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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

Legal RiskISDA/PRMIA Risk Management Seminar

Dermot Turing


legal risk latest developments
Legal Risk – Latest Developments
  • Basel II
    • With a footnote on business continuity
  • Securities Certainty – Giovannini
the new basel framework
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
computing the charge
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
the ama in practice
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
the main operational risk areas
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?
legal risk under basel ii
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
reducing legal risk for basel
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
business continuity
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”


securities account certainty
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
ownership issues with securities
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
giovannini proposals
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