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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