CONFIDENTIAL – NOT FOR FURTHER DISTRIBUTION

​Morgan Stanley
BGE University Presentation (Part 1) -
​Capital and MREL/TLAC
​Recovery and Resolution Planning
​Csaba Pálinkás / Abbas Abbaszade
​24 October 2023
PART 1

Introduction
What Does Treasury Do?

MORGAN STANLEY PRESENTATION CONFIDENTIAL 3

Treasury by the Numbers
Morgan Stanley as of 30th June 2023

Capital Liquidity Funding

~$68 Bn ~$311 Bn ~$248 Bn

Common Equity Tier 1 Consolidated Total Long Term Unsecured

(CET 1) Liquidity Resources Debt Issued by Treasury

Source: Morgan Stanley Fixed Income Presentation 2Q’23

MORGAN STANLEY PRESENTATION CONFIDENTIAL 4

What is capital and why is it needed?

​What is capital?
Assets Liabilities and Capital
• Capital appears alongside liabilities as a source of funding on Morgan (’Use of funds’) (’Sources of funds’)

Stanley’s balance sheet Liquid assets Large amounts of

debt with a thin
capital base...
• Capital can be considered as a bank’s ‘own funds’ - items such as its
ordinary share capital and retained earnings i.e. not money lent to the bank ’Safer’ loans
that has to be repaid Debt
Mix of retail
deposits and
​Why do we need capital? wholesale
funding ...combined with
high-risk loans...
• The key characteristic of capital is that it represents a bank’s ability to
absorb unexpected losses while it remains a ‘going concern’ ’Riskier’ loans

• If there is insufficient capital to absorb losses, the bank would be deemed

Capital
insolvent
Liquid assets ...means that if a
What counts as capital? large share of the
loans go bad and
cannot be repaid...

Shareholders’ Equity Hybrid Instruments Subordinated debt ’Safer’ loans

Debt
Mix of retail
deposits and
wholesale
funding ...then capital,
Equity Debt which absorbs
’Riskier’ loans losses, is depleted
and the bank’s
Common Equity Tier 1 Additional Tier 1 Tier 2 liabilities are
(CET1) (AT1) greater than its
assets. The bank is
insolvent.

Most loss absorbing Source: Bank of England Q3 2013 Quarterly Bulletin

Least loss absorbing
Most expensive Least expensive

MORGAN STANLEY PRESENTATION CONFIDENTIAL 5

Capital Management Overview

Capital Planning and Management

Management of Capital Stress Legal Entity Capital

Capital Position Testing Management

• The Capital Team coordinates across capital functions and relies on a variety of groups
including Regulatory Controllers, Financial Planning, Risk Management, Business Units,
Economists, and Treasury to successfully manage the capital position

‒ Capital is allocated to Business Units and supports business growth

‒ A significant process is undertaken with regards to planning capital returns to shareholders

‒ Capital Stress Testing is performed and reviewed by the regulator (ICAAP / CCAR).
Institution-specifc capital buffers are a result of these assessments.

MORGAN STANLEY PRESENTATION CONFIDENTIAL 6

PART 2

Regulatory Requirements
Regulatory Capital Ratios

• Basel III was introduced following the 2008 Global Financial Crisis to improve the banks’ ability to handle shocks from financial
stress and improved the deficiencies of previous regulation
• The Committees Guidelines are adopted in 27 jurisdictions with certain differences including the core locations where Morgan
Stanley runs business (US, EU, UK, Hong Kong). In Morgan Stanley capital is managed on Firm-level based on the US capital
rules, but also MS subsidiaries must be compliant with their relevant local regulations on a solo entity level
• In this presentation we focus on the EU-wide regulation, illustrated on the example of Morgan Stanley Europe Holding SE
(MSEHSE), which is a Germany-based broker-dealer and banking entity
• Under Basel III regime the following ratios are applicable to assess minimum capital requirements for European Union Banks:

Risk-based Capital Ratios:

Common
Common Tier 1 Capital Total Capital
Equity Tier 1
Equity Tier 1 Total
Capital Capital
Tier 1 Risk-Weighted Risk-Weighted Risk-Weighted
Assets Assets Assets

Leverage Ratio:

Tier 1 Capital
Leverage
Ratio Leverage
1) Total Assets adjusted for Tier 1 deductions +
Exposure(1)
Off B/S, Derivative and Secured Funding Exposures

MORGAN STANLEY PRESENTATION CONFIDENTIAL 8

Leverage vs Risk-Based Ratios
Leverage and risk-based capital requirements function in a complementary manner
Risk Weighted Ratios
(Total Capital, Tier 1 and CET1 %)
Benefits
 Ensures banks manage the amount risky
positions on the balance sheet
 Further regulation is being implemented to
improve transparency of calculations of risk
ratios
Costs
 With risk-based ratios, there is a lack of
transparency of regulatory and internal
calculations of risk
 May incentivise banks to expand through debt
financing rather than accumulate
equity capital
MORGAN STANLEY PRESENTATION
Leverage Ratio
Benefits
 LR ‘simplicity’ makes it easier for supervisors
and market participants to understand and
compare leverage across banks
 Greater robustness of capital requirements
against uncertainties and risks
Costs
 LR does not provide information about banks’
underlying risk profiles, which may incentivise
banks to take on riskier positions
CONFIDENTIAL 9
Capital Resources

Basel III Capital Calculation

Ordinary Share Capital
Share Premium
Retained Earnings + Preferred Shares = Balance Sheet Capital
Accumulated Other Comprehensive Income (“AOCI”) and other disclosed reserves
Qualifying Common Shares Issued by Non-Controlling Interest (“NCI”)

Common Shareholders’ Equity

– Regulatory Adjustments to CET1 Capital1

= Common Equity Tier 1 (“CET1”)

+ Perpetual Preferred Stock Required % of Total Capital

(excluding regulatory buffers)
+ Qualifying AT1 Capital Issued by NCI AT1
– Regulatory Adjustments to Tier 1 Capital AT1
18.75% Tier 2
25%
= Tier 1 Capital

+ Qualifying Subordinated Debt

+ Qualifying Tier 2 Capital Issued by NCI T2
CET1
– Regulatory Adjustments to Tier 2 Capital 56.25%

= Total Capital

1. Includes goodwill and other intangibles, defined benefit pension fund assets, prudential valuation adjustments and investments in the capital of financial institutions >10% CET1

MORGAN STANLEY PRESENTATION CONFIDENTIAL 10

Comparison of Capital Instruments
​Basel III criteria for the classification as regulatory capital

CET1 AT1 Tier 2

Shareholders’ Equity Hybrid Instruments Subordinated Debt

Accounting Equity Equity / Liability Liability

Above Tier 1 but junior to

Subordination Most Junior Senior only to Equity senior creditors and
depostis
> 5 yrs. Eligible amount
Maturity Perpetual Perpetual amortizes by 20% p.a. In
each of last 5 yrs

First Issuer Call > 5 yrs. Limited early calls with regulatory
Calls None
approval. No incentives to redeem or early repurchase

Discretionary within MDA Discretionary, non- Mandatory coupon payment,

Distributions restrictions, paid out of cumulative dividend / no capital acceleration
distributable items coupon allowed

Cost ROE Fixed coupon Floating coupon

Source: White & Case, own collection

MORGAN STANLEY PRESENTATION CONFIDENTIAL 11

 Components of the Capital Requirement
Basel Pillars
Pillar 1: Minimum Capital Requirements
Components of the Capital Requirement
(EU regulation) • Total capital ratio must be no lower than 8% of Risk Weighted
Assets at all times
General Op. Buffer
Pillar 2: Supervisory Review Process
(GOB)
Pillar 2 Requirement (P2R):
Pillar 2 Guidance
(P2G) Risks not adequately captured or not taken into account in Pillar1.
Bank-specific, determined by the regulator during the SREP.
Should be covered proportionally with CET1 / T1 / Total Capital
Combined Buffer R.
(CBR) Combined Buffer Requirement (CBR):
Designed to ensure that banks build up capital buffers outside
periods of stress which can be drawn down as losses are
incurred. To be met with 100% CET1 capital:
Pillar 2 Requirement
• Capital Conservation Buffer
(P2R)
Total SREP Capital Requirement (TSCR)

• Counter-Cyclical Buffer
Overall Capital Requirement (OCR)

8.0% • SII Buffer (G-SII / O-SII)

BIII Tier 2 • Systemic Risk Buffer
Pillar 1 Requirement (Basel III)

Internal Capital Target Level

(2.0%) Pillar 2 Guidance (P2G):

6.0% Bank-specific recommendation determined based on the results
BIII AT1
of regulatory stress test. Not legally binding
(1.5%)
4.5% General Operating Buffer (GOB):
Internal buffer determined by the management based on the
BIII CET1 capital policy, taking into account the uncertainties in earnings,
(4.5%) RWA and regulatory ratios

Pillar 3: Market Discipline

Source: ECB SREP Methodology Note, Own collection • Qualitative and quantitative disclosure requirements to allow market
participants to assess risk exposures and capital adequacy of the bank
and to enhance transparency and comparability between banks

MORGAN STANLEY PRESENTATION CONFIDENTIAL 12

PART 3

Capital Planning and Optimisation

Case Study – Capital Adequacy in MSEHSE Group

MSEHSE Group Capital Requirements Q2’23 MSEHSE Group Risk Exposure (RWA)
USD Bn
Credit Risk Settlement Risk
CVA Risk Market Risk 33.7
Operational R. 0.6
29.2 29.9
28.0 1.0 28.4
0.6
10.9 1.0 1.0
28.8% Total
21.9 8.7 8.8 7.3
28.9% 21.1 21.2 8.6
Tier2% 0.6 0.6 0.6
3.7
3.52% 5.8 6.6 3.5 0.1 3.3 4.4
6.3
Tier1 0.2 3.4
0.0
0.0
0.0

AT1%
25.3% 3.7 3.6 3.6
0.1 0.3 0.1
3.52% 18.3 16.8
16.2 15.7
CET1 10.9 10.9
14.9
10.4
21.8%

Q3'21 Q4'21 Q1'22 Q2'22 Q3'22 Q4'22 Q1'23 Q2'23

14.1%
Total min MSEHSE Group Capital Ratios (%)
P2R T2
14.1%
BIII T2 28.9%
Tier 1 min P2R AT1 CET1% 25.7% 25.3%
11.4% BIII AT1 21.81% 23.6% 23.9% 24.0%
22.8% 22.1%
21.4% 21.8%
20.6%
CET1 min CBR 18.9% 19.4%
18.5% 18.6%
18.0% 18.0% 17.3%
9.4% 16.1% 16.6%
15.5%
15.2% 14.5%
P2R CET1 12.6%

BIII CET1
CET1 ratio CET1 limit
Tier1 ratio Tier1 limit
Total ratio Total limit
Capital Requirements Capital Resources
Q3'21 Q4'21 Q1'22 Q2'22 Q3'22 Q4'22 Q1'23 Q2'23
Source: MSEHSE Pillar 3 report – Key Ratios Table

MORGAN STANLEY PRESENTATION CONFIDENTIAL 14

Case Study – how to set up and capitalize a fast-growing subsidiary

​Background information
• In this case study, we follow the lifecycle of a new banking entity from a capital planning perspective
• The entity is set up to provide service in a new EU-country – first asset side contains mostly cash and low-risk investments but
we expect that risk exposures will continue to grow generated by new lending origination
• The entity had rapid growth in the past and after some consolidation we expect dynamic growth to continue in future

Development of Capital Adequacy C

Initial CET1 infusion

A to cover future growth
Available capital resources
CET1 AT1 T2

Optimize Capital
B Structure
B Issuance of AT1 and Tier 2
Own Funds instruments
requirement
Tier 1
A requirement
Growth phase
CET 1
requirement C Organic: accumulating capital
from annual profits covers
business growth

Strategic: model and regulatory

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 changes, acquisitions – to be
'19 '20 '21 '22 '23 covered by capital infusion

Source: MSEHSE capital requirement and available regulatory capital – Pillar 3 and internal reports

MORGAN STANLEY PRESENTATION CONFIDENTIAL 15

Capital Usage | risk-return optimization
Capital is a loss absorbing source of funding, however it is scarce and costly

Return
INVEST IN
ORGANIC
GROWTH
Risk Resource

SHARE ACQUISITIONS
BUYBACKS AND MERGERS
Returns
Like any source of funding, capital requires a
How to use capital rate of return for shareholders
ROE target approved by the management

Risk
Risk drives returns, however exposes bank to
losses
Board approved risk appetite and limits
PAY-OFF
PAY DIVIDENDS
DEBTS Resources
Enough capital should be held to cover risks
and generate the required returns
Regulatory capital ratio targets

MORGAN STANLEY PRESENTATION CONFIDENTIAL 16

Capital Allocation: Return on Equity and Cost of Capital

• Capital Allocation is a key responsibility of the senior management, to decide where to spend money that the company has
earned to increase efficiency and maximize returns within the approved limits and risk appetite
• Return on Equity target is used in Banks to prioritize investment opportunities and determine the boundary of the
investments that the firm is willing to take based on their risk and return
• Following factors can be taken into account when setting up ROE targets:
• Top-down management / shareholder’s expectation
• Analysis of historical profitability of the bank / the banking sector
• If publicly listed, ROE can be derived from market prices with models (eg. CAPM). Note that investor expectation for
returns may not follow CAPM, and can be skewed in low-rate environments

Return on Common Equity (%) – MS and Peers

GS Goldman Sachs
Morgan Stanley Historical US Large Banks Peer Group CITI CitiGroup
15.32 (avg 2018-22) JPM JP Morgan
14.31 BOA Bank of America
13.49 WFC Wells Fargo
12.68
11.70 11.76 Competitor MS Morgan Stanley
11.10 10.68 Average
9.43
10.92% 8.82 8.55

2018 2019 2020 2021 2022 '23 H1 GS CITI JPM BOA WFC

Source: Capital IQ data

MORGAN STANLEY PRESENTATION CONFIDENTIAL 17

Case Study - Cost of Capital Calculation

Deal A Deal B Key notes

PD 2.0% 0.4% • Although Deal A pays higher coupon / interest, from
LGD 50% 50% risk-return perspective it is less desirable
Risk

EL (PDxLGD) 1.0% 0.2% • Based on the risk-return calculation Deal B will be

prioritized by the management
RW (IRB) 128% 74%
• Every business decision should include risk-return
Interest rate 6.0% 4.5% assessment to ensure the efficient use of capital,
Tenor 10Y 5Y incorporating all the material factors in the calculation
Funding cost 3.5% 3.0%
Other factors to consider
Profitability

Net Interest Margin 2.5% 1.5%

(Interest Rate - Funding Cost) • How the deal fits in approved risk appetite and limits?
Risk Cost (EL) 1.0% 0.2% • What is the impact on other risk types – eg. market
risk, operational risk, concentration risk?
Allocated costs 0.4% 0.3%
• Strategic linkages between different business and
Net Margin before Capital 1.1% 1.0%
client activities (synergies, dependencies)
EAD 100 100 • Approach needs to be usable in a timely manner for
RW (IRB) 128% 74%
trading businesses
ROE (EVA)

CET1 min
Capital Requirement
(EADxRWxCET1 min)
Return on Equity
(Net Margin/Capital Req) x 100
8.65% 8.65% • How the current pricing parameters may be subject to
change on the planning horizon (risk parameters,
11.04 6.39 costs, capital requirements and binding constraints).
• Markets are cyclical and returns may vary year-to-
10.0% 15.7% year, but not possible to withdraw entirely from
activities and then re-enter – total life of the deal /
business should be considered

MORGAN STANLEY PRESENTATION CONFIDENTIAL 18

Appendix
Additional references and reading materials

1. Introduction
• MS Earnings Release: https://www.morganstanley.com/content/dam/msdotcom/en/about-us-ir/shareholder/2q2023.pdf
• MS Fixed Income Presenation:
https://www.morganstanley.com/content/dam/msdotcom/en/about-us-ir/pdf/Morgan_Stanley_2Q23_Fixed_Income_Investor_Presentation.
pdf
• MS 10Q SEC filing: https://www.morganstanley.com/content/dam/msdotcom/en/about-us-ir/shareholder/10q0623.pdf

2. Regulatory Requirements
• Full set of Standards of the Basel Framework: https://www.bis.org/basel_framework/
• European Central Bank ICAAP Guidelines: https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.icaap_guide_201811.en.pdf
• National Bank of Hungary ICAAP Methodology Handbook (Hungarian language):
https://www.mnb.hu/felugyelet/szabalyozas/felugyeleti-szabalyozo-eszkozok/modszertani-kezikonyvek/icaap-ilaap-bma-felugyeleti-felulviz
sgalatok

3. Capital Allocation
• Capital Allocation Insights: https://www.morganstanley.com/im/publication/insights/articles/article_capitalallocation.pdf
• EBA Guidelines on Loan Origination & Monitoring (see pricing in Chapter 6):
https://www.eba.europa.eu/regulation-and-policy/credit-risk/guidelines-on-loan-origination-and-monitoring
• CAPM – In Practice: https://pages.stern.nyu.edu/~adamodar/New_Home_Page/lectures/risk.html
• Best practices to estimate Cost of Capital:
https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID2686738_code359140.pdf?abstractid=2686738&mirid=1

MORGAN STANLEY PRESENTATION CONFIDENTIAL 20

List of Abbreviations

AT1 Additional Tier 1 LAA Loss Absorption Amount

BIII Basel 3 LGD Loss-given Default

BRRD Bank Recovery and Resolution Directive MREL Minimum Requirement for Own Funds and Eligible Liabilities

CAPM Capital Asset Pricing Model MS Morgan Stanley

CBR Combined Buffer Requirement MSEHSE Morgan Stanley Europe Holding SE

CCB Capital Conservation Buffer OCR Overall Capital Requirement (TSCR + CBR)

CCyB Counter-Cyclical Capital Buffer P2G Pillar 2 Guidance

CET1 Common Equity Tier 1 P2R Pillar 2 Requirement

CoC Cost of Capital PD Probability of Default

CRR Capital Requirement Regulation RCA Recapitalization Amount

ECB European Central Bank ROE Return on Equity

EAD Exposure at Default RWA Risk-Weighted Assets

EL Expected Loss SRB Systemic Risk Buffer

GOB General Operating Buffer SREP Supervisory Review and Evaluation Process

G-SII Global Systemically Important Institution TCR Total Capital Ratio

ICAAP Internal Capital Adequacy Assessment Process TLAC Total Loss Absorbing Capacity

IRB Internal Rating-Based Method TSCR Total SREP Capital Requirement (BIII minimum + P2R)

MORGAN STANLEY PRESENTATION CONFIDENTIAL 21

​Recovery and Resolution Planning
Background and Motivation
​Recovery and Resolution Planning (RRP) established as lesson learned from the
2008 global financial crisis to improve resiliency of major financial institutions and to
enable their orderly resolution

2008 Financial Crisis RRP as regulatory response to end “Too big to fail”

• Recovery and Resolution Planning is the process by

which firms and regulatory authorities plan to
manage periods of severe financial distress, including
the failure (bankruptcy) of firms

• The 2008 financial crisis exposed deficiencies in the

legal and regulatory framework for bank failure and large
amounts of taxpayer funds were required to support
failing banks

• As a result, a number of regulatory reforms were

instituted globally, with the aim of making resolution of
Relevant movies: failed firms feasible without severe systemic disruption
Too Big to Fail
and without exposing taxpayers to loss, while protecting
The Big Short
critical economic functions
Inside Job

MORGAN STANLEY PRESENTATION CONFIDENTIAL 23

Recovery and Resolution
Regulatory and Legislative journey since 2008

2008 2010 2011 2012

Lehman collapse U.S. Dodd-Frank Act FSB1 publishes Morgan Stanley

exposes passed, large US “Key Attributes (MS) files its first
weaknesses in firms required to for Effective global Title I
the framework for develop “living will” Resolution Resolution Plan
large bank failure Resolution Plans Regimes”
(“too big to fail”)

2016 2015 2014 2013

FDIC2 publishes FSB publishes EU Bank Recovery FDIC publishes

Resolution Plan standard on Total and Resolution “Single Point of
guidance, including Loss Absorbing Directive finalised Entry” Resolution
requirements on Capacity (TLAC) Strategy for large
resolution modelling U.S. firms

2020 2021 2023

Single Resolution Board Bank of England SRB deadline for

(SRB) publishes deadline for banks to banks to be fully
“Expectations for be fully resolvable resolvable
Banks” on resolvability Morgan Stanley to file
its ninth global
Resolution Plan
1
Financial Stability Board (FSB)
2
Federal Deposit Insurance Corporation (FDIC)

MORGAN STANLEY PRESENTATION CONFIDENTIAL 24

RRP as a Reform
Resolution regimes have been established with powers for regulatory authorities to intervene
and resolve failed firms (Financial Stability Board Key Attributes1)

Cross-border cooperation has been enhanced between home and host authorities in the
resolution of globally systemic firms, including through Crisis Management Groups

Resolution strategies and plans have been developed. These may be developed by firms
themselves (United States) or by the authorities (UK/EU/Asia)

Recovery
and
Legal, financial and operational capabilities to ensure that firms are resolvable have been Resolution
Planning
developed at Morgan
Stanley
(MS)
Maintain minimum amounts of loss absorbing capacity 1 in the form of capital and bail-inable
debt (“bail-in” rather than “bail-out”) are required for firms

RRP at Morgan Stanley

• Morgan Stanley views the maintenance of its resiliency and resolvability as integral to:
1. meeting its risk management and strategic planning objectives; and
2. promoting the integrity of the financial system in which it operates.

1
See https://www.fsb.org/wp-content/uploads/r_141015.pdf
2
Requirements known globally as TLAC (Total Loss Absorbing Capacity) and in UK/EU as MREL (Minimum Requirement for own funds and Eligible Liabilities)
MORGAN STANLEY PRESENTATION CONFIDENTIAL 25
Recovery and Resolution in the UK/EU
BAU Recovery Resolution

Risk Appetite Framework Recovery Plan Resolution Plan

Return
ICAAP1 (Capital) • Bail-in
• Solvent
Reverse Stress Test
Wind Down

Risk Resource ILAAP2 (Liquidity)

Stage 1: Normal Stage 2: Elevated Stage 3: High Stage 4: Severe Stage 5: Resolution

Recovery Resolution
• Stage of stress during which management would • The orderly management of the failure of a firm
take steps to aim to recover • Aims of resolution include avoiding market
• The recovery plan is the plan to deal with this stage disruption of critical functions, systemic risk and
of stress recourse to public funds (“bail-out”)
• Steps would be taken when a firm reaches the point
of non-viability
• Steps taken may be by:
• The firm itself; or
• The resolution authority
(i.e. Bank of England (BoE), Single
Resolution Board)
1
Internal Capital Adequacy Assessment Process
2
Internal Liquidity Adequacy Assessment Process
MORGAN STANLEY PRESENTATION CONFIDENTIAL 26
Recovery Planning
Recovery Planning framework demonstrates the resiliency of a firm, including its
subsidiaries, in a range of stress events
• The Recovery Plan establishes the framework for identifying actual, anticipated or perceived financial stress and the
range of actions that could be taken to maintain financial position adequacy under such circumstances
• The 4 core components of MS’s Recovery Plans:

Trigger and Escalation Framework Communications Playbooks

• Strategy for managing and executing communications

• Framework for the identification and escalation of stress with key stakeholders during a period of stress
to take actions in a timely manner
• Consistent global Playbooks for MS and its subsidiaries

Recovery Actions Scenario Analysis

• Actions that could be taken in response to various types

of stress to generate or conserve financial resources • Assessment of the ability to restore financial position
through the execution of select recovery actions
• Consistent global Playbooks for MS and its subsidiaries

Recovery Action examples:

• Limit new business activities • Asset Monetization
• De-risking of portfolios by sale of • Debt issuance
assets • Executing equity related actions
• Novation/transfer of business

MORGAN STANLEY PRESENTATION CONFIDENTIAL 27

Resolution Planning - MS Preferred Resolution Strategy
​Single Point of Entry strategy involving business divestitures and solvent wind down
• MS Parent and its Funding Intermediary Holding Company (Funding IHC) hold substantial capital and liquidity and provide
Material Entities with necessary resources

• MS Parent files for bankruptcy in the US while Material Entities across various jurisdictions remain solvent without filing their own
resolution proceedings

• Strategy results in MS effectively ceasing to exist

Sale of WM and IM Solvent wind down of ISG

WM and U.S. Banks IM ISG

• MSSB • MSIM Inc. • MSCO • MSCS • MSESE

Material
• MSBNA • MSIM Ltd. • MSIP • MSCG • MSBAG Operating
• MSPBNA • MSMS Entities (MOEs)

Support Services

• Continuity strategy for MSEs owning or controlling essential infrastructure, support function personnel and
other operational resources through resolution Material Service
Entities (MSEs)
• Funding IHC is the primary resolution funding vehicle, providing resources to Material Entities

Exhibit 3.2. Firm Resolution Strategy – 2023 Resolution Plan Public Section (pg. 25)
https://www.federalreserve.gov/supervisionreg/resolution-plans/morgan-stanley-1g-20230701.pdf

MORGAN STANLEY PRESENTATION CONFIDENTIAL 28

Resolution Planning - Three Pillars of Resolution Planning 1
​The Firm focuses on three pillars of resolvability in its resolution plan

1 2 3
Legal Framework Financial Adequacy Operational Continuity

Do governance mechanisms and Would each Material Entity have Would each Material Entity have
contractual frameworks support the access to capital and liquidity access to operational resources
execution of the resolution strategy? necessary to execute resolution necessary to execute resolution
strategy? strategy?

• Governance Mechanisms • Liquidity Adequacy, Positioning and • Payment, Clearing and Settlement
Execution Needs Capabilities
• Trigger and Escalation Framework
• Capital Adequacy, Positioning and • Managing, Identifying and Valuing
• Support Agreement Framework Execution Needs Collateral

• Legal Entity Rationalization (LER) • Derivatives and Trading Capabilities • Management Information Systems
and Wind Down Strategies Capabilities

• Separability • Shared and Outsourced Services

Capabilities

Global Recovery and Resolution Assessment

Framework (GRRAF) tests capabilities across
pillars

1
Based on Exhibit 1-1: Morgan Stanley Approach to Credible Resolution Strategy – 2023 Resolution Plan Public Section (pg. 5)
https://www.federalreserve.gov/supervisionreg/resolution-plans/morgan-stanley-1g-20230701.pdf

MORGAN STANLEY PRESENTATION CONFIDENTIAL 29

​Thank you for your attention!
Appendix
Additional references and reading materials
1. Regulatory Background
• Federal Reserves – Living Wills: https://www.federalreserve.gov/supervisionreg/resolution-plans.htm
• FSB - Key Attributes of Effective Resolution Regimes for Financial Institutions:
https://www.fsb.org/wp-content/uploads/r_141015.pdf
• FDIC - “Single Point of Entry” Resolution Strategy:
https://www.federalregister.gov/documents/2013/12/18/2013-30057/resolution-of-systemically-important-financial-instituti
ons-the-single-point-of-entry-strategy
• EU - Bank Recovery and Resolution Directive: Directive 2014/59/EU of the European Parliament and of the Council of 15
May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms and
amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC,
2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012, of
the European Parliament and of the Council Text with EEA relevance
• SRB - Expectations for Banks:
https://www.srb.europa.eu/system/files/media/document/efb_main_doc_final_web_0_0.pdf
• Crisis Management Groups: https://www.fsb.org/2021/11/good-practices-for-crisis-management-groups-cmgs-2/

2. MS Publications
• 2023 Resolution Plan Public Section -
https://www.federalreserve.gov/supervisionreg/resolution-plans/morgan-stanley-1g-20230701.pdf

3. Additional reading materials

• Bank of England – Financial stability: https://www.bankofengland.co.uk/financial-stability
• FDIC – Resolution: https://www.fdic.gov/resources/resolutions/
• SRB: https://www.srb.europa.eu/en

MORGAN STANLEY PRESENTATION CONFIDENTIAL 32

 CONFIDENTIAL – NOT FOR FURTHER DISTRIBUTION

​Morgan Stanley
BGE University Presentation (Part 2) -
​Asset-Liability Management

​Zoltán Molnár
24 October 2023
Asset-Liability Management

Managing the mismatches between assets and liabilities in the balance sheet to reduce financial risk:
• Liquidity Risk: The risk that the firm is not able to fulfill expected and unexpected financial obligations on time.
• Interest Rate Risk: The firm suffers losses on PnL or value of Equity from unfavourable market interest rate moves.

Managing liquidity position: Managing interest rate position:

• Finding the appropriate level of HQLA (High Quality
Liquid Asset) to meet regulatory and internal
requirements (LCR and internal stress test)
• Delivering the right amount of stable funding to maintain
long-term resilience (NSFR)
• Handling the duration mismatch between assets and
liabilities to avoid losses on Economic Value of Equity
(EVE)
• Managing the repricing frequency between assets and
liabilities to avoid losses on Net Interest Income (NII)

MORGAN STANLEY PRESENTATION CONFIDENTIAL 34

Liquidity management
Liquidity Risk in General
​The risk that the firm will not have enough cash to meet its scheduled or unscheduled
payment obligations or unable to meet at a sustainable cost
1. Different interpretations for liquidity:
Market liquidity:
• The market is liquid if it is easy to trade on it
• Big turnover
• Low bid-ask spread
• Low transaction cost
• Easy access: low entry cost
Funding liquidity:
• The firm has enough surplus liquid asset to maintain its operation in a safe manner
• The firm is able to get funding from the market
• Most of the funding need is predictable based on the contractual schedules of the
liabilities, but the unscheduled portion still creates material uncertainty

2. Unscheduled (unpredicted) liquidity need can come up from:

• Bank run: Clients would like to withdraw their deposits as they believe the bank will
stop operating. It can be idiosyncratic (related to a single entity/firm) or industry
wide
• Refinancing risk: Refinancing maturing debt is not possible due to market
constraints or manageable only with material additional cost
• Margin calls: Additional margin need from the outstanding unhedged derivative
positions
• Option risk: Client’s option to call for funding creates additional liquidity need
MORGAN STANLEY PRESENTATION CONFIDENTIAL 36
Evolution of Liquidity Risk
2007-2008 crisis experience:
• Prior to the crisis funding from market was usually available at cheap cost
• The dropping confidence between market participants due to the fear of toxic
assets resulted severe illiquidity on funding.
• Credit commitments were withdrawn
• Counterparty limits were cut down
• Short-term funding markets like Commercial Paper (CP) and unsecured interbank
market dried up
• Illiquidity resulted further market volatility resulting additional margin calls and
liquidity need
• Central bank measures mainly focused on injecting liquidity to the markets to
restore the confidence and prevent from market/wide liquidity crisis:
• Lending facilities
• Asset purchase
Basel III regulation:
• To manage their liquidity in a prudent manner Basel Committee prescribed how
liquidity risk framework should be set up to financial institutions and supervisors
• 2 minimum requirements were created:
• Liquidity Coverage Ratio (LCR) to make sure firms have enough liquid assets for
short term liquidity shocks
• Net Stable Funding Ratio (NSFR) to make sure stable (long-term, illiquid) assets
are funded by stable funding
• In addition, financial institutions also need to maintain an internal liquidity stress
test which describes their individual liquidity profile
MORGAN STANLEY PRESENTATION CONFIDENTIAL 37
Liquidity Coverage Ratio (LCR)
• Basel Committee on Banking Supervision (BCBS) introduced the LCR as part of the Basel III post-crisis reforms
• The LCR is designed to ensure that banks hold a sufficient reserve of High-Quality Liquid Assets (HQLA) to allow them to survive a
period of significant liquidity stress lasting 30 calendar days
• Financial institutions are stimulated to maintain a liquid portfolio which absorbs all the expected and unexpected liquidity need
• LCR focuses on the short-term resilience in terms of liquidity, prescribes the survival of a 30-day liquidity stress event

HQLA: cash, cash equivalent or any assets which can be easily converted into cash without significant loss of value:
• Cash at central bank
• Cash at agent bank
• Reverse Repo
• Liquid securities

30-days net cash outflow:

• Total expected cash outflow minus inflow
• Each liability and off-balance sheet items have a certain 30-days outflow ratio

LCR minimum requirement is set to 100% since 2019

MORGAN STANLEY PRESENTATION CONFIDENTIAL 38

Net Stable Funding Ratio (NSFR)

• NSFR focuses on the long-term resilience in terms of liquidity

• The NSFR is defined as the amount of available stable funding relative to the amount of required stable funding
• To mitigate refinancing risk, stable, long-term assets need to be funded by stable liabilities

• ASF is the portion of its capital and liabilities that will remain with the institution for more than one year
• Liabilities have ASF factors between 0% and 100%, the more stable item receive the higher factor

• RSF is the amount of stable funding that it is required to hold based on the liquidity nature and contractual maturities of its assets
and related off-balance sheet exposures
• RSF factors are allocated to assets based on their maturity and level of liquidity

MORGAN STANLEY PRESENTATION CONFIDENTIAL 39

Interest Rate Risk Management
Banking Book vs. Trading Book Characteristics

Banking Book Trading Book

Assets & liabilities on a firm’s

Assets & liabilities held by a firm
Definition balance sheet that are not
that are actively traded
expected to be actively traded

Accounting Primarily Accrual Accounting Mark-to-Market

Sensitivity analysis (NII, EVE,

Metrics Pv01) and limits under various Value-at-Risk (“VaR”)
scenarios

MORGAN STANLEY PRESENTATION CONFIDENTIAL 41

What is Interest Rate Risk in the Banking Book (IRRBB)?

Economic Value of Equity (EVE) Net Interest Income (NII)

• EVE is the net present value of firm’s asset and liability cash
flows
• Dynamic view to identify asset/liability mismatch over the
lifetime of positions
• Helps to identify mismatch between the assets and liabilities
through maturity/duration
• NII is the difference between revenues generated by
interest-bearing assets and the cost of servicing interest-
bearing liabilities
• Primary metric to express risk appetite for earning
volatility
• Measures the accrual interest income over a pre-
determined horizon (typically 1 or 5 years)

EVE NII

POSITION Run-Off Going Concern

HORIZON Lifetime Fixed (1 – 5

Yrs)

VALUE DCF Accrual Based

EQUITY No Sensitivity Fixed 0%

MORGAN STANLEY PRESENTATION CONFIDENTIAL 42

Interest Rate Risk in the Banking Book Overview
​Components of Interest Rate Risk

Risk Type Cause Scenario Outcome

Refinancing Asset/Liability Maturity Interest Rates ↑

Interest Income ↓
Risk Mismatches Liabilities Mature

Asset/Liability Maturity Interest Rates ↓

Option Risk Mismatches from Customer Exercises Interest Income ↓
Option Exercise Option to Pay Off Loan

Change in Difference Basis Spread ↑

Interest Income ↓
Basis Risk Between Floating Rate Between O/N Rate and
(Interest Expense ↑)
Indices 3ML

MORGAN STANLEY PRESENTATION CONFIDENTIAL 43

IRRBB: Regulatory Background
​Basel Committee published the most recent IRRBB standard document in 2016.

• Principles were set up to define the requirements for IRRBB framework:

• Governance, importance of both NII and EVE, appropriate shock scenarios, etc.
• Highlighting behavioral assumptions: modeling deposits without maturity, prepayment risk, early redemption
risk, loan commitments
• 6 prescribed interest rate shock scenarios:
• Yield curves move parallel up/down
• Only short-term rates move up/down
• Yield curve steepening (short rate down, long rates up)/flattening (short rates up/long rates down)
• Potential EVE loss (sensitivity) should not exceed 15% on these scenarios
• European Banking Authority published its IRRBB and CSRBB guideline in 2022 to implement the Basel principles
• Office of the Comptroller of the Currency (OCC): Comptroller’s Handbook: Interest Rate Risk (2020) refers to the
requirements on US market

MORGAN STANLEY PRESENTATION CONFIDENTIAL 44

Case study for IRRBB Calculation and Reporting
IRRBB Calculation on a Hypothetic Portfolio
100
• The firm has 90Bn funding beyond equity, mainly client deposits
Cash
80
• Client deposits have no contractual but modelled maturity, their Gov. Bond Client
interest rate is decided by the firm based on the rate Deposit
60
environment. The deposits rate currently picks up 40% of
interest rate market shock (40% beta). 40 Lending
Issued
• On asset side 30Bn is allocated to HQLA (Cash, Government 20 Bond
Bond), the rest is used by the business for lending.
Equity
0
Assets Liabilities
Assets Liabilities
Name Modelling Pricing Amount (Bn) Name Modelling Pricing Amount (Bn)
Free Cash O/N USD FF rate 20 Client Deposit 4-year runoff, beta: 40%, floor at 0% Initial rate is 60bps -60
Gov. Bond Fix rate, 3-year maturity Fix 2.5% 10 Issued Bond Fix rate, 5-year Fix 3% -30
Lending Floating rate with 6 months, 5-y mat. 6m term SOFR+200bps 70 Equity Non-earning 0% -10
Total 100 Total -100

Off-balance Sheet
IRS Fix rate, 5-year Fix 2.5% 30 IRS 3-month floater 3-month Libor -30

• There is a hedge accounting* connection between the Issued Bond and the Interest Rate Swap (IRS). The IRS transforms our fix
rate liability to 3-month floater.
Assets Liabilities
Name Modelling Pricing Amount (Bn) Name Modelling Pricing Amount (Bn)
Free Cash O/N USD FF rate 20 Client Deposit 4-year runoff, beta: 40%, floor at 0% Initial rate is 60bps -60
Gov. Bond Fix rate, 3-year Fix 2.5% 10 Issued Bond 3-month floater 3-month Libor+50bps -30
Lending Floating rate, 6 months 6m term SOFR+200bps 70 Equity Non-earning 0% -10
Total 100 Total -100

* With hedge accounting the change of the value of the underlying instrument can be offset with the change of the value of the hedge transaction in financial reporting.

MORGAN STANLEY PRESENTATION CONFIDENTIAL 46

Net Interest Income Calculation
• Net Interest Income is calculated for 1-year horizon on implied forward rates (Base scenario, there is no interest rate shock) and
on 4 parallel hypothetic shock scenarios: all the market rate are shocked by -200, -100, +100, +200bps
• NII sensitivity is the difference against Base scenario NII
• Our balance sheet assumption is static here: the balance of all the positions stays constant within the horizon
Assets Next Liabilities Next
Name repricing Duration Beta Initial rate Amount (Bn) Name repricing Duration Beta Initial rate Amount (Bn)
Free Cash in 1 day 0 100% 3.0% 20 Client Deposit N/A 4 years 40% 0.6% -60
Gov. Bond N/A 2.9 years 0% 3.5% 10 Issued Bond in 2 months 0.17 years 83% 4.0% -30
Lending in 3 months 0.25 years 75% 5.0% 70 Equity N/A N/A 0% 0.0% -10
Total 100 Total -100

Assets Yield Liabilities Yield

Name Base Down200 Down100 Up100 Up200 Name Base Down200 Down100 Up100 Up200
Free Cash 3.00% 1.00% 2.00% 4.00% 5.00% Client Deposit 0.60% 0.00% 0.20% 1.00% 1.40%
Gov. Bond 3.50% 3.50% 3.50% 3.50% 3.50% Issued Bond 4.00% 2.34% 3.17% 4.83% 5.66%
Lending 5.00% 3.50% 4.25% 5.75% 6.50% Equity 0.00% 0.00% 0.00% 0.00% 0.00%
Total 4.45% 3.00% 3.73% 5.18% 5.90% Total 1.56% 0.70% 1.07% 2.05% 2.54%

Assets Net Interest Income (mn) Liabilities Net Interest Income (mn)
Name Base Down200 Down100 Up100 Up200 Name Base Down200 Down100 Up100 Up200
Free Cash 600 200 400 800 1,000 Client Deposit -360 0 -120 -600 -840
Gov. Bond 350 350 350 350 350 Issued Bond -1,200 -702 -951 -1,449 -1,698
Lending 3,500 2,450 2,975 4,025 4,550 Equity 0 0 0 0 0
Total 4,450 3,000 3,725 5,175 5,900 Total -1,560 -702 -1,071 -2,049 -2,538
Total total 2,890 2,298 2,654 3,126 3,362

Assets Net Interest Income sensitivity (mn) Liabilities Net Interest Income sensitivity (mn)
Name Base Down200 Down100 Up100 Up200 Name Base Down200 Down100 Up100 Up200
Free Cash 0 -400 -200 200 400 Client Deposit 0 360 240 -240 -480
Gov. Bond 0 0 0 0 0 Issued Bond 0 498 249 -249 -498
Lending 0 -1,050 -525 525 1,050 Equity 0 0 0 0 0
Total 0 -1,450 -725 725 1,450 Total 0 858 489 -489 -978
Total total 0 -592 -236 236 472

MORGAN STANLEY PRESENTATION CONFIDENTIAL 47

Net Interest Income Analysis

• Assets are repricing faster than liabilities resulting positive Up shocks and negative Down shocks
• In other terms, Net Interest Margin (NIM) widens on Up, narrows on Down shocks
• On down shocks the less interest income on assets can be just partially offset by lower interest expense on liabilities
• Up200 and Down200 sensitivities are not linear due to the 0% floor on Client Deposits: the firm can just partially benefit from less
interest expense on client deposits between Down100 and Down200 scenarios, beta is dropping here

NII sensitivity of the balance sheet items Net Interest Margin between Assets and Liabilities
1,500 mn 7%

1,000 6%

500 5%

0 4% 3.36%
3.13%
-500
3% 2.89%
2.65%
2% 2.30%
-1,000
1%
-1,500
Down200 Down100 Base Up100 Up200 0%
Free Cash Lending Client Deposit Down200 Down100 Base Up100 Up200

Issued Bond Sensitivity Assets yield Liabilities yield

MORGAN STANLEY PRESENTATION CONFIDENTIAL 48

Economic Value of Equity Calculation

• Cash flows from all the balance sheet items are discounted for all the scenarios
• Net present value of the products increases on Down, decreases on Up shocks

Assets Economic Value of Equity (% of notional) Liabilities Economic Value of Equity (% of notional)
Name Base Down200 Down100 Up100 Up200 Name Base Down200 Down100 Up100 Up200
Free Cash 100.0% 100.0% 100.0% 100.0% 100.0% Client Deposit 89.3% 94.2% 91.3% 87.4% 85.6%
Gov. Bond 97.2% 102.9% 100.0% 94.5% 91.9% Issued Bond 102.3% 102.7% 102.5% 102.0% 101.8%
Lending 109.0% 110.1% 109.5% 108.5% 108.1% Equity N/A N/A N/A N/A N/A

Assets Economic Value of Equity (mn) Liabilities Economic Value of Equity (mn)
Name Base Down200 Down100 Up100 Up200 Name Base Down200 Down100 Up100 Up200
Free Cash 20,000 20,000 20,000 20,000 20,000 Client Deposit -53,609 -56,531 -54,808 -52,466 -51,377
Gov. Bond 9,720 10,291 10,000 9,450 9,191 Issued Bond -30,677 -30,818 -30,747 -30,610 -30,544
Lending 76,321 77,041 76,675 75,979 75,647 Equity N/A N/A N/A N/A N/A

Assets Economic Value of Equity sensitivity (mn) Liabilities Economic Value of Equity sensitivity (mn)
Name Base Down200 Down100 Up100 Up200 Name Base Down200 Down100 Up100 Up200
Free Cash 0 0 0 0 0 Client Deposit 0 -2,922 -1,200 1,143 2,232
Gov. Bond 0 571 280 -270 -529 Issued Bond 0 -141 -69 68 133
Lending 0 719 354 -343 -674 Equity N/A N/A N/A N/A N/A
Total 0 1,291 634 -612 -1,204 0 -3,063 -1,269 1,210 2,365
Total total 0 -1,772 -635 598 1,161
% of Equity -17.7% -6.4% 6.0% 11.6%

MORGAN STANLEY PRESENTATION CONFIDENTIAL 49

Economic Value of Equity Analysis
• Client deposits drive the EVE sensitivity while Lending and Government Bond create a partially offset
• The higher the beta the lower the EVE sensitivity as the repricing nature of float rate creates an offset impact at discounting ~
positions with daily repricing are mainly risk free while fix rate deals have the maximum sensitivity
• Duration and lower beta on liability is higher than on assets resulting negative exposure on Down shocks
• Down100 is slightly more negative than the positivity of Up100 as sensitivity (and duration) increases on lower yield environment,
decreases on higher yield environment creating an additional nonlinear impact
• Flooring on client deposit creates additional negative impact on Down200

EVE sensitivity of the balance sheet items

3,000 mn percent of Equity 30%

2,000 20%

1,000 10%

0 0%

-1,000 -10%
Basel threshold
-2,000 -20%

-3,000 -30%
Down200 Down100 Base Up100 Up200

Gov. Bond Lending Client Deposit

Issued Bond Sensitivity

MORGAN STANLEY PRESENTATION CONFIDENTIAL 50

Managing Interest Rate position Actively – Potential Steps (1)
• Regulators prescribe to maintain a limit framework for both up and down shocks based on our internal risk appetite
• If the current limit exposures are not in line with risk appetite and the limits set up, the following potential products can provide a
benefit:

1. Security Portfolio (Government Bond):

• Changing cash for additional bond can create a benefit for both NII and EVE on Down
• Selling current bond portfolio and repurchasing with longer tenor only supports EVE but does not impact NII sensitivity

NII and EVE impact changing 10Bn 3-year Government Bond to 10-year

NII EVE
600 mn 1,500 mn

400 1,000

500
200
0
0
-500
-200
-1,000

-400 -1,500

-600 -2,000
Down200 Down100 Base Up100 Up200 Down200 Down100 Base Up100 Up200

MORGAN STANLEY PRESENTATION CONFIDENTIAL 51

Managing Interest Rate Position Actively – Potential Steps (2)

2. Interest Rate Swap:

• Payer IRS (receive fix/pay float) creates additional NII benefit on Down shock and more duration to support the offsetting impact
on EVE
• Linear impact: Benefit on Down shocks, but the same negative impact on Up shocks

NII and EVE impact of transacting 10Bn 5-year payer IRS

NII EVE
600 mn 1,500 mn

400 1,000

500
200
0
0
-500
-200
-1,000

-400 -1,500

-600 -2,000
Down200 Down100 Base Up100 Up200 Down200 Down100 Base Up100 Up200

MORGAN STANLEY PRESENTATION CONFIDENTIAL 52

Managing Interest Rate Position Actively – Potential Steps (3)

3. Swaption:
• Option to contract an IRS
• A payer swaption gives the option for a payer IRS resulting a benefit on Down scenarios
• We need to pay the option fee impacting all the scenarios including Base
• Nonlinear impact as the option turns to in-the-money (ITM) on Down shocks resulting positive impact, but there is no loss on Up

NII and EVE impact of transacting 10Bn 5-year payer swaption

NII EVE
600 mn 1,500 mn

400 1,000

500
200
0
0
-500
-200
-1,000

-400 -1,500

-600 -2,000
Down200 Down100 Base Up100 Up200 Down200 Down100 Base Up100 Up200

MORGAN STANLEY PRESENTATION CONFIDENTIAL 53

Additional Behavioural Models on IRRBB

Certain portfolios contain embedded options resulting different balance sheet compositions between scenarios:

1. Callability on debt:
• Option for the firm to call back the Issued Bond prior maturity
• Higher interest rate environment usually correlates with higher credit spread making the firm less motivated for an early callback on
Up shocks

2. Putability on debt:
• Investor has the right to give back the issued debt

3. Prepayment on loans:
• Clients can make early prepayment on loans like mortgages
• For a fix rate mortgage loan willingness for early prepay is higher on down shocks

4. Pull through on pipeline loans:

• Once the application for mortgage loan is approved by the bank, clients have a certain time window (~3 months) to call the loan
• If market rates drop in the meantime, they are less motivated for the call

MORGAN STANLEY PRESENTATION CONFIDENTIAL 54

​Thank you for your attention!
Literature

• Basel Committee on Banking Supervision: Basel III: the net stable funding ratio (2014)

• Basel Committee on Banking Supervision: Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools (2013)

• European Banking Authority: Final report on guidelines on the management of interest rate risk and credit spread risk arising
from nontrading book activities (2022)

• Basel Committee on Banking Supervision: Interest rate risk in the banking book standards (2016)

• Office of the Comptroller of the Currency (OCC): Comptroller’s Handbook: Interest Rate Risk (2020)

MORGAN STANLEY PRESENTATION CONFIDENTIAL 56