Overview of the Supervisory Review and Evaluation Process framework used by the PFSA Polish Financial Supervision Authority, Financial Services, Licensing and Functional Supervision Department

AGENDA Regulations Basic definitions (ICAAP, SPEP, internal capital, regulatory capital) PART 1 Introduction BION – cycle Rating Time requirements Technical aspects of BION PART 2 Organizational issues of SREP (BION) Ongoing supervision Presentation Off/on-site Inspection PART 3 BION of brokerage houses in detail

AGENDA Regulations Basic definitions (ICAAP, SPEP, internal capital, regulatory capital) PART 1 Introduction BION – cycle Rating Time requirements Technical aspects of BION PART 2 Organizational issues of SREP (BION) Ongoing supervision Presentation Off/on-site Inspection PART 3 BION of brokerage houses in detail

SELECTED INFORMATION ON POLISH CAPITAL MARKET

All in PLN % of budget Number of entities Brokerage houses45 n/a Brokerage offices77 n/a Total assetsBrokerage houses ,24% Brokerage offices ,44% Clients’ assets under management Brokerage houses ,19% Brokerage offices ,07% Clients’ assets on accounts Brokerage houses ,96% Brokerage offices ,93% Government income in 2010:

Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions Directive 2006/49/EC of the European Parliament and of the Council of 14 June 2006 on the capital adequacy of investment firms and credit institutions Act on Trading in Financial Instruments of 29 July 2005 (Dz. U. No. 183, item 1538) Regulation of the Minister of Finance of 20 November 2009 on Supervisory Review and Evaluation Process of brokerage houses Regulations

Article Taking into account the technical criteria set out in Annex XI, the competent authorities shall review the arrangements, strategies, processes and mechanisms implemented by the credit institutions to comply with this Directive and evaluate the risks to which the credit institutions are or might be exposed. 2. The scope of the review and evaluation referred to in paragraph 1 shall be that of the requirements of this Directive. Directive 2006/48/EC

Article On the basis of the review and evaluation (…), the competent authorities shall determine whether the arrangements, strategies, processes and mechanisms implemented by the credit institutions and the own funds held by these ensure a sound management and coverage of their risks. 4. Competent authorities shall establish the frequency and intensity of the review and evaluation (…) having regard to the size, systemic importance, nature, scale and complexity of the activities of the credit institution concerned and taking into account the principle of proportionality. The review and evaluation shall be updated at least on an annual basis. Directive 2006/48/EC

Basel II (Capital Requirement Directive, CRD) Directive 2006/48/EC of the European Parliament and of the Council of 14 June 2006 relating to the taking up and pursuit of the business of credit institutions; and Directive 2006/49/EC of the European Parliament and of the Council of 14 June 2006 on the capital adequacy of investment firms and credit institutions. Basel II

Basel II is structured around three so-called pillars. Pillar 1 – minimum regulatory requirements. They address and allocate capital for the principal risks faced by brokerage house (credit risk, market risk and operational risk). Pillar 2 – ICAAP/SREP. It’s aim is to ensure that a brokerage house's capital level is sufficient to cover its overall risk. Pillar 3 – market discipline. Also relates to minimum levels of public disclosure. Basel II

The ICAAP is the firm’s own assessment of the internal capital it needs to hold against its risks. The SREP is how supervisors assess the overall risks of firm/group, covering inherent business risk, control factors and internal governance. SREP includes a quantitative and qualitative assessment of the ICAAP. ICAAP/SREP

Regulations Basic definitions (ICAAP, SPEP, internal capital, regulatory capital) PART 1 Introduction BION – cycle Rating Time requirements Technical aspects of BION PART 2 Organizational issues of SREP (BION) Ongoing supervision Presentation Off/on-site Inspection PART 3 BION of brokerage houses in detail AGENDA

BION – basic cycle Off-site, on-site, inspection Results, rating Process clousure Planning Presentation Ongoing supervision

SREP (BION) Off-site Presentation On-site Inspection Prudential monitoring Rating

SREP (BION) 1 Presentation art. 88 of Act on Trading in Financial Instruments 2 Off-site art. 88 of Act on Trading in Financial Instruments 3 On-site § of Regulation on SREP of brokerage houses 4 Inspection chapter 4. of Act on Capital Market Supervision

Assess the capital allocated against following risks: 1.Credit risk 2.Market risk 3.Operational risk 4.Liquidity risk 5.Other risks Also assessed: 1.ICAAP SREP (BION) Areas assessed : 1.Risk’s policy 2.Identification of risk 3.Mitigation/control 4.Monitoring

Time requirements

Time vs. risk concerns Preliminary risk profile Analytical Review Presentation On-site Inspection Time Risk Off-site

1.Every brokerage house has to be ranked 2.Team organization 3.Methodology basic level training – up to 10 working days 4.Balance between tools/time 5.Staff turnover ca. 1,5 year 6.Skill level (employees who passed CFA level 1 are decision makers) 6.Transparency to the market 7.Simplicity before complexity Key boundaries

Regulations Basic definitions (ICAAP, SPEP, internal capital, regulatory capital) PART 1 Introduction BION – cycle Rating Time requirements Technical aspects of BION PART 2 Organizational issues of SREP (BION) Ongoing supervision Presentation Off/on-site Inspection PART 3 BION of brokerage houses in detail AGENDA

BION – basic cycle Off-site, on-site, inspection Results, rating Process clousure Planning Presentation Ongoing supervision

All available data and information, ranging from qualitative to quantitative, is taken into account This includes, for example, data and information from: – corep, – regulatory reports (entity’s current data – S01), – annual financial statements (audited), – the latest on-site examination report, – other relevant information. Ongoing supervision

46 entities divided into 6 portfolios Ongoing supervision 46 entities P1P2P3P4P5P6

Includes information about: – the value of total assets, – the value of total capital requirement, – the value of assets under management, – qualifications (if any), – auditor, – information from other departments, – information from consolidating supervisor. Key decision parameters, Input for kick off meetings, Rating can be assigned basing on Main table only. Main table

Review/Planning Risk control Risk exposure Outlier Outliers

BION – basic cycle Off-site, on-site, inspection Results, rating Process clousure Planning Presentation Ongoing supervision

Divided into: – Module A – Overview – standardized questions about an entity (shareholding structure, capital group, capital allocated for risks) – Module B – Risk profile – detailed questions (material risks, key employees, IT structure) Two approaches Presentation

Pros + easy to aggregate results, + convenient for a supervisor (no additional analysis). Standard presentation Cons – preparation for such presentation is time- consuming (extensive set), – some questions may not apply to a particular brokerage house.

Pros + less burdensome for small brokerage houses. Tailored presentation Cons – nearly impossible to aggregate results, – requires additional work of a supervisor, – some questions can be accidentally not included.

Supervisor – Notification (date, set of questions…) Presentation to-do list Company – Prepares and gives presentation – Communicates with a supervisor – Provides electronic deliverables

Structure of the capital group Ways of reporting within capital group Documentation flow (reports provided to the Board) Way of choosing members of Board of Directors and Supervisory Board (strategic plan, role in the ICAAP) Dependencies delegation and scope of delegation Experience and competence of managers Organizational structure We ask about…

Key employees Scale of capital and personal dependencies Amount of capital allocated on risk in Pillar I and II Types of risks estimated as material (policies and procedures…) Measurement of risk materiality Expenditures allocated on risk management ICAAP (comprehensive…) We ask about…

BION – basic cycle Off-site, on-site, inspection Results, rating N/Y Planning /End/ Planning Presentation Ongoing supervision

Off-site Requires additional communication with the brokerage house and further exchange of information. Off-site supervision uses additional information obtained from the brokerage house that was not included in the presentation but is necessary from the supervisor’s point of view to properly rank a brokerage house.

An on-site examination focuses on detailed assessment of the brokerage house's business and financial condition It involves looking at financial statements, systems and procedures, transactions and documentation, as well as meeting with management and staff Reliable supervisory tool (low risk) On-site

On-site examinations have some limitations, they: – involve significant supervisory resources, – can be costly and burdensome for brokerage houses, – relate to the assessment of a brokerage house at a specific point in time, – in addition, information contained in examination does not remain valid for long. On-site limitations

Similar to an on-site examination Unlike an on-site examination, inspection also involves assessment of compliance Inspection

BION – basic cycle Off-site, on-site, inspection Results, rating Process clousure Planning Presentation Ongoing supervision

Each component of risk is rated on a scale from 1 (best) through 4 (worst) based on supervisory criteria and guidelines Results are aggregated using weights (summing up to 1) Final rating – a number with two decimal points (only range is communicated i.e. 1 – 1,5) Exception – when an on-site examination or inspection are conducted we communicate the exact number i.e. 2,14 Rating

Meaning 1 – 1,5Good general situation of the entity in the context of risk. Supervisory strategy determined as result of BION narrows down to monitoring reports and other information that are likely to influence the exposure and the level of risk. 1,5 – 2,5Satisfying general situation of the entity in all of the assessed areas. Irregularities that appear (if any) aren't material from the point of view of safety of the entity. 2,5 – 3,5General situation is not satisfying. Appearing irregularities aren't at present substantial from the point of view of safety of the entity, however if they aren't eliminated they can become a threat. 3,5 – 4,0Critical situation of the assessed entity. Appearing irregularities are alarming – entity’s ability to continue it’s business is doubtful. Scale

BION – basic cycle Off-site, on-site, inspection Results, rating Process clousure Planning Presentation Ongoing supervision

Communication with brokerage houses – Rating – Pointing out the weakest elements in the risk management process (Action Plan) – Correction Plan (if an inspection is conducted) Taking up appropriate supervisory actions Ongoing monitoring of entity’s rating (possible change of rating if the circumstances change) Communication

Intensify the monitoring of the brokerage house Require the brokerage house to raise additional capital Restrict current activities Prohibit new activities or acquisitions Supervisory actions Restrict or prohibit the payment of dividends Fines Legal action Withdrawal of authorisation (license)

Next year’s issue Statistics & Research Feedback & technology update … Process closure