Methodology for Supervisory Examination and Assessment for Investment Firms

Methodology for Supervisory Examination and Assessment for Investment Firms OFFICE OF THE FINANCIAL SUPERVISION AUTHORITY WARSAW, APRIL 2016

KNF – BION Methodology for Investment Firms 1 Table of Contents

1. INTRODUCTION ......................................................................................................... 2 1.1 Purpose of BION .................................................................................................................... 2 1.2 Formal conditions for the BION process............................................................... 2
2. ORGANIZATION OF THE BION PROCESS............................................................... 5 2.1 Phases of the BION process ................................................................................................... 5 2.2 Basic principles and assumptions of the BION process ....................................... 6 2.3 Areas subject to supervisory assessment .................................................................. 8 2.4 Basic model for assigning a supervisory assessment ....................................... 8
3. CRITERIA FOR ASSESSING INDIVIDUAL AREAS.................................... 10 3.1 General criteria ........................................................................................................ 10 3.2 Specific criteria............................................................................................... 12 3.2.1 Business Model Analysis.............................................................................. 12 3.2.2 Management .......................................................................................... 12 3.2.2.1 Management of the investment firm................................................................ 12 3.2.2.2 Risk management and control tools.................................................... 13 3.2.2.3 ICAAP Process ............................................................................... 15 3.2.2.4 Reporting ......................................................................................... 16 3.2.3 Capital adequacy..................................................................................... 16 3.2.3.1 Level of capital adequacy .............................................................. 16 3.2.3.2 Credit risk ........................................................................................ 16 3.2.3.3 Market risk ........................................................................................... 17 3.2.3.4 Operational risk ....................................................................................... 18 3.2.3.5 Other types of risk.............................................................................. 18 3.2.3.6 Other elements........................................................................................ 19 3.2.4 Adequacy of liquidity and funding resources .............................................. 19 3.3 Additional factors correcting the assessment.................................................. 19
4. SUPERVISORY ASSESSMENT................................................................................. 21 4.1 Aggregation of assessments for individual areas ............................................ 21 4.2 Boundary interpretation of assessments ................................................................. 23 APPENDIX NO. 1 – RISK CLASSES – DEFINITIONS .................................................. 24

KNF – BION Methodology for Investment Firms 2

1. Introduction 1.1 Purpose of BION The purpose of the supervisory examination and assessment process (hereinafter: the BION process) is to identify threats to the stability of an investment firm by determining the level and nature of risks to which the investment firm is exposed, assessing the quality of management processes (including the risk management system), assessing the adequacy of capital covering risk resulting from the investment firm's operations, assessing the adequacy of liquidity and funding resources, and assessing compliance with legal regulations governing the activities of investment firms. 1.2 Formal conditions for the BION process List of formal conditions related to the BION process:  Act of 29 July 2005 on Trading in Financial Instruments (Journal of Laws of 2014, item 94, as amended, hereinafter referred to as: "Trading Act"),  Act on Macroprudential Supervision over the Financial System and Crisis Management in the Financial System (Journal of Laws of 2015, item 1513, hereinafter referred to as: "Macroprudential Supervision Act"),  Act of 29 July 2005 on Supervision over the Capital Market (Journal of Laws of 2014, item 1537, as amended, hereinafter referred to as: "Capital Market Supervision Act"),  Act of 21 July 2006 on Supervision over the Financial Market (Journal of Laws of 2016, item 174, hereinafter referred to as: "Financial Market Supervision Act"),  Regulation of the Minister of Finance of 20 November 2009 on conducting supervisory examination and assessment of investment firms (Journal of Laws of 2009, No. 207, item 1596, hereinafter referred to as: "BION Regulation"),  Regulation (EU) No 575/2013 of the European Parliament and of the Council of 26 June 2013 on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012 (Official Journal of the European Union L 176 of 27.6.2013, as amended, hereinafter referred to as: "CRR Regulation") and Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC (Official Journal of the European Union L 176 of 27.6.2013, as amended, hereinafter referred to as: "CRD IV Directive"),  Regulatory Technical Standards and Implementing Technical Standards constituting implementing regulations for the CRD IV/CRR package (hereinafter referred to respectively as: "RTS" and "ITS"),  Regulation of the Minister of Finance of 24 September 2012 on specifying detailed technical and organizational conditions for investment firms, banks referred to in Article 70(2) of the Act on Trading in Financial Instruments, and custodian banks, and conditions for estimating internal capital by an investment firm (Journal of Laws of 2012, item 1072, hereinafter referred to as: "ICAAP Regulation"),

KNF – BION Methodology for Investment Firms 3  EBA Guidelines on common procedures and methodologies for the supervisory review and evaluation process of 19 December 2014 (hereinafter referred to as: "SREP Guidelines") and other EBA guidelines regarding areas subject to supervisory assessment in accordance with this methodology,  KNF guidelines, principles, and positions covering the activities of investment firms. Due to regulatory changes occurring in Europe regarding prudential supervision over investment firms, including in particular the introduction of the requirements of the CRD IV Directive and the CRR Regulation, it became necessary for both investment firms and supervisory authorities to adapt mechanisms and processes subject to the above changes. The basis for conducting BION has so far been Article 98i of the Trading Act and the BION Regulation. It should be noted that Article 98i of the Trading Act, due to the necessity of transposing the provisions of the CRD IV Directive into Polish law, was repealed by Article 72 point 17 of the Macroprudential Supervision Act. The amendment to the Trading Act entered into force on 1 November 2015. At the same time, the transitional provision of the Macroprudential Supervision Act, Article 93(1), indicates that executive provisions issued on the basis of Article 98i(2) of the Trading Act remain in force in their current wording until the entry into force of executive provisions issued on the basis of Article 110x of the Trading Act, but no longer than 18 months from the date of entry into force of the Macroprudential Supervision Act (i.e., until 2 May 2017). Due to the fact that, at the time of drafting this methodology, the executive acts referred to in Article 110x of the Trading Act have not been issued, the BION Regulation is the basis for conducting the BION process. Furthermore, new provisions conditioning the conduct of the BION process by the Financial Supervision Authority (hereinafter: the Authority) have been introduced into the Trading Act, i.e., in particular, Articles 110r and 110s. At the same time, to ensure consistency of supervisory reviews, assessments, and measures within EU Member States, the European Banking Authority (EBA) – in accordance with Article 107(3) of the CRD IV Directive – issued the SREP Guidelines, which indicated the deadline for the implementation of these guidelines by Member States from 1 January 2016 and their application starting from the BION cycle taking place in 2016. The purpose of this BION Methodology is to indicate how to conduct the BION process in accordance with the SREP Guidelines, including in particular presenting the scope of supervisory examination and assessment and the principles for assigning supervisory assessments within the framework of supervisory activities performed. The BION Methodology applies to investment firms referred to in Article 95(1) of the Act of 29 July 2005 on Trading in Financial Instruments. With respect to investment firms that, from the catalog of brokerage activities in Article 69(2) of the Trading Act, conduct only activities specified in point 1 or 5 and at the same time do not conduct activities specified in Article 69(4) point 1 of the Trading Act, this methodology will be applied to a limited extent, inter alia, by excluding selected areas from the supervisory assessment. At the same time, it should be noted that after the executive acts referred to in Article 110x of the Trading Act are issued, this methodology may be subject to changes.

KNF – BION Methodology for Investment Firms 5 2. Organization of the BION process 2.1 Phases of the BION process The Authority conducts the BION process for investment firms based on the following general model:  Conducting supervisory stress tests.  Developing a supervisory assessment program and planning the BION process:  determining the method of performing planned supervisory activities and resource allocation,  determining the formula for assigning the BION assessment: full/ simplified/ supervisory visit/ inspection,  assigning cut-off dates for individual entities,  determining the scope of the BION questionnaire.  Preparation and sending of BION invitations/questionnaires.  Analysis of received documents.  Conducting a technical meeting with representatives of the investment firm responsible for risk management issues and clarifying doubts regarding the received materials (as a rule, in the full formula).  Conducting a main meeting with representatives of the Management Board and Supervisory Board of the investment firm and formulating findings from the process (as a rule, in the full formula).  Gathering additional information and explanations necessary for assigning a supervisory assessment.  Assigning a supervisory assessment.  Providing the investment firm with the supervisory assessment, along with justification and a list of findings or recommendations made during the process.  Determining additional supervisory measures and actions.  Review of tools and methodologies used for conducting the BION process. Phase II of the above model may vary depending on the assessment assignment formula and identified threats to the stability of the investment firm. Phase I Preliminary actions Phase II Core actions Phase III Final actions Ongoing supervision, conducted continuously

KNF – BION Methodology for Investment Firms 6 2.2 Basic principles and assumptions of the BION process

1. The Authority annually prepares and implements a supervisory assessment program, as referred to in Article 110s of the Trading Act.
2. Supervisory assessments are assigned to all investment firms in a given calendar year. This means that for each entity, a supervisory assessment is issued at least once in a calendar year.
3. The supervisory assessment is updated as of a specific date (cut-off date). There are two cut-off dates: 30 June and 31 December.
4. In the BION process, analytical supervision is the primary tool for assigning an assessment.
5. Within the framework of analytical supervision, the supervisory examination and assessment may be conducted in a simplified formula (based on documents and information provided by the investment firm) or a full formula (based on documents and information provided by the investment firm, as well as statements and explanations submitted by the entity's representatives at meetings held at the KNF office).
6. The supervisory examination and assessment process may be carried out using a supervisory visit or an inspection.
7. For the purposes of supervisory examination and assessment, the Authority uses the results of supervisory stress tests, as referred to in Article 110t of the Trading Act.
8. In the event of obtaining information which, in the Authority's opinion, may affect the investment firm's compliance with capital adequacy requirements, the Authority may update a previously issued assessment within no more than 6 months from the date of obtaining the information forming the basis for the update.
9. The principle of proportionality in BION is maintained, inter alia, by adjusting the scope of questions in BION questionnaires, as well as adapting the intensity of supervisory activities conducted to the size and type of brokerage activity carried out and the risk level of the investment firm.
10. The BION process is carried out based on a dialogue with the investment firm. This dialogue includes clarifying any doubts related to the risk in the investment firm's operations and the assigned supervisory assessment, followed by communicating the B