Legal risk

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Basel II classified legal risk as a subset of operational risk in 2003. This conception is based on a business perspective, recognizing that there are threats entailed in the business operating environment. The idea is that businesses do not operate in a vacuum and that, in the exploitation of opportunities and their engagement with other businesses, their activities tend to become subjects of legal liabilities and obligations. [1]

Basel II is the second of the Basel Accords,, which are recommendations on banking laws and regulations issued by the Basel Committee on Banking Supervision.

Operational risk is "the risk of a change in value caused by the fact that actual losses, incurred for inadequate or failed internal processes, people and systems, or from external events, differ from the expected losses". This definition, adopted by the European Solvency II Directive for insurers, is a variation from that adopted in the Basel II regulations for banks. In October 2014, the Basel Committee on Banking Supervision proposed a revision to its operational risk capital framework that sets out a new standardized approach to replace the basic indicator approach and the standardized approach for calculating operational risk capital.

The outcome of business operations is the harvesting of value from assets owned by a business. Assets can be either physical or intangible. An example of value derived from a physical asset, like a building, is rent. An example of value derived from an intangible asset, like an idea, is a royalty. The effort involved in "harvesting" this value is what constitutes business operations cycles.

One of the primary reasons why legal risk is associated with operational risk involves fraud since it is recognized as the most significant category of operational loss events and considered to be a legal issue as well. [2] These, however, do not mean that legal risk is only confined to this conceptualization because it is defined in more than way. For instance, there are specific sets of legal risks that are defined by the European Union (EU) Law. In 2005, the European Central Bank declared that it will develop its own legal risk definition to help "facilitate proper risk assessment and risk management, as well as ensure a consistent approach between EU credit institutions." [3]

In law, fraud is intentional deception to secure unfair or unlawful gain, or to deprive a victim of a legal right. Fraud can violate civil law, a criminal law, or it may cause no loss of money, property or legal right but still be an element of another civil or criminal wrong. The purpose of fraud may be monetary gain or other benefits, for example by obtaining a passport, travel document, or driver's license, or mortgage fraud, where the perpetrator may attempt to qualify for a mortgage by way of false statements.

European Union law body of treaties and legislation which have direct effect or indirect effect on the laws of European Union member states

European Union law is the system of laws operating within the member states of the European Union. The EU has political institutions and social and economic policies. According to its Court of Justice, the EU represents "a new legal order of international law". The EU's legal foundations are the Treaty on European Union and the Treaty on the Functioning of the European Union, unanimously agreed by the governments of 28 member states. New states may join the EU, if they agree to operate by the rules of the organisation, and existing members may leave according to their "own constitutional requirements". Citizens are able to vote directly in elections to the Parliament, while their national governments operate on behalf of them in the Council of the European Union and the European Council. The Commission is the executive branch. The Council of the European Union represents member state governments, while the Court of Justice is meant to uphold the rule of law and human rights. As the Court of Justice said, the EU is "not merely an economic union" but is intended to "ensure social progress and seek the constant improvement of the living and working conditions of their peoples".

European Central Bank central bank for the euro

The European Central Bank (ECB) is the central bank for the euro and administers monetary policy within the Eurozone, which comprises 19 member states of the European Union and is one of the largest monetary areas in the world. Established by the Treaty of Amsterdam, the ECB is one of the world's most important central banks and serves as one of seven institutions of the European Union, being enshrined in the Treaty on European Union (TEU). The bank's capital stock is owned by all 28 central banks of each EU member state. The current President of the ECB is Mario Draghi. Headquartered in Frankfurt, Germany, the bank formerly occupied the Eurotower prior to the construction of its new seat.

Definitions

There is no standard definition, but there are at least two primary/secondary definition sets in circulation.

Mcormick, R. 2004 Legal risk is the risk of loss to an institution which is primarily caused by:
(a) a defective transaction; or
(b) a claim (including a defense to a claim or a counterclaim) being made or some other event occurring which results in a liability for the institution or other loss (for example, as a result of the termination of a contract) or;
(c) failing to take appropriate measures to protect assets (for example, intellectual property) owned by the institution; or
(d) change in law. [4]

Mcormick, R. 2004 Management of legal risk is not a precise science and subjective to the situation of the institution, and primarily caused by the lack of proper communication channel, undefined institutional objectives (such as the lack of policies and regulations), unclarified information flow between different personnel and department, lack of delegation of power to specify task on mitigation of risks. [5]

Johnson and Swanson. 2007

The expenses of litigation of a company. [6]

Whalley, M. 2016

Legal risk is the risk of financial or reputational loss that can result from lack of awareness or misunderstanding of, ambiguity in, or reckless indifference to, the way law and regulation apply to your business, its relationships, processes, products and services. [7]

Tsui TC. 2013

The cost and loss of income caused by legal uncertainty, multiplied by possibility of the individual event or legal environment as a whole. [8]

One of the most obvious legal risks of doing business not mentioned in the above definitions is the risk of arrest and prosecution.

All definitions contain more detail.

Related Research Articles

Insurance equitable transfer of the risk of a loss, from one entity to another in exchange for payment

Insurance is a means of protection from financial loss. It is a form of risk management, primarily used to hedge against the risk of a contingent or uncertain loss.

Risk management Set of measures for the systematic identification, analysis, assessment, monitoring and control of risks

Risk management is the identification, evaluation, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability or impact of unfortunate events or to maximize the realization of opportunities.

The precautionary principle generally defines actions on issues considered to be uncertain, for instance applied in assessing risk management. The principle is used by policy makers to justify discretionary decisions in situations where there is the possibility of harm from making a certain decision when extensive scientific knowledge on the matter is lacking. The principle implies that there is a social responsibility to protect the public from exposure to harm, when scientific investigation has found a plausible risk. These protections can be relaxed only if further scientific findings emerge that provide sound evidence that no harm will result.

Financial regulation

Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the integrity of the financial system. This may be handled by either a government or non-government organization. Financial regulation has also influenced the structure of banking sectors by increasing the variety of financial products available. Financial regulation forms one of three legal categories which constitutes the content of financial law, the other two being market practices, case law.

Due diligence legal term

Due diligence is the investigation or exercise of care that a reasonable business or person is expected to take before entering into an agreement or contract with another party, or an act with a certain standard of care.

In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system, that can be contained therein without harming the entire system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries". It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a cascading failure, which could potentially bankrupt or bring down the entire system or market. It is also sometimes erroneously referred to as "systematic risk".

In general, compliance means conforming to a rule, such as a specification, policy, standard or law. Regulatory compliance describes the goal that organizations aspire to achieve in their efforts to ensure that they are aware of and take steps to comply with relevant laws, policies, and regulations. Due to the increasing number of regulations and need for operational transparency, organizations are increasingly adopting the use of consolidated and harmonized sets of compliance controls. This approach is used to ensure that all necessary governance requirements can be met without the unnecessary duplication of effort and activity from resources.

A feasibility study is an assessment of the practicality of a proposed project or system. A feasibility study aims to objectively and rationally uncover the strengths and weaknesses of an existing business or proposed venture, opportunities and threats present in the natural environment, the resources required to carry through, and ultimately the prospects for success. In its simplest terms, the two criteria to judge feasibility are cost required and value to be attained.

Enterprise risk management (ERM) in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. ERM provides a framework for risk management, which typically involves identifying particular events or circumstances relevant to the organization's objectives, assessing them in terms of likelihood and magnitude of impact, determining a response strategy, and monitoring process. By identifying and proactively addressing risks and opportunities, business enterprises protect and create value for their stakeholders, including owners, employees, customers, regulators, and society overall.

Financial risk Any of various types of risk associated with financing

Financial risk is any of various types of risk associated with financing, including financial transactions that include company loans in risk of default. Often it is understood to include only downside risk, meaning the potential for financial loss and uncertainty about its extent.

The legal principle of vicarious liability applies to hold one person liable for the actions of another when engaged in some form of joint or collective activity.

Foreign exchange risk is a financial risk that exists when a financial transaction is denominated in a currency other than the domestic currency of the company. The exchange risk arises when there is a risk of significant appreciation of the domestic currency in relation to the denominated currency before the date when the transaction is completed.

Asset and liability management is the practice of managing financial risks that arise due to mismatches between the assets and liabilities as part of an investment strategy in financial accounting.

Professional liability insurance (PLI), also called professional indemnity insurance (PII) but more commonly known as errors & omissions (E&O) in the US, is a form of liability insurance which helps protect professional advice- and service-providing individuals and companies from bearing the full cost of defending against a negligence claim made by a client, and damages awarded in such a civil lawsuit. The coverage focuses on alleged failure to perform on the part of, financial loss caused by, and error or omission in the service or product sold by the policyholder. These are causes for legal action that would not be covered by a more general liability insurance policy which addresses more direct forms of harm. Professional liability insurance may take on different forms and names depending on the profession, especially medical and legal, and is sometimes required under contract by other businesses that are the beneficiaries of the advice or service.

Bank financial institution

A bank is a financial institution that accepts deposits from the public and creates credit. Lending activities can be performed either directly or indirectly through capital markets. Due to their importance in the financial stability of a country, banks are highly regulated in most countries. Most nations have institutionalized a system known as fractional reserve banking under which banks hold liquid assets equal to only a portion of their current liabilities. In addition to other regulations intended to ensure liquidity, banks are generally subject to minimum capital requirements based on an international set of capital standards, known as the Basel Accords.

A specialized investment fund or SIF is a lightly regulated and tax-efficient regulatory regime aimed for a broader range of eligible investors. This type of investment fund is governed by the Luxembourg law of 13 February 2007 replacing the law of 1991 defining the legal framework for institutional funds and enlarging the distribution scope to “well-informed investors”. The SIF law significantly simplified the rules for setting up investment fund structures ranging from straightforward investment strategies investing in listed securities to hedge funds, real estate and private equity funds.

Financial law

Financial law is the law and regulation of the insurance, derivatives, commercial banking, capital markets and investment management sectors. Understanding Financial law is crucial to appreciating the creation and formation of banking and financial regulation, as well as the legal framework for finance generally. Financial law forms a substantial portion of commercial law, and notably a substantial proportion of the global economy, and legal billables are dependent on sound and clear legal policy pertaining to financial transactions. Therefore financial law as the law for financial industries involves public and private law matters. Understanding the legal implications of transactions and structures such as an indemnity, or overdraft is crucial to appreciating their effect in financial transactions. This is the core of Financial law. Thus, Financial law draws a narrower distinction than commercial or corporate law by focusing primarily on financial transactions, the financial market, and its participants; for example, the sale of goods may be part of commercial law but is not financial law. Financial law may be understood as being formed of three overarching methods, or pillars of law formation and categorised into five transaction silos which form the various financial positions prevalent in finance.

The term business risks refers to the possibility of a commercial business making inadequate profits due to uncertainties - for example: changes in tastes, changing preferences of consumers, strikes, increased competition, changes in government policy, obsolescence etc. Every business organization faces various risk elements while doing business. Business risk implies uncertainty in profits or danger of loss and the events that could pose a risk due to some unforeseen events in future, which causes business to fail.

Proactive Contracting is akin to Proactive Law and focuses on the same properties, namely to prevent problems and promote relationships. The legal area of research developed in Scandinavia in the 1990s and has gradually gained attention. Proactive Contracting deals with Contract Management, Relational Management, Risk Management and Business Process Management.

References

  1. Chapman, Robert (2011). Simple Tools and Techniques for Enterprise Risk Management. Chichester, West Sussex: John Wiley & Sons. p. 435. ISBN   9781119989974.
  2. Moosa, Imad (2007). Operational Risk Management. New York: Palgrave Macmillan. p. 95. ISBN   9781349352951.
  3. Mišćenić, Emilia; Raccah, Aurélien (2016). Legal Risks in EU Law: Interdisciplinary Studies on Legal Risk Management and Better Regulation in Europe. Berlin: Springer. p. 6. ISBN   9783319285955.
  4. Roger McCormick. "Legal Risk in the Financial Markets", Oxford University Press
  5. Roger McCormick. "The Management of Legal RIsk by Financial Institutions", RSM
  6. IMA. "Issues". imanet.org.
  7. "Legal risk 2.0: Show you're in control" (PDF).
  8. "Experience from the Anti-Monopoly Law Decision in China (Cost and Benefit of Rule of Law)". ssrn.com. SSRN   2260965 .Missing or empty |url= (help)