Introduction – Macquarie's risk management  framework Risk appetite setting The acceptance of risk is an integral part of Macquarie’s  businesses. Management of that risk is, therefore, critical to  Macquarie’s continuing profitability. Strong independent  prudential management has been a key to Macquarie’s  success and stability over many years. Where risk is  assumed it is within a calculated and controlled framework  that assigns clear risk roles and responsibilities represented  by ‘three lines of defence’.  The primary responsibility for risk management lies at the  business level, which forms the first line of defence. Part of  the role of all business managers throughout the Macquarie  business units is to ensure risks are managed appropriately.  The risk management function forms the second line of  defence and independently assesses all material risks. The  third line, which includes internal audit, independently  reviews and challenge the group’s risk management  controls, processes and systems.  Macquarie’s core risk management principles have remained  stable and continue to be highly effective. These are:  Ownership of risk at the business level  – Operating Group  Heads are responsible for identifying risks within their  businesses and ensuring that they are managed  appropriately. Before taking decisions, clear analysis  of the risks is sought to ensure risks taken are consistent  with the risk appetite and strategy of Macquarie. Business  ownership of risk is an essential element in understanding  and controlling risk.  Understanding worst case outcomes  – Macquarie's risk  management approach is based on examining the  consequences of worst case outcomes and determining  whether these are acceptable. This approach is adopted  for all material risk types and is often achieved by stress  testing. In particular, Macquarie's market risk framework  is based primarily on the application of stress tests, rather  than statistical models. The effectiveness of this approach  was demonstrated over the recent past. Shocks observed in  the markets generally remained within Macquarie's stress  scenarios, resulting in very few of our worst case loss  scenarios being exceeded. While Macquarie operates a  number of sophisticated quantitative risk management  processes, the foundation of its risk management approach  is the informed consideration of both quantitative and  qualitative inputs by highly experienced professionals. Requirement for an independent signoff by risk  management  – Macquarie places significant importance  on having a strong independent Risk Management Group  (RMG) that is charged with signing off all material risk  acceptance decisions. It is essential RMG has the capability  to do this effectively and hence RMG has invested in  recruiting skilled professionals, many with previous trading  or investment banking experience. For all material proposals,  RMG's opinion is sought at an early stage in the decision  making process and independent input from RMG on risk  and return is included in the approval document submitted  to senior management.  Risk appetite is the nature and amount of risk that the Group  is willing to accept. At Macquarie, this is expressed through  the Board-approved risk appetite statement, aggregate and  specific risk limits, relevant policies, and requirement to  consider risk adjusted returns. The Board reviews and endorses Macquarie’s risk appetite  as part of the annual corporate strategy review process. Macquarie's risk appetite statement is approved by the  Board and sets out the degree of risk Macquarie is willing to  take overall and for each material risk type. It also conveys  the process for ensuring that risk limits (tolerances) are set at  an appropriate level, monitored and reviewed. Macquarie  determines its overall appetite for risk with reference to  earnings and not just capital. Aggregate risk is expressed by  setting a Global Risk Limit designed to ensure that in a  prolonged and severe downturn, losses would be covered  by earnings and surplus capital, and market confidence in  Macquarie is maintained.  These consist of specific risk limits given to various  businesses and products or industry sectors as well as the  Global Risk Limit that constrains Macquarie’s aggregate level  of risk. In accordance with Macquarie’s ‘no limits, no dealing’  approach, individual credit and equity exposures must also  fit within approved counterparty limits. Market risk exposures  are governed by a suite of individual and portfolio limits. There are numerous Macquarie-wide policies that set out the  principles that govern the acceptance and management of  risks. A key policy is the  New Product and Business  Approval Policy , which is designed so that the proposed  transaction or operation can be managed properly and does  not create unknown or unwanted risks for Macquarie in the  future.  At Macquarie, proposals for all significant new deals,  products and businesses must contain an analysis of risk-adjusted returns. Risk capacity is allocated to activities that earn an  appropriate reward for the risk. This is a binding discipline  on risk acceptance to ensure the risk-return trade-off does  not deteriorate. The level of acceptable return for any  proposal must also account for strategic fit and broader  risk analysis (for example tail risk and concentration).  Existing businesses are subject to regular risk-return  monitoring and reporting. Risk-adjusted performance metrics  for each division are a significant input into performance  based remuneration.  23  1 Risk Appetite Statement  2 Limits  3 Relevant policies  4 Requirement to consider risk-adjusted returns  Risk Management Report 