Legal Risk ISDA/PRMIA Risk Management Seminar

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Legal RiskISDA/PRMIA Risk Management Seminar

• Dermot Turing

London-2/1430864/01
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Legal Risk Latest Developments

• Basel II
• With a footnote on business continuity
• Securities Certainty Giovannini

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The new Basel Framework

• Operational risk charge
• Definition of operational risk
• the risk of loss resulting from inadequate or
  failed internal processes, people, and systems or
  from external events
• includes legal risk but excludes strategic and
  reputational risk
• but ? presumably not credit or market risk

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Computing the charge

• Basic Indicator Approach
• 15 average gross income over 3 years
• Standardised Approach
• S percentage average gross income over 3
  years, summed over each of 8 business lines
• regulatory requirements apply
• Advanced Management Approach
• bespoke model, subject to qualifying criteria
• regulatory requirements apply

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The AMA in practice

• Using PL
• Relying on historical loss data
• reliability
• problems you have cured
• Getting credit for safe operational risk
  management
• business environment and control factors can be
  taken into account if relevant, quantifiable, and
  sensitive to change, and can be audited/validated
• Insurance for up to 20 of the capital charge

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The main operational risk areas

• Business continuity
• Outsourcing
• Employment practices
• Collateral
• collateral management failures count as credit
  risk for capital but must be captured in
  operational risk statistics
• Mergers
• IT resources
• and legal risk?

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Legal Risk under Basel II

• What is legal risk?
• The risk that one is unable to enforce rights
  against, or rely on obligations incurred by, a
  counterparty in the event of a default or a
  dispute.
• The risk that contracts are not legally
  enforceable or documented correctly (an old
  Basel/IOSCO definition)
• Financial Markets Law Committee
• IBA Legal Risk Working Party

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Reducing legal risk for Basel

• Difficulties with documentation and rights
• not just documentation ownership
  non-contractual liabilities
• no agreement no documentation counterparty
  misled terms do not work in circumstances
  supervening events unreliable legal environment
  etc
• Historical loss data
• Making risk reduction more quantitative
• investigating what legal sign-off means
• legal opinions from external counsel
• Integration of legal with the business line

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Business Continuity

• What is the meaning of the counterpartys failure
  to perform?
• A common framework for giving grace in times of
  disruption?
• should exchanges or regulators mandate a period
  of standstill?
• bank holidays
• force majeure clauses
• definition of business day

1430864
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Securities Account Certainty

• What the Collateral Directive does
• Abolishes formalities for taking and enforcing
  collateral
• Provides legal certainty for outright transfer
  collateral and netting
• What the Hague (PRIMA) Convention does
• Determines which legal system answers ownership
  questions about securities held with an
  intermediary
• What neither of them does
• Answers the ownership questions

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Ownership issues with securities

• Upper tier attachment
• For example, Italian investor holds a portfolio
  of bonds via a London account with a US
  custodian. Investor pledges the contents of his
  account to Bank. Investor goes bankrupt. Can his
  liquidator seize the Italian securities on the
  basis that the pledge was not perfected in Italy?
• Certification/Is it a security
• Effect of reconciliation mismatch between
  intermediaries
• Set-off between investor and issuer

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Giovannini proposals

• When securities are held with an intermediary,
  the accounts of the intermediary establish
  ownership of the securities

• Nature and extent of ownership rights
• Protection from insolvency of intermediary
• Debits and credits are definitive

• Priority of competing interests
• Shortfall protection