Morgan Stanley : Finance LLC - Annual Report - 31 December 2021

MORGAN STANLEY FINANCE LLC

Annual Financial Report

December 31, 2021

MORGAN STANLEY FINANCE LLC

TABLE OF CONTENTS

Directors' Report

Directors' Responsibility Statement

Independent Auditor's Report

Statements of Financial Condition

Statements of Comprehensive Income (Loss)

Statements of Cash Flows

Statements of Changes in Member's Equity (Deficit)

Notes to the Financial Statements

Glossary of Common Terms and Acronyms

DIRECTORS' REPORT

Year ended 31 December 2021

The Directors present their report and financial statements (which comprise the statement of financial condition, the statement of comprehensive income (loss), the statement of cash flows, the statement of changes in member's equity (deficit) and the related notes as well as a glossary of common terms and acronyms for Morgan Stanley Finance LLC (the "Company") for the year ended 31 December 2021.

RESULTS AND DIVIDENDS

The comprehensive income for the twelve months was $277,000,000 (31 December 2020: loss of $394,000,000).

During the period, no dividends were paid or proposed.

PRINCIPAL ACTIVITY

The Company is wholly owned by Morgan Stanley (the "Parent"), which together with its consolidated subsidiaries, form "the Firm".

The principal activity of the Company is the issuance of Borrowings ("Structured Notes"), the cash proceeds being lent to its Parent and the hedging of the obligations arising pursuant to such issuances.

The Company was established under Delaware law on March 27, 2002. The business office of the Company is at 1585 Broadway, New York, NY 10036, U.S.A.

FUTURE OUTLOOK

There have not been any significant changes in the Company's principal activity during the year, other than those disclosed in the notes to the financial statements and no significant change is expected.

BUSINESS REVIEW

The Company is a "finance subsidiary" of the Parent, as defined in SEC Regulation S-X. The Company issues structured notes to themarketplace that are fully and unconditionally guaranteed by the Parent. Proceeds from issuances are lent to the Parent in the form of Intercompany notes.

The Company has a rating of BBB+ from S&P.

The issuance of Structured Notes exposes the Company to various types of risk including foreign exchange, equity, interest rate, and commodities risk. The Company hedges these risks through the use of derivative instruments.

The statement of comprehensive income (loss) for the twelve months is set out on page 4 of the audited financial statements. The Company did not make any gains or losses over $1,000,000 in the period.

In the period, Structured Notes that are measured at fair value pursuant to the fair value option election requires presenting unrealized DVA of $277,000,000 as 'Other comprehensive income' in the statement of comprehensive income (loss).

The statement of financial condition for the Company is set out on page 3 of the audited financial statements. At 31 December 2021 the Company's total assets were $29,817,000,000, an increase of $4,251,000,000 or 17% compared to 31 December 2020 and total liabilities were $30,226,000,000 an increase of $3,974,000,000 or 15%, compared to 31 December 2020.

The changes to the statements of comprehensive income (loss) and financial condition are in line with the Company's primary activity during the period due to growth of the business.

The performance of the Company is included in the results of the Firm, which are disclosed in the Firm's Annual Report on Form 10-K and quarterly on Form 10Q to the SEC. The Firm manages its key performance indicators on a global basis but in consideration of individual legal entities. For this reason, the Company's Directors believe that providing

DIRECTORS' REPORT

Year ended 31 December 2021

further performance indicators for the Company itself would not enhance an understanding of the development, performance or position of the business of the Company.

The risk management section below sets out the Company's and the Firm's policies for the management of significant business risks.

Risk management

The Company's risk management practices are aligned with those of the Firm. These practices are administered on a coordinated global and legal entity basis with consideration given to the Company's specific internal capital requirements.

Risk is an inherent part of the Firm's business and activities. Management believes effective risk management is vital to the success of the Firm's business activities. Accordingly, the Firm has policies and procedures in place to identify, assess, monitor and manage the significant risks involved in the activities of its business and support functions.

The cornerstone of the Firm's risk management philosophy is the pursuit of risk-adjusted returns through prudent risk-taking that protects the Firm's capital base and franchise. Five key principles underlie this philosophy: integrity, comprehensiveness, independence, accountability, and transparency. To help ensure the efficacy of risk management, which is an essential component of the Firm's reputation, senior management requires thorough and frequent communication and the appropriate escalation of risk matters. The fast-paced, complex, and constantly-evolving nature of global financial markets requires that the Firm maintains a risk management culture that is incisive, knowledgeable about specialized products and markets, and subject to ongoing review and enhancement.

Market risk

Market risk refers to the risk that a change in the level of one or more market prices, rates, spreads, indices, volatilities, correlations or other market factors, such as market liquidity, will result in losses for a position or portfolio. Generally, the Firm incurs market risk as a result of trading, investing and client facilitation activities, principally within the Institutional Securities business segment where the substantial majority of the Firm's market risk exposure is generated.

The Company has exposures to a wide range of risks relating to interest rates, equity prices and foreign exchange rates as well as the associated implied volatilities and spreads of the global markets in which the Company conducts its trading activities.

Sound market risk management is an integral part of the Firm's culture. The various business units and trading desks are responsible for ensuring that market risk exposures are well-managed and prudent. Market risk is also monitored through various measures: by use of statistics; by measures of position size and sensitivity; and through routine stress testing, which measures the impact on the value of existing portfolios of specified changes in market factors, and scenarios designed by the Market Risk Department in collaboration with business units.

Credit risk

Credit risk refers to the risk of loss arising when a borrower, counterparty or issuer does not meet its financial obligations to the Firm. The Firm is primarily exposed to credit risk exposure from institutions and individuals. This risk may arise from a variety of business activities, including, but not limited to, entering into swap or other derivative contracts under which counterparties have obligations to make payments to the Firm; extending credit to clients; providing short-or long-term funding that is secured by

DIRECTORS' REPORT

Year ended 31 December 2021

physical or financial collateral whose value may at times be insufficient to fully cover the repayment amount; and posting margin and/or collateral to counterparties. This type of risk requires credit analysis of specific counterparties, both initially and on an ongoing basis. The Firm also incurs credit risk in traded securities and whereby the value of these assets may fluctuate based on realized or expected defaults on the underlying obligations or loans.

The Firm establishes practices to evaluate, monitor and control credit risk exposure both within and across business segments. The Firm is responsible for ensuring timely and transparent communication of material credit risks, ensuring compliance with established limits, and escalating risk concentrations to appropriate senior management. The Firm's credit risk exposure is managed by credit professionals and risk committees that monitor risk exposures, including credit sensitive, higher risk transactions.

Operational Risk

Operational risk refers to the risk of loss, or of damage to the Firm's reputation, resulting from inadequate or failed processes or systems, from human factors or from external events (e.g. cyber attacks or third-party vulnerabilities) that may manifest as, for example, loss of information, business disruption, theft and fraud, legal and compliance risks, or damage to physical assets. The Firm may incur operational risk across the full scope of its business activities, including revenue-generating activities (e.g., sales and trading) and control groups (e.g. information technology and trade processing).

The Firm's operational risk framework is established to identify, measure, monitor and control risk. Effective operational risk management is essential to reducing the impact of operational risk incidents and mitigating legal, regulatory and reputational risks. The framework is continually evolving to account for changes in the Firm and to respond to the changing regulatory and business environment.

Model Risk

Model risk refers to the potential for adverse consequences from decisions based on incorrect or misused model outputs. Model risk can lead to financial loss, poor business and strategic decision making or damage to the Company's or the Firm's reputation. The risk inherent in a model is a function of the materiality, complexity and uncertainty around inputs and assumptions.

Model risk is generated from the use of models impacting financial statements, regulatory filings, capital adequacy assessments and the formulation of strategy.

Sound model risk management is an integral part of our Risk Management Framework. The MRM is a distinct department in Risk Management responsible for the oversight of model risk.

MRM establishes a model risk tolerance in line with the Firm's risk appetite. The tolerance is based on an assessment of the materiality of the risk of financial loss or reputational damage due to errors in design, implementation and/or inappropriate use of models. The tolerance is monitored through model-specific and aggregate business-level assessments, which are based upon qualitative and quantitative factors.