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Legal Risk ISDA/PRMIA Risk Management Seminar

Legal Risk ISDA/PRMIA Risk Management Seminar. Dermot Turing. London-2/1430864/01. Legal Risk – Latest Developments. Basel II With a footnote on business continuity Securities Certainty – Giovannini. The new Basel Framework. Operational risk charge Definition of operational risk

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Legal Risk ISDA/PRMIA Risk Management Seminar

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  1. Legal RiskISDA/PRMIA Risk Management Seminar Dermot Turing London-2/1430864/01

  2. Legal Risk – Latest Developments • Basel II • With a footnote on business continuity • Securities Certainty – Giovannini

  3. 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

  4. Computing the charge • Basic Indicator Approach • 15% average gross income over 3 years • Standardised Approach • Σ [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

  5. The AMA in practice • Using P&L • 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

  6. 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?

  7. 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

  8. 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

  9. Business Continuity • What is the meaning of the counterparty’s 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

  10. 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

  11. 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

  12. 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

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