiquidity. We are ency of the traded market risk, the Credit Portfolio VaR has aware of these and other limitations and, therefore, use VaR been disclosed as a separate category from the Primary Risk as only one component in our risk management oversight Categories. The Credit Portfolio includes counterparty CVA process. This process also incorporates stress testing and and related hedges, as well as loans that are carried at fair scenario analyses and extensive risk monitoring, analysis and value and associated hedges. control at the trading desk, division and Firm levels. 95%/One-Day Management VaR
Our VaR model evolves over time in response to changes in 2018 the composition of trading portfolios and to improvements in Period modeling techniques and systems capabilities. We are $ in millions End Average High2 Low2 committed to continuous review and enhancement of VaR Interest rate and credit spread $ 38$34$51$25 methodologies and assumptions in order to capture evolving Equity price 14 14 18 11 risks associated with changes in market structure and Foreign exchange rate 13 11 16 7 dynamics. As part of our regular process improvements, addi- Commodity price 13 9 18 7 tional systematic and name-specific risk factors may be added Less: Diversification benefit1 (27) (27) N/A N/A to improve the VaR model’s ability to more accurately esti- Primary Risk Categories $ 51$41$62$33 mate risks to specific asset classes or industry sectors. Credit Portfolio 15 12 16 9 Less: Diversification benefit1 (9) (8) N/A N/A Since the reported VaR statistics are estimates based on Total Management VaR $ 57$45$67$38 historical data, VaR should not be viewed as predictive of our future revenues or financial performance or of our ability to
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2017 Daily 95%/One-Day Total Management VaR for 20181 Period ($ in millions) $ in millions End Average High2 Low2 108 Interest rate and credit spread $ 32 $ 31 $ 44 $ 23 Equity price 11 15 26 10 78 Foreign exchange rate 9 10 18 6 Commodity price 7 8 11 6 Less: Diversification benefit1 (20) (24) N/A N/A Primary Risk Categories $ 39 $ 40 $ 60 $ 28 37
Credit Portfolio 9 12 17 8 Number of Days 28 Less: Diversification benefit1 (5) (8) N/A N/A Total Management VaR $ 43 $ 44 $ 64 $ 33 7 0 1 1 0
1. Diversification benefit equals the difference between the total Management VaR and the sum of the component VaRs. This benefit arises because the simulated one-day losses for each of the components occur on different <$35 >$70 days; similar diversification benefits also are taken into account within each component. $35 to $40 $40 to $45 $45 to $50 $50 to $55 $55 to $60 $60 to $65 $65 to $70 2. The high and low VaR values for the total Management VaR and each of the 1. The average 95%/one-day total Management VaR for 2018 was $45 million. component VaRs might have occurred on different days during the quarter, and therefore, the diversification benefit is not an applicable measure. Daily Net Trading Revenues for 2018 Average total Management VaR and average Management ($ in millions) VaR for the Primary Risk Categories were relatively 103 unchanged from 2017.
Distribution of VaR Statistics and Net Revenues 70
One method of evaluating the reasonableness of our VaR 52 model as a measure of our potential volatility of net revenues is to compare VaR with corresponding actual trading reve- Number of Days nues. Assuming no intraday trading, for a 95%/one-day VaR, 14 12 5 the expected number of times that trading losses should 0 2 1 1 0 exceed VaR during the year is 13, and, in general, if trading losses were to exceed VaR more than 21 times in a year, the >$175 adequacy of the VaR model would be questioned. <$(50) $0 to $25 $25 to $50 $50 to $75 $(25) to $0 $75 to $100 $100 to $125 $125 to $150 $150 to $175 We evaluate the reasonableness of our VaR model by $(50) to $(25) comparing the potential declines in portfolio values generated by the model with corresponding actual trading results for the The previous histogram shows the distribution of daily net Firm, as well as individual business units. For days where trading revenues for 2018. Daily net trading revenues include losses exceed the VaR statistic, we examine the drivers of profits and losses from Interest rate and credit spread, Equity trading losses to evaluate the VaR model’s accuracy relative price, Foreign exchange rate, Commodity price, and Credit to realized trading results. There were no days in 2018 on Portfolio positions and intraday trading activities for our which trading losses exceeded VaR. trading businesses. Certain items such as fees, commissions and net interest income are excluded from daily net trading revenues and the VaR model. Revenues required for Regula- tory VaR backtesting further exclude intraday trading.
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Non-Trading Risks Investments Sensitivity, Including Related Performance Fees Loss from 10% Decline We believe that sensitivity analysis is an appropriate repre- At At sentation of our non-trading risks. The following sensitivity December 31, December 31, analyses cover substantially all of the non-trading risk in our $ in millions 2018 2017 portfolio. Investments related to Investment Management activities $ 298 $ 316 Credit Spread Risk Sensitivity1 Other investments: MUMSS 165 168 At At December 31, December 31, Other Firm investments 179 178 $ in millions 2018 2017 MUMSS—Mitsubishi UFJ Morgan Stanley Securities Co., Ltd. Derivatives $6$6 Funding liabilities2 34 29 We have exposure to public and private companies through direct investments, as well as through funds that invest in 1. Amounts represent the increase in value for each 1 bps widening of our these assets. These investments are predominantly equity credit spread. 2. Relates to structured note liabilities carried at fair value. positions with long investment horizons, a portion of which is for business facilitation purposes. The market risk related to Credit spread risk sensitivity for funding liabilities as of these investments is measured by estimating the potential December 31, 2018 has increased compared with reduction in net income associated with a 10% decline in December 31, 2017, primarily as a result of new structured investment values and related impact on performance fees. note issuances in the Fixed Income Division of the Institu- tional Securities business segment. Equity Market Sensitivity
U.S. Bank Subsidiaries’ Net Interest Income Sensitivity Analysis In the Wealth Management and Investment Management business segments, certain fee-based revenue streams are At At December 31, December 31, driven by the value of clients’ equity holdings. The overall $ in millions 2018 2017 level of revenues for these streams also depends on multiple Basis point change additional factors that include, but are not limited to, the level +200 $ 340 $ 489 and duration of the equity market increase or decline, price +100 182 367 volatility, the geographic and industry mix of client assets, -100 (428) (500) the rate and magnitude of client investments and redemp- tions, and the impact of such market increase or decline and price volatility on client behavior. Therefore, overall reve- The previous table presents an analysis of selected instanta- nues do not correlate completely with changes in the equity neous upward and downward parallel interest rate shocks on markets. net interest income over the next 12 months for our U.S. Bank Subsidiaries. These shocks are applied to our 12-month forecast for our U.S. Bank Subsidiaries, which incorporates Credit Risk market expectations of interest rates and our forecasted busi- ness activity. Credit risk refers to the risk of loss arising when a borrower, counterparty or issuer does not meet its financial obligations We do not manage to any single rate scenario but rather to us. We primarily incur credit risk to institutions and indi- manage net interest income in our U.S. Bank Subsidiaries to viduals through our Institutional Securities and Wealth optimize across a range of possible outcomes, including Management business segments. non-parallel rate change scenarios. The sensitivity analysis assumes that we take no action in response to these scenarios, We may incur credit risk in our Institutional Securities busi- assumes there are no changes in other macroeconomic varia- ness segment through a variety of activities, including, but bles normally correlated with changes in interest rates, and not limited to, the following: includes subjective assumptions regarding customer and market re-pricing behavior and other factors. The change in • extending credit to clients through lending commitments; sensitivity to interest rates between December 31, 2018 and December 31, 2017 is related to overall changes in our asset- • entering into swap or other derivative contracts under liability profile and higher market rates. which counterparties may have obligations to make payments to us;
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• providing short- or long-term funding that is secured by control credit risk concentrations arising from lending and physical or financial collateral whose value may at times be trading activities. The stress tests shock market factors (e.g., insufficient to fully cover the repayment amount; interest rates, commodity prices, credit spreads), risk parame- ters (e.g., default probabilities and loss given default), • posting margin and/or collateral to clearinghouses, clearing recovery rates and expected losses in order to assess the agencies, exchanges, banks, securities firms and other impact of stresses on exposures, profit and loss, and our financial counterparties; capital position. Stress tests are conducted in accordance with our established policies and procedures. • placing funds on deposit at other financial institutions to support our clearing and settlement obligations; and Credit Evaluation
• investing or trading in securities and loan pools, whereby The evaluation of corporate and institutional counterparties the value of these assets may fluctuate based on realized or and borrowers includes assigning obligor credit ratings, expected defaults on the underlying obligations or loans. which reflect an assessment of an obligor’s probability of default and loss given default. Credit evaluations typically We incur credit risk in our Wealth Management business involve the assessment of financial statements; leverage; segment, primarily through lending to individuals and enti- liquidity; capital strength; asset composition and quality; ties, including, but not limited to, the following: market capitalization; access to capital markets; adequacy of • margin loans collateralized by securities; collateral, if applicable; and in the case of certain loans, cash flow projections and debt service requirements. CRM also • securities-based lending and other forms of secured loans, evaluates strategy, market position, industry dynamics, including tailored lending, to high net worth clients; and management and other factors that could affect the obligor’s risk profile. Additionally, CRM evaluates the relative posi- • single-family residential mortgage loans in conforming, tion of our exposure in the borrower’s capital structure and non-conforming or HELOC form, primarily to existing relative recovery prospects, as well as other structural Wealth Management clients. elements of the particular transaction.
Monitoring and Control The evaluation of consumer borrowers is tailored to the specific type of lending. Margin and securities-based loans In order to help protect us from losses, the Credit Risk are evaluated based on factors that include, but are not Management Department (“CRM”) establishes Firm-wide limited to, the amount of the loan, the degree of leverage and practices to evaluate, monitor and control credit risk at the the quality, diversification, price volatility and liquidity of the transaction, obligor and portfolio levels. CRM approves collateral. The underwriting of residential real estate loans extensions of credit, evaluates the creditworthiness of the includes, but is not limited to, review of the obligor’s income, counterparties and borrowers on a regular basis, and helps net worth, liquidity, collateral, loan-to-value ratio and credit ensure that credit exposure is actively monitored and bureau information. Subsequent credit monitoring for indi- managed. The evaluation of counterparties and borrowers vidual loans is performed at the portfolio level, and collateral includes an assessment of the probability that an obligor will values are monitored on an ongoing basis. default on its financial obligations and any losses that may occur when an obligor defaults. In addition, credit risk expo- Credit risk metrics assigned to our borrowers during the eval- sure is actively managed by credit professionals and commit- uation process are incorporated into CRM maintenance of the tees within CRM and through various risk committees, whose allowance for loan losses for loans held for investment. Such membership includes individuals from CRM. A comprehen- allowance serves as a reserve for probable inherent losses, as sive and global Credit Limits Framework is utilized to well as probable losses related to loans identified as manage credit risk levels across the Firm. The Credit Limits impaired. For more information on the allowance for loan Framework is calibrated within our risk tolerance and losses, see Notes 2 and 7 to the financial statements. includes single-name limits and portfolio concentration limits by country, industry and product type. Risk Mitigation
CRM helps ensure timely and transparent communication of We may seek to mitigate credit risk from our lending and material credit risks, compliance with established limits and trading activities in multiple ways, including collateral provi- escalation of risk concentrations to appropriate senior sions, guarantees and hedges. At the transaction level, we management. CRM also works closely with the Market Risk seek to mitigate risk through management of key risk Department and applicable business units to monitor risk elements such as size, tenor, financial covenants, seniority exposures and to perform stress tests to identify, analyze and and collateral. We actively hedge our lending and derivatives
December 2018 Form 10-K 72
− 310 − Risk Disclosures exposure. Hedging activities consist of the purchase or sale of Loans and Lending Commitments positions in related securities and financial instruments, At December 31, 2018 including a variety of derivative products (e.g., futures, $ in millions IS WM IM1 Total forwards, swaps, and options). Additionally, we may sell, Corporate $ 20,020 $ 16,884 $ 5 $ 36,909 assign or syndicate loans and lending commitments to other Consumer — 27,868 — 27,868 financial institutions in the primary and secondary loan Residential real estate — 27,466 — 27,466 markets. Wholesale real estate 7,810 — — 7,810 Loans held for investment, gross of allowance 27,830 72,218 5 100,053 In connection with our derivatives trading activities, we Allowance for loan losses (193) (45) — (238) generally enter into master netting agreements and collateral Loans held for investment, arrangements with counterparties. These agreements provide net of allowance 27,637 72,173 5 99,815 us with the ability to demand collateral, as well as to liquidate Corporate 13,886 — — 13,886 collateral and offset receivables and payables covered under Residential real estate 121— 22 the same master agreement in the event of a counterparty Wholesale real estate 1,856 — — 1,856 default. A collateral management group monitors collateral Loans held for sale 15,743 21 — 15,764 levels against requirements and oversees the administration Corporate 9,150 — 21 9,171 of the collateral function. See Note 6 to the financial state- Residential real estate 1,153 — — 1,153 Wholesale real estate 601 — — 601 ments for additional information about our collateralized Loans held at fair value 10,904 — 21 10,925 transactions. Total loans 54,284 72,194 26 126,504 Lending commitments2, 3 95,065 10,663 — 105,728 Loans and Lending Commitments Total loans and lending commitments2, 3 $ 149,349 $ 82,857 $ 26 $ 232,232 We provide loans and lending commitments to a variety of At December 31, 2017 customers, from large corporate and institutional clients to $ in millions IS WM IM1 Total high net worth individuals. In addition, we purchase loans in Corporate $ 15,332 $ 14,417 $ 5 $ 29,754 the secondary market. In the balance sheets, these loans and Consumer — 26,808 — 26,808 lending commitments are carried as held for investment, Residential real estate — 26,635 — 26,635 which are recorded at amortized cost; as held for sale, which Wholesale real estate 9,980 — — 9,980 are recorded at the lower of cost or fair value; or at fair value Loans held for investment, with changes in fair value recorded in earnings. Loans held gross of allowance 25,312 67,860 5 93,177 for investment and loans held for sale are classified in Loans, Allowance for loan losses (182) (42) — (224) and loans held at fair value are classified in Trading assets in Loans held for investment, the balance sheets. See Notes 3, 7 and 12 to the financial net of allowance 25,130 67,818 5 92,953 statements for further information. Corporate 9,456 — — 9,456 Residential real estate 1 34 — 35 Wholesale real estate 1,682 — — 1,682 Loans held for sale 11,139 34 — 11,173 Corporate 8,336 — 22 8,358 Residential real estate 799 — — 799 Wholesale real estate 1,579 — — 1,579 Loans held at fair value 10,714 — 22 10,736 Total loans 46,983 67,852 27 114,862 Lending commitments2, 3 92,588 9,481 — 102,069 Total loans and lending commitments2, 3 $ 139,571 $ 77,333 $ 27 $ 216,931 1. Investment Management business segment loans are entered into in conjunction with certain investment advisory activities. 2. Lending commitments represent the notional amount of legally binding obli- gations to provide funding to clients for lending transactions. Since commit- ments associated with these business activities may expire unused or may not be utilized to full capacity, they do not necessarily reflect the actual future cash funding requirements. 3. For syndications led by us, any lending commitments accepted by the borrower but not yet closed are net of amounts syndicated. For syndications that we participate in and do not lead, any lending commitments accepted by the borrower but not yet closed include only the amount that we expect will be allocated from the lead syndicate bank. Due to the nature of our obliga- tions under the commitments, these amounts include certain commitments participated to third parties.
73 December 2018 Form 10-K
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In 2018, total loans and lending commitments increased by Institutional Securities approximately $15 billion primarily due to increases in corporate collateralized and event-driven loans and lending In connection with certain Institutional Securities business commitments within the Institutional Securities business segment activities, we provide loans and lending commit- segment and growth in securities-based lending within the ments to a diverse group of corporate and other institutional Wealth Management business segment. clients. We also purchase a variety of loans in the secondary market. Our loans and lending commitments may have Credit exposure arising from our loans and lending commit- varying terms; may be senior or subordinated; may be ments is measured in accordance with our internal risk secured or unsecured; are generally contingent upon repre- management standards. Risk factors considered in deter- sentations, warranties and contractual conditions applicable mining the aggregate allowance for loan and commitment to the borrower; and may be syndicated, traded or hedged by losses include the borrower’s financial strength, industry, us. facility structure, loan-to-value ratio, debt service ratio, collateral and covenants. Qualitative and environmental We also participate in securitization activities, whereby we factors such as economic and business conditions, nature and extend short- or long-term collateralized lines of credit and volume of the portfolio and lending terms, and volume and term loans with various types of collateral, including residen- severity of past due loans may also be considered. tial real estate, commercial real estate, corporate and financial assets. These collateralized loans and lending commitments Allowance for Loans and Lending Commitments Held for generally provide for over-collateralization. Credit risk with Investment respect to these loans and lending commitments arises from At At the failure of a borrower to perform according to the terms of December 31, December 31, the loan agreement or a decline in the underlying collateral $ in millions 2018 2017 value. The Firm monitors collateral levels against the require- Loans $ 238 $ 224 ments of lending agreements. See Note 13 to the financial Lending commitments 203 198 statements for information about our securitization activities. Total allowance for loans and lending commitments $ 441 $ 422 Institutional Securities Loans and Lending Commitments1
The aggregate allowance for loans and lending commitment At December 31, 2018 losses increased during 2018, primarily due to overall port- Years to Maturity folio changes and qualitative and environmental factors $ in millions Less than 1 1-3 3-5 Over 5 Total impacting the inherent allowance within the Institutional Loans AA $ 7 $ 430 $ — $ 19 $ 456 Securities business segment. See Note 7 to the financial state- A 565 1,580 858 267 3,270 ments for further information. BBB 3,775 4,697 4,251 495 13,218 Status of Loans Held for Investment NIG 7,151 12,882 9,313 5,889 35,235 Unrated2 88 95 160 1,762 2,105 At December 31, 2018 At December 31, 2017 Total loans 11,586 19,684 14,582 8,432 54,284 IS WM IS WM Lending commitments Current 99.8% 99.9% 99.5% 99.9% AAA 90 75 — — 165 Nonaccrual1 0.2% 0.1% 0.5% 0.1% AA 2,491 1,177 2,863 — 6,531 A 2,892 6,006 9,895 502 19,295 1. These loans are on nonaccrual status because the loans were past due for a BBB 2,993 11,825 19,461 638 34,917 period of 90 days or more or payment of principal or interest was in doubt. NIG 1,681 10,604 16,075 5,751 34,111 Unrated2 8 — 38 — 46 Total lending commitments 10,155 29,687 48,332 6,891 95,065 Total exposure $ 21,741 $ 49,371 $ 62,914 $ 15,323 $ 149,349
December 2018 Form 10-K 74
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At December 31, 2017 At December 31, 2017 Years to Maturity Years to Maturity $ in millions Less than 1 1-3 3-5 Over 5 Total $ in millions Less than 1 1-3 3-5 Over 5 Total Loans $ 1,458 $ 1,058 $ 639 $ 2,012 $ 5,167 Loans AA $ 14 $ 503 $ 30 $ 5 $ 552 Lending commitments 1,272 3,206 2,091 1,874 8,443 A 1,608 1,710 1,235 693 5,246 Total loans and lending commitments $ 2,730 $ 4,264 $ 2,730 $ 3,886 $ 13,610 BBB 2,791 6,558 3,752 646 13,747 NIG 4,760 12,311 4,480 3,245 24,796 Event-driven loans and lending commitments, which comprise Unrated2 243 291 621 1,487 2,642 a portion of corporate loans and lending commitments within Total loans 9,416 21,373 10,118 6,076 46,983 the Institutional Securities business segment, are associated Lending commitments AAA — 165 — — 165 with a particular event or transaction, such as to support client AA 3,745 1,108 3,002 — 7,855 merger, acquisition, recapitalization or project finance activ- A 3,769 5,533 11,774 197 21,273 ities. Event-driven loans and lending commitments typically BBB 3,987 12,345 16,818 1,095 34,245 consist of revolving lines of credit, term loans and bridge loans. NIG 4,159 9,776 12,279 2,698 28,912 The increase in event-driven lending commitments in 2018 is Unrated2 9404247138primarily due to an increase in held-for-sale commitments Total lending driven by client M&A transactions. commitments 15,669 28,967 43,915 4,037 92,588 Total exposure $ 25,085 $ 50,340 $ 54,033 $ 10,113 $ 139,571 Wealth Management
NIG–Non-investment grade 1. Obligor credit ratings are internally determined by CRM. The principal Wealth Management business segment lending 2. Unrated loans and lending commitments are primarily trading positions that are activities include securities-based lending and residential real measured at fair value and risk managed as a component of market risk. For a further discussion of our market risk, see “Quantitative and Qualitative Disclosures estate loans. about Risk—Risk Management—Market Risk” herein. Securities-based lending provided to our retail clients is Institutional Securities Loans and Lending Commitments by primarily conducted through our Liquidity Access Line Industry (“LAL”) platform. The LAL platform allows the client to At At borrow money against the value of qualifying securities, December 31, December 31, generally for any purpose other than purchasing securities. $ in millions 2018 20171 We establish approved credit lines against qualifying securi- Industry ties and monitor limits daily and, pursuant to such guidelines, Financials $ 32,655 $ 22,112 require customers to deposit additional collateral, or Real estate 24,133 28,426 reduce debt positions, when necessary. These credit lines are Industrials 13,701 11,090 primarily uncommitted loan facilities, as we reserve the right Communications services 11,244 9,126 to not make any advances or may terminate these credit lines Healthcare 10,158 9,956 at any time. Factors considered in the review of these loans Information technology 9,896 10,361 include, but are not limited to, the loan amount, the client’s Utilities 9,856 9,592 credit profile, the degree of leverage, collateral diversifica- Energy 9,847 10,233 tion, price volatility and liquidity of the collateral. Consumer discretionary 8,314 8,102 Consumer staples 7,921 8,315 Residential real estate loans consist of first and second lien Materials 5,969 5,069 mortgages, including HELOCs. Our underwriting policy is Insurance 3,744 4,739 designed to ensure that all borrowers pass an assessment of Other 1,911 2,450 capacity and willingness to pay, which includes an analysis Total $ 149,349 $ 139,571 utilizing industry standard credit scoring models (e.g., FICO
1. Prior period amounts have been revised to conform to reclassifications in the scores), debt ratios and assets of the borrower. Loan-to-value Global Industry Classification Standard structure. ratios are determined based on independent third-party prop- erty appraisals and valuations, and security lien positions are Event-Driven Loans and Lending Commitments established through title and ownership reports. The vast At December 31, 2018 majority of mortgage and HELOC loans are held for invest- Years to Maturity ment in the Wealth Management business segment’s loan $ in millions Less than 1 1-3 3-5 Over 5 Total portfolio. Loans $ 2,582 $ 287 $ 656 $ 1,618 $ 5,143 Lending commitments 1,506 2,456 2,877 3,658 10,497 Total loans and lending commitments $ 4,088 $ 2,743 $ 3,533 $ 5,276 $ 15,640
75 December 2018 Form 10-K
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Wealth Management Loans and Lending Commitments Employee Loans
At December 31, 2018 At At Contractual Years to Maturity December 31, December 31, $ in millions Less than 1 1-3 3-5 Over 5 Total $ in millions 2018 2017 Securities-based lending and Balance $ 3,415 $ 4,185 other loans $ 38,144 $ 3,573 $ 2,004 $ 1,006 $ 44,727 Allowance for loan losses (63) (77) Residential real estate loans — 30 1 27,436 27,467 Balance, net $ 3,352 $ 4,108 Total loans $ 38,144 $ 3,603 $ 2,005 $ 28,442 $ 72,194 Repayment term range, in years 1to20 1to20 Lending commitments 9,197 1,151 42 273 10,663 Total loans and lending commitments $ 47,341 $ 4,754 $ 2,047 $ 28,715 $ 82,857 In 2018, the balance of employee loans decreased as a result Securities-based lending—LAL platform loans $ 33,247 of the repayment of existing loans and a decline in new note issuances. Employee loans are generally granted to retain and At December 31, 2017 recruit certain Wealth Management representatives, are full Contractual Years to Maturity $ in millions Less than 1 1-3 3-5 Over 5 Total recourse and generally require periodic repayments. We Securities-based lending and establish an allowance for loan amounts to terminated other loans $ 34,389 $ 3,687 $ 1,899 $ 1,231 $ 41,206 employees that we do not consider recoverable, which is Residential real estate loans — 24 15 26,607 26,646 recorded in Compensation and benefits expense. Total loans $ 34,389 $ 3,711 $ 1,914 $ 27,838 $ 67,852 Lending commitments 7,253 1,827 120 281 9,481 Derivatives Total loans and lending commitments $ 41,642 $ 5,538 $ 2,034 $ 28,119 $ 77,333 Counterparty Credit Rating and Remaining Contractual Securities-based lending—LAL platform loans $ 32,230 Maturity of OTC Derivative Assets at Fair Value
Credit Rating1 In 2018, Loans and Lending commitments associated with the $ in millions AAA AA A BBB NIG Total Wealth Management business segment increased by approxi- At December 31, 2018 mately 7%, primarily due to growth in securities-based <1 year $ 878 $ 7,430 $ 38,718 $ 15,009 $ 7,183 $ 69,218 lending and other loans. 1-3 years 664 2,362 22,239 10,255 7,097 42,617 3-5 years 621 2,096 11,673 6,014 2,751 23,155 Customer and Other Receivables Over 5 years 3,535 9,725 67,166 36,087 11,112 127,625 Total, gross $ 5,698 $ 21,613 $ 139,796 $ 67,365 $ 28,143 $ 262,615 Margin Loans Counterparty netting (2,325) (13,771) (113,045) (49,658) (16,681) (195,480) At December 31, 2018 Cash and $ in millions IS WM Total securities Customer receivables representing margin loans $ 14,842 $ 11,383 $ 26,225 collateral (3,214) (5,766) (21,931) (12,702) (8,269) (51,882) Total, net $ 159 $ 2,076 $ 4,820 $ 5,005 $ 3,193 $ 15,253 At December 31, 2017 $ in millions IS WM Total Credit Rating1, 2 Customer receivables representing margin loans $ 19,977 $ 12,135 $ 32,112 $ in millions AAA AA A BBB NIG Total At December 31, 2017 The Institutional Securities and Wealth Management business <1 year $ 356 $ 5,302 $ 36,001 $ 11,577 $ 5,904 $ 59,140 segments provide margin lending arrangements which allow 1-3 years 558 4,118 23,137 8,887 4,827 41,527 customers to borrow against the value of qualifying securi- 3-5 years 702 3,183 15,577 5,489 4,879 29,830 ties. Margin lending activities generally have minimal credit Over 5 years 5,470 11,667 78,779 37,286 12,079 145,281 risk due to the value of collateral held and their short-term Total, gross $ 7,086 $ 24,270 $ 153,494 $ 63,239 $ 27,689 $ 275,778 nature. Amounts may fluctuate from period to period as Counterparty overall client balances change as a result of market levels, netting (3,018) (15,261) (125,378) (45,421) (15,828) (204,906) client positioning and leverage. Cash and securities collateral (3,188) (6,785) (23,257) (12,844) (9,123) (55,197) Total, net $ 880 $ 2,224 $ 4,859 $ 4,974 $ 2,738 $ 15,675
1. Obligor credit ratings are determined internally by CRM. 2. Prior period amounts have been revised to conform to the current presentation.
December 2018 Form 10-K 76
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OTC Derivative Products at Fair Value, Net of Collateral, by manage our exposure to residential and commercial mortgage Industry loans and corporate lending exposures. The effectiveness of At At our CDS protection as a hedge of our exposures may vary December 31, December 31, $ in millions 2018 20171 depending upon a number of factors, including the contrac- Industry tual terms of the CDS. Financials $ 4,480 $ 3,330 We actively monitor our counterparty credit risk related to Utilities 4,324 4,382 credit derivatives. A majority of our counterparties are Industrials 1,335 1,124 composed of banks, broker-dealers, insurance and other Healthcare 787 882 financial institutions. Contracts with these counterparties may Regional governments 779 1,005 include provisions related to counterparty rating downgrades, Information technology 695 573 which may result in the counterparty posting additional Not-for-profit organizations 583 703 collateral to us. As with all derivative contracts, we consider Sovereign governments 385 1,084 counterparty credit risk in the valuation of our positions and Communication services 373 294 recognize CVAs as appropriate within Trading revenues in Real estate 283 374 the income statements. Materials 275 329 Insurance 235 206 For additional credit exposure information on our credit Consumer staples 216 161 derivative portfolio, see Note 4 to the financial statements Energy 199 646 and “Single Name and Index Credit Derivatives Included in Consumer discretionary 188 357 Net Inventory” herein. Other 116 225 Total $ 15,253 $ 15,675
1. Prior period amounts have been revised to conform to reclassifications in the Country Risk Global Industry Classification Standard structure. Country risk exposure is the risk that events in, or that affect, We incur credit risk as a dealer in OTC derivatives. Credit a foreign country (any country other than the U.S.) might risk with respect to derivative instruments arises from the adversely affect us. We actively manage country risk expo- possibility that a counterparty may fail to perform according sure through a comprehensive risk management framework to the terms of the contract. For a description of our risk miti- that combines credit and market fundamentals and allows us gation strategies, see “Credit Risk—Risk Mitigation” herein. to effectively identify, monitor and limit country risk. Country risk exposure before and after hedging is monitored Credit Derivatives and managed.
A credit derivative is a contract between a seller and buyer of Our obligor credit evaluation process may also identify indi- protection against the risk of a credit event occurring on one rect exposures, whereby an obligor has vulnerability or expo- or more debt obligations issued by a specified reference sure to another country or jurisdiction. Examples of indirect entity. The buyer typically pays a periodic premium over the exposures include mutual funds that invest in a single life of the contract and is protected for the period. If a credit country, offshore companies whose assets reside in another event occurs, the seller is required to make payment to the country to that of the offshore jurisdiction and finance beneficiary based on the terms of the credit derivative company subsidiaries of corporations. Indirect exposures contract. Credit events, as defined in the contract, may be one identified through the credit evaluation process may result in or more of the following defined events: bankruptcy, dissolu- a reclassification of country risk. tion or insolvency of the referenced entity, failure to pay, obligation acceleration, repudiation, payment moratorium and We conduct periodic stress testing that seeks to measure the restructurings. impact on our credit and market exposures of shocks stem- ming from negative economic or political scenarios. When We trade in a variety of credit derivatives and may either deemed appropriate by our risk managers, the stress test purchase or write protection on a single name or portfolio of scenarios include possible contagion effects and second order referenced entities. In transactions referencing a portfolio of risks. This analysis, and results of the stress tests, may result entities or securities, protection may be limited to a tranche of in the amendment of limits or exposure mitigation. exposure or a single name within the portfolio. We are an active market maker in the credit derivatives markets. As a In addition to our country risk exposure, we disclose our market maker, we work to earn a bid-offer spread on client cross-border risk exposure in “Financial Statements and flow business and manage any residual credit or correlation Supplementary Data—Financial Data Supplement risk on a portfolio basis. Further, we use credit derivatives to (Unaudited).” It is based on the FFIEC regulatory guidelines
77 December 2018 Form 10-K
− 315 − Risk Disclosures for reporting cross-border information and represents the Japan $ in millions Sovereigns Non-sovereigns Total amounts that we may not be able to obtain from a foreign Net inventory1 $ 7,051 $ 535 $ 7,586 country due to country-specific events, including unfavorable Net counterparty exposure2 37 3,059 3,096 economic and political conditions, economic and social insta- Loans — 319 319 bility, and changes in government policies. Lending commitments ——— Exposure before hedges 7,088 3,913 11,001 There can be substantial differences between our country risk Hedges3 (118) (115) (233) exposure and cross-border risk exposure. For instance, unlike Net exposure $ 6,970 $ 3,798 $ 10,768 the cross-border risk exposure, our country risk exposure includes the effect of certain risk mitigants. In addition, the Germany $ in millions Sovereigns Non-sovereigns Total basis for determining the domicile of the country risk expo- Net inventory1 $ 1,843 $ 239 $ 2,082 sure is different from the basis for determining the cross- Net counterparty exposure2 133 2,013 2,146 border risk exposure. Cross-border risk exposure is reported Loans — 961 961 based on the country of jurisdiction for the obligor or guar- Lending commitments — 3,174 3,174 antor. For country risk exposure, we consider factors in addi- Exposure before hedges 1,976 6,387 8,363 tion to that of country of jurisdiction, including physical loca- Hedges3 (268) (1,072) (1,340) tion of operations or assets, location and source of cash flows Net exposure $ 1,708 $ 5,315 $ 7,023 or revenues and location of collateral (if applicable) in order to determine the basis for country risk exposure. Furthermore, Spain cross-border risk exposure incorporates CDS only where $ in millions Sovereigns Non-sovereigns Total 1 protection is purchased, while country risk exposure incorpo- Net inventory $ (533) $ 73 $ (460) 2 rates CDS where protection is purchased or sold. Net counterparty exposure — 201 201 Loans — 4,732 4,732 Lending commitments — 1,747 1,747 Our sovereign exposures consist of financial contracts and Exposure before hedges (533) 6,753 6,220 obligations entered into with sovereign and local govern- Hedges3 — (199) (199) ments. Our non-sovereign exposures consist of financial Net exposure $ (533) $ 6,554 $ 6,021 contracts and obligations entered into primarily with corpora- tions and financial institutions. Index credit derivatives are Brazil included in the following country risk exposure table. Index $ in millions Sovereigns Non-sovereigns Total exposures are allocated to the underlying reference entities in Net inventory1 $ 4,734 $ 51 $ 4,785 proportion to the notional weighting of the country of each Net counterparty exposure2 — 211 211 reference entity in the index, adjusted for any fair value Loans —2323 receivable or payable for that reference entity. Where credit Lending commitments — 279 279 risk crosses multiple jurisdictions, for example, a CDS Exposure before hedges 4,734 564 5,298 purchased from a counterparty in a specific country that Hedges3 (11) (18) (29) references bonds issued by an entity in a different country, Net exposure $ 4,723 $ 546 $ 5,269 the fair value of the CDS is reflected in the Net Counterparty France Exposure row based on the country of the CDS counterparty. $ in millions Sovereigns Non-sovereigns Total Further, the notional amount of the CDS adjusted for the fair Net inventory1 $ 239 $ (68) $ 171 value of the receivable or payable is reflected in the Net Net counterparty exposure2 1 2,113 2,114 Inventory row based on the country of the underlying refer- Loans — 314 314 ence entity. Lending commitments — 2,092 2,092 Exposure before hedges 240 4,451 4,691 Hedges3 (56) (631) (687) Top 10 Non-U.S. Country Exposures at December 31, 2018 Net exposure $ 184 $ 3,820 $ 4,004
United Kingdom China $ in millions Sovereigns Non-sovereigns Total $ in millions Sovereigns Non-sovereigns Total Net inventory1 $ (827) $ 1,121 $ 294 Net inventory1 $ 156 $ 1,010 $ 1,166 Net counterparty exposure2 13 10,259 10,272 Net counterparty exposure2 258 149 407 Loans — 2,046 2,046 Loans — 1,427 1,427 Lending commitments — 4,524 4,524 Lending commitments — 619 619 Exposure before hedges (814) 17,950 17,136 Exposure before hedges 414 3,205 3,619 Hedges3 (353) (1,381) (1,734) Hedges3 (40) (10) (50) Net exposure $ (1,167) $ 16,569 $ 15,402 Net exposure $ 374 $ 3,195 $ 3,569
December 2018 Form 10-K 78
− 316 − Risk Disclosures
India Benefit of Collateral Received against Net Counterparty $ in millions Sovereigns Non-sovereigns Total Exposure Net inventory1 $ 1,712 $ 617 $ 2,329 At 2 Net counterparty exposure — 637 637 December 31, Loans ———$ in millions 2018 Lending commitments ———Counterparty credit exposure Collateral1 Exposure before hedges 1,712 1,254 2,966 Germany Germany and France $ 8,937 Hedges3 ———United Kingdom U.K., U.S. and Spain 8,661 Net exposure $ 1,712 $ 1,254 $ 2,966 Other Japan, France and U.S. 14,022 1. Collateral primarily consists of cash and government obligations. Netherlands $ in millions Sovereigns Non-sovereigns Total Country Risk Exposures Related to the U.K. Net inventory1 $ (112) $ 592 $ 480 At December 31, 2018, our country risk exposures in the Net counterparty exposure2 — 758 758 U.K. included net exposures of $15,402 million as shown in Loans — 921 921 the Top 10 Country Exposures table, and overnight deposits Lending commitments — 1,081 1,081 of $4,590 million. The $16,569 million of exposures to Exposure before hedges (112) 3,352 3,240 non-sovereigns were diversified across both names and Hedges3 (32) (269) (301) sectors. Of these exposures, $5,053 million were to U.K.- Net exposure $ (144) $ 3,083 $ 2,939 focused counterparties that generate more than one-third of Canada their revenues in the U.K., $3,347 million were to geographi- $ in millions Sovereigns Non-sovereigns Total cally diversified counterparties, and $7,092 million were to Net inventory1 $ (782) $ 405 $ (377) exchanges and clearinghouses. Net counterparty exposure2 59 1,796 1,855 Loans —7070 Lending commitments — 1,519 1,519 Operational Risk Exposure before hedges (723) 3,790 3,067 Operational risk refers to the risk of loss, or of damage to our Hedges3 — (206) (206) reputation, resulting from inadequate or failed processes or Net exposure $ (723) $ 3,584 $ 2,861 systems, from human factors or from external events (e.g., 1. Net inventory represents exposure to both long and short single-name and index fraud, theft, legal and compliance risks, cyber attacks or positions (i.e., bonds and equities at fair value and CDS based on a notional amount assuming zero recovery adjusted for the fair value of any receivable or damage to physical assets). We may incur operational risk payable). 2. Net counterparty exposure (i.e., repurchase transactions, securities lending and across the full scope of our business activities, including OTC derivatives) takes into consideration legally enforceable master netting agree- revenue-generating activities (e.g., sales and trading) and ments and collateral. Net counterparty exposure is net of the benefit of collateral received. For more information, see “Additional Information—Top 10 Non-U.S. support and control groups (e.g., information technology and Country Exposures” herein. trade processing). 3. Amounts represent CDS hedges (purchased and sold) on net counterparty expo- sure and lending executed by trading desks responsible for hedging counterparty and lending credit risk exposures. Amounts are based on the CDS notional amount We have established an operational risk framework to iden- assuming zero recovery adjusted for any fair value receivable or payable. For a tify, measure, monitor and control risk across the Firm. Effec- further description of the contractual terms for purchased credit protection and whether they may limit the effectiveness of our hedges, see “Derivatives” herein. tive operational risk management is essential to reducing the impact of operational risk incidents and mitigating legal, Additional Information—Top 10 Non-U.S. Country regulatory and reputational risks. The framework is continu- Exposures ally evolving to account for changes in the Firm and to respond to the changing regulatory and business environment. Single-Name and Index Credit Derivatives Included in Net Inventory We have implemented operational risk data and assessment systems to monitor and analyze internal and external opera- At tional risk events, to assess business environment and internal December 31, $ in millions 2018 control factors, and to perform scenario analysis. The Gross purchased protection $ (70,035) collected data elements are incorporated in the operational Gross written protection 68,543 risk capital model. The model encompasses both quantitative Net exposure $ (1,492) and qualitative elements. Internal loss data and scenario anal- ysis results are direct inputs to the capital model, while external operational incidents, business environment and internal control factors are evaluated as part of the scenario analysis process.
79 December 2018 Form 10-K
− 317 − Risk Disclosures
In addition, we employ a variety of risk processes and miti- ments. These policies and procedures cover a broad range of gants to manage our operational risk exposures. These areas, including: identification of internal and external include a governance framework, a comprehensive risk threats, access control, data security, protective controls, management program and insurance. Operational risks and detection of malicious or unauthorized activity, incident associated risk exposures are assessed relative to the risk response and recovery planning. tolerance reviewed and confirmed by the Board and are prioritized accordingly. Business Continuity Management and Disaster Recovery We maintain global programs for business continuity The breadth and range of operational risk are such that the management and technology disaster recovery that facilitate types of mitigating activities are wide-ranging. Examples of activities designed to mitigate risk to the Firm during a busi- activities include: continuous enhancement of defenses ness continuity event. A business continuity event is an inter- against cyber attacks; use of legal agreements and contracts ruption with potential impact to normal business activity of to transfer and/or limit operational risk exposures; due dili- the Firm’s people, operations, technology, suppliers and/or gence; implementation of enhanced policies and procedures; facilities. The business continuity management program’s technology change management controls; exception manage- core functions are business continuity planning and crisis ment processing controls; and segregation of duties. management. As part of business continuity planning, busi- Primary responsibility for the management of operational risk ness units within the Firm maintain business continuity plans, is with the business segments, the control groups and the identifying processes and strategies to continue business- business managers therein. The business managers maintain critical processes during a business continuity event. Crisis processes and controls designed to identify, assess, manage, management is the process of identifying and managing the mitigate and report operational risk. Each of the business Firm’s operations during business continuity events. Disaster segments has a designated operational risk coordinator. The recovery plans supporting business continuity are in place for operational risk coordinator regularly reviews operational risk critical facilities and resources across the Firm. issues and reports to our senior management within each Third Party Risk Management business. Each control group also has a designated opera- tional risk coordinator and a forum for discussing operational In connection with our ongoing operations, we utilize the risk matters with our senior management. Oversight of opera- services of third party suppliers, which we anticipate will tional risk is provided by the Operational Risk Oversight continue and may increase in the future. These services Committee, legal entity risk committees, regional risk include, for example, outsourced processing and support committees and senior management. In the event of a merger; functions and other professional services. Our risk-based joint venture; divestiture; reorganization; or creation of a new approach to managing exposure to these services includes the legal entity, a new product, or a business activity, operational performance of due diligence, implementation of service risks are considered, and any necessary changes in processes level and other contractual agreements, consideration of or controls are implemented. operational risks and ongoing monitoring of third-party suppliers’ performance. We maintain and continue to enhance The Operational Risk Department provides independent over- our third-party risk management program which includes sight of operational risk and assesses, measures and monitors appropriate governance, policies, procedures and technology operational risk against tolerance. The Operational Risk that supports alignment with our risk tolerance and is Department works with the divisions and control groups to designed to meet regulatory requirements. The third-party help ensure a transparent, consistent and comprehensive risk management program includes the adoption of appro- framework for managing operational risk within each area priate risk management controls and practices through the and across the Firm. supplier management life cycle, including, but not limited to, assessment of information security, service failure, financial The Operational Risk Department scope includes oversight of stability, disaster recoverability, reputational risk, contractual technology risk, cybersecurity risk, information security risk, risk and safeguards against corruption. the fraud risk management and prevention program, and third-party risk management (supplier and affiliate risk over- sight and assessment). Model Risk
Cybersecurity Model risk refers to the potential for adverse consequences from decisions based on incorrect or misused model outputs. Our cybersecurity and information security policies, proce- Model risk can lead to financial loss, poor business and stra- dures, and technologies are designed to protect our, client and tegic decision making or damage to a Firm’s reputation. The employee data against unauthorized disclosure, modification risk inherent in a model is a function of the materiality, or misuse and are also designed to address regulatory require- complexity and uncertainty around inputs and assumptions.
December 2018 Form 10-K 80
− 318 − Risk Disclosures
Model risk is generated from the use of models impacting Liquidity Risk Department ensures transparency of material financial statements, regulatory filings, capital adequacy liquidity and funding risks, compliance with established risk assessments and the formulation of strategy. limits and escalation of risk concentrations to appropriate senior management. Sound model risk management is an integral part of our Risk Management Framework. The Model Risk Management To execute these responsibilities, the Liquidity Risk Depart- Department (“MRM”) is a distinct department in Risk ment establishes limits in line with our risk appetite, identi- Management responsible for the oversight of model risk. fies and analyzes emerging liquidity and funding risks to ensure such risks are appropriately mitigated, monitors and MRM establishes a model risk tolerance in line with our risk reports risk exposures against metrics and limits, and reviews appetite. The tolerance is based on an assessment of the mate- the methodologies and assumptions underpinning our riality of the risk of financial loss or reputational damage due Liquidity Stress Tests to ensure sufficient liquidity and to errors in design, implementation and/or inappropriate use funding under a range of adverse scenarios. The liquidity and of models. The tolerance is monitored through model-specific funding risks identified by these processes are summarized in and aggregate business-level assessments, which are based reports produced by the Liquidity Risk Department that are upon qualitative and quantitative factors. circulated to and discussed with senior management, the FRC, the BRC and the Board, as appropriate. A guiding principle for managing model risk is the “effective The Treasury Department and applicable business units have challenge” of models. The effective challenge of models is primary responsibility for evaluating, monitoring and control- represented by the critical analysis by objective, informed ling the liquidity and funding risks arising from our business parties who can identify model limitations and assumptions activities and for maintaining processes and controls to and drive appropriate changes. MRM provides effective chal- manage the key risks inherent in their respective areas. The lenge of models, independently validates and approves Liquidity Risk Department coordinates with the Treasury models for use, annually recertifies models, identifies and Department and these business units to help ensure a consis- tracks remediation plans for model limitations and reports on tent and comprehensive framework for managing liquidity model risk metrics. The department also oversees the devel- and funding risk across the Firm. See also “Management’s opment of controls to support a complete and accurate Firm- Discussion and Analysis of Financial Condition and Results wide model inventory. The head of MRM reports on our of Operations—Liquidity and Capital Resources.” model risk relative to risk tolerance and presents these reports to the Model Oversight Committee, the FRC and the Chief Risk Officer. The Chief Risk Officer and head of MRM also Legal and Compliance Risk provide quarterly updates to the BRC on model risk metrics. Legal and compliance risk includes the risk of legal or regula- tory sanctions, material financial loss, including fines, penal- Liquidity Risk ties, judgments, damages and/or settlements, or loss to repu- tation that we may suffer as a result of failure to comply with Liquidity risk refers to the risk that we will be unable to laws, regulations, rules, related self-regulatory organization finance our operations due to a loss of access to the capital standards and codes of conduct applicable to our business markets or difficulty in liquidating our assets. Liquidity risk activities. This risk also includes contractual and commercial also encompasses our ability (or perceived ability) to meet our risk, such as the risk that a counterparty’s performance obli- financial obligations without experiencing significant business gations will be unenforceable. It also includes compliance disruption or reputational damage that may threaten our with AML, terrorist financing, and anti-corruption rules and viability as a going concern. Liquidity risk also encompasses regulations. We are generally subject to extensive regulation the associated funding risks triggered by the market or idiosyn- in the different jurisdictions in which we conduct our busi- cratic stress events that may negatively affect our liquidity and ness (see also “Business—Supervision and Regulation” and may impact our ability to raise new funding. Generally, we “Risk Factors”). incur liquidity and funding risk as a result of our trading, lending, investing and client facilitation activities. We have established procedures based on legal and regula- tory requirements on a worldwide basis that are designed to Our Liquidity Risk Management Framework is critical to facilitate compliance with applicable statutory and regulatory helping ensure that we maintain sufficient liquidity reserves requirements and to require that our policies relating to busi- and durable funding sources to meet our daily obligations and ness conduct, ethics and practices are followed globally. In to withstand unanticipated stress events. The Liquidity Risk addition, we have established procedures to mitigate the risk Department is a distinct area in Risk Management responsible that a counterparty’s performance obligations will be unen- for the oversight and monitoring of liquidity risk. The forceable, including consideration of counterparty legal
81 December 2018 Form 10-K
− 319 − Risk Disclosures authority and capacity, adequacy of legal documentation, the permissibility of a transaction under applicable law and whether applicable bankruptcy or insolvency laws limit or alter contractual remedies. The heightened legal and regula- tory focus on the financial services and banking industries globally presents a continuing business challenge for us.
December 2018 Form 10-K 82
− 320 − Financial Statements and Supplementary Data
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors of Morgan Stanley:
Opinion on the Financial Statements Basis for Opinion
We have audited the accompanying consolidated balance These financial statements are the responsibility of the Firm’s sheets of Morgan Stanley and subsidiaries (the “Firm”) as of management. Our responsibility is to express an opinion on December 31, 2018 and 2017, the related consolidated the Firm’s financial statements based on our audits. We are a income statements, comprehensive income statements, cash public accounting firm registered with the PCAOB and are flow statements and statements of changes in total equity for required to be independent with respect to the Firm in accor- each of the three years ended December 31, 2018, 2017, and dance with the U.S. federal securities laws and the applicable 2016, and the related notes (collectively referred to as the rules and regulations of the Securities and Exchange “financial statements”). In our opinion, the financial state- Commission and the PCAOB. ments present fairly, in all material respects, the financial position of the Firm as of December 31, 2018 and 2017, and We conducted our audits in accordance with the standards of the results of its operations and its cash flows for each of the the PCAOB. Those standards require that we plan and three years ended December 31, 2018, 2017, and 2016, in perform the audit to obtain reasonable assurance about conformity with accounting principles generally accepted in whether the financial statements are free of material misstate- the United States of America. ment, whether due to error or fraud. Our audits included performing procedures to assess the risks of material We have also audited, in accordance with the standards of the misstatement of the financial statements, whether due to error Public Company Accounting Oversight Board (United States) or fraud, and performing procedures that respond to those (PCAOB), the Firm’s internal control over financial reporting risks. Such procedures included examining, on a test basis, as of December 31, 2018, based on criteria established in evidence regarding the amounts and disclosures in the finan- Internal Control — Integrated Framework (2013) issued by cial statements. Our audits also included evaluating the the Committee of Sponsoring Organizations of the Treadway accounting principles used and significant estimates made by Commission and our report dated February 26, 2019, management, as well as evaluating the overall presentation of expressed an unqualified opinion on the Firm’s internal the financial statements. We believe that our audits provide a control over financial reporting. reasonable basis for our opinion.
/s/ Deloitte & Touche LLP New York, New York February 26, 2019
We have served as the Firm’s auditor since 1997.
83 December 2018 Form 10-K
− 321 − Consolidated Income Statements in millions, except per share data 2018 2017 2016 Revenues Investment banking $ 6,482 $ 6,003 $ 4,933 Trading 11,551 11,116 10,209 Investments 437 820 160 Commissions and fees 4,190 4,061 4,109 Asset management 12,898 11,797 10,697 Other 743 848 825 Total non-interest revenues 36,301 34,645 30,933 Interest income 13,892 8,997 7,016 Interest expense 10,086 5,697 3,318 Net interest 3,806 3,300 3,698 Net revenues 40,107 37,945 34,631 Non-interest expenses Compensation and benefits 17,632 17,166 15,878 Occupancy and equipment 1,391 1,329 1,308 Brokerage, clearing and exchange fees 2,393 2,093 1,920 Information processing and communications 2,016 1,791 1,787 Marketing and business development 691 609 587 Professional services 2,265 2,169 2,128 Other 2,482 2,385 2,175 Total non-interest expenses 28,870 27,542 25,783 Income from continuing operations before income taxes 11,237 10,403 8,848 Provision for income taxes 2,350 4,168 2,726 Income from continuing operations 8,887 6,235 6,122 Income (loss) from discontinued operations, net of income taxes (4) (19) 1 Net income $ 8,883 $ 6,216 $ 6,123 Net income applicable to noncontrolling interests 135 105 144 Net income applicable to Morgan Stanley $ 8,748 $ 6,111 $ 5,979 Preferred stock dividends and other 526 523 471 Earnings applicable to Morgan Stanley common shareholders $ 8,222 $ 5,588 $ 5,508
Earnings per basic common share Income from continuing operations $ 4.81 $ 3.15 $ 2.98 Income (loss) from discontinued operations — (0.01) — Earnings per basic common share $ 4.81 $ 3.14 $ 2.98
Earnings per diluted common share Income from continuing operations $ 4.73 $ 3.08 $ 2.92 Income (loss) from discontinued operations — (0.01) — Earnings per diluted common share $ 4.73 $ 3.07 $ 2.92
Average common shares outstanding Basic 1,708 1,780 1,849 Diluted 1,738 1,821 1,887
December 2018 Form 10-K 84 See Notes to Consolidated Financial Statements
− 322 − Consolidated Comprehensive Income Statements
$ in millions 2018 2017 2016 Net income $ 8,883 $ 6,216 $ 6,123 Other comprehensive income (loss), net of tax: Foreign currency translation adjustments $ (90) $ 251 $ (11) Change in net unrealized gains (losses) on available-for-sale securities (272) 41 (269) Pension, postretirement and other 137 (117) (100) Change in net debt valuation adjustment 1,517 (588) (296) Total other comprehensive income (loss) $ 1,292 $ (413) $ (676) Comprehensive income $ 10,175 $ 5,803 $ 5,447 Net income applicable to noncontrolling interests 135 105 144 Other comprehensive income (loss) applicable to noncontrolling interests 87 4 (1) Comprehensive income applicable to Morgan Stanley $ 9,953 $ 5,694 $ 5,304
See Notes to Consolidated Financial Statements 85 December 2018 Form 10-K
− 323 − Consolidated Balance Sheets
At At December 31, December 31, $ in millions, except share data 2018 2017 Assets Cash and cash equivalents: Cash and due from banks $ 30,541 $ 24,816 Interest bearing deposits with banks 21,299 21,348 Restricted cash 35,356 34,231 Trading assets at fair value ($120,437 and $169,735 were pledged to various parties) 266,299 298,282 Investment securities (includes $61,061 and $55,203 at fair value) 91,832 78,802 Securities purchased under agreements to resell 98,522 84,258 Securities borrowed 116,313 124,010 Customer and other receivables 53,298 56,187 Loans: Held for investment (net of allowance of $238 and $224) 99,815 92,953 Held for sale 15,764 11,173 Goodwill 6,688 6,597 Intangible assets (net of accumulated amortization of $2,877 and $2,730) 2,163 2,448 Other assets 15,641 16,628 Total assets $ 853,531 $ 851,733
Liabilities Deposits (includes $442 and $204 at fair value) $ 187,820 $ 159,436 Trading liabilities at fair value 126,747 131,295 Securities sold under agreements to repurchase (includes $812 and $800 at fair value) 49,759 56,424 Securities loaned 11,908 13,592 Other secured financings (includes $5,245 and $3,863 at fair value) 9,466 11,271 Customer and other payables 179,559 191,510 Other liabilities and accrued expenses 17,204 17,157 Borrowings (includes $51,184 and $46,912 at fair value) 189,662 192,582 Total liabilities 772,125 773,267
Commitments and contingent liabilities (see Note 12)
Equity Morgan Stanley shareholders’ equity: Preferred stock 8,520 8,520 Common stock, $0.01 par value: Shares authorized: 3,500,000,000; Shares issued: 2,038,893,979; Shares outstanding: 1,699,828,943 and 1,788,086,805 20 20 Additional paid-in capital 23,794 23,545 Retained earnings 64,175 57,577 Employee stock trusts 2,836 2,907 Accumulated other comprehensive income (loss) (2,292) (3,060) Common stock held in treasury at cost, $0.01 par value (339,065,036 and 250,807,174 shares) (13,971) (9,211) Common stock issued to employee stock trusts (2,836) (2,907) Total Morgan Stanley shareholders’ equity 80,246 77,391 Noncontrolling interests 1,160 1,075 Total equity 81,406 78,466 Total liabilities and equity $ 853,531 $ 851,733
December 2018 Form 10-K 86 See Notes to Consolidated Financial Statements
− 324 − Consolidated Statements of Changes in Total Equity
Common Common Stock Accumulated Stock Issued to Additional Employee Other Held in Employee Non- Preferred Common Paid-in Retained Stock Comprehensive Treasury Stock controlling Total $ in millions Stock Stock Capital Earnings Trusts Income (Loss) at Cost Trusts Interests Equity Balance at December 31, 2015 7,520 20 24,153 49,204 2,409 (1,656) (4,059) (2,409) 1,002 76,184 Cumulative adjustment for accounting change related to DVA1 — — — 312 — (312) — — — — Net adjustment for accounting change related to consolidation2 ————— — — — 106 106 Net income applicable to Morgan Stanley — — — 5,979 — — — — — 5,979 Net income applicable to noncontrolling interests ————— — — — 144 144 Preferred stock dividends3 — — — (468) — — — — — (468) Common stock dividends ($0.70 per share) — — — (1,348) — — — — — (1,348) Shares issued under employee plans and related tax effects — — (892) — 442 — 2,195 (442) — 1,303 Repurchases of common stock and employee tax withholdings ————— — (3,933) — — (3,933) Net change in Accumulated other comprehensive income (loss) ————— (675) — — (1) (676) Other net increases (decreases) — — 10 — — — — — (124) (114) Balance at December 31, 2016 7,520 20 23,271 53,679 2,851 (2,643) (5,797) (2,851) 1,127 77,177 Cumulative adjustments for accounting changes4 — — 45 (35) — — — — — 10 Net income applicable to Morgan Stanley — — — 6,111 — — — — — 6,111 Net income applicable to noncontrolling interests ————— — — — 105 105 Preferred stock dividends3 — — — (523) — — — — — (523) Common stock dividends ($0.90 per share) — — — (1,655) — — — — — (1,655) Shares issued under employee plans — — 306 — 56 — 878 (56) — 1,184 Repurchases of common stock and employee tax withholdings ————— — (4,292) — — (4,292) Net change in Accumulated other comprehensive income (loss) ————— (417) — — 4 (413) Issuance of preferred stock 1,000 — (6) — — — — — — 994 Other net decreases — — (71) — — — — — (161) (232) Balance at December 31, 2017 $ 8,520 $ 20 $ 23,545 $ 57,577 $ 2,907 $ (3,060) $ (9,211) $ (2,907) $ 1,075 $ 78,466 Cumulative adjustments for accounting changes4 — — — 306 — (437) — — — (131) Net income applicable to Morgan Stanley — — — 8,748 — — — — — 8,748 Net income applicable to noncontrolling interests ————— — — — 135 135 Preferred stock dividends3 — — — (526) — — — — — (526) Common stock dividends ($1.10 per share) — — — (1,930) — — — — — (1,930) Shares issued under employee plans — — 249 — (71) — 806 71 — 1,055 Repurchases of common stock and employee tax withholdings ————— — (5,566) — — (5,566) Net change in Accumulated other comprehensive income (loss) ————— 1,205 — — 87 1,292 Other net decreases ————— — — — (137) (137) Balance at December 31, 2018 $ 8,520 $ 20 $ 23,794 $ 64,175 $ 2,836 $ (2,292) $ (13,971) $ (2,836) $ 1,160 $ 81,406
1. In accordance with the early adoption of a provision of the accounting update Recognition and Measurement of Financial Assets and Financial Liabilities, a cumulative catch-up adjustment was recorded as of January 1, 2016 to move the cumulative unrealized DVA amount, net of noncontrolling interests and tax, related to outstanding liabilities under the fair value option election from Retained earnings into AOCI. See Note 15 for further information. 2. In accordance with the accounting update Amendments to the Consolidation Analysis, a net adjustment was recorded as of January 1, 2016 to both consolidate and deconsolidate certain entities under the new guidance. 3. See Note 15 for information regarding dividends per share for each class of preferred stock. 4. Cumulative adjustments for accounting changes relate to the adoption of certain accounting updates during 2018 and 2017. See Notes 2 and 15 for further information.
See Notes to Consolidated Financial Statements 87 December 2018 Form 10-K
− 325 − Consolidated Cash Flow Statements
$ in millions 2018 2017 2016 Cash flows from operating activities Net income $ 8,883 $ 6,216 $ 6,123 Adjustments to reconcile net income to net cash provided by (used for) operating activities: Deferred income taxes 449 2,747 1,579 Stock-based compensation expense 920 1,026 1,136 Depreciation and amortization 1,844 1,753 1,736 (Release of) Provision for credit losses on lending activities (15) 29 144 Other operating adjustments 199 153 (102) Changes in assets and liabilities: Trading assets, net of Trading liabilities 23,732 (27,588) (24,079) Securities borrowed 7,697 1,226 17,180 Securities loaned (1,684) (2,252) (3,514) Customer and other receivables and other assets (728) (9,315) (371) Customer and other payables and other liabilities (13,063) 2,007 1,913 Securities purchased under agreements to resell (14,264) 17,697 (14,298) Securities sold under agreements to repurchase (6,665) 1,796 17,936 Net cash provided by (used for) operating activities 7,305 (4,505) 5,383
Cash flows from investing activities Proceeds from (payments for): Other assets—Premises, equipment and software, net (1,865) (1,629) (1,276) Changes in loans, net (8,794) (12,125) (9,604) Investment securities: Purchases (27,800) (23,962) (50,911) Proceeds from sales 3,208 18,131 33,716 Proceeds from paydowns and maturities 12,668 7,445 8,367 Other investing activities (298) (251) 200 Net cash provided by (used for) investing activities (22,881) (12,391) (19,508)
Cash flows from financing activities Net proceeds from (payments for): Noncontrolling interests (130) (83) (96) Other secured financings (1,226) (1,573) 1,333 Deposits 28,384 3,573 (171) Proceeds from: Issuance of preferred stock, net of issuance costs — 994 — Issuance of Borrowings 40,059 55,416 43,626 Payments for: Borrowings (34,781) (35,825) (31,596) Repurchases of common stock and employee tax withholdings (5,566) (4,292) (3,933) Cash dividends (2,375) (2,085) (1,746) Other financing activities (160) 136 (54) Net cash provided by (used for) financing activities 24,205 16,261 7,363 Effect of exchange rate changes on cash and cash equivalents (1,828) 3,670 (1,430) Net increase (decrease) in cash and cash equivalents 6,801 3,035 (8,192) Cash and cash equivalents, at beginning of period 80,395 77,360 85,552 Cash and cash equivalents, at end of period $ 87,196 $ 80,395 $ 77,360 Cash and cash equivalents: Cash and due from banks $ 30,541 $ 24,816 $ 22,017 Interest bearing deposits with banks 21,299 21,348 21,364 Restricted cash 35,356 34,231 33,979 Cash and cash equivalents, at end of period $ 87,196 $ 80,395 $ 77,360
Supplemental Disclosure of Cash Flow Information Cash payments for: Interest $ 9,977 $ 5,377 $ 2,834 Income taxes, net of refunds 1,377 1,390 831
December 2018 Form 10-K 88 See Notes to Consolidated Financial Statements
− 326 − Notes to Consolidated Financial Statements 1. Introduction and Basis of Presentation
The Firm funds, insurance companies, third-party fund sponsors and corporations. Individual clients are served through Morgan Stanley is a global financial services firm that main- intermediaries, including affiliated and non-affiliated tains significant market positions in each of its business distributors. segments—Institutional Securities, Wealth Management and Investment Management. Morgan Stanley, through its subsid- Basis of Financial Information iaries and affiliates, provides a wide variety of products and services to a large and diversified group of clients and The consolidated financial statements (“financial state- customers, including corporations, governments, financial ments”) are prepared in accordance with U.S. GAAP, which institutions and individuals. Unless the context otherwise require the Firm to make estimates and assumptions requires, the terms “Morgan Stanley” or the “Firm” mean regarding the valuations of certain financial instruments, the Morgan Stanley (the “Parent Company”) together with its valuation of goodwill and intangible assets, compensation, consolidated subsidiaries. See the “Glossary of Common deferred tax assets, the outcome of legal and tax matters, Acronyms” for the definition of certain acronyms used allowance for credit losses and other matters that affect its throughout the 2018 Form 10-K. financial statements and related disclosures. The Firm believes that the estimates utilized in the preparation of its A description of the clients and principal products and financial statements are prudent and reasonable. Actual services of each of the Firm’s business segments is as results could differ materially from these estimates. Intercom- follows: pany balances and transactions have been eliminated. Certain reclassifications have been made to prior periods to conform Institutional Securities provides investment banking, sales to the current presentation. and trading, lending and other services to corporations, governments, financial institutions, and high to ultra-high Consolidation net worth clients. Investment banking services consist of capital raising and financial advisory services, including The financial statements include the accounts of the Firm, its services relating to the underwriting of debt, equity and wholly owned subsidiaries and other entities in which the other securities, as well as advice on mergers and acquisi- Firm has a controlling financial interest, including certain tions, restructurings, real estate and project finance. Sales VIEs (see Note 13). For consolidated subsidiaries that are less and trading services include sales, financing, prime than wholly owned, the third-party holdings of equity inter- brokerage and market-making activities in equity and fixed ests are referred to as noncontrolling interests. The net income products, including foreign exchange and commod- income attributable to noncontrolling interests for such ities. Lending activities include originating corporate loans, subsidiaries is presented as Net income applicable to noncon- commercial mortgage lending, asset-backed lending and trolling interests in the consolidated income statements financing extended to sales and trading customers. Other (“income statements”). The portion of shareholders’ equity activities include investments and research. that is attributable to noncontrolling interests for such subsid- iaries is presented as noncontrolling interests, a component of Wealth Management provides a comprehensive array of total equity, in the consolidated balance sheets (“balance financial services and solutions to individual investors and sheets”). small to medium-sized businesses and institutions covering brokerage and investment advisory services; financial and For entities where the total equity investment at risk is suffi- wealth planning services; annuity and insurance products; cient to enable the entity to finance its activities without addi- securities-based lending, residential real estate loans and tional subordinated financial support and the equity holders other lending products; banking and retirement plan bear the economic residual risks and returns of the entity and services. have the power to direct the activities of the entity that most significantly affect its economic performance, the Firm Investment Management provides a broad range of invest- consolidates those entities it controls either through a ment strategies and products that span geographies, asset majority voting interest or otherwise. For VIEs (i.e., entities classes, and public and private markets to a diverse group that do not meet the aforementioned criteria), the Firm of clients across institutional and intermediary channels. consolidates those entities where it has the power to make the Strategies and products include equity, fixed income, decisions that most significantly affect the economic perfor- liquidity and alternative/other products. Institutional clients mance of the VIE and has the obligation to absorb losses or include defined benefit/defined contribution plans, founda- the right to receive benefits that could potentially be signifi- tions, endowments, government entities, sovereign wealth cant to the VIE.
89 December 2018 Form 10-K
− 327 − Notes to Consolidated Financial Statements
For investments in entities in which the Firm does not have a Underwriting revenues are generally recognized on trade date controlling financial interest but has significant influence if there is no uncertainty or contingency related to the amount over operating and financial decisions, it applies the equity to be paid. Underwriting costs are deferred and recognized in method of accounting with net gains and losses recorded the relevant non-interest expenses line items when the related within Other revenues (see Note 8) unless the Firm has underwriting revenues are recorded. elected to measure the investment at fair value, in which case net gains and losses are recorded within Investments revenues Advisory fees are recognized as advice is provided to the (see Note 3). client, based on the estimated progress of work and when revenues are not probable of a significant reversal. Advisory Equity and partnership interests held by entities qualifying for costs are recognized as incurred in the relevant non-interest accounting purposes as investment companies are carried at expenses line items, including when reimbursed. fair value. Commissions and Fees The Firm’s significant regulated U.S. and international subsidiaries include Morgan Stanley & Co. LLC Commission and fee revenues result from transaction-based (“MS&Co.”), Morgan Stanley Smith Barney LLC (“MSSB arrangements in which the client is charged a fee for the LLC”), Morgan Stanley & Co. International plc (“MSIP”), execution of transactions. Such revenues primarily arise from Morgan Stanley MUFG Securities Co., Ltd. (“MSMS”), transactions in equity securities; services related to sales and Morgan Stanley Bank, N.A. (“MSBNA”) and Morgan trading activities; and sales of mutual funds, alternative Stanley Private Bank, National Association (“MSPBNA”). funds, futures, insurance products and options. Commission and fee revenues are recognized on trade date when the Consolidated Cash Flow Statements Presentation performance obligation is satisfied.
For purposes of the consolidated cash flow statements (“cash Asset Management Revenues flow statements”), cash and cash equivalents consist of Cash and due from banks, Interest bearing deposits with banks and Asset management, distribution and administration fees are Restricted cash. Cash and cash equivalents includes highly generally based on related asset levels being managed, such liquid investments with original maturities of three months or as the AUM of a customer’s account or the net asset value of less that are held for investment purposes and are readily a fund. These fees are generally recognized when services are convertible to known amounts of cash. performed and the fees become known. Management fees are reduced by estimated fee waivers and expense caps, if any, Restricted cash includes cash in banks subject to withdrawal provided to the customer. restrictions, restricted deposits held as compensating balances and cash segregated in compliance with federal or other regulations. Performance-based fees not in the form of carried interest are recorded when the annual performance target is met and the revenues are not probable of a significant reversal. 2. Significant Accounting Policies Sales commissions paid by the Firm in connection with the Revenue Recognition sale of certain classes of shares of its open-end mutual fund products are accounted for as deferred commission assets and Revenues are recognized when the promised goods or amortized to expense over the expected life of the contract. services are delivered to our customers, in an amount that is The Firm periodically tests deferred commission assets for based on the consideration the Firm expects to receive in recoverability based on cash flows expected to be received in exchange for those goods or services when such amounts are future periods. Other asset management and distribution costs not probable of significant reversal. These policies reflect the are recognized as incurred in the relevant non-interest adoption of Revenue from Contracts with Customers on expenses line items. January 1, 2018. Please see “Accounting Updates Adopted” herein for the more significant differences in policies applied Carried Interest in prior periods. The Firm is entitled to receive performance-based fees in the Investment Banking form of carried interest when the return on assets under management exceeds certain benchmark returns or other Revenues from investment banking activities consist of reve- performance targets. When the Firm earns carried interest nues earned from underwriting primarily equity and fixed from funds as specified performance thresholds are met, that income securities and advisory fees for mergers, acquisitions, carried interest and any related general or limited partner restructurings and advisory assignments. interest is accounted for under the equity method of
December 2018 Form 10-K 90
− 328 − Notes to Consolidated Financial Statements accounting and measured based on the Firm’s claim on the Interest income and interest expense are recorded within the NAV of the fund at the reporting date, taking into account the income statements depending on the nature of the instrument distribution terms applicable to the interest held. and related market conventions. When interest is included as a component of the instruments’ fair value, interest is See Note 21 for information regarding the net cumulative included within Trading revenues or Investments reve- unrealized amount of performance-based fee revenues at risk nues. Otherwise, it is included within Interest income or of reversal. See Note 12 for information regarding general Interest expense. Dividend income is recorded in Trading partner guarantees, which include potential obligations to revenues or Investments revenues depending on the business return performance fee distributions previously received. activity.
Other Items The fair value of OTC financial instruments, including deriv- ative contracts related to financial instruments and commod- Revenues from certain commodities-related contracts are ities, is presented in the accompanying balance sheets on a recognized as the promised goods or services are delivered to net-by-counterparty basis, when appropriate. Additionally, the customer. the Firm nets the fair value of cash collateral paid or received against the fair value amounts recognized for net derivative Receivables from contracts with customers are recognized in positions executed with the same counterparty under the same Customer and other receivables in the balance sheets when the master netting agreement. underlying performance obligations have been satisfied and the Firm has the right per the contract to bill the customer. Fair Value Option Contract assets are recognized in Other assets when the Firm has satisfied its performance obligations but customer payment The Firm has elected to measure certain eligible instruments is conditional. Contract liabilities are recognized in Other at fair value, including certain Securities purchased under liabilities when the Firm has collected payment from a agreements to resell, loans and lending commitments, equity customer based on the terms of the contract but the underlying method investments, Deposits (i.e., structured certificates of performance obligations are not yet satisfied. deposit), Securities sold under agreements to repurchase, Other secured financings and Borrowings (primarily struc- For contracts with a term less than one year, incremental tured notes). costs to obtain the contract are expensed as incurred. Reve- nues are not discounted when payment is expected within one Fair Value Measurement—Definition and Hierarchy year. Fair value is defined as the price that would be received to The Firm presents, net within revenues, all taxes assessed by sell an asset or paid to transfer a liability (i.e., the “exit a governmental authority that are both imposed on and price”) in an orderly transaction between market participants concurrent with a specific revenue-producing transaction and at the measurement date. collected by the Firm from a customer. Fair value is a market-based measure considered from the Fair Value of Financial Instruments perspective of a market participant rather than an entity- specific measure. Therefore, even when market assumptions Instruments within Trading assets and Trading liabilities are are not readily available, assumptions are set to reflect those measured at fair value, either as required by accounting guid- that the Firm believes market participants would use in ance or through the fair value option election (discussed pricing the asset or liability at the measurement date. Where below). These financial instruments primarily represent the the Firm manages a group of financial assets, financial liabil- Firm’s trading and investment positions and include both ities, and nonfinancial items accounted for as derivatives on cash and derivative products. In addition, debt and equity the basis of its net exposure to either market risks or credit securities classified as AFS securities are measured at fair risk, the Firm measures the fair value of that group of finan- value. cial instruments consistently with how market participants would price the net risk exposure at the measurement date. Gains and losses on instruments carried at fair value are reflected in Trading revenues, Investments revenues or In determining fair value, the Firm uses various valuation Investment banking revenues in the income statements, approaches and establishes a hierarchy for inputs used in except for AFS securities (see “Investment Securities—AFS measuring fair value that requires the most observable inputs and HTM securities” section herein and Note 5) and deriva- be used when available. tives accounted for as hedges (see “Hedge Accounting” section herein and Note 4). Observable inputs are inputs that market participants would use in pricing the asset or liability that were developed based
91 December 2018 Form 10-K
− 329 − Notes to Consolidated Financial Statements on market data obtained from sources independent of the party is willing to accept for an asset. The Firm carries posi- Firm. Unobservable inputs are inputs that reflect assumptions tions at the point within the bid-ask range that meets its best the Firm believes other market participants would use in estimate of fair value. For offsetting positions in the same pricing the asset or liability that are developed based on the financial instrument, the same price within the bid-ask spread best information available in the circumstances. The fair is used to measure both the long and short positions. value hierarchy is broken down into three levels based on the observability of inputs as follows, with Level 1 being the Fair value for many cash instruments and OTC derivative highest and Level 3 being the lowest level: contracts is derived using pricing models. Pricing models take into account the contract terms, as well as multiple Level 1. Valuations based on quoted prices in active markets inputs, including, where applicable, commodity prices, equity that the Firm has the ability to access for identical assets or prices, interest rate yield curves, credit curves, correlation, liabilities. Valuation adjustments and block discounts are not creditworthiness of the counterparty, creditworthiness of the applied to Level 1 instruments. Since valuations are based on Firm, option volatility and currency rates. quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a Where appropriate, valuation adjustments are made to account significant degree of judgment. for various factors such as liquidity risk (bid-ask adjustments), credit quality, model uncertainty and concentration risk. Level 2. Valuations based on one or more quoted prices in Adjustments for liquidity risk adjust model-derived markets that are not active or for which all significant inputs mid-market levels of Level 2 and Level 3 financial instruments are observable, either directly or indirectly. for the bid-mid or mid-ask spread required to properly reflect the exit price of a risk position. Bid-mid and mid-ask spreads Level 3. Valuations based on inputs that are unobservable are marked to levels observed in trade activity, broker quotes and significant to the overall fair value measurement. or other external third-party data. Where these spreads are unobservable for the particular position in question, spreads are The availability of observable inputs can vary from product to derived from observable levels of similar positions. product and is affected by a wide variety of factors, for example, the type of product, whether the product is new and The Firm applies credit-related valuation adjustments to its not yet established in the marketplace, the liquidity of Borrowings (primarily structured notes) for which the fair markets and other characteristics particular to the product. To value option was elected and to OTC derivatives. The Firm the extent that valuation is based on models or inputs that are considers the impact of changes in its own credit spreads less observable or unobservable in the market, the determina- based upon observations of the secondary bond market tion of fair value requires more judgment. Accordingly, the spreads when measuring the fair value for Borrowings. degree of judgment exercised by the Firm in determining fair value is greatest for instruments categorized in Level 3 of the For OTC derivatives, the impact of changes in both the fair value hierarchy. Firm’s and the counterparty’s credit rating is considered when measuring fair value. In determining the expected The Firm considers prices and inputs that are current as of the exposure, the Firm simulates the distribution of the future measurement date, including during periods of market disloca- exposure to a counterparty, then applies market-based default tion. In periods of market dislocation, the observability of prices probabilities to the future exposure, leveraging external third- and inputs may be reduced for many instruments. This condition party CDS spread data. Where CDS spread data are unavail- could cause an instrument to be reclassified from Level 1 to able for a specific counterparty, bond market spreads, CDS Level 2 or from Level 2 to Level 3 of the fair value hierarchy. spread data based on the counterparty’s credit rating or CDS spread data that reference a comparable counterparty may be In certain cases, the inputs used to measure fair value may utilized. The Firm also considers collateral held and legally fall into different levels of the fair value hierarchy. In enforceable master netting agreements that mitigate its expo- such cases, the total fair value amount is disclosed in the level sure to each counterparty. appropriate for the lowest level input that is significant to the total fair value of the asset or liability. Adjustments for model uncertainty are taken for positions whose underlying models are reliant on significant inputs that Valuation Techniques are neither directly nor indirectly observable, hence requiring reliance on established theoretical concepts in their deriva- Many cash instruments and OTC derivative contracts have tion. These adjustments are derived by making assessments of bid and ask prices that can be observed in the marketplace. the possible degree of variability using statistical approaches Bid prices reflect the highest price that a party is willing to and market-based information where possible. pay for an asset. Ask prices represent the lowest price that a
December 2018 Form 10-K 92
− 330 − Notes to Consolidated Financial Statements
The Firm may apply concentration adjustments to certain of sought legal advice to support the enforceability of the agree- its OTC derivative portfolios to reflect the additional cost of ment. In cases where the Firm has not determined an agree- closing out a particularly large risk exposure. Where possible, ment to be enforceable, the related amounts are not offset these adjustments are based on observable (see Note 4). market information, but in many instances, significant judg- ment is required to estimate the costs of closing The Firm’s policy is generally to receive securities and cash out concentrated risk exposures due to the lack of liquidity in posted as collateral (with rights of rehypothecation), irrespec- the marketplace. tive of the enforceability determination regarding the master netting and collateral agreement. In certain cases, the Firm The Firm applies an FVA in the fair value measurements of may agree for such collateral to be posted to a third-party OTC uncollateralized or partially collateralized derivatives custodian under a control agreement that enables it to take and in collateralized derivatives where the terms of the agree- control of such collateral in the event of a counterparty ment do not permit the reuse of the collateral received. In default. The enforceability of the master netting agreement is general, FVA reflects a market funding risk premium inherent taken into account in the Firm’s risk management practices in the noted derivative instruments. The methodology for and application of counterparty credit limits. measuring FVA leverages the Firm’s existing credit-related valuation adjustment calculation methodologies, which apply For information related to offsetting of derivatives and certain to both assets and liabilities. collateralized transactions, see Notes 4 and 6, respectively.
See Note 3 for a description of valuation techniques applied Hedge Accounting to the major categories of financial instruments measured at fair value. The Firm applies hedge accounting using various derivative financial instruments for the following types of hedges: Assets and Liabilities Measured at Fair Value on a hedges of changes in the fair value of assets and liabilities Non-recurring Basis due to the risk being hedged (fair value hedges); and hedges of net investments in foreign operations whose functional Certain of the Firm’s assets and liabilities are measured at fair currency is different from the reporting currency of the Parent value on a non-recurring basis. The Firm incurs losses or Company (net investment hedges). These financial instru- gains for any adjustments of these assets or liabilities to fair ments are included within Trading assets—Derivative and value. other contracts or Trading liabilities—Derivative and other contracts in the balance sheets. For hedges where hedge For assets and liabilities measured at fair value on a accounting is being applied, the Firm performs effectiveness non-recurring basis, fair value is determined by using various testing and other procedures. valuation approaches. The same hierarchy for inputs as described above, which requires that observable inputs be Fair Value Hedges—Interest Rate Risk used when available, is used in measuring fair value for these items. The Firm’s designated fair value hedges consist primarily of interest rate swaps designated as fair value hedges of changes For further information on financial assets and liabilities that in the benchmark interest rate of certain fixed rate senior are measured at fair value on a recurring and non-recurring borrowings. In the third quarter of 2018, the Firm also began basis, see Note 3. designating interest rate swaps as fair value hedges of changes in the benchmark interest rate of certain AFS securi- Offsetting of Derivative Instruments ties. The Firm is permitted to hedge the full, or part of the, contractual term of the hedged instrument. The Firm uses In connection with its derivative activities, the Firm generally regression analysis to perform an ongoing prospective and enters into master netting agreements and collateral agree- retrospective assessment of the effectiveness of these hedging ments with its counterparties. These agreements provide the relationships. A hedging relationship is deemed effective if Firm with the right, in the event of a default by the counter- the change in fair value of the hedging instrument (deriva- party, to net a counterparty’s rights and obligations under the tive) and the change in fair value of the hedged item (debt agreement and to liquidate and set off collateral against any liability or AFS security) due to changes in the benchmark net amount owed by the counterparty. interest rate offset within a range of 80% to 125%. The Firm considers the impact of valuation adjustments related to its However, in certain circumstances, the Firm may not have own credit spreads and counterparty credit spreads to deter- such an agreement in place; the relevant insolvency regime mine whether they would cause the hedging relationship to be may not support the enforceability of the master netting ineffective. agreement or collateral agreement; or the Firm may not have
93 December 2018 Form 10-K
− 331 − Notes to Consolidated Financial Statements
For qualifying fair value hedges of benchmark interest rates, Other-than-Temporary Impairment the change in the fair value of the derivative is recognized in earnings each period, offset by the change in the fair value AFS debt securities and HTM securities with a current fair value attributable to the change in the benchmark interest rate risk less than their amortized cost are analyzed as part of the Firm’s of the hedged asset (liability), and is recorded in Interest periodic assessment of temporary versus OTTI at the individual income (expense). For AFS securities, the change in fair security level. A temporary impairment is recognized in AOCI value of the hedged item due to changes other than the risk for AFS debt securities. OTTI is recognized in the income state- being hedged will continue to be reported in OCI. When a ments with the exception of the non-credit portion related to a derivative is de-designated as a hedge, any basis adjustment debt security that the Firm does not intend to sell and is not likely remaining on the hedged asset (liability) is amortized to to be required to sell, which is recognized in AOCI. Interest income (expense) over the remaining life of the asset (liability) using the effective interest method. For AFS debt securities that the Firm either has the intent to sell or that the Firm is likely to be required to sell before Net Investment Hedges recovery of its amortized cost basis, the impairment is consid- ered OTTI. The Firm uses forward foreign exchange contracts to manage a portion of the currency exposure relating to its net invest- For those AFS debt securities that the Firm does not have the ments in foreign operations. To the extent that the notional intent to sell or is not likely to be required to sell, and for all amounts of the hedging instruments equal the portion of the HTM securities, the Firm evaluates whether it expects to investments being hedged and the underlying exchange rate recover the entire amortized cost basis of the debt security. If of the derivative hedging instrument is the same as the the Firm does not expect to recover the entire amortized cost exchange rate between the functional currency of the investee of those AFS debt securities or HTM securities, the impair- and the intermediate parent entity’s functional currency, it is ment is considered OTTI, and the Firm determines what considered to be perfectly effective, with no income state- portion of the impairment relates to a credit loss and what ment recognition. If these exchange rates are not the same, portion relates to non-credit factors. the Firm uses regression analysis to assess the prospective and retrospective effectiveness of the hedge relationships. A credit loss exists if the present value of cash flows expected The gain or loss from revaluing hedges of net investments in to be collected (discounted at the implicit interest rate at foreign operations at the spot rate is reported within AOCI. acquisition of the security or discounted at the effective yield The forward points on the hedging instruments are excluded for securities that incorporate changes in prepayment assump- from hedge effectiveness testing and changes in the fair value tions) is less than the amortized cost basis of the security. of this excluded component are recorded currently in Interest Changes in prepayment assumptions alone are not considered income. to result in a credit loss.
For further information on derivative instruments and When determining if a credit loss exists, the Firm considers hedging activities, see Note 4. relevant information, including:
Investment Securities—Available-for-Sale and • the length of time and the extent to which the fair value has Held-to-Maturity been less than the amortized cost basis;
AFS securities are reported at fair value in the balance sheets • adverse conditions specifically related to the security, its with unrealized gains and losses reported in AOCI, net of tax. industry or geographic area; Interest and dividend income, including amortization of • changes in the financial condition of the issuer of the secu- premiums and accretion of discounts, is included in Interest rity, the presence of explicit or implicit guarantees of income in the income statements. Realized gains and losses repayment by the U.S. Government for U.S. Government on sales of AFS securities are classified within Other reve- and Agency securities or, in the case of an asset-backed nues in the income statements (see Note 5). The Firm utilizes debt security, changes in the financial condition of the the “first-in, first-out” method as the basis for determining the underlying loan obligors; cost of AFS securities. • the historical and implied volatility of the fair value of the HTM securities are reported at amortized cost in the balance security; sheets. Interest income, including amortization of premiums and accretion of discounts on HTM securities, is included in • the payment structure of the debt security and the likeli- Interest income in the income statements. hood of the issuer being able to make payments that increase in the future;
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− 332 − Notes to Consolidated Financial Statements
• failure of the issuer of the security to make scheduled determining impairment include payment status, fair value of interest or principal payments; collateral, and probability of collecting scheduled principal and interest payments when due. The impairment analysis • the current rating and any changes to the rating of the secu- required depends on the nature and type of loans. Loans clas- rity by a rating agency; sified as Doubtful or Loss are considered impaired.
• recoveries or additional declines in fair value after the There are two components of the allowance for loan losses: balance sheet date. the specific allowance component and the inherent allowance component. When estimating the present value of expected cash flows, information includes the remaining payment terms of the The specific allowance component of the allowance for loan security, prepayment speeds, financial condition of the losses is used to estimate probable losses for exposures that issuer(s), expected defaults and the value of any underlying have been specifically identified for impairment analysis by collateral. the Firm and determined to be impaired. When a loan is specifically identified for impairment, the impairment is For AFS equity securities, the Firm considers various factors, measured based on the present value of expected future cash including the intent and ability to hold the equity security for flows discounted at the loan’s effective interest rate or the a period of time sufficient to allow for any anticipated observable market price of the loan or the fair value of the recovery in market value, in evaluating whether an OTTI collateral if the loan is collateral dependent. A loan is collat- exists. If the equity security is considered other-than- eral dependent if the repayment of the loan is expected to be temporarily impaired, the entire OTTI (i.e., the difference provided solely by the sale or operation of the underlying between the fair value recorded in the balance sheet and the collateral. If the present value of the expected future cash cost basis) will be recognized in the income statements. flows (or alternatively, the observable market price of the loan or the fair value of the collateral) is less than the Loans recorded investment in the loan, then the Firm recognizes an The Firm accounts for loans based on the following catego- allowance and a charge to the provision for loan losses within ries: loans held for investment; loans held for sale; and loans Other revenues. at fair value. The inherent allowance component of the allowance for loan Loans Held for Investment losses represents an estimate of the probable losses inherent in the loan portfolio and includes loans that have not been Loans held for investment are reported at outstanding prin- identified as impaired. The Firm maintains methodologies by cipal adjusted for any charge-offs, the allowance for loan loan product for calculating an allowance for loan losses that losses, any unamortized deferred fees or costs for originated estimates the inherent losses in the loan portfolio. Generally, loans, and any unamortized premiums or discounts for inherent losses in the portfolio for non-impaired loans are purchased loans. estimated using statistical analysis and judgment regarding the exposure at default, the probability of default and the loss Interest Income. Interest income on performing loans held given default. for investment is accrued and recognized as interest income at the contractual rate of interest. Purchase price discounts or Qualitative and environmental factors such as economic and premiums, as well as net deferred loan fees or costs, are business conditions, nature and volume of the portfolio, and amortized into interest income over the life of the loan to lending terms and volume and severity of past due loans may produce a level rate of return. also be considered in the calculations. The allowance for loan losses is maintained at a level to ensure that it is reasonably Allowance for Loan Losses. The allowance for loan losses likely to adequately absorb the estimated probable losses represents an estimate of probable losses related to loans inherent in the portfolio. When the Firm recognizes an allow- specifically identified for impairment in addition to the prob- ance, there is also a charge to the provision for loan losses able losses inherent in the held-for-investment loan portfolio. within Other revenues.
The Firm utilizes the U.S. banking agencies’ definition of Troubled Debt Restructurings. The Firm may modify the criticized exposures, which consist of the Special Mention, terms of certain loans for economic or legal reasons related to Substandard, Doubtful and Loss categories as credit quality a borrower’s financial difficulties by granting one or more indicators. For further information on the credit quality indi- concessions that the Firm would not otherwise consider. Such cators, see Note 7. Substandard loans are regularly reviewed modifications are accounted for and reported as a TDR. A for impairment. Factors considered by management when loan that has been modified in a TDR is generally considered
95 December 2018 Form 10-K
− 333 − Notes to Consolidated Financial Statements to be impaired and is evaluated for the extent of impairment Loans Held for Sale using the Firm’s specific allowance methodology. TDRs are also generally classified as nonaccrual and may be returned to Loans held for sale are measured at the lower of cost or fair accrual status only after considering the borrower’s sustained value, with valuation changes recorded in Other revenues. repayment performance for a reasonable period. The Firm determines the valuation allowance on an indi- vidual loan basis, except for residential mortgage loans for Nonaccrual Loans. The Firm places loans on nonaccrual which the valuation allowance is determined at the loan status if principal or interest is past due for a period of 90 product level. Any decreases in fair value below the initial days or more or payment of principal or interest is in doubt carrying amount and any recoveries in fair value up to the unless the obligation is well-secured and in the process of initial carrying amount are recorded in Other revenues. collection. A loan is considered past due when a payment due Increases in fair value above initial carrying value are not according to the contractual terms of the loan agreement has recognized. not been remitted by the borrower. Substandard loans, if identified as impaired, are categorized as nonaccrual, as are Interest income on loans held for sale is accrued and recog- loans classified as Doubtful or Loss. nized based on the contractual rate of interest. Loan origina- tion fees or costs and purchase price discounts or premiums Payments received on nonaccrual loans held for investment are deferred as an adjustment to the loan’s cost basis until the are applied to principal if there is doubt regarding the ulti- related loan is sold, and as such, are included in the periodic mate collectibility of principal. If collection of the principal determination of the lower of cost or fair value adjustments of nonaccrual loans held for investment is not in doubt, and the gain or loss recognized at the time of sale. interest income is realized on a cash basis. If neither principal nor interest collection is in doubt, loans are placed on accrual Lending Commitments. Commitments to fund mortgage loans status and interest income is recognized using the effective held for sale are derivatives and are reported in Trading assets interest method. Loans that are on nonaccrual status may not or Trading liabilities in the balance sheets with an offset to be restored to accrual status until all delinquent principal and/ Trading revenues in the income statements. or interest has been brought current after a reasonable period of performance, typically a minimum of six months. For commitments to fund non-mortgage loans the Firm records the liability and related expense for the fair value Charge-offs. The Firm charges off a loan in the period that exposure below cost of such commitments in Other liabilities it is deemed uncollectible and records a reduction in the and accrued expenses in the balance sheets with an offset to allowance for loan losses and the balance of the loan. In Other revenues in the income statements. general, any portion of the recorded investment in a collateral dependent loan (including any capitalized accrued interest, Loans and lending commitments held for sale are subject to net deferred loan fees or costs, and unamortized premium or the nonaccrual policies described above in the Loans Held for discount) in excess of the fair value of the collateral that can Investment—Nonaccrual loans section. Because loans and be identified as uncollectible, and is therefore deemed a lending commitments held for sale are recognized at the confirmed loss, is charged off against the allowance for loan lower of cost or fair value, the allowance for loan losses and losses. In addition, for loan transfers from loans held for charge-off policies does not apply to these loans. investment to loans held for sale, at the time of transfer any Loans at Fair Value reduction in the loan value is reflected as a charge-off of the recorded investment, resulting in a new cost basis. Loans for which the fair value option is elected are carried at fair value, with changes in fair value recognized in earnings. Lending Commitments. The Firm records the liability and Loans carried at fair value are not evaluated for purposes of related expense for the credit exposure related to commit- recording an allowance for loan losses. For further informa- ments to fund loans that will be held for investment in a tion on loans carried at fair value and classified as Trading manner similar to outstanding loans discussed above. The assets and Trading liabilities, see Note 3. analysis also incorporates a credit conversion factor, which is the expected utilization of the undrawn commitment. The Lending Commitments. The Firm records the liability and liability is recorded in Other liabilities and accrued expenses related expense for the fair value exposure related to commit- in the balance sheets, and the expense is recorded in Other ments to fund loans that will be measured at fair value. The non-interest expenses in the income statements. For more liability is recorded in Trading liabilities in the balance information regarding loan commitments, standby letters of sheets, and the expense is recorded in Trading revenues in the credit and financial guarantees, see Note 12. income statements.
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− 334 − Notes to Consolidated Financial Statements
Loans and lending commitments at fair value are subject to Estimated Useful Lives of Assets the nonaccrual policies described above in the Loans Held for in years Estimated Useful Life Investment—Nonaccrual loans section. Because such loans Buildings 39 and lending commitments are reported at fair value, the Leasehold improvements—Building term of lease to 25 allowance for loan losses and charge-off policies do not apply Leasehold improvements—Other term of lease to 15 to these loans. Furniture and fixtures 7 For further information on loans, see Note 7. Computer and communications equipment 3 to 9 Power generation assets 15 to 29 Transfers of Financial Assets Terminals, pipelines and equipment 3 to 30 Software costs 2 to 10 Transfers of financial assets are accounted for as sales when the Firm has relinquished control over the transferred assets. Premises, equipment and software costs are tested for impair- Any related gain or loss on sale is recorded in Net revenues. ment whenever events or changes in circumstances suggest Transfers that are not accounted for as sales are treated as a that an asset’s carrying value may not be fully recoverable. collateralized financing, in certain cases referred to as “failed sales.” Securities borrowed or purchased under agreements to Goodwill and Intangible Assets resell and securities loaned or sold under agreements to repurchase are treated as collateralized financings The Firm tests goodwill for impairment on an annual basis (see Note 6). and on an interim basis when certain events or circumstances exist. The Firm tests goodwill for impairment at the reporting Securities purchased under agreements to resell (“reverse unit level, which is generally at the level of or one level repurchase agreements”) and Securities sold under agree- below its business segments. For both the annual and interim ments to repurchase (“repurchase agreements”) are carried in tests, the Firm has the option to either (i) perform a the balance sheets at the amount of cash paid or received, quantitative impairment test or (ii) first perform a qualitative plus accrued interest, except for certain repurchase agree- assessment to determine whether it is more likely than not ments for which the Firm has elected the fair value option that the fair value of a reporting unit is less than its carrying (see Note 3). Where appropriate, repurchase agreements and amount, in which case the quantitative test would be reverse repurchase agreements with the same counterparty are performed. reported on a net basis. Securities borrowed and securities loaned are recorded at the amount of cash collateral advanced When performing a quantitative impairment test, the Firm or received. compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of the reporting In instances where the Firm is the lender in unit is less than its carrying amount, the goodwill impairment securities-for-securities transactions and is permitted to sell loss is equal to the excess of the carrying value over the fair or repledge these securities, the fair value of the collateral value, limited to the carrying amount of goodwill allocated to received is reported in Trading assets and the related obliga- that reporting unit. tion to return the collateral is reported in Trading liabilities in the balance sheets. Securities-for-securities transactions The estimated fair values of the reporting units are derived where the Firm is the borrower are not included in the based on valuation techniques the Firm believes market balance sheets. participants would use for each respective reporting unit. The estimated fair values are generally determined by utilizing a Premises, Equipment and Software Costs discounted cash flow methodology or methodologies that incorporate price-to-book and price-to-earnings multiples of Premises, equipment and software costs consist of buildings, certain comparable companies. leasehold improvements, furniture, fixtures, computer and communications equipment, power generation assets, termi- Intangible assets are amortized over their estimated useful nals, pipelines and software (externally purchased and devel- lives and are reviewed for impairment on an interim basis oped for internal use). Premises, equipment and software when impairment indicators are present. Impairment losses costs are stated at cost less accumulated depreciation and are recorded within Other expenses in the income statements. amortization and are included in Other assets in the balance sheets. Depreciation and amortization are provided by the straight-line method over the estimated useful life of the asset.
97 December 2018 Form 10-K
− 335 − Notes to Consolidated Financial Statements
Earnings per Common Share common stock or the relevant model valuation, as appro- priate, until conversion, exercise or expiration. Basic EPS is computed by dividing earnings available to Morgan Stanley common shareholders by the weighted Employee Stock Trusts average number of common shares outstanding for the period. Earnings available to Morgan Stanley common shareholders In connection with certain stock-based compensation plans, represents net income applicable to Morgan Stanley reduced the Firm maintains and utilizes employee stock trusts at its by preferred stock dividends. Common shares outstanding discretion. The assets of the employee stock trusts are include common stock and vested RSUs where recipients consolidated and are therefore accounted for in a manner have satisfied either the explicit vesting terms or retirement- similar to treasury stock, where the shares of common stock eligibility requirements. Diluted EPS reflects the assumed outstanding are offset by an equal amount of common stock conversion of all dilutive securities. issued to employee stock trusts in the balance sheets.
Share-based awards that pay dividend equivalents subject to The Firm uses the grant-date fair value of stock-based vesting are included in diluted shares outstanding (if dilutive) compensation as the basis for recognition of the assets in the under the treasury stock method. employee stock trusts. Subsequent changes in the fair value are not recognized as the Firm’s stock-based compensation The Firm has granted PSUs that vest and convert to shares of plans must be settled by delivery of a fixed number of shares common stock only if predetermined performance and market of the Firm’s common stock. goals are satisfied. Since the issuance of the shares is contin- gent upon the satisfaction of certain conditions, the PSUs are Deferred Cash-Based Compensation included in diluted EPS based on the number of shares (if any) that would be issuable if the end of the reporting period Compensation expense for deferred cash-based compensation was the end of the contingency period. plans is calculated based on the notional value of the award granted, adjusted for changes in the fair value of the refer- For the calculation of basic and diluted EPS, see Note 16. enced investments that employees select. Compensation expense is recognized over the relevant vesting period for Deferred Compensation each separately vesting portion of the award. Compensation expense for these awards is adjusted based on notional earn- Stock-Based Compensation ings of the referenced investments until distribution.
The Firm measures compensation expense for stock-based The Firm invests directly, as a principal, in investments or awards at fair value. The Firm determines the fair value of other financial instruments to economically hedge its obliga- RSUs (including PSUs with non-market performance condi- tions under its deferred cash-based compensation plans. tions) based on the grant-date fair value of its common stock, Changes in the value of such investments made by the Firm measured as the volume-weighted average price on the date are recorded in Trading revenues and Investments revenues. of grant. PSUs that contain market-based conditions are Although changes in compensation expense resulting from valued using a Monte Carlo valuation model. changes in the fair value of the referenced investments will generally be offset by changes in the fair value of investments Compensation expense is recognized over the relevant made by the Firm, there is typically a timing difference vesting period for each separately vesting portion of the between the immediate recognition of gains and losses on the award. Compensation expense for awards with performance Firm’s investments and the deferred recognition of the related conditions is recognized based on the probable outcome of compensation expense over the vesting period. the performance condition at each reporting date. Compensa- tion expense for awards with market-based conditions is Retirement-Eligible Employee Compensation recognized irrespective of the probability of the market condition being achieved and is not reversed if the market For year-end stock-based awards and deferred cash-based condition is not met. The Firm accounts for forfeitures as compensation awards anticipated to be granted to retirement- they occur. eligible employees under award terms that do not contain a future service requirement, the Firm accrues the estimated Stock-based awards generally contain claw back and cancel- cost of the awards over the course of the calendar year lation provisions. Certain awards provide the Firm discretion preceding the grant date, which reflects the period over which to claw back or cancel all or a portion of the award under the compensation is earned. specified circumstances. Compensation expense for those awards is adjusted for changes in the fair value of the Firm’s
December 2018 Form 10-K 98
− 336 − Notes to Consolidated Financial Statements
Income Taxes Accounting Updates Adopted
Deferred tax assets and liabilities are recorded based upon the The Firm adopted the following accounting updates in 2018. temporary differences between the financial statement and See Note 15 for a summary of the Retained earnings impacts income tax bases of assets and liabilities using currently of these and other minor adoptions effective in 2018. enacted tax rates in effect for the year in which the differ- ences are expected to reverse. The effect of a change in tax Revenues from Contracts with Customers rates on deferred tax assets and liabilities is recognized in income tax expense (benefit) in the period that includes the On January 1, 2018, the Firm adopted Revenues from enactment date. Such effects are recorded in income tax Contracts with Customers using the modified retrospective expense (benefit) from continuing operations regardless of method, which resulted in a net decrease to Retained earnings where deferred taxes were originally recorded. of $32 million, net of tax. Prior period amounts were not restated. The Firm recognizes net deferred tax assets to the extent that it believes these assets are more likely than not to be realized. In Our revised accounting policy in accordance with this adop- making such a determination, the Firm considers all available tion was effective January 1, 2018 and is included above. positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable The more significant differences to the accounting policy in income, tax planning strategies and results of recent operations. place prior to adoption were (i) the presentation of certain When performing the assessment, the Firm considers all types costs related to underwriting and advisory activities in that of deferred tax assets in combination with each other, regard- such costs were recorded net of Investment Banking revenues less of the origin of the underlying temporary difference. If a versus the current practice of recording the costs in the rele- deferred tax asset is determined to be unrealizable, a valuation vant non-compensation expense line item (ii) the presentation allowance is established. If the Firm subsequently determines of certain costs related to the selling and distribution of that it would be able to realize deferred tax assets in excess of investment funds in that such costs were recorded net of their net recorded amount, it would make an adjustment to the Asset Management revenues versus the current practice of deferred tax asset valuation allowance, which would reduce the recording the costs in the relevant non-compensation expense provision for income taxes. line item (iii) the recognition of certain performance fees from fund management activities not in the form of carried The Firm recognizes tax expense associated with GILTI interest that were recognized quarterly versus the current included in the Tax Cuts and Jobs Act (“Tax Act”) as it is practice of deferring the revenues until the fees are not prob- incurred as part of the current income taxes to be paid or able of a significant reversal, and (iv) the timing of the recog- refunded for the current period. nition of advisory fees in that such fees were recorded when realizable versus the current practice of recognizing the fees Uncertain tax positions are recorded on the basis of a as advice is provided to the client, based on the estimated two-step process, whereby (i) the Firm determines whether it progress of work and when the revenue is not probable of a is more likely than not that the tax positions will be sustained significant reversal. on the basis of the technical merits of the position and (ii) for those tax positions that meet this threshold, the Firm recog- Derivatives and Hedging–Targeted Improvements to nizes the largest amount of tax benefit that is more likely than Accounting for Hedging Activities not to be realized upon ultimate settlement with the related tax authority. Interest and penalties related to unrecognized The Firm adopted this accounting update in the first quarter tax benefits are classified as provision for income taxes. of 2018, with our revised accounting policy effective January 1, 2018. Upon adoption, the Firm recorded a cumula- Foreign Currencies tive catch-up adjustment, decreasing Retained earnings by $99 million, net of tax. This adjustment represents the cumu- Assets and liabilities of operations with non-U.S. dollar func- lative effect of applying the new rules from the inception of tional currencies are translated at year-end rates of certain fair value hedges of the interest rate risk of our exchange. Gains or losses resulting from translating foreign borrowings, in particular the provision allowing only the currency financial statements, net of hedge gains or losses and benchmark rate component of coupon cash flows to be related tax effects, are reflected in AOCI in the balance hedged. sheets. Gains or losses resulting from remeasurement of foreign currency transactions are included in net income, and The more significant differences to the accounting policy in amounts recognized in the income statement are translated at place prior to adoption were: the provision permitting the the rate of exchange on the respective date of recognition for hedged item in a fair value hedge of interest rate risk to be each amount. defined as including only the benchmark rate component of
99 December 2018 Form 10-K
− 337 − Notes to Consolidated Financial Statements contractual coupon cash flows versus the previous require- Aside from the above treatment related to the Tax Act, the ment to include the total contractual coupon cash flows as the Firm releases stranded tax effects from AOCI into earnings hedged item; and the allowance to hedge part of the contrac- once the related category of instruments or transactions tual term of the hedged item by assuming maturity at the end giving rise to these effects no longer exists. For further detail of the hedge term, whereas previously it could not be on the tax effects reclassified, refer to Note 15 to the financial assumed that the instrument matures at the end of the desig- statements. nated partial term.
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income
This accounting update, which the Firm elected to early adopt as of January 1, 2018, allows companies to reclassify from AOCI to Retained earnings the stranded tax effects associated with enactment of the Tax Act on December 22, 2017. These stranded tax effects resulted from the requirement to reflect the total amount of the remeasurement of and other adjust- ments to deferred tax assets and liabilities in 2017 in income from continuing operations, regardless of whether the deferred taxes were originally recorded in AOCI. Accord- ingly, as of January 1, 2018, the Firm recorded a net increase to Retained earnings as a result of the reclassification of $443 million of such stranded tax effects previously recorded in AOCI, which were primarily the result of the remeasure- ment of deferred tax assets and liabilities associated with the change in tax rates.
December 2018 Form 10-K 100
− 338 − Notes to Consolidated Financial Statements 3. Fair Values
Fair Value Measurements
Valuation Techniques for Assets and Liabilities Measured at Fair Value on a Recurring Basis
Asset and Liability/Valuation Technique Valuation Hierarchy Classification U.S. Treasury and Agency Securities U.S. Treasury Securities • Level 1 • Fair value is determined using quoted market prices.
U.S. Agency Securities • Level 1 - non-callable agency-issued • Non-callable agency-issued debt securities are generally valued using quoted market prices, and debt securities callable agency-issued debt securities are valued by benchmarking model-derived prices to • Generally Level 2 - callable agency- quoted market prices and trade data for comparable instruments. issued debt securities, agency mortgage • The fair value of agency mortgage pass-through pool securities is model-driven based on pass-through pool securities and CMOs spreads of comparable to-be-announced securities. • Level 3 - in instances where the inputs • CMOs are generally valued using quoted market prices and trade data adjusted by subsequent are unobservable changes in related indices for comparable instruments. Other Sovereign Government Obligations • Generally Level 1 • Fair value is determined using quoted prices in active markets when available. • Level 2 - if the market is less active or prices are dispersed • Level 3 - in instances where the prices are unobservable State and Municipal Securities • Generally Level 2 – if value based on • Fair value is determined using recently executed transactions, market price quotations or pricing observable market data for comparable models that factor in, where applicable, interest rates, bond or CDS spreads and volatility and/or instruments volatility skew, adjusted for any basis difference between cash and derivative instruments. • Level 3 in instances where market data is not observable RMBS, CMBS, ABS (collectively known as Mortgage- and Asset-backed securities (“MABS”)) • Generally Level 2 - if value based on • Mortgage- and asset-backed securities may be valued based on price or spread data obtained observable market data for comparable from observed transactions or independent external parties such as vendors or brokers. instruments • When position-specific external price data are not observable, the fair value determination may • Level 3 - if external prices or significant require benchmarking to comparable instruments, and/or analyzing expected credit losses, spread inputs are unobservable, or if the default and recovery rates, and/or applying discounted cash flow techniques. When evaluating comparability assessment involves the comparable instruments for use in the valuation of each security, security collateral-specific significant subjectivity related to prop- attributes, including payment priority, credit enhancement levels, type of collateral, delinquency erty type differences, cash flows, perfor- rates and loss severity, are considered. In addition, for RMBS borrowers, FICO scores and the mance or other inputs level of documentation for the loan are considered. • Market standard models, such as Intex, Trepp or others, may be deployed to model the specific collateral composition and cash flow structure of each transaction. Key inputs to these models are market spreads, forecasted credit losses, and default and prepayment rates for each asset category. • Valuation levels of RMBS and CMBS indices are used as an additional data point for bench- marking purposes or to price outright index positions. Corporate and other debt Corporate Bonds • Generally Level 2 - if value based on • Fair value is determined using recently executed transactions, market price quotations, bond observable market data for comparable spreads, CDS spreads, or at the money volatility and/or volatility skew obtained from independent instruments external parties, such as vendors and brokers, adjusted for any basis difference between cash • Level 3 – in instances where prices or and derivative instruments. significant spread inputs are unobservable • The spread data used are for the same maturity as the bond. If the spread data do not reference the issuer, then data that reference a comparable issuer are used. When position-specific external price data are not observable, fair value is determined based on either benchmarking to comparable instruments or cash flow models with yield curves, bond or single-name CDS spreads and recovery rates as significant inputs. CDO • The Firm holds cash CDOs that typically reference a tranche of an underlying synthetic portfolio • Level 2 - when either comparable of single-name CDS spreads collateralized by corporate bonds (CLN) or cash portfolio of ABS/ market transactions are observable, or loans (“asset-backed CDOs”). credit correlation input is insignificant • Credit correlation, a primary input used to determine the fair value of CLNs, is usually unobserv- • Level 3 - when either comparable market able and derived using a benchmarking technique. Other model inputs such as credit spreads, transactions are unobservable, or the including collateral spreads, and interest rates are typically observable. credit correlation input is significant • Asset-backed CDOs are valued based on an evaluation of the market and model input parame- ters sourced from comparable instruments as indicated by market activity. Each asset-backed CDO position is evaluated independently taking into consideration available comparable market levels, underlying collateral performance and pricing, deal structures and liquidity.
101 December 2018 Form 10-K
− 339 − Notes to Consolidated Financial Statements
Asset and Liability/Valuation Technique Valuation Hierarchy Classification Loans and Lending Commitments • Level 2 - if value based on observable • Fair value of corporate loans is determined using recently executed transactions, market price market data for comparable instruments quotations (where observable), implied yields from comparable debt, market observable CDS • Level 3 - in instances where prices or spread levels obtained from independent external parties adjusted for any basis difference significant spread inputs are between cash and derivative instruments, along with proprietary valuation models and default unobservable recovery analysis where such transactions and quotations are unobservable. • Fair value of contingent corporate lending commitments is determined by using executed transac- tions on comparable loans and the anticipated market price based on pricing indications from syndicate banks and customers. The valuation of loans and lending commitments also takes into account fee income that is considered an attribute of the contract. • Fair value of mortgage loans is determined using observable prices based on transactional data or third-party pricing for comparable instruments, when available. • Where position-specific external prices are not observable, fair value is estimated based on benchmarking to prices and rates observed in the primary market for similar loan or borrower types or based on the present value of expected future cash flows using the Firm’s best available estimates of the key assumptions, including forecasted credit losses, prepayment rates, forward yield curves and discount rates commensurate with the risks involved or a methodology that utilizes the capital structure and credit spreads of recent comparable securitization transactions. • Fair value of equity margin loans is determined by discounting future interest cash flows, net of estimated credit losses. The estimated credit losses are derived by benchmarking to market observable CDS spreads, implied debt yields or volatility metrics of the loan collateral. Corporate Equities • Level 1 - exchange-traded securities • Exchange-traded equity securities are generally valued based on quoted prices from the and fund units if actively traded exchange. To the extent these securities are actively traded, valuation adjustments are not applied. • Level 2 - exchange-traded securities if • Unlisted equity securities are generally valued based on an assessment of each security, consid- not actively traded, or if undergoing a ering rounds of financing and third-party transactions, discounted cash flow analyses and market- recent M&A event or corporate action based information, including comparable transactions, trading multiples and changes in market • Level 3 - exchange-traded securities if outlook, among other factors. not actively traded, or if undergoing an • Listed fund units are generally marked to the exchange-traded price if actively traded, or NAV if aged M&A event or corporate action not. Unlisted fund units are generally marked to NAV. Derivative and Other Contracts Listed Derivative Contracts • Level 1 - listed derivatives that are • Listed derivatives that are actively traded are valued based on quoted prices from the exchange. actively traded • Listed derivatives that are not actively traded are valued using the same techniques as those • Level 2 - listed derivatives that are not applied to OTC derivatives. actively traded OTC Derivative Contracts • Generally Level 2 - OTC derivative • OTC derivative contracts include forward, swap and option contracts related to interest rates, products valued using observable foreign currencies, credit standing of reference entities, equity prices or commodity prices. inputs, or where the unobservable input • Depending on the product and the terms of the transaction, the fair value of OTC derivative prod- is not deemed significant ucts can be modeled using a series of techniques, including closed-form analytic formulas, such • Level 3 - OTC derivative products for as the Black-Scholes option-pricing model, simulation models or a combination thereof. Many which the unobservable input is deemed pricing models do not entail material subjectivity as the methodologies employed do not necessi- significant tate significant judgment since model inputs may be observed from actively quoted markets, as is the case for generic interest rate swaps, many equity, commodity and foreign currency option contracts, and certain CDS. In the case of more established derivative products, the pricing models used by the Firm are widely accepted by the financial services industry. • More complex OTC derivative products are typically less liquid and require more judgment in the implementation of the valuation technique since direct trading activity or quotes are unobserv- able. This includes certain types of interest rate derivatives with both volatility and correlation exposure, equity, commodity or foreign currency derivatives that are either longer-dated or include exposure to multiple underlyings, and credit derivatives, including CDS on certain mort- gage- or asset-backed securities and basket CDS. Where required inputs are unobservable, rela- tionships to observable data points, based on historical and/or implied observations, may be employed as a technique to estimate the model input values.
For further information on the valuation techniques for OTC derivative products, see Note 2.
December 2018 Form 10-K 102
− 340 − Notes to Consolidated Financial Statements
Asset and Liability/Valuation Technique Valuation Hierarchy Classification Investments • Level 1 - exchange-traded direct equity • Investments include direct investments in equity securities, as well as various investment investments in an active market management funds, which include investments made in connection with certain employee • Level 2 - non-exchange-traded direct deferred compensation plans. equity investments and investments in • For direct investments, initially, the transaction price is generally considered by the Firm as the various investment management funds exit price and is its best estimate of fair value. if valued based on rounds of financing • After initial recognition, in determining the fair value of non-exchange-traded internally and exter- or third-party transactions; exchange- nally managed funds, the Firm generally considers the NAV of the fund provided by the fund traded direct equity investments if not manager to be the best estimate of fair value. actively traded • For non-exchange-traded investments either held directly or held within internally managed • Level 3 - non-exchange-traded direct funds, fair value after initial recognition is based on an assessment of each underlying invest- equity investments and investments in ment, considering rounds of financing and third-party transactions, discounted cash flow analyses various investment management funds and market-based information, including comparable Firm transactions, trading multiples and where rounds of financing or third-party changes in market outlook, among other factors. transactions are not available • Exchange-traded direct equity investments are generally valued based on quoted prices from the exchange. Physical Commodities • Level 2 • The Firm trades various physical commodities, including natural gas and precious metals. • Fair value is determined using observable inputs, including broker quotations and published indices. Investment Securities—AFS Securities • For further information on the determi- • AFS securities are composed of U.S. government and agency securities (e.g., U.S. Treasury nation of valuation hierarchy classifica- securities, agency-issued debt, agency mortgage pass-through securities and CMOs), CMBS, tion, see the corresponding Valuation FFELP student loan ABS, state and municipal securities, corporate bonds, and CLOs. Hierarchy Classification described herein. For further information on the determination of fair value, refer to the corresponding asset/liability Valuation Technique described herein for the same instruments. Deposits • Generally Level 2 Certificates of Deposit • Level 3 - in instances where the unob- • The Firm issues FDIC-insured certificates of deposit that pay either fixed coupons or that have servable input is deemed significant repayment terms linked to the performance of debt or equity securities, indices or currencies. The fair value of these certificates of deposit is determined using valuation models that incorporate observable inputs referencing identical or comparable securities, including prices to which the deposits are linked, interest rate yield curves, option volatility and currency rates, equity prices, and the impact of the Firm’s own credit spreads, adjusted for the impact of the FDIC insurance, which is based on vanilla deposit issuance rates. Securities Purchased under Agreements to Resell and Securities Sold under Agreements to • Generally Level 2 Repurchase • Level 3 - in instances where the unob- • Fair value is computed using a standard cash flow discounting methodology. servable inputs are deemed significant • The inputs to the valuation include contractual cash flows and collateral funding spreads, which are the incremental spread over the OIS rate for a specific collateral rate (which refers to the rate applicable to a specific type of security pledged as collateral). Other Secured Financings For further information on the determi- • Other secured financings are composed of short-dated notes secured by Corporate equities, nation of valuation hierarchy classifica- agreements to repurchase Physical commodities, the liability portion of failed sales of Loans and tion, see the corresponding Valuation lending commitments and contracts which are not classified as OTC derivatives because they fail Hierarchy Classification described net investment criteria. herein.
For further information on the determination of fair value, refer to the corresponding asset/liability Valuation Technique described herein. Borrowings • Generally Level 2 Structured Notes • Level 3 - in instances where the unob- • The Firm issues structured notes which are primarily composed of: instruments whose payments servable inputs are deemed significant and redemption values are linked to the performance of a specific index, a basket of stocks, a specific equity security, a commodity, a credit exposure or basket of credit exposures; and instru- ments with various interest-rate-related features including step-ups, step-downs, and zero coupons. • Fair value of structured notes is determined using valuation models for the derivative and debt portions of the notes. These models incorporate observable inputs referencing identical or comparable securities, including prices to which the notes are linked, interest rate yield curves, option volatility and currency rates, and commodity or equity prices. • Independent, external and traded prices for the notes are considered as well as the impact of the Firm’s own credit spreads which are based on observed secondary bond market spreads.
103 December 2018 Form 10-K
− 341 − Notes to Consolidated Financial Statements
Assets and Liabilities Measured at Fair Value on a Recurring Basis
At December 31, 2018 At December 31, 2017 $ in millions Level 1 Level 2 Level 3 Netting1 Total $ in millions Level 1 Level 2 Level 3 Netting1 Total Assets at fair value Assets at fair value Trading assets: Trading assets: U.S. Treasury and agency U.S. Treasury and agency securities $ 38,767 $ 29,594 $ 54 $ — $ 68,415 securities $ 22,077 $ 26,888 $ — $ — $ 48,965 Other sovereign government Other sovereign government obligations 28,395 5,529 17 — 33,941 obligations 20,234 7,825 1 — 28,060 State and municipal State and municipal securities — 3,161 148 — 3,309 securities — 3,592 8 — 3,600 MABS — 2,154 354 — 2,508 MABS — 2,364 423 — 2,787 Loans and lending Loans and lending commitments2 — 4,055 6,870 — 10,925 commitments2 — 4,791 5,945 — 10,736 Corporate and other debt — 18,129 1,076 — 19,205 Corporate and other debt — 16,837 701 — 17,538 Corporate equities3 93,626 522 95 — 94,243 Corporate equities3 149,697 492 166 — 150,355 Derivative and other contracts: Derivative and other contracts: Interest rate 2,793 155,027 1,045 — 158,865 Interest rate 472 178,704 1,763 — 180,939 Credit — 5,707 421 — 6,128 Credit — 7,602 420 — 8,022 Foreign exchange 62 63,023 161 — 63,246 Foreign exchange 58 53,724 15 — 53,797 Equity 1,256 45,596 1,022 — 47,874 Equity 1,101 40,359 3,530 — 44,990 Commodity and other 963 8,517 2,992 — 12,472 Commodity and other 1,126 5,390 4,147 — 10,663 Netting1 (4,151) (210,190) (896) (44,175) (259,412) Netting1 (2,088) (216,764) (1,575) (47,171) (267,598) Total derivative and other Total derivative and other contracts 923 67,680 4,745 (44,175) 29,173 contracts 669 69,015 8,300 (47,171) 30,813 Investments4 412 293 757 — 1,462 Investments4 297 523 1,020 — 1,840 Physical commodities — 536 — — 536 Physical commodities — 1,024 — — 1,024 Total trading assets4 162,123 131,653 14,116 (44,175) 263,717 Total trading assets4 192,974 133,351 16,564 (47,171) 295,718 Investment securities—AFS 36,399 24,662 — — 61,061 Investment securities— AFS 27,522 27,681 — — 55,203 Intangible assets —5——5Intangible assets — 3 — — 3 Total assets at fair value $ 198,522 $ 156,320 $ 14,116 $ (44,175) $ 324,783 Total assets at fair value $ 220,496 $ 161,035 $ 16,564 $ (47,171) $ 350,924
At December 31, 2018 At December 31, 2017 $ in millions Level 1 Level 2 Level 3 Netting1 Total $ in millions Level 1 Level 2 Level 3 Netting1 Total Liabilities at fair value Liabilities at fair value Deposits $ — $ 415 $ 27 $ — $ 442 Deposits $ — $ 157 $ 47 $ — $ 204 Trading liabilities: Trading liabilities: U.S. Treasury and agency U.S. Treasury and agency securities 11,272 543 — — 11,815 securities 17,802 24 — — 17,826 Other sovereign government Other sovereign government obligations 21,391 1,454 — — 22,845 obligations 24,857 2,016 — — 26,873 Corporate and other debt — 8,550 1 — 8,551 Corporate and other debt — 7,141 3 — 7,144 Corporate equities3 56,064 199 15 — 56,278 Corporate equities3 52,653 82 22 — 52,757 Derivative and other contracts: Derivative and other contracts: Interest rate 2,927 142,746 427 — 146,100 Interest rate 364 162,239 545 — 163,148 Credit — 5,772 381 — 6,153 Credit — 8,166 379 — 8,545 Foreign exchange 41 63,379 86 — 63,506 Foreign exchange 23 55,118 127 — 55,268 Equity 1,042 47,091 2,507 — 50,640 Equity 1,001 44,666 2,322 — 47,989 Commodity and other 1,228 6,872 940 — 9,040 Commodity and other 1,032 5,156 2,701 — 8,889 Netting1 (4,151) (210,190) (896) (32,944) (248,181) Netting1 (2,088) (216,764) (1,575) (36,717) (257,144) Total derivative and other Total derivative and other contracts 1,087 55,670 3,445 (32,944) 27,258 contracts 332 58,581 4,499 (36,717) 26,695 Total trading liabilities 89,814 66,416 3,461 (32,944) 126,747 Total trading liabilities 95,644 67,844 4,524 (36,717) 131,295 Securities sold under Securities sold under agreements to repurchase — 812 — — 812 agreements to repurchase — 650 150 — 800 Other secured financings — 5,037 208 — 5,245 Other secured financings — 3,624 239 — 3,863 Borrowings — 47,378 3,806 — 51,184 Borrowings — 43,928 2,984 — 46,912 Total liabilities at fair value $ 89,814 $ 120,058 $ 7,502 $ (32,944) $ 184,430 Total liabilities at fair value $ 95,644 $ 116,203 $ 7,944 $ (36,717) $ 183,074
MABS—Mortgage- and asset-backed securities 1. For positions with the same counterparty that cross over the levels of the fair value hierarchy, both counterparty netting and cash collateral netting are included in the column titled “Netting.” Positions classified within the same level that are with the same counterparty are netted within that level. For further information on derivative instruments and hedging activities, see Note 4. 2. For a further breakdown by type, see the following Loans and Lending Commitments at Fair Value table. 3. For trading purposes, the Firm holds or sells short equity securities issued by entities in diverse industries and of varying sizes. 4. Amounts exclude certain investments that are measured based on NAV per share, which are not classified in the fair value hierarchy. For additional disclosure about such investments, see “Fund Interests Measured Based on Net Asset Value” herein.
December 2018 Form 10-K 104
− 342 − Notes to Consolidated Financial Statements
Breakdown of Loans and Lending Commitments at Fair Value $ in millions 2018 2017 2016 MABS Beginning balance $ 423 $ 217 $ 438 At At December 31, December 31, Realized and unrealized gains (losses) 82 47 (69) $ in millions 2018 2017 Purchases 177 289 82 Corporate $ 9,171 $ 8,358 Sales (338) (158) (323) Residential real estate 1,153 799 Settlements (17) (37) — Wholesale real estate 601 1,579 Net transfers 27 65 89 Total $ 10,925 $ 10,736 Ending balance $ 354 $ 423 $ 217 Unrealized gains (losses) $ (9) $ (7) $ (77)
Unsettled Fair Value of Futures Contracts1 Loans and lending commitments Beginning balance $ 5,945 $ 5,122 $ 5,936 Realized and unrealized gains (losses) (100) 182 (79)
At At 1 December 31, December 31, Purchases 5,746 3,616 2,261 $ in millions 2018 2017 Sales (2,529) (1,561) (954) Customer and other receivables, net $ 615 $ 831 Settlements (2,281) (1,463) (1,863)
1. These contracts are primarily Level 1, actively traded, valued based on quoted Net transfers 89 49 (179) prices from the exchange and are excluded from the previous recurring fair value Ending balance $ 6,870 $ 5,945 $ 5,122 tables. Unrealized gains (losses) $ (137) $ 131 $ (80)
Corporate and other debt Changes in Level 3 Assets and Liabilities Measured at Beginning balance $ 701 $ 475 $ 1,145 Fair Value on a Recurring Basis Realized and unrealized gains (losses) 106 82 40 Purchases 734 487 350 Sales (251) (420) (708) Rollforward of Level 3 Assets and Liabilities Measured at Fair Settlements (11) (9) — Value on a Recurring Basis Net transfers (203) 86 (352) Ending balance $ 1,076 $ 701 $ 475
$ in millions 2018 2017 2016 Unrealized gains (losses) $70$ 23 $ (38) U.S. Treasury and agency securities Beginning balance $ — $ 74 $ — Corporate equities Beginning balance $ 166 $ 446 $ 434 Realized and unrealized gains (losses) 1 (1) (4) Realized and unrealized gains (losses) 29 (54) (2) Purchases 53 —72 Purchases 13 173 242 Sales — (240) — Sales (161) (632) (154) Settlements — —— Settlements — —— Net transfers — 167 6 Net transfers 48 233 (74) Ending balance $54$—$74 Unrealized gains (losses) $1$ — $ (4) Ending balance $95$ 166 $ 446 Unrealized gains (losses) $17$ (6) $ — Other sovereign government obligations Beginning balance $ 1 $ 6 $ 4 Net derivatives: Interest rate2 Realized and unrealized gains (losses) — —1Beginning balance $ 1,218 $ 420 $ 260 Purchases 41 —4Realized and unrealized gains (losses) 111 322 529 Sales (26) (5) (7) Purchases 63 29 1 Settlements — ——Issuances (19) (18) — Net transfers 1 —4Settlements (172) 608 (83) Ending balance $17$1$6 Net transfers (583) (143) (287) Unrealized gains (losses) $—$—$— Ending balance $ 618 $ 1,218 $ 420 Unrealized gains (losses) $ 140 $ 341 $ 463 State and municipal securities Beginning balance $ 8 $ 250 $ 19 Net derivatives: Credit2 Realized and unrealized gains (losses) — 3—Beginning balance $ 41 $ (373) $ (844) Purchases 147 6 249 Realized and unrealized gains (losses) 33 (43) (176) Sales (9) (83) (18) Purchases 13 —— Settlements — —— Issuances (95) (1) (4) Net transfers 2 (168) — Settlements 56 455 623 Ending balance $ 148 $ 8 $ 250 Net transfers (8) 328 Unrealized gains (losses) $—$—$— Ending balance $40$ 41 $ (373) Unrealized gains (losses) $23$ (18) $ (167)
105 December 2018 Form 10-K
− 343 − Notes to Consolidated Financial Statements
$ in millions 2018 2017 2016 $ in millions 2018 2017 2016 Net derivatives: Foreign exchange2 Securities sold under agreements to repurchase Beginning balance $ (112) $ (43) $ 141 Beginning balance $ 150 $ 149 $ 151 Realized and unrealized gains (losses) 179 (108) (27) Realized and unrealized losses (gains) — — (2) Purchases 3 ——Purchases — —— Issuances (1) (1) — Issuances — 1— Settlements 2 31 (220) Settlements — —— Net transfers 4 963Net transfers (150) —— Ending balance $75$ (112) $ (43) Ending balance $—$ 150 $ 149 Unrealized gains (losses) $ 118 $ (89) $ (23) Unrealized losses (gains) $—$ — $ (2)
Net derivatives: Equity2 Other secured financings Beginning balance $ 1,208 $ 184 $ (2,031) Beginning balance $ 239 $ 434 $ 461 Realized and unrealized gains (losses) 305 136 539 Realized and unrealized losses (gains) (39) 35 5 Purchases 122 988 809 Purchases — —— Issuances (1,179) (524) (337) Issuances 8 64 79 Settlements 314 396 1,073 Settlements (17) (251) (45) Net transfers3 (2,255) 28 131 Net transfers 17 (43) (66) Ending balance $ (1,485) $ 1,208 $ 184 Ending balance $ 208 $ 239 $ 434 Unrealized gains (losses) $ 211 $ 159 $ 376 Unrealized losses (gains) $ (39) $28$5
Net derivatives: Commodity and other2 Borrowings Beginning balance $ 1,446 $ 1,600 $ 1,050 Beginning balance $ 2,984 $ 2,014 $ 1,988 Realized and unrealized gains (losses) 500 515 544 Realized and unrealized losses (gains) (385) 196 19 Purchases 34 24 24 Purchases — —— Issuances (18) (57) (114) Issuances 1,554 1,968 648 Settlements (81) (343) (44) Settlements (274) (424) (305) Net transfers 171 (293) 140 Net transfers (73) (770) (336) Ending balance $ 2,052 $ 1,446 $ 1,600 Ending balance $ 3,806 $ 2,984 $ 2,014 Unrealized gains (losses) $ 272 $ 20 $ 304 Unrealized losses (gains) $ (379) $ 173 $ 30
Investments 1. Loan originations are included within Purchases. Beginning balance $ 1,020 $ 958 $ 707 2. Net derivatives represent Trading assets—Derivative and other contracts, net of Realized and unrealized gains (losses) (25) 96 (32) Trading liabilities—Derivative and other contracts. Amounts shown are presented before counterparty netting. Purchases 149 102 398 3. During 2018, the Firm transferred from Level 3 to Level 2 $2.4 billion of Equity Sales (212) (57) (75) Derivatives due to a reduction in the significance of the unobservable inputs relating Settlements — (78) (59) to volatility. 4. Includes corporate and other debt and corporate equities. Excludes derivatives Net transfers (175) (1) 19 which are reflected within net derivatives. Ending balance $ 757 $ 1,020 $ 958 Unrealized gains (losses) $ (27) $ 88 $ (50) Level 3 instruments may be hedged with instruments classi- fied in Level 1 and Level 2. The realized and unrealized gains Deposits Beginning balance $ 47 $ 42 $ 19 (losses) for assets and liabilities within the Level 3 category Realized and unrealized losses (gains) (1) 3—presented in the previous tables do not reflect the related real- Purchases — ——ized and unrealized gains (losses) on hedging instruments that Issuances 9 12 23 have been classified by the Firm within the Level 1 and/or Settlements (2) (3) — Level 2 categories. Net transfers (26) (7) — Ending balance $27$47$42 The unrealized gains (losses) during the period for assets and Unrealized losses (gains) $ (1) $3$—liabilities within the Level 3 category may include changes in fair value during the period that were attributable to both Trading liabilities4 Beginning balance $ 25 $ 71 $ 22 observable and unobservable inputs. Total realized and unre- Realized and unrealized losses (gains) (6) (1) (13) alized gains (losses) are primarily included in Trading reve- Purchases (18) (139) (109) nues in the income statements. Sales 9 20 234 Settlements — ——Additionally, in the previous tables, consolidations of VIEs Net transfers 6 74 (63) are included in Purchases and deconsolidations of VIEs are Ending balance $16$25$71 included in Settlements. Unrealized losses (gains) $ (7) $—$—
December 2018 Form 10-K 106
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Balance / Range (Average1) Significant Unobservable Inputs Used in Recurring and $ in millions, except inputs At December 31, 2018 At December 31, 2017 Nonrecurring Level 3 Fair Value Measurements Net derivative and other contracts: Interest rate $ 618 $ 1,218 The following disclosures provide information on the valua- Option model: tion techniques, significant unobservable inputs, and their IR volatility skew 22% to 95% (48% / 51%) 31% to 97% (41% / 47%) ranges and averages for each major category of assets and Inflation volatility 23% to 65% (44% / 40%) 23% to 63% (44% / 41%) liabilities measured at fair value on a recurring and nonrecur- IR curve 1% 2% ring basis with a significant Level 3 balance. The level of Credit $ 40 $41 aggregation and breadth of products cause the range of inputs Comparable pricing: to be wide and not evenly distributed across the inventory. Cash-synthetic basis 8 to 9 points (9 points) 12 to 13 points (12 points) Further, the range of unobservable inputs may differ across Bond price 0 to 75 points (26 points) 0 to 75 points (25 points) firms in the financial services industry because of diversity in Credit spread 246 to 499 bps (380 bps) N/M Funding spread 47 to 98 bps (93 bps) N/M the types of products included in each firm’s inventory. There Correlation model: are no predictable relationships between multiple significant Credit correlation 36% to 69% (44%) 38% to 100% (48%) unobservable inputs attributable to a given valuation tech- Foreign exchange2 $75$ (112) nique. A single amount is disclosed when there is no signifi- Option model: cant difference between the minimum, maximum and IR FX correlation 53% to 56% (55% / 55%) 54% to 57% (56% / 56%) average. IR volatility skew 22% to 95% (48% / 51%) 31% to 97% (41% / 47%) Contingency probability 90% to 95% (93% / 95%) 95% to 100% (96% /95%) Valuation Techniques and Sensitivity of Unobservable Inputs Equity2 $ (1,485) $ 1,208 Used in Level 3 Fair Value Measurements Option model: Recurring Fair Value Measurement At the money volatility 17% to 63% (38%) 7% to 54% (32%) Volatility skew -2% to 0% (-1%) -5% to 0% (-1%) Balance / Range (Average1) Equity correlation 5% to 96% (71%) 5% to 99% (76%) $ in millions, except inputs At December 31, 2018 At December 31, 2017 FX correlation -60% to 55% (-26%) -55% to 40% (36%) Assets at Fair Value U.S. Treasury and agency IR correlation -7% to 45% (15% / 12%) -7% to 49% (18% / 20%) securities $ 54 $—Commodity and other $ 2,054 $ 1,446 Comparable pricing: Option model: Bond price 100 to 104 points (100 points) N/A Forward power price $3 to $185 ($31) per MWh $4 to $102 ($31) per MWh State and municipal Commodity volatility 7% to 187% (17%) 7% to 205% (17%) securities $ 148 $8 Cross-commodity correlation 5% to 99% (93%) 5% to 99% (92%) Comparable pricing: Investments $ 757 $ 1,020 Bond price 94 to 100 points (96 points) N/M Discounted cash flow: MABS $ 354 $ 423 WACC 9% to 15% (10%) 8% to 15% (9%) Comparable pricing: Exit multiple 7 to 10 times (10 times) 8 to 11 times (10 times) Bond price 0 to 97 points (38 points) 0 to 95 points (26 points) Market approach: Loans and lending EBITDA multiple 6 to 24 times (12 times) 6 to 25 times (11 times) commitments $ 6,870 $ 5,945 Comparable pricing: Margin loan model: Equity price 75% to 100% (96%) 45% to 100% (92%) Discount rate 1% to 7% (2%) 0% to 3% (1%)
Volatility skew 19% to 56% (28%) 7% to 41% (22%) Liabilities at Fair Value Credit Spread 14 to 90 bps (36 bps) N/M Other secured financings $ 208 $ 239 Comparable pricing: Discounted cash flow: Loan price 60 to 101 points (95 points) 55 to 102 points (95 points) Funding spread 103 to 193 bps (148 bps) 39 to 76 bps (57 bps) Corporate and other debt $ 1,076 $ 701 Option model: Comparable pricing: Volatility skew -1% -1% Bond price 12 to 100 points (72 points) 3 to 134 points (59 points) At the money volatility 10% to 40% (25%) 10% to 40% (26%) Discounted cash flow: Borrowings $ 3,806 $ 2,984 Recovery rate 20% 6% to 36% (27%) Option model: Discount rate 15% to 21% (16%) 7% to 20% (14%) At the money volatility 5% to 35% (22%) 5% to 35% (22%) Option model: Volatility skew -2% to 0% (0%) -2% to 0% (0%) At the money volatility 24% to 78% (50%) 17% to 52% (52%) Equity correlation 45% to 98% (85%) 39% to 95% (86%) Corporate equities $ 95 $ 166 Equity - FX correlation -75% to 50% (-27%) -55% to 10% (-18%) Comparable pricing: IR Correlation 58% to 97% (85% / 91%) N/M Equity price 100% 100% IR FX Correlation 28% to 58% (44% / 44%) N/M
107 December 2018 Form 10-K
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Balance / Range (Average1) $ in millions, except inputs At December 31, 2018 At December 31, 2017 between companies from an operational perspective as the Nonrecurring Fair Value Measurement effect of capital structure, taxation and depreciation/ Loans $ 1,380 $ 924 amortization is excluded. Corporate loan model: Credit spread 97 to 434 bps (181 bps) 93 to 563 bps (239 bps) • Recovery rate: Amount expressed as a percentage of par Expected recovery: Asset coverage N/M 95% to 99% (95%) that is expected to be received when a credit event occurs. Warehouse model: Credit spread 223 to 313 bps (247 bps) N/M An increase (decrease) to the following inputs would gener-
Points—Percentage of par ally result in a lower (higher) fair value. IR—Interest rate FX—Foreign exchange • Cash-synthetic basis: The measure of the price differential 1. Amounts represent weighted averages except where simple averages and between cash financial instruments and their synthetic the median of the inputs are more relevant. 2. Includes derivative contracts with multiple risks (i.e., hybrid products). derivative-based equivalents. The range disclosed in the table above signifies the number of points by which the Significant Unobservable Inputs—Description and synthetic bond equivalent price is higher than the quoted Sensitivity price of the underlying cash bonds.
An increase (decrease) to the following inputs would gener- • Credit spread: The credit spread reflects the additional net ally result in a higher (lower) fair value. yield an investor can earn from a security with more credit risk relative to one with less credit risk. The credit spread • Asset coverage: The ratio of a borrower’s underlying of a particular security is often quoted in relation to the pledged assets less applicable costs relative to their yield on a credit risk-free benchmark security or reference outstanding debt (while considering the loan’s principal rate, typically either U.S. Treasury or LIBOR. and the seniority and security of the loan commitment). • Funding spread: The cost of borrowing defined as the • Comparable bond or loan price: A pricing input used when incremental spread over the OIS rate for a specific collat- prices for the identical instrument are not available. Signifi- eral rate (which refers to the rate applicable to a specific cant subjectivity may be involved when fair value is deter- type of security pledged as collateral). mined using pricing data available for comparable instru- ments. Valuation using comparable instruments can be • WACC: WACC theoretically represents the required rate of done by calculating an implied yield (or spread over a return to debt and equity investors. The WACC implied by liquid benchmark) from the price of a comparable bond or the current value of equity in a discounted cash flow loan, then adjusting that yield (or spread) to derive a value model. The model assumes that the cash flow assumptions, for the bond or loan. The adjustment to yield (or spread) including projections, are fully reflected in the current should account for relevant differences in the bonds or equity value, while the debt to equity ratio is held constant. loans such as maturity or credit quality. Alternatively, a price-to-price basis can be assumed between the compa- An increase (decrease) to the following inputs would rable instrument and the bond or loan being valued in order generally result in an impact to the fair value, but the to establish the value of the bond or loan. magnitude and direction of the impact would depend on whether the Firm is long or short the exposure. • Comparable equity price: A price derived from equity raises, share buybacks and external bid levels, etc. A discount or • Correlation: A pricing input where the payoff is driven premium may be included in the fair value estimate. by more than one underlying risk. Correlation is a measure of the relationship between the movement of • Contingency probability: Probability associated with the two variables (i.e., how the change in one variable influ- realization of an underlying event upon which the value of ences a change in the other variable). an asset is contingent. • Interest rate curve: The term structure of interest rates • EBITDA multiple / Exit multiple: The ratio of Enterprise (relationship between interest rates and the time to matu- Value to EBITDA, where Enterprise Value is the aggregate rity) and a market’s measure of future interest rates at the value of equity and debt minus cash and cash equivalents. time of observation. An interest rate curve is used to set The EBITDA multiple reflects the value of the company in interest rate and foreign exchange derivative cash flows terms of its full-year EBITDA, whereas the exit multiple and is a pricing input used in the discounting of any OTC reflects the value of the company in terms of its full-year derivative cash flow. expected EBITDA at exit. Either multiple allows comparison
December 2018 Form 10-K 108
− 346 − Notes to Consolidated Financial Statements
• Volatility: The measure of variability in possible returns See Note 12 for information regarding general partner guar- for an instrument given how much that instrument antees, which include potential obligations to return perfor- changes in value over time. Volatility is a pricing input mance fee distributions previously received. See Note 21 for for options and, generally, the lower the volatility, the information regarding related performance fees at risk of less risky the option. The level of volatility used in the reversal, including performance fees in the form of carried valuation of a particular option depends on a number of interest. factors, including the nature of the risk underlying that option, the tenor and the strike price of the option. Nonredeemable Funds by Contractual Maturity Carrying Value at December 31, 2018 • Volatility skew: The measure of the difference in implied $ in millions Private Equity Real Estate volatility for options with identical underliers and expiry Less than 5 years $ 707 $ 618 dates but with different strikes. 5-10 years 642 440 Fund Interests Measured Based on Net Asset Value Over 10 years 25 47 Total $ 1,374 $ 1,105 At December 31, 2018 At December 31, 2017 Carrying Carrying $ in millions Value Commitment Value Commitment Fair Value Option Private equity $ 1,374 $ 316 $ 1,674 $ 308 Real estate 1,105 161 800 183 The Firm elected the fair value option for certain eligible Hedge1 103 4 90 4 instruments that are risk managed on a fair value basis to Total $ 2,582 $ 481 $ 2,564 $ 495 mitigate income statement volatility caused by measurement basis differences between the elected instruments and their 1. Investments in hedge funds may be subject to initial period lock-up or gate associated risk management transactions or to eliminate provisions, which restrict an investor from withdrawing from the fund during a certain initial period or restrict the redemption amount on any redemption complexities of applying certain accounting models. date, respectively. Borrowings Measured at Fair Value on a Recurring Basis
Amounts in the previous table represent the Firm’s carrying At At value of general and limited partnership interests in fund December 31, December 31, investments, as well as any related performance fees in the $ in millions 2018 2017 form of carried interest. The carrying amounts are measured Business Unit Responsible for Risk Management Equity $ 24,494 $ 25,903 based on the NAV of the fund taking into account the distri- bution terms applicable to the interest held. This same Interest rates 22,343 19,230 measurement applies whether the fund investments are Commodities 2,735 298 accounted for under the equity method or fair value. Credit 856 815 Foreign exchange 756 666 Private Equity. Funds that pursue multiple strategies, Total $ 51,184 $ 46,912 including leveraged buyouts, venture capital, infrastructure growth capital, distressed investments and mezzanine capital. Earnings Impact of Borrowings under the Fair Value Option In addition, the funds may be structured with a focus on specific domestic or foreign geographic regions. $ in millions 2018 2017 2016 Trading revenues $ 2,679 $ (4,507) $ (707) Real Estate. Funds that invest in real estate assets such as Interest expense (321) (443) (483) commercial office buildings, retail properties, multi-family Net revenues1 $ 2,358 $ (4,950) $ (1,190) residential properties, developments or hotels. In addition, the funds may be structured with a focus on specific domestic or 1. Amounts do not reflect any gains or losses on related hedging instruments. foreign geographic regions. Gains (losses) are mainly attributable to changes in foreign Investments in private equity and real estate funds generally exchange rates, or interest rates or movements in the refer- are not redeemable due to the closed-ended nature of these ence price or index. funds. Instead, distributions from each fund will be received as the underlying investments of the funds are disposed and monetized.
Hedge. Funds that pursue various investment strategies, including long-short equity, fixed income/credit, event-driven and multi-strategy.
109 December 2018 Form 10-K
− 347 − Notes to Consolidated Financial Statements
Gains (Losses) Due to Changes in Instrument-Specific Credit Fair Value Loans on Nonaccrual Status Risk At At Trading December 31, December 31, $ in millions Revenues OCI $ in millions 2018 2017 2018 Nonaccrual loans $ 1,497 $ 1,240 Borrowings $ (24) $ 1,962 Nonaccrual loans 90 or more Loans and other debt1 165 — days past due $ 812 $ 779 Lending commitments2 (3) — Other (32) 41 Assets and Liabilities Measured at Fair Value on a 2017 Nonrecurring Basis Borrowings $ (12) $ (903) Loans and other debt1 159 — At December 31, 2018 Fair Value Lending commitments2 (2) — $ in millions Level 2 Level 31 Total Other — (7) Assets 2016 Loans $ 2,307 $ 1,380 $ 3,687 Borrowings $ 31 $ (460) Other assets—Other investments 14 100 114 Loans and other debt1 (71) — Other assets—Premises, equipment Lending commitments2 4— and software ——— Other — — Total $ 2,321 $ 1,480 $ 3,801 At At Liabilities $ in millions December 31, 2018 December 31, 2017 Other liabilities and accrued Cumulative pre-tax DVA gain expenses—Lending commitments $ 292 $ 65 $ 357 (loss) recognized in AOCI $ 172 $ (1,831) Total $ 292 $ 65 $ 357
1. Loans and other debt instrument-specific credit gains (losses) were determined by At December 31, 2017 excluding the non-credit components of gains and losses. 2. Gains (losses) on lending commitments were generally determined based on the Fair Value difference between estimated expected client yields and contractual yields at each $ in millions Level 2 Level 31 Total respective period-end. Assets Loans $ 1,394 $ 924 $ 2,318 Excess of Contractual Principal Amount Over Fair Value Other assets—Other investments — 144 144 At At Other assets—Premises, equipment December 31, December 31, and software ——— $ in millions 2018 2017 Total $ 1,394 $ 1,068 $ 2,462 Loans and other debt1 $ 13,094 $ 13,481 Liabilities Loans 90 or more days past due Other liabilities and accrued and/or on nonaccrual status1 10,831 11,253 expenses—Lending commitments $ 158 $ 38 $ 196 Borrowings2 2,657 71 Total $ 158 $ 38 $ 196
1. The majority of the difference between principal and fair value amounts for loans 1. For significant Level 3 balances, refer to “Significant Unobservable Inputs Used in and other debt relates to distressed debt positions purchased at amounts well Recurring and Nonrecurring Level 3 Fair Value Measurements” section herein for below par. details of the significant unobservable inputs used for nonrecurring fair value 2. Borrowings in this table do not include structured notes where the repayment of the measurement. initial principal amount fluctuates based on changes in a reference price or index.
The previous tables exclude non-recourse debt from consoli- dated VIEs, liabilities related to failed sales of financial assets, pledged commodities and other liabilities that have specified assets attributable to them.
December 2018 Form 10-K 110
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Gains (Losses) from Nonrecurring Fair Value Financial Instruments Not Measured at Fair Value Remeasurements1 At December 31, 2018 $ in millions 2018 2017 2016 Carrying Fair Value $ in millions Value Level 1 Level 2 Level 3 Total Assets Loans2 $ (68) $18$40 Financial assets Cash and cash equivalents: Other assets—Other investments3 (56) (66) (52) Cash and due from banks $ 30,541 $30,541 $ — $ — $ 30,541 Other assets—Premises, Interest bearing equipment and software (46) (25) (76) deposits with Intangible assets — — (2) banks 21,299 21,299 — — 21,299 Total $ (170) $ (73) $ (90) Restricted cash 35,356 35,356 — — 35,356 Liabilities Investment Other liabilities and accrued securities—HTM 30,771 17,473 12,018 474 29,965 expenses—Lending Securities commitments2 $ (48) $ 75 $ 121 purchased under agreements to Total $ (48) $ 75 $ 121 resell 98,522 — 97,611 866 98,477 Securities borrowed 116,313 — 116,312 — 116,312 1. Gains and losses for Loans and Other assets—Other investments are classi- Customer and other fied in Other revenues. For other items, gains and losses are recorded in receivables1 47,972 — 44,620 3,219 47,839 Other revenues if the item is held for sale; otherwise they are recorded in 2 Other expenses. Loans 115,579 — 25,604 90,121 115,725 2. Nonrecurring changes in the fair value of loans and lending commitments Other assets 461 — 461 — 461 were calculated as follows: for the held-for-investment category, based on the value of the underlying collateral; and for the held-for-sale category, Financial liabilities based on recently executed transactions, market price quotations, valuation Deposits $ 187,378 $ — $187,372 $ — $187,372 models that incorporate market observable inputs where possible, such as comparable loan or debt prices and CDS spread levels adjusted for any basis Securities sold under agreements to difference between cash and derivative instruments, or default recovery anal- repurchase 48,947 — 48,385 525 48,910 ysis where such transactions and quotations are unobservable. 3. Losses related to Other assets—Other investments were determined using Securities loaned 11,908 — 11,906 — 11,906 techniques that included discounted cash flow models, methodologies that Other secured incorporate multiples of certain comparable companies and recently financings 4,221 — 3,233 994 4,227 executed transactions. Customer and other payables1 176,561 — 176,561 — 176,561 Borrowings 138,478 — 140,085 30 140,115 Commitment Amount Lending commitments3 $ 104,844 $ — $ 1,249 $ 321 $ 1,570
111 December 2018 Form 10-K
− 349 − Notes to Consolidated Financial Statements At December 31, 2017 4. Derivative Instruments and Hedging Carrying Fair Value $ in millions Value Level 1 Level 2 Level 3 Total Activities Financial assets Cash and cash equivalents: Cash and due from The Firm trades and makes markets globally in listed futures, banks $ 24,816 $24,816 $ — $ — $ 24,816 OTC swaps, forwards, options and other derivatives refer- Interest bearing encing, among other things, interest rates, equities, curren- deposits with banks 21,348 21,348 — — 21,348 cies, investment grade and non-investment grade corporate Restricted cash 34,231 34,231 — — 34,231 credits, loans, bonds, U.S. and other sovereign securities, Investment emerging market bonds and loans, credit indices, ABS securities—HTM 23,599 11,119 11,673 289 23,081 indices, property indices, mortgage-related and other ABS, Securities purchased under and real estate loan products. The Firm uses these instruments agreements to for market-making, foreign currency exposure management, resell 84,258 — 78,239 5,978 84,217 and asset and liability management. Securities borrowed 124,010 — 124,018 1 124,019 Customer and other receivables1 51,269 — 47,159 3,984 51,143 The Firm manages its market-making positions by employing Loans2 104,126 — 21,290 82,928 104,218 a variety of risk mitigation strategies. These strategies include Other assets 433 — 433 — 433 diversification of risk exposures and hedging. Hedging activ- ities consist of the purchase or sale of positions in related Financial liabilities securities and financial instruments, including a variety of Deposits $ 159,232 $ — $ 159,232 $ — $159,232 derivative products (e.g., futures, forwards, swaps and Securities sold under agreements to options). The Firm manages the market risk associated with repurchase 55,624 — 51,752 3,867 55,619 its market-making activities on a Firm-wide basis, on a Securities loaned 13,592 — 13,191 401 13,592 worldwide trading division level and on an individual product Other secured basis. financings 7,408 — 5,987 1,431 7,418 Customer and other payables1 188,464 — 188,464 — 188,464 Borrowings 145,670 — 151,692 30 151,722 Commitment Amount Lending commitments3 $ 100,151 $ — $ 620 $ 174 $ 794
1. Accrued interest and dividend receivables and payables where carrying value approximates fair value have been excluded. 2. Amounts include loans measured at fair value on a nonrecurring basis. 3. Represents Lending Commitments accounted for as Held for Investment and Held for Sale. For a further discussion on lending commitments, see Note 12.
The previous tables exclude certain financial instruments such as equity method investments and all non-financial assets and liabilities such as the value of the long-term rela- tionships with the Firm’s deposit customers.
December 2018 Form 10-K 112
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Derivative Fair Values At December 31, 2018 At December 31, 2017
Assets Assets Bilateral Cleared Exchange- Bilateral Cleared Exchange- $ in millions OTC OTC Traded Total $ in millions OTC OTC Traded Total Designated as accounting hedges Designated as accounting hedges Interest rate contracts $ 512 $ 1 $ — $ 513 Interest rate contracts $ 1,057 $ — $ — $ 1,057 Foreign exchange contracts 27 8 — 35 Foreign exchange contracts 57 6 — 63 Total 539 9 — 548 Total 1,114 6 — 1,120 Not designated as accounting hedges Not designated as accounting hedges Interest rate contracts 153,768 3,887 697 158,352 Interest rate contracts 177,948 1,700 234 179,882 Credit contracts 4,630 1,498 — 6,128 Credit contracts 5,740 2,282 — 8,022 Foreign exchange contracts 61,846 1,310 55 63,211 Foreign exchange contracts 52,878 798 58 53,734 Equity contracts 24,590 — 23,284 47,874 Equity contracts 24,452 — 20,538 44,990 Commodity and other contracts 10,538 — 1,934 12,472 Commodity and other contracts 8,861 — 1,802 10,663 Total 255,372 6,695 25,970 288,037 Total 269,879 4,780 22,632 297,291 Total gross derivatives $ 255,911 $ 6,704 $ 25,970 $ 288,585 Total gross derivatives $ 270,993 $ 4,786 $ 22,632 $ 298,411 Amounts offset Amounts offset Counterparty netting (190,220) (5,260) (24,548) (220,028) Counterparty netting (201,051) (3,856) (19,861) (224,768) Cash collateral netting (38,204) (1,180) — (39,384) Cash collateral netting (42,141) (689) — (42,830) Total in Trading assets $ 27,487 $ 264 $ 1,422 $ 29,173 Total in Trading assets $ 27,801 $ 241 $ 2,771 $ 30,813 Amounts not offset1 Amounts not offset1 Financial instruments collateral (12,467) — — (12,467) Financial instruments collateral (12,363) — — (12,363) Other cash collateral (31) — — (31) Other cash collateral (4) — — (4) Net amounts $ 14,989 $ 264 $ 1,422 $ 16,675 Net amounts $ 15,434 $ 241 $ 2,771 $ 18,446 Net amounts for which master netting or collateral agreements are Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable $ 2,206 not in place or may not be legally enforceable $ 3,154
Liabilities Liabilities Bilateral Cleared Exchange- Bilateral Cleared Exchange- $ in millions OTC OTC Traded Total $ in millions OTC OTC Traded Total Designated as accounting hedges Designated as accounting hedges Interest rate contracts $ 176 $ — $ — $ 176 Interest rate contracts $ 67 $ 1 $ — $ 68 Foreign exchange contracts 62 24 — 86 Foreign exchange contracts 72 57 — 129 Total 238 24 — 262 Total 139 58 — 197 Not designated as accounting hedges Not designated as accounting hedges Interest rate contracts 142,592 2,669 663 145,924 Interest rate contracts 161,758 1,178 144 163,080 Credit contracts 4,545 1,608 — 6,153 Credit contracts 6,273 2,272 — 8,545 Foreign exchange Foreign exchange contracts 62,099 1,302 19 63,420 contracts 54,191 925 23 55,139 Equity contracts 27,119 — 23,521 50,640 Equity contracts 27,993 — 19,996 47,989 Commodity and other contracts 6,983 — 2,057 9,040 Commodity and other contracts 7,117 — 1,772 8,889 Total 243,338 5,579 26,260 275,177 Total 257,332 4,375 21,935 283,642 Total gross derivatives $ 243,576 $ 5,603 $ 26,260 $ 275,439 Total gross derivatives $ 257,471 $ 4,433 $ 21,935 $ 283,839 Amounts offset Amounts offset Counterparty netting (190,220) (5,260) (24,548) (220,028) Counterparty netting (201,051) (3,856) (19,861) (224,768) Cash collateral netting (27,860) (293) — (28,153) Cash collateral netting (31,892) (484) — (32,376) Total in Trading liabilities $ 25,496 $ 50 $ 1,712 $ 27,258 Total in Trading liabilities $ 24,528 $ 93 $ 2,074 $ 26,695 Amounts not offset1 Amounts not offset1 Financial instruments collateral (4,709) — (766) (5,475) Financial instruments collateral (5,523) — (412) (5,935) Other cash collateral (53) (1) — (54) Other cash collateral (18) (14) — (32) Net amounts $ 20,734 $ 49 $ 946 $ 21,729 Net amounts $ 18,987 $ 79 $ 1,662 $ 20,728 Net amounts for which master netting or collateral agreements are Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable $ 4,773 not in place or may not be legally enforceable $ 3,751
1. Amounts relate to master netting agreements and collateral agreements that have been determined by the Firm to be legally enforceable in the event of default but where certain other criteria are not met in accordance with applicable offsetting accounting guidance.
See Note 3 for information related to the unsettled fair value of futures contracts not designated as accounting hedges, which are excluded from the previous tables.
113 December 2018 Form 10-K
− 351 − Notes to Consolidated Financial Statements
Derivative Notionals Liabilities Bilateral Cleared Exchange- At December 31, 2018 $ in billions OTC OTC Traded Total Assets Designated as accounting hedges Bilateral Cleared Exchange- Interest rate contracts $ 2 $ 102 $ — $ 104 $ in billions OTC OTC Traded Total Foreign exchange contracts 4 2 — 6 Designated as accounting hedges Total 6 104 — 110 Interest rate contracts $ 15 $ 52 $ — $ 67 Not designated as accounting hedges Foreign exchange contracts 51 —6 Interest rate contracts 4,199 6,325 1,089 11,613 Total 20 53 — 73 Credit contracts 226 80 — 306 Not designated as accounting hedges Foreign exchange contracts 2,014 78 51 2,143 Interest rate contracts 4,807 6,708 1,157 12,672 Equity contracts 394 — 405 799 Credit contracts 162 74 — 236 Commodity and other contracts 68 — 61 129 Foreign exchange contracts 2,436 118 14 2,568 Total 6,901 6,483 1,606 14,990 Equity contracts 373 — 371 744 Total gross derivatives $ 6,907 $ 6,587 $ 1,606 $15,100 Commodity and other contracts 97 — 67 164 Total 7,875 6,900 1,609 16,384 The Firm believes that the notional amounts of derivative Total gross derivatives $ 7,895 $ 6,953 $ 1,609 $16,457 contracts generally overstate its exposure. In most circum- Liabilities stances notional amounts are only used as a reference point Bilateral Cleared Exchange- from which to calculate amounts owed between the parties to $ in billions OTC OTC Traded Total the contract. Furthermore, notional amounts do not reflect the Designated as accounting hedges Interest rate contracts $ 2 $ 107 $ — $ 109 benefit of legally enforceable netting arrangements or risk Foreign exchange contracts 51 —6 mitigating transactions. Total 7 108 — 115 Gains (Losses) on Accounting Hedges Not designated as accounting hedges Interest rate contracts 4,946 5,735 781 11,462 $ in millions 2018 2017 2016 Credit contracts 162 73 — 235 Fair Value Hedges—Recognized in Interest Expense Foreign exchange contracts 2,451 114 17 2,582 Interest rate contracts $ (1,529) $ (1,591) $ (1,738) Equity contracts 389 — 602 991 Borrowings 1,511 1,393 1,541 Commodity and other contracts 72 — 65 137 Net Investment Hedges—Foreign exchange contracts Recognized in OCI $ 295 $ (365) $ (1) Total 8,020 5,922 1,465 15,407 Forward points excluded from hedge Total gross derivatives $ 8,027 $ 6,030 $ 1,465 $15,522 effectiveness testing—Recognized in Interest income 68 (20) (74) At December 31, 2017 Fair Value Hedges—Hedged Items Assets Bilateral Cleared Exchange- At December 31, $ in billions OTC OTC Traded Total $ in millions 2018 Designated as accounting hedges Investment Securities—AFS1 Interest rate contracts $ 20 $ 46 $ — $ 66 Carrying amount2 currently or previously hedged $ 201 Foreign exchange contracts 4 — — 4 Borrowings 2 Total 24 46 — 70 Carrying amount currently or previously hedged $ 102,899 3 Not designated as accounting hedges Basis adjustments included in carrying amount $ (1,689) Interest rate contracts 3,999 6,458 2,714 13,171 1. In the third quarter of 2018, the Firm began designating interest rate swaps as fair Credit contracts 194 100 — 294 value hedges of certain AFS securities. Amounts recognized in interest income and Foreign exchange contracts 1,960 67 9 2,036 basis adjustments related to AFS securities were not material. 2. Carrying amount represents amortized cost basis. Equity contracts 397 — 334 731 3. Hedge accounting basis adjustments for Borrowings are primarily related to Commodity and other contracts 86 — 72 158 outstanding hedges. Total 6,636 6,625 3,129 16,390 Total gross derivatives $ 6,660 $ 6,671 $ 3,129 $16,460
December 2018 Form 10-K 114
− 352 − Notes to Consolidated Financial Statements
Credit Risk-Related Contingencies Credit Derivatives and Other Credit Contracts
Net Derivative Liabilities and Collateral Posted The Firm enters into credit derivatives, principally CDS, under which it receives or provides protection against the risk At At December 31, December 31, of default on a set of debt obligations issued by a specified $ in millions 2018 2017 reference entity or entities. A majority of the Firm’s counter- Net derivative liabilities with credit risk- related contingent features $ 16,403 $ 20,675 parties for these derivatives are banks, broker-dealers, and Collateral posted 11,981 16,642 insurance and other financial institutions.
Maximum Potential Payout/Notional of Credit Protection Sold1 The previous table presents the aggregate fair value of certain derivative contracts that contain credit risk-related contingent Years to Maturity at December 31, 2018 features that are in a net liability position for which the Firm $ in millions < 1 1-3 3-5 Over 5 Total has posted collateral in the normal course of business. Single-name CDS Investment grade $22,297 $23,876 $ 19,469 $ 7,844 $ 73,486 Incremental Collateral and Termination Payments upon Non-investment grade 10,135 11,061 9,020 861 31,077 Potential Future Ratings Downgrade Total $32,432 $34,937 $ 28,489 $ 8,705 $104,563 Index and basket CDS At Investment grade $ 5,341 $ 9,901 $ 60,887 $ 6,816 $ 82,945 December 31, $ in millions 2018 Non-investment grade 4,574 5,820 12,855 13,272 36,521 One-notch downgrade $ 460 Total $ 9,915 $15,721 $ 73,742 $20,088 $119,466 Two-notch downgrade 321 Total CDS sold $42,347 $50,658 $102,231 $28,793 $224,029 Bilateral downgrade agreements included in the amounts Other credit contracts — — — 116 116 above1 $ 707 Total credit protection sold $42,347 $50,658 $102,231 $28,909 $224,145 1. Amount represents arrangements between the Firm and other parties where upon CDS protection sold with identical protection purchased $209,972 the downgrade of one party, the downgraded party must deliver collateral to the other party. These bilateral downgrade arrangements are used by the Firm to manage the risk of counterparty downgrades. Years to Maturity at December 31, 2017 $ in millions < 1 1-3 3-5 Over 5 Total The additional collateral or termination payments that may be Single-name CDS Investment grade $39,721 $42,591 $18,157 $ 8,872 $109,341 called in the event of a future credit rating downgrade vary by Non-investment grade 14,213 16,293 6,193 908 37,607 contract and can be based on ratings by either or both of Total $53,934 $58,884 $24,350 $ 9,780 $146,948 Moody’s Investors Service, Inc. (“Moody’s”) and S&P Index and basket CDS Global Ratings. The previous table shows the future potential Investment grade $29,046 $15,418 $37,343 $ 6,807 $ 88,614 collateral amounts and termination payments that could be Non-investment grade 5,246 7,371 32,417 9,289 54,323 called or required by counterparties or exchange and clearing Total $34,292 $22,789 $69,760 $16,096 $142,937 organizations in the event of one-notch or two-notch down- Total CDS sold $88,226 $81,673 $94,110 $25,876 $289,885 grade scenarios based on the relevant contractual downgrade Other credit contracts 2 — — 134 136 triggers. Total credit protection sold $88,228 $81,673 $94,110 $26,010 $290,021 CDS protection sold with identical protection purchased $274,473
115 December 2018 Form 10-K
− 353 − Notes to Consolidated Financial Statements
Fair Value (Asset)/Liability of Credit Protection Sold1 issuer. The protection buyer pays a periodic premium (gener-
At At ally quarterly) over the life of the contract and is protected for December 31, December 31, the period. The Firm, in turn, performs under a CDS if a $ in millions 2018 2017 credit event as defined under the contract occurs. Typical Single-name CDS Investment grade $ (118) $ (1,167) credit events include bankruptcy, dissolution or insolvency of Non-investment grade 403 (110) the referenced entity, failure to pay and restructuring of the Total $ 285 $ (1,277) obligations of the referenced entity. Index and basket CDS Investment grade $ (314) $ (1,091) Index and Basket CDS. Index and basket CDS are products Non-investment grade 1,413 408 where credit protection is provided on a portfolio of single Total $ 1,099 $ (683) name CDS. Generally, in the event of a default on one of the Total CDS sold $ 1,384 $ (1,960) underlying names, the Firm pays a pro rata portion of the Other credit contracts 14 16 total notional amount of the CDS. Total credit protection sold $ 1,398 $ (1,944) The Firm also enters into tranched index and basket CDS 1. Investment grade/non-investment grade determination is based on the internal where credit protection is provided on a particular portion of credit rating of the reference obligation. the portfolio loss distribution. The most junior tranches cover The fair value amounts as shown in the previous table are initial defaults, and once losses exceed the notional of the prior to cash collateral or counterparty netting. Internal credit tranche, they are passed on to the next most senior tranche in ratings serve as the Credit Risk Management Department’s the capital structure. assessment of credit risk and the basis for a comprehensive credit limits framework used to control credit risk. The Firm Other Credit Contracts. The Firm has invested in CLNs and uses quantitative models and judgment to estimate the various CDOs, which are hybrid instruments containing embedded risk parameters related to each obligor. derivatives, in which credit protection has been sold to the issuer of the note. If there is a credit event of a reference Protection Purchased with CDS entity underlying the instrument, the principal balance of the note may not be repaid in full to the Firm. At December 31, 2018 $ in millions Fair Value (Asset)/Liability Notional Single name $ (277) $ 116,333 Index and basket (1,333) 117,022 Tranched index and basket 251 13,524 Total $ (1,359) $ 246,879
At December 31, 2017 $ in millions Fair Value (Asset)/Liability Notional Single name $ 1,658 $ 164,773 Index and basket 209 120,348 Tranched index and basket 616 24,498 Total $ 2,483 $ 309,619
The purchase of credit protection does not represent the sole manner in which the Firm risk manages its exposure to credit derivatives. The Firm manages its exposure to these deriva- tive contracts through a variety of risk mitigation strategies, which include managing the credit and correlation risk across single-name, non-tranched indices and baskets, tranched indices and baskets, and cash positions. Aggregate market risk limits have been established for credit derivatives, and market risk measures are routinely monitored against these limits. The Firm may also recover amounts on the underlying reference obligation delivered to the Firm under CDS where credit protection was sold.
Single-Name CDS. A CDS protects the buyer against the loss of principal on a bond or loan in case of a default by the
December 2018 Form 10-K 116
− 354 − Notes to Consolidated Financial Statements 5. Investment Securities
AFS and HTM Securities
At December 31, 2018 At December 31, 2017 Gross Gross Gross Gross Amortized Unrealized Unrealized Fair Amortized Unrealized Unrealized Fair $ in millions Cost Gains Losses Value $ in millions Cost Gains Losses Value AFS securities AFS debt securities U.S. government and agency U.S. government and agency securities: securities: U.S. Treasury securities $ 36,268 $ 40 $ 656 $ 35,652 U.S. Treasury securities $ 26,842 $ — $ 589 $ 26,253 U.S. agency securities1 20,740 10 497 20,253 U.S. agency securities1 22,803 28 247 22,584 Total U.S. government and Total U.S. government and agency securities 57,008 50 1,153 55,905 agency securities 49,645 28 836 48,837 Corporate and other debt: Corporate and other debt: Agency CMBS 1,054 — 62 992 Agency CMBS 1,370 2 49 1,323 Non-agency CMBS 461 — 14 447 Non-agency CMBS 1,102 — 8 1,094 Corporate bonds 1,585 — 32 1,553 Corporate bonds 1,379 5 12 1,372 State and municipal securities 200 2 — 202 CLO 398 1 — 399 FFELP student loan ABS2 1,967 10 15 1,962 FFELP student loan ABS2 2,165 15 7 2,173 Total corporate and other debt 5,267 12 123 5,156 Total corporate and other debt 6,414 23 76 6,361 Total AFS securities 62,275 62 1,276 61,061 Total AFS debt securities 56,059 51 912 55,198 HTM securities AFS equity securities 15 — 10 5 U.S. government and Total AFS securities 56,074 51 922 55,203 agency securities: U.S. Treasury securities 17,832 44 403 17,473 HTM securities U.S. government and 1 U.S. agency securities 12,456 8 446 12,018 agency securities: Total U.S. government and U.S. Treasury securities 11,424 — 305 11,119 agency securities 30,288 52 849 29,491 U.S. agency securities1 11,886 7 220 11,673 Corporate and other debt: Non-agency CMBS 483 — 9 474 Total U.S. government and agency securities 23,310 7 525 22,792 Total HTM securities 30,771 52 858 29,965 Corporate and other debt: Total investment securities $ 93,046 $ 114 $ 2,134 $ 91,026 Non-agency CMBS 289 1 1 289 Total HTM securities 23,599 8 526 23,081 Total investment securities $ 79,673 $ 59 $ 1,448 $ 78,284
1. U.S. agency securities consist mainly of agency-issued debt, agency mortgage pass-through pool securities and CMOs. 2. Underlying loans are backed by a guarantee, ultimately from the U.S. Department of Education, of at least 95% of the principal balance and interest outstanding.
117 December 2018 Form 10-K
− 355 − Notes to Consolidated Financial Statements
Investment Securities in an Unrealized Loss Position
At December 31, 2018 Less than 12 Months 12 Months or Longer Total Gross Gross Gross Unrealized Unrealized Unrealized $ in millions Fair Value Losses Fair Value Losses Fair Value Losses AFS securities U.S. government and agency securities: U.S. Treasury securities $ 19,937 $ 541 $ 5,994 $ 115 $ 25,931 $ 656 U.S. agency securities 12,904 383 4,142 114 17,046 497 Total U.S. government and agency securities 32,841 924 10,136 229 42,977 1,153 Corporate and other debt: Agency CMBS 808 62 — — 808 62 Non-agency CMBS — — 446 14 446 14 Corporate bonds 470 7 1,010 25 1,480 32 FFELP student loan ABS 1,366 15 — — 1,366 15 Total corporate and other debt 2,644 84 1,456 39 4,100 123 Total AFS securities 35,485 1,008 11,592 268 47,077 1,276 HTM securities U.S. government and agency securities: U.S. Treasury securities — — 11,161 403 11,161 403 U.S. agency securities 410 1 10,004 445 10,414 446 Total U.S. government and agency securities 410 1 21,165 848 21,575 849 Corporate and other debt: Non-agency CMBS 206 1 216 8 422 9 Total HTM securities 616 2 21,381 856 21,997 858 Total investment securities $ 36,101 $ 1,010 $ 32,973 $ 1,124 $ 69,074 $ 2,134
At December 31, 2017 Less than 12 Months 12 Months or Longer Total Gross Gross Gross Unrealized Unrealized Unrealized $ in millions Fair Value Losses Fair Value Losses Fair Value Losses AFS debt securities U.S. government and agency securities: U.S. Treasury securities $ 21,941 $ 495 $ 4,287 $ 94 $ 26,228 $ 589 U.S. agency securities 12,673 192 2,513 55 15,186 247 Total U.S. government and agency securities 34,614 687 6,800 149 41,414 836 Corporate and other debt: Agency CMBS 930 49 — — 930 49 Non-agency CMBS 257 1 559 7 816 8 Corporate bonds 316 3 389 9 705 12 FFELP student loan ABS 984 7 — — 984 7 Total corporate and other debt 2,487 60 948 16 3,435 76 Total AFS debt securities 37,101 747 7,748 165 44,849 912 AFS equity securities —— 510510 Total AFS securities 37,101 747 7,753 175 44,854 922 HTM securities U.S. government and agency securities: U.S. Treasury securities 6,608 86 4,512 219 11,120 305 U.S. agency securities 2,879 24 7,298 196 10,177 220 Total U.S. government and agency securities 9,487 110 11,810 415 21,297 525 Corporate and other debt: Non-agency CMBS 124 1 — — 124 1 Total HTM securities 9,611 111 11,810 415 21,421 526 Total investment securities $ 46,712 $ 858 $ 19,563 $ 590 $ 66,275 $ 1,448
December 2018 Form 10-K 118
− 356 − Notes to Consolidated Financial Statements
The Firm believes there are no securities in an unrealized loss At December 31, 2018 Annualized position that are other-than-temporarily impaired after Amortized Average performing the analysis described in Note 2. For AFS debt $ in millions Cost Fair Value Yield securities, the Firm does not intend to sell the securities and is FFELP student loan ABS: not likely to be required to sell the securities prior to recovery After 1 year through 5 years $ 81 $ 80 0.8% of the amortized cost basis. Furthermore, for AFS and HTM After 5 years through 10 years 307 303 0.8% debt securities, the securities have not experienced credit After 10 years 1,579 1,579 1.2% losses as the net unrealized losses reported in the previous Total 1,967 1,962 table are primarily due to higher interest rates since those Total corporate and other debt 5,267 5,156 1.8% securities were purchased. Total AFS securities 62,275 61,061 2.0% HTM securities See Note 13 for additional information on securities issued by U.S. government and agency securities: VIEs, including U.S. agency mortgage-backed securities, U.S. Treasury securities: non-agency CMBS, CLO and FFELP student loan ABS. Due within 1 year 1,875 1,870 1.2% After 1 year through 5 years 7,478 7,435 2.3% Investment Securities by Contractual Maturity After 5 years through 10 years 7,753 7,536 2.2% After 10 years 726 632 2.3% At December 31, 2018 Total 17,832 17,473 Annualized Amortized Fair Average U.S. agency securities: $ in millions Cost Value Yield After 5 years through 10 years 30 29 1.9% AFS securities After 10 years 12,426 11,989 2.7% U.S. government and agency securities: Total 12,456 12,018 U.S. Treasury securities: Total U.S. government and agency Due within 1 year $ 4,419 $ 4,387 1.6% securities 30,288 29,491 2.4% After 1 year through 5 years 28,607 28,179 2.0% Corporate and other debt: After 5 years through 10 years 3,242 3,086 1.9% Non-agency CMBS: Total 36,268 35,652 Due within 1 year 65 65 3.5% U.S. agency securities: After 1 year through 5 years 70 69 4.4% Due within 1 year 434 431 1.0% After 5 years through 10 years 302 294 4.0% After 1 year through 5 years 796 784 1.2% After 10 years 46 46 4.4% After 5 years through 10 years 1,635 1,583 1.8% Total corporate and other debt 483 474 4.1% After 10 years 17,875 17,455 2.2% Total HTM securities 30,771 29,965 2.4% Total 20,740 20,253 Total investment securities $ 93,046 $ 91,026 2.1% Total U.S. government and agency securities 57,008 55,905 2.0% Gross Realized Gains (Losses) on Sales of AFS Securities Corporate and other debt: $ in millions 2018 2017 2016 Agency CMBS: After 1 year through 5 years 283 281 1.4% Gross realized gains $12 $ 46 $133 After 5 years through 10 years 21 20 1.2% Gross realized (losses) (4) (11) (21) After 10 years 750 691 1.6% Total1 $8 $ 35 $112 Total 1,054 992 1. Realized gains and losses are recognized in Other revenues in the income statements. Non-agency CMBS: After 1 year through 5 years 36 34 2.5% After 10 years 425 413 2.4% Total 461 447 6. Collateralized Transactions Corporate bonds: The Firm enters into securities purchased under agreements Due within 1 year 70 70 1.7% After 1 year through 5 years 1,365 1,335 2.5% to resell, securities sold under agreements to repurchase, After 5 years through 10 years 150 148 3.3% securities borrowed and securities loaned transactions to, Total 1,585 1,553 among other things, acquire securities to cover short positions State and municipal securities: and settle other securities obligations, to accommodate After 5 years through 10 years 200 202 3.7% customers’ needs and to finance its inventory positions. Total 200 202 The Firm manages credit exposure arising from such transac- tions by, in appropriate circumstances, entering into master netting agreements and collateral agreements with counterparties
119 December 2018 Form 10-K
− 357 − Notes to Consolidated Financial Statements that provide the Firm, in the event of a counterparty default (such Offsetting of Certain Collateralized Transactions as bankruptcy or a counterparty’s failure to pay or perform), with At December 31, 2018 the right to net a counterparty’s rights and obligations under such Net agreement and liquidate and set off collateral held by the Firm Gross Amounts Amounts Amounts Net $ in millions Amounts Offset Presented Not Offset1 Amounts against the net amount owed by the counterparty. Assets Securities purchased The Firm’s policy is generally to take possession of securities under agreements purchased or borrowed in connection with securities to resell $ 262,976 $ (164,454) $ 98,522 $ (95,610) $ 2,912 purchased under agreements to resell and securities borrowed Securities borrowed 134,711 (18,398) 116,313 (112,551) 3,762 transactions, respectively, and to receive cash and securities Liabilities delivered under securities sold under agreements to repur- Securities sold under agreements to chase or securities loaned transactions (with rights of rehy- repurchase $ 214,213 $ (164,454) $ 49,759 $ (41,095) $ 8,664 pothecation). In certain cases, the Firm may be permitted to Securities loaned 30,306 (18,398) 11,908 (11,677) 231 post collateral to a third-party custodian under a tri-party Net amounts for which master netting agreements are not in place or may arrangement that enables the Firm to take control of such not be legally enforceable collateral in the event of a counterparty default. Securities purchased under agreements to resell $ 2,579 Securities borrowed 724 The Firm also monitors the fair value of the underlying secu- Securities sold under agreements to repurchase 6,762 rities as compared with the related receivable or payable, Securities loaned 191 including accrued interest, and, as necessary, requests addi- tional collateral, as provided under the applicable agreement At December 31, 2017 Net to ensure such transactions are adequately collateralized, or Gross Amounts Amounts Amounts Net the return of excess collateral. $ in millions Amounts Offset Presented Not Offset1 Amounts Assets The risk related to a decline in the market value of collateral Securities purchased under agreements pledged or received is managed by setting appropriate to resell $ 199,044 $ (114,786) $ 84,258 $ (78,009) $ 6,249 market-based haircuts. Increases in collateral margin calls on Securities borrowed 133,431 (9,421) 124,010 (119,358) 4,652 secured financing due to market value declines may be miti- Liabilities gated by increases in collateral margin calls on securities Securities sold under purchased under agreements to resell and securities borrowed agreements to transactions with similar quality collateral. Additionally, the repurchase $ 171,210 $ (114,786) $ 56,424 $ (48,067) $ 8,357 Firm may request lower quality collateral pledged be replaced Securities loaned 23,014 (9,422) 13,592 (13,271) 321 Net amounts for which master netting agreements are not in place or may with higher quality collateral through collateral substitution not be legally enforceable rights in the underlying agreements. Securities purchased under agreements to resell $ 5,687 Securities borrowed 572 The Firm actively manages its secured financings in a manner Securities sold under agreements to repurchase 6,945 that reduces the potential refinancing risk of secured financings Securities loaned 307 of less liquid assets. The Firm considers the quality of collat- eral when negotiating collateral eligibility with counterparties, 1. Amounts relate to master netting agreements that have been determined by the Firm to be legally enforceable in the event of default but where certain other criteria as defined by its fundability criteria. The Firm utilizes shorter are not met in accordance with applicable offsetting accounting guidance. term secured financing for highly liquid assets and has estab- lished longer tenor limits for less liquid assets, for which For information related to offsetting of derivatives, see funding may be at risk in the event of a market disruption. Note 4.
December 2018 Form 10-K 120
− 358 − Notes to Consolidated Financial Statements
Gross Secured Financing Balances by Remaining Contractual The Firm pledges its trading assets and loans to collateralize Maturity securities sold under agreements to repurchase, securities At December 31, 2018 loaned, other secured financings and derivatives and to cover Overnight Less than 30-90 Over customer short sales. Counterparties may or may not have the $ in millions and Open 30 Days Days 90 Days Total right to sell or repledge the collateral. Securities sold under agreements to repurchase $ 56,503 $ 93,427 $ 35,692 $ 28,591 $ 214,213 Pledged financial instruments that can be sold or repledged Securities loaned 18,397 3,609 1,985 6,315 30,306 by the secured party are identified as Trading assets (pledged Total included in the to various parties) in the balance sheets. offsetting disclosure $ 74,900 $ 97,036 $ 37,677 $ 34,906 $ 244,519 Trading liabilities— Fair Value of Collateral Received with Right to Sell or Obligation to return securities received Repledge as collateral 17,594 — — — 17,594 At At Total $ 92,494 $ 97,036 $ 37,677 $ 34,906 $ 262,113 December 31, December 31, $ in millions 2018 2017 At December 31, 2017 Collateral received with right to sell or Overnight Less than 30-90 Over repledge $ 639,610 $ 599,244 $ in millions and Open 30 Days Days 90 Days Total Collateral that was sold or repledged1 487,983 475,113 Securities sold under agreements to 1. Does not include securities used to meet federal regulations for the Firm’s broker-dealers. repurchase $ 41,332 $ 66,593 $ 28,682 $ 34,603 $ 171,210 Securities loaned 12,130 873 1,577 8,434 23,014 Restricted Cash and Segregated Securities Total included in the offsetting disclosure $ 53,462 $ 67,466 $ 30,259 $ 43,037 $ 194,224 At At December 31, December 31, Trading liabilities— $ in millions 2018 2017 Obligation to return securities received Restricted cash $ 35,356 $ 34,231 as collateral 22,555 — — — 22,555 Segregated securities1 26,877 20,549 Total $ 76,017 $ 67,466 $ 30,259 $ 43,037 $ 216,779 Total $ 62,233 $ 54,780
Gross Secured Financing Balances by Class of Collateral 1. Securities segregated under federal regulations for the Firm’s U.S. broker-dealers Pledged are sourced from Securities purchased under agreements to resell and Trading assets in the balance sheets. At At December 31, December 31, $ in millions 2018 2017 The Firm receives collateral in the form of securities in Securities sold under agreements to repurchase connection with securities purchased under agreements to U.S. Treasury and agency securities $ 68,487 $ 43,346 resell, securities borrowed, securities-for-securities transac- State and municipal securities 925 2,451 tions, derivative transactions, customer margin loans and Other sovereign government obligations 120,432 87,141 securities-based lending. In many cases, the Firm is permitted ABS 3,017 1,130 to sell or repledge these securities held as collateral and use Corporate and other debt 8,719 7,737 Corporate equities 12,079 28,497 the securities to secure securities sold under agreements to Other 554 908 repurchase, to enter into securities lending and derivative Total $ 214,213 $ 171,210 transactions or for delivery to counterparties to cover short Securities loaned positions. Other sovereign government obligations $ 19,021 $ 9,489 Corporate equities 10,800 13,174 Concentration Based on the Firm’s Total Assets Other 485 351 At At Total $ 30,306 $ 23,014 December 31, December 31, 2018 2017 Total included in the offsetting disclosure $ 244,519 $ 194,224 U.S. government and agency securities and Trading liabilities—Obligation to return securities received as collateral other sovereign government obligations: Corporate equities $ 17,594 $ 22,555 Trading assets1 12% 9% Total $ 262,113 $ 216,779 Off balance sheet—Collateral received2 17% 14%
Carrying Value of Assets Loaned or Pledged without Counterparty 1. Other sovereign government obligations included in Trading assets primarily Right to Sell or Repledge consist of the U.K., Japan and Brazil. 2. Collateral received is primarily related to Securities purchased under agreements to At At resell and Securities borrowed. December 31, December 31, $ in millions 2018 2017 Trading assets $ 39,430 $ 31,324 Loans (gross of allowance for loan losses) — 228 Total $ 39,430 $ 31,552
121 December 2018 Form 10-K
− 359 − Notes to Consolidated Financial Statements
The Firm is subject to concentration risk by holding large Other Secured Financings positions in certain types of securities, loans or commitments to purchase securities of a single issuer, including sovereign Other secured financings include the liabilities related to governments and other entities, issuers located in a particular transfers of financial assets that are accounted for as financ- country or geographic area, public and private issuers ings rather than sales, consolidated VIEs where the Firm is involving developing countries or issuers engaged in a partic- deemed to be the primary beneficiary, and certain ELNs and ular industry. other secured borrowings. These liabilities are generally payable from the cash flows of the related assets, which are Positions taken and underwriting and financing commitments, accounted for as Trading assets (see Notes 11 and 13). including those made in connection with the Firm’s private equity, principal investment and lending activities, often involve substantial amounts and significant exposure to indi- 7. Loans, Lending Commitments and Allowance vidual issuers and businesses, including investment grade and for Credit Losses non-investment grade issuers. Loans Customer Margin Lending
At At The Firm’s loan portfolio consists of the following types of December 31, December 31, loans: $ in millions 2018 2017 Customer receivables representing margin loans $ 26,225 $ 32,112 • Corporate. Corporate loans primarily include commercial and industrial lending used for general corporate purposes, The Firm provides margin lending arrangements which allow working capital and liquidity, event-driven loans and asset- customers to borrow against the value of qualifying securi- backed lending products. Event-driven loans support client ties. Receivables under margin lending arrangements are merger, acquisition, recapitalization or project finance included within Customer and other receivables in the activities. Corporate loans are structured as revolving lines balance sheets. Under these agreements and transactions, the of credit, letter of credit facilities, term loans and bridge Firm receives collateral, including U.S. government and loans. Risk factors considered in determining the allowance agency securities, other sovereign government obligations, for corporate loans include the borrower’s financial corporate and other debt, and corporate equities. Customer strength, industry, facility structure, collateral, and cove- receivables generated from margin lending activities are nants along with other qualitative factors. collateralized by customer-owned securities held by the Firm. The Firm monitors required margin levels and established • Consumer. Consumer loans include unsecured loans and credit terms daily and, pursuant to such guidelines, requires securities-based lending, which allows clients to borrow customers to deposit additional collateral, or reduce positions, money against the value of qualifying securities for any when necessary. suitable purpose other than purchasing, trading, or carrying Margin loans are extended on a demand basis and generally securities or refinancing margin debt. The majority of are not committed facilities. Factors considered in the review consumer loans are structured as revolving lines of credit of margin loans are the amount of the loan, the intended and letter of credit facilities and are primarily offered purpose, the degree of leverage being employed in the through the Firm’s Liquidity Access Line program. The account, and an overall evaluation of the portfolio to ensure allowance methodology for unsecured loans considers the proper diversification or, in the case of concentrated posi- specific attributes of the loan, as well as the borrower’s tions, appropriate liquidity of the underlying collateral or source of repayment. The allowance methodology for secu- potential hedging strategies to reduce risk. Underlying collat- rities-based lending considers the collateral type underlying eral for margin loans is reviewed with respect to the liquidity the loan (e.g., diversified securities, concentrated securities of the proposed collateral positions, valuation of securities, or restricted stock). historic trading range, volatility analysis and an evaluation of industry concentrations. For these transactions, adherence to • Residential Real Estate. Residential real estate loans the Firm’s collateral policies significantly limits its credit mainly include non-conforming loans and HELOC. The exposure in the event of a customer default. The Firm may allowance methodology for non-conforming residential request additional margin collateral from customers, if appro- mortgage loans considers several factors, including, but not priate, and, if necessary, may sell securities that have not limited to, loan-to-value ratio, FICO score, home price been paid for or purchase securities sold but not delivered index and delinquency status. The methodology for from customers. HELOC considers credit limits and utilization rates in addi- tion to the factors considered for non-conforming residen- tial mortgages.
December 2018 Form 10-K 122
− 360 − Notes to Consolidated Financial Statements
• Wholesale Real Estate. Wholesale real estate loans rates and market dynamics. For residential real estate and include owner-occupied loans and income-producing loans. consumer loans, the initial credit evaluation typically The principal risk factors for determining the allowance for includes, but is not limited to, review of the obligor’s income, wholesale real estate loans are the underlying collateral net worth, liquidity, collateral, loan-to-value ratio and credit type, loan-to-value ratio and debt service ratio. bureau information. Subsequent credit monitoring for resi- dential real estate loans is performed at the portfolio level. Loans by Type Consumer loan collateral values are monitored on an ongoing At December 31, 2018 basis. Loans Held Loans Held $ in millions for Investment for Sale Total Loans The Firm utilizes the following credit quality indicators, Corporate $ 36,909 $ 13,886 $ 50,795 which are consistent with U.S. banking agencies’ definitions Consumer 27,868 — 27,868 of criticized exposures, as applicable, in its credit monitoring Residential real estate 27,466 22 27,488 process for loans held for investment: Wholesale real estate 7,810 1,856 9,666 Total loans, gross 100,053 15,764 115,817 • Pass. A credit exposure rated pass has a continued expec- Allowance for loan losses (238) — (238) tation of timely repayment, all obligations of the borrower Total loans, net $ 99,815 $ 15,764 $ 115,579 are current, and the obligor complies with material terms Fixed rate loans, net $ 15,632 and conditions of the lending agreement. Floating or adjustable rate loans, net 99,947 Loans to non-U.S. borrowers, net 17,568 • Special Mention. Extensions of credit that have potential weakness that deserve management’s close attention and, if At December 31, 2017 Loans Held Loans Held left uncorrected, may, at some future date, result in the dete- $ in millions for Investment for Sale Total Loans rioration of the repayment prospects or collateral position. Corporate $ 29,754 $ 9,456 $ 39,210 Consumer 26,808 — 26,808 • Substandard. Obligor has a well-defined weakness that Residential real estate 26,635 35 26,670 jeopardizes the repayment of the debt and has a high proba- Wholesale real estate 9,980 1,682 11,662 bility of payment default with the distinct possibility that Total loans, gross 93,177 11,173 104,350 the Firm will sustain some loss if noted deficiencies are not Allowance for loan losses (224) — (224) corrected. Total loans, net $ 92,953 $ 11,173 $ 104,126 Fixed rate loans, net $ 13,339 • Doubtful. Inherent weakness in the exposure makes the Floating or adjustable rate loans, net 90,787 collection or repayment in full, based on existing facts, Loans to non-U.S. borrowers, net 9,977 conditions and circumstances, highly improbable, and the amount of loss is uncertain. See Note 3 for further information regarding Loans and lending commitments held at fair value. See Note 12 for • Loss. Extensions of credit classified as loss are consid- details of current commitments to lend in the future. ered uncollectible and are charged off.
Credit Quality Loans considered as Doubtful or Loss are considered impaired. Substandard loans are regularly reviewed for CRM evaluates new obligors before credit transactions are impairment. For further information, see Note 2. initially approved and at least annually thereafter for corporate and wholesale real estate loans. For corporate loans, credit evaluations typically involve the evaluation of financial state- ments, assessment of leverage, liquidity, capital strength, asset composition and quality, market capitalization and access to capital markets, cash flow projections and debt service require- ments, and the adequacy of collateral, if applicable.
CRM also evaluates strategy, market position, industry dynamics, obligor’s management and other factors that could affect an obligor’s risk profile. For wholesale real estate loans, the credit evaluation is focused on property and trans- action metrics, including property type, loan-to-value ratio, occupancy levels, debt service ratio, prevailing capitalization
123 December 2018 Form 10-K
− 361 − Notes to Consolidated Financial Statements
Loans Held for Investment before Allowance by Credit Impaired Loans and Total Allowance by Region Quality At December 31, 2018 At December 31, 2018 $ in millions Americas EMEA Asia Total Residential Wholesale Impaired loans $ 125 $ — $ — $ 125 $ in millions Corporate Consumer Real Estate Real Estate Total Total Allowance for loan losses 193 42 3 238 Pass $ 36,217 $ 27,863 $ 27,387 $ 7,378 $ 98,845 Special mention 492 5 — 312 809 At December 31, 2017 Substandard 200 — 79 120 399 $ in millions Americas EMEA Asia Total Doubtful ————— Impaired loans $ 160 $ 9 $ 10 $ 179 Loss ————— Total Allowance for loan losses 194 27 3 224 Total $ 36,909 $ 27,868 $ 27,466 $ 7,810 $ 100,053
Troubled Debt Restructurings At December 31, 2017 Residential Wholesale At At $ in millions Corporate Consumer Real Estate Real Estate Total December 31, December 31, Pass $ 29,166 $ 26,802 $ 26,562 $ 9,480 $ 92,010 $ in millions 2018 2017 Special mention 188 6 — 200 394 Loans $38$51 Substandard 393 — 73 300 766 Lending commitments 45 28 Doubtful 7 — — — 7 Allowance for loan losses and lending commitments 4 10 Loss — — — — — Total $ 29,754 $ 26,808 $ 26,635 $ 9,980 $ 93,177 Impaired loans and lending commitments classified as held Impaired Loans and Lending Commitments before Allowance for investment within corporate loans include TDRs as shown in the previous table. These restructurings typically include At December 31, 2018 modifications of interest rates, collateral requirements, other Residential $ in millions Corporate Real Estate Total loan covenants and payment extensions. Loans Allowance for Loan Losses Rollforward With allowance $24$—$24 Without allowance1 32 69 101 Residential Wholesale $ in millions Corporate Consumer Real Estate Real Estate Total Total impaired loans $ 56 $ 69 $ 125 UPB 63 70 133 December 31, 2017 $ 126 $ 4 $ 24 $ 70 $ 224 Lending commitments Gross charge-offs (5) — (1) — (6) With allowance $19$—$19 Recoveries1 54 — — — 54 Without allowance1 34 — 34 Net recoveries (charge-offs) 49 — (1) — 48 Total impaired lending commitments 53 — 53 Provision (release)1 (29) 3 (3) 5 (24) At December 31, 2017 Other (2) — — (8) (10) Residential December 31, 2018 $ 144 $ 7 $ 20 $ 67 $ 238 $ in millions Corporate Real Estate Total Inherent $ 139 $ 7 $ 20 $ 67 $ 233 Loans Specific 5———5 With allowance $ 16 $ — $ 16 1 Without allowance 118 45 163 Residential Wholesale Total impaired loans $ 134 $ 45 $ 179 $ in millions Corporate Consumer Real Estate Real Estate Total UPB 146 46 192 December 31, 2016 $ 195 $ 4 $ 20 $ 55 $ 274 Lending commitments Gross charge-offs (75) — — — (75) Without allowance1 $ 199 $ — $ 199 Recoveries 1 — — — 1 Net recoveries 1. At December 31, 2018 and December 31, 2017, no allowance was recorded for (charge-offs) (74) — — — (74) these loans and lending commitments as the present value of the expected future cash flows or value of the collateral held equaled or exceeded the carrying value. Provision (release) 5 — 4 13 22 Other ——— 2 2 Loans and lending commitments in the previous table have December 31, 2017 $ 126 $ 4 $ 24 $ 70 $ 224 been evaluated for a specific allowance. All remaining loans Inherent $ 119 $ 4 $ 24 $ 70 $ 217 and lending commitments are assessed under the inherent Specific 7 — — — 7 allowance methodology.
December 2018 Form 10-K 124
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Residential Wholesale $ in millions Corporate Consumer Real Estate Real Estate Total repayments. These loans are recorded in Customer and other December 31, 2015 $ 166 $ 5 $ 17 $ 37 $ 225 receivables in the balance sheets. The Firm establishes an Gross charge-offs (16) — (1) — (17) allowance for loan amounts it does not consider recoverable, Gross recoveries 3 — — — 3 and the related provision is recorded in Compensation and Net recoveries benefits expense. (charge-offs) (13) — (1) — (14) Provision (release) 110 (1) 4 18 131 Other2 (68) — — — (68) 8. Equity Method Investments December 31, 2016 $ 195 $ 4 $ 20 $ 55 $ 274 Inherent $ 133 $ 4 $ 20 $ 55 $ 212 Overview Specific 62 — — — 62 Equity method investments, other than certain investments in 1. During 2018 the release was primarily due to the recovery of an energy industry related loan charged off in 2017. funds, are summarized below and are included in Other assets 2. The reduction is primarily related to loans of $492 million that were transferred to in the balance sheets with related income or loss included in loans held for sale during 2016. Other revenues in the income statements. See the Fund Inter- ests Measured Based on Net Asset Value table in Note 3 for Allowance for Lending Commitments Rollforward the carrying value of the Firm’s fund interests, which are Residential Wholesale comprised of general and limited partnership interests, as $ in millions Corporate Consumer Real Estate Real Estate Total well as any related performance-based fees in the form of December 31, 2017 $ 194 $ 1 $ — $ 3 $ 198 carried interest. Provision (release) 71— 19 Other (3) — — (1) (4) Equity Method Investment Balances December 31, 2018 $ 198 $ 2 $ — $ 3 $ 203 Inherent $ 193 $ 2 $ — $ 3 $ 198 At At December 31, December 31, Specific 5———5$ in millions 2018 2017 Investments $ 2,432 $ 2,623 Residential Wholesale $ in millions Corporate Consumer Real Estate Real Estate Total December 31, 2016 $ 185 $ 1 $ — $ 4 $ 190 $ in millions 2018 2017 2016 Provision (release) 8 — — (1) 7 Income (loss)1 $20$ (34) $ (79) Other 1 — — — 1 1. Includes impairments of the Investment Management business December 31, 2017 $ 194 $ 1 $ — $ 3 $ 198 segment’s interest in a third-party asset manager of $46 million in 2018 Inherent $ 192 $ 1 $ — $ 3 $ 196 and $53 million in 2017. Specific 2 — — — 2 Japanese Securities Joint Venture Residential Wholesale $ in millions Corporate Consumer Real Estate Real Estate Total $ in millions 2018 2017 2016 December 31, 2015 $ 180 $ 1 $ — $ 4 $ 185 Income from investment in MUMSS $ 105 $ 123 $ 93 Provision (release) 13 — — — 13 Other (8) — — — (8) Included in equity method investments is the Firm’s 40% December 31, 2016 $ 185 $ 1 $ — $ 4 $ 190 voting interest in Mitsubishi UFJ Morgan Stanley Securities Inherent $ 185 $ 1 $ — $ 4 $ 190 Co., Ltd. (“MUMSS”). Mitsubishi UFJ Financial Group, Inc. Specific ————— (“MUFG”) holds the other 60% voting interest in MUMSS. The Firm accounts for its equity method investment in Employee Loans MUMSS within the Institutional Securities business segment.
At At December 31, December 31, $ in millions 2018 2017 9. Goodwill and Intangible Assets Balance $ 3,415 $ 4,185 Allowance for loan losses (63) (77) Goodwill Balance, net $ 3,352 $ 4,108 Repayment term range, in years 1to20 1to20 The Firm completed its annual goodwill impairment testing as of July 1, 2018 and July 1, 2017. The Firm’s impairment Employee loans are granted in conjunction with a program testing for each period did not indicate any goodwill impair- established to retain and recruit certain Wealth Management ment, as each of the Firm’s reporting units with goodwill had a representatives, are full recourse and generally require periodic fair value that was substantially in excess of its carrying value.
125 December 2018 Form 10-K
− 363 − Notes to Consolidated Financial Statements Goodwill Rollforward 10. Deposits
$ in millions IS WM IM Total Deposits At December 31, 20161 $ 275 $ 5,533 $ 769 $ 6,577 Foreign currency and other 20 — — 20 At At December 31, December 31, At December 31, 20171 $ 295 $ 5,533 $ 769 $ 6,597 $ in millions 2018 2017 Foreign currency and other (21) — — (21) Savings and demand deposits $ 154,897 $ 144,487 Acquired — — 112 112 Time deposits 32,923 14,949 At December 31, 20181 $ 274 $ 5,533 $ 881 $ 6,688 Total $ 187,820 $ 159,436 Accumulated impairments2 673 — 27 700 Deposits subject to FDIC insurance $ 144,515 $ 127,017 IS—Institutional Securities Time deposits that equal or exceed WM—Wealth Management the FDIC insurance limit $11$38 IM—Investment Management 1. Balances represent cumulative the amount of the Firm’s goodwill after accumulated impairments. Time Deposit Maturities 2. Balances represent cumulative amounts at December 31, 2018, 2017 and 2016 of impairments recognized prior to 2016. At December 31, Intangible Assets by Business Segment $ in millions 2018 2019 $ 17,111 $ in millions IS WM IM Total 2020 10,580 Amortizable intangibles $ 349 $ 2,092 $ 4 $ 2,445 2021 Mortgage servicing rights — 3 — 3 2,249 At December 31, 2017 $ 349 $ 2,095 $ 4 $ 2,448 2022 997 Amortizable intangibles $ 270 $ 1,828 $ 60 $ 2,158 2023 1,795 Mortgage servicing rights 23—5Thereafter 191 At December 31, 2018 $ 272 $ 1,831 $ 60 $ 2,163
Gross Amortizable Intangible Assets by Type 11. Borrowings and Other Secured Financings At December 31, 2018 At December 31, 2017 Gross Gross Maturities and Terms of Borrowings Carrying Accumulated Carrying Accumulated $ in millions Amount Amortization Amount Amortization Parent Company Subsidiaries At At Trademarks $3$1$1$— Fixed Variable Fixed Variable December 31, December 31, $ in millions Rate Rate1 Rate Rate1 2018 2017 Tradename 283 59 283 50 Original maturities of one year or less: Customer relationships 4,067 2,446 4,059 2,193 Next 12 Management months $ — $ — $ — $ 1,545 $ 1,545 $ 1,519 contracts 507 311 503 299 Original maturities greater than one year: Other 175 60 329 188 2018 $ —$—$—$—$ —$ 23,870 Total $ 5,035 $ 2,877 $ 5,175 $ 2,730 2019 12,749 7,100 26 4,819 24,694 24,549 Estimated annual amortization expense for the next five years $ 296 2020 10,957 7,618 13 2,692 21,280 21,414 2021 13,434 7,774 18 3,416 24,642 19,063 Net Amortizable Intangible Assets Rollforward 2022 6,450 8,519 16 1,800 16,785 17,586 2023 8,419 3,134 13 2,372 13,938 9,868 $ in millions IS WM IM Total Thereafter 55,966 14,127 131 16,554 86,778 74,713 At December 31, 2016 $ 346 $ 2,361 $ 11 $ 2,718 Total $ 107,975 $ 48,272 $ 217 $ 31,653 $ 188,117 $ 191,063 Acquired 51 — — 51 Total Disposals (15) — — (15) borrowings $ 107,975 $ 48,272 $ 217 $ 33,198 $ 189,662 $ 192,582 Weighted average coupon Amortization expense (33) (269) (7) (309) at period end2 3.8% 2.6% 6.4% N/M 3.5% 3.3% At December 31, 2017 $ 349 $ 2,092 $ 4 $ 2,445 Acquired — — 66 66 1. Variable rate borrowings bear interest based on a variety of indices, including LIBOR and federal funds rates. Amounts include notes carried at fair value with various payment Disposals (6) — — (6) provisions, including notes linked to the performance of a specific index, a basket of Amortization expense (70) (264) (10) (344) stocks, a specific equity security, a commodity, a credit exposure or basket of credit expo- sures, and instruments with various interest-rate-related features including step-ups, step- Other (3) — — (3) downs, and zero coupons. At December 31, 2018 $ 270 $ 1,828 $ 60 $ 2,158 2. Includes only borrowings with original maturities greater than one year. Weighted average coupon is calculated utilizing U.S. and non-U.S. dollar interest rates and excludes finan- cial instruments for which the fair value option was elected. Virtually all of the variable rate notes issued by subsidiaries are carried at fair value so a weighted average coupon is not meaningful.
December 2018 Form 10-K 126
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Borrowings with Original Maturities Greater than One Year Subordinated debt generally is issued to meet the capital requirements of the Firm or its regulated subsidiaries and At At December 31, December 31, primarily is U.S. dollar denominated. Maturities of subordi- $ in millions 2018 2017 nated notes range from 2022 to 2027. Senior $ 178,027 $ 180,835 Subordinated 10,090 10,228 Asset and Liability Management Total $ 188,117 $ 191,063 Weighted average stated maturity, in years 6.5 6.6 In general, other than securities inventories financed by secured funding sources, the majority of the Firm’s assets are Certain senior debt securities are denominated in various financed with a combination of deposits, short-term funding, non-U.S. dollar currencies and may be structured to provide a floating rate long-term debt or fixed rate long-term debt return that is linked to equity, credit, commodity or other swapped to a floating rate. The Firm uses interest rate swaps to indices (e.g., the consumer price index). Senior debt also may more closely match these borrowings to the duration, holding be structured to be callable by the Firm or extendible at the period and interest rate characteristics of the assets being option of holders of the senior debt securities. funded and to manage interest rate risk. These swaps effec- tively convert certain of the Firm’s fixed rate borrowings into Senior Debt—Structured Borrowings. The Firm’s Borrowings floating rate obligations. In addition, for non-U.S. dollar include notes carried and managed on a fair value basis. currency borrowings that are not used to fund assets in the These include instruments whose payments and redemption same currency, the Firm has entered into currency swaps that values are linked to the performance of a specific index, a effectively convert the borrowings into U.S. dollar obligations. basket of stocks, a specific equity security, a commodity, a credit exposure or basket of credit exposures, and instruments The Firm’s use of swaps for asset and liability management with various interest-rate-related features including step-ups, affects its effective average borrowing rate. step-downs, and zero coupons. To minimize the exposure from such instruments, the Firm has entered into various Rates for Borrowings with Original Maturities Greater than swap contracts and purchased options that effectively convert One Year the borrowing costs into floating rates. The Firm generally At December 31, carries the entire structured borrowing at fair value. The 2018 2017 2016 swaps and purchased options used to economically hedge the Contractual weighted average coupon1 3.5% 3.3% 3.7% embedded features are derivatives and also are carried at fair Effective weighted average coupon after swaps 3.6% 2.5% 2.5% value. Changes in fair value related to the notes and economic 1. Weighted average coupon was calculated utilizing U.S. and non-U.S. dollar interest hedges are reported in Trading revenues. See Notes 2 and 3 rates and excludes financial instruments for which the fair value option was elected. for further information on structured borrowings. Other Secured Financings by Original Maturity and Type Senior Debt Subject to Put Options or Liquidity Obligations At At December 31, December 31, At At $ in millions 2018 2017 December 31, December 31, $ in millions 2018 2017 Original maturities: Put options embedded in debt agreements $ 520 $ 3,023 Greater than one year $ 6,772 $ 8,685 Liquidity obligations1 $ 1,284 $ 1,414 One year or less 2,036 2,034 1. Includes obligations to support secondary market trading. Failed sales 658 552
Subordinated Debt Total $ 9,466 $ 11,271
2018 2017 Contractual weighted average coupon 4.5% 4.5%
127 December 2018 Form 10-K
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Maturities and Terms of Secured Financings liabilities in Other secured financings at fair value in the balance sheets. At December 31, 2018 At Fixed Variable December 31, The assets transferred to certain unconsolidated VIEs in trans- $ in millions Rate Rate1 Total 2017 actions accounted for as failed sales cannot be removed Original maturities of one year or less: unilaterally by the Firm and are not generally available to the Next 12 months $ 2,036 $ — $ 2,036 $ 2,034 Firm. The related liabilities are also non-recourse to the Firm. Original maturities greater than one year: In certain other failed sale transactions, the Firm has the right 2018 $—$—$—$ 4,992 to remove assets or provides additional recourse through 2019 159 5,741 5,900 2,637 derivatives such as total return swaps, guarantees or other 2020 197 402 599 505 forms of involvement. 2021 1— 1 2 2022 18586 151 2023 —2626 398 12. Commitments, Guarantees and Contingencies Thereafter 74 86 160 — Commitments Total $ 432 $ 6,340 $ 6,772 $ 8,685 Years to Maturity at December 31, 2018 Weighted average coupon Less at period-end2 3.9% 2.4% 2.5% 1.7% $ in millions than 1 1-3 3-5 Over 5 Total Lending: 1. Variable rate borrowings bear interest based on a variety of indices, including Corporate $ 12,132 $ 30,294 $ 47,955 $ 6,910 $ 97,291 LIBOR and federal funds rates. Amounts include notes carried at fair value with various payment provisions, including notes linked to equity, credit, Consumer 7,145 1 11 — 7,157 commodity or other indices. Residential and wholesale real estate 75 544 408 253 1,280 2. Includes only other secured financings with original maturities greater than one year. Weighted average coupon is calculated utilizing U.S. and non-U.S. Forward-starting secured financing dollar interest rates and excludes secured financings that are linked to receivables 85,541 — — 3,700 89,241 non-interest indices and for which the fair value option was elected. Underwriting 687 — — — 687 Investment activities 509 82 16 267 874 Other secured financings include the liabilities related to Letters of credit and certain ELNs, transfers of financial assets that are accounted other financial guarantees 180 1 — 39 220 Total $ 106,269 $ 30,922 $ 48,390 $ 11,169 $ 196,750 for as financings rather than sales, pledged commodities, Corporate lending commitments participated to third parties $ 8,078 consolidated VIEs where the Firm is deemed to be the Forward-starting secured financing receivables settled within three primary beneficiary and other secured borrowings. These business days $ 80,559 liabilities are generally payable from the cash flows of the related assets accounted for as Trading assets. See Note 13 for Since commitments associated with these instruments may further information on other secured financings related to expire unused, the amounts shown do not necessarily reflect VIEs and securitization activities. the actual future cash funding requirements.
Failed Sales by Maturity Types of Commitments
At At Lending Commitments. Lending commitments primarily December 31, December 31, $ in millions 2018 2017 represent the notional amount of legally binding obligations 2018 $—$22to provide funding to clients for different types of loan trans- actions. This category also includes commitments in loan 2019 40 4 form provided to clearinghouses or associated depositories of 2020 62 109 which the Firm is a member and are contingent upon the 2021 69 29 default of a clearinghouse member or other stress event. For 2022 33 59 syndications that are led by the Firm, the lending commit- 2023 — — ments accepted by the borrower but not yet closed are net of Thereafter 494 289 the amounts agreed to by counterparties that will participate Total $ 658 $ 552 in the syndication. For syndications that the Firm participates in and does not lead, lending commitments accepted by the For transfers that fail to meet the accounting criteria for a borrower but not yet closed include only the amount that the sale, the Firm continues to recognize the assets in Trading Firm expects it will be allocated from the lead syndicate bank. assets at fair value, and the Firm recognizes the associated Due to the nature of the Firm’s obligations under the
December 2018 Form 10-K 128
− 366 − Notes to Consolidated Financial Statements commitments, these amounts include certain commitments $ in millions 2018 2017 2016 participated to third parties. Rent expense $ 753 $ 704 $ 689
Forward-Starting Secured Financing Receivables. This Occupancy lease agreements, in addition to base rentals, amount includes securities purchased under agreements to generally provide for rent and operating expense escalations resell and securities borrowed that the Firm has entered into resulting from increased assessments for real estate taxes and prior to the balance sheet date that will settle after the balance other charges. sheet date. Also included are commitments to enter into secu- rities purchased under agreements to resell that are provided Guarantees to certain clearinghouses or associated depositories of which the Firm is a member and are contingent upon the default of a Obligations under Guarantee Arrangements at December 31, 2018 clearinghouse member or other stress event. These transac- tions are primarily secured by collateral from U.S. govern- Maximum Potential Payout/Notional ment agency securities and other sovereign government obli- Years to Maturity $ in millions Less than 1 1-3 3-5 Over 5 Total gations when they are funded. Credit derivatives $ 42,347 $ 50,658 $ 102,231 $ 28,793 $ 224,029 Other credit contracts — — — 116 116 Underwriting Commitments. The Firm provides underwriting Non-credit derivatives 1,826,642 1,398,077 454,910 600,312 4,279,941 commitments in connection with its capital raising sources to Standby letters of credit a diverse group of corporate and other institutional clients. and other financial guarantees issued1 1,017 978 1,326 4,914 8,235 Investment Activities. The Firm sponsors several Market value guarantees 83 126 26 — 235 non-consolidated investment management funds for third- Liquidity facilities 4,449 — — — 4,449 party investors where it typically acts as general partner of, Whole loan sales guarantees — 1 — 23,210 23,211 and investment advisor to, these funds and typically commits Securitization to invest a minority of the capital of such funds, with representations and subscribing third-party investors contributing the majority. warranties — — — 63,552 63,552 The Firm has contractual capital commitments, guarantees General partner guarantees 9 112 160 44 325 and counterparty arrangements with respect to these invest- ment management funds. Carrying Amount Letters of Credit and Other Financial Guarantees. The Firm (Asset)/ Collateral/ has outstanding letters of credit and other financial guarantees $ in millions Liability Recourse issued by third-party banks to certain of the Firm’s counter- Credit derivatives2 $ 1,384 $ — parties. The Firm is contingently liable for these letters of Other credit contracts 14 — credit and other financial guarantees, which are primarily Non-credit derivatives2 53,434 — Standby letters of credit and other financial used to provide collateral for securities and commodities guarantees issued1 (226) 6,901 traded and to satisfy various margin requirements in lieu of Market value guarantees — 124 depositing cash or securities with these counterparties. Liquidity facilities (5) 7,353 Premises and Equipment. The Firm has non-cancelable oper- Whole loan sales guarantees 9— ating leases covering premises and equipment. Future Securitization representations and warranties3 42 — minimum rental commitments under such leases (net of General partner guarantees 71 — sublease commitments, principally on office rentals) were as 1. These amounts include certain issued standby letters of credit participated to follows: third parties, totaling $0.6 billion of notional and collateral/recourse, due to the nature of the Firm’s obligations under these arrangements. Operating Premises Leases 2. Carrying amounts of derivative contracts are shown on a gross basis prior to cash collateral or counterparty netting. For further information on derivative At contracts, see Note 4. December 31, 3. Primarily related to residential mortgage securitizations. $ in millions 2018 2019 $ 677 2020 657 Types of Guarantees 2021 602 2022 555 Derivative Contracts. Certain derivative contracts meet the 2023 507 accounting definition of a guarantee, including certain written Thereafter 2,639 options, contingent forward contracts and CDS (see Note 4 Total $ 5,637 Total minimum rental income to be received in the future regarding credit derivatives in which the Firm has sold credit under non-cancelable operating subleases $7protection to the counterparty). All derivative contracts that
129 December 2018 Form 10-K
− 367 − Notes to Consolidated Financial Statements could meet this accounting definition of a guarantee are and warranties is equal to the current UPB of such loans. included in the previous table, with the notional amount used Since the Firm no longer services these loans, it has no infor- as the maximum potential payout for certain derivative mation on the current UPB of those loans, and accordingly, contracts, such as written interest rate caps and written the amount included in the previous table represents the UPB foreign currency options. at the time of the whole loan sale or at the time when the Firm last serviced any of those loans. The current UPB In certain situations, collateral may be held by the Firm for balances could be substantially lower than the maximum those contracts that meet the definition of a guarantee. Gener- potential payout amount included in the previous table. The ally, the Firm sets collateral requirements by counterparty so related liability primarily relates to sales of loans to the that the collateral covers various transactions and products federal mortgage agencies. and is not allocated specifically to individual contracts. Also, the Firm may recover amounts related to the underlying asset Securitization Representations and Warranties. As part of delivered to the Firm under the derivative contract. the Firm’s Institutional Securities business segment’s securi- tizations and related activities, the Firm has provided, or Standby Letters of Credit and Other Financial Guarantees otherwise agreed to be responsible for, representations and Issued. In connection with its corporate lending business and warranties regarding certain assets transferred in securitiza- other corporate activities, the Firm provides standby letters of tion transactions sponsored by the Firm. The extent and credit and other financial guarantees to counterparties. Such nature of the representations and warranties, if any, vary arrangements represent obligations to make payments to third among different securitizations. Under certain circumstances, parties if the counterparty fails to fulfill its obligation under a the Firm may be required to repurchase certain assets or make borrowing arrangement or other contractual obligation. A other payments related to such assets if such representations majority of the Firm’s standby letters of credit are provided and warranties are breached. The maximum potential amount on behalf of counterparties that are investment grade. of future payments the Firm could be required to make would be equal to the current outstanding balances of, or losses Market Value Guarantees. Market value guarantees are associated with, the assets subject to breaches of such repre- issued to guarantee timely payment of a specified return to sentations and warranties. The amount included in the investors in certain affordable housing tax credit funds. These previous table for the maximum potential payout includes the guarantees are designed to return an investor’s contribution to current UPB or historical losses where known, and the UPB a fund and the investor’s share of tax losses and tax credits at the time of sale when the current UPB is not known. expected to be generated by a fund. General Partner Guarantees. As a general partner in certain Liquidity Facilities. The Firm has entered into liquidity investment management funds, the Firm receives certain facilities with SPEs and other counterparties, whereby the distributions from the partnerships related to achieving Firm is required to make certain payments if losses or certain return hurdles according to the provisions of the part- defaults occur. Primarily, the Firm acts as liquidity provider nership agreements. The Firm may be required to return all or to municipal bond securitization SPEs and for standalone a portion of such distributions to the limited partners in the municipal bonds in which the holders of beneficial interests event the limited partners do not achieve a certain return as issued by these SPEs or the holders of the individual bonds, specified in the various partnership agreements, subject to respectively, have the right to tender their interests for certain limitations. purchase by the Firm on specified dates at a specified price. The Firm often may have recourse to the underlying assets Other Guarantees and Indemnities held by the SPEs in the event payments are required under such liquidity facilities, as well as make-whole or recourse In the normal course of business, the Firm provides guaran- provisions with the trust sponsors. Primarily all of the tees and indemnifications in a variety of transactions. These underlying assets in the SPEs are investment grade. provisions generally are standard contractual terms. Certain Liquidity facilities provided to municipal tender option of these guarantees and indemnifications are described below: bond trusts are classified as derivatives. • Indemnities. The Firm provides standard indemnities to Whole Loan Sales Guarantees. The Firm has provided, or counterparties for certain contingent exposures and taxes, otherwise agreed to be responsible for, representations and including U.S. and foreign withholding taxes, on interest warranties regarding certain whole loan sales. Under certain and other payments made on derivatives, securities and circumstances, the Firm may be required to repurchase such stock lending transactions, certain annuity products and assets or make other payments related to such assets if such other financial arrangements. These indemnity payments representations and warranties are breached. The Firm’s could be required based on a change in the tax laws, a maximum potential payout related to such representations change in interpretation of applicable tax rulings or a
December 2018 Form 10-K 130
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change in factual circumstances. Certain contracts contain In addition, in the ordinary course of business, the Firm guar- provisions that enable the Firm to terminate the agreement antees the debt and/or certain trading obligations (including upon the occurrence of such events. The maximum poten- obligations associated with derivatives, foreign exchange tial amount of future payments that the Firm could be contracts and the settlement of physical commodities) of required to make under these indemnifications cannot be certain subsidiaries. These guarantees generally are entity or estimated. product specific and are required by investors or trading counterparties. The activities of the Firm’s subsidiaries • Exchange/Clearinghouse Member Guarantees. The Firm covered by these guarantees (including any related debt or is a member of various U.S. and non-U.S. exchanges and trading obligations) are included in the financial statements. clearinghouses that trade and clear securities and/or deriva- tive contracts. Associated with its membership, the Firm Contingencies may be required to pay a certain amount as determined by the exchange or the clearinghouse in case of a default of Legal. In addition to the matters described below, in the normal any of its members or pay a proportionate share of the course of business, the Firm has been named, from time to financial obligations of another member that may default time, as a defendant in various legal actions, including arbitra- on its obligations to the exchange or the clearinghouse. tions, class actions and other litigation, arising in connection While the rules governing different exchange or clearing- with its activities as a global diversified financial services insti- house memberships and the forms of these guarantees may tution. Certain of the actual or threatened legal actions include vary, in general the Firm’s obligations under these rules claims for substantial compensatory and/or punitive damages would arise only if the exchange or clearinghouse had or claims for indeterminate amounts of damages. In some previously exhausted its resources. cases, the entities that would otherwise be the primary defen- dants in such cases are bankrupt or are in financial distress. In addition, some clearinghouse rules require members to These actions have included, but are not limited to, residential assume a proportionate share of losses resulting from the mortgage and credit crisis-related matters. clearinghouse’s investment of guarantee fund contributions and initial margin, and of other losses unrelated to the default While the Firm has identified below any individual of a clearing member, if such losses exceed the specified proceedings where the Firm believes a material loss to be resources allocated for such purpose by the clearinghouse. reasonably possible and reasonably estimable, there can be no assurance that material losses will not be incurred from claims The maximum potential payout under these rules cannot be that have not yet been asserted or are not yet determined to be estimated. The Firm has not recorded any contingent probable or possible and reasonably estimable losses. liability in its financial statements for these agreements and believes that any potential requirement to make payments The Firm contests liability and/or the amount of damages as under these agreements is remote. appropriate in each pending matter. Where available informa- tion indicates that it is probable a liability had been incurred • Merger and Acquisition Guarantees. The Firm may, from at the date of the financial statements and the Firm can time to time, in its role as investment banking advisor be reasonably estimate the amount of that loss, the Firm accrues required to provide guarantees in connection with certain the estimated loss by a charge to income. European merger and acquisition transactions. If required $ in millions 2018 2017 2016 by the regulating authorities, the Firm provides a guarantee Legal expenses $ 206 $ 342 $ 263 that the acquirer in the merger and acquisition transaction has or will have sufficient funds to complete the transaction The Firm’s future legal expenses may fluctuate from period and would then be required to make the acquisition to period, given the current environment regarding govern- payments in the event the acquirer’s funds are insufficient ment investigations and private litigation affecting global at the completion date of the transaction. These arrange- financial services firms, including the Firm. ments generally cover the time frame from the transaction offer date to its closing date and, therefore, are generally In many proceedings and investigations, however, it is inher- short term in nature. The Firm believes the likelihood of ently difficult to determine whether any loss is probable or any payment by the Firm under these arrangements is even possible or to estimate the amount of any loss. In addi- remote given the level of its due diligence in its role as tion, even where a loss is possible or an exposure to loss investment banking advisor. exists in excess of the liability already accrued with respect to a previously recognized loss contingency, it is not always possible to reasonably estimate the size of the possible loss or range of loss.
131 December 2018 Form 10-K
− 369 − Notes to Consolidated Financial Statements
For certain legal proceedings and investigations, the Firm Trustee of the Morgan Stanley Mortgage Loan Trust 2007-2AX cannot reasonably estimate such losses, particularly for (MSM 2007-2AX) v. Morgan Stanley Mortgage Capital Hold- proceedings and investigations where the factual record is ings LLC, Successor-by-Merger to Morgan Stanley Mortgage being developed or contested or where plaintiffs or govern- Capital Inc. and GreenPoint Mortgage Funding, Inc., pending in ment entities seek substantial or indeterminate damages, resti- the Supreme Court of NY. The complaint asserts claims for tution, disgorgement or penalties. Numerous issues may need breach of contract and alleges, among other things, that the loans to be resolved, including through potentially lengthy in the trust, which had an original principal balance of approxi- discovery and determination of important factual matters, mately $650 million, breached various representations and determination of issues related to class certification and the warranties. The complaint seeks, among other relief, specific calculation of damages or other relief, and by addressing performance of the loan breach remedy procedures in the trans- novel or unsettled legal questions relevant to the proceedings action documents, unspecified damages and interest. On or investigations in question, before a loss or additional loss August 22, 2013, the Firm filed a motion to dismiss the or range of loss or additional range of loss can be reasonably complaint, which was granted in part and denied in part on estimated for a proceeding or investigation. November 24, 2014. On August 13, 2018, the Firm filed a motion to renew its motion to dismiss. Based on currently avail- For certain other legal proceedings and investigations, the able information, the Firm believes that it could incur a loss in Firm can estimate reasonably possible losses, additional this action of up to approximately $240 million, the total original losses, ranges of loss or ranges of additional loss in excess of unpaid balance of the mortgage loans for which the Firm amounts accrued but does not believe, based on current received repurchase demands that it did not repurchase, plus pre- knowledge and after consultation with counsel, that such and post-judgment interest, fees and costs, but plaintiff is losses will have a material adverse effect on the Firm’s finan- seeking to expand the number of loans at issue and the possible cial statements as a whole, other than the matters referred to range of loss could increase. in the following paragraphs. On September 19, 2014, Financial Guaranty Insurance Company On July 15, 2010, China Development Industrial Bank (“CDIB”) (“FGIC”) filed a complaint against the Firm in the Supreme filed a complaint against the Firm, styled China Development Court of NY, styled Financial Guaranty Insurance Company v. Industrial Bank v. Morgan Stanley & Co. Incorporated et al., Morgan Stanley ABS Capital I Inc. et al. relating to a securitiza- which is pending in the Supreme Court of the State of New York, tion issued by Basket of Aggregated Residential NIMS 2007-1 New York County (“Supreme Court of NY”). The complaint Ltd. The complaint asserts claims for breach of contract and relates to a $275 million CDS referencing the super senior portion alleges, among other things, that the net interest margin securi- of the STACK 2006-1 CDO. The complaint asserts claims for ties (“NIMS”) in the trust breached various representations and common law fraud, fraudulent inducement and fraudulent warranties. FGIC issued a financial guaranty policy with respect concealment and alleges that the Firm misrepresented the risks of to certain notes that had an original balance of approximately the STACK 2006-1 CDO to CDIB, and that the Firm knew that $475 million. The complaint seeks, among other relief, specific the assets backing the CDO were of poor quality when it entered performance of the NIMS breach remedy procedures in the into the CDS with CDIB. The complaint seeks compensatory transaction documents, unspecified damages, reimbursement of damages related to the approximately $228 million that CDIB certain payments made pursuant to the transaction documents, alleges it has already lost under the CDS, rescission of CDIB’s attorneys’ fees and interest. On November 24, 2014, the Firm obligation to pay an additional $12 million, punitive damages, filed a motion to dismiss the complaint, which the court denied equitable relief, fees and costs. On February 28, 2011, the court on January 19, 2017. On September 13, 2018, the Appellate denied the Firm’s motion to dismiss the complaint. On Division, First Department, affirmed the lower court’s order December 21, 2018, the court denied the Firm’s motion for denying the Firm’s motion to dismiss. Based on currently avail- summary judgment and granted in part the Firm’s motion for able information, the Firm believes that it could incur a loss in sanctions relating to spoliation of evidence. Based on currently this action of up to approximately $126 million, the unpaid available information, the Firm believes it could incur a loss in this balance of these notes, plus pre- and post-judgment interest, fees action of up to approximately $240 million plus pre- and post- and costs, as well as claim payments that FGIC has made and judgment interest, fees and costs. On January 18, 2019, CDIB will make in the future. filed a motion to clarify and resettle the portion of the court’s December 21, 2018 order granting spoliation sanctions. On On September 23, 2014, FGIC filed a complaint against the January 24, 2019, CDIB filed a notice of appeal from the court’s Firm in the Supreme Court of NY styled Financial Guaranty December 21, 2018 order, and on January 25, 2019, the Firm filed Insurance Company v. Morgan Stanley ABS Capital I Inc. et a notice of appeal from the same order. al. relating to the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4. The complaint asserts claims for breach of On July 8, 2013, U.S. Bank National Association, in its contract and fraudulent inducement and alleges, among other capacity as trustee, filed a complaint against the Firm styled things, that the loans in the trust breached various representa- U.S. Bank National Association, solely in its capacity as tions and warranties and defendants made untrue statements
December 2018 Form 10-K 132
− 370 − Notes to Consolidated Financial Statements and material omissions to induce FGIC to issue a financial the Firm did not repurchase, plus pre- and post-judgment guaranty policy on certain classes of certificates that had an interest, fees and costs, but plaintiff is seeking to expand the original balance of approximately $876 million. The number of loans at issue and the possible range of loss could complaint seeks, among other relief, specific performance of increase. the loan breach remedy procedures in the transaction docu- ments, compensatory, consequential and punitive damages, In matters styled Case number 15/3637 and Case number attorneys’ fees and interest. On January 23, 2017, the court 15/4353, the Dutch Tax Authority (“Dutch Authority”) has denied the Firm’s motion to dismiss the complaint. On challenged, in the District Court in Amsterdam, the prior September 13, 2018, the Appellate Division, First Depart- set-off by the Firm of approximately €124 million (approxi- ment, affirmed in part and reversed in part the lower court’s mately $142 million) plus accrued interest of withholding tax order denying the Firm’s motion to dismiss. On credits against the Firm’s corporation tax liabilities for the tax December 20, 2018, the Appellate Division denied plaintiff’s years 2007 to 2013. The Dutch Authority alleges that the Firm motion for leave to appeal the decision of the Appellate Divi- was not entitled to receive the withholding tax credits on the sion, First Department, to the New York Court of Appeals or, basis, inter alia, that a Firm subsidiary did not hold legal title to in the alternative, for reargument. Based on currently avail- certain securities subject to withholding tax on the relevant able information, the Firm believes that it could incur a loss dates. The Dutch Authority has also alleged that the Firm failed in this action of up to approximately $277 million, the total to provide certain information to the Dutch Authority and keep original unpaid balance of the mortgage loans for which the adequate books and records. A hearing took place in this matter Firm received repurchase demands from a certificate holder on September 19, 2017. On April 26, 2018, the District Court and FGIC that the Firm did not repurchase, plus pre- and in Amsterdam issued a decision dismissing the Dutch Authori- post-judgment interest, fees and costs, as well as claim ty’s claims. On June 4, 2018, the Dutch Authority filed an payments that FGIC has made and will make in the future. In appeal before the Court of Appeal in Amsterdam in matters re- addition, plaintiff is seeking to expand the number of loans at styled Case number 18/00318 and Case number 18/00319. A issue and the possible range of loss could increase. hearing of the Dutch Authority’s appeal has been scheduled for June 26, 2019. Based on currently available information, the On January 23, 2015, Deutsche Bank National Trust Firm believes that it could incur a loss in this action of up to Company, in its capacity as trustee, filed a complaint against approximately €124 million (approximately $142 million) plus the Firm styled Deutsche Bank National Trust Company accrued interest. solely in its capacity as Trustee of the Morgan Stanley ABS Capital I Inc. Trust 2007-NC4 v. Morgan Stanley Mortgage Capital Holdings LLC as Successor-by-Merger to Morgan 13. Variable Interest Entities and Securitization Stanley Mortgage Capital Inc., and Morgan Stanley ABS Activities Capital I Inc., pending in the Supreme Court of NY. The complaint asserts claims for breach of contract and alleges, Overview among other things, that the loans in the trust, which had an original principal balance of approximately $1.05 billion, The Firm is involved with various SPEs in the normal course breached various representations and warranties. The of business. In most cases, these entities are deemed to be complaint seeks, among other relief, specific performance of VIEs. the loan breach remedy procedures in the transaction docu- ments, compensatory, consequential, rescissory, equitable and The Firm’s variable interests in VIEs include debt and equity punitive damages, attorneys’ fees, costs and other related interests, commitments, guarantees, derivative instruments expenses, and interest. On December 11, 2015, the court and certain fees. The Firm’s involvement with VIEs arises granted in part and denied in part the Firm’s motion to primarily from: dismiss the complaint. On October 19, 2018, the court • Interests purchased in connection with market-making granted the Firm’s motion for leave to amend its answer and activities, securities held in its Investment securities port- to stay the case pending resolution of Deutsche Bank folio and retained interests held as a result of securitization National Trust Company’s appeal to the New York Court of activities, including re-securitization transactions. Appeals in another case. On January 17, 2019, the First Department reversed the trial court’s order to the extent that it • Guarantees issued and residual interests retained in connec- had granted in part the Firm’s motion to dismiss the tion with municipal bond securitizations. complaint. Based on currently available information, the Firm believes that it could incur a loss in this action of up to • Loans made to and investments in VIEs that hold debt, approximately $277 million, the total original unpaid balance equity, real estate or other assets. of the mortgage loans for which the Firm received repurchase demands from a certificate holder and a monoline insurer that • Derivatives entered into with VIEs.
133 December 2018 Form 10-K
− 371 − Notes to Consolidated Financial Statements
• Structuring of CLNs or other asset-repackaged notes Consolidated VIEs designed to meet the investment objectives of clients. Assets and Liabilities by Type of Activity
• Other structured transactions designed to provide At December 31, 2018 At December 31, 2017 tax-efficient yields to the Firm or its clients. $ in millions VIE Assets VIE Liabilities VIE Assets VIE Liabilities OSF $ 267 $ — $ 378 $ 3 The Firm determines whether it is the primary beneficiary of MABS1 59 38 249 210 a VIE upon its initial involvement with the VIE and reas- Other2 809 48 1,174 250 sesses whether it is the primary beneficiary on an ongoing Total $ 1,135 $ 86 $ 1,801 $ 463 basis as long as it has any continuing involvement with the OSF—Other structured financings VIE. This determination is based upon an analysis of the 1. Amounts include transactions backed by residential mortgage loans, commercial design of the VIE, including the VIE’s structure and activ- mortgage loans and other types of assets, including consumer or commercial ities, the power to make significant economic decisions held assets. The value of assets is determined based on the fair value of the liabilities and the interests owned by the Firm in such VIEs as the fair values for the liabilities by the Firm and by other parties, and the variable interests and interests owned are more observable. owned by the Firm and other parties. 2. Other primarily includes investment funds, certain operating entities and structured transactions. During 2018, Other included a fund managed by Mesa West Capital, LLC (which was acquired by the Firm in the first quarter of 2018), until the fund was The power to make the most significant economic decisions deconsolidated in the fourth quarter of 2018 due to the termination of a credit facility may take a number of different forms in different types of provided by the Firm to this fund. VIEs. The Firm considers servicing or collateral management Assets and Liabilities by Balance Sheet Caption decisions as representing the power to make the most signifi- cant economic decisions in transactions such as securitiza- At At December 31, December 31, tions or CDOs. As a result, the Firm does not consolidate $ in millions 2018 2017 securitizations or CDOs for which it does not act as the Assets servicer or collateral manager unless it holds certain other Cash and cash equivalents: rights to replace the servicer or collateral manager or to Cash and due from banks $77$69 require the liquidation of the entity. If the Firm serves as Restricted cash 171 222 servicer or collateral manager, or has certain other rights Trading assets at fair value 314 833 described in the previous sentence, the Firm analyzes the Customer and other receivables 25 19 interests in the VIE that it holds and consolidates only those Goodwill 18 18 VIEs for which it holds a potentially significant interest in the Intangible assets 128 155 VIE. Other assets 402 485 Total $ 1,135 $ 1,801 For many transactions, such as re-securitization transactions, Liabilities Other secured financings $64$ 438 CLNs and other asset-repackaged notes, there are no signifi- Other liabilities and accrued expenses 22 25 cant economic decisions made on an ongoing basis. In these Total $ 86 $ 463 cases, the Firm focuses its analysis on decisions made prior to Noncontrolling interests $ 106 $ 189 the initial closing of the transaction and at the termination of the transaction. The Firm concluded in most of these transac- Consolidated VIE assets and liabilities are presented in the tions that decisions made prior to the initial closing were previous tables after intercompany eliminations. Most assets shared between the Firm and the initial investors based upon owned by consolidated VIEs cannot be removed unilaterally the nature of the assets, including whether the assets were by the Firm and are not generally available to the Firm. Most issued in a transaction sponsored by the Firm and the extent related liabilities issued by consolidated VIEs are of the information available to the Firm and to investors, the non-recourse to the Firm. In certain other consolidated VIEs, number, nature and involvement of investors, other rights the Firm either has the unilateral right to remove assets or held by the Firm and investors, the standardization of the provides additional recourse through derivatives such as total legal documentation and the level of continuing involvement return swaps, guarantees or other forms of involvement. by the Firm, including the amount and type of interests owned by the Firm and by other investors. The Firm focused In general, the Firm’s exposure to loss in consolidated VIEs its control decision on any right held by the Firm or investors is limited to losses that would be absorbed on the VIE net related to the termination of the VIE. Most re-securitization assets recognized in its financial statements, net of amounts transactions, CLNs and other asset-repackaged notes have no absorbed by third-party variable interest holders. such termination rights.
December 2018 Form 10-K 134
− 372 − Notes to Consolidated Financial Statements
Non-consolidated VIEs The Firm’s maximum exposure to loss is dependent on the
At December 31, 2018 nature of the Firm’s variable interest in the VIE and is limited to: $ in millions MABS CDO MTOB OSF Other VIE assets (UPB) $ 71,287 $ 10,848 $ 7,014 $ 3,314 $ 19,682 • notional amounts of certain liquidity facilities; Maximum exposure to loss1 • other credit support; Debt and equity • total return swaps; interests $ 8,234 $ 1,169 $ — $ 1,622 $ 4,645 • written put options; and Derivative and other • fair value of certain other derivatives and investments the contracts — — 4,449 — 1,768 Firm has made in the VIE. Commitments, guarantees and other 397 3 — 235 327 The Firm’s maximum exposure to loss in the previous tables Total $ 8,631 $ 1,172 $ 4,449 $ 1,857 $ 6,740 does not include the offsetting benefit of hedges or any reduc- Carrying value of exposure to loss—Assets tions associated with the amount of collateral held as part of a Debt and equity interests $ 8,234 $ 1,169 $ — $ 1,205 $ 4,645 transaction with the VIE or any party to the VIE directly Derivative and other against a specific exposure to loss. contracts ——6—87 Total $ 8,234 $ 1,169 $ 6 $ 1,205 $ 4,732 Liabilities issued by VIEs generally are non-recourse to the Additional VIE assets owned2 $ 11,969 Firm.
Carrying value of exposure to loss—Liabilities Mortgage- and Asset-Backed Securitization Assets Derivative and other contracts $—$—$—$—$185 At December 31, 2018 At December 31, 2017 Total $ — $ — $ — $ — $ 185 Debt and Debt and Equity Equity $ in millions UPB Interests UPB Interests At December 31, 2017 Residential mortgages $ 6,954 $ 745 $ 15,636 $ 1,272 $ in millions MABS CDO MTOB OSF Other Commercial mortgages 42,974 1,237 46,464 2,331 VIE assets (UPB) $ 89,288 $ 9,807 $ 5,306 $ 3,322 $ 31,934 U.S. agency 1 Maximum exposure to loss collateralized Debt and equity mortgage obligations 14,969 3,443 16,223 3,439 interests $ 10,657 $ 1,384 $ 80 $ 1,628 $ 4,730 Other consumer or Derivative and other commercial loans 6,390 2,809 10,965 3,615 contracts — — 3,333 — 1,686 Total $ 71,287 $ 8,234 $ 89,288 $ 10,657 Commitments, guarantees and other 1,214 668 — 164 433 Total $ 11,871 $ 2,052 $ 3,413 $ 1,792 $ 6,849 Securitization Activities
Carrying value of exposure to loss—Assets In a securitization transaction, the Firm transfers assets Debt and equity interests $ 10,657 $ 1,384 $ 43 $ 1,202 $ 4,730 (generally commercial or residential mortgage loans or U.S. Derivative and other agency securities) to an SPE, sells to investors most of the contracts — — 5 — 184 beneficial interests, such as notes or certificates, issued by the Total $ 10,657 $ 1,384 $ 48 $ 1,202 $ 4,914 SPE, and, in many cases, retains other beneficial interests. Additional VIE assets owned2 $ 11,318 The purchase of the transferred assets by the SPE is financed MTOB—Municipal tender option bonds through the sale of these interests. 1. Where notional amounts are utilized in quantifying the maximum exposure related to derivatives, such amounts do not reflect changes in fair value recorded by the Firm. In many securitization transactions involving commercial 2. Additional VIE assets owned represents the carrying value of total exposure to non-consolidated VIEs for which the maximum exposure to loss is less than specific mortgage loans, the Firm transfers a portion of the assets to thresholds, primarily interests issued by securitization SPEs. The Firm’s primary risk the SPE with unrelated parties transferring the remaining exposure is to the most subordinate class of beneficial interest and maximum expo- sure to loss generally equals the fair value of the assets owned. These assets are assets. primarily included in Trading assets and Investment securities and are measured at fair value (see Note 3). The Firm does not provide additional support in these trans- In some of these transactions, primarily involving residential actions through contractual facilities, guarantees or similar derivatives. mortgage loans in the U.S., the Firm serves as servicer for The majority of the VIEs included in the previous tables are some or all of the transferred loans. In many securitizations, sponsored by unrelated parties; the Firm’s involvement particularly involving residential mortgage loans, the Firm generally is the result of its secondary market-making activ- also enters into derivative transactions, primarily interest rate ities, securities held in its Investment securities portfolio (see swaps or interest rate caps, with the SPE. Note 5) and certain investments in funds.
135 December 2018 Form 10-K
− 373 − Notes to Consolidated Financial Statements
Although not obligated, the Firm generally makes a market in Credit Protection Purchased through Credit-Linked Notes the securities issued by SPEs in securitization transactions. As a market maker, the Firm offers to buy these securities CLN transactions are designed to provide investors with from, and sell these securities to, investors. Securities exposure to certain credit risk on referenced asset. In these purchased through these market-making activities are not transactions, the Firm transfers assets (generally high-quality considered to be retained interests; these beneficial interests securities or money market investments) to an SPE, enters generally are included in Trading assets—Corporate and into a derivative transaction in which the SPE sells protection other debt and are measured at fair value. on an unrelated referenced asset or group of assets, through a credit derivative, and sells the securities issued by the SPE to The Firm enters into derivatives, generally interest rate swaps investors. In some transactions, the Firm may also enter into and interest rate caps, with a senior payment priority in many interest rate or currency swaps with the SPE. securitization transactions. The risks associated with these and similar derivatives with SPEs are essentially the same as Upon the occurrence of a credit event related to the refer- similar derivatives with non-SPE counterparties and are enced asset, the SPE will deliver securities collateral as managed as part of the Firm’s overall exposure. See Note 4 payment to the Firm, which exposes the Firm to changes in for further information on derivative instruments and hedging the collateral’s value. Depending on the structure, the assets activities. and liabilities of the SPE may be recognized in the Firm’s balance sheets or accounted for as a sale of assets and the Available-for-Sale Securities SPE is not consolidated. The Firm holds AFS issued by VIEs not sponsored by the Derivative payments by the SPE are collateralized. The risks Firm within the Investment securities portfolio. These securi- associated with these and similar derivatives with SPEs are ties are composed of those related to transactions sponsored essentially the same as those with non-SPE counterparties, by the federal mortgage agencies and the most senior securi- and are managed as part of the Firm’s overall exposure. ties issued by VIEs backed by student loans, automobile loans, commercial mortgage loans or CLOs. Transactions Other Structured Financings sponsored by the federal mortgage agencies include an explicit or implicit guarantee provided by the U.S. govern- The Firm invests in interests issued by entities that develop ment. See Note 5 for further information on the Investment and own low-income communities (including low-income Securities Portfolio. housing projects) and entities that construct and own facilities Municipal Tender Option Bond Trusts that will generate energy from renewable resources. The interests entitle the Firm to a share of tax credits and tax In a municipal tender option bond trust transaction, the client losses generated by these projects. In addition, the Firm has transfers a municipal bond to a trust. The trust issues short- issued guarantees to investors in certain low-income housing term securities that the Firm, as the remarketing agent, sells funds. The guarantees are designed to return an investor’s to investors. The client generally retains a residual interest. contribution to a fund and the investor’s share of tax losses The short-term securities are supported by a liquidity facility and tax credits expected to be generated by the fund. The pursuant to which the investors may put their short-term Firm is also involved with entities designed to provide interests. In some programs, the Firm provides this liquidity tax-efficient yields to the Firm or its clients. facility; in most programs, a third-party provider will provide such liquidity facility. Collateralized Loan and Debt Obligations
The Firm may, in lieu of purchasing short term securities for CLOs and CDOs are SPEs that purchase a pool of assets remarketing, decide to extend a temporary loan to the trust. consisting of corporate loans, corporate bonds, ABS or The client can generally terminate the transaction at any time. synthetic exposures on similar assets through derivatives, and The liquidity provider can generally terminate the transaction issues multiple tranches of debt and equity securities to inves- upon the occurrence of certain events. When the transaction tors. The Firm underwrites the securities issued in CLO trans- is terminated, the municipal bond is generally sold or actions on behalf of unaffiliated sponsors and provides advi- returned to the client. Any losses suffered by the liquidity sory services to these unaffiliated sponsors. The Firm sells provider upon the sale of the bond are the responsibility of corporate loans to many of these SPEs, in some cases repre- the client. This obligation is generally collateralized. senting a significant portion of the total assets purchased. Liquidity facilities provided to municipal tender option bond Although not obligated, the Firm generally makes a market in trusts are classified as derivatives. The Firm consolidates any the securities issued by SPEs in these transactions and may municipal tender option bond trusts in which it holds the retain unsold securities. These beneficial interests are residual interest. included in Trading assets and are measured at fair value.
December 2018 Form 10-K 136
− 374 − Notes to Consolidated Financial Statements
Equity-Linked Notes Fair Value at December 31, 2018 $ in millions Level 2 Level 3 Total Retained interests ELN transactions are designed to provide investors with Investment grade $ 1,580 $ 13 $ 1,593 exposure to certain risks related to the specific equity secu- Non-investment grade 174 252 426 rity, equity index or other index. In an ELN transaction, the Total $ 1,754 $ 265 $ 2,019 Firm typically transfers to an SPE either a note issued by the Interests purchased in the secondary market Firm, the payments on which are linked to the performance of Investment grade $ 193 $ 7 $ 200 a specific equity security, equity index, or other index, or debt Non-investment grade 83 16 99 Total $ 276 $ 23 $ 299 securities issued by other companies and a derivative Derivative assets $ 121 $ 95 $ 216 contract, the terms of which will relate to the performance of Derivative liabilities 175 3 178 a specific equity security, equity index or other index. These ELN transactions with SPEs were not consolidated at Fair Value at December 31, 2017 December 31, 2018 and December 31, 2017. $ in millions Level 2 Level 3 Total Retained interests Transfers of Assets with Continuing Involvement Investment grade $ 407 $ 4 $ 411 Non-investment grade 22 555 577 At December 31, 2018 Total $ 429 $ 559 $ 988 U.S. Agency CLN and Interests purchased in the secondary market 1 $ in millions RML CML CMO Other Investment grade $ 531 $ 2 $ 533 2 SPE assets (UPB) $ 14,376 $ 68,593 $ 16,594 $ 14,608 Non-investment grade 57 29 86 Retained interests Total $ 588 $ 31 $ 619 Investment grade $ 17 $ 483 $ 1,573 $ 3 Derivative assets $ 78 $ 149 $ 227 Non-investment grade (fair value) 4 212 — 210 Derivative liabilities 81 4 85 Total $ 21 $ 695 $ 1,573 $ 213 Interests purchased in the secondary market (fair value) The previous tables include transactions with SPEs in which Investment grade $ 7 $ 91 $ 102 $ — the Firm, acting as principal, transferred financial assets with Non-investment grade 28 71 — — continuing involvement and received sales treatment. Total $ 35 $ 162 $ 102 $ — Derivative assets (fair Transferred assets are carried at fair value prior to securitiza- value) $—$—$—$216 tion, and any changes in fair value are recognized in the Derivative liabilities (fair value) — — — 178 income statements. The Firm may act as underwriter of the beneficial interests issued by these securitization vehicles, for At December 31, 2017 which Investment banking revenues are recognized. The Firm U.S. Agency CLN and $ in millions RML CML CMO Other1 may retain interests in the securitized financial assets as one or SPE assets (UPB)2 $ 15,555 $ 62,744 $ 11,612 $ 17,060 more tranches of the securitization. These retained interests Retained interests are generally carried at fair value in the balance sheets with Investment grade $ — $ 293 $ 407 $ 4 changes in fair value recognized in the income statements. Non-investment grade (fair value) 1 98 — 478 Proceeds from New Securitization Transactions and Sales of Total $ 1 $ 391 $ 407 $ 482 Loans Interests purchased in the secondary market (fair value) Investment grade $ — $ 94 $ 439 $ — $ in millions 2018 2017 2016 Non-investment grade 16 66 — 4 New transactions1 $ 23,821 $ 23,939 $ 18,975 Total $ 16 $ 160 $ 439 $ 4 Retained interests 2,904 2,337 2,701 Derivative assets (fair Sales of corporate loans to CLO SPEs1, 2 317 191 475 value) $ 1 $ — $ — $ 226 Derivative liabilities (fair 1. Net gains on new transactions and sales of corporate loans to CLO entities at the value) — — — 85 time of the sale were not material for all periods presented. 2. Sponsored by non-affiliates. RML—Residential mortgage loans CML—Commercial mortgage loans The Firm has provided, or otherwise agreed to be responsible 1. Amounts include CLO transactions managed by unrelated third parties. 2. Amounts include assets transferred by unrelated transferors. for, representations and warranties regarding certain assets transferred in securitization transactions sponsored by the Firm (see Note 12).
137 December 2018 Form 10-K
− 375 − Notes to Consolidated Financial Statements
Assets Sold with Retained Exposure • The Common Equity Tier 1 G-SIB capital surcharge, At At currently at 3%; and December 31, December 31, $ in millions 2018 2017 • Up to a 2.5% Common Equity Tier 1 CCyB, currently set Gross cash proceeds from sale of assets1 $ 27,121 $ 19,115 Fair value by U.S. banking agencies at zero. Assets sold $ 26,524 $ 19,138 Derivative assets recognized in the In 2018 and 2017, each of the buffers was 75% and 50%, balance sheets 164 176 respectively, of the fully phased-in 2019 requirement noted Derivative liabilities recognized in the balance sheets 763 153 above. Failure to maintain the buffers would result in restric- tions on the Firm’s ability to make capital distributions, 1. The carrying value of assets derecognized at the time of sale approximates gross cash proceeds. including the payment of dividends and the repurchase of stock, and to pay discretionary bonuses to executive officers. The Firm enters into transactions in which it sells securities, primarily equities and contemporaneously enters into bilateral Risk-Weighted Assets OTC derivatives with the purchasers of the securities, through which it retains exposure to the sold securities. RWA reflects both the Firm’s on- and off-balance sheet risk, as well as capital charges attributable to the risk of loss arising from the following: 14. Regulatory Requirements • Credit risk: The failure of a borrower, counterparty or Regulatory Capital Framework issuer to meet its financial obligations to the Firm; The Firm is an FHC under the Bank Holding Company Act of • Market risk: Adverse changes in the level of one or more 1956, as amended, and is subject to the regulation and over- market prices, rates, indices, volatilities, correlations or sight of the Board of Governors of the Federal Reserve System other market factors, such as market liquidity; and (“Federal Reserve”). The Federal Reserve establishes capital requirements for the Firm, including well-capitalized stan- • Operational risk: Inadequate or failed processes or systems, dards, and evaluates the Firm’s compliance with such capital from human factors or from external events (e.g., fraud, requirements. The OCC establishes similar capital require- theft, legal and compliance risks, cyber attacks or damage ments and standards for MSBNA and MSPBNA (collectively, to physical assets). the “U.S. Bank Subsidiaries”). The regulatory capital require- ments are largely based on the Basel III capital standards The Firm’s risk-based capital ratios for purposes of deter- established by the Basel Committee on Banking Supervision mining regulatory compliance are the lower of the capital and also implement certain provisions of the Dodd-Frank Wall ratios computed under (i) the standardized approaches for Street Reform and Consumer Protection Act. calculating credit risk and market risk RWA (“Standardized Approach”) and (ii) the applicable advanced approaches for Regulatory Capital Requirements calculating credit risk, market risk and operational risk RWA The Firm is required to maintain minimum risk-based and (“Advanced Approach”). At December 31, 2018, the Firm’s leverage-based capital ratios under regulatory capital require- risk-based capital ratios are based on the Standardized ments. A summary of the calculations of regulatory capital, Approach rules, while at December 31, 2017, the ratios were RWA and transition provisions follows. based on the Standardized Approach transitional rules.
Minimum risk-based capital ratio requirements apply to The Firm’s Regulatory Capital and Capital Ratios
Common Equity Tier 1 capital, Tier 1 capital and Total At December 31, 2018 capital (which includes Tier 2 capital). Certain adjustments to Required and deductions from capital are required for purposes of $ in millions Ratio1 Amount Ratio determining these ratios, such as goodwill, intangible assets, Risk-based capital Common Equity Tier 1 capital 8.6% $ 62,086 16.9% certain deferred tax assets, other amounts in AOCI and Tier 1 capital 10.1% 70,619 19.2% investments in the capital instruments of unconsolidated Total capital 12.1% 80,052 21.8% financial institutions. Total RWA 367,309 In addition to the minimum risk-based capital ratio require- Leverage-based capital Tier 1 leverage 4.0% $ 70,619 8.4% ments, the Firm is subject to the following buffers in 2019: Adjusted average assets2 843,074 • A greater than 2.5% Common Equity Tier 1 capital conser- SLR3 5.0% 70,619 6.5% vation buffer; Supplementary leverage exposure4 1,092,672
December 2018 Form 10-K 138
− 376 − Notes to Consolidated Financial Statements
At December 31, 2017 MSBNA’s Regulatory Capital Required $ in millions Ratio1 Amount Ratio5 At December 31, 2018 Risk-based capital Required Common Equity Tier 1 capital 7.3% $ 61,134 16.5% $ in millions Ratio1 Amount Ratio Tier 1 capital 8.8% 69,938 18.9% Risk-based capital Total capital 10.8% 80,275 21.7% Common Equity Tier 1 capital 6.5% $ 15,221 19.5% Total RWA 369,578 Tier 1 capital 8.0% 15,221 19.5% Total capital Leverage-based capital 10.0% 15,484 19.8% Tier 1 leverage 4.0% $ 69,938 8.3% Leverage-based capital Tier 1 leverage 5.0% $ 15,221 10.5% Adjusted average assets2 842,270 SLR2 6.0% 15,221 8.2% 1. Percentages represent minimum required regulatory capital ratios—for risk-based capital, the ratios are under the transitional rules. At December 31, 2017 2. Adjusted average assets represents the denominator of the Tier 1 leverage ratio and is composed of the average daily balance of consolidated on-balance sheet Required $ in millions Ratio1 Amount Ratio3 assets under U.S. GAAP during the quarters ended December 31, 2018 and December 31, 2017, adjusted for disallowed goodwill, intangible assets, certain Risk-based capital deferred tax assets, certain investments in the capital instruments of unconsoli- Common Equity Tier 1 capital 6.5% $ 15,196 20.5% dated financial institutions and other adjustments. Tier 1 capital 8.0% 15,196 20.5% 3. The SLR became effective as a capital standard on January 1, 2018. 4. Supplementary leverage exposure is the sum of Adjusted average assets used in Total capital 10.0% 15,454 20.8% the Tier 1 leverage ratio and other adjustments, primarily (i) potential future expo- Leverage-based capital sure for derivative exposures, gross-up for cash collateral netting where qualifying Tier 1 leverage 5.0% $ 15,196 11.8% criteria are not met, and the effective notional principal amount of sold credit protec- tion offset by qualifying purchased credit protection; (ii) the counterparty credit risk for repo-style transactions; and (iii) the credit equivalent amount for off-balance MSPBNA’s Regulatory Capital sheet exposures. 5. For risk- and leverage-based capital, regulatory compliance at December 31, 2017 At December 31, 2018 was determined based on capital ratios calculated under transitional rules. Required $ in millions Ratio1 Amount Ratio U.S. Bank Subsidiaries’ Regulatory Capital and Capital Risk-based capital Ratios Common Equity Tier 1 capital 6.5% $ 7,183 25.2% Tier 1 capital 8.0% 7,183 25.2% The OCC establishes capital requirements for the Firm’s U.S. Total capital 10.0% 7,229 25.4% Bank Subsidiaries and evaluates their compliance with such Leverage-based capital capital requirements. Regulatory capital requirements for the Tier 1 leverage 5.0% $ 7,183 10.0% 2 U.S. Bank Subsidiaries are calculated in a similar manner to SLR 6.0% 7,183 9.6% the Firm’s regulatory capital requirements, although G-SIB At December 31, 2017 capital surcharge requirements do not apply to the U.S. Bank Required Subsidiaries. $ in millions Ratio1 Amount Ratio3 Risk-based capital The OCC’s regulatory capital framework includes Prompt Common Equity Tier 1 capital 6.5% $ 6,215 24.4% Corrective Action (“PCA”) standards, including “well- Tier 1 capital 8.0% 6,215 24.4% capitalized” PCA standards that are based on specified regu- Total capital 10.0% 6,258 24.6% Leverage-based capital latory capital ratio minimums. For the Firm to remain an Tier 1 leverage 5.0% $ 6,215 9.7% FHC, the U.S. Bank Subsidiaries must remain well- 1. Ratios that are required in order to be considered well-capitalized for U.S. regula- capitalized in accordance with the OCC’s PCA standards. In tory purposes. addition, failure by the U.S. Bank Subsidiaries to meet 2. The SLR became effective as a capital standard on January 1, 2018. minimum capital requirements may result in certain manda- 3. For risk- and leverage-based capital, regulatory compliance at December 31, 2017 was determined based on capital ratios calculated under transitional rules. tory and discretionary actions by regulators that, if under- taken, could have a direct material effect on the U.S. Bank U.S. Broker-Dealer Regulatory Capital Requirements Subsidiaries’ and the Firm’s financial statements. MS&Co. Regulatory Capital At December 31, 2018, the U.S. Bank Subsidiaries’ risk- based capital ratios are based on the Standardized Approach $ in millions At December 31, 2018 At December 31, 2017 rules, while at December 31, 2017, the ratios were based on Net capital $ 13,797 $ 10,142 Excess net capital 11,333 8,018 the Standardized Approach transitional rules. In each period, the ratios exceeded well-capitalized requirements.
139 December 2018 Form 10-K
− 377 − Notes to Consolidated Financial Statements
MS&Co. is a registered U.S. broker-dealer and registered Restrictions on Payments futures commission merchant and, accordingly, is subject to the minimum net capital requirements of the SEC and the The regulatory capital requirements referred to above, and CFTC. MS&Co. has consistently operated with capital in certain covenants contained in various agreements governing excess of its regulatory capital requirements. indebtedness of the Firm, may restrict the Firm’s ability to withdraw capital from its subsidiaries. The following table As an Alternative Net Capital broker-dealer, and in accor- represents net assets of consolidated subsidiaries that may be dance with the market and credit risk standards of Appendix restricted as to the payment of cash dividends and advances E of SEC Rule 15c3-1, MS&Co. is subject to minimum net to the Parent Company. capital and tentative net capital requirements. In addition, At At MS&Co. must notify the SEC if its tentative net capital falls December 31, December 31, below certain levels. At December 31, 2018 and $ in millions 2018 2017 December 31, 2017, MS&Co. has exceeded its net capital Restricted net assets $ 29,222 $ 29,894 requirement and has tentative net capital in excess of the minimum and notification requirements. 15. Total Equity MSSB LLC Regulatory Capital
$ in millions At December 31, 2018 At December 31, 2017 Morgan Stanley Shareholders’ Equity Net capital $ 3,455 $ 2,567 Common Stock Excess net capital 3,313 2,400 Rollforward of Common Stock Outstanding MSSB LLC is a registered U.S. broker-dealer and introducing in millions 2017 broker for the futures business and, accordingly, is subject to 2018 Shares outstanding at beginning of period 1,852 the minimum net capital requirements of the SEC. MSSB 1,788 Treasury stock purchases1 (92) LLC has consistently operated with capital in excess of its (110) Other2 28 regulatory capital requirements. 22 Shares outstanding at end of period 1,700 1,788
Other Regulated Subsidiaries 1. The Firm’s Board has authorized the repurchase of the Firm’s outstanding stock under a share repurchase program (“Share Repurchase Program”). In addition to the Firm’s Share Repurchase Program, Treasury stock purchases MSIP, a London-based broker-dealer subsidiary, is subject to include repurchases of common stock for employee tax withholding. the capital requirements of the PRA, and MSMS, a Tokyo- 2. Other includes net shares issued to and forfeited from Employee stock trusts based broker-dealer subsidiary, is subject to the capital and issued for RSU conversions. requirements of the Financial Services Agency. MSIP and MSMS have consistently operated with capital in excess of Share Repurchases their respective regulatory capital requirements. $ in millions 2018 2017 Repurchases of common stock under the Certain other U.S. and non-U.S. subsidiaries of the Firm are Firm’s Share Repurchase Program $ 4,860 $ 3,750 subject to various securities, commodities and banking regu- lations, and capital adequacy requirements promulgated by The Firm’s 2018 Capital Plan (“Capital Plan”) includes the the regulatory and exchange authorities of the countries in share repurchase of up to $4.7 billion of outstanding common which they operate. These subsidiaries have consistently stock for the period beginning July 1, 2018 through June 30, operated with capital in excess of their local capital adequacy 2019. Additionally, the Capital Plan includes quarterly requirements. common stock dividends of up to $0.30 per share.
December 2018 Form 10-K 140
− 378 − Notes to Consolidated Financial Statements
On April 18, 2018, the Firm entered into a sales plan with The Firm is authorized to issue 30 million shares of preferred MUFG, whereby MUFG sells shares of the Firm’s common stock. The preferred stock has a preference over the common stock to the Firm, as part of the Firm’s Share Repurchase stock upon liquidation. The Firm’s preferred stock qualifies Program. The sales plan is only intended to maintain as Tier 1 capital in accordance with regulatory capital MUFG’s ownership percentage below 24.9% in order to requirements (see Note 14). comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System and will have no impact on the strategic alliance between MUFG and the Firm, Preferred Stock Issuance Description including the joint ventures in Japan. Redemption Depositary Shares Shares Price Pursuant to the Share Repurchase Program, the Firm Series1, 2 Issued per Share per Share3 Date4 considers, among other things, business segment capital A 44,000 1,000 $ 25,000 July 15, 2011 needs, as well as stock-based compensation and benefit plan C5 1,160,791 N/A 1,100 October 15, 2011 requirements. Share repurchases under the program will be E 34,500 1,000 25,000 October 15, 2023 exercised from time to time at prices the Firm deems appro- F 34,000 1,000 25,000 January 15, 2024 priate subject to various factors, including the Firm’s capital G 20,000 1,000 25,000 July 15, 2019 position and market conditions. The share repurchases may H 52,000 25 25,000 July 15, 2019 be effected through open market purchases or privately nego- I 40,000 1,000 25,000 October 15, 2024 tiated transactions, including through Rule 10b5-1 plans, and J 60,000 25 25,000 July 15, 2020 may be suspended at any time. Share repurchases by the Firm K 40,000 1,000 25,000 April 15, 2027 are subject to regulatory approval. 1. All shares issued are non-cumulative. Each share has a par value of $0.01, except Series C. Employee Stock Trusts 2. Dividends on Series A are based on a floating rate, and dividends on Series C and G are based on a fixed rate. Dividends on all other Series are based The Firm has established Employee stock trusts to provide on a fixed-to-floating rate. common stock voting rights to certain employees who hold 3. Series A and C are redeemable at the redemption price plus accrued and unpaid dividends, regardless of whether dividends are actually declared, up outstanding RSUs. The assets of the Employee stock trusts to but excluding the date of redemption. All other Series are redeemable at are consolidated with those of the Firm, and the value of the the redemption price plus any declared and unpaid dividends, up to but stock held in the Employee stock trusts is classified in excluding the date fixed for redemption. 4. Series A and C are redeemable at the Firm’s option, in whole or in part, on or Morgan Stanley shareholders’ equity and generally accounted after the redemption date. All other Series are redeemable at the Firm’s for in a manner similar to treasury stock. option (i) in whole or in part, from time to time, on any dividend payment date on or after the redemption date or (ii) in whole but not in part at any time Preferred Stock Outstanding within 90 days following a regulatory capital treatment event (as described in the terms of that series). Shares 5. Series C is non-voting perpetual preferred stock. Dividends on the Series C Outstanding Carrying Value preferred stock are payable, on a non-cumulative basis, as and if declared by the Board, in cash, at the rate of 10% per annum of the liquidation preference $ in millions, At Liquidation At At except per December 31, Preference December 31, December 31, of $1,000 per share. share data 2018 per Share 2018 2017 Series Preferred Stock Dividends A 44,000 $ 25,000 $ 1,100 $ 1,100 2018 2017 2016 C1 519,882 1,000 408 408 $ in millions, E 34,500 25,000 862 862 except per Per Per Per share data Share1 Total Share1 Total Share1 Total F 34,000 25,000 850 850 Series G 20,000 25,000 500 500 A $ 1,011 $ 45 $ 1,014 $ 45 $ 1,017 $ 45 H 52,000 25,000 1,300 1,300 C 100 52 100 52 100 52 I 40,000 25,000 1,000 1,000 E 1,781 61 1,781 61 1,781 62 J 60,000 25,000 1,500 1,500 F 1,719 58 1,719 58 1,719 58 K 40,000 25,000 1,000 1,000 G 1,656 33 1,656 33 1,656 33 Total $ 8,520 $ 8,520 H 1,363 71 1,363 71 1,363 71 1. Series C is composed of the issuance of 1,160,791 shares of Series C I 1,594 64 1,594 64 1,594 64 Preferred Stock to MUFG for an aggregate purchase price of $911 million, less the redemption of 640,909 shares of Series C Preferred Stock of $503 million, J 1,388 83 1,388 83 1,388 83 which were converted to common shares of approximately $705 million. K 1,463 59 1,402 56 N/A N/A Total $ 526 $ 523 $ 468
1. Dividends on all series are payable quarterly, except for Series H and J, which are payable semiannually until July 15, 2019 and July 15, 2020, respectively, and then quarterly thereafter.
141 December 2018 Form 10-K
− 379 − Notes to Consolidated Financial Statements
2017 Comprehensive Income (Loss) Income Pre-tax Tax After-tax Non- Gain Benefit Gain controlling 1 Accumulated Comprehensive Income (Loss) $ in millions (Loss) (Provision) (Loss) Interests Net Foreign currency translation adjustments Foreign Currency Pensions, OCI activity $ 64 $ 187 $ 251 $ 32 $ 219 Translation Postretirement $ in millions Adjustments AFS Securities and Other DVA Total Reclassified to earnings — — — — — December 31, 2015 $ (963) $ (319) $ (374) $ — $ (1,656) Net OCI $ 64 $ 187 $ 251 $ 32 $ 219 Cumulative adjustment for accounting change2 — — — (312) (312) Change in net unrealized gains (losses) on AFS securities OCI during the period (23) (269) (100) (283) (675) OCI activity $ 100 $ (36) $ 64 $ — $ 64 December 31, 2016 (986) (588) (474) (595) (2,643) Reclassified to earnings (35) 12 (23) — (23) OCI during the period 219 41 (117) (560) (417) Net OCI $ 65 $ (24) $ 41 $ — $ 41 December 31, 2017 (767) (547) (591) (1,155) (3,060) Cumulative adjustment Pension, postretirement and other for accounting changes3 (8) (111) (124) (194) (437) OCI activity $ (193) $ 75 $ (118) $ — $(118) OCI during the period (114) (272) 137 1,454 1,205 Reclassified to earnings 2 (1) 1 — 1 December 31, 2018 $ (889) $ (930) $ (578)$ 105 $ (2,292) Net OCI $ (191) $ 74 $ (117) $ — $(117) 1. Amounts are net of tax and noncontrolling interests. 2. In accordance with the early adoption of a provision of the accounting update Recognition Change in net DVA and Measurement of Financial Assets and Financial Liabilities, a cumula- OCI activity $ (922) $ 325 $ (597) $ (28) $(569) tive catch-up adjustment was recorded as of January 1, 2016, to move the cumulative Reclassified to earnings 12 (3) 9 — 9 unrealized DVA amount related to outstanding liabilities under the fair value option elec- tion from Retained earnings into AOCI. Net OCI $ (910) $ 322 $ (588) $ (28) $(560) 3. The cumulative adjustment for accounting changes is primarily the effect of the adoption of the accounting update Reclassification of Certain Tax Effects from Accumulated Other 20162 Comprehensive Income. This adjustment was recorded as of January 1, 2018 to reclassify Income certain income tax effects related to enactment of the Tax Act from AOCI to Retained Pre-tax Tax After-tax Non- earnings, primarily related to the remeasurement of deferred tax assets and liabilities Gain Benefit Gain controlling $ in millions (Loss) (Provision) (Loss) Interests Net resulting from the reduction in the corporate income tax rate to 21%. See Note 2 for further information. Foreign currency translation adjustments OCI activity $ (24) $ 9 $ (15) $ 12 $ (27) Components of Period Changes in OCI Reclassified to earnings 4 — 4 — 4 Net OCI $ (20) $ 9 $ (11) $ 12 $ (23) 20181 Pre-tax Income After-tax Non- Change in net unrealized gains (losses) on AFS securities Gain Tax Benefit Gain controlling OCI activity $ (313) $ 116 $ (197) $ — $(197) $ in millions (Loss) (Provision) (Loss) Interests Net Foreign currency translation adjustments Reclassified to earnings (113) 41 (72) — (72) OCI activity $ (11) $ (79) $ (90) $ 24 $ (114) Net OCI $ (426) $ 157 $ (269) $ — $(269) Reclassified to earnings ————— Pension, postretirement and other Net OCI $ (11) $ (79) $ (90) $ 24 $ (114) OCI activity $ (162) $ 64 $ (98) $ — $ (98)
Change in net unrealized gains (losses) on AFS securities Reclassified to earnings (3) 1 (2) — (2) OCI activity $ (346) $ 80 $ (266) $ — $ (266) Net OCI $ (165) $ 65 $ (100) $ — $(100) Reclassified to earnings (8) 2 (6) — (6) Change in net DVA Net OCI $ (354) $ 82 $ (272) $ — $ (272) OCI activity $ (429) $ 153 $ (276) $ (13) $(263)
Pension, postretirement and other Reclassified to earnings (31) 11 (20) — (20) OCI activity $ 156 $ (37) $ 119 $ — $ 119 Net OCI $ (460) $ 164 $ (296) $ (13) $(283) Reclassified to earnings 26 (8) 18 — 18 1. Exclusive of cumulative adjustments related to the adoption of certain accounting updates Net OCI $ 182 $ (45) $ 137 $ — $ 137 in 2018. Refer to the table below and Note 2 for further information. 2. Exclusive of 2016 cumulative adjustment for accounting change related to DVA. Change in net DVA OCI activity $1,947 $ (472) $ 1,475 $ 63 $1,412 Cumulative Adjustments to Retained Earnings Related to Reclassified to earnings 56 (14) 42 — 42 Adoption of Accounting Updates Net OCI $2,003 $ (486) $ 1,517 $ 63 $1,454 $ in millions 2018 Revenues from contracts with customers $ (32) Derivatives and hedging—targeted improvements to accounting for hedging activities (99) Reclassification of certain tax effects from AOCI 443 Other1 (6) Total $ 306
December 2018 Form 10-K 142
− 380 − Notes to Consolidated Financial Statements $ in millions 2017 16. Earnings per Common Share Improvements to employee share-based payment accounting2 $ (30) Intra-entity transfers of assets other than inventory (5) Calculation of Basic and Diluted EPS
Total $ (35) in millions, except for per share data 2018 2017 2016
1. Other includes the adoption of accounting updates related to Recognition and Measure- Income from continuing operations $ 8,887 $ 6,235 $ 6,122 ment of Financial Assets and Financial Liabilities (other than the provision around Income (loss) from discontinued operations (4) (19) 1 presenting unrealized DVA in OCI, which the Firm early adopted in 2016) and Net income 8,883 6,216 6,123 Derecognition of Nonfinancial Assets. The impact of these adoptions on Retained earn- ings was not significant. Net income applicable to noncontrolling 2. In 2017, in accordance with the adoption of a provision of the accounting update interests 135 105 144 Improvements to Employee Share-Based Payment Accounting, the Firm has elected to Net income applicable to Morgan Stanley 8,748 6,111 5,979 account for forfeitures on an actual basis as they occur. Upon adoption, the Firm recorded Preferred stock dividends and other 526 523 471 a cumulative catch-up adjustment. Earnings applicable to Morgan Stanley common shareholders $ 8,222 $ 5,588 $ 5,508 Cumulative Foreign Currency Translation Adjustments Basic EPS Cumulative foreign currency translation adjustments include Weighted average common shares gains or losses resulting from translating foreign currency outstanding 1,708 1,780 1,849 Earnings per basic common share financial statements from their respective functional curren- Income from continuing operations $ 4.81 $ 3.15 $ 2.98 cies to U.S. dollars, net of hedge gains or losses and related Income (loss) from discontinued operations — (0.01) — tax effects. The Firm uses foreign currency contracts to Earnings per basic common share $ 4.81 $ 3.14 $ 2.98 manage the currency exposure relating to its net investments Diluted EPS in non-U.S. dollar functional currency subsidiaries and deter- Weighted average common shares mines the amount of exposure to hedge on a pre-tax basis. outstanding 1,708 1,780 1,849 The Firm may also elect not to hedge its net investments in Effect of dilutive securities: certain foreign operations due to market conditions or other Stock options and RSUs 30 41 38 Weighted average common shares reasons, including the availability of various currency outstanding and common stock contracts at acceptable costs. Information relating to the equivalents 1,738 1,821 1,887 effects on cumulative foreign currency translation adjust- Earnings per diluted common share ments that resulted from the translation of foreign currency Income from continuing operations $ 4.73 $ 3.08 $ 2.92 financial statements and from gains and losses from hedges Income (loss) from discontinued operations — (0.01) — of the Firm’s net investments in non-U.S. dollar functional Earnings per diluted common share $ 4.73 $ 3.07 $ 2.92 Weighted average antidilutive RSUs and currency subsidiaries is summarized in the following table. stock options (excluded from the computation of diluted EPS) 1 —13 Cumulative Foreign Currency Translation Adjustments
At At December 31, December 31, $ in millions 2018 2017 Associated with net investments in subsidiaries with a non-U.S. dollar functional currency $ (1,851) $ (1,434) Hedges, net of tax 962 667 Total $ (889) $ (767) Carrying value of net investments in non-U.S. dollar functional currency subsidiaries subject to hedges $ 11,608 $ 10,139
143 December 2018 Form 10-K
− 381 − Notes to Consolidated Financial Statements 17. Interest Income and Interest Expense Tax Benefit Related to Stock-Based Compensation Expense
$ in millions 2018 2017 2016 $ in millions 2018 2017 2016 Interest income Tax benefit1 $ 193 $ 225 $ 381 Investment securities $ 1,744 $ 1,334 $ 1,142 Loans 4,249 3,298 2,724 1. Excludes income tax consequences related to employee share-based Securities purchased under agreements award conversions. to resell and Securities borrowed1 1,976 169 (374) Trading assets, net of Trading liabilities 2,392 2,029 2,131 Unrecognized Compensation Cost Related to Unvested Customer receivables and Other2 3,531 2,167 1,393 Stock-Based Awards Total interest income $ 13,892 $ 8,997 $ 7,016 At December 31, Interest expense $ in millions 20181 Deposits $ 1,255 $ 187 $ 83 To be recognized in: Borrowings 5,031 4,285 3,606 2019 $ 364 Securities sold under agreements to repurchase and Securities loaned3 1,898 1,237 977 2020 167 Customer payables and Other4 1,902 (12) (1,348) Thereafter 30 Total interest expense $ 10,086 $ 5,697 $ 3,318 Total $ 561 Net interest $ 3,806 $ 3,300 $ 3,698 1. Amounts do not include forfeitures, cancellations, accelerations or 2018 1. Includes fees paid on Securities borrowed. performance year compensation awarded in January 2019, which will 2. Includes interest from Customer receivables and Cash and cash equivalents. begin to be amortized in 2019 (see the Annual Compensation Cost for 3. Includes fees received on Securities loaned. 2018 Performance Year Awards table herein). 4. Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions. In connection with awards under its stock-based compensa- Interest income and Interest expense are classified in the tion plans, the Firm is authorized to issue shares of common income statements based on the nature of the instrument and stock held in treasury or newly issued shares. related market conventions. When included as a component The Firm generally uses treasury shares, if available, to of the instrument’s fair value, interest is included within deliver shares to employees or employee stock trusts, and has Trading revenues or Investments revenues. Otherwise, it is an ongoing repurchase authorization that includes repur- included within Interest income or Interest expense. chases in connection with awards under its stock-based compensation plans. Share repurchases by the Firm are subject to regulatory approval. 18. Deferred Compensation Plans Common Shares Available for Future Awards under Stock- Stock-Based Compensation Plans Based Compensation Plans
Stock-Based Compensation Expense At December 31, $ in millions 2018 2017 2016 in millions 2018 RSUs $ 892 $ 951 $ 1,054 Shares 138 Stock options — —2 PSUs 28 75 81 See Note 15 for additional information on the Firm’s Share Total1 $ 920 $ 1,026 $ 1,137 Repurchase Program. Includes: Restricted Stock Units Retirement-eligible awards2 $ 110 $85$73 RSUs are subject to vesting over time, generally one to four 1. Net of cancellations. years from the date of award, contingent upon continued 2. Relates to stock-based compensation anticipated to be awarded in employment and subject to restrictions on sale, transfer or January of the following year that does not contain a future service assignment until conversion to common stock. All or a requirement. portion of an award may be canceled if employment is termi- nated before the end of the relevant vesting period and after the relevant vesting period in certain situations. Recipients of RSUs may have voting rights, at the Firm’s discretion, and generally receive dividend equivalents if the awards vest.
December 2018 Form 10-K 144
− 382 − Notes to Consolidated Financial Statements
Vested and Unvested RSU Activity PSU Fair Value on Award Date
2018 2018 2017 2016 Weighted MS Adjusted ROE $ 56.84 $ 42.64 $ 25.19 Average Relative MS TSR 65.81 48.02 24.51 Number of Award Date shares in millions Shares Fair Value RSUs at beginning of period 88 $ 32.46 The Relative MS TSR fair values on the award date were esti- Awarded 20 55.40 mated using a Monte Carlo simulation and the following Conversions to common stock (32) 34.36 assumptions. Canceled (2) 37.78 Monte Carlo Simulation Assumptions RSUs at end of period1 74 $ 37.59 Expected Aggregate intrinsic value of RSUs at Risk-Free Stock Price Correlation end of period (dollars in millions) $ 2,899 Award Year Interest Rate Volatility Coefficient Weighted average award date fair value 2018 2.2% 26.8% 0.89 RSUs awarded in 2017 $ 42.98 2017 1.5% 27.0% 0.89 RSUs awarded in 2016 25.48 2016 1.1% 25.4% 0.84
1. At December 31, 2018, the weighted average remaining term until The risk-free interest rate was determined based on the yields delivery for the outstanding RSUs was approximately 1.0 year. available on U.S. Treasury zero-coupon issues. The expected Unvested RSU Activity stock price volatility was determined using historical vola- tility. The correlation coefficient was developed based on 2018 historical price data of the Firm and the S&P 500 Financials Weighted Average Sector Index. The model also uses an expected dividend yield Number of Award Date which is calibrated to be equivalent to reinvesting dividends. shares in millions Shares Fair Value Unvested RSUs at beginning of period 50 $ 33.64 Deferred Cash-Based Compensation Plans Awarded 20 55.40 Vested (27) 38.43 Deferred cash-based compensation plans generally provide a Canceled (2) 37.78 return to the plan participants based upon the performance of Unvested RSUs at end of period1 41 $ 40.65 each participant’s referenced investments. Deferred Cash-Based Compensation Expense 1. Unvested RSUs represent awards where recipients have yet to satisfy either the explicit vesting terms or retirement-eligible requirements. $ in millions 2018 2017 2016 Deferred cash-based awards $ 1,174 $ 1,039 $ 950 Fair Value of RSU Activity Return on referenced investments 108 696 228 $ in millions 2018 2017 2016 Total1 $ 1,282 $ 1,735 $ 1,178 Conversions to common stock $ 1,790 $ 1,333 $ 1,068 Includes: Vested 1,504 1,470 1,088 Retirement-eligible awards2 $ 193 $ 176 $ 151
Performance-Based Stock Units 1. Net of cancellations. 2. Relates to deferred cash-based compensation anticipated to be PSUs will vest and convert to shares of common stock only if awarded in January of the following year that does not contain a future service requirement. the Firm satisfies predetermined performance and market- based conditions over a three-year performance period. The Unrecognized Compensation Cost Related to Unvested number of PSUs that will actually vest ranges from 0% to Deferred Cash-Based Awards 150% of the target award, based on the extent to which the At Firm achieves the specified performance goals. One-half of December 31, 1 the award will be earned based on the Firm’s average return $ in millions 2018 To be recognized in: on equity, excluding certain adjustments specified in the plan 2019 $ 423 terms (“MS Adjusted ROE”). The other half of the award will 2020 151 be earned based on the Firm’s total shareholder return, rela- Thereafter 227 tive to the total shareholder return of the S&P 500 Financials Total $ 801 Sector Index (“Relative MS TSR”). PSUs have vesting, 1. Amounts do not include forfeitures, cancellations, accelerations, future restriction and cancellation provisions that are generally return on referenced investments or 2018 performance year compensa- similar to those of RSUs. At December 31, 2018, approxi- tion awarded in January 2019, which will begin to be amortized in 2019 mately three million PSUs were outstanding. (see below).
145 December 2018 Form 10-K
− 383 − Notes to Consolidated Financial Statements
Annual Compensation Cost for 2018 Performance Year The Firm’s pension plans generally provide pension benefits Awards1 that are based on each employee’s years of credited service and on compensation levels specified in the plans. $ in millions 2019 2020 Thereafter Total Stock-based awards $ 558 $ 197 $ 151 $ 906 The Firm has an unfunded postretirement benefit plan that Deferred cash-based awards 630 284 122 1,036 provides medical and life insurance for eligible U.S. retirees Total $ 1,188 $ 481 $ 273 $ 1,942 and medical insurance for their dependents.
1. Awarded in January 2019 and contain a future service requirement. Amounts do not include forfeitures, cancellations, accelerations, or Rollforward of Pre-tax AOCI future return on referenced investments. Pension Plans $ in millions 2018 2017 2016 19. Employee Benefit Plans Beginning balance $ (947) $ (761) $ (625) Net gain (loss) 158 (205) (149) Pension and Other Postretirement Plans Prior service credit (cost) (15) 21 Components of Net Periodic Benefit Expense (Income) Amortization of prior service credit (1) ——
Pension Plans Amortization of net loss 26 17 12 $ in millions 2018 2017 2016 Changes recognized in OCI 168 (186) (136) Service cost, benefits earned during the Ending balance $ (779) $ (947) $ (761) period $16$16$17 Interest cost on projected benefit Other Postretirement Plan obligation 134 146 150 $ in millions 2018 2017 2016 Expected return on plan assets (112) (117) (122) Beginning balance $ 1 $ 17 $ 36 Net amortization of prior service credit (1) —— Net gain (loss) 13 — (2) Net amortization of actuarial loss 26 17 12 Amortization of prior service credit (1) (16) (17) Net periodic benefit expense (income) $ 63 $62$57 Changes recognized in OCI 12 (16) (19) Other Postretirement Plan Ending balance $ 13 $1$17 $ in millions 2018 2017 2016 Service cost, benefits earned during the The Firm generally amortizes into net periodic benefit period $1$1$1 expense (income) the unrecognized net gains and losses Interest cost on projected benefit exceeding 10% of the greater of the projected benefit obliga- obligation 3 34tion or the market-related value of plan assets. The U.S. Net amortization of prior service credit (1) (16) (17) pension plans amortize the unrecognized net gains and losses Net periodic benefit expense (income) $ 3 $ (12) $ (12) over the average life expectancy of participants. The remaining plans generally amortize the unrecognized net Certain U.S. employees of the Firm and its U.S. affiliates gains and losses and prior service credit over the average who were hired before July 1, 2007 are covered by the U.S. remaining service period of active participants. pension plan, a non-contributory defined benefit pension plan that is qualified under Section 401(a) of the Internal Revenue Weighted Average Assumptions Used to Determine Net Periodic Benefit Expense (Income) Code (“U.S. Qualified Plan”). The U.S. Qualified Plan has ceased future benefit accruals. Pension Plans 2018 2017 2016 Unfunded supplementary plans (“Supplemental Plans”) cover Discount rate 3.46% 4.01% 4.27% certain executives. Liabilities for benefits payable under the Supplemental Plans are accrued by the Firm and are funded Expected long-term rate of return on plan assets 3.50% 3.52% 3.61% when paid. The Morgan Stanley Supplemental Executive Retirement and Excess Plan (“SEREP”), a non-contributory Rate of future compensation increases 3.38% 3.10% 3.19% defined benefit plan that is not qualified under Section 401(a) of the Internal Revenue Code, has ceased future benefit Other Postretirement Plan accruals. 2018 2017 2016 Discount rate 3.44% 4.01% 4.13% Certain of the Firm’s non-U.S. subsidiaries also have defined benefit pension plans covering their eligible employees.
December 2018 Form 10-K 146
− 384 − Notes to Consolidated Financial Statements
The accounting for pension and other postretirement plans Pension Plans with Benefit Obligations in Excess of the Fair involves certain assumptions and estimates. The expected Value of Plan Assets long-term rate of return for the U.S. Qualified Plan was esti- At At mated by computing a weighted average of the underlying December 31, December 31, long-term expected returns based on the investment manag- $ in millions 2018 2017 ers’ target allocations. Projected benefit obligation $ 575 $ 3,676 Accumulated benefit obligation 559 3,663 Benefit Obligation and Funded Status Fair value of plan assets 64 3,091
Rollforward of the Benefit Obligation and Fair Value of Plan The pension plans included in each of the above amounts Assets may differ based on their funding status as of December 31st Other Postretirement of each year. Pension Plans Plan $ in millions 2018 2017 2018 2017 Weighted Average Assumptions Used to Determine Benefit Rollforward of benefit obligation Obligation Benefit obligation at beginning of year $ 3,966 $ 3,711 $ 86 $ 88 Pension Plans Other Postretirement Plan Service cost 16 16 1 1 At At At At December 31, December 31, December 31, December 31, Interest cost 134 146 3 3 2018 2017 2018 2017 1 Actuarial loss (gain) (340) 304 (13) — Discount rate 4.01% 3.46% 4.07% 3.44% Plan amendments 15 (2) — — Rate of future Plan settlements (11) (9) — — compensation increase 3.34% 3.38% N/A N/A Benefits paid (195) (242) (6) (6) Other2 (22) 42 — — The discount rates used to determine the benefit obligation Benefit obligation at for the U.S. pension and postretirement plans were selected end of year $ 3,563 $ 3,966 $71$86 by the Firm, in consultation with its independent actuaries, Rollforward of fair value of plan assets using a pension discount yield curve based on the characteris- Fair value of plan assets tics of the plans, each determined independently. The pension at beginning of year $ 3,468 $ 3,431 $ — $ — discount yield curve represents spot discount yields based on Actual return on plan assets (69) 217 — — duration implicit in a representative broad-based Aa-rated Employer contributions 34 32 6 6 corporate bond universe of high-quality fixed income invest- Benefits paid (195) (242) (6) (6) ments. For all non-U.S. pension plans, the Firm set the Plan settlements (11) (9) — — assumed discount rates based on the nature of liabilities, local Other2 (24) 39 — — economic environments and available bond indices. Fair value of plan Assumed Health Care Cost Trend Rates Used to Determine assets at end of year $ 3,203 $ 3,468 $—$— the U.S. Postretirement Benefit Obligation Funded (unfunded) status $ (360) $ (498) $ (71) $ (86) At At December 31, December 31, Amounts recognized in the balance sheets 2018 2017 Assets $ 151 $87$—$— Health care cost trend rate assumed for next year Liabilities (511) (585) (71) (86) Medical 5.66% 5.81% Net amount recognized $ (360) $ (498) $ (71) $ (86) Prescription 7.66% 8.49% Rate to which the cost trend rate is assumed 1. Pension amounts primarily reflect the impact of year-over-year discount rate fluctuations. to decline (ultimate trend rate) 4.50% 4.50% 2. Includes foreign currency exchange rate changes. Year that the rate reaches the ultimate Accumulated Benefit Obligation trend rate 2038 2038
At At December 31, December 31, $ in millions 2018 2017 Pension plans $ 3,546 $ 3,953
147 December 2018 Form 10-K
− 385 − Notes to Consolidated Financial Statements
Plan Assets Rollforward of Level 3 Plan Assets
Fair Value of Plan Assets $ in millions 2018 2017 Balance at beginning of period $47$38 At December 31, 2018 Actual return on plan assets related to $ in millions Level 1 Level 2 Level 3 Total assets held at end of period — 1 Assets Purchases, sales, other settlements Cash and cash equivalents1 $3$—$—$3 and issuances, net 1 8 U.S. government and Balance at end of period $ 48 $47 agency securities: U.S. Treasury securities 2,197 — — 2,197 There were no transfers between levels during 2018 and U.S. agency securities — 317 — 317 2017. Total U.S. government and agency securities 2,197 317 — 2,514 The U.S. Qualified Plan’s assets represent 87% of the Firm’s Corporate and other debt — CDO —11—11total pension plan assets. The U.S. Qualified Plan uses a combination of active and risk-controlled fixed income Derivative contracts —22—22 investment strategies. The fixed income asset allocation Other investments — — 48 48 consists primarily of fixed income securities and related Total $ 2,200 $ 350 $ 48 $ 2,598 derivative instruments designed to approximate the expected Assets Measured at NAV Commingled trust funds: cash flows of the plan’s liabilities in order to help reduce plan Money market 252 exposure to interest rate variation and to better align assets Foreign funds: with the obligation. The longer-duration fixed income alloca- Fixed income 134 tion is expected to help protect the plan’s funded status and Liquidity 12 maintain the stability of plan contributions over the long run. Targeted cash flow 207 The investment portfolio performance is assessed by Total $ 605 comparing actual investment performance with changes in the Fair value of plan assets $ 3,203 estimated present value of the U.S. Qualified Plan’s benefit obligation. At December 31, 2017 $ in millions Level 1 Level 2 Level 3 Total Derivative instruments are permitted in the U.S. Qualified Assets Plan’s investment portfolio only to the extent that they Cash and cash equivalents1 $6$—$—$6 comply with all of the plan’s investment policy guidelines U.S. government and and are consistent with the plan’s risk and return objectives. agency securities: U.S. Treasury securities 2,398 — — 2,398 As a fundamental operating principle, any restrictions on the U.S. agency securities — 318 — 318 underlying assets apply to a respective derivative product. Total U.S. government This includes percentage allocations and credit quality. and agency securities 2,398 318 — 2,716 Derivatives are used solely for the purpose of enhancing Corporate and other debt — investment in the underlying assets and not to circumvent CDO — 14 — 14 portfolio restrictions. Derivative contracts — 1 — 1 Other investments — — 47 47 Plan assets are measured at fair value using valuation tech- Other receivables1 26 — — 26 niques that are consistent with the valuation techniques Other liabilities1 (11) (2) — (13) applied to the Firm’s major categories of assets and liabilities Total $ 2,419 $ 331 $ 47 $ 2,797 as described in Notes 2 and 3. OTC derivative contracts Assets Measured at NAV consist of investments in interest rate swaps. Commingled trust funds: Money market 285 Other investments consist of pledged insurance annuity Foreign funds: contracts held by non-U.S.-based plans. The pledged insur- Fixed income 126 ance annuity contracts are valued based on the premium Liquidity 41 reserve of the insurer for a guarantee that the insurer has Targeted cash flow 219 given to the employee benefit plan that approximates fair Total $ 671 value. The pledged insurance annuity contracts are catego- Fair value of plan assets $ 3,468 rized in Level 3 of the fair value hierarchy.
1. Cash and cash equivalents, other receivables and other liabilities are valued at their carrying value, which approximates fair value.
December 2018 Form 10-K 148
− 386 − Notes to Consolidated Financial Statements
Commingled trust funds are privately offered funds that are U.S. employees meeting certain eligibility requirements may regulated, supervised and subject to periodic examination by a participate in the Morgan Stanley 401(k) Plan. Eligible U.S. federal or state agency and available to institutional employees receive discretionary 401(k) matching cash contri- clients. The trust must be maintained for the collective invest- butions as determined annually by the Firm. For 2018, 2017 and ment or reinvestment of assets contributed to it from U.S. 2016, the Firm matched employee contributions up to 4% of tax-qualified employee benefit plans maintained by more than eligible pay, up to the IRS limit. Matching contributions were one employer or controlled group of corporations. The invested among available funds according to each participant’s sponsor of the commingled trust funds values the funds based investment direction on file. Eligible employees with eligible on the fair value of the underlying securities. Commingled pay less than or equal to $100,000 also received a fixed contri- trust funds are redeemable at NAV at the measurement date or bution under the 401(k) Plan equal to 2% of eligible pay. Tran- in the near future. sition contributions relating to acquired entities or frozen plans are allocated to certain eligible employees. The Firm match, Some non-U.S.-based plans hold foreign funds that consist of fixed contribution and transition contribution are included in the investments in fixed income funds, target cash flow funds and Firm’s 401(k) expense. liquidity funds. Fixed income funds invest in individual secu- rities quoted on a recognized stock exchange or traded in a Non-U.S. Defined Contribution Pension Plans regulated market. Certain fixed income funds aim to produce $ in millions 2018 2017 2016 returns consistent with certain Financial Times Stock Expense $ 116 $ 106 $ 101 Exchange indexes. Target cash flow funds are designed to provide a series of fixed annual cash flows achieved by The Firm maintains separate defined contribution pension investing in government bonds and derivatives. Liquidity plans that cover eligible employees of certain non-U.S. funds place a high priority on capital preservation, stable subsidiaries. Under such plans, benefits are generally deter- value and a high liquidity of assets. Foreign funds are readily mined based on a fixed rate of base salary with certain vesting redeemable at NAV. requirements. The Firm generally considers the NAV of commingled trust funds and foreign funds provided by the fund manager to be 20. Income Taxes the best estimate of fair value. Provision for (Benefit from) Income Taxes
Expected Contributions Components of Provision for (Benefit from) Income Taxes
The Firm’s policy is to fund at least the amount sufficient to $ in millions 2018 2017 2016 meet minimum funding requirements under applicable Current U.S.: employee benefit and tax laws. At December 31, 2018, the Federal $ 686 $ 476 $ 330 Firm expected to contribute approximately $50 million to its State and local 207 125 221 pension and postretirement benefit plans in 2019 based upon Non-U.S.: the plans’ current funded status and expected asset return U.K. 328 401 196 assumptions for 2019. Japan 268 56 28 Hong Kong 94 48 14 Expected Future Benefit Payments Other 318 308 359 Total $ 1,901 $ 1,414 $ 1,148 At December 31, 2018 Other Postretirement $ in millions Pension Plans Plan Deferred U.S.: 2019 $ 139 $ 6 Federal $ 330 $ 2,656 $ 1,336 2020 144 6 State and local 56 84 74 2021 151 6 Non-U.S.: U.K. 54 18 56 2022 160 6 Japan (10) (17) 127 2023 163 7 Hong Kong (3) (2) 31 2024-2028 904 27 Other 22 15 (46) Total $ 449 $ 2,754 $ 1,578 Morgan Stanley 401(k) Plan Provision for income taxes from continuing operations $ 2,350 $ 4,168 $ 2,726 $ in millions 2018 2017 2016 Provision for (benefit from) income Expense $ 272 $ 258 $ 250 taxes from discontinued operations $ (1) $ (7) $ 1
149 December 2018 Form 10-K
− 387 − Notes to Consolidated Financial Statements
Selected Other Non-U.S. Tax Provisions The Tax Act, enacted on December 22, 2017, significantly revised U.S. corporate income tax law by reducing the corpo- $ in millions Tax Provisions rate income tax rate to 21%, partially or wholly eliminating 2018: Brazil $71tax deductions for certain expenses and implementing a Spain 67 modified territorial tax system. The modified territorial tax system includes a one-time transition tax on deemed repatri- India 39 ated earnings of non-U.S. subsidiaries and also imposes a 2017: Brazil 82 minimum tax on GILTI and an alternative BEAT on U.S. India 49 corporations with operations outside of the U.S. Canada 36 The Firm’s effective tax rate from continuing operations for 2016: Brazil 125 2016 included intermittent net discrete tax benefits of $68 million. These net discrete tax benefits were primarily India 46 related to the remeasurement of reserves and related interest France 38 due to new information regarding the status of multi-year IRS tax examinations, partially offset by adjustments for other tax Effective Income Tax Rate matters. Reconciliation of the U.S. Federal Statutory Income Tax Rate Deferred Tax Assets and Liabilities to the Effective Income Tax Rate
2018 2017 2016 At At December 31, December 31, U.S. federal statutory income tax rate 21.0% 35.0% 35.0% $ in millions 2018 2017 U.S. state and local income taxes, net of Gross deferred tax assets U.S. federal income tax benefits 2.0 1.4 2.2 Net operating loss and tax credit Domestic tax credits (0.9) (1.6) (2.5) carryforwards $ 264 $ 391 Tax exempt income (0.4) (0.1) (0.1) Employee compensation and benefit plans 2,053 2,146 Non-U.S. earnings Foreign tax rate differential 1.2 (5.0) (3.1) Valuation and liability allowances 318 377 Change in foreign tax rates 0.1 — 0.1 Valuation of inventory, investments and receivables 242 645 Tax Act enactment — 11.5 — Total deferred tax assets 2,877 3,559 Employee share-based awards1 (1.5) (1.5) — Deferred tax assets valuation Other (0.6) 0.4 (0.8) allowance 143 144 Effective income tax rate 20.9% 40.1% 30.8% Deferred tax assets after valuation allowance $ 2,734 $ 3,415 1. Beginning in 2017, the income tax consequences related to employee share-based awards are required to be recognized in Provision for income taxes in the income statements upon the conversion of employee share-based awards instead of addi- Gross deferred tax liabilities tional paid-in capital. See Note 2 to the financial statements for information on the Non-U.S. operations $12$20 adoption of the accounting update Improvements to Employee Share-Based Fixed assets 825 627 Payment Accounting. See Note 21 for more information on the net discrete tax provisions (benefits). Other 224 194 Total deferred tax liabilities $ 1,061 $ 841 The Firm’s effective tax rate from continuing operations for Net deferred tax assets $ 1,673 $ 2,574 2018 included an intermittent net discrete tax benefit of $203 million primarily associated with the remeasurement of Deferred income taxes reflect the net tax effects of temporary reserves and related interest due to the resolution of multi- differences between the financial reporting and tax bases of jurisdiction tax examinations. assets and liabilities and are measured using the enacted tax The Firm’s effective tax rate from continuing operations for rates and laws that will be in effect when such differences are 2017 included an intermittent net discrete tax provision of expected to reverse. $968 million, which included approximately $1.2 billion The Firm believes the recognized net deferred tax assets primarily related to the remeasurement of certain net deferred (after valuation allowance) at December 31, 2018 are more tax assets as a result of the Tax Act, partially offset by likely than not to be realized based on expectations as to $233 million of net discrete tax benefits primarily associated future taxable income in the jurisdictions in which it operates. with the remeasurement of reserves and related interest due to new information regarding the status of multi-year IRS tax examinations.
December 2018 Form 10-K 150
− 388 − Notes to Consolidated Financial Statements
The earnings of certain foreign subsidiaries are indefinitely The Firm believes that the resolution of the above tax exami- reinvested due to regulatory and other capital requirements in nations will not have a material effect on the annual financial foreign jurisdictions. As a result of the Tax Act’s one-time statements, although a resolution could have a material transition tax on the earnings of foreign subsidiaries and an impact in the income statements and on the effective tax rate annual minimum tax on GILTI, as of December 31, 2018 the for any period in which such resolution occurs. unrecognized deferred tax liability attributable to indefinitely reinvested earnings is immaterial. See Note 12 regarding the Dutch Tax Authority’s challenge, in the District Court in Amsterdam (matters styled Case Unrecognized Tax Benefits number 15/3637 and Case number 15/4353), of the Firm’s Rollforward of Unrecognized Tax Benefits entitlement to certain withholding tax credits which may impact the balance of unrecognized tax benefits. $ in millions 2018 2017 2016 Balance at beginning of period $ 1,594 $ 1,851 $ 1,804 It is reasonably possible that significant changes in the Increase based on tax balance of unrecognized tax benefits occur within the next 12 positions related to the current period 83 63 172 months. At this time, however, it is not possible to reasonably Increase based on tax estimate the expected change to the total amount of unrecog- positions related to prior nized tax benefits and the impact on the Firm’s effective tax periods 34 170 14 rate over the next 12 months. Decrease based on tax positions related to prior Earliest Tax Year Subject to Examination in Major Tax Juris- periods (404) (312) (134) dictions Decreases related to settlements with taxing Jurisdiction Tax Year authorities (139) (155) — U.S. 2013 Decreases related to lapse of New York State and New York City 2007 statute of limitations (88) (23) (5) Hong Kong 2012 Balance at end of period $ 1,080 $ 1,594 $ 1,851 U.K. 2011 Net unrecognized tax benefits1 $ 746 $ 873 $ 1,110 Japan 2015 1. Represent ending unrecognized tax benefits adjusted for the impact of the federal benefit of state issues, competent authority arrangements and foreign tax credit offsets. If recognized, these net benefits would favorably impact the effective tax rate in future periods. 21. Segment, Geographic and Revenue Interest Expense (Benefit), Net of Federal and State Income Information Tax Benefits Segment Information $ in millions 2018 2017 2016 Recognized in income The Firm structures its segments primarily based upon the statements $ (40) $ (3) $ 28 nature of the financial products and services provided to Accrued at end of period 91 147 150 customers and its management organization. The Firm provides a wide range of financial products and services to its Interest and penalties related to unrecognized tax benefits are customers in each of the business segments: Institutional classified as provision for income taxes. Penalties related to Securities, Wealth Management and Investment Manage- unrecognized tax benefits for the years mentioned above were ment. For a further discussion of the business segments, see immaterial. Note 1.
Tax Authority Examinations Revenues and expenses directly associated with each respec- The Firm is under continuous examination by the IRS and tive business segment are included in determining its oper- other tax authorities in certain countries, such as Japan and ating results. Other revenues and expenses that are not the U.K., and in states and localities in which it has signifi- directly attributable to a particular business segment are cant business operations, such as New York. The Firm has generally allocated based on each business segment’s respec- established a liability for unrecognized tax benefits, and asso- tive net revenues, non-interest expenses or other relevant ciated interest, if applicable (“tax liabilities”), that it believes measures. is adequate in relation to the potential for additional assess- ments. Once established, the Firm adjusts such tax liabilities only when new information is available or when an event occurs necessitating a change.
151 December 2018 Form 10-K
− 389 − Notes to Consolidated Financial Statements
As a result of revenues and expenses from transactions with 2017 other operating segments being treated as transactions with $ in millions IS WM IM I/E Total external parties for purposes of segment disclosures, the Firm Investment banking $ 5,537 $ 533 $ — $ (67)$ 6,003 includes an Intersegment Eliminations category to reconcile Trading 10,295 848 (22) (5) 11,116 the business segment results to the consolidated results. Investments 368 3 449 — 820 Commissions and fees 2,433 1,737 — (109) 4,061 Selected Financial Information by Business Segment Asset management 359 9,342 2,196 (100) 11,797 Other 630 268 (37) (13) 848 2018 Total non-interest $ in millions IS WM IM I/E Total revenues 19,622 12,731 2,586 (294) 34,645 Investment banking1, 2 $ 6,088 $ 475 $ — $ (81) $ 6,482 Interest income 5,377 4,591 4 (975) 8,997 Trading 11,191 279 25 56 11,551 Interest expense 6,186 486 4 (979) 5,697 Investments 182 1 254 — 437 Net interest (809) 4,105 — 4 3,300 Commissions and fees1 2,671 1,804 — (285) 4,190 Net revenues $ 18,813 $ 16,836 $ 2,586 $ (290)$ 37,945 Asset management1 421 10,158 2,468 (149) 12,898 Income from continuing Other 535 248 (30) (10) 743 operations before income taxes $ 5,644 $ 4,299 $ 456 $ 4 $ 10,403 Total non-interest revenues3, 4 21,088 12,965 2,717 (469) 36,301 Provision for income taxes 1,993 1,974 201 — 4,168 Interest income 9,271 5,498 57 (934) 13,892 Income from continuing operations 3,651 2,325 255 4 6,235 Interest expense 9,777 1,221 28 (940) 10,086 Income (loss) from Net interest (506) 4,277 29 6 3,806 discontinued operations, Net revenues $20,582 $ 17,242 $ 2,746 $ (463) $ 40,107 net of income taxes (19) — — — (19) Income from continuing Net income 3,632 2,325 255 4 6,216 operations before Net income applicable to income taxes $ 6,260 $ 4,521 $ 464 $ (8) $ 11,237 noncontrolling interests 96 — 9 — 105 Provision for income taxes 1,230 1,049 73 (2) 2,350 Net income applicable to Income from continuing Morgan Stanley $ 3,536 $ 2,325 $ 246 $ 4 $ 6,111 operations 5,030 3,472 391 (6) 8,887 Income (loss) from discontinued operations, net of income taxes (6) — 2 — (4) Net income 5,024 3,472 393 (6) 8,883 Net income applicable to noncontrolling interests 118 — 17 — 135 Net income applicable to Morgan Stanley $ 4,906 $ 3,472 $ 376 $ (6) $ 8,748
December 2018 Form 10-K 152
− 390 − Notes to Consolidated Financial Statements
2016 Net Discrete Tax Provision (Benefit) by Segment $ in millions IS WM IM I/E Total $ in millions IS WM IM Total Investment banking $ 4,476 $ 484 $ — $ (27) $ 4,933 2018 Trading 9,387 861 (2) (37) 10,209 Intermittent net discrete tax Investments 147 — 13 — 160 provision (benefit) $ (182) $ — $ (21) $ (203) Commissions and fees 2,456 1,745 3 (95) 4,109 Recurring: Employee share-based Asset management 293 8,454 2,063 (113) 10,697 awards1 (104) (50) (11) (165) Other 535 277 31 (18) 825 Total $ (286) $ (50) $ (32) $ (368) Total non-interest 2017 revenues 17,294 11,821 2,108 (290) 30,933 Intermittent: Interest income 4,005 3,888 5 (882) 7,016 Tax Act enactment2 $ 705 $ 402 $ 94 $ 1,201 Interest expense 3,840 359 1 (882) 3,318 Remeasurement of reserves Net interest 165 3,529 4 — 3,698 and related interest (168) — — (168) Net revenues $ 17,459 $ 15,350 $ 2,112 $ (290) $ 34,631 Other (66) 9 (8) (65) Income from continuing Total intermittent net discrete operations before tax provision (benefit) $ 471 $ 411 $ 86 $ 968 income taxes $ 5,123 $ 3,437 $ 287 $ 1 $ 8,848 Recurring: Provision for income taxes 1,318 1,333 75 — 2,726 Employee share-based awards1 (93) (54) (8) (155) Income from continuing operations 3,805 2,104 212 1 6,122 Total $ 378 $ 357 $ 78 $ 813 Income (loss) from 20163 $ (68) discontinued operations, 1. Beginning in 2017, with the adoption of the accounting update, net of income taxes (1) — 2 — 1 Improvements to Employee Share-Based Payment Accounting, the Net income 3,804 2,104 214 1 6,123 income tax consequences associated with employee share-based Net income applicable to awards are recognized in Provision for income taxes in the income state- noncontrolling interests 155 — (11) — 144 ments. The Firm considers these employee share-based award related provisions (benefits) to be recurring-type (“Recurring”) discrete tax items, Net income applicable to as we anticipate some level of conversion activity each year. Morgan Stanley $ 3,649 $ 2,104 $ 225 $ 1 $ 5,979 2. For further discussion on the Tax Act, see Note 20. I/E–Intersegment Eliminations 3. The intermittent net discrete tax benefit for 2016 was principally within 1. Approximately 86% of Investment banking revenues and substantially all of the Institutional Securities business segment. Commissions and fees and Asset management revenues in 2018 were deter- Total Assets by Business Segment mined under the Revenues from Contracts with Customers accounting update. At At 2. Institutional Securities Investment banking revenues in 2018 are composed of December 31, December 31, $2,436 million of Advisory and $3,652 million of Underwriting revenues. Insti- $ in millions 2018 2017 tutional Securities Investment banking revenues in 2017 are composed of $2,077 million of Advisory and $3,460 million of Underwriting revenues. Insti- Institutional Securities $ 646,427 $ 664,974 tutional Securities Investment banking revenues in 2016 are composed of Wealth Management 202,392 182,009 $2,220 million of Advisory and $2,256 million of Underwriting revenues. 3. The Firm enters into certain contracts that contain a current obligation to Investment Management 4,712 4,750 perform services in the future. Excluding contracts where billing is commen- Total1 $ 853,531 $ 851,733 surate with the value of the services performed at each stage of the contract, contracts with variable consideration that is subject to reversal, and contracts 1. Parent assets have been fully allocated to the business segments. with less than one year duration, we expect to record the following approxi- mate revenues in the future: $100 million per year in 2019 and 2020; between Additional Segment Information—Investment Management $40 million and $60 million per year in 2021 through 2025; and $10 million per year in 2026 through 2035. These revenues are primarily related to Net Unrealized Performance-Based Fees certain commodities contracts with customers. At At 4. Includes $2,821 million in revenues recognized in 2018 where some or all December 31, December 31, services were performed in prior periods. This amount is primarily composed $ in millions 2018 2017 of investment banking advisory fees and distribution fees. Net cumulative unrealized performance- based fees at risk of reversing $ 434 $ 442
153 December 2018 Form 10-K
− 391 − Notes to Consolidated Financial Statements
The Firm’s portion of net cumulative unrealized Income from Continuing Operations before Income Tax performance-based fees (for which the Firm is not obligated Expense (Benefit) to pay compensation) are at risk of reversing if the fund $ in millions 2018 2017 2016 performance falls below the stated investment management U.S. $ 7,804 $ 5,686 $ 5,694 agreement benchmarks. See Note 12 for information Non-U.S.1 3,433 4,717 3,154 regarding general partner guarantees, which include potential Total $ 11,237 $ 10,403 $ 8,848 obligations to return performance fee distributions previously received. 1. Non-U.S. income is defined as income generated from operations located outside the U.S. Reduction of Fees due to Fee Waivers Total Assets by Region $ in millions 2018 2017 2016 Fee waivers $56$86$91 At At December 31, December 31, $ in millions 2018 2017 The Firm waives a portion of its fees in the Investment Americas $ 576,532 $ 570,489 Management business segment from certain registered money EMEA 200,194 191,398 market funds that comply with the requirements of Rule 2a-7 Asia 76,805 89,846 of the Investment Company Act of 1940. Total $ 853,531 $ 851,733 Separately, the Firm’s employees, including its senior offi- cers, may participate on the same terms and conditions as Revenue Information other investors in certain funds that the Firm sponsors Trading Revenues by Product Type primarily for client investment, and the Firm may waive or lower applicable fees and charges for its employees. $ in millions 2018 2017 2016 Interest rate $ 2,696 $ 2,091 $ 1,522 Geographic Information Foreign exchange 914 647 1,156 Equity security and index1 6,157 6,291 5,690 The Firm operates in both U.S. and non-U.S. markets. The Commodity and other 1,174 740 56 Firm’s non-U.S. business activities are principally conducted and managed through EMEA and Asia locations. The net Credit 610 1,347 1,785 revenues disclosed in the following table reflect the regional Total $ 11,551 $ 11,116 $ 10,209 view of the Firm’s consolidated net revenues on a managed 1. Dividend income is included within equity security and index contracts. basis, based on the following methodology: The previous table summarizes gains and losses included in Institutional Securities: client location for advisory and Trading revenues in the income statements. These activities equity underwriting, revenue recording location for debt include revenues related to derivative and non-derivative underwriting, trading desk location for sales and trading. financial instruments. The Firm generally utilizes financial instruments across a variety of product types in connection Wealth Management: representatives operate in the with its market-making and related risk management strat- Americas. egies. The trading revenues presented in the table are not representative of the manner in which the Firm manages its Investment Management: client location, except certain business activities and are prepared in a manner similar to the closed-end funds, which are based on asset location. presentation of trading revenues for regulatory reporting Net Revenues by Region purposes.
$ in millions 2018 2017 2016 Americas $ 29,301 $ 27,817 $ 25,487 EMEA 6,092 5,714 4,994 Asia 4,714 4,414 4,150 Total $ 40,107 $ 37,945 $ 34,631
December 2018 Form 10-K 154
− 392 − Notes to Consolidated Financial Statements Change in Revenues and Expenses as a Result of 22. Parent Company Application of the New Revenue Recognition Standard Parent Company Only—Condensed Income Statements and $ in millions 2018 Comprehensive Income Statements Gross presentation impact—Revenues Investment banking—Advisory $75 $ in millions 2018 2017 2016 Investment banking—Underwriting 193 Revenues Dividends from subsidiaries1 $ 4,973 $ 2,567 $ 2,448 Asset management1 30 Trading (260) 96 Other 52 54 Other 64 38 Subtotal 350 (5) Total non-interest revenues 2,371 2,582 Gross presentation impact—Expenses 5,022 Brokerage, clearing and exchange fees1 $30 Interest income 5,172 3,783 3,008 Marketing and business development 31 Interest expense 4,816 4,079 4,036 Professional services 102 Net interest 356 (296) (1,028) Other2 187 Net revenues 5,378 2,075 1,554 Subtotal 350 Non-interest expenses 225 240 126 Timing impact—Revenues Income before income taxes 5,153 1,835 1,428 Investment banking—Advisory $15 Provision for (benefit from) Asset management (4) income taxes 22 (206) (383) Other 19 Net income before undistributed gain of subsidiaries 5,131 2,041 1,811 Subtotal 30 Undistributed gain of Net change in revenues and expenses $ 30 subsidiaries 3,617 4,070 4,168 1. Intersegment transactions of $48 million have been eliminated. Net income 8,748 6,111 5,979 2. Primarily composed of Investment banking transaction-related costs. OCI, net of tax: Foreign currency translation As a result of adopting the accounting update Revenue from adjustments (114) 219 (23) Contracts with Customers, the accounting for certain transac- Change in net unrealized tions has changed (see Note 2 for further details). As summa- gains (losses) on AFS rized in the previous table, the change is composed of trans- securities (272) 41 (269) actions that are now presented on a gross basis within both Pensions, postretirement Non-interest revenues and Non-interest expenses, as well as and other 137 (117) (100) transactions where revenues are recognized with different Change in net DVA 1,454 (560) (283) timing compared with the previous GAAP. For example, Comprehensive income $ 9,953 $ 5,694 $ 5,304 timing impacts shown as negative amounts in the previous Net income $ 8,748 $ 6,111 $ 5,979 table represent revenues for which recognition has been Preferred stock dividends and deferred to future periods under the new standard. other 526 523 471 Earnings applicable to Receivables from Contracts with Customers Morgan Stanley common At At shareholders $ 8,222 $ 5,588 $ 5,508 December 31, January 1, $ in millions 2018 2018 1. In 2018, we recorded approximately $3 billion of dividends from bank subsidiaries. Customer and other receivables $ 2,308 $ 2,805
Receivables from contracts with customers, which are included within Customer and other receivables in the balance sheets, arise when the Firm has both recorded reve- nues and has the right per the contract to bill the customer.
155 December 2018 Form 10-K
− 393 − Notes to Consolidated Financial Statements
Parent Company Only—Condensed Balance Sheets Parent Company Only—Condensed Cash Flow Statements
At At December 31, December 31, $ in millions 2018 2017 2016 $ in millions, except share data 2018 2017 Cash flows from operating activities Assets Net income $ 8,748 $ 6,111 $ 5,979 Cash and cash equivalents: Adjustments to reconcile net income to net cash Cash and due from banks $6$11 provided by (used for) operating activities: Deposits with bank subsidiaries 7,476 8,120 Undistributed gain of subsidiaries (3,617) (4,070) (4,168) Restricted cash — 1 Other operating activities 964 1,087 1,367 Trading assets at fair value 10,039 5,752 Changes in assets and liabilities (7,231) 619 (151) Net cash provided by (used for) operating Investment Securities (includes $15,500 and activities (1,136) 3,747 3,027 $13,219 at fair value) 22,588 19,268 Securities purchased under agreement to resell Cash flows from investing activities with affiliates 25,535 38,592 Proceeds from (payments for): Advances to subsidiaries: Investment securities: Bank and BHC 30,954 30,145 Purchases (8,155) (5,263) — Non-bank 97,405 112,557 Proceeds from sales 1,252 3,620 — Equity investments in subsidiaries: Proceeds from paydowns and maturities 3,729 1,038 — Bank and BHC 42,848 35,971 Securities purchased under agreements to resell Non-bank 32,418 31,856 with affiliates 13,057 19,314 (10,846) Other assets 1,244 2,704 Securities sold under agreements to repurchase with affiliates (8,753) 8,753 — Total assets $ 270,513 $ 284,977 Advances to and investments in subsidiaries1 11,841 (35,686) (141) Liabilities Net cash provided by (used for) investing Trading liabilities at fair value $ 276 $ 148 activities 12,971 (8,224) (10,987) Securities sold under agreements to repurchase with affiliates — 8,753 Cash flows from financing activities Payables to and advances from subsidiaries 30,861 28,781 Proceeds from: Other liabilities and accrued expenses 2,548 2,421 Issuance of preferred stock, net of issuance costs — 994 — Borrowings (includes $18,599 and $22,603 at fair value) 156,582 167,483 Issuance of Borrowings 14,918 36,833 32,795 Payments for: Total liabilities 190,267 207,586 Borrowings (21,418) (24,668) (24,793) Commitments and contingent liabilities (see Note 12) Repurchases of common stock and employee tax withholdings (5,566) (4,292) (3,933) Equity Cash dividends (2,375) (2,085) (1,746) Preferred stock 8,520 8,520 Net change in advances from subsidiaries1 2,122 1,861 (2,361) Common stock, $0.01 par value: Other financing activities — 26 66 Shares authorized: 3,500,000,000; Shares issued: 2,038,893,979; Shares outstanding: Net cash provided by (used for) financing 1,699,828,943 and 1,788,086,805 shares 20 20 activities (12,319) 8,669 28 Additional paid-in capital 23,794 23,545 Effect of exchange rate changes on cash and cash equivalents (166) 221 (250) Retained earnings 64,175 57,577 Net increase (decrease) in cash and cash Employee stock trusts 2,836 2,907 equivalents (650) 4,413 (8,182) AOCI (2,292) (3,060) Cash and cash equivalents, at beginning of Common stock held in treasury at cost, $0.01 par period 8,132 3,719 11,901 value (339,065,036 and 250,807,174 shares) (13,971) (9,211) Cash and cash equivalents, at end of period $ 7,482 $ 8,132 $ 3,719 Common stock issued to employee stock trusts (2,836) (2,907) Cash and cash equivalents: Total shareholders’ equity 80,246 77,391 Cash and due from banks $6$ 11 $ 116 Total liabilities and equity $ 270,513 $ 284,977 Deposits with bank subsidiaries 7,476 8,120 3,600 Restricted cash — 13 Cash and cash equivalents, at end of period $ 7,482 $ 8,132 $ 3,719
Supplemental Disclosure of Cash Flow Information Cash payments for: Interest $ 4,798 $ 3,570 $ 3,650 Income taxes, net of refunds 437 201 201
1. Reclassifications have been made to prior periods to conform to the current presen- tation.
December 2018 Form 10-K 156
− 394 − Notes to Consolidated Financial Statements
Parent Company’s Borrowings with Original Maturities The Parent Company has issued guarantees on behalf of its Greater than One Year subsidiaries to various U.S. and non-U.S. exchanges and At At clearinghouses that trade and clear securities and/or futures December 31, December 31, contracts. Under these guarantee arrangements, the Parent $ in millions 2018 2017 Company may be required to pay the financial obligations of Senior $ 146,492 $ 157,255 its subsidiaries related to business transacted on or with the Subordinated 10,090 10,228 exchanges and clearinghouses in the event of a subsidiary’s Total $ 156,582 $ 167,483 default on its obligations to the exchange or the clearing- house. The Parent Company has not recorded any contingent Transactions with Subsidiaries liability in its condensed financial statements for these arrangements and believes that any potential requirements to The Parent Company has transactions with its consolidated make payments under these arrangements are remote. subsidiaries determined on an agreed-upon basis and has guaranteed certain unsecured lines of credit and contractual Guarantees of Debt Instruments and Warrants Issued by obligations on certain of its consolidated subsidiaries. Subsidiaries At At Guarantees December 31, December 31, $ in millions 2018 2017 In the normal course of its business, the Parent Company Aggregate balance $ 24,286 $ 19,392 guarantees certain of its subsidiaries’ obligations under deriv- ative and other financial arrangements. The Parent Company Guarantees under Subsidiary Lease Obligations records Trading assets and Trading liabilities, which include derivative contracts, at fair value in its condensed balance At At sheets. December 31, December 31, $ in millions 2018 2017 The Parent Company also, in the normal course of its busi- Aggregate balance1 $ 1,003 $ 1,082 ness, provides standard indemnities to counterparties on 1. Amounts primarily relate to the U.K. behalf of its subsidiaries for taxes, including U.S. and foreign withholding taxes, on interest and other payments made on Finance Subsidiary derivatives, securities and stock lending transactions, and certain annuity products. These indemnity payments could be The Parent Company fully and unconditionally guarantees the required based on a change in the tax laws or change in inter- securities issued by Morgan Stanley Finance LLC, a 100%- pretation of applicable tax rulings. Certain contracts contain owned finance subsidiary. provisions that enable the Parent Company to terminate the Resolution and Recovery Planning agreement upon the occurrence of such events. The maximum potential amount of future payments that the Parent Company As indicated in the Firm’s 2017 resolution plan submitted to could be required to make under these indemnifications the Federal Reserve and the FDIC, the Parent Company has cannot be estimated. The Parent Company has not recorded amended and restated its support agreement with its material any contingent liability in its condensed financial statements entities, as defined in the Firm’s 2017 resolution plan. Under for these indemnifications and believes that the occurrence of the secured amended and restated support agreement, upon any events that would trigger payments under these contracts the occurrence of a resolution scenario, the Parent Company is remote. would be obligated to contribute or loan on a subordinated basis all of its contributable material assets, other than shares in subsidiaries of the Parent Company and certain intercom- pany receivables, to provide capital and liquidity, as appli- cable, to its material entities.
157 December 2018 Form 10-K
− 395 − Notes to Consolidated Financial Statements
2017 Quarter 23. Quarterly Results (Unaudited) $ in millions, except per share data First Second Third Fourth2,3 2018 Quarter Total non-interest revenues $ 8,974 $ 8,752 $ 8,414 $ 8,505 $ in millions, except per share data First Second Third Fourth2,3 Net interest 771 751 783 995 Total non-interest revenues1 $ 10,102 $ 9,704 $ 8,936 $ 7,559 Net revenues 9,745 9,503 9,197 9,500 Net interest 975 906 936 989 Total non-interest expenses 6,937 6,861 6,715 7,029 Net revenues 11,077 10,610 9,872 8,548 Income from continuing operations Total non-interest expenses1 7,657 7,501 7,021 6,691 before income taxes 2,808 2,642 2,482 2,471 Income from continuing Provision for income taxes 815 846 697 1,810 operations before income Income from continuing operations 1,993 1,796 1,785 661 taxes 3,420 3,109 2,851 1,857 Income (loss) from discontinued Provision for income taxes 714 640 696 300 operations (22) (5) 6 2 Income from continuing Net income 1,971 1,791 1,791 663 operations 2,706 2,469 2,155 1,557 Net income applicable to Income (loss) from noncontrolling interests 41 34 10 20 discontinued operations (2) (2) (1) 1 Net income applicable to Morgan Net income 2,704 2,467 2,154 1,558 Stanley $ 1,930 $ 1,757 $ 1,781 $ 643 Net income applicable to Preferred stock dividends and other 90 170 93 170 noncontrolling interests 36 30 42 27 Earnings applicable to Morgan Net income applicable to Stanley common shareholders $ 1,840 $ 1,587 $ 1,688 $ 473 Morgan Stanley $ 2,668 $ 2,437 $ 2,112 $ 1,531 Earnings (loss) per basic common share4: Preferred stock dividends and Income from continuing operations $ 1.03 $ 0.89 $ 0.95 $ 0.27 other 93 170 93 170 Income (loss) from discontinued Earnings applicable to operations (0.01) — — — Morgan Stanley common Earnings per basic common share $ 1.02 $ 0.89 $ 0.95 $ 0.27 shareholders $ 2,575 $ 2,267 $ 2,019 $ 1,361 Earnings (loss) per diluted common share4: Earnings (loss) per basic common share4: Income from continuing operations $ 1.01 $ 0.87 $ 0.93 $ 0.26 Income from continuing operations $ 1.48 $ 1.32 $ 1.19 $ 0.81 Income (loss) from discontinued operations (0.01) — — — Income (loss) from discontinued operations ————Earnings per diluted common share $ 1.00 $ 0.87 $ 0.93 $ 0.26 Earnings per basic common Dividends declared per common share $ 1.48 $ 1.32 $ 1.19 $ 0.81 share $ 0.20 $ 0.20 $ 0.25 $ 0.25 Earnings (loss) per diluted Book value per common share $ 37.48 $ 38.22 $ 38.87 $ 38.52 common share4: Income from continuing 1. Effective January 1, 2018, the Firm adopted new accounting guidance operations $ 1.46 $ 1.30 $ 1.17 $ 0.80 related to Revenue from Contracts with Customers, which among other things, requires a gross presentation of certain costs that were previ- Income (loss) from ously netted against net revenues. Prior periods have not been restated discontinued operations (0.01) — — — pursuant to this guidance. For further information on the full impact of Earnings per diluted common adoption of this new accounting guidance, see the following table and share $ 1.45 $ 1.30 $ 1.17 $ 0.80 Note 21. Dividends declared per 2. The fourth quarter of 2018 included net intermittent discrete tax benefits common share $ 0.25 $ 0.25 $ 0.30 $ 0.30 of $111 million, primarily associated with the remeasurement of reserves and related interest due to the resolution of multi-jurisdiction tax exami- Book value per common nations. The fourth quarter of 2017 included net intermittent discrete tax share $ 39.19 $ 40.34 $ 40.67 $ 42.20 benefits of $168 million, primarily related to the remeasurement of reserves and related interest due to new information regarding the status of multi-year IRS tax examinations. The fourth quarter of 2017 also included an intermittent net discrete tax provision of approximately $1.2 billion, primarily related to the remeasurement of certain net deferred tax assets using the lower corporate tax rate as a result of the enactment of the Tax Act. Income tax consequences arising from conversion of employee share-based awards are excluded from inter- mittent net discrete tax provisions (benefits), as we anticipate conver- sion activity each year (see Notes 2 and 20). 3. Total non-interest revenues includes impairments of the Investment Management business segment’s interest in a third-party asset manager of $46 million in 2018 and $53 million in 2017. 4. The sum of the quarters’ earnings per common share may not equal the annual amounts due to the averaging effect of the number of shares and share equivalents throughout the year.
December 2018 Form 10-K 158
− 396 − Notes to Consolidated Financial Statements Quarterly Change in Revenue and Expense as a Result of 24. Subsequent Events Application of the New Revenue Recognition Standard
2018 Quarter The Firm has evaluated subsequent events for adjustment to $ in millions First Second Third Fourth or disclosure in the financial statements through the date of Non-interest revenues this report and has not identified any recordable or disclos- Gross presentation able events not otherwise reported in these financial state- impact1 $ 79 $ 108 $ 93 $ 70 ments or the notes thereto. Timing impact 4 — (12) 38 Non-interest expenses Gross presentation impact1 79 108 93 70 Net change in revenue and expense $ 4 $ — $ (12) $ 38
1. Intersegment transactions have been eliminated.
159 December 2018 Form 10-K
− 397 − Financial Data Supplement (Unaudited) Average Balances and Interest Rates and Net Interest Income
2018 2017 2016 Average Average Average Daily Average Daily Average Daily Average $ in millions Balance Interest Rate Balance Interest Rate Balance Interest Rate Interest earning assets Investment securities1 $ 81,977 $ 1,744 2.1% $ 76,746 $ 1,334 1.7% $ 78,562 $ 1,142 1.5% Loans1 109,681 4,249 3.9 98,727 3,298 3.3 89,875 2,724 3.0 Securities purchased under agreements to resell and Securities borrowed2: U.S. 134,223 2,262 1.7 125,453 606 0.5 144,744 (172) (0.1) Non-U.S. 86,430 (286) (0.3) 95,478 (437) (0.5) 86,622 (202) (0.2) Trading assets, net of Trading liabilities3: U.S. 57,780 2,144 3.7 59,335 1,876 3.2 49,746 1,894 3.8 Non-U.S. 9,014 248 2.8 4,326 153 3.5 12,843 237 1.8 Customer receivables and Other4: U.S. 73,695 2,592 3.5 72,440 1,614 2.2 78,766 1,080 1.4 Non-U.S. 54,396 939 1.7 40,179 553 1.4 34,214 313 0.9 Total $ 607,196 $ 13,892 2.3% $ 572,684 $ 8,997 1.6% $ 575,372 $ 7,016 1.2% Interest bearing liabilities Deposits1 $ 169,226 $ 1,255 0.7% $ 151,442 $ 187 0.1% $ 155,143 $ 83 0.1% Borrowings1, 5 191,692 5,031 2.6 184,453 4,285 2.3 163,647 3,606 2.2 Securities sold under agreements to repurchase and Securities loaned6: U.S. 24,426 1,408 5.8 30,866 900 2.9 32,359 555 1.7 Non-U.S. 37,319 490 1.3 39,396 337 0.9 31,491 422 1.3 Customer payables and Other7: U.S. 120,228 1,061 0.9 128,274 (213) (0.2) 114,606 (1,187) (1.0) Non-U.S. 70,855 841 1.2 65,496 201 0.3 76,096 (161) (0.2) Total $ 613,746 $ 10,086 1.6% $ 599,927 $ 5,697 0.9% $ 573,342 $ 3,318 0.6% Net interest income and net interest rate spread $ 3,806 0.7% $ 3,300 0.7% $ 3,698 0.6%
1. Amounts include primarily U.S. balances. 2. Includes fees paid on Securities borrowed. 3. Excludes non-interest earning assets and non-interest bearing liabilities, such as equity securities. 4. Includes interest from Customer receivables and Cash and cash equivalents. Prior period amounts have been revised to conform to the current presentation. 5. Includes structured notes, whose interest expense is considered part of its value and therefore is recorded within Trading revenues (see Notes 3 and11to the financial statements). 6. Includes fees received on Securities loaned. The annualized average rate was calculated using (a) interest expense incurred on all securities sold under agreements to repurchase and securities loaned transactions, whether or not such transactions were reported in the balance sheets and (b) net average on-balance sheet balances, which exclude certain securities-for-securities transactions. 7. Includes fees received from prime brokerage customers for stock loan transactions incurred to cover customers’ short positions.
December 2018 Form 10-K 160
− 398 − Financial Data Supplement (Unaudited) Effect of Volume and Rate Changes on Net Interest Income
2018 versus 2017 2017 versus 2016 Increase (Decrease) Increase (Decrease) Due to Change in: Due to Change in: $ in millions Volume Rate Net Change Volume Rate Net Change Interest earning assets Investment securities $ 91 $ 319 $ 410 $ (26) $ 218 $ 192 Loans 366 585 951 268 306 574 Securities purchased under agreements to resell and Securities borrowed: U.S. 42 1,614 1,656 23 755 778 Non-U.S. 41 110 151 (21) (214) (235) Trading assets, net of Trading liabilities: U.S. (49) 317 268 365 (383) (18) Non-U.S. 166 (71) 95 (157) 73 (84) Customer receivables and Other: U.S. 28 950 978 (87) 621 534 Non-U.S. 196 190 386 55 185 240 Change in interest income $ 881 $ 4,014 $ 4,895 $ 420 $ 1,561 $ 1,981 Interest bearing liabilities Deposits $ 22 $ 1,046 $ 1,068 $ (2) $ 106 $ 104 Borrowings 168 578 746 458 221 679 Securities sold under agreements to repurchase and Securities loaned: U.S. (188) 696 508 (26) 371 345 Non-U.S. (18) 171 153 106 (191) (85) Customer payables and Other: U.S. 13 1,261 1,274 (142) 1,116 974 Non-U.S. 16 624 640 22 340 362 Change in interest expense $ 13 $ 4,376 $ 4,389 $ 416 $ 1,963 $ 2,379 Change in net interest income $ 868 $ (362) $ 506 $ 4 $ (402) $ (398)
161 December 2018 Form 10-K
− 399 − Financial Data Supplement (Unaudited)—(Continued)
Deposits Cross-Border Outstandings
Average Daily Deposits At December 31, 2018 2018 2017 2016 Non-banking Average Average Average Average Average Average Financial $ in millions Amount Rate Amount Rate Amount Rate $ in millions Banks Governments Institutions Other Total Deposits1: Country: Savings $ 142,753 0.4% $ 144,870 0.1% $ 153,387 —% Japan $ 16,130 $ 14,974 $ 30,301 $ 9,951 $ 71,356 Time 26,473 2.4% 6,572 1.6% 1,756 2.4% U.K. 3,978 7,683 20,168 11,083 42,912 Total $ 169,226 0.7% $ 151,442 0.1% $ 155,143 0.1% Cayman Islands 14 — 28,164 5,342 33,520 France 3,750 1,420 17,343 6,584 29,097 1. The Firm’s deposits were primarily held in U.S. offices. Canada 6,808 2,153 2,005 2,455 13,421 Ratios Ireland 664 24 8,466 4,191 13,345 European Central 2018 2017 2016 Bank — 12,008 — — 12,008 Net income to average total assets1 1.0% 0.7% 0.7% Brazil 2,464 5,074 579 2,133 10,250 ROE1, 2 11.8% 8.0% 8.0% Germany 822 1,499 4,137 3,022 9,480 Return on total equity1, 3 11.1% 7.8% 7.8% Luxembourg 101 291 7,139 1,289 8,820 Dividend payout ratio4 23.3% 29.3% 24.0% Total average common equity to average assets1 8.1% 8.2% 8.5% At December 31, 2017 Total average equity to average total assets1 9.1% 9.2% 9.4% Non-banking Financial $ in millions Banks Governments Institutions Other Total 1. Represents a non-GAAP measure. See “Executive Summary—Selected Non-GAAP Financial Information.” Country: 2. Percentage is based on Net income applicable to Morgan Stanley less Preferred stock Japan $ 12,239 $ 18,103 $ 18,125 $ 10,874 $ 59,341 dividends and other as a percentage of average common equity. 3. Percentage is based on Net income applicable to Morgan Stanley as a percentage of U.K. 4,870 6,741 24,731 13,992 50,334 average total equity. France 3,401 900 12,781 8,445 25,527 4. Percentage is based on dividends declared per common share as a percentage of earn- ings per diluted common share. Cayman Islands 17 1 16,041 4,999 21,058 Ireland 391 52 8,577 4,601 13,621 Securities Sold under Agreements to Repurchase and Germany 1,045 1,191 6,286 3,765 12,287 Securities Loaned Canada 4,225 621 3,072 3,695 11,613
$ in millions 2018 2017 20161 Brazil 2,761 3,470 315 3,809 10,355 Period-end balance $ 61,667 $ 70,016 $ 70,472 China 902 1,713 940 5,852 9,407 Average balance2 61,745 70,262 63,850 South Korea 447 2,871 1,020 4,922 9,260 Maximum balance at any month-end 72,161 77,063 72,154 Netherlands 313 982 2,446 4,377 8,118 Weighted average interest rate during the period3 3.1% 1.8% 1.5% At December 31, 20161 Weighted average interest rate on Non-banking Financial period-end balance3 4.1% 1.5% 0.6% $ in millions Banks Governments Institutions Other Total Country: 1. 2016 has been revised to conform to the current presentation. 2. The Firm calculated its average balances based upon daily amounts. Japan $ 12,465 $ 12,388 $ 32,380 $ 9,264 $ 66,497 3. The weighted average interest rate was calculated using (a) interest expense U.K. 3,589 4,794 22,456 11,637 42,476 incurred on all securities sold under agreements to repurchase and securities loaned transactions, whether or not such transactions were reported in the balance France 3,069 6,264 15,917 7,623 32,873 sheets and (b) net average or period-end balances excluding certain Cayman Islands 5 — 16,272 3,124 19,401 securities-for-securities transactions as applicable. Germany 1,609 3,828 4,983 3,524 13,944 Ireland 478 160 6,998 4,504 12,140 Canada 3,503 838 2,570 3,419 10,330 Brazil 1,682 4,675 159 2,236 8,752 South Korea 290 2,563 996 4,233 8,082
December 2018 Form 10-K 162
− 400 − Financial Data Supplement (Unaudited)—(Continued)
Cross-border outstandings are based upon the FFIEC regula- tory guidelines for reporting cross-border risk. Claims include cash, customer and other receivables, securities purchased under agreements to resell, securities borrowed and cash trading instruments, but exclude commitments. Securities purchased under agreements to resell and securities borrowed are presented based on the domicile of the counterparty, without reduction for related securities collateral held. For information regarding the Firm’s country risk exposure, see “Quantitative and Qualitative Disclosures about Risk— Country Risk.”
The previous tables set forth cross-border outstandings for each country, excluding derivative exposure, in which cross- border outstandings exceed 1% of the Firm’s consolidated assets or 20% of the Firm’s total capital, whichever is less, in accordance with the FFIEC guidelines:
$ in millions Cross-Border Exposure2 At December 31, 2018 Netherlands $ 7,338 At December 31, 2017 Australia, European Central Bank, Luxembourg and India $ 29,257 At December 31, 2016 Singapore and Switzerland $ 14,626
1. 2016 was revised to conform to the current presentation. 2. Cross-border exposure, including derivative contracts, that exceeds 0.75% but does not exceed 1% of the Firm’s consolidated assets.
163 December 2018 Form 10-K
− 401 − Glossary of Common Acronyms
2018 Form 10-K Annual Report on Form 10-K for year E.U. European Union ended December 31, 2018 filed with the SEC FDIC Federal Deposit Insurance Corporation
ABS Asset-backed securities FFELP Federal Family Education Loan Program
AFS Available-for-sale FFIEC Federal Financial Institutions Examination Council AML Anti-money laundering FHC Financial Holding Company AOCI Accumulated other comprehensive income (loss) FICO Fair Isaac Corporation
AUM Assets under management or supervision FVA Funding valuation adjustment
BEAT Base erosion and anti-abuse tax GILTI Global Intangible Low-Taxed Income
BHC Bank holding company GLR Global liquidity reserve
bps Basis points; one basis point equals G-SIB Global systemically important banks 1/100th of 1% HELOC Home Equity Line of Credit CCAR Comprehensive Capital Analysis and Review HQLA High-quality liquid assets
CCyB Countercyclical capital buffer HTM Held-to-maturity
CDO Collateralized debt obligation(s), I/E Intersegment eliminations including Collateralized loan IHC Intermediate holding company obligation(s) IM Investment Management CDS Credit default swaps IRS Internal Revenue Service CECL Current expected credit loss IS Institutional Securities CFTC U.S. Commodity Futures Trading Commission LCR Liquidity coverage ratio, as adopted by the U.S. banking agencies CLN Credit-linked note(s) LIBOR London Interbank Offered Rate CLO Collateralized loan obligation(s) M&A Merger, acquisition and restructuring CMBS Commercial mortgage-backed securities transaction CMO Collateralized mortgage obligation(s) MSBNA Morgan Stanley Bank, N.A. CVA Credit valuation adjustment MS&Co. Morgan Stanley & Co. LLC DVA Debt valuation adjustment MSIP Morgan Stanley & Co. International plc EBITDA Earnings before interest, taxes, MSMS Morgan Stanley MUFG Securities Co., Ltd. depreciation and amortization MSPBNA Morgan Stanley Private Bank, National ELN Equity-linked note(s) Association EMEA Europe, Middle East and Africa MSSB LLC Morgan Stanley Smith Barney LLC EPS Earnings per common share
December 2018 Form 10-K 164
− 402 − Glossary of Common Acronyms
MUFG Mitsubishi UFJ Financial Group, Inc. RWA Risk-weighted assets
MUMSS Mitsubishi UFJ Morgan Stanley Securities SEC U.S. Securities and Exchange Commission Co., Ltd. SLR Supplementary leverage ratio MWh Megawatt hour S&P Standard & Poor’s N/A Not Applicable SPE Special purpose entity NAV Net asset value SPOE Single point of entry N/M Not Meaningful TDR Troubled debt restructuring Non-GAAP Non-generally accepted accounting principles TLAC Total loss-absorbing capacity
NSFR Net stable funding ratio, as proposed by the U.K. United Kingdom U.S. banking agencies UPB Unpaid principal balance OCC Office of the Comptroller of the Currency U.S. United States of America OCI Other comprehensive income (loss) U.S. DOL U.S. Department of Labor OIS Overnight index swap U.S. GAAP Accounting principles generally accepted in OTC Over-the-counter the United States of America
PRA Prudential Regulation Authority VaR Value-at-Risk
PSU Performance-based stock unit VAT Value-added tax
RMBS Residential mortgage-backed securities VIE Variable interest entity
ROE Return on average common equity WACC Implied weighted average cost of capital
ROTCE Return on average tangible common equity WM Wealth Management
RSU Restricted stock unit
165 December 2018 Form 10-K
− 403 − Changes in and Disagreements with Accountants The internal control over financial reporting includes those on Accounting and Financial Disclosure policies and procedures that:
None. • Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Firm; Controls and Procedures • Provide reasonable assurance that transactions are recorded Conclusion Regarding the Effectiveness of Disclosure as necessary to permit preparation of financial statements Controls and Procedures in accordance with U.S. GAAP, and that receipts and expenditures are being made only in accordance with Under the supervision and with the participation of the Firm’s authorizations of the Firm’s management and directors; and management, including the Chief Executive Officer and Chief Financial Officer, the Firm conducted an evaluation of • Provide reasonable assurance regarding prevention or disclosure controls and procedures, as such term is defined timely detection of unauthorized acquisition, use or dispo- under Exchange Act Rule 13a-15(e). Based on this evalua- sition of Firm assets that could have a material effect on the tion, the Chief Executive Officer and Chief Financial Officer Firm’s financial statements. concluded that the Firm’s disclosure controls and procedures were effective as of the end of the period covered by this Because of its inherent limitations, internal control over annual report. financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future Management’s Report on Internal Control Over periods are subject to the risk that controls may become inad- Financial Reporting equate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. The Firm’s management is responsible for establishing and maintaining adequate internal control over financial Management assessed the effectiveness of the Firm’s internal reporting. The Firm’s internal control over financial reporting control over financial reporting as of December 31, 2018. In is designed to provide reasonable assurance regarding the making this assessment, management used the criteria set reliability of financial reporting and the preparation of finan- forth by the Committee of Sponsoring Organizations of the cial statements for external purposes in accordance with Treadway Commission (“COSO”) in Internal Control— generally accepted accounting principles in the United States Integrated Framework (2013). Based on management’s of America (“U.S. GAAP”). assessment and those criteria, management believes that the Firm maintained effective internal control over financial reporting as of December 31, 2018.
The Firm’s independent registered public accounting firm has audited and issued a report on the Firm’s internal control over financial reporting, which appears below.
December 2018 Form 10-K 166
− 404 − Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Morgan whether effective internal control over financial reporting Stanley: was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial Opinion on Internal Control over Financial Reporting reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness We have audited the internal control over financial reporting of internal control based on the assessed risk, and performing of Morgan Stanley and subsidiaries (the “Firm”) as of such other procedures as we considered necessary in the December 31, 2018, based on criteria established in Internal circumstances. We believe that our audit provides a reason- Control — Integrated Framework (2013) issued by the able basis for our opinion. Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Firm maintained, in Definition and Limitations of Internal Control over all material respects, effective internal control over financial Financial Reporting reporting as of December 31, 2018, based on criteria estab- lished in Internal Control — Integrated Framework A company’s internal control over financial reporting is a (2013) issued by COSO. process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of We have also audited, in accordance with the standards of the financial statements for external purposes in accordance with Public Company Accounting Oversight Board (United States) generally accepted accounting principles. A company’s (PCAOB), the consolidated financial statements of the Firm internal control over financial reporting includes those poli- as of and for the year ended December 31, 2018 and our cies and procedures that (1) pertain to the maintenance of report dated February 26, 2019, expressed an unqualified records that, in reasonable detail, accurately and fairly reflect opinion on those financial statements. the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions Basis for Opinion are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting The Firm’s management is responsible for maintaining effec- principles, and that receipts and expenditures of the company tive internal control over financial reporting and for its are being made only in accordance with authorizations of assessment of the effectiveness of internal control over finan- management and directors of the company; and (3) provide cial reporting, included in the accompanying Management’s reasonable assurance regarding prevention or timely detection Report on Internal Control Over Financial Reporting. Our of unauthorized acquisition, use, or disposition of the compa- responsibility is to express an opinion on the Firm’s internal ny’s assets that could have a material effect on the financial control over financial reporting based on our audit. We are a statements. public accounting firm registered with the PCAOB and are required to be independent with respect to the Firm in accor- Because of its inherent limitations, internal control over dance with the U.S. federal securities laws and the applicable financial reporting may not prevent or detect misstate- rules and regulations of the Securities and Exchange ments. Also, projections of any evaluation of effectiveness to Commission and the PCAOB. future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that We conducted our audit in accordance with the standards of the degree of compliance with the policies or procedures may the PCAOB. Those standards require that we plan and deteriorate. perform the audit to obtain reasonable assurance about
/s/ Deloitte & Touche LLP New York, New York February 26, 2019
167 December 2018 Form 10-K
− 405 − Changes in Internal Control Over Financial Reporting Properties
No change in the Firm’s internal control over financial The Firm has offices, operations and data centers located reporting (as such term is defined in Exchange Act Rule around the world. The Firm’s properties that are not owned 13a-15(f)) occurred during the quarter ended December 31, are leased on terms and for durations that are reflective of 2018 that materially affected, or is reasonably likely to mate- commercial standards in the communities where these prop- rially affect, the Firm’s internal control over financial erties are located. The Firm believes the facilities owned or reporting. occupied are adequate for the purposes for which they are currently used and are well-maintained. The Firm’s principal offices include the following properties: Other Information Approximate None. Square Footage Owned/ Lease at December 31, Location Leased Expiration 20181 Unresolved Staff Comments U.S. Locations 1585 Broadway The Firm, like other well-known seasoned issuers, from time New York, New York to time receives written comments from the staff of the SEC (Global 1,335,500 Owned N/A regarding its periodic or current reports under the Exchange Headquarters and square feet Act. There are no comments that remain unresolved that the Institutional Securities Firm received not less than 180 days before the end of the Headquarters) year to which this report relates that the Firm believes are 2000 Westchester material. Avenue 626,100 square feet Purchase, New York Owned N/A (Wealth Management Headquarters) 522 Fifth Avenue 564,900 New York, New York square feet Owned N/A (Investment Management Headquarters) International Locations 20 Bank Street 546,500 London Leased 2038 square feet (London Headquarters)
1 Austin Road West 499,900 Kowloon Leased 2029 square feet (Hong Kong Headquarters) Otemachi Financial City South Tower 245,600 Otemachi, Chiyoda-ku Leased 2028 square feet (Tokyo Headquarters)
1. The indicated total aggregate square footage leased does not include space leased by branch offices.
December 2018 Form 10-K 168
− 406 − Legal Proceedings outcome of such proceedings and investigations will not have a material adverse effect on the financial condition of the In addition to the matters described below, in the normal Firm, although the outcome of such proceedings or investiga- course of business, the Firm has been named, from time to tions could be material to the Firm’s operating results and time, as a defendant in various legal actions, including arbi- cash flows for a particular period depending on, among other trations, class actions and other litigation, arising in connec- things, the level of the Firm’s revenues or income for such tion with its activities as a global diversified financial period. services institution. Certain of the actual or threatened legal actions include claims for substantial compensatory and/or While the Firm has identified below certain proceedings that punitive damages or claims for indeterminate amounts of the Firm believes to be material, individually or collectively, damages. In some cases, the entities that would otherwise be there can be no assurance that additional material losses will the primary defendants in such cases are bankrupt or are in not be incurred from claims that have not yet been asserted or financial distress. are not yet determined to be material.
The Firm is also involved, from time to time, in other Residential Mortgage and Credit Crisis Related Matters reviews, investigations and proceedings (both formal and On July 15, 2010, China Development Industrial Bank informal) by governmental and self-regulatory agencies (“CDIB”) filed a complaint against the Firm, styled China regarding the Firm’s business, and involving, among other Development Industrial Bank v. Morgan Stanley & Co. Incor- matters, sales and trading activities, financial products or porated et al., which is pending in the Supreme Court of the offerings sponsored, underwritten or sold by the Firm, and State of New York, New York County (“Supreme Court of accounting and operational matters, certain of which may NY”). The complaint relates to a $275 million CDS refer- result in adverse judgments, settlements, fines, penalties, encing the super senior portion of the STACK 2006-1 CDO. injunctions or other relief. The complaint asserts claims for common law fraud, fraudu- lent inducement and fraudulent concealment and alleges that The Firm contests liability and/or the amount of damages as the Firm misrepresented the risks of the STACK 2006-1 CDO appropriate in each pending matter. Where available informa- to CDIB, and that the Firm knew that the assets backing the tion indicates that it is probable a liability had been incurred CDO were of poor quality when it entered into the CDS with at the date of the financial statements and the Firm can CDIB. The complaint seeks compensatory damages related to reasonably estimate the amount of that loss, the Firm accrues the approximately $228 million that CDIB alleges it has the estimated loss by a charge to income. The Firm’s future already lost under the CDS, rescission of CDIB’s obligation legal expenses may fluctuate from period to period, given the to pay an additional $12 million, punitive damages, equitable current environment regarding government investigations and relief, pre- and post-judgment interest, fees and costs. On private litigation affecting global financial services firms, February 28, 2011, the court denied the Firm’s motion to including the Firm. dismiss the complaint. On December 21, 2018, the court denied the Firm’s motion for summary judgment and granted In many proceedings and investigations, however, it is inher- in part the Firm’s motion for sanctions related to the spolia- ently difficult to determine whether any loss is probable or tion of evidence. On January 18, 2019, CDIB filed a motion even possible, or to estimate the amount of any loss. The to clarify and resettle the portion of the court’s December 21, Firm cannot predict with certainty if, how or when such 2018 order granting spoliation sanctions. On January 24, proceedings or investigations will be resolved or what the 2019, CDIB filed a notice of appeal from the court’s eventual settlement, fine, penalty or other relief, if any, may December 21, 2018 order, and on January 25, 2019, the Firm be, particularly for proceedings and investigations where the filed a notice of appeal from the same order. factual record is being developed or contested or where plain- tiffs or government entities seek substantial or indeterminate On May 17, 2013, plaintiff in IKB International S.A. in Liqui- damages, restitution, disgorgement or penalties. Numerous dation, et al. v. Morgan Stanley, et al. filed a complaint issues may need to be resolved, including through potentially against the Firm and certain affiliates in the Supreme Court of lengthy discovery and determination of important factual NY. The complaint alleges that defendants made material matters, determination of issues related to class certification misrepresentations and omissions in the sale to plaintiff of and the calculation of damages or other relief, and by certain mortgage pass-through certificates backed by securiti- addressing novel or unsettled legal questions relevant to the zation trusts containing residential mortgage loans. The total proceedings or investigations in question, before a loss or amount of certificates allegedly sponsored, underwritten and/ additional loss or range of loss or additional loss can be or sold by the Firm to plaintiff was approximately reasonably estimated for a proceeding or investigation. $133 million. The complaint alleges causes of action against Subject to the foregoing, the Firm believes, based on current the Firm for common law fraud, fraudulent concealment, knowledge and after consultation with counsel, that the aiding and abetting fraud, and negligent misrepresentation,
169 December 2018 Form 10-K
− 407 − and seeks, among other things, compensatory and punitive motion to dismiss the complaint. On August 13, 2018, the damages. On October 29, 2014, the court granted in part and Firm filed a motion to renew its motion to dismiss. denied in part the Firm’s motion to dismiss. All claims regarding four certificates were dismissed. After these dismissals, the On November 6, 2013, Deutsche Bank, in its capacity as remaining amount of certificates allegedly issued by the Firm or trustee, became the named plaintiff in Federal Housing sold to plaintiff by the Firm was approximately $116 million. On Finance Agency, as Conservator for the Federal Home Loan August 11, 2016, the Appellate Division, First Department Mortgage Corporation, on behalf of the Trustee of the (“First Department”) affirmed the trial court’s order denying in Morgan Stanley ABS Capital I Inc. Trust, Series 2007-NC3 part the Firm’s motion to dismiss the complaint. (MSAC 2007-NC3) v. Morgan Stanley Mortgage Capital Holdings LLC, and filed a complaint in the Supreme Court of On July 2, 2013, Deutsche Bank, in its capacity as trustee, became NY under the caption Deutsche Bank National Trust the named plaintiff in Federal Housing Finance Agency, as Company, solely in its capacity as Trustee for Morgan Conservator for the Federal Home Loan Mortgage Corporation, Stanley ABS Capital I Inc. Trust, Series 2007-NC3 v. Morgan on behalf of the Trustee of the Morgan Stanley ABS Capital I Inc. Stanley Mortgage Capital Holdings LLC, as Trust, Series 2007-NC1 (MSAC 2007-NC1) v. Morgan Stanley Successor-by-Merger to Morgan Stanley Mortgage Capital ABS Capital I Inc., and filed a complaint in the Supreme Court of Inc. The complaint asserts claims for breach of contract and NY under the caption Deutsche Bank National Trust Company, as breach of the implied covenant of good faith and fair dealing Trustee for the Morgan Stanley ABS Capital I Inc. Trust, Series and alleges, among other things, that the loans in the trust, 2007-NC1 v. Morgan Stanley ABS Capital I, Inc. On February 3, which had an original principal balance of approximately 2014, the plaintiff filed an amended complaint, which asserts $1.3 billion, breached various representations and warranties. claims for breach of contract and breach of the implied covenant The complaint seeks, among other relief, specific perfor- of good faith and fair dealing and alleges, among other things, that mance of the loan breach remedy procedures in the transac- the loans in the trust, which had an original principal balance of tion documents, unspecified damages, rescission, interest and approximately $1.25 billion, breached various representations and costs. On April 12, 2016, the court granted the Firm’s motion warranties. The amended complaint seeks, among other relief, to dismiss the complaint, and granted the plaintiff the ability specific performance of the loan breach remedy procedures in the to seek to replead certain aspects of the complaint. On transaction documents, unspecified damages, rescission and January 17, 2017, the First Department affirmed the lower interest. On April 12, 2016, the court granted in part and denied in court’s order granting the motion to dismiss the complaint. part the Firm’s motion to dismiss the amended complaint, On January 9, 2017, plaintiff filed a motion to amend its dismissing all claims except a single claim alleging failure to complaint. On April 13, 2017, the First Department denied notify, regarding which the motion was denied without prejudice. plaintiff’s motion for leave to appeal to the New York Court On December 9, 2016, the Firm renewed its motion to dismiss that of Appeals. On March 8, 2018, the trial court granted plain- notification claim. On January 17, 2017, the First Department tiff’s motion to amend its complaint to include failure to affirmed the lower court’s April 12, 2016 order. On April 13, notify claims. On March 19, 2018, the Firm filed an answer 2017, the First Department denied plaintiff’s motion for leave to to plaintiff’s amended complaint. appeal to the New York Court of Appeals. On March 8, 2018, the trial court denied the Firm’s renewed motion to dismiss the notifi- On September 19, 2014, Financial Guaranty Insurance cation claims. Company (“FGIC”) filed a complaint against the Firm in the Supreme Court of NY, styled Financial Guaranty Insurance On July 8, 2013, U.S. Bank National Association, in its Company v. Morgan Stanley ABS Capital I Inc. et al. relating capacity as trustee, filed a complaint against the Firm styled to a securitization issued by Basket of Aggregated Residential U.S. Bank National Association, solely in its capacity as NIMS 2007-1 Ltd. The complaint asserts claims for breach of Trustee of the Morgan Stanley Mortgage Loan Trust contract and alleges, among other things, that the net interest 2007-2AX (MSM 2007-2AX) v. Morgan Stanley Mortgage margin securities (“NIMS”) in the trust breached various Capital Holdings LLC, Successor-by-Merger to Morgan representations and warranties. FGIC issued a financial guar- Stanley Mortgage Capital Inc. and GreenPoint Mortgage anty policy with respect to certain notes that had an original Funding, Inc., pending in the Supreme Court of NY. The balance of approximately $475 million. The complaint seeks, complaint asserts claims for breach of contract and alleges, among other relief, specific performance of the NIMS breach among other things, that the loans in the trust, which had an remedy procedures in the transaction documents, unspecified original principal balance of approximately $650 million, damages, reimbursement of certain payments made pursuant breached various representations and warranties. The to the transaction documents, attorneys’ fees and interest. On complaint seeks, among other relief, specific performance of November 24, 2014, the Firm filed a motion to dismiss the the loan breach remedy procedures in the transaction docu- complaint, which the court denied on January 19, 2017. On ments, unspecified damages and interest. On November 24, February 24, 2017, the Firm filed a notice of appeal of the 2014, the court granted in part and denied in part the Firm’s denial of its motion to dismiss the complaint and perfected its
December 2018 Form 10-K 170
− 408 − appeal on November 22, 2017. On September 13, 2018, the On April 1, 2016, the California Attorney General’s Office court affirmed the lower court’s order denying the Firm’s filed an action against the Firm in California state court styled motion to dismiss the complaint. California v. Morgan Stanley, et al., on behalf of California investors, including the California Public Employees’ Retire- On September 23, 2014, FGIC filed a complaint against the ment System and the California Teachers’ Retirement Firm in the Supreme Court of NY styled Financial Guaranty System. The complaint alleges that the Firm made misrepre- Insurance Company v. Morgan Stanley ABS Capital I Inc. et sentations and omissions regarding RMBS and notes issued al. relating to the Morgan Stanley ABS Capital I Inc. Trust by the Cheyne SIV, and asserts violations of the California 2007-NC4. The complaint asserts claims for breach of False Claims Act and other state laws and seeks treble contract and fraudulent inducement and alleges, among other damages, civil penalties, disgorgement, and injunctive relief. things, that the loans in the trust breached various representa- On September 30, 2016, the court granted the Firm’s tions and warranties and defendants made untrue statements demurrer, with leave to replead. On October 21, 2016, the and material omissions to induce FGIC to issue a financial California Attorney General filed an amended complaint. On guaranty policy on certain classes of certificates that had an January 25, 2017, the court denied the Firm’s demurrer with original balance of approximately $876 million. The respect to the amended complaint. complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction docu- Antitrust Related Matters ments, compensatory, consequential and punitive damages, attorneys’ fees and interest. On January 23, 2017, the court The Firm and other financial institutions are responding to a denied the Firm’s motion to dismiss the complaint. On number of governmental investigations and civil litigation February 24, 2017, the Firm filed a notice of appeal of the matters related to allegations of anticompetitive conduct in denial of its motion to dismiss the complaint and perfected its various aspects of the financial services industry, including appeal on November 22, 2017. On September 13, 2018, the the matters described below. First Department affirmed in part and reversed in part the lower court’s order denying the Firm’s motion to dismiss the Beginning in February of 2016, the Firm was named as a complaint. On December 20, 2018, the First Department defendant in multiple purported antitrust class actions now denied plaintiff’s motion for leave to appeal to the New York consolidated into a single proceeding in the United States Court of Appeals or, in the alternative, for reargument. District Court for the Southern District of New York (“SDNY”) styled In Re: Interest Rate Swaps Antitrust On January 23, 2015, Deutsche Bank National Trust Litigation. Plaintiffs allege, inter alia, that the Firm, together Company, in its capacity as trustee, filed a complaint against with a number of other financial institution defendants, the Firm styled Deutsche Bank National Trust Company violated U.S. and New York state antitrust laws from 2008 solely in its capacity as Trustee of the Morgan Stanley ABS through December of 2016 in connection with their alleged Capital I Inc. Trust 2007-NC4 v. Morgan Stanley Mortgage efforts to prevent the development of electronic exchange- Capital Holdings LLC as Successor-by-Merger to Morgan based platforms for interest rates swaps trading. Complaints Stanley Mortgage Capital Inc., and Morgan Stanley ABS were filed both on behalf of a purported class of investors Capital I Inc., pending in the Supreme Court of NY. The who purchased interest rates swaps from defendants, as well complaint asserts claims for breach of contract and alleges, as on behalf of two swap execution facilities that allegedly among other things, that the loans in the trust, which had an were thwarted by the defendants in their efforts to develop original principal balance of approximately $1.05 billion, such platforms. The consolidated complaints seek, among breached various representations and warranties. The other relief, certification of the investor class of plaintiffs and complaint seeks, among other relief, specific performance of treble damages. On July 28, 2017, the court granted in part the loan breach remedy procedures in the transaction docu- and denied in part the defendants’ motion to dismiss the ments, compensatory, consequential, rescissory, equitable and complaints. punitive damages, attorneys’ fees, costs and other related expenses, and interest. On December 11, 2015, the court In August of 2017, the Firm was named as a defendant in a granted in part and denied in part the Firm’s motion to purported antitrust class action in the United States District dismiss the complaint. . On October 19, 2018, the court Court for the SDNY styled Iowa Public Employees’ granted the Firm’s motion for leave to amend its answer and Retirement System et al. v. Bank of America Corporation et to stay the case pending resolution of Deutsche Bank al. Plaintiffs allege, inter alia, that the Firm, together with a National Trust Company’s appeal to the New York Court of number of other financial institution defendants, violated U.S. Appeals in another case. On January 17, 2019, the First antitrust laws and New York state law in connection with Department reversed the trial court’s order to the extent that it their alleged efforts to prevent the development of electronic had granted in part the Firm’s motion to dismiss the exchange-based platforms for securities lending. The class complaint. action complaint was filed on behalf of a purported class of
171 December 2018 Form 10-K
− 409 − borrowers and lenders who entered into stock loan transac- years 2007 to 2013. The Dutch Authority alleges that the tions with the defendants. The class action complaint seeks, Firm was not entitled to receive the withholding tax credits among other relief, certification of the class of plaintiffs and on the basis, inter alia, that a Firm subsidiary did not hold treble damages. On September 27, 2018, the court denied the legal title to certain securities subject to withholding tax on defendants’ motion to dismiss the class action complaint. the relevant dates. The Dutch Authority has also alleged that the Firm failed to provide certain information to the Dutch European Matters Authority and keep adequate books and records. On April 26, 2018, the District Court in Amsterdam issued a decision On October 11, 2011, an Italian financial institution, Banco dismissing the Dutch Authority’s claims. On June 4, 2018, Popolare Societá Cooperativa (“Banco Popolare”), filed a the Dutch Authority filed an appeal before the Court of civil claim against the Firm in the Milan courts, styled Banco Appeal in Amsterdam in matters re-styled Case number Popolare Societá Cooperativa v Morgan Stanley & Co. Inter- 18/00318 and Case number 18/00319. A hearing of the Dutch national plc & others, related to its purchase of €100 million Authority’s appeal has been scheduled for June 26, 2019. of bonds issued by Parmalat. The claim asserted by Banco Popolare alleges, among other things, that the Firm was On October 5, 2017, various institutional investors filed a claim aware of Parmalat’s impending insolvency and conspired against the Firm and another bank in a matter now styled Case with others to deceive Banco Popolare into buying bonds by number B-803-18 (previously BS 99-6998/2017), in the City Court concealing both Parmalat’s true financial condition and of Copenhagen, Denmark concerning their roles as underwriters certain features of the bonds from the market and Banco of the initial public offering (“IPO”) in March 2014 of the Danish Popolare. Banco Popolare seeks damages of €76 million company OW Bunker A/S. The claim seeks damages of DKK (approximately $87 million) plus damages for loss of oppor- 534,270,456 (approximately $82 million) plus interest in respect tunity and moral damages. The Firm filed its answer on of alleged losses arising from investing in shares in OW Bunker, April 20, 2012. On September 11, 2018, the court dismissed which entered into bankruptcy in November 2014. Separately, on in full the claim against the Firm. The plaintiff has until November 29, 2017, another group of institutional investors joined March 11, 2019 to file an appeal. the Firm and another bank as defendants to pending proceedings in the High Court of Eastern Denmark against various other On June 22, 2017, the public prosecutor for the Court of parties involved in the IPO in a matter styled Case number Accounts for the Republic of Italy filed a claim against the B-2073-16. The claim brought against the Firm and the other bank Firm styled Case No. 2012/00406/MNV, which is pending in has been given its own Case number B-2564-17. The investors the Regional Prosecutor’s Office at the Judicial Section of the claim damages of DKK 767,235,885 (approximately $118 Court of Auditors for Lazio, Italy. The claim relates to certain million) plus interest, from the Firm and the other bank on a joint derivative transactions between the Republic of Italy and the and several basis with the Defendants to these proceedings. Both Firm. The transactions were originally entered into between claims are based on alleged prospectus liability; the second claim 1999 and 2005, and were restructured (and certain of the also alleges professional liability of banks acting as financial transactions were terminated) in December 2011 and January intermediaries. On June 8, 2018, the City Court of Copenhagen, 2012. The claim alleges, inter alia, that the Firm effectively Denmark ordered that the matters now styled Case number B-803- acted as an agent of the state in connection with these trans- 18, B-2073-16 and Case number B-2564-17 be heard together actions and asserts claims related to, among other things, before the High Court of Eastern Denmark. On June 29, 2018, the whether the Ministry of Finance was authorized to enter into Firm filed its defense to the matter now styled Case number B- these transactions, whether the transactions were appropriate 2564-17. On February 4, 2019, the Firm filed its defense to the and whether the Firm’s conduct related to the termination of matter now styled Case number B-803-18. certain transactions was proper. The prosecutor is seeking The following matters were terminated during or damages through an administrative process against the Firm following the quarter ended December 31, 2018: for €2.76 billion (approximately $3.2 billion). On March 30, 2018, the Firm filed its defense to the claim. On June 15, On October 20, 2014, a purported class action complaint was 2018, the Court issued a decision declining jurisdiction and filed against the Firm and other defendants styled Genesee dismissing the claim against the Firm. A hearing of the public County Employees’ Retirement System v. Bank of America prosecutor’s appeal was held on January 10, 2019. Corporation et al. in the SDNY. The action was later consoli- dated with four similar actions in SDNY under the lead case In matters styled Case number 15/3637 and Case number styled Alaska Electrical Pension Fund v. Bank of America 15/4353, the Dutch Tax Authority (“Dutch Authority”) has Corporation et al. A consolidated amended complaint was challenged in the District Court in Amsterdam the prior € filed on February 2, 2015 asserting claims for alleged viola- set-off by the Firm of approximately 124 million (approxi- tions of the Sherman Act, breach of contract, breach of the mately $142 million) plus accrued interest of withholding tax implied covenant of good faith and fair dealing, unjust credits against the Firm’s corporation tax liabilities for the tax
December 2018 Form 10-K 172
− 410 − enrichment, and tortious interference with contract. The containing residential mortgage loans. The total amount of consolidated amended complaint alleges, among other things, certificates allegedly sponsored, underwritten and/or sold by that the defendants engaged in antitrust violations with the Firm to plaintiff was approximately $597 million. The regards to the process of setting ISDAfix, a financial bench- complaint raises common law claims of fraud, fraudulent mark and seeks treble damages, injunctive relief, attorneys’ inducement, negligent misrepresentation, and aiding and abet- fees and other relief. On June 22, 2018, the parties entered ting fraud and seeks, among other things, compensatory and into an agreement to settle the litigation. On November 13, punitive damages. The plaintiff filed an amended complaint on 2018, the court entered a final judgment and order granting December 1, 2015. On April 12, 2017, the Supreme Court of final approval of the settlement and dismissing the action as the State of NY granted the Firm’s motion to dismiss the to the Firm and the other remaining defendants. amended complaint. On October 9, 2018, the Appellate Divi- sion, First Department affirmed the lower court’s order On December 14, 2012, Royal Park Investments SA/NV filed a dismissing the amended complaint. On January 15, 2019, complaint against the Firm, certain affiliates, and other defen- plaintiff’s motion for leave to appeal to the New York Court of dants in the Supreme Court of NY, styled Royal Park Invest- Appeals was denied. ments SA/NV v. Merrill Lynch et al. On October 24, 2013, plaintiff filed a new complaint against the Firm in the Supreme Court of NY, styled Royal Park Investments SA/NV v. Morgan Mine Safety Disclosures Stanley et al., alleging that defendants made material misrepre- sentations and omissions in the sale to plaintiff of certain mort- Not applicable. gage pass-through certificates backed by securitization trusts
173 December 2018 Form 10-K
− 411 − Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Morgan Stanley’s common stock trades under the symbol “MS” on the New York Stock Exchange. As of February 15, 2019, the Firm had 56,561 holders of record; however, the Firm believes the number of beneficial owners of the Firm’s common stock exceeds this number.
The table below sets forth the information with respect to purchases made by or on behalf of the Firm of its common stock during the fourth quarter of the year ended December 31, 2018.
Issuer Purchases of Equity Securities
Approximate Total Number of Dollar Value of Average Shares Purchased Shares That May Total Number of Price as Part of Publicly Yet Be Purchased Shares Paid per Announced Plans under the Plans $ in millions, except per share data Purchased Share or Programs1 or Programs Month #1 (October 1, 2018-October 31, 2018) Share Repurchase Program2 6,132,280 $ 45.41 6,132,280 $ 3,262 Employee transactions3 42,464 $ 46.30 — —
Month #2 (November 1, 2018-November 30, 2018) Share Repurchase Program2 8,382,000 $ 44.81 8,382,000 $ 2,886 Employee transactions3 10,692 $ 45.37 — —
Month #3 (December 1, 2018-December 31, 2018) Share Repurchase Program2 12,442,923 $ 42.27 12,442,923 $ 2,360 Employee transactions3 105,496 $ 41.76 — —
Quarter ended December 31, 2018 Share Repurchase Program2 26,957,203 $ 43.77 26,957,203 $ 2,360 Employee transactions3 158,652 $ 43.22 — —
1. Share purchases under publicly announced programs are made pursuant to open-market purchases, Rule 10b5-1 plans or privately negotiated transac- tions (including with employee benefit plans) as market conditions warrant and at prices the Firm deems appropriate and may be suspended at any time. On April 18, 2018, the Firm entered into a sales plan with Mitsubishi UFJ Financial Group, Inc. (“MUFG”) and Morgan Stanley & Co. LLC (“MS&Co.”) whereby MUFG will sell shares of the Firm’s common stock to the Firm, through the Firm’s agent MS&Co., as part of the Company’s share repurchase program (as defined below). The sales plan is only intended to maintain MUFG’s ownership percentage below 24.9% in order to comply with MUFG’s passivity commitments to the Board of Governors of the Federal Reserve System (the “Federal Reserve”) and will have no impact on the strategic alliance between MUFG and the Firm, including the joint ventures in Japan. 2. The Firm’s Board of Directors has authorized the repurchase of the Firm’s outstanding stock under a share repurchase program (the “Share Repurchase Program”). The Share Repurchase Program is a program for capital management purposes that considers, among other things, business segment capital needs, as well as equity-based compensation and benefit plan requirements. The Share Repurchase Program has no set expiration or termination date. Share repurchases by the Firm are subject to regulatory approval. On June 28, 2018, the Federal Reserve published summary results of CCAR and the Firm received a conditional non-objection to its 2018 Capital Plan, where the only condition was that the Firm’s capital distributions not exceed the greater of the actual distributions it made over the previous four calendar quarters or the annualized average of actual distributions over the previous eight calendar quarters. As a result, the Firm’s 2018 Capital Plan includes a share repurchase of up to $4.7 billion of its outstanding common stock during the period beginning July 1, 2018 through June 30, 2019. During the quarter ended December 31, 2018, the Firm repurchased approximately $1.2 billion of the Firm’s outstanding common stock as part of its Share Repurchase Program. For further information, see “Liquidity and Capital Resources—Capital Management.” 3. Includes shares acquired by the Firm in satisfaction of the tax withholding obligations on stock-based awards granted under the Firm’s stock-based compensation plans.
December 2018 Form 10-K 174
− 412 − Stock Performance Graph
The following graph compares the cumulative total shareholder return (rounded to the nearest whole dollar) of the Firm’s common stock, the S&P 500 Stock Index and the S&P 500 Financials Sector Index for the last five years. The graph assumes a $100 investment at the closing price on December 31, 2013 and reinvestment of dividends on the respective dividend payment dates without commissions. This graph does not forecast future performance of the Firm’s common stock.
Cumulative Total Return December 31, 2013 – December 31, 2018
$300
$250
$200 150.27 $150 146.60 138.56 $100
$50
$0 Dec-2013 Dec-2014 Dec-2015 Dec-2016 Dec-2017 Dec-2018
Morgan Stanley S&P 500 Stock Index S&P 500 Financials Sector Index
At December 31, 2013 2014 2015 2016 2017 2018 Morgan Stanley $100.00 $125.09 $104.13 $141.68 $179.40 138.56 S&P 500 Stock Index 100.00 113.68 115.24 129.02 157.17 150.27 S&P 500 Financials Sector Index 100.00 115.18 113.38 139.17 168.59 146.60
175 December 2018 Form 10-K
− 413 − Directors, Executive Officers and Corporate At December 31, 2018 Governance (a) (b) (c) Number of Number of securities Information relating to the Firm’s directors and nominees in securities to Weighted- remaining available be issued average for future the Firm’s definitive proxy statement for its 2019 annual upon exercise issuance under exercise of price of equity meeting of shareholders (“Morgan Stanley’s Proxy State- outstanding outstanding compensation ment”) is incorporated by reference herein. options, options, plans (excluding warrants warrants securities reflected plan category and rights1 and rights in column (a)) Information relating to the Firm’s executive officers is Equity compensation plans contained in the “Business” section of this report under approved by security “Executive Officers of Morgan Stanley.” holders 79,940,303 $ — 138,179,204 2 Equity compensation plans not approved by security Morgan Stanley’s Code of Ethics and Business Conduct applies holders —— — to all directors, officers and employees, including its Chief Total 79,940,303 $ — 138,179,204 Executive Officer, Chief Financial Officer and Deputy Chief Financial Officer. You can find the Code of Ethics and Business 1. Includes outstanding restricted stock unit and performance stock unit awards. Conduct on the Internet site, www.morganstanley.com/ The number of outstanding performance stock unit awards is based on the about-us-governance/ethics.html. The Firm will post any target number of units granted to senior executives. 2. Includes the following: amendments to the Code of Ethics and Business Conduct, and (a)39,182,870 shares available under the Employee Stock Purchase Plan any waivers that are required to be disclosed by the rules of (“ESPP”). Pursuant to this plan, which is qualified under Section 423 of the either the U.S. Securities and Exchange Commission or the New Internal Revenue Code, eligible employees were permitted to purchase shares of common stock at a discount to market price through regular York Stock Exchange LLC, on the Internet site. payroll deduction. The Compensation, Management Development and Succession Committee of the Board (“CMDS Committee”) approved the discontinuation of the ESPP, effective June 1, 2009, such that no further Executive Compensation contributions to the plan will be permitted following such date, until such time as the CMDS Committee determines to recommence contributions under the plan. Information relating to director and executive officer (b)82,686,133 shares available under the Equity Incentive Compensation compensation in Morgan Stanley’s Proxy Statement is incor- Plan. Awards may consist of stock options, stock appreciation rights, porated by reference herein. restricted stock, restricted stock units to be settled by the delivery of shares of common stock (or the value thereof), performance-based units, other awards that are valued by reference to or otherwise based on the fair market value of common stock, and other equity-based or equity- Security Ownership of Certain Beneficial related awards approved by the CMDS Committee. Owners and Management and Related (c)14,869,924 shares available under the Employee Equity Accumulation Plan, which includes 733,757 shares available for awards of restricted Stockholder Matters stock and restricted stock units. Awards may consist of stock options, stock appreciation rights, restricted stock, restricted stock units to be Equity Compensation Plan Information settled by the delivery of shares of common stock (or the value thereof), other awards that are valued by reference to or otherwise based on the fair market value of common stock, and other equity-based or equity- The following table provides information about outstanding related awards approved by the CMDS Committee. awards and shares of common stock available for future (d)355,243 shares available under the Tax Deferred Equity Participation awards under all of Morgan Stanley’s equity compensation Plan. Awards consist of restricted stock units, which are settled by the delivery of shares of common stock. plans. Morgan Stanley has not made any grants of common (e)1,085,034 shares available under the Directors’ Equity Capital Accumula- stock outside of its equity compensation plans. tion Plan. This plan provides for periodic awards of shares of common stock and stock units to non-employee directors and also allows non-employee directors to defer the cash fees they earn for services as a director in the form of stock units.
Other information relating to security ownership of certain beneficial owners and management is set forth under the caption “Beneficial Ownership of Company Common Stock” in Morgan Stanley’s Proxy Statement and such information is incorporated by reference herein.
December 2018 Form 10-K 176
− 414 − Certain Relationships and Related Transactions and Director Independence
Information regarding certain relationships and related trans- actions in Morgan Stanley’s Proxy Statement is incorporated by reference herein.
Information regarding director independence in Morgan Stan- ley’s Proxy Statement is incorporated by reference herein.
Principal Accountant Fees and Services
Information regarding principal accountant fees and services in Morgan Stanley’s Proxy Statement is incorporated by reference herein.
Exhibits and Financial Statement Schedules Documents filed as part of this report • The financial statements required to be filed in this Annual Report on Form 10-K are included in the section titled “Financial Statements and Supplementary Data.”
• An exhibit index has been filed as part of this report begin- ning on page E-1 and is incorporated by reference herein.
Form 10-K Summary
None.
177 December 2018 Form 10-K
− 415 − SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
EXHIBITS TO FORM 10-K
For the year ended December 31, 2018 Commission File No. 1-11758
− 416 − Exhibit Index Certain of the following exhibits, as indicated parenthetically, were previously filed as exhibits to registration statements filed by Morgan Stanley or its predecessor companies under the Securities Act or to reports or registration statements filed by Morgan Stanley or its predecessor companies under the Exchange Act and are hereby incorporated by reference to such statements or reports. Morgan Stanley’s Exchange Act file number is 1-11758. The Exchange Act file number of Morgan Stanley Group Inc., a predecessor company (“MSG”), was 1-9085.(1) Exhibit No. Description
3.1 Amended and Restated Certificate of Incorporation of Morgan Stanley, as amended to date (Exhibit 3.1 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2017). 3.2 Amended and Restated Bylaws of Morgan Stanley, as amended to date (Exhibit 3.1 to Morgan Stanley’s Current Report on Form 8-K dated October 29, 2015). 4.1 Amended and Restated Senior Indenture dated as of May 1, 1999 between Morgan Stanley and The Bank of New York, as trustee (Exhibit 4-e to Morgan Stanley’s Registration Statement on Form S-3/A (No. 333-75289) as amended by Fourth Supplemental Senior Indenture dated as of October 8, 2007 (Exhibit 4.3 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2007). 4.2 Senior Indenture dated as of November 1, 2004 between Morgan Stanley and The Bank of New York, as trustee (Exhibit 4-f to Morgan Stanley’s Registration Statement on Form S-3/A (No. 333-117752), as amended by First Supplemental Senior Indenture dated as of September 4, 2007 (Exhibit 4.5 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2007), Second Supplemental Senior Indenture dated as of January 4, 2008 (Exhibit 4.1 to Morgan Stanley’s Current Report on Form 8-K dated January 4, 2008), Third Supplemental Senior Indenture dated as of September 10, 2008 (Exhibit 4 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended August 31, 2008), Fourth Supplemental Senior Indenture dated as of December 1, 2008 (Exhibit 4.1 to Morgan Stanley’s Current Report on Form 8-K dated December 1, 2008), Fifth Supplemental Senior Indenture dated as of April 1, 2009 (Exhibit 4 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2009), Sixth Supplemental Senior Indenture dated as of September 16, 2011 (Exhibit 4.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2011), Seventh Supplemental Senior Indenture dated as of November 21, 2011 (Exhibit 4.4 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2011), Eighth Supplemental Senior Indenture dated as of May 4, 2012 (Exhibit 4.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2012), Ninth Supplemental Senior Indenture dated as of March 10, 2014 (Exhibit 4.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2014) and Tenth Supplemental Senior Indenture dated as of January 11, 2017 (Exhibit 4.1 to Morgan Stanley’s Current Report on Form 8-K dated January 11, 2017). 4.3 The Unit Agreement Without Holders’ Obligations, dated as of August 29, 2008, between Morgan Stanley and The Bank of New York Mellon, as Unit Agent, as Trustee and Paying Agent under the Senior Indenture referred to therein and as Warrant Agent under the Warrant Agreement referred to therein (Exhibit 4.1 to Morgan Stanley’s Current Report on Form 8-K dated August 29, 2008). 4.4 Subordinated Indenture dated as of October 1, 2004 between Morgan Stanley and The Bank of New York, as trustee (Exhibit 4-g to Morgan Stanley’s Registration Statement on Form S-3/A (No. 333-117752)). 4.5 Junior Subordinated Indenture dated as of October 12, 2006 between Morgan Stanley and The Bank of New York, as trustee (Exhibit 4.1 to Morgan Stanley’s Current Report on Form 8-K dated October 12, 2006). 4.6 Deposit Agreement dated as of July 6, 2006 among Morgan Stanley, JPMorgan Chase Bank, N.A. and the holders from time to time of the depositary receipts described therein (Exhibit 4.3 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended May 31, 2006).
(1) For purposes of this Exhibit Index, references to “The Bank of New York” mean in some instances the entity successor to JPMorgan Chase Bank, N.A. or J.P. Morgan Trust Company, National Association; references to “JPMorgan Chase Bank, N.A.” mean the entity formerly known as The Chase Manhattan Bank, in some instances as the successor to Chemical Bank; references to “J.P. Morgan Trust Company, N.A.” mean the entity formerly known as Bank One Trust Company, N.A., as successor to The First National Bank of Chicago.
E-1 December 2018 Form 10-K
− 417 − Exhibit No. Description 4.7 Form of Deposit Agreement among Morgan Stanley, JPMorgan Chase Bank, N.A. and the holders from time to time of the depositary receipts representing interests in the Series A Preferred Stock described therein (Exhibit 2.4 to Morgan Stanley’s Registration Statement on Form 8-A dated July 5, 2006). 4.8 Depositary Receipt for Depositary Shares, representing Floating Rate Non-Cumulative Preferred Stock, Series A (included in Exhibit 4.7 hereto). 4.9 Form of Deposit Agreement among Morgan Stanley, The Bank of New York Mellon and the holders from time to time of the depositary receipts representing interests in the Series E Preferred Stock described therein (Exhibit 2.6 to Morgan Stanley’s Registration Statement on Form 8-A dated September 27, 2013). 4.10 Depositary Receipt for Depositary Shares, representing Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series E (included in Exhibit 4.9 hereto). 4.11 Form of Deposit Agreement among Morgan Stanley, The Bank of New York Mellon and the holders from time to time of the depositary receipts representing interests in the Series F Preferred stock described therein (Exhibit 2.4 to Morgan Stanley’s Registration Statement on Form 8-A dated December 9, 2013). 4.12 Depositary Receipt for Depositary Shares, representing Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series F (included in Exhibit 4.11 hereto). 4.13 Form of Deposit Agreement among Morgan Stanley, The Bank of New York Mellon and the holders from time to time of the depositary receipts representing interests in the Series G Preferred stock described therein (Exhibit 2.4 to Morgan Stanley’s Registration Statement on Form 8-A dated April 28, 2014). 4.14 Depositary Receipt for Depositary Shares, representing 6.625% Non-Cumulative Preferred Stock, Series G (included in Exhibit 4.13 hereto). 4.15 Form of Deposit Agreement among Morgan Stanley, The Bank of New York Mellon and the holders from time to time of the depositary receipts representing interests in the Series H Preferred stock described therein (Exhibit 4.6 to Morgan Stanley’s Current Report on Form 8-K dated April 29, 2014). 4.16 Depositary Receipt for Depositary Shares, representing Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series H (included in Exhibit 4.15 hereto). 4.17 Form of Deposit Agreement among Morgan Stanley, The Bank of New York Mellon and the holders from time to time of the depositary receipts representing interests in the Series I Preferred stock described therein (Exhibit 2.4 to Morgan Stanley’s Registration Statement on Form 8-A dated September 17, 2014). 4.18 Depositary Receipt for Depositary Shares, representing Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series I (included in Exhibit 4.17 hereto). 4.19 Form of Deposit Agreement among Morgan Stanley, The Bank of New York Mellon and the holders from time to time of the depositary receipts representing interests in the Series J Preferred Stock described therein (Exhibit 4.3 to Morgan Stanley’s Current Report on Form 8-K dated March 18, 2015). 4.20 Depositary Receipt for Depositary Shares, representing Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series J (included in Exhibit 4.19 hereto). 4.21 Form of Deposit Agreement among Morgan Stanley, The Bank of New York Mellon and the holders from time to time of the depositary receipts representing interests in the Series K Preferred Stock described therein (Exhibit 2.4 to Morgan Stanley’s Current Report on Form 8-A dated January 30, 2017). 4.22 Depositary Receipt for Depositary Shares, representing Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series K (included in Exhibit 4.21 hereto). 10.1 Amended and Restated Trust Agreement dated as of January 1, 2018 by and between Morgan Stanley and State Street Bank and Trust Company (Exhibit 10.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2018).
December 2018 Form 10-K E-2
− 418 − Exhibit No. Description 10.2 Amended and Restated Investor Agreement dated as of June 30, 2011 by and between Morgan Stanley and Mitsubishi UFJ Financial Group, Inc. (Exhibit 10.1 to Morgan Stanley’s Current Report on Form 8-K dated June 30, 2011), as amended by Third Amendment, dated October 3, 2013 (Exhibit 10.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013) and Fourth Amendment, dated April 6, 2016 (Exhibit 10.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016).
10.3† Morgan Stanley 401(k) Plan, amended and restated as of January 1, 2013 (Exhibit 10.6 to Morgan Stanley Annual Report on Form 10-K for the year ended December 31, 2012), as amended by Amendment (Exhibit 10.5 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2013), Amendment (Exhibit 10.6 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2013), Amendment (Exhibit 10.5 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2014), Amendment (Exhibit 10.5 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2015), Amendment (Exhibit 10.4 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2016), Amendment (Exhibit 10.4 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2017), and Amendment (Exhibit 10.5 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2017).
10.4†* Amendment to Morgan Stanley 401(k) Plan, dated as of December 11, 2018.
10.5† Tax Deferred Equity Participation Plan as amended and restated as of November 26, 2007 (Exhibit 10.9 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2007).
10.6†* Directors’ Equity Capital Accumulation Plan as amended and restated as of November 1, 2018.
10.7† Employees’ Equity Accumulation Plan as amended and restated as of November 26, 2007 (Exhibit 10.12 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2007).
10.8† Employee Stock Purchase Plan as amended and restated as of February 1, 2009 (Exhibit 10.20 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2008).
10.9† Morgan Stanley Supplemental Executive Retirement and Excess Plan, amended and restated effective December 31, 2008 (Exhibit 10.2 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2009) as amended by Amendment (Exhibit 10.5 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2009), Amendment (Exhibit 10.19 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2010), Amendment (Exhibit 10.3 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2011) and Amendment (Exhibit 10.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014).
10.10† 1995 Equity Incentive Compensation Plan (Annex A to MSG’s Proxy Statement for its 1996 Annual Meeting of Stockholders) as amended by Amendment (Exhibit 10.39 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2000), Amendment (Exhibit 10.5 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended August 31, 2005), Amendment (Exhibit 10.3 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2006), Amendment (Exhibit 10.24 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2006) and Amendment (Exhibit 10.22 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2007).
10.11† Form of Deferred Compensation Agreement under the Pre-Tax Incentive Program 2 (Exhibit 10.12 to MSG’s Annual Report for the fiscal year ended November 30, 1996).
10.12† Key Employee Private Equity Recognition Plan (Exhibit 10.43 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2000).
10.13† Morgan Stanley UK Share Ownership Plan (Exhibit 4.1 to Morgan Stanley’s Registration Statement on Form S-8 (No. 333-146954)).
E-3 December 2018 Form 10-K
− 419 − Exhibit No. Description 10.14† Supplementary Deed of Participation for the Morgan Stanley UK Share Ownership Plan, dated as of November 5, 2009 (Exhibit 10.36 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2009).
10.15† Aircraft Time Sharing Agreement, dated as of January 1, 2010, by and between Corporate Services Support Corp. and James P. Gorman (Exhibit 10.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010).
10.16† Agreement between Morgan Stanley and James P. Gorman, dated August 16, 2005, and amendment dated December 17, 2008 (Exhibit 10.2 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2010), as amended by Amendment (Exhibit 10.25 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2013).
10.17† Form of Restrictive Covenant Agreement (Exhibit 10 to Morgan Stanley’s Current Report on Form 8-K dated November 22, 2005).
10.18† Equity Incentive Compensation Plan, as amended and restated as of March 30, 2017 (Exhibit 10.1 to Morgan Stanley’s Current Report on Form 8-K dated May 22, 2017).
10.19† Morgan Stanley 2006 Notional Leveraged Co-Investment Plan, as amended and restated as of November 28, 2008 (Exhibit 10.47 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2008).
10.20† Form of Award Certificate under the 2006 Notional Leveraged Co-Investment Plan (Exhibit 10.7 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended February 29, 2008).
10.21† Morgan Stanley 2007 Notional Leveraged Co-Investment Plan, amended as of June 4, 2009 (Exhibit 10.6 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2009).
10.22† Form of Award Certificate under the 2007 Notional Leveraged Co-Investment Plan for Certain Management Committee Members (Exhibit 10.8 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended February 29, 2008).
10.23† Morgan Stanley Compensation Incentive Plan (Exhibit 10.54 to Morgan Stanley’s Annual Report on Form 10-K for the fiscal year ended November 30, 2008).
10.24†*. Morgan Stanley Schedule of Non-Employee Directors Annual Compensation, effective as of November 1, 2018.
10.25† Morgan Stanley UK Limited Alternative Retirement Plan, dated as of October 8, 2009 (Exhibit 10.2 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
10.26† Agreement between Morgan Stanley and Colm Kelleher, dated January 5, 2015 (Exhibit 10.1 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2015).
10.27† Description of Operating Committee Medical Coverage (Exhibit 10.2 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2015).
10.28† Form of Award Certificate for Discretionary Retention Awards of Stock Units. (Exhibit 10.33 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2017).
10.29† Form of Award Certificate for Discretionary Retention Awards under the Morgan Stanley Compensation Incentive Plan. (Exhibit 10.34 to Morgan Stanley’s Annual Report on Form 10-K for the year ended December 31, 2017).
10.30†* Form of Award Certificate for Long-Term Incentive Program Awards.
10.31† Memorandum to Colm Kelleher Regarding Relocation to New York, dated February 25, 2016 (Exhibit 10.2 to Morgan Stanley’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2016).
December 2018 Form 10-K E-4
− 420 − Exhibit No. Description 21* Subsidiaries of Morgan Stanley.
23.1* Consent of Deloitte & Touche LLP.
24 Powers of Attorney (included on signature page).
31.1* Rule 13a-14(a) Certification of Chief Executive Officer.
31.2* Rule 13a-14(a) Certification of Chief Financial Officer.
32.1** Section 1350 Certification of Chief Executive Officer.
32.2** Section 1350 Certification of Chief Financial Officer.
101 Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Income Statements—Twelve Months Ended December 31, 2018, December 31, 2017, and December 31, 2016, (ii) the Consolidated Comprehensive Income Statements —Twelve Months Ended December 31, 2018, December 31, 2017 and December 31, 2016, (iii) the Consolidated Balance Sheets—December 31, 2018 and December 31, 2017, (iv) the Consolidated Statements of Changes in Total Equity—Twelve Months Ended December 31, 2018, December 31, 2017 and December 31, 2016, (v) the Consolidated Cash Flow Statements—Twelve Months Ended December 31, 2018, December 31, 2017 and December 31, 2016, and (vi) Notes to Consolidated Financial Statements.
* Filed herewith. ** Furnished herewith. † Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 15(b).
Note: Other instruments defining the rights of holders of long-term debt securities of Morgan Stanley and its subsidiaries are omitted pursuant to Section (b)(4)(iii) of Item 601 of Regulation S-K. Morgan Stanley hereby agrees to furnish copies of these instruments to the U.S. Securities and Exchange Commission upon request.
E-5 December 2018 Form 10-K
− 421 − Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 26, 2019.
MORGAN STANLEY
(REGISTRANT) By: /s/ JAMES P. GORMAN (James P. Gorman) Chairman of the Board and Chief Executive Officer
POWER OF ATTORNEY
We, the undersigned, hereby severally constitute Jonathan Pruzan, Eric F. Grossman and Martin M. Cohen, and each of them singly, our true and lawful attorneys with full power to them and each of them to sign for us, and in our names in the capacities indicated below, any and all amendments to the Annual Report on Form 10-K filed with the Securities and Exchange Commis- sion, hereby ratifying and confirming our signatures as they may be signed by our said attorneys to any and all amendments to said Annual Report on Form 10-K.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 26th day of February, 2019.
Signature Title
/S/JAMES P. GORMAN Chairman of the Board and Chief Executive Officer (James P. Gorman) (Principal Executive Officer)
/S/JONATHAN PRUZAN Executive Vice President and Chief Financial Officer (Jonathan Pruzan) (Principal Financial Officer)
/S/PAUL C. WIRTH Deputy Chief Financial Officer (Paul C. Wirth) (Principal Accounting Officer)
/S/ELIZABETH CORLEY Director (Elizabeth Corley)
/S/ALISTAIR DARLING Director (Alistair Darling)
/S/THOMAS H. GLOCER Director (Thomas H. Glocer)
/S/ROBERT H. HERZ Director (Robert H. Herz)
/S/NOBUYUKI HIRANO Director (Nobuyuki Hirano)
/S/JAMI MISCIK Director (Jami Miscik)
/S/DENNIS M. NALLY Director (Dennis M. Nally)
S-1 December 2018 Form 10-K
− 422 − Signature Title
/S/HUTHAM S. OLAYAN Director (Hutham S. Olayan)
/S/MARY L. SCHAPIRO Director (Mary L. Schapiro)
/S/RYOSUKE TAMAKOSHI Director (Ryosuke Tamakoshi)
/S/PERRY M. TRAQUINA Director (Perry M. Traquina)
/S/RAYFORD WILKINS,JR. Director (Rayford Wilkins, Jr.)
December 2018 Form 10-K S-2
− 423 − ANNEX 8
EXTRACT OF THE GUARANTOR’S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED 31 MARCH 2019
This information in this Annex 8 has been extracted from the guarantor’s quarterly report on Form 10-Q for the quarterly period ended 31 March 2019. References to page numbers in this Annex 8 are to the pages in the guarantor’s quarterly report on Form 10-Q and not to the pages in this document.
− 424 − Consolidated Income Statements (Unaudited)
Three Months Ended March 31, in millions, except per share data 2019 2018 Revenues Investment banking $ 1,242 $ 1,634 Trading 3,441 3,770 Investments 273 126 Commissions and fees 966 1,173 Asset management 3,049 3,192 Other 301 207 Total non-interest revenues 9,272 10,102 Interest income 4,290 2,860 Interest expense 3,276 1,885 Net interest 1,014 975 Net revenues 10,286 11,077 Non-interest expenses Compensation and benefits 4,651 4,914 Occupancy and equipment 347 336 Brokerage, clearing and exchange fees 593 627 Information processing and communications 532 478 Marketing and business development 141 140 Professional services 514 510 Other 553 652 Total non-interest expenses 7,331 7,657 Income from continuing operations before income taxes 2,955 3,420 Provision for income taxes 487 714 Income from continuing operations 2,468 2,706 Income (loss) from discontinued operations, net of income taxes — (2) Net income $ 2,468 $ 2,704 Net income applicable to noncontrolling interests 39 36 Net income applicable to Morgan Stanley $ 2,429 $ 2,668 Preferred stock dividends and other 93 93 Earnings applicable to Morgan Stanley common shareholders $ 2,336 $ 2,575
Earnings per common share Basic $ 1.41 $ 1.48 Diluted $ 1.39 $ 1.45
Average common shares outstanding Basic 1,658 1,740 Diluted 1,677 1,771
March 2019 Form 10-Q 34 See Notes to Consolidated Financial Statements
− 425 − Consolidated Comprehensive Income Statements (Unaudited)
Three Months Ended March 31, $ in millions 2019 2018 Net income $ 2,468 $ 2,704 Other comprehensive income (loss), net of tax: Foreign currency translation adjustments $ (22) $ 117 Change in net unrealized gains (losses) on available-for-sale securities 429 (410) Pension, postretirement and other 1 5 Change in net debt valuation adjustment (620) 451 Total other comprehensive income (loss) $ (212) $ 163 Comprehensive income $ 2,256 $ 2,867 Net income applicable to noncontrolling interests 39 36 Other comprehensive income (loss) applicable to noncontrolling interests (31) 72 Comprehensive income applicable to Morgan Stanley $ 2,248 $ 2,759
See Notes to Consolidated Financial Statements 35 March 2019 Form 10-Q
− 426 − Consolidated Balance Sheets
(Unaudited) At At March 31, December 31, $ in millions, except share data 2019 2018 Assets Cash and cash equivalents: Cash and due from banks $ 35,472 $ 30,541 Interest bearing deposits with banks 14,498 21,299 Restricted cash 30,712 35,356 Trading assets at fair value ($103,750 and $120,437 were pledged to various parties) 264,818 266,299 Investment securities (includes $61,641 and $61,061 at fair value) 97,944 91,832 Securities purchased under agreements to resell (includes $5 and $— at fair value) 96,570 98,522 Securities borrowed 138,891 116,313 Customer and other receivables 52,667 53,298 Loans: Held for investment (net of allowance of $259 and $238) 101,266 99,815 Held for sale 14,931 15,764 Goodwill 6,686 6,688 Intangible assets (net of accumulated amortization of $2,952 and $2,877) 2,084 2,163 Other assets 19,425 15,641 Total assets $ 875,964 $ 853,531
Liabilities Deposits (includes $692 and $442 at fair value) $ 179,731 $ 187,820 Trading liabilities at fair value 144,565 126,747 Securities sold under agreements to repurchase (includes $622 and $812 at fair value) 47,948 49,759 Securities loaned 12,508 11,908 Other secured financings (includes $4,283 and $5,245 at fair value) 8,043 9,466 Customer and other payables 193,092 179,559 Other liabilities and accrued expenses 17,494 17,204 Borrowings (includes $56,464 and $51,184 at fair value) 190,691 189,662 Total liabilities 794,072 772,125
Commitments and contingent liabilities (see Note 11)
Equity Morgan Stanley shareholders’ equity: Preferred stock 8,520 8,520 Common stock, $0.01 par value: Shares authorized: 3,500,000,000; Shares issued: 2,038,893,979; Shares outstanding: 1,685,996,391 and 1,699,828,943 20 20 Additional paid-in capital 23,178 23,794 Retained earnings 66,061 64,175 Employee stock trusts 3,000 2,836 Accumulated other comprehensive income (loss) (2,473) (2,292) Common stock held in treasury at cost, $0.01 par value (352,897,588 and 339,065,036 shares) (14,582) (13,971) Common stock issued to employee stock trusts (3,000) (2,836) Total Morgan Stanley shareholders’ equity 80,724 80,246 Noncontrolling interests 1,168 1,160 Total equity 81,892 81,406 Total liabilities and equity $ 875,964 $ 853,531
March 2019 Form 10-Q 36 See Notes to Consolidated Financial Statements
− 427 − Consolidated Statements of Changes in Total Equity (Unaudited)
Common Common Stock Accumulated Stock Issued to Additional Employee Other Held in Employee Non- Preferred Common Paid-in Retained Stock Comprehensive Treasury Stock controlling Total $ in millions Stock Stock Capital Earnings Trusts Income (Loss) at Cost Trusts Interests Equity Balance at December 31, 2018 $ 8,520 $ 20 $ 23,794 $ 64,175 $ 2,836 $ (2,292) $ (13,971) $ (2,836) $ 1,160 $ 81,406 Cumulative adjustments for accounting changes1 —— — 63— — — — — 63 Net income applicable to Morgan Stanley — — — 2,429 — — — — — 2,429 Net income applicable to noncontrolling interests — — — — — — — — 39 39 Preferred stock dividends2 — — — (93) — — — — — (93) Common stock dividends ($0.30 per share) — — — (513) — — — — — (513) Shares issued under employee plans — — (618) — 164 — 1,034 (164) — 416 Repurchases of common stock and employee tax withholdings ————— — (1,645) — — (1,645) Net change in Accumulated other comprehensive income (loss) — — — — — (181) — — (31) (212) Other net increases —— 2 — — — — — — 2 Balance at March 31, 2019 $ 8,520 $ 20 $ 23,178 $ 66,061 $ 3,000 $ (2,473) $ (14,582) $ (3,000) $ 1,168 $ 81,892 Balance at December 31, 2017 $ 8,520 $ 20 $ 23,545 $ 57,577 $ 2,907 $ (3,060) $ (9,211) $ (2,907) $ 1,075 $ 78,466 Cumulative adjustments for accounting changes1 — — — 306 — (437) — — — (131) Net income applicable to Morgan Stanley — — — 2,668 — — — — — 2,668 Net income applicable to noncontrolling interests ————— — — — 36 36 Preferred stock dividends2 — — — (93) — — — — — (93) Common stock dividends ($0.25 per share) — — — (449) — — — — — (449) Shares issued under employee plans — — (285) — — — 710 — — 425 Repurchases of common stock and employee tax withholdings ————— — (1,868) — — (1,868) Net change in Accumulated other comprehensive income (loss) ————— 91 — — 72 163 Other net increases ————— — — — 272 272 Balance at March 31, 2018 $ 8,520 $ 20 $ 23,260 $ 60,009 $ 2,907 $ (3,406) $ (10,369) $ (2,907) $ 1,455 $ 79,489
1. Cumulative adjustments for accounting changes relate to the adoption of certain accounting updates during the current and prior year quarters. See Notes 2 and 14 for further information. 2. See Note 14 for information regarding dividends per share for each class of preferred stock.
See Notes to Consolidated Financial Statements 37 March 2019 Form 10-Q
− 428 − Consolidated Cash Flow Statements (Unaudited)
Three Months Ended March 31, $ in millions 2019 2018 Cash flows from operating activities Net income $ 2,468 $ 2,704 Adjustments to reconcile net income to net cash provided by (used for) operating activities: Stock-based compensation expense 293 321 Depreciation and amortization 658 390 Provision for credit losses on lending activities 36 26 Other operating adjustments (92) (37) Changes in assets and liabilities: Trading assets, net of Trading liabilities 23,977 33,832 Securities borrowed (22,578) (11,825) Securities loaned 600 (36) Customer and other receivables and other assets 1,567 (13,019) Customer and other payables and other liabilities 9,971 1,129 Securities purchased under agreements to resell 1,952 4,012 Securities sold under agreements to repurchase (1,811) (4,849) Net cash provided by (used for) operating activities 17,041 12,648
Cash flows from investing activities Proceeds from (payments for): Other assets—Premises, equipment and software, net (529) (410) Changes in loans, net (1,329) (3,801) Investment securities: Purchases (15,895) (5,482) Proceeds from sales 7,875 810 Proceeds from paydowns and maturities 2,663 2,125 Other investing activities (12) (164) Net cash provided by (used for) investing activities (7,227) (6,922)
Cash flows from financing activities Net proceeds from (payments for): Other secured financings (1,575) (2,101) Deposits (8,089) 988 Proceeds from: Issuance of Borrowings 8,091 15,370 Payments for: Borrowings (11,927) (11,377) Repurchases of common stock and employee tax withholdings (1,645) (1,868) Cash dividends (663) (599) Other financing activities (56) (50) Net cash provided by (used for) financing activities (15,864) 363 Effect of exchange rate changes on cash and cash equivalents (464) 860 Net increase (decrease) in cash and cash equivalents (6,514) 6,949 Cash and cash equivalents, at beginning of period 87,196 80,395 Cash and cash equivalents, at end of period $ 80,682 $ 87,344
Cash and cash equivalents: Cash and due from banks $ 35,472 $ 29,073 Interest bearing deposits with banks 14,498 22,980 Restricted cash 30,712 35,291 Cash and cash equivalents, at end of period $ 80,682 $ 87,344 Supplemental Disclosure of Cash Flow Information Cash payments for: Interest $ 2,896 $ 1,407 Income taxes, net of refunds 245 250
March 2019 Form 10-Q 38 See Notes to Consolidated Financial Statements
− 429 − Notes to Consolidated Financial Statements (Unaudited)
1. Introduction and Basis of Presentation contribution plans, foundations, endowments, government entities, sovereign wealth funds, insurance companies, The Firm third-party fund sponsors and corporations. Individual clients are served through intermediaries, including Morgan Stanley is a global financial services firm that affiliated and non-affiliated distributors. maintains significant market positions in each of its business segments—Institutional Securities, Wealth Management and Basis of Financial Information Investment Management. Morgan Stanley, through its subsidiaries and affiliates, provides a wide variety of products The unaudited consolidated financial statements (“financial and services to a large and diversified group of clients and statements”) are prepared in accordance with U.S. GAAP, customers, including corporations, governments, financial which requires the Firm to make estimates and assumptions institutions and individuals. Unless the context otherwise regarding the valuations of certain financial instruments, the requires, the terms “Morgan Stanley” or the “Firm” mean valuation of goodwill and intangible assets, compensation, Morgan Stanley (the “Parent Company”) together with its deferred tax assets, the outcome of legal and tax matters, consolidated subsidiaries. See the “Glossary of Common allowance for credit losses and other matters that affect its Acronyms” for definitions of certain acronyms used financial statements and related disclosures. The Firm throughout this Form 10-Q. believes that the estimates utilized in the preparation of its financial statements are prudent and reasonable. Actual results A description of the clients and principal products and could differ materially from these estimates. Intercompany services of each of the Firm’s business segments is as follows: balances and transactions have been eliminated. Certain reclassifications have been made to prior periods to conform Institutional Securities provides investment banking, sales to the current presentation. and trading, lending and other services to corporations, governments, financial institutions, and high to ultra-high The accompanying financial statements should be read in net worth clients. Investment banking services consist of conjunction with the Firm’s financial statements and notes capital raising and financial advisory services, including thereto included in the 2018 Form 10-K. Certain footnote services relating to the underwriting of debt, equity and disclosures included in the 2018 Form 10-K have been other securities, as well as advice on mergers and condensed or omitted from these financial statements as they acquisitions, restructurings, real estate and project finance. are not required for interim reporting under U.S. GAAP. The Sales and trading services include sales, financing, prime financial statements reflect all adjustments of a normal, brokerage and market-making activities in equity and fixed recurring nature that are, in the opinion of management, income products, including foreign exchange and necessary for the fair presentation of the results for the interim commodities. Lending activities include originating period. The results of operations for interim periods are not corporate loans, commercial mortgage lending, providing necessarily indicative of results for the entire year. secured lending facilities and extending financing to sales and trading customers. Other activities include investments Consolidation and research. The financial statements include the accounts of the Firm, its wholly owned subsidiaries and other entities in which the Wealth Management provides a comprehensive array of Firm has a controlling financial interest, including certain financial services and solutions to individual investors and VIEs (see Note 12). For consolidated subsidiaries that are not small to medium-sized businesses and institutions covering wholly owned, the third-party holdings of equity interests are brokerage and investment advisory services; financial and referred to as noncontrolling interests. The net income wealth planning services; annuity and insurance products; attributable to noncontrolling interests for such subsidiaries is securities-based lending, residential real estate loans and presented as Net income applicable to noncontrolling interests other lending products; banking and retirement plan services. in the consolidated income statements (“income statements”). Investment Management provides a broad range of The portion of shareholders’ equity that is attributable to investment strategies and products that span geographies, noncontrolling interests for such subsidiaries is presented as asset classes, and public and private markets to a diverse noncontrolling interests, a component of total equity, in the group of clients across institutional and intermediary consolidated balance sheets (“balance sheets”). channels. Strategies and products include equity, fixed For a discussion of the Firm’s involvement with VIEs and its income, liquidity and alternative/other products. significant regulated U.S. and international subsidiaries, see Institutional clients include defined benefit/defined Note 1 to the financial statements in the 2018 Form 10-K.
39 March 2019 Form 10-Q
− 430 − Notes to Consolidated Financial Statements (Unaudited)
2. Significant Accounting Policies prepaid lease payments and initial direct costs incurred and are reduced by lease incentives. For these leases, lease For a detailed discussion about the Firm’s significant expense is recognized on a straight-line basis over the lease accounting policies, see Note 2 to the financial statements in term if the ROU asset has not been impaired or abandoned. the 2018 Form 10-K. Derivatives and Hedging (ASU 2018-16) During the three months ended March 31, 2019 (“current quarter”), there were no significant revisions to the Firm’s The amendments in this update permit use of the OIS rate significant accounting policies, other than for the accounting based on the Secured Overnight Financing Rate as a U.S. updates adopted. benchmark interest rate for hedge accounting purposes. The Firm adopted this update on a prospective basis for qualifying Accounting Updates Adopted new or redesignated hedging relationships. This update did not impact the Firm’s pre-existing hedges. The Firm adopted the following accounting updates on January 1, 2019. Prior periods are presented under previous policies. 3. Fair Values
Leases Recurring Fair Value Measurements
The Firm adopted Leases, and recognized leases with terms Assets and Liabilities Measured at Fair Value on a Recurring Basis exceeding one year in the March 31, 2019 balance sheet as right-of-use (“ROU”) assets and corresponding liabilities. The At March 31, 2019 1 adoption resulted in an increase to Retained earnings of $ in millions Level 1 Level 2 Level 3 Netting Total Assets at fair value approximately $63 million, net of tax, related to deferred Trading assets: revenue from previously recorded sale-leaseback transactions. U.S. Treasury and agency At transition on January 1, 2019, the adoption also resulted in securities $ 47,877 $ 22,821 $ 7 $ — $ 70,705 Other sovereign government a balance sheet gross-up of approximately $4 billion reflected obligations 29,063 4,890 5 — 33,958 in Other assets and Other liabilities and accrued expenses. See State and municipal securities — 3,175 12 — 3,187 Note 11 for lease disclosures, including amounts reflected in MABS — 1,864 301 — 2,165 the March 31, 2019 balance sheet. Prior period amounts were Loans and lending commitments2 — 5,012 6,343 — 11,355 not restated. Corporate and other debt — 20,014 1,061 — 21,075 Corporate equities3 88,020 527 152 — 88,699 As allowed by the guidance, the Firm elected not to reassess Derivative and other contracts: the following at transition: whether existing contracts are or Interest rate 3,238 166,248 998 — 170,484 contain leases, and for existing leases, lease classification and Credit — 5,696 485 — 6,181 initial direct costs. In addition, the Firm continues to account Foreign exchange 22 60,900 59 — 60,981 Equity 1,621 38,006 1,293 — 40,920 for existing land easements as service contracts. Commodity and other 593 7,002 2,902 — 10,497 Netting1 (3,633) (212,585) (873) (43,036) (260,127) Both at transition and for new leases thereafter, ROU assets Total derivative and other and lease liabilities are initially recognized based on the contracts 1,841 65,267 4,864 (43,036) 28,936 present value of the future minimum lease payments over the Investments4 369 149 974 — 1,492 Physical commodities — 441 — — 441 lease term, including non-lease components such as fixed Total trading assets4 167,170 124,160 13,719 (43,036) 262,013 common area maintenance costs and other fixed costs such as Investment securities—AFS 32,527 29,114 — — 61,641 real estate taxes and insurance. Securities purchased under agreements to resell —5——5 The discount rates used in determining the present value of Total assets at fair value $ 199,697 $ 153,279 $ 13,719 $(43,036) $ 323,659 leases are the Firm’s incremental borrowing rates, developed based upon each lease’s term and currency of payment. The lease term includes options to extend or terminate the lease when it is reasonably certain that the Firm will exercise that option. For operating leases, the ROU assets also include any
March 2019 Form 10-Q 40
− 431 − Notes to Consolidated Financial Statements (Unaudited)
At March 31, 2019 At December 31, 2018 $ in millions Level 1 Level 2 Level 3 Netting1 Total $ in millions Level 1 Level 2 Level 3 Netting1 Total Liabilities at fair value Liabilities at fair value Deposits $ — $ 593 $ 99 $ — $ 692 Deposits $ — $ 415 $ 27 $ — $ 442 Trading liabilities: Trading liabilities: U.S. Treasury and agency U.S. Treasury and agency securities 13,169 251 — — 13,420 securities 11,272 543 — — 11,815 Other sovereign government Other sovereign government obligations 25,301 1,970 — — 27,271 obligations 21,391 1,454 — — 22,845 Corporate and other debt — 9,030 23 — 9,053 Corporate and other debt — 8,550 1 — 8,551 Corporate equities3 64,961 94 20 — 65,075 Corporate equities3 56,064 199 15 — 56,278 Derivative and other contracts: Derivative and other contracts: Interest rate 3,271 155,949 447 — 159,667 Interest rate 2,927 142,746 427 — 146,100 Credit — 6,019 746 — 6,765 Credit — 5,772 381 — 6,153 Foreign exchange 11 59,864 54 — 59,929 Foreign exchange 41 63,379 86 — 63,506 Equity 1,393 40,912 3,053 — 45,358 Equity 1,042 47,091 2,507 — 50,640 Commodity and other 732 5,444 796 — 6,972 Commodity and other 1,228 6,872 940 — 9,040 Netting1 (3,633) (212,585) (873) (31,854) (248,945) Netting1 (4,151) (210,190) (896) (32,944) (248,181) Total derivative and other Total derivative and other contracts 1,774 55,603 4,223 (31,854) 29,746 contracts 1,087 55,670 3,445 (32,944) 27,258 Total trading liabilities 105,205 66,948 4,266 (31,854) 144,565 Total trading liabilities 89,814 66,416 3,461 (32,944) 126,747 Securities sold under Securities sold under agreements to repurchase — 622 — — 622 agreements to repurchase — 812 — — 812 Other secured financings — 4,130 153 — 4,283 Other secured financings — 5,037 208 — 5,245 Borrowings — 52,689 3,775 — 56,464 Borrowings — 47,378 3,806 — 51,184 Total liabilities at fair value $105,205 $124,982 $ 8,293 $(31,854) $206,626 Total liabilities at fair value $ 89,814 $120,058 $ 7,502 $(32,944) $184,430
MABS—Mortgage- and asset-backed securities At December 31, 2018 1. For positions with the same counterparty classified in different levels of the fair value $ in millions Level 1 Level 2 Level 3 Netting1 Total hierarchy, both counterparty netting and cash collateral netting are included in the column titled “Netting.” Positions classified within the same level that are with the same Assets at fair value counterparty are netted within the column for that level. For further information on Trading assets: derivative instruments and hedging activities, see Note 4. U.S. Treasury and agency 2. For a further breakdown by type, see the following Loans and Lending Commitments at securities $ 38,767 $ 29,594 $ 54 $ — $ 68,415 Fair Value table. 3. For trading purposes, the Firm holds or sells short equity securities issued by entities in Other sovereign government diverse industries and of varying sizes. obligations 28,395 5,529 17 — 33,941 4. Amounts exclude certain investments that are measured based on NAV per share, which State and municipal are not classified in the fair value hierarchy. For additional disclosure about such securities — 3,161 148 — 3,309 investments, see “Net Asset Value Measurements—Fund Interests” herein. MABS — 2,154 354 — 2,508 Loans and lending Breakdown of Loans and Lending Commitments at Fair Value commitments2 — 4,055 6,870 — 10,925 At At Corporate and other debt — 18,129 1,076 — 19,205 March 31, December 31, Corporate equities3 93,626 522 95 — 94,243 $ in millions 2019 2018 Derivative and other contracts: Corporate $ 8,307 $ 9,171 Interest rate 2,793 155,027 1,045 — 158,865 Residential real estate 1,282 1,153 Credit — 5,707 421 — 6,128 Commercial real estate 1,766 601 Foreign exchange 62 63,023 161 — 63,246 Total $ 11,355 $ 10,925 Equity 1,256 45,596 1,022 — 47,874 Commodity and other 963 8,517 2,992 — 12,472 Unsettled Fair Value of Futures Contracts1 Netting1 (4,151) (210,190) (896) (44,175) (259,412) At At Total derivative and other March 31, December 31, contracts 923 67,680 4,745 (44,175) 29,173 $ in millions 2019 2018 Investments4 412 293 757 — 1,462 Customer and other receivables, net $ 727 $ 615 Physical commodities — 536 — — 536 Total trading assets4 162,123 131,653 14,116 (44,175) 263,717 1. These contracts are primarily Level 1, actively traded, valued based on quoted prices from the exchange and are excluded from the previous recurring fair value tables. Investment securities—AFS 36,399 24,662 — — 61,061 Intangible assets — 5 — — 5 For a description of the valuation techniques applied to the Total assets at fair value $198,522 $156,320 $ 14,116 $(44,175) $324,783 Firm’s major categories of assets and liabilities measured at fair value on a recurring basis, see Note 3 to the financial statements in the 2018 Form 10-K. During the current quarter, there were no significant revisions made to the Firm’s valuation techniques.
41 March 2019 Form 10-Q
− 432 − Notes to Consolidated Financial Statements (Unaudited)
Rollforward of Level 3 Assets and Liabilities Measured at Fair Three Months Ended Value on a Recurring Basis March 31, $ in millions 2019 2018 Three Months Ended Corporate equities March 31, Beginning balance $ 95 $ 166 $ in millions 2019 2018 Realized and unrealized gains (losses) 6 — Assets at Fair value Purchases 51 166 U.S. Treasury and agency securities Sales (9) (132) Beginning balance $ 54 $ — Net transfers 9 33 Sales (50) — Ending balance $ 152 $ 233 Net transfers 3 — Unrealized gains (losses) $7$ (9) Ending balance $7$— Investments Unrealized gains (losses) $—$— Beginning balance $ 757 $ 1,020 Other sovereign government obligations Realized and unrealized gains (losses) 10 44 Beginning balance $ 17 $ 1 Purchases 10 21 Purchases 2 7 Sales (4) (78) Sales (2) — Net transfers 201 5 Net transfers (12) (1) Ending balance $ 974 $ 1,012 Ending balance $5$7Unrealized gains (losses) $14$22 Unrealized gains (losses) $—$— Net derivative and other contracts: State and municipal securities Interest rate Beginning balance $ 148 $ 8 Beginning balance $ 618 $ 1,218 Realized and unrealized gains (losses) (48) 52 Realized and unrealized gains (losses) 1 — Purchases 24 32 Purchases 10 1 Issuances (19) (41) Sales (44) (7) Settlements (12) (81) Net transfers (103) — Net transfers (12) (510) Ending balance $12$2 Ending balance $ 551 $ 670 Unrealized gains (losses) $1$— Unrealized gains (losses) $ (43) $75 MABS Beginning balance $ 354 $ 423 Credit Beginning balance $ 40 $ 41 Realized and unrealized gains (losses) (7) 77 Realized and unrealized gains (losses) 162 (107) Purchases 19 64 Purchases 26 — Sales (83) (238) Issuances (442) — Settlements (3) (16) Settlements (33) 38 Net transfers 21 32 Net transfers (14) (2) Ending balance $ 301 $ 342 Ending balance $ (261) $ (30) Unrealized gains (losses) $ (14) $2 Unrealized gains (losses) $ 167 $ (109) Loans and lending commitments Foreign exchange Beginning balance $ 6,870 $ 5,945 Beginning balance $ 75 $ (112) Realized and unrealized gains (losses) — 28 Realized and unrealized gains (losses) (113) 57 Purchases and originations 1,255 3,740 Purchases 1 — Sales (108) (283) Issuances — (31) Settlements (820) (1,218) Settlements 8 33 Net transfers (854) (84) Net transfers 34 20 Ending balance $ 6,343 $ 8,128 Ending balance $5$ (33) Unrealized gains (losses) $ (7) $ (9) Unrealized gains (losses) $3$ (9)
Corporate and other debt Equity Beginning balance $ 1,076 $ 701 Beginning balance $ (1,485) $ 1,208 Realized and unrealized gains (losses) 43 1 Realized and unrealized gains (losses) (191) 356 Purchases 204 350 Purchases 34 142 Sales (127) (243) Issuances (193) (799) Settlements (3) — Settlements 139 159 Net transfers (132) 5 Net transfers (64) (51) Ending balance $ 1,061 $ 814 Ending balance $ (1,760) $ 1,015 Unrealized gains (losses) $41$ (1) Unrealized gains (losses) $ (203) $ 315
March 2019 Form 10-Q 42
− 433 − Notes to Consolidated Financial Statements (Unaudited)
Three Months Ended March 31, related realized and unrealized gains (losses) on hedging $ in millions 2019 2018 instruments that have been classified by the Firm within the Commodity and other Level 1 and/or Level 2 categories. Beginning balance $ 2,052 $ 1,446 Realized and unrealized gains (losses) 43 217 The unrealized gains (losses) during the period for assets and Purchases 5 13 liabilities within the Level 3 category may include changes in Issuances (1) (6) Settlements (81) (57) fair value during the period that were attributable to both Net transfers 88 47 observable and unobservable inputs. Total realized and Ending balance $ 2,106 $ 1,660 unrealized gains (losses) are primarily included in Trading Unrealized gains (losses) $ (25) $ 149 revenues in the income statements.
Liabilities at Fair Value Additionally, in the previous tables, consolidations of VIEs Deposits Beginning balance $ 27 $ 47 are included in Purchases and deconsolidations of VIEs are Realized and unrealized losses (gains) 6 (1) included in Settlements. Issuances 24 9 Settlements (1) (1) Significant Unobservable Inputs Used in Recurring and Net transfers 43 (10) Nonrecurring Level 3 Fair Value Measurements Ending balance $99$44 Unrealized losses (gains) $6$ (1) Valuation Techniques and Unobservable Inputs
Nonderivative trading liabilities Balance / Range (Average1) Beginning balance $ 16 $ 25 $ in millions, except inputs At March 31, 2019 At December 31, 2018 Realized and unrealized losses (gains) (1) (4) Assets Measured at Fair Value on a Recurring Basis Purchases (6) (7) MABS $ 301 $ 354 Sales 23 15 Comparable pricing: Net transfers 11 10 Bond price 1 to 91 points (37 points) 0 to 97 points (38 points) Ending balance $43$39Loans and lending Unrealized losses (gains) $ (1) $ (4) commitments $ 6,343 $ 6,870 Margin loan model: Securities sold under agreements to repurchase Discount rate 1% to 6% (2%) 1% to 7% (2%) Beginning balance $ — $ 150 Volatility skew 18% to 57% (25%) 19% to 56% (28%) Net transfers — (150) Credit Spread 11 to 62 bps (27 bps) 14 to 90 bps (36 bps) Ending balance $—$—Comparable pricing: Unrealized losses (gains) $—$—Loan price 85 to 104 points (98 points) 60 to 101 points (95 points) Corporate and other debt $ 1,061 $ 1,076 Other secured financings Comparable pricing: Beginning balance $ 208 $ 239 Bond price 12 to 100 points (72 points) 12 to 100 points (72 points) Realized and unrealized losses (gains) 4 (13) Discounted cash flow: Issuances — 4 Recovery rate 27% 20% Settlements (7) (10) Discount rate N/M 15% to 21% (16%) Net transfers (52) — Option model: Ending balance $ 153 $ 220 At the money volatility 24% to 70% (56%) 24% to 78% (50%) Unrealized losses (gains) $4$ (13) Corporate equities $ 152 $95 Borrowings Comparable pricing: Beginning balance $ 3,806 $ 2,984 Equity price 100% 100% Realized and unrealized losses (gains) 287 (102) Investments $ 974 $ 757 Issuances 264 640 Discounted cash flow: Settlements (115) (83) WACC 9% to 16% (11%) 9% to 15% (10%) Net transfers (467) 187 Exit multiple 9 to 10 times (10 times) 7 to 10 times (10 times) Ending balance $ 3,775 $ 3,626 Market approach: EBITDA multiple 5 to 24 times (10 times) 6 to 24 times (12 times) Unrealized losses (gains) $ 276 $ (99) Comparable pricing: Portion of Unrealized losses (gains) recorded in OCI—Change in net DVA 59 (44) Equity price 75% to 100% (99%) 75% to 100% (96%) Net derivative and other Level 3 instruments may be hedged with instruments contracts: Interest rate $ 551 $ 618 classified in Level 1 and Level 2. The realized and unrealized Option model: gains (losses) for assets and liabilities within the Level 3 IR volatility skew 23% to 98% (59% / 61%) 22% to 95% (48% / 51%) category presented in the previous tables do not reflect the Inflation volatility 22% to 62% (42% / 39%) 23% to 65% (44% / 40%) IR curve 1% 1%
43 March 2019 Form 10-Q
− 434 − Notes to Consolidated Financial Statements (Unaudited)
Balance / Range (Average1) The previous tables provide information for each major $ in millions, except inputs At March 31, 2019 At December 31, 2018 category of assets and liabilities measured at fair value on a Credit $ (261) $40recurring and nonrecurring basis with a significant Level 3 Comparable pricing: balance. The level of aggregation and breadth of products Cash-synthetic basis 12 points 8 to 9 points (9 points) cause the range of inputs to be wide and not evenly distributed Bond price 0 to 83 points (38 points) 0 to 75 points (26 points) across the inventory. Further, the range of unobservable inputs Credit spread 227 to 584 bps (307 bps) 246 to 499 bps (380 bps) Funding spread 42 to 112 bps (91 bps) 47 to 98 bps (93 bps) may differ across firms in the financial services industry Correlation model: because of diversity in the types of products included in each Credit correlation 36% to 68% (42%) 36% to 69% (44%) firm’s inventory. There are no predictable relationships Foreign exchange2 $5$75between multiple significant unobservable inputs attributable Option model: to a given valuation technique. A single amount is disclosed IR FX correlation 5% to 57% (36% / 36%) 53% to 56% (55% / 55%) when there is no significant difference between the minimum, IR volatility skew 23% to 98% (59% / 61%) 22% to 95% (48% / 51%) maximum and average. Contingency probability 80% to 95% (90% / 90%) 90% to 95% (93% / 95%) Equity2 $ (1,760) $ (1,485) For a description of the Firm’s significant unobservable inputs Option model: and qualitative information about the effect of hypothetical At the money volatility 6% to 69% (36%) 17% to 63% (38%) changes in the values of those inputs, see Note 3 to the Volatility skew -2% to 0% (-1%) -2% to 0% (-1%) financial statements in the 2018 Form 10-K. During the Equity correlation 5% to 96% (65%) 5% to 96% (71%) current quarter, there were no significant revisions made to FX correlation -60% to 55% (-21%) -60% to 55% (-26%) IR correlation -7% to 45% (16% / 13%) -7% to 45% (15% / 12%) the descriptions of the Firm’s significant unobservable inputs. Commodity and other $ 2,106 $ 2,052 Net Asset Value Measurements Option model: Forward power price $4 to $172 ($30) per MWh $ 3 to $185 ($31) per MWh Fund Interests Commodity volatility 7% to 130% (16%) 7% to 187% (17%) At March 31, 2019 At December 31, 2018 Cross-commodity Carrying Carrying correlation 5% to 99% (93%) 5% to 99% (93%) $ in millions Value Commitment Value Commitment Liabilities Measured at Fair Value on a Recurring Basis Private equity $ 1,455 $ 314 $ 1,374 $ 316 Deposits $ 99 $27Real estate 1,248 149 1,105 161 Option Model Hedge1 102 4 103 4 At the money volatility 15% to 42% (21%) N/M $ 2,582 $ 481 Other secured financings $ 153 $ 208 Total $ 2,805 $ 467 Discounted cash flow: 1. Investments in hedge funds may be subject to initial period lock-up or Funding spread 112 to 205 bps (158 bps) 103 to 193 bps (148 bps) gate provisions, which restrict an investor from withdrawing from the fund Option model: during a certain initial period or restrict the redemption amount on any Volatility skew N/M -1% redemption date, respectively. At the money volatility 10% to 40% (26%) 10% to 40% (25%) Borrowings $ 3,775 $ 3,806 For a description of the Firm’s investments in private equity Option model: funds, real estate funds and hedge funds, which are measured At the money volatility 6% to 34% (21%) 5% to 35% (22%) based on NAV, see Note 3 to the financial statements in the Volatility skew -2% to 0% (0%) -2% to 0% (0%) 2018 Form 10-K. Equity correlation 38% to 98% (81%) 45% to 98% (85%) Equity - FX correlation -55% to 30% (-27%) -75% to 50% (-27%) Amounts in the previous table represent the Firm’s carrying IR Correlation N/M 58% to 97% (85% / 91%) value of general and limited partnership interests in fund IR FX Correlation 27% to 58% (39% / 34%) 28% to 58% (44% / 44%) investments, as well as any carried interest. The carrying Nonrecurring Fair Value Measurement amounts are measured based on the NAV of the fund taking Loans $ 1,166 $ 1,380 into account the distribution terms applicable to the interest Corporate loan model: held. This same measurement applies whether the fund Credit spread 72 to 366 bps (150 bps) 97 to 434 bps (181 bps) investments are accounted for under the equity method or fair Warehouse model: value. Credit spread 262 to 309 bps (299 bps) 223 to 313 bps (247 bps) See Note 11 for information regarding general partner Points—Percentage of par guarantees, which include potential obligations to return IR—Interest rate FX—Foreign exchange performance-based fees in the form of carried interest 1. Amounts represent weighted averages except where simple averages and the median of previously received. See Note 18 for information regarding the inputs are more relevant. 2. Includes derivative contracts with multiple risks (i.e., hybrid products). carried interest at risk of reversal.
March 2019 Form 10-Q 44
− 435 − Notes to Consolidated Financial Statements (Unaudited)
Nonredeemable Funds by Contractual Maturity Gains (Losses) Due to Changes in Instrument-Specific Credit Risk
Carrying Value at March 31, 2019 Three Months Ended March 31, $ in millions Private Equity Real Estate 2019 2018 Less than 5 years $ 705 $ 634 Trading Trading $ in millions Revenues OCI Revenues OCI 5-10 years 723 555 Borrowings $ (4) $ (816) $ (15) $ 593 Over 10 years 27 59 Loans and other debt1 93 — 81 — Total $ 1,455 $ 1,248 Lending commitments (1) — 2— Fair Value Option Other — (4) —2 At At The Firm elected the fair value option for certain eligible March 31, December 31, instruments that are risk managed on a fair value basis to $ in millions 2019 2018 mitigate income statement volatility caused by measurement Cumulative pre-tax DVA gain (loss) basis differences between the elected instruments and their recognized in AOCI $ (648) $ 172 associated risk management transactions or to eliminate the 1. Loans and other debt instrument-specific credit gains (losses) were complexities of applying certain accounting models. determined by excluding the non-credit components of gains and losses.
Borrowings Measured at Fair Value on a Recurring Basis Excess of Contractual Principal Amount Over Fair Value
At At At At March 31, December 31, March 31, December 31, $ in millions 2019 2018 $ in millions 2019 2018 Business Unit Responsible for Risk Management Loans and other debt1 $ 13,031 $ 13,094 Equity $ 27,807 $ 24,494 Nonaccrual loans1 10,677 10,831 Interest rates 23,945 22,343 Borrowings2 730 2,657 Commodities 3,209 2,735 1. The majority of the difference between principal and fair value amounts Credit 981 856 for loans and other debt relates to distressed debt positions purchased at Foreign exchange 522 756 amounts well below par. Total $ 56,464 $ 51,184 2. Borrowings in this table do not include structured notes where the repayment of the initial principal amount fluctuates based on changes in a reference price or index. Earnings Impact of Borrowings under the Fair Value Option
Three Months Ended March 31, The previous tables exclude non-recourse debt from $ in millions 2019 2018 consolidated VIEs, liabilities related to failed sales of Trading revenues $ (2,903) $26financial assets, pledged commodities and other liabilities that have specified assets attributable to them. Interest expense (93) (102) Net revenues1 $ (2,996) $ (76) Fair Value Loans on Nonaccrual Status
1. Amounts do not reflect any gains or losses from related economic At At hedges. March 31, December 31, $ in millions 2019 2018 Gains (losses) are mainly attributable to movements in the Nonaccrual loans $ 1,198 $ 1,497 reference price or index, interest rates or foreign exchange Nonaccrual loans 90 or more rates. days past due $ 769 $ 812
45 March 2019 Form 10-Q
− 436 − Notes to Consolidated Financial Statements (Unaudited)
Nonrecurring Fair Value Measurements
Carrying and Fair Values Gains (Losses) from Fair Value Remeasurements1
At March 31, 2019 Three Months Ended Fair Value March 31, $ in millions Level 2 Level 31 Total $ in millions 2019 2018 Assets Assets Loans $ 2,160 $ 1,166 $ 3,326 Loans2 $36$8 Other assets—Other Other assets—Other investments (5) — investments —3030Other assets—Premises, equipment and Other assets—Premises, software (2) (8) equipment and software ———Total $ 29 $— Total $ 2,160 $ 1,196 $ 3,356 Liabilities Liabilities Other liabilities and accrued expenses— Other liabilities and accrued Lending commitments2 $67$6 expenses—Lending Total $ 67 $6 commitments $ 186 $ 49 $ 235 Total $ 186 $ 49 $ 235 1. Gains and losses for Loans and Other assets—Other investments are classified in Other revenues. For other items, gains and losses are recorded in Other revenues if the item is held for sale; otherwise they are recorded in At December 31, 2018 Other expenses. Fair Value 2. Nonrecurring changes in the fair value of loans and lending commitments $ in millions Level 2 Level 31 Total were calculated as follows: for the held-for-investment category, based on the Assets value of the underlying collateral; and for the held-for-sale category, based on recently executed transactions, market price quotations, valuation models that Loans $ 2,307 $ 1,380 $ 3,687 incorporate market observable inputs where possible, such as comparable Other assets—Other loan or debt prices and CDS spread levels adjusted for any basis difference investments 14 100 114 between cash and derivative instruments, or default recovery analysis where Other assets—Premises, such transactions and quotations are unobservable. equipment and software — — — Total $ 2,321 $ 1,480 $ 3,801 Liabilities Other liabilities and accrued expenses—Lending commitments $ 292 $ 65 $ 357 Total $ 292 $ 65 $ 357
1. For significant Level 3 balances, refer to “Significant Unobservable Inputs Used in Recurring and Nonrecurring Level 3 Fair Value Measurements” section herein for details of the significant unobservable inputs used for nonrecurring fair value measurement.
March 2019 Form 10-Q 46
− 437 − Notes to Consolidated Financial Statements (Unaudited)
Financial Instruments Not Measured at Fair Value
Carrying and Fair Values
At March 31, 2019 At December 31, 2018 Carrying Fair Value Carrying Fair Value $ in millions Value Level 1 Level 2 Level 3 Total $ in millions Value Level 1 Level 2 Level 3 Total Financial assets Financial assets Cash and cash equivalents: Cash and cash equivalents: Cash and due from banks $ 35,472 $ 35,472 $ — $ — $ 35,472 Cash and due from banks $ 30,541 $ 30,541 $ — $ — $ 30,541 Interest bearing deposits Interest bearing deposits with banks 14,498 14,498 — — 14,498 with banks 21,299 21,299 — — 21,299 Restricted cash 30,712 30,712 — — 30,712 Restricted cash 35,356 35,356 — — 35,356 Investment securities—HTM 36,303 21,270 14,218 536 36,024 Investment securities—HTM 30,771 17,473 12,018 474 29,965 Securities purchased under Securities purchased under agreements to resell 96,565 — 95,841 714 96,555 agreements to resell 98,522 — 97,611 866 98,477 Securities borrowed 138,891 — 138,891 — 138,891 Securities borrowed 116,313 — 116,312 — 116,312 Customer and other Customer and other receivables1 47,854 — 44,907 2,836 47,743 receivables1 47,972 — 44,620 3,219 47,839 Loans2 116,197 — 24,888 91,610 116,498 Loans2 115,579 — 25,604 90,121 115,725 Other assets 461 — 461 — 461 Other assets 461 — 461 — 461
Financial liabilities Financial liabilities Deposits $ 179,039 $ — $179,168 $ — $179,168 Deposits $ 187,378 $ — $187,372 $ — $187,372 Securities sold under Securities sold under agreements to repurchase 47,326 — 46,765 550 47,315 agreements to repurchase 48,947 — 48,385 525 48,910 Securities loaned 12,508 — 12,508 — 12,508 Securities loaned 11,908 — 11,906 — 11,906 Other secured financings 3,760 — 3,539 226 3,765 Other secured financings 4,221 — 3,233 994 4,227 Customer and other payables1 189,712 — 189,712 — 189,712 Customer and other payables1 176,561 — 176,561 — 176,561 Borrowings 134,227 — 137,906 30 137,936 Borrowings 138,478 — 140,085 30 140,115 Commitment Commitment Amount Amount Lending commitments3 $ 113,418 $ — $ 947 $ 294 $ 1,241 Lending commitments3 $ 104,844 $ — $ 1,249 $ 321 $ 1,570
1. Accrued interest and dividend receivables and payables where carrying value approximates fair value have been excluded. 2. Amounts include loans measured at fair value on a nonrecurring basis. 3. Represents Lending Commitments accounted for as Held for Investment and Held for Sale. For a further discussion on lending commitments, see Note 11.
The previous tables exclude certain financial instruments such as equity method investments and all non-financial assets and liabilities such as the value of the long-term relationships with the Firm’s deposit customers.
47 March 2019 Form 10-Q
− 438 − Notes to Consolidated Financial Statements (Unaudited)
4. Derivative Instruments and Hedging Activities
Fair Values of Derivative Contracts At March 31, 2019 At December 31, 2018
Assets Assets Bilateral Cleared Exchange- Bilateral Cleared Exchange- $ in millions OTC OTC Traded Total $ in millions OTC OTC Traded Total Designated as accounting hedges Designated as accounting hedges Interest rate $ 489 $ 1 $ — $ 490 Interest rate $ 512 $ 1 $ — $ 513 Foreign exchange 107 14 — 121 Foreign exchange 27 8 — 35 Total 596 15 — 611 Total 539 9 — 548 Not designated as accounting hedges Not designated as accounting hedges Interest rate 164,693 4,602 699 169,994 Interest rate 153,768 3,887 697 158,352 Credit 4,327 1,854 — 6,181 Credit 4,630 1,498 — 6,128 Foreign exchange 59,462 1,336 62 60,860 Foreign exchange 61,846 1,310 55 63,211 Equity 21,593 — 19,327 40,920 Equity 24,590 — 23,284 47,874 Commodity and other 9,011 — 1,486 10,497 Commodity and other 10,538 — 1,934 12,472 Total 259,086 7,792 21,574 288,452 Total 255,372 6,695 25,970 288,037 Total gross derivatives $ 259,682 $7,807 $ 21,574 $ 289,063 Total gross derivatives $ 255,911 $6,704 $ 25,970 $ 288,585 Amounts offset Amounts offset Counterparty netting (194,262) (6,453) (20,683) (221,398) Counterparty netting (190,220) (5,260) (24,548) (220,028) Cash collateral netting (37,487) (1,242) — (38,729) Cash collateral netting (38,204) (1,180) — (39,384) Total in Trading assets $ 27,933 $ 112 $ 891 $ 28,936 Total in Trading assets $ 27,487 $ 264 $ 1,422 $ 29,173 Amounts not offset1 Amounts not offset1 Financial instruments Financial instruments collateral (12,603) — — (12,603) collateral (12,467) — — (12,467) Other cash collateral (59) — — (59) Other cash collateral (31) — — (31) Net amounts $ 15,271 $ 112 $ 891 $ 16,274 Net amounts $ 14,989 $ 264 $ 1,422 $ 16,675 Net amounts for which master netting or collateral agreements are Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable $ 2,118 not in place or may not be legally enforceable $ 2,206
Liabilities Liabilities Bilateral Cleared Exchange- Bilateral Cleared Exchange- $ in millions OTC OTC Traded Total $ in millions OTC OTC Traded Total Designated as accounting hedges Designated as accounting hedges Interest rate $88$3$—$91Interest rate $ 176 $ — $ — $ 176 Foreign exchange 17 32 — 49 Foreign exchange 62 24 — 86 Total 105 35 — 140 Total 238 24 — 262 Not designated as accounting hedges Not designated as accounting hedges Interest rate 155,653 3,395 528 159,576 Interest rate 142,592 2,669 663 145,924 Credit 4,631 2,134 — 6,765 Credit 4,545 1,608 — 6,153 Foreign exchange 58,577 1,302 1 59,880 Foreign exchange 62,099 1,302 19 63,420 Equity 25,681 — 19,677 45,358 Equity 27,119 — 23,521 50,640 Commodity and other 5,514 — 1,458 6,972 Commodity and other 6,983 — 2,057 9,040 Total 250,056 6,831 21,664 278,551 Total 243,338 5,579 26,260 275,177 Total gross derivatives $ 250,161 $6,866 $ 21,664 $ 278,691 Total gross derivatives $ 243,576 $5,603 $ 26,260 $ 275,439 Amounts offset Amounts offset Counterparty netting (194,262) (6,453) (20,683) (221,398) Counterparty netting (190,220) (5,260) (24,548) (220,028) Cash collateral netting (27,167) (380) — (27,547) Cash collateral netting (27,860) (293) — (28,153) Total in Trading liabilities $ 28,732 $ 33 $ 981 $ 29,746 Total in Trading liabilities $ 25,496 $ 50 $ 1,712 $ 27,258 Amounts not offset1 Amounts not offset1 Financial instruments Financial instruments collateral (8,466) — (392) (8,858) collateral (4,709) — (766) (5,475) Other cash collateral (48) (30) — (78) Other cash collateral (53) (1) — (54) Net amounts $ 20,218 $ 3 $ 589 $ 20,810 Net amounts $ 20,734 $ 49 $ 946 $ 21,729 Net amounts for which master netting or collateral agreements are Net amounts for which master netting or collateral agreements are not in place or may not be legally enforceable $ 3,116 not in place or may not be legally enforceable $ 4,773
1. Amounts relate to master netting agreements and collateral agreements that have been determined by the Firm to be legally enforceable in the event of default but where certain other criteria are not met in accordance with applicable offsetting accounting guidance.
See Note 3 for information related to the unsettled fair value of futures contracts not designated as accounting hedges, which are excluded from the previous tables.
March 2019 Form 10-Q 48
− 439 − Notes to Consolidated Financial Statements (Unaudited)
Notionals of Derivative Contracts Liabilities At March 31, 2019 Bilateral Cleared Exchange- $ in billions OTC OTC Traded Total Assets Designated as accounting hedges Bilateral Cleared Exchange- Interest rate $ 2 $ 107 $ — $ 109 $ in billions OTC OTC Traded Total Foreign exchange 5 1 — 6 Designated as accounting hedges Total 7 108 — 115 Interest rate $ 15 $ 83 $ — $ 98 Not designated as accounting hedges Foreign exchange 10 1 — 11 Interest rate 4,946 5,735 781 11,462 Total 25 84 — 109 Credit 162 73 — 235 Not designated as accounting hedges Foreign exchange 2,451 114 17 2,582 Interest rate 4,785 7,900 1,042 13,727 Equity 389 — 602 991 Credit 139 74 — 213 Commodity and other 72 — 65 137 Foreign exchange 2,731 104 13 2,848 Total 8,020 5,922 1,465 15,407 Equity 455 — 367 822 Total gross derivatives $ 8,027 $ 6,030 $ 1,465 $15,522 Commodity and other 98 — 68 166 Total 8,208 8,078 1,490 17,776 Total gross derivatives $ 8,233 $ 8,162 $ 1,490 $17,885 The Firm believes that the notional amounts of derivative contracts generally overstate its exposure. In most Liabilities circumstances notional amounts are only used as a reference Bilateral Cleared Exchange- point from which to calculate amounts owed between the $ in billions OTC OTC Traded Total parties to the contract. Furthermore, notional amounts do not Designated as accounting hedges reflect the benefit of legally enforceable netting arrangements Interest rate $2$75$—$77 or risk mitigating transactions. Foreign exchange 21 — 3 Total 476— 80For a discussion of the Firm’s derivative instruments and Not designated as accounting hedges Interest rate 4,956 7,059 880 12,895 hedging activities, see Note 4 to the financial statements in the Credit 156 84 — 240 2018 Form 10-K. Foreign exchange 2,748 102 12 2,862 Gains (Losses) on Accounting Hedges Equity 410 — 558 968 Commodity and other 80 — 64 144 Three Months Ended March 31, Total 8,350 7,245 1,514 17,109 $ in millions 2019 2018 Total gross derivatives $ 8,354 $ 7,321 $ 1,514 $17,189 Fair Value Hedges—Recognized in Interest Expense Interest rate contracts $ 1,577 $(1,841) At December 31, 2018 Borrowings (1,621) 1,852 Assets Net Investment Hedges—Foreign exchange contracts Bilateral Cleared Exchange- Recognized in OCI, net of tax $64$ (148) $ in billions OTC OTC Traded Total Forward points excluded from hedge effectiveness Designated as accounting hedges testing—Recognized in Interest income 35 7 Interest rate $ 15 $ 52 $ — $ 67 Foreign exchange 5 1 — 6 Fair Value Hedges—Hedged Items Total 20 53 — 73 At March 31, At December 31, Not designated as accounting hedges $ in millions 2019 2018 Interest rate 4,807 6,708 1,157 12,672 Investment Securities—AFS1 Credit 162 74 — 236 Carrying amount2 currently or Foreign exchange 2,436 118 14 2,568 previously hedged $ 413 $ 201 Equity 373 — 371 744 Borrowings Commodity and other 97 — 67 164 Carrying amount2 currently or Total 7,875 6,900 1,609 16,384 previously hedged $ 103,460 $ 102,899 Total gross derivatives $ 7,895 $ 6,953 $ 1,609 $16,457 Basis adjustments included in carrying amount3 $ (74) $ (1,689)
1. Amounts recognized in interest income and basis adjustments related to AFS securities were not material. 2. Carrying amount represents amortized cost basis. 3. Hedge accounting basis adjustments for Borrowings are primarily related to outstanding hedges.
49 March 2019 Form 10-Q
− 440 − Notes to Consolidated Financial Statements (Unaudited)
Net Derivative Liabilities and Collateral Posted Years to Maturity at December 31, 2018 $ in millions < 1 1-3 3-5 Over 5 Total At At Single-name CDS December 31, March 31, Investment grade $22,297 $23,876 $ 19,469 $ 7,844 $ 73,486 $ in millions 2019 2018 Non-investment grade 10,135 11,061 9,020 861 31,077 Net derivative liabilities with credit risk-related contingent features $ 18,373 $ 16,403 Total $32,432 $34,937 $ 28,489 $ 8,705 $104,563 Index and basket CDS Collateral posted 14,473 11,981 Investment grade $ 5,341 $ 9,901 $ 60,887 $ 6,816 $ 82,945 Non-investment grade 4,574 5,820 12,855 13,272 36,521 The previous table presents the aggregate fair value of certain Total $ 9,915 $15,721 $ 73,742 $20,088 $119,466 derivative contracts that contain credit risk-related contingent Total CDS sold $42,347 $50,658 $102,231 $28,793 $224,029 features that are in a net liability position for which the Firm Other credit contracts — — — 116 116 has posted collateral in the normal course of business. Total credit protection sold $42,347 $50,658 $102,231 $28,909 $224,145 Incremental Collateral and Termination Payments upon CDS protection sold with identical protection purchased $209,972 Potential Future Ratings Downgrade Fair Value Asset (Liability) of Credit Protection Sold1 At March 31, At At $ in millions 2019 March 31, December 31, One-notch downgrade $ 452 $ in millions 2019 2018 Two-notch downgrade 277 Single-name CDS Investment grade $ 401 $ 118 Bilateral downgrade agreements included in the amounts above1 $ 685 Non-investment grade (440) (403) Total $ (39) $ (285) 1. Amount represents arrangements between the Firm and other parties where upon the downgrade of one party, the downgraded party must deliver collateral to the Index and basket CDS other party. These bilateral downgrade arrangements are used by the Firm to Investment grade $ 708 $ 314 manage the risk of counterparty downgrades. Non-investment grade (460) (1,413) Total $ 248 $ (1,099) The additional collateral or termination payments that may be Total CDS sold $ 209 $ (1,384) called in the event of a future credit rating downgrade vary by Other credit contracts (8) (14) contract and can be based on ratings by either or both of Total credit protection sold $ 201 $ (1,398) Moody’s Investors Service, Inc. (“Moody’s”) and S&P Global 1. Investment grade/non-investment grade determination is based on the internal credit Ratings. The previous table shows the future potential rating of the reference obligation. Internal credit ratings serve as the Credit Risk collateral amounts and termination payments that could be Management Department’s assessment of credit risk and the basis for a comprehensive credit limits framework used to control credit risk. The Firm uses called or required by counterparties or exchange and clearing quantitative models and judgement to estimate the various risk parameters related organizations in the event of one-notch or two-notch to each obligor. downgrade scenarios based on the relevant contractual Protection Purchased with CDS downgrade triggers. At March 31, 2019 1 Maximum Potential Payout/Notional of Credit Protection Sold $ in millions Fair Value Asset (Liability) Notional
Years to Maturity at March 31, 2019 Single name $ (148) $116,753 $ in millions < 1 1-3 3-5 Over 5 Total Index and basket (170) 105,819 Single-name CDS Tranched index and basket (475) 15,677 Investment grade $19,721 $21,800 $20,305 $11,743 $ 73,569 Total $ (793) $238,249 Non-investment grade 9,173 12,154 8,908 3,159 33,394 Total $28,894 $33,954 $29,213 $14,902 $106,963 At December 31, 2018 Index and basket CDS $ in millions Fair Value Asset (Liability) Notional Investment grade $ 4,886 $ 9,022 $36,038 $22,143 $ 72,089 Single name $ 277 $116,333 Non-investment grade 5,608 5,482 10,281 14,131 35,502 Index and basket 1,333 117,022 Total $10,494 $14,504 $46,319 $36,274 $107,591 Tranched index and basket (251) 13,524 Total CDS sold $39,388 $48,458 $75,532 $51,176 $214,554 Total $ 1,359 $246,879 Other credit contracts — — — 105 105 Total credit protection sold $39,388 $48,458 $75,532 $51,281 $214,659 CDS protection sold with identical protection purchased $199,507
March 2019 Form 10-Q 50
− 441 − Notes to Consolidated Financial Statements (Unaudited)
The Firm enters into credit derivatives, principally CDS, At December 31, 2018 Gross Gross under which it receives or provides protection against the risk Amortized Unrealized Unrealized of default on a set of debt obligations issued by a specified $ in millions Cost Gains Losses Fair Value reference entity or entities. A majority of the Firm’s AFS securities U.S. government and agency securities: counterparties for these derivatives are banks, broker-dealers, U.S. Treasury securities $ 36,268 $ 40 $ 656 $ 35,652 and insurance and other financial institutions. U.S. agency securities1 20,740 10 497 20,253 Total U.S. government and The fair value amounts as shown in the previous tables are agency securities 57,008 50 1,153 55,905 prior to cash collateral or counterparty netting. For further Corporate and other debt: information on credit derivatives and other contracts, see Agency CMBS 1,054 — 62 992 Note 4 to the financial statements in the 2018 Form 10-K. Non-agency CMBS 461 — 14 447 Corporate bonds 1,585 — 32 1,553 State and municipal securities 200 2 — 202 5. Investment Securities FFELP student loan ABS2 1,967 10 15 1,962 Total corporate and other debt 5,267 12 123 5,156 AFS and HTM Securities Total AFS securities 62,275 62 1,276 61,061 At March 31, 2019 Gross Gross HTM securities Amortized Unrealized Unrealized U.S. government and agency securities: $ in millions Cost Gains Losses Fair Value U.S. Treasury securities 17,832 44 403 17,473 AFS securities U.S. agency securities1 12,456 8 446 12,018 U.S. government and agency securities: Total U.S. government and U.S. Treasury securities $ 32,144 $ 83 $ 448 $ 31,779 agency securities 30,288 52 849 29,491 U.S. agency securities1 23,857 82 318 23,621 Corporate and other debt: Total U.S. government and Non-agency CMBS 483 — 9 474 agency securities 56,001 165 766 55,400 Total HTM securities 30,771 52 858 29,965 Corporate and other debt: Total investment securities $ 93,046 $ 114 $ 2,134 $ 91,026 Agency CMBS 1,965 18 54 1,929
Non-agency CMBS 343 — 7 336 1. U.S. agency securities consist mainly of agency-issued debt, agency mortgage Corporate bonds 1,724 4 10 1,718 pass-through pool securities and CMOs. 2. Underlying loans are backed by a guarantee, ultimately from the U.S. Department of State and municipal securities 394 6 — 400 Education, of at least 95% of the principal balance and interest outstanding. FFELP student loan ABS2 1,868 6 16 1,858 Total corporate and other debt 6,294 34 87 6,241 Total AFS securities 62,295 199 853 61,641 HTM securities U.S. government and agency securities: U.S. Treasury securities 21,349 172 251 21,270 U.S. agency securities1 14,424 46 252 14,218 Total U.S. government and agency securities 35,773 218 503 35,488 Corporate and other debt: Non-agency CMBS 530 7 1 536 Total HTM securities 36,303 225 504 36,024 Total investment securities $ 98,598 $ 424 $ 1,357 $ 97,665
51 March 2019 Form 10-Q
− 442 − Notes to Consolidated Financial Statements (Unaudited)
Investment Securities in an Unrealized Loss Position
At March 31, 2019 Less than 12 Months 12 Months or Longer Total Gross Gross Gross Unrealized Unrealized Unrealized $ in millions Fair Value Losses Fair Value Losses Fair Value Losses AFS securities U.S. government and agency securities: U.S. Treasury securities $ 124 $ — $ 22,670 $ 448 $ 22,794 $ 448 U.S. agency securities 3,641 29 13,307 289 16,948 318 Total U.S. government and agency securities 3,765 29 35,977 737 39,742 766 Corporate and other debt: Agency CMBS 64 — 802 54 866 54 Non-agency CMBS — — 336 7 336 7 Corporate bonds 276 1 818 9 1,094 10 FFELP student loan ABS 615 5 702 11 1,317 16 Total corporate and other debt 955 6 2,658 81 3,613 87 Total AFS securities 4,720 35 38,635 818 43,355 853 HTM securities U.S. government and agency securities: U.S. Treasury securities 99 — 9,495 251 9,594 251 U.S. agency securities 303 2 9,505 250 9,808 252 Total U.S. government and agency securities 402 2 19,000 501 19,402 503 Corporate and other debt: Non-agency CMBS 66 1 110 — 176 1 Total HTM securities 468 3 19,110 501 19,578 504 Total investment securities $ 5,188 $ 38 $ 57,745 $ 1,319 $ 62,933 $ 1,357
At December 31, 2018 Less than 12 Months 12 Months or Longer Total Gross Gross Gross Unrealized Unrealized Unrealized $ in millions Fair Value Losses Fair Value Losses Fair Value Losses AFS securities U.S. government and agency securities: U.S. Treasury securities $ 19,937 $ 541 $ 5,994 $ 115 $ 25,931 $ 656 U.S. agency securities 12,904 383 4,142 114 17,046 497 Total U.S. government and agency securities 32,841 924 10,136 229 42,977 1,153 Corporate and other debt: Agency CMBS 808 62 — — 808 62 Non-agency CMBS — — 446 14 446 14 Corporate bonds 470 7 1,010 25 1,480 32 FFELP student loan ABS 1,366 15 — — 1,366 15 Total corporate and other debt 2,644 84 1,456 39 4,100 123 Total AFS securities 35,485 1,008 11,592 268 47,077 1,276 HTM securities U.S. government and agency securities: U.S. Treasury securities — — 11,161 403 11,161 403 U.S. agency securities 410 1 10,004 445 10,414 446 Total U.S. government and agency securities 410 1 21,165 848 21,575 849 Corporate and other debt: Non-agency CMBS 206 1 216 8 422 9 Total HTM securities 616 2 21,381 856 21,997 858 Total investment securities $ 36,101 $ 1,010 $ 32,973 $ 1,124 $ 69,074 $ 2,134
March 2019 Form 10-Q 52
− 443 − Notes to Consolidated Financial Statements (Unaudited)
The Firm believes there are no securities in an unrealized loss At March 31, 2019 Annualized position that are other-than-temporarily impaired after Amortized Fair Average performing the analysis described in Note 2 to the financial $ in millions Cost Value Yield statements in the 2018 Form 10-K. For AFS securities, the State and municipal securities: Firm does not intend to sell the securities and is not likely to After 5 years through 10 years $ 209 $ 209 3.5% be required to sell the securities prior to recovery of the After 10 Years 185 191 4.7% amortized cost basis. Furthermore, for both AFS and HTM Total 394 400 FFELP student loan ABS: securities, the securities have not experienced credit losses as After 1 year through 5 years 78 77 0.8% the unrealized losses reported in the previous table are After 5 years through 10 years 418 411 0.8% primarily due to higher interest rates since those securities After 10 years 1,372 1,370 1.2% were purchased. Total 1,868 1,858 See Note 12 for additional information on securities issued by Total corporate and other debt 6,294 6,241 2.2% VIEs, including U.S. agency mortgage-backed securities, Total AFS securities 62,295 61,641 2.1% HTM securities non-agency CMBS and FFELP student loan ABS. U.S. government and agency securities: U.S. Treasury securities: Investment Securities by Contractual Maturity Due within 1 year 774 771 1.4%
At March 31, 2019 After 1 year through 5 years 9,504 9,525 2.4% Annualized After 5 years through 10 years 9,987 9,953 2.3% Amortized Fair Average After 10 years 1,084 1,021 2.5% $ in millions Cost Value Yield Total 21,349 21,270 AFS securities U.S. government and agency securities: U.S. agency securities: U.S. Treasury securities: After 5 years through 10 years 28 28 1.9% Due within 1 year $ 4,665 $ 4,647 1.7% After 10 years 14,396 14,190 2.7% After 1 year through 5 years 22,997 22,730 1.9% Total 14,424 14,218 After 5 years through 10 years 4,482 4,402 2.1% Total U.S. government and agency Total 32,144 31,779 securities 35,773 35,488 2.5% U.S. agency securities: Corporate and other debt: Due within 1 year 498 496 1.1% Non-agency CMBS: After 1 year through 5 years 699 691 1.1% Due within 1 year 61 61 4.4% After 5 years through 10 years 1,584 1,554 1.8% After 1 year through 5 years 86 86 4.8% After 10 years 21,076 20,880 2.4% After 5 years through 10 years 344 350 4.1% Total 23,857 23,621 After 10 years 39 39 4.4% Total U.S. government and agency Total corporate and other debt 530 536 4.3% securities 56,001 55,400 2.1% Total HTM securities 36,303 36,024 2.5% Corporate and other debt: Total investment securities $ 98,598 $ 97,665 2.3% Agency CMBS: After 1 year through 5 years 228 227 1.4% Gross Realized Gains (Losses) on Sales of AFS Securities After 5 years through 10 years 994 1,011 3.2% After 10 years 743 691 1.6% Three Months Ended March 31, Total 1,965 1,929 Non-agency CMBS: $ in millions 2019 2018 After 1 year through 5 years 36 35 2.5% Gross realized gains $19 $1 After 10 years 307 301 2.3% Gross realized (losses) (9) (1) Total 343 336 Total1 $10 $— Corporate bonds: Due within 1 year 23 23 1.4% 1. Realized gains and losses are recognized in Other revenues in the income statements. After 1 year through 5 years 1,427 1,421 2.6% After 5 years through 10 years 274 274 3.3% Total 1,724 1,718
53 March 2019 Form 10-Q
− 444 − Notes to Consolidated Financial Statements (Unaudited)
Gross Secured Financing Balances by Remaining Contractual 6. Collateralized Transactions Maturity
Offsetting of Certain Collateralized Transactions At March 31, 2019 Overnight Less than 30-90 Over At March 31, 2019 $ in millions and Open 30 Days Days 90 Days Total Net Securities sold under Gross Amounts Amounts Amounts Net agreements to 1 $ in millions Amounts Offset Presented Not Offset Amounts repurchase $ 72,663 $ 53,332 $ 42,658 $ 37,406 $ 206,059 Assets Securities loaned 19,131 6,858 2,715 6,067 34,771 Securities purchased Total included in the under agreements offsetting disclosure $ 91,794 $ 60,190 $ 45,373 $ 43,473 $ 240,830 to resell $ 254,681 $(158,111) $ 96,570 $ (93,718) $ 2,852 Trading liabilities— Securities borrowed 161,154 (22,263) 138,891 (134,107) 4,784 Obligation to return Liabilities securities received as collateral Securities sold under 19,861 — — — 19,861 agreements to Total $ 111,655 $ 60,190 $ 45,373 $ 43,473 $ 260,691 repurchase $ 206,059 $(158,111) $ 47,948 $ (41,675) $ 6,273 Securities loaned 34,771 (22,263) 12,508 (12,382) 126 At December 31, 2018 Net amounts for which master netting agreements are not in place or may Overnight Less than 30-90 Over $ in millions and Open 30 Days Days 90 Days Total not be legally enforceable Securities sold under Securities purchased under agreements to resell $ 2,419 agreements to Securities borrowed 773 repurchase $ 56,503 $ 93,427 $ 35,692 $ 28,591 $ 214,213 Securities sold under agreements to repurchase 5,148 Securities loaned 18,397 3,609 1,985 6,315 30,306 Securities loaned 107 Total included in the offsetting disclosure $ 74,900 $ 97,036 $ 37,677 $ 34,906 $ 244,519 Trading liabilities— At December 31, 2018 Obligation to return Net securities received as Gross Amounts Amounts Amounts Net collateral 17,594 — — — 17,594 $ in millions Amounts Offset Presented Not Offset1 Amounts Total $ 92,494 $ 97,036 $ 37,677 $ 34,906 $ 262,113 Assets Securities purchased under agreements Gross Secured Financing Balances by Class of Collateral to resell $ 262,976 $(164,454) $ 98,522 $ (95,610) $ 2,912 Pledged Securities borrowed 134,711 (18,398) 116,313 (112,551) 3,762 At At Liabilities March 31, December 31, Securities sold under $ in millions 2019 2018 agreements to Securities sold under agreements to repurchase repurchase $ 214,213 $(164,454) $ 49,759 $ (41,095) $ 8,664 U.S. Treasury and agency securities $ 59,851 $ 68,487 Securities loaned 30,306 (18,398) 11,908 (11,677) 231 State and municipal securities 1,633 925 Other sovereign government obligations 123,089 120,432 Net amounts for which master netting agreements are not in place or may not be legally enforceable ABS 2,112 3,017 Securities purchased under agreements to resell $ 2,579 Corporate and other debt 7,327 8,719 Corporate equities 11,624 12,079 Securities borrowed 724 Other 423 554 Securities sold under agreements to repurchase 6,762 Total $ 206,059 $ 214,213 Securities loaned 191 Securities loaned Other sovereign government obligations $ 22,656 $ 19,021 1. Amounts relate to master netting agreements that have been determined by the Firm to be legally enforceable in the event of default but where certain other criteria Corporate equities 11,736 10,800 are not met in accordance with applicable offsetting accounting guidance. Other 379 485 Total $ 34,771 $ 30,306 For further discussion of the Firm’s collateralized Total included in the offsetting disclosure $ 240,830 $ 244,519 transactions, see Note 6 to the financial statements in the 2018 Trading liabilities—Obligation to return securities received as collateral Corporate equities $ 19,861 $ 17,594 Form 10-K. For information related to offsetting of Total $ 260,691 $ 262,113 derivatives, see Note 4.
March 2019 Form 10-Q 54
− 445 − Notes to Consolidated Financial Statements (Unaudited)
Carrying Value of Assets Loaned or Pledged without The Firm provides margin lending arrangements which allow Counterparty Right to Sell or Repledge customers to borrow against the value of qualifying securities. At At Receivables under margin lending arrangements are included March 31, December 31, within Customer and other receivables in the balance sheets. $ in millions 2019 2018 Trading assets $ 35,543 $ 39,430 Under these agreements and transactions, the Firm receives collateral, including U.S. government and agency securities, other sovereign government obligations, corporate and other The Firm pledges its trading assets to collateralize securities debt, and corporate equities. Customer receivables generated sold under agreements to repurchase, securities loaned, other from margin lending activities are collateralized by customer- secured financings and derivatives and to cover customer owned securities held by the Firm. The Firm monitors short sales. Counterparties may or may not have the right to required margin levels and established credit terms daily and, sell or repledge the collateral. pursuant to such guidelines, requires customers to deposit additional collateral, or reduce positions, when necessary. Pledged financial instruments that can be sold or repledged by the secured party are identified as Trading assets (pledged to For a further discussion of the Firm’s margin lending various parties) in the balance sheets. activities, see Note 6 to the financial statements in the 2018 Form 10-K. Fair Value of Collateral Received with Right to Sell or Repledge The Firm has additional secured liabilities. For a further discussion of other secured financings, see Notes 10 and 12. At At March 31, December 31, $ in millions 2019 2018 Collateral received with right to sell 7. Loans, Lending Commitments and Allowance or repledge $ 697,669 $ 639,610 for Credit Losses Collateral that was sold or repledged1 553,625 487,983 Loans by Type 1. Does not include securities used to meet federal regulations for the Firm’s U.S. At March 31, 2019 broker-dealers. Loans Held Loans Held $ in millions for Investment for Sale Total Loans Restricted Cash and Segregated Securities Corporate $ 38,424 $ 12,469 $ 50,893
At At Consumer 27,300 — 27,300 March 31, December 31, Residential real estate 28,037 22 28,059 $ in millions 2019 2018 Restricted cash $ 30,712 $ 35,356 Commercial real estate 7,764 2,440 10,204 Segregated securities1 24,752 26,877 Total loans, gross 101,525 14,931 116,456 Total $ 55,464 $ 62,233 Allowance for loan losses (259) — (259) Total loans, net $ 101,266 $ 14,931 $ 116,197 1. Securities segregated under federal regulations for the Firm’s U.S. broker-dealers Fixed rate loans, net $ 16,450 are sourced from Securities purchased under agreements to resell and Trading assets in the balance sheets. Floating or adjustable rate loans, net 99,747 Loans to non-U.S. borrowers, net 18,072 The Firm receives collateral in the form of securities in connection with securities purchased under agreements to At December 31, 2018 resell, securities borrowed, securities-for-securities Loans Held Loans Held $ in millions for Investment for Sale Total Loans transactions, derivative transactions, customer margin loans Corporate $ 36,909 $ 13,886 $ 50,795 and securities-based lending. In many cases, the Firm is Consumer 27,868 — 27,868 permitted to sell or repledge these securities held as collateral Residential real estate 27,466 22 27,488 and use the securities to secure securities sold under Commercial real estate1 7,810 1,856 9,666 agreements to repurchase, to enter into securities lending and derivative transactions or for delivery to counterparties to Total loans, gross 100,053 15,764 115,817 cover short positions. Allowance for loan losses (238) — (238) Total loans, net $ 99,815 $ 15,764 $ 115,579 Customer Margin Lending Fixed rate loans, net $ 15,632 Floating or adjustable rate loans, net 99,947 At At March 31, December 31, Loans to non-U.S. borrowers, net 17,568 $ in millions 2019 2018 1. Beginning in 2019, loans previously referred to as Wholesale real estate are Customer receivables representing margin loans $ 27,427 $ 26,225 referred to as Commercial real estate.
55 March 2019 Form 10-Q
− 446 − Notes to Consolidated Financial Statements (Unaudited)
Loans Held for Investment before Allowance by Credit Quality Loans and lending commitments in the previous table have been evaluated for a specific allowance. All remaining loans At March 31, 2019 and lending commitments are assessed under the inherent Residential Commercial allowance methodology. $ in millions Corporate Consumer Real Estate Real Estate Total Pass $ 37,806 $ 27,294 $ 27,954 $ 7,332 $100,386 Impaired Loans and Total Allowance by Region Special mention 171 — 9 312 492 Substandard 447 6 74 120 647 At March 31, 2019 Doubtful —— — ——$ in millions Americas EMEA Asia Total Loss —— — —— Impaired loans $ 355 $ — $ — $355 Total $ 38,424 $ 27,300 $ 28,037 $ 7,764 $101,525 Total Allowance for loan losses 211 46 2 259
At December 31, 2018 At December 31, 2018 Residential Commercial $ in millions Americas EMEA Asia Total $ in millions Corporate Consumer Real Estate Real Estate Total Impaired loans $ 125 $ — $ — $125 Pass $ 36,217 $ 27,863 $ 27,387 $ 7,378 $ 98,845 Total Allowance for loan losses 193 42 3 238 Special mention 492 5 — 312 809 Substandard 200 — 79 120 399 Troubled Debt Restructurings Doubtful ————— Loss ————— At At Total $ 36,909 $ 27,868 $ 27,466 $ 7,810 $100,053 March 31, December 31, $ in millions 2019 2018 Impaired Loans and Lending Commitments before Allowance Loans $ 93 $38 Lending commitments 68 45 At March 31, 2019 Allowance for loan losses and lending Residential commitments 5 4 $ in millions Corporate Consumer Real Estate Total Loans Impaired loans and lending commitments classified as held With allowance $ 265 $ — $ — $ 265 for investment within corporate loans include TDRs as shown Without allowance1 20 5 65 90 in the previous table. These restructurings typically include Total impaired loans $ 285 $ 5 $ 65 $ 355 UPB 292 5 66 363 modifications of interest rates, collateral requirements, other Lending commitments loan covenants and payment extensions. With allowance $ 17$ —$ —$ 17 Allowance for Loan Losses Rollforward Without allowance1 45 — — 45 Total impaired lending commitments 62 — — 62 Residential Commercial $ in millions Corporate Consumer Real Estate Real Estate Total At December 31, 2018 December 31, 2018 $ 144 $ 7 $ 20 $ 67 $ 238 Residential Provision (release) 26 (1) 2 — 27 $ in millions Corporate Consumer Real Estate Total Other (6) — — — (6) Loans March 31, 2019 $ 164 $ 6 $ 22 $ 67 $ 259 With allowance $ 24 $ — $ — $ 24 Inherent $ 150 $ 6 $ 22 $ 67 $ 245 Without allowance1 32 — 69 101 Specific 14 — — — 14 Total impaired loans $ 56 $ — $ 69 $125 UPB 63 — 70 133 Residential Commercial Lending commitments $ in millions Corporate Consumer Real Estate Real Estate Total With allowance $ 19 $ — $ — $ 19 December 31, 2017 $ 126 $ 4 $ 24 $ 70 $ 224 Without allowance1 34 — — 34 Provision (release) 6 — (1) 14 19 Total impaired lending commitments 53 — —53 Other (1) — — 1 — 1. No allowance was recorded for these loans and lending commitments as the March 31, 2018 $ 131 $ 4 $ 23 $ 85 $ 243 present value of the expected future cash flows or value of the collateral equaled or Inherent $ 126 $ 4 $ 23 $ 85 $ 238 exceeded the carrying value. Specific 5 — — — 5
March 2019 Form 10-Q 56
− 447 − Notes to Consolidated Financial Statements (Unaudited)
Allowance for Lending Commitments Rollforward 8. Equity Method Investments
Residential Commercial $ in millions Corporate Consumer Real Estate Real Estate Total Equity Method Investment Balances December 31, 2018 $ 198 $ 2 $ — $ 3 $ 203 At At Provision (release) 8— — 19 March 31, December 31, Other — (1) — — (1) $ in millions 2019 2018 March 31, 2019 $ 206 $ 1 $ — $ 4 $ 211 Investments $ 2,391 $ 2,432 Inherent $ 202 $ 1 $ — $ 4 $ 207 Specific 4— — —4 Three Months Ended March 31, Residential Commercial $ in millions 2019 2018 $ in millions Corporate Consumer Real Estate Real Estate Total Income (loss) $ (10) $50 December 31, 2017 $ 194 $ 1 $ — $ 3 $ 198 Provision (release) 7 — — — 7 Equity method investments, other than certain investments in Other —— — —— funds, are summarized above and are included in Other assets March 31, 2018 $ 201 $ 1 $ — $ 3 $ 205 in the balance sheets with related income or loss included in Inherent $ 200 $ 1 $ — $ 3 $ 204 Other revenues in the income statements. See “Net Asset Specific 1 — — — 1 Value Measurements—Fund Interests” in Note 3 for the carrying value of the Firm’s fund interests, which are For a further discussion of the Firm’s loans, including loan comprised of general and limited partnership interests, as well types and categories, as well as the Firm’s allowance as any related carried interest. methodology, refer to Notes 2 and 7 to the financial statements in the 2018 Form 10-K. See Note 3 for further Japanese Securities Joint Venture information regarding Loans and lending commitments held at fair value. See Note 11 for details of current commitments Three Months Ended to lend in the future. March 31, $ in millions 2019 2018 Employee Loans Income from investment in MUMSS $3 $56
At At March 31, December 31, The Firm and Mitsubishi UFJ Financial Group, Inc. $ in millions 2019 2018 (“MUFG”) formed a joint venture in Japan comprising their Balance $ 3,011 $ 3,415 respective investment banking and securities businesses by Allowance for loan losses (64) (63) forming two joint venture companies, Mitsubishi UFJ Morgan Balance, net $ 2,947 $ 3,352 Stanley Securities Co., Ltd. (“MUMSS”) and Morgan Stanley Repayment term range, in years 1to20 1to20 MUFG Securities Co., Ltd. (“MSMS”) (the “Joint Venture”). The Firm owns a 40% economic interest in the Joint Venture Employee loans are granted in conjunction with a program and MUFG owns the other 60%. established primarily to recruit certain Wealth Management representatives, are full recourse and generally require The Firm’s 40% voting interest in MUMSS is accounted for periodic repayments. These loans are recorded in Customer under the equity method within the Institutional Securities and other receivables in the balance sheets. The Firm business segment, and is included in the equity method establishes an allowance for loan amounts it does not consider investment balances above. The Firm consolidates MSMS recoverable, and the related provision is recorded in into the Institutional Securities business segment, based on its Compensation and benefits expense. 51% voting interest. The Firm engages in transactions in the ordinary course of business with MUFG and its affiliates, for example investment banking, financial advisory, sales and trading, derivatives, investment management, lending, securitization and other financial services transactions. Such transactions are on substantially the same terms as those that would be available to unrelated third parties for comparable transactions.
57 March 2019 Form 10-Q
− 448 − Notes to Consolidated Financial Statements (Unaudited)
9. Deposits Other secured financings include the liabilities related to certain ELNs, transfers of financial assets that are accounted Deposits for as financings rather than sales, pledged commodities, consolidated VIEs where the Firm is deemed to be the At At March 31, December 31, primary beneficiary and other secured borrowings. These $ in millions 2019 2018 liabilities are generally payable from the cash flows of the Savings and demand deposits $ 143,201 $ 154,897 related assets accounted for as Trading assets. See Note 12 for Time deposits 36,530 32,923 further information on other secured financings related to Total $ 179,731 $ 187,820 VIEs and securitization activities. Deposits subject to FDIC insurance $ 141,737 $ 144,515 For transfers that fail to meet the accounting criteria for a sale, Time deposits that equal or the Firm continues to recognize the assets in Trading assets at exceed the FDIC insurance limit $22$11fair value, and the Firm recognizes the associated liabilities in Other secured financings at fair value in the balance sheets. Time Deposit Maturities The assets transferred to certain unconsolidated VIEs in At transactions accounted for as failed sales cannot be removed March 31, $ in millions 2019 unilaterally by the Firm and are not generally available to the 2019 $ 14,100 Firm. The related liabilities are also non-recourse to the Firm. 2020 13,381 In certain other failed sale transactions, the Firm has the right 2021 4,272 to remove assets or provides additional recourse through derivatives such as total return swaps, guarantees or other 2022 1,866 forms of involvement. 2023 2,069 Thereafter 842 Total $ 36,530 11. Commitments, Leases, Guarantees and Contingencies
10. Borrowings and Other Secured Financings Commitments
Borrowings Years to Maturity at March 31, 2019 At At Less March 31, December 31, $ in millions than 1 1-3 3-5 Over 5 Total $ in millions 2019 2018 Lending: Original maturities of one year or less $ 1,498 $ 1,545 Corporate $ 19,594 $ 30,583 $ 49,944 $ 5,286 $ 105,407 Original maturities greater than one year Consumer 7,442 1 11 — 7,454 Senior $ 178,926 $ 178,027 Residential and commercial Subordinated 10,267 10,090 real estate 66 751 89 554 1,460 Total $ 189,193 $ 188,117 Forward-starting Total borrowings $ 190,691 $ 189,662 secured financing receivables 121,612 — — 8,322 129,934 Weighted average stated maturity, in years1 6.7 6.5 Underwriting 2,299 — — — 2,299 Investment activities 513 93 49 243 898 1. Only includes borrowings with original maturities greater than one year. Letters of credit and Other Secured Financings other financial guarantees 187 1 — 2 190 At At Total $ 151,713 $ 31,429 $ 50,093 $ 14,407 $ 247,642 March 31, December 31, Corporate lending commitments participated to third parties $ 8,674 $ in millions 2019 2018 Forward-starting secured financing receivables settled within Original maturities: three business days $ 110,917 Greater than one year $ 5,254 $ 6,772 One year or less 2,074 2,036 Since commitments associated with these instruments may Failed sales 715 658 expire unused, the amounts shown do not necessarily reflect Total $ 8,043 $ 9,466 the actual future cash funding requirements.
March 2019 Form 10-Q 58
− 449 − Notes to Consolidated Financial Statements (Unaudited)
For a further description of these commitments, refer to Note Minimum Future Lease Commitments (under Previous GAAP) At 12 to the financial statements in the 2018 Form 10-K. December 31, $ in millions 2018 Leases 2019 $ 677 Balance Sheet Amounts Related to Leases 2020 657 2021 602 At March 31, 2022 555 $ in millions 2019 2023 507 Other assets—ROU assets $ 3,886 Thereafter 2,639 Other liabilities and accrued expenses— Total undiscounted cash flows $ 5,637 Lease liabilities 4,653 Minimum rental income to be received in the future Weighted average: under non-cancelable operating subleases $ 7 Remaining lease term, in years 10.0 The Firm’s leases are principally non-cancelable operating Discount rate 3.7% real estate leases. Lease Liabilities Guarantees At Obligations under Guarantee Arrangements at March 31, 2019 March 31, Maximum Potential Payout/Notional $ in millions 2019 Years to Maturity Remainder of 2019 $ 552 $ in millions Less than 1 1-3 3-5 Over 5 Total 2020 687 Credit derivatives $ 39,388 $ 48,458 $ 75,532 $ 51,176 $ 214,554 2021 634 Other credit contracts — — — 105 105 Non-credit derivatives 1,585,096 1,425,027 450,368 791,729 4,252,220 2022 583 Standby letters of 2023 532 credit and other financial Thereafter 2,766 guarantees issued1 1,015 1,037 1,302 4,174 7,528 Total undiscounted cash flows $ 5,754 Market value guarantees 104 103 4 — 211 Difference between undiscounted and Liquidity facilities 4,478 — — — 4,478 discounted cash flows 1,101 Whole loan sales Amount on balance sheet $ 4,653 guarantees — 1 — 23,175 23,176 Securitization representations Lease Costs and warranties — — — 64,939 64,939 General partner Three Months Ended guarantees 9 112 162 50 333 $ in millions March 31, 2019 Fixed costs $ 170 Carrying Variable costs1 34 Amount Asset Collateral/ Less: Sublease income (1) $ in millions (Liability) Recourse Total lease cost, net 203 Credit derivatives2 $ 209 $ — Other credit contracts (8) — 1. Includes common area maintenance charges and other variable costs Non-credit derivatives2 (41,254) — not included in the measurement of ROU assets and lease liabilities. Standby letters of credit and other financial Cash Flows Statement Supplemental Information guarantees issued1 222 6,350 Market value guarantees — 107 Three Months Ended $ in millions March 31, 2019 Liquidity facilities 6 7,620 Cash outflows—Lease liabilities $ 165 Whole loan sales guarantees (9) — 3 Non-cash—ROU assets recorded for new and Securitization representations and warranties (42) — modified leases 40 General partner guarantees (71) —
1. These amounts include certain issued standby letters of credit participated to third parties, totaling $0.6 billion of notional and collateral/recourse, due to the nature of the Firm’s obligations under these arrangements. 2. Carrying amounts of derivative contracts are shown on a gross basis prior to cash collateral or counterparty netting. For further information on derivative contracts, see Note 4. 3. Primarily related to residential mortgage securitizations.
59 March 2019 Form 10-Q
− 450 − Notes to Consolidated Financial Statements (Unaudited)
The Firm has obligations under certain guarantee arrangements, Contingencies including contracts and indemnification agreements, that contingently require the Firm to make payments to the Legal. In addition to the matters described below, in the normal guaranteed party based on changes in an underlying measure course of business, the Firm has been named, from time to time, (such as an interest or foreign exchange rate, security or as a defendant in various legal actions, including arbitrations, commodity price, an index, or the occurrence or non-occurrence class actions and other litigation, arising in connection with its of a specified event) related to an asset, liability or equity security activities as a global diversified financial services institution. of a guaranteed party. Also included as guarantees are contracts Certain of the actual or threatened legal actions include claims that contingently require the Firm to make payments to the for substantial compensatory and/or punitive damages or claims guaranteed party based on another entity’s failure to perform for indeterminate amounts of damages. In some cases, the entities under an agreement, as well as indirect guarantees of the that would otherwise be the primary defendants in such cases are indebtedness of others. bankrupt or are in financial distress. These actions have included, but are not limited to, residential mortgage and credit crisis- In certain situations, collateral may be held by the Firm for related matters. those contracts that meet the definition of a guarantee. Generally, the Firm sets collateral requirements by counterparty While the Firm has identified below any individual so that the collateral covers various transactions and products proceedings where the Firm believes a material loss to be and is not allocated specifically to individual contracts. Also, reasonably possible and reasonably estimable, there can be no the Firm may recover amounts related to the underlying asset assurance that material losses will not be incurred from claims delivered to the Firm under a derivative contract. that have not yet been asserted or are not yet determined to be probable or possible and reasonably estimable losses. For more information on the nature of the obligation and related business activity for market value guarantees, liquidity The Firm contests liability and/or the amount of damages as facilities, whole loan sales guarantees and general partner appropriate in each pending matter. Where available guarantees related to certain investment management funds, information indicates that it is probable a liability had been as well as the other products in the previous table, see Note 12 incurred at the date of the financial statements and the Firm to the financial statements in the 2018 Form 10-K. can reasonably estimate the amount of that loss, the Firm accrues the estimated loss by a charge to income. Other Guarantees and Indemnities In many proceedings and investigations, however, it is In the normal course of business, the Firm provides inherently difficult to determine whether any loss is probable guarantees and indemnifications in a variety of transactions. or even possible or to estimate the amount of any loss. In These provisions generally are standard contractual terms. addition, even where a loss is possible or an exposure to loss Certain of these guarantees and indemnifications related to exists in excess of the liability already accrued with respect to indemnities, exchange and clearinghouse member guarantees a previously recognized loss contingency, it is not always and merger and acquisition guarantees are described in Note possible to reasonably estimate the size of the possible loss or 12 to the financial statements in the 2018 Form 10-K. range of loss.
In addition, in the ordinary course of business, the Firm For certain legal proceedings and investigations, the Firm guarantees the debt and/or certain trading obligations (including cannot reasonably estimate such losses, particularly for obligations associated with derivatives, foreign exchange proceedings and investigations where the factual record is contracts and the settlement of physical commodities) of certain being developed or contested or where plaintiffs or subsidiaries. These guarantees generally are entity or product government entities seek substantial or indeterminate specific and are required by investors or trading counterparties. damages, restitution, disgorgement or penalties. Numerous The activities of the Firm’s subsidiaries covered by these issues may need to be resolved, including through potentially guarantees (including any related debt or trading obligations) are lengthy discovery and determination of important factual included in the financial statements. matters, determination of issues related to class certification and the calculation of damages or other relief, and by Finance Subsidiary addressing novel or unsettled legal questions relevant to the proceedings or investigations in question, before a loss or The Parent Company fully and unconditionally guarantees the additional loss or range of loss or additional range of loss can securities issued by Morgan Stanley Finance LLC, a be reasonably estimated for a proceeding or investigation. 100%-owned finance subsidiary.
March 2019 Form 10-Q 60
− 451 − Notes to Consolidated Financial Statements (Unaudited)
For certain other legal proceedings and investigations, the the loan breach remedy procedures in the transaction Firm can estimate reasonably possible losses, additional documents, unspecified damages and interest. On losses, ranges of loss or ranges of additional loss in excess of November 24, 2014, the court granted in part and denied in amounts accrued but does not believe, based on current part the Firm’s motion to dismiss the complaint. On April 4, knowledge and after consultation with counsel, that such 2019, the court denied the Firm’s motion to renew its motion losses will have a material adverse effect on the Firm’s to dismiss. Based on currently available information, the Firm financial statements as a whole, other than the matters believes that it could incur a loss in this action of up to referred to in the following paragraphs. approximately $240 million, the total original unpaid balance of the mortgage loans for which the Firm received repurchase On July 15, 2010, China Development Industrial Bank demands that it did not repurchase, plus pre- and post- (“CDIB”) filed a complaint against the Firm, styled China judgment interest, fees and costs, but plaintiff is seeking to Development Industrial Bank v. Morgan Stanley & Co. expand the number of loans at issue and the possible range of Incorporated et al., which is pending in the Supreme Court of loss could increase. the State of New York, New York County (“Supreme Court of NY”). The complaint relates to a $275 million CDS On September 19, 2014, Financial Guaranty Insurance referencing the super senior portion of the STACK 2006-1 Company (“FGIC”) filed a complaint against the Firm in the CDO. The complaint asserts claims for common law fraud, Supreme Court of NY, styled Financial Guaranty Insurance fraudulent inducement and fraudulent concealment and Company v. Morgan Stanley ABS Capital I Inc. et al. relating alleges that the Firm misrepresented the risks of the STACK to a securitization issued by Basket of Aggregated Residential 2006-1 CDO to CDIB, and that the Firm knew that the assets NIMS 2007-1 Ltd. The complaint asserts claims for breach of backing the CDO were of poor quality when it entered into contract and alleges, among other things, that the net interest the CDS with CDIB. The complaint seeks compensatory margin securities (“NIMS”) in the trust breached various damages related to the approximately $228 million that CDIB representations and warranties. FGIC issued a financial alleges it has already lost under the CDS, rescission of guaranty policy with respect to certain notes that had an CDIB’s obligation to pay an additional $12 million, punitive original balance of approximately $475 million. The damages, equitable relief, fees and costs. On February 28, complaint seeks, among other relief, specific performance of 2011, the court denied the Firm’s motion to dismiss the the NIMS breach remedy procedures in the transaction complaint. On December 21, 2018, the court denied the documents, unspecified damages, reimbursement of certain Firm’s motion for summary judgment and granted in part the payments made pursuant to the transaction documents, Firm’s motion for sanctions relating to spoliation of evidence. attorneys’ fees and interest. On November 24, 2014, the Firm On January 24, 2019, CDIB filed a notice of appeal from the filed a motion to dismiss the complaint, which the court court’s December 21, 2018 order, and on January 25, 2019, denied on January 19, 2017. On September 13, 2018, the the Firm filed a notice of appeal from the same order. On Appellate Division, First Department, affirmed the lower March 7, 2019, the court denied the relief that CDIB sought in court’s order denying the Firm’s motion to dismiss. Based on a motion to clarify and resettle the portion of the court’s currently available information, the Firm believes that it could December 21, 2018 order granting spoliation sanctions. Based incur a loss in this action of up to approximately $126 million, on currently available information, the Firm believes it could the unpaid balance of these notes, plus pre- and post-judgment incur a loss in this action of up to approximately $240 million interest, fees and costs, as well as claim payments that FGIC plus pre- and post-judgment interest, fees and costs. has made and will make in the future.
On July 8, 2013, U.S. Bank National Association, in its On September 23, 2014, FGIC filed a complaint against the capacity as trustee, filed a complaint against the Firm styled Firm in the Supreme Court of NY styled Financial Guaranty U.S. Bank National Association, solely in its capacity as Insurance Company v. Morgan Stanley ABS Capital I Inc. et Trustee of the Morgan Stanley Mortgage Loan Trust al. relating to the Morgan Stanley ABS Capital I Inc. Trust 2007-2AX (MSM 2007-2AX) v. Morgan Stanley Mortgage 2007-NC4. The complaint asserts claims for breach of Capital Holdings LLC, Successor-by-Merger to Morgan contract and fraudulent inducement and alleges, among other Stanley Mortgage Capital Inc. and GreenPoint Mortgage things, that the loans in the trust breached various Funding, Inc., pending in the Supreme Court of NY. The representations and warranties and defendants made untrue complaint asserts claims for breach of contract and alleges, statements and material omissions to induce FGIC to issue a among other things, that the loans in the trust, which had an financial guaranty policy on certain classes of certificates that original principal balance of approximately $650 million, had an original balance of approximately $876 million. The breached various representations and warranties. The complaint seeks, among other relief, specific performance of complaint seeks, among other relief, specific performance of the loan breach remedy procedures in the transaction
61 March 2019 Form 10-Q
− 452 − Notes to Consolidated Financial Statements (Unaudited) documents, compensatory, consequential and punitive Department’s decision. Based on currently available damages, attorneys’ fees and interest. On January 23, 2017, information, the Firm believes that it could incur a loss in this the court denied the Firm’s motion to dismiss the complaint. action of up to approximately $277 million, the total original On September 13, 2018, the Appellate Division, First unpaid balance of the mortgage loans for which the Firm Department, affirmed in part and reversed in part the lower received repurchase demands from a certificate holder and a court’s order denying the Firm’s motion to dismiss. On monoline insurer that the Firm did not repurchase, plus pre- December 20, 2018, the Appellate Division denied plaintiff’s and post-judgment interest, fees and costs, but plaintiff is motion for leave to appeal the decision of the Appellate seeking to expand the number of loans at issue and the Division, First Department, to the New York Court of possible range of loss could increase. Appeals or, in the alternative, for re-argument. Based on currently available information, the Firm believes that it could In matters styled Case number 15/3637 and Case number incur a loss in this action of up to approximately $277 million, 15/4353, the Dutch Tax Authority (“Dutch Authority”) has the total original unpaid balance of the mortgage loans for challenged, in the District Court in Amsterdam, the prior € which the Firm received repurchase demands from a set-off by the Firm of approximately 124 million certificate holder and FGIC that the Firm did not repurchase, (approximately $139 million) plus accrued interest of plus pre- and post-judgment interest, fees and costs, as well as withholding tax credits against the Firm’s corporation tax claim payments that FGIC has made and will make in the liabilities for the tax years 2007 to 2013. The Dutch Authority future. In addition, plaintiff is seeking to expand the number alleges that the Firm was not entitled to receive the of loans at issue and the possible range of loss could increase. withholding tax credits on the basis, inter alia, that a Firm subsidiary did not hold legal title to certain securities subject On January 23, 2015, Deutsche Bank National Trust to withholding tax on the relevant dates. The Dutch Authority Company, in its capacity as trustee, filed a complaint against has also alleged that the Firm failed to provide certain the Firm styled Deutsche Bank National Trust Company information to the Dutch Authority and keep adequate books solely in its capacity as Trustee of the Morgan Stanley ABS and records. A hearing took place in this matter on Capital I Inc. Trust 2007-NC4 v. Morgan Stanley Mortgage September 19, 2017. On April 26, 2018, the District Court in Capital Holdings LLC as Successor-by-Merger to Morgan Amsterdam issued a decision dismissing the Dutch Stanley Mortgage Capital Inc., and Morgan Stanley ABS Authority’s claims. On June 4, 2018, the Dutch Authority Capital I Inc., pending in the Supreme Court of NY. The filed an appeal before the Court of Appeal in Amsterdam in complaint asserts claims for breach of contract and alleges, matters re-styled Case number 18/00318 and Case number among other things, that the loans in the trust, which had an 18/00319. A hearing of the Dutch Authority’s appeal has been original principal balance of approximately $1.05 billion, scheduled for June 26, 2019. Based on currently available breached various representations and warranties. The information, the Firm believes that it could incur a loss in this complaint seeks, among other relief, specific performance of action of up to approximately €124 million (approximately the loan breach remedy procedures in the transaction $139 million) plus accrued interest. documents, compensatory, consequential, rescissory, equitable and punitive damages, attorneys’ fees, costs and Matters settled. On April 1, 2016, the California Attorney other related expenses, and interest. On December 11, 2015, General’s Office filed an action against the Firm in California the court granted in part and denied in part the Firm’s motion state court styled California v. Morgan Stanley, et al.,on to dismiss the complaint. On October 19, 2018, the court behalf of California investors, including the California Public granted the Firm’s motion for leave to amend its answer and Employees’ Retirement System and the California Teachers’ to stay the case pending resolution of Deutsche Bank National Retirement System. The complaint alleges that the Firm made Trust Company’s appeal to the New York Court of Appeals in misrepresentations and omissions regarding RMBS and notes another case. On January 17, 2019, the First Department issued by the Cheyne SIV, and asserts violations of the reversed the trial court’s order to the extent that it had granted California False Claims Act and other state laws and seeks in part the Firm’s motion to dismiss the complaint. On treble damages, civil penalties, disgorgement, and injunctive February 15, 2019, the Firm filed a motion for leave to appeal, relief. On April 24, 2019, the parties reached an agreement to or in the alternative, for the re-argument of the First settle the litigation.
March 2019 Form 10-Q 62
− 453 − Notes to Consolidated Financial Statements (Unaudited)
12. Variable Interest Entities and Securitization recognized in its financial statements, net of amounts Activities absorbed by third-party variable interest holders.
Consolidated VIEs Non-consolidated VIEs
Assets and Liabilities by Type of Activity At March 31, 2019
At March 31, 2019 At December 31, 2018 $ in millions MABS CDO MTOB OSF Other $ in millions VIE Assets VIE Liabilities VIE Assets VIE Liabilities VIE assets (UPB) $ 75,970 $ 9,766 $ 7,110 $ 3,302 $ 19,512 OSF $ 260 $ — $ 267 $ — Maximum exposure to loss1 MABS1 37 18 59 38 Debt and equity interests $ 8,080 $ 938 $ 3 $ 1,613 $ 5,261 Other2 842 63 809 48 Derivative and other contracts — — 4,478 — 1,966 Total $ 1,139 $ 81 $ 1,135 $ 86 Commitments, guarantees and other 735 — — 211 327 OSF—Other structured financings 1. Amounts include transactions backed by residential mortgage loans, commercial Total $ 8,815 $ 938 $ 4,481 $ 1,824 $ 7,554 mortgage loans and other types of assets, including consumer or commercial assets. The value of assets is determined based on the fair value of the liabilities Carrying value of exposure to loss—Assets and the interests owned by the Firm in such VIEs as the fair values for the liabilities Debt and equity interests $ 8,080 $ 938 $ 3 $ 1,194 $ 5,261 and interests owned are more observable. Derivative and other 2. Other primarily includes certain operating entities, investment funds and structured contracts — — 6 — 228 transactions. Total $ 8,080 $ 938 $ 9 $ 1,194 $ 5,489 Assets and Liabilities by Balance Sheet Caption Additional VIE assets owned2 $ 11,144 Carrying value of exposure to loss—Liabilities At At Derivative and other March 31, December 31, $ in millions 2019 2018 contracts $ —$—$—$—$205 Assets Cash and cash equivalents: At December 31, 2018 Cash and due from banks $92$77 $ in millions MABS CDO MTOB OSF Other Restricted cash 171 171 VIE assets (UPB) $ 71,287 $ 10,848 $ 7,014 $ 3,314 $ 19,682 Trading assets at fair value 311 314 Maximum exposure to loss1 Customer and other receivables 21 25 Debt and equity interests $ 8,234 $ 1,169 $ — $ 1,622 $ 4,645 Goodwill 18 18 Derivative and other Intangible assets 104 128 contracts — — 4,449 — 1,768 Other assets 422 402 Commitments, guarantees and other 397 3 — 235 327 Total $ 1,139 $ 1,135 Total $ 8,631 $ 1,172 $ 4,449 $ 1,857 $ 6,740 Liabilities Other secured financings $49$64Carrying value of exposure to loss—Assets Other liabilities and accrued expenses 32 22 Debt and equity interests $ 8,234 $ 1,169 $ — $ 1,205 $ 4,645 Total $ 81 $86Derivative and other contracts — — 6 — 87 Noncontrolling interests $ 115 $ 106 Total $ 8,234 $ 1,169 $ 6 $ 1,205 $ 4,732
2 Consolidated VIE assets and liabilities are presented in the Additional VIE assets owned $ 11,969 Carrying value of exposure to loss—Liabilities previous tables after intercompany eliminations. Most assets Derivative and other owned by consolidated VIEs cannot be removed unilaterally contracts $ — $ — $ — $ — $ 185 by the Firm and are not generally available to the Firm. Most MTOB—Municipal tender option bonds related liabilities issued by consolidated VIEs are 1. Where notional amounts are utilized in quantifying the maximum exposure related to non-recourse to the Firm. In certain other consolidated VIEs, derivatives, such amounts do not reflect changes in fair value recorded by the Firm. the Firm either has the unilateral right to remove assets or 2. Additional VIE assets owned represents the carrying value of total exposure to non-consolidated VIEs for which the maximum exposure to loss is less than specific provides additional recourse through derivatives such as total thresholds, primarily interests issued by securitization SPEs. The Firm’s primary risk return swaps, guarantees or other forms of involvement. exposure is to the most subordinate class of beneficial interest and maximum exposure to loss generally equals the fair value of the assets owned. These assets are primarily included in Trading assets and Investment securities and are In general, the Firm’s exposure to loss in consolidated VIEs is measured at fair value (see Note 3). The Firm does not provide additional support in limited to losses that would be absorbed on the VIE net assets these transactions through contractual facilities, guarantees or similar derivatives.
63 March 2019 Form 10-Q
− 454 − Notes to Consolidated Financial Statements (Unaudited)
The majority of the VIEs included in the previous tables are At December 31, 2018 U.S. Agency CLN and sponsored by unrelated parties; the Firm’s involvement $ in millions RML CML CMO Other1 generally is the result of its secondary market-making SPE assets (UPB)2 $ 14,376 $ 68,593 $ 16,594 $ 14,608 activities and securities held in its Investment securities Retained interests portfolio (see Note 5). Investment grade $ 17 $ 483 $ 1,573 $ 3 Non-investment grade The Firm’s maximum exposure to loss is dependent on the (fair value) 4 212 — 210 nature of the Firm’s variable interest in the VIE and is limited Total $ 21 $ 695 $ 1,573 $ 213 to: Interests purchased in the secondary market (fair value) Investment grade $ 7 $ 91 $ 102 $ — • notional amounts of certain liquidity facilities; Non-investment grade 28 71 — — • other credit support; Total $ 35 $ 162 $ 102 $ — • total return swaps; Derivative assets (fair value) $ — $ — $ — $ 216 • written put options; and Derivative liabilities (fair value) — — — 178
• fair value of certain other derivatives and investments the RML—Residential mortgage loans Firm has made in the VIE. CML—Commercial mortgage loans 1. Amounts include CLO transactions managed by unrelated third parties. 2. Amounts include assets transferred by unrelated transferors. The Firm’s maximum exposure to loss in the previous tables does not include the offsetting benefit of hedges or any Fair Value at March 31, 2019 reductions associated with the amount of collateral held as $ in millions Level 2 Level 3 Total part of a transaction with the VIE or any party to the VIE Retained interests directly against a specific exposure to loss. Investment grade $ 356 $ 24 $ 380 Non-investment grade 7 94 101 Liabilities issued by VIEs generally are non-recourse to the Total $ 363 $ 118 $ 481 Firm. Interests purchased in the secondary market Investment grade $ 320 $ 7 $ 327 Mortgage- and Asset-Backed Securitization Assets Non-investment grade 101 13 114 Total $ 421 $ 20 $ 441 At March 31, 2019 At December 31, 2018 Debt and Debt and Derivative assets $ 47 $ 82 $ 129 Equity Equity Derivative liabilities 104 2 106 $ in millions UPB Interests UPB Interests Residential mortgages $ 6,590 $ 628 $ 6,954 $ 745 Fair Value at December 31,2018 Commercial mortgages 41,021 1,754 42,974 1,237 U.S. agency collateralized $ in millions Level 2 Level 3 Total mortgage obligations 15,072 2,640 14,969 3,443 Retained interests Other consumer or Investment grade $ 1,580 $ 13 $ 1,593 commercial loans 13,287 3,058 6,390 2,809 Non-investment grade 174 252 426 Total $ 75,970 $ 8,080 $ 71,287 $ 8,234 Total $ 1,754 $ 265 $ 2,019 Interests purchased in the secondary market Transfers of Assets with Continuing Involvement Investment grade $ 193 $ 7 $ 200 Non-investment grade 83 16 99 At March 31, 2019 Total $ 276 $ 23 $ 299 U.S. Agency CLN and $ in millions RML CML CMO Other1 Derivative assets $ 121 $ 95 $ 216 SPE assets (UPB)2 $ 13,937 $ 73,268 $ 22,907 $ 15,068 Derivative liabilities 175 3 178 Retained interests Investment grade $ 17 $ 525 $ 349 $ 2 The transfers of assets with continuing involvement tables Non-investment grade 4 166 — 90 include transactions with SPEs in which the Firm, acting as Total $ 21 $ 691 $ 349 $ 92 principal, transferred financial assets with continuing Interests purchased in the secondary market (fair value) Investment grade $ 9 $ 72 $ 246 $ — involvement and received sales treatment. Non-investment grade 14 100 — — Transferred assets are carried at fair value prior to Total $ 23 $ 172 $ 246 $ — Derivative assets (fair value) $—$—$—$129 securitization, and any changes in fair value are recognized in Derivative liabilities (fair value) — — — 106 the income statements. The Firm may act as underwriter of the beneficial interests issued by these securitization vehicles,
March 2019 Form 10-Q 64
− 455 − Notes to Consolidated Financial Statements (Unaudited) for which Investment banking revenues are recognized. The The Firm is required to maintain minimum risk-based and Firm may retain interests in the securitized financial assets as leverage-based capital ratios under regulatory capital one or more tranches of the securitization. These retained requirements. A summary of the calculations of regulatory interests are generally carried at fair value in the balance capital, RWA and transition provisions follows. sheets with changes in fair value recognized in the income statements. Minimum risk-based capital ratio requirements apply to Common Equity Tier 1 capital, Tier 1 capital and Total capital Proceeds from New Securitization Transactions and Sales of (which includes Tier 2 capital). Certain adjustments to and Loans deductions from capital are required for purposes of Three Months Ended determining these ratios, such as goodwill, intangible assets, March 31, certain deferred tax assets, other amounts in AOCI and $ in millions 2019 2018 investments in the capital instruments of unconsolidated New transactions1 $ 4,733 $ 6,134 financial institutions. Retained interests 2,887 481
1, 2 Sales of corporate loans to CLO SPEs — 94 In addition to the minimum risk-based capital ratio
1. Net gains on new transactions and sales of corporate loans to CLO entities at the requirements, the Firm is subject to the following buffers in time of the sale were not material for all periods presented. 2019: 2. Sponsored by non-affiliates. • A greater than 2.5% Common Equity Tier 1 capital The Firm has provided, or otherwise agreed to be responsible conservation buffer; for, representations and warranties regarding certain assets transferred in securitization transactions sponsored by the • The Common Equity Tier 1 G-SIB capital surcharge, Firm (see Note 11). currently at 3%; and
Assets Sold with Retained Exposure • Up to a 2.5% Common Equity Tier 1 CCyB, currently set At At by U.S. banking agencies at zero. March 31, December 31, $ in millions 2019 2018 In 2018, each of these buffers was 75% of the fully phased-in 1 Gross cash proceeds from sale of assets $ 27,444 $ 27,121 2019 requirement noted above. Failure to maintain the buffers Fair value Assets sold $ 27,560 $ 26,524 would result in restrictions on the Firm’s ability to make Derivative assets recognized capital distributions, including the payment of dividends and in the balance sheets 264 164 the repurchase of stock, and to pay discretionary bonuses to Derivative liabilities recognized executive officers. in the balance sheets 73 763
1. The carrying value of assets derecognized at the time of sale approximates gross The Firm’s Regulatory Capital and Capital Ratios cash proceeds. At March 31, 2019 The Firm enters into transactions in which it sells securities, Required $ in millions Ratio1 Amount Ratio primarily equities and contemporaneously enters into bilateral Risk-based capital OTC derivatives with the purchasers of the securities, through Common Equity Tier 1 capital 10.0% $ 63,344 16.7% which it retains exposure to the sold securities. Tier 1 capital 11.5% 71,910 19.0% For a discussion of the Firm’s VIEs, the determination and Total capital 13.5% 81,570 21.6% structure of VIEs and securitization activities, see Note 13 to Total RWA 378,420 the financial statements in the 2018 Form 10-K. Leverage-based capital Tier 1 leverage 4.0% $ 71,910 8.4% Adjusted average assets2 855,192 13. Regulatory Requirements SLR 5.0% 71,910 6.5% Supplementary leverage exposure3 1,104,264 Regulatory Capital Framework and Requirements
For a discussion of the Firm’s regulatory capital framework, see Note 14 to the financial statements in the 2018 Form 10-K.
65 March 2019 Form 10-Q
− 456 − Notes to Consolidated Financial Statements (Unaudited)
At December 31, 2018 At March 31, 2019 and December 31, 2018, the U.S. Bank Required $ in millions Ratio1 Amount Ratio Subsidiaries’ risk-based capital ratios are based on the Risk-based capital Standardized Approach rules, and in each period, the ratios Common Equity Tier 1 capital 8.6% $ 62,086 16.9% exceeded well-capitalized requirements. Tier 1 capital 10.1% 70,619 19.2% Total capital 12.1% 80,052 21.8% MSBNA’s Regulatory Capital Total RWA 367,309 At March 31, 2019 Leverage-based capital Required Tier 1 leverage 4.0% $ 70,619 8.4% $ in millions Ratio1 Amount Ratio Adjusted average assets2 843,074 Risk-based capital Common Equity Tier 1 capital 6.5% $ 16,285 19.9% SLR 5.0% 70,619 6.5% Supplementary leverage exposure3 1,092,672 Tier 1 capital 8.0% 16,285 19.9% Total capital 10.0% 16,569 20.2% 1. Required ratios are inclusive of any buffers applicable as of the date presented. For Leverage-based capital 2018, the minimum required regulatory capital ratios for risk-based capital are under Tier 1 leverage 5.0% $ 16,285 11.1% the transitional rules. 2. Adjusted average assets represents the denominator of the Tier 1 leverage ratio and SLR 6.0% 16,285 8.7% is composed of the average daily balance of consolidated on-balance sheet assets under U.S. GAAP during the quarters ended March 31, 2019 and December 31, At December 31, 2018 2018, adjusted for disallowed goodwill, intangible assets, certain deferred tax Required assets, certain investments in the capital instruments of unconsolidated financial $ in millions Ratio1 Amount Ratio institutions and other adjustments. 3. Supplementary leverage exposure is the sum of Adjusted average assets used in Risk-based capital the Tier 1 leverage ratio and other adjustments, primarily (i) potential future Common Equity Tier 1 capital 6.5% $ 15,221 19.5% exposure for derivative exposures, gross-up for cash collateral netting where Tier 1 capital 8.0% 15,221 19.5% qualifying criteria are not met, and the effective notional principal amount of sold Total capital 10.0% 15,484 19.8% credit protection offset by qualifying purchased credit protection; (ii) the counterparty credit risk for repo-style transactions; and (iii) the credit equivalent amount for Leverage-based capital off-balance sheet exposures. Tier 1 leverage 5.0% $ 15,221 10.5% SLR 6.0% 15,221 8.2% At March 31, 2019 and December 31, 2018, the Firm’ risk- MSPBNA’s Regulatory Capital based capital ratios are based on the Standardized Approach rules. At March 31, 2019 Required $ in millions Ratio1 Amount Ratio U.S. Bank Subsidiaries’ Regulatory Capital and Capital Risk-based capital Ratios Common Equity Tier 1 capital 6.5% $ 7,545 26.4% Tier 1 capital 8.0% 7,545 26.4% The OCC establishes capital requirements for the Firm’s U.S. Total capital 10.0% 7,590 26.6% Bank Subsidiaries and evaluates their compliance with such capital Leverage-based capital requirements. Regulatory capital requirements for the U.S. Bank Tier 1 leverage 5.0% $ 7,545 10.1% Subsidiaries are calculated in a similar manner to the Firm’s SLR 6.0% 7,545 9.7% regulatory capital requirements, although G-SIB capital surcharge requirements do not apply to the U.S. Bank Subsidiaries. At December 31, 2018 Required 1 The OCC’s regulatory capital framework includes Prompt $ in millions Ratio Amount Ratio Risk-based capital Corrective Action (“PCA”) standards, including “well- Common Equity Tier 1 capital 6.5% $ 7,183 25.2% capitalized” PCA standards that are based on specified Tier 1 capital 8.0% 7,183 25.2% regulatory capital ratio minimums. For the Firm to remain an Total capital 10.0% 7,229 25.4% FHC, the U.S. Bank Subsidiaries must remain well-capitalized Leverage-based capital Tier 1 leverage 5.0% $ 7,183 10.0% in accordance with the OCC’s PCA standards. In addition, SLR 6.0% 7,183 9.6% failure by the U.S. Bank Subsidiaries to meet minimum capital requirements may result in certain mandatory and 1. Ratios that are required in order to be considered well-capitalized for U.S. regulatory discretionary actions by regulators that, if undertaken, could purposes. have a direct material effect on the U.S. Bank Subsidiaries’ and the Firm’s financial statements.
March 2019 Form 10-Q 66
− 457 − Notes to Consolidated Financial Statements (Unaudited)
U.S. Broker-Dealer Regulatory Capital Requirements 14. Total Equity MS&Co. Regulatory Capital Share Repurchases $ in millions At March 31, 2019 At December 31, 2018 Three Months Ended Net capital $ 13,925 $ 13,797 March 31, Excess net capital 11,403 11,333 $ in millions 2019 2018 Repurchases of common stock under our MS&Co. is a registered U.S. broker-dealer and registered Share Repurchase Program $ 1,180 $ 1,250 futures commission merchant and, accordingly, is subject to the minimum net capital requirements of the SEC and the The Firm’s 2018 Capital Plan (“Capital Plan”) includes the CFTC. MS&Co. has consistently operated with capital in share repurchase of up to $4.7 billion of outstanding common excess of its regulatory capital requirements. stock for the period beginning July 1, 2018 through June 30, 2019. Additionally, the Capital Plan includes quarterly As an Alternative Net Capital broker-dealer, and in common stock dividends of up to $0.30 per share. accordance with the market and credit risk standards of Appendix E of SEC Rule 15c3-1, MS&Co. is subject to A portion of common stock repurchases in the current quarter minimum net capital and tentative net capital requirements. In was conducted under a sales plan with MUFG, whereby MUFG addition, MS&Co. must notify the SEC if its tentative net sold shares of the Firm’s common stock to the Firm, as part of capital falls below certain levels. At March 31, 2019 and the Firm’s Share Repurchase Program. The sales plan is only December 31, 2018, MS&Co. has exceeded its net capital intended to maintain MUFG’s ownership percentage below requirement and has tentative net capital in excess of the 24.9% in order to comply with MUFG’s passivity commitments minimum and notification requirements. to the Board of Governors of the Federal Reserve System and has no impact on the strategic alliance between MUFG and the Firm, MSSB LLC Regulatory Capital including the joint ventures in Japan.
$ in millions At March 31, 2019 At December 31, 2018 Preferred Stock Outstanding Net capital $ 3,041 $ 3,455 Excess net capital 2,901 3,313 Shares Outstanding Carrying Value At Liquidation At At MSSB LLC is a registered U.S. broker-dealer and introducing $ in millions, except March 31, Preference March 31, December 31, broker for the futures business and, accordingly, is subject to per share data 2019 per Share 2019 2018 Series the minimum net capital requirements of the SEC. MSSB A 44,000 $ 25,000 $ 1,100 $ 1,100 LLC has consistently operated with capital in excess of its C1 519,882 1,000 408 408 regulatory capital requirements. E 34,500 25,000 862 862 F 34,000 25,000 850 850 G 20,000 25,000 500 500 Other Regulated Subsidiaries H 52,000 25,000 1,300 1,300 I 40,000 25,000 1,000 1,000 MSIP, a London-based broker-dealer subsidiary, is subject to J 60,000 25,000 1,500 1,500 the capital requirements of the PRA, and MSMS, a Tokyo- K 40,000 25,000 1,000 1,000 based broker-dealer subsidiary, is subject to the capital Total $ 8,520 $ 8,520 requirements of the Financial Services Agency. MSIP and 1. Series C is composed of the issuance of 1,160,791 shares of Series C Preferred MSMS have consistently operated with capital in excess of Stock to MUFG for an aggregate purchase price of $911 million, less the redemption their respective regulatory capital requirements. of 640,909 shares of Series C Preferred Stock of $503 million, which were converted to common shares of approximately $705 million. Certain other U.S. and non-U.S. subsidiaries of the Firm are subject to various securities, commodities and banking For a description of Series A through Series K preferred stock regulations, and capital adequacy requirements promulgated by issuances, see Note 15 to the financial statements in the 2018 the regulatory and exchange authorities of the countries in which Form 10-K. The Firm is authorized to issue 30 million shares they operate. These subsidiaries have consistently operated with of preferred stock. The preferred stock has a preference over capital in excess of their local capital adequacy requirements. the common stock upon liquidation. The Firm’s preferred stock qualifies as Tier 1 capital in accordance with regulatory capital requirements (see Note 13).
67 March 2019 Form 10-Q
− 458 − Notes to Consolidated Financial Statements (Unaudited)
Preferred Stock Dividends Three Months Ended March 31, 20181 Pre-tax Income After-tax Non- Three Months Ended Three Months Ended Gain Tax Benefit Gain controlling March 31, 2019 March 31, 2018 $ in millions (Loss) (Provision) (Loss) Interests Net $ in millions, except per share data Per Share1 Total Per Share1 Total Foreign currency translation adjustments Series OCI activity $ 78 $ 39 $ 117 $ 57 $ 60 A $ 250 $ 11 $ 250 $ 11 C 25 13 25 13 Reclassified to earnings — — — — — E 445 15 445 15 Net OCI $ 78 $ 39 $ 117 $ 57 $ 60 F 430 15 430 15 Change in net unrealized gains (losses) on AFS securities G 414 8 414 8 I 398 16 398 16 OCI activity $ (535) $ 125 $ (410) $ — $ (410) K 366 15 366 15 Reclassified to earnings — — — — — Total $ 93 $93 Net OCI $ (535) $ 125 $ (410) $ — $ (410)
1. In addition to the dividends on the series of preferred stock included above, which are Pension, postretirement and other payable quarterly, Series H and J are payable semiannually until July 15, 2019 and July 15, 2020, respectively, and quarterly thereafter. OCI activity $ — $ — $ — $ — $ — Reclassified to earnings 6 (1) 5 — 5 Accumulated Other Comprehensive Income (Loss)1 Net OCI $6$(1)$5$—$5
Foreign Change in net DVA Currency Pension, Translation AFS Postretirement $ in millions Adjustments Securities and Other DVA Total OCI activity $ 580 $ (140) $ 440 $ 15 $ 425 December 31, 2018 $ (889) $ (930) $ (578) $ 105 $ (2,292) Reclassified to earnings 15 (4) 11 — 11 OCI during the period (12) 429 1 (599) (181) Net OCI $ 595 $ (144) $ 451 $ 15 $ 436 March 31, 2019 $ (901) $ (501) $ (577) $ (494) $ (2,473) 1. Exclusive of cumulative adjustments related to the adoption of certain accounting updates. December 31, 2017 $ (767) $ (547) $ (591) $ (1,155) $ (3,060) Refer to the table below and Note 2 for further information. Cumulative adjustment for accounting Cumulative Adjustments to Retained Earnings Related to changes2 (8) (111) (124) (194) (437) Adoption of Accounting Updates OCI during the period 60 (410) 5 436 91 March 31, 2018 $ (715) $ (1,068) $ (710) $ (913) $ (3,406) Three Months Ended $ in millions March 31, 2019 1. Amounts are net of tax and exclude noncontrolling interests. Leases $63 2. The cumulative adjustment for accounting changes is primarily the effect of the adoption of the accounting update Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This adjustment was recorded as of January 1, 2018 to reclassify Three Months Ended certain income tax effects related to enactment of the Tax Act from AOCI to Retained $ in millions March 31, 2018 earnings, primarily related to the remeasurement of deferred tax assets and liabilities resulting Revenues from contracts with customers1 (32) from the reduction in the corporate income tax rate to 21%. See Note 2 for further information. Derivatives and hedging—targeted improvements Components of Period Changes in OCI to accounting for hedging activities1 (99) Reclassification of certain tax effects from AOCI1 $ 443 Three Months Ended 2 March 31, 20191 Other (6) Pre-tax Income After-tax Non- Total $ 306 Gain Tax Benefit Gain controlling $ in millions (Loss) (Provision) (Loss) Interests Net Foreign currency translation adjustments 1. See Note 2 to the 2018 Form 10-K for further information. OCI activity $ (4) $ (18) $ (22) $ (10) $ (12) 2. Other includes the adoption of accounting updates related to Recognition and Measurement of Financial Assets and Financial Liabilities (other than the provision around Reclassified to earnings —— —— — presenting unrealized DVA in OCI, which the Firm early adopted in 2016) and Net OCI $ (4) $ (18) $ (22) $ (10) $ (12) Derecognition of Nonfinancial Assets. The impact of these adoptions on Retained earnings was not significant. Change in net unrealized gains (losses) on AFS securities OCI activity $ 570 $ (133) $ 437 $ — $ 437 Reclassified to earnings (10) 2 (8) — (8) Net OCI $ 560 $ (131) $ 429 $ — $ 429
Pension, postretirement and other OCI activity $ — $ (1) $ (1) $ — $ (1) Reclassified to earnings 3 (1) 2 — 2 Net OCI $ 3 $ (2) $ 1 $ — $ 1
Change in net DVA OCI activity $ (824) $ 201 $ (623) $ (21) $ (602) Reclassified to earnings 4 (1) 3 — 3 Net OCI $ (820) $ 200 $ (620) $ (21) $ (599)
March 2019 Form 10-Q 68
− 459 − Notes to Consolidated Financial Statements (Unaudited)
15. Earnings per Common Share 17. Income Taxes
Three Months Ended The Firm is under continuous examination by the IRS and March 31, other tax authorities in certain countries, such as Japan and the in millions, except for per share data 2019 2018 U.K., and in states and localities in which it has significant Earnings applicable to Morgan business operations, such as New York. The Firm has Stanley common shareholders $ 2,336 $ 2,575 established a liability for unrecognized tax benefits, and Basic EPS associated interest, if applicable (“tax liabilities”), that it Weighted average common shares outstanding 1,658 1,740 believes is adequate in relation to the potential for additional Earnings per basic common share $ 1.41 $ 1.48 assessments. Once established, the Firm adjusts such tax liabilities only when new information is available or when an Diluted EPS Weighted average common shares outstanding 1,658 1,740 event occurs necessitating a change. Effect of dilutive RSUs and PSUs 19 31 Weighted average common The Firm believes that the resolution of the above tax shares outstanding and examinations will not have a material effect on the annual common stock equivalents 1,677 1,771 financial statements, although a resolution could have a Earnings per diluted common share $ 1.39 $ 1.45 material impact in the income statements and on the effective Weighted average antidilutive RSUs (excluded from the computation of diluted EPS) 6 1 tax rate for any period in which such resolution occurs.
See Note 11 regarding the Dutch Tax Authority’s challenge, 16. Interest Income and Interest Expense in the District Court in Amsterdam (matters styled Case number 15/3637 and Case number 15/4353), of the Firm’s Three Months Ended entitlement to certain withholding tax credits which may March 31, impact the balance of unrecognized tax benefits. $ in millions 2019 2018 Interest income It is reasonably possible that significant changes in the Investment securities $ 475 $ 424 balance of unrecognized tax benefits occur within the next 12 Loans 1,195 938 months. At this time, however, it is not possible to reasonably Securities purchased under agreements to estimate the expected change to the total amount of resell and Securities borrowed1 947 215 unrecognized tax benefits and the impact on the Firm’s Trading assets, net of Trading liabilities 713 540 effective tax rate over the next 12 months. Customer receivables and Other2 960 743 Total interest income $ 4,290 $ 2,860 The Firm’s effective tax rate for the current quarter included recurring-type discrete tax benefits associated with employee Interest expense share-based payments of $107 million. The Firm’s effective Deposits $ 462 $ 159 tax rate for the current quarter included an intermittent net Borrowings 1,380 1,138 discrete tax benefit of $101 million primarily associated with Securities sold under agreements to the remeasurement of reserves and related interest due to new repurchase and Securities loaned3 600 402 information with regard to multi-jurisdiction tax Customer payables and Other4 834 186 examinations. Total interest expense $ 3,276 $ 1,885 Net interest $ 1,014 $ 975
1. Includes fees paid on Securities borrowed. 2. Includes interest from Customer receivables and Cash and cash equivalents. 3. Includes fees received on Securities loaned. 4. Includes fees received from prime brokerage customers for stock loan transactions entered into to cover customers’ short positions.
Interest income and Interest expense are classified in the income statements based on the nature of the instrument and related market conventions. When included as a component of the instrument’s fair value, interest is included within Trading revenues or Investments revenues. Otherwise, it is included within Interest income or Interest expense.
69 March 2019 Form 10-Q
− 460 − Notes to Consolidated Financial Statements (Unaudited)
18. Segment, Geographic and Revenue Information Segment Information Selected Financial Information by Business Segment
Three Months Ended March 31, 2019 Three Months Ended March 31, 2018 $ in millions IS WM IM I/E Total $ in millions IS WM IM I/E Total Investment banking1, 2 $ 1,151 $ 109 $ — $ (18) $ 1,242 Investment banking1, 2 $ 1,513 $ 140 $ — $ (19) $ 1,634 Trading 3,130 302 (3) 12 3,441 Trading 3,643 109 5 13 3,770 Investments 81 1 191 — 273 Investments 49 — 77 — 126 Commissions and fees1 621 406 — (61) 966 Commissions and fees1 744 498 — (69) 1,173 Asset management1 107 2,361 617 (36) 3,049 Asset management1 110 2,495 626 (39) 3,192 Other 222 80 3 (4) 301 Other 136 63 10 (2) 207 Total non-interest Total non-interest revenues3, 4 5,312 3,259 808 (107) 9,272 revenues3, 4 6,195 3,305 718 (116) 10,102 Interest income 3,056 1,413 4 (183) 4,290 Interest income 1,804 1,280 1 (225) 2,860 Interest expense 3,172 283 8 (187) 3,276 Interest expense 1,899 211 1 (226) 1,885 Net interest (116) 1,130 (4) 4 1,014 Net interest (95) 1,069 — 1 975 Net revenues $ 5,196 $ 4,389 $ 804 $ (103) $ 10,286 Net revenues $ 6,100 $ 4,374 $ 718 $ (115) $ 11,077 Income from continuing Income from continuing operations before operations before income taxes $ 1,595 $ 1,188 $ 174 $ (2) $ 2,955 income taxes $ 2,112 $ 1,160 $ 148 $ — $ 3,420 Provision for income taxes 190 264 33 — 487 Provision for income taxes 449 246 19 — 714 Income from continuing Income from continuing operations 1,405 924 141 (2) 2,468 operations 1,663 914 129 — 2,706 Income (loss) from Income (loss) from discontinued operations, discontinued operations, net of income taxes ————— net of income taxes (2) — — — (2) Net income 1,405 924 141 (2) 2,468 Net income 1,661 914 129 — 2,704 Net income applicable to Net income applicable to noncontrolling interests 34 — 5 — 39 noncontrolling interests 34 — 2 — 36 Net income applicable to Net income applicable to Morgan Stanley $ 1,371 $ 924 $ 136 $ (2) $ 2,429 Morgan Stanley $ 1,627 $ 914 $ 127 $ — $ 2,668
I/E–Intersegment Eliminations 1. Approximately 85% of Investment banking revenues and substantially all of Commissions and fees and Asset management revenues in the current quarter and prior year quarter were accounted for under the Revenues from Contracts with Customers accounting update. 2. Current quarter Institutional Securities Investment banking revenues are composed of $406 million of Advisory and $745 million of Underwriting revenues. Prior year quarter Institutional Securities Investment banking revenues are composed of $574 million of Advisory and $939 million of Underwriting revenues. 3. The Firm enters into certain contracts which contain a current obligation to perform services in the future. Excluding contracts where billing is commensurate with the value of the services performed at each stage of the contract, contracts with variable consideration that is subject to reversal, and contracts with less than one year duration, we expect to record the following approximate revenues in the future: $105 million in the remainder of 2019 and $105 million in 2020; between $40 million and $70 million per year in 2021 through 2025; and $10 million per year thereafter through 2035. These revenues are primarily related to certain commodities contracts with customers. 4. Includes $671 million and $902 million in revenue recognized in the current quarter and prior year quarter, respectively, where some or all services were performed in prior periods. This amount is primarily composed of investment banking advisory fees and distribution fees.
For a discussion about the Firm’s business segments, see Note 21 to the financial statements in the 2018 Form 10-K.
March 2019 Form 10-Q 70
− 461 − Notes to Consolidated Financial Statements (Unaudited)
Total Assets by Business Segment For a discussion about the Firm’s geographic net revenues, At At see Note 21 to the financial statements in the 2018 Form March 31, December 31, 10-K. $ in millions 2019 2018 Institutional Securities $ 675,770 $ 646,427 Revenue Information Wealth Management 194,897 202,392 Investment Management 5,297 4,712 Trading Revenues by Product Type Total1 $ 875,964 $ 853,531 Three Months Ended March 31, 1. Parent assets have been fully allocated to the business segments. $ in millions 2019 2018 Interest rate $ 785 $ 871 Additional Segment Information—Investment Management Foreign exchange 241 261 Net Unrealized Carried Interest Equity security and index1 1,451 1,877 Commodity and other 422 435 At At March 31, December 31, Credit 542 326 $ in millions 2019 2018 Total $ 3,441 $ 3,770 Net cumulative unrealized carried interest at risk of reversing $ 469 $ 434 1. Dividend income is included within equity security and index contracts.
The Firm’s portion of net cumulative unrealized carried interest The previous table summarizes gains and losses included in (for which the Firm is not obligated to pay compensation) are at Trading revenues in the income statements. These activities risk of reversing if the fund performance falls below the stated include revenues related to derivative and non-derivative investment management agreement benchmarks. See Note 11 financial instruments. The Firm generally utilizes financial for information regarding general partner guarantees, which instruments across a variety of product types in connection include potential obligations to return performance-based fees with its market-making and related risk management in the form of carried interest previously received. strategies. The trading revenues presented in the table are not representative of the manner in which the Firm manages its Reduction of Fees due to Fee Waivers business activities and are prepared in a manner similar to the presentation of trading revenues for regulatory reporting Three Months Ended March 31, purposes. $ in millions 2019 2018 Fee waivers $11 $18Receivables related to Revenues from Contracts with Customers
At At The Firm waives a portion of its fees in the Investment March 31, December 31, Management business segment from certain registered money $ in millions 2019 2018 market funds that comply with the requirements of Rule 2a-7 Customer and other receivables $ 2,206 $ 2,308 of the Investment Company Act of 1940. Receivables from contracts with customers, which are Separately, the Firm’s employees, including its senior included within Customer and other receivables in the balance officers, may participate on the same terms and conditions as sheets, arise when the Firm has both recorded revenues and other investors in certain funds that the Firm sponsors has the right per the contract to bill the customer. primarily for client investment, and the Firm may waive or lower applicable fees and charges for its employees. 19. Subsequent Events Geographic Information The Firm has evaluated subsequent events for adjustment to Net Revenues by Region or disclosure in the financial statements through the date of Three Months Ended March 31, this report and has not identified any recordable or disclosable $ in millions 2019 2018 events not otherwise reported in these financial statements or the notes thereto. Americas $ 7,321 $ 8,018 EMEA 1,702 1,708 Asia 1,263 1,351 Total $ 10,286 $ 11,077
71 March 2019 Form 10-Q
− 462 − Financial Data Supplement (Unaudited)
Average Balances and Interest Rates and Net Interest Income
Three Months Ended March 31, 2019 2018 Annualized Average Annualized Average Average Daily Average $ in millions Daily Balance Interest Rate Balance Interest Rate Interest earning assets Investment securities1 $ 94,906 $ 475 2.0 % $ 80,532 $ 424 2.1 % Loans1 116,698 1,195 4.2 104,407 938 3.6 Securities purchased under agreements to resell and Securities borrowed2: U.S. 141,806 934 2.7 124,172 309 1.0 Non-U.S. 77,256 13 0.1 87,581 (94) (0.4) Trading assets, net of Trading liabilities3: U.S. 74,152 631 3.5 53,488 487 3.7 Non-U.S. 11,861 82 2.8 5,059 53 4.2 Customer receivables and Other4: U.S. 63,649 697 4.4 74,118 542 3.0 Non-U.S. 55,142 263 1.9 50,080 201 1.6 Total $ 635,470 $ 4,290 2.7 % $ 579,437 $ 2,860 2.0 % Interest bearing liabilities Deposits1 $ 181,017 $ 462 1.0 % $ 159,948 $ 159 0.4 % Borrowings1, 5 189,181 1,380 3.0 194,558 1,138 2.4 Securities sold under agreements to repurchase and Securities loaned6: U.S. 26,615 450 6.9 25,009 286 4.6 Non-U.S. 32,350 150 1.9 40,675 116 1.2 Customer payables and Other7: U.S. 117,932 554 1.9 121,438 49 0.2 Non-U.S. 65,498 280 1.7 69,646 137 0.8 Total $ 612,593 $ 3,276 2.2 % $ 611,274 $ 1,885 1.3 % Net interest income and net interest rate spread $ 1,014 0.5 % $ 975 0.7 %
1. Amounts include primarily U.S. balances. 2. Includes fees paid on Securities borrowed. 3. Excludes non-interest earning assets and non-interest bearing liabilities, such as equity securities. 4. Includes interest from Customer receivables and Cash and cash equivalents. Prior period amounts have been revised to conform to the current presentation. 5. Includes structured notes, whose interest expense is considered part of its value and therefore is recorded within Trading revenues. 6. Includes fees received on Securities loaned. The annualized average rate was calculated using (a) interest expense incurred on all securities sold under agreements to repurchase and securities loaned transactions, whether or not such transactions were reported in the balance sheets and (b) net average on-balance sheet balances, which exclude certain securities-for-securities transactions. 7. Includes fees received from prime brokerage customers for stock loan transactions entered into to cover customers’ short positions.
March 2019 Form 10-Q 72
− 463 − PARTIES
Issuer Guarantor
Morgan Stanley Asia Products Limited Morgan Stanley c/o Maples Corporate Services Limited PO Box 309 Registered Office Ugland House The Corporation Trust Company Grand Cayman Corporation Trust Center KY1-1104 1209 Orange Street Cayman Islands Wilmington DE 19801United States of America
Principal Executive Office 1585 Broadway New York NY 10036 United States of America
Manager
Morgan Stanley Asia Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
Liquidity Provider
Morgan Stanley Hong Kong Securities Limited Level 46 International Commerce Centre 1 Austin Road West, Kowloon Hong Kong
Legal Advisers to the Issuer and the Guarantor
King & Wood Mallesons 13/F, Gloucester Tower The Landmark 15 Queen’s Road Central Hong Kong
Issuer’s Auditor
Deloitte LLP 1 New Street Square London EC4A 3HQ United Kingdom
Guarantor’s Auditor
Deloitte & Touche LLP Independent Registered Public Accounting Firm 30 Rockefeller Plaza New York New York 10112 United States of America Printed by ProTop Financial Press Limited 190128-01