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For more details on risk management.
The activity of PJSC RusHydro is associated with some risks which, under certain circumstances, may have negative influence on the production and financial results of the RusHydro, as well as the social and natural environment of the Company. The Company has developed a risk management system in order to minimize the negative influence of possible risks and implementation of favourable opportunities. The system is developed in order to ensure the execution of the Company’s strategy.
For risk management processes structuring, the Risk Control and Risk Management Department (hereinafter – CDandRM) was established within the Internal Control and Risk Management Unit.
CDandRM in its activity framework does the following key tasks:
INDEPENDENT EVALUATION OF THE RISK MANAGEMENT SYSTEM
The external evaluation of the CSICandRM effectiveness is carried out regularly during the audit of the performance of the Long-Term Development Program of the RusHydro Group, external audit of financial statements, survey of RusHydro’s facilities, compulsory due diligence as part of Mergers & Acquisitions risk assessment, and Conducting complex assessments of the effectiveness of the internal control system and risk management of the Company by invited independent experts.
The quality of the risk management system of PJSC RusHydro is regularly confirmed by an independent jury of international competitions (RusHydro’s victory in risk management in the contest «Best Risk Management-2015» in the category «Production Organizations», wins in the categories «The Best Integrated Risk Management Program», «The Best Risk Manager of Russia», conducted by the Russian Risk Management Society RusRisk – the Russian National Association of Risk Managers, member of the Federation of European Risk Management Associations FERMA, etc.).
More information about the risk management policy.
RISK MANAGEMENT METHODS AND APPROACH
The list of methods and approaches to risk management is defined by the Internal Control and Risk Management Policy (approved by the Board of Directors of PJSC RusHydro, Minutes No. 227 of 16.11.2015). The Company uses the following set of methods and approaches to risk management:
According to the PJSC RusHydro strategic management provision, the Company compiles the Register of strategic risks on an annual basis. This document is subject to approval by the Board of Directors. The Board approves the plan of strategic risk management for dealing with the critical and significant risks. The plan stipulates the terms of actions, persons responsible for them, and their expected results. The efficiency of the execution of risk management actions and the KPIs is taken into consideration in the distribution of bonuses to employees. The monitoring and control of the plan’s execution is carried out by the risk managers of the Company.
STAGES OF STRATEGIC RISK MANAGEMENT
The risk managers interact with the members of the Audit Committee of the Board of Directors for the purpose of controlling the functioning of the risk management system of PJSC RusHydro, which corresponds to the guidelines on the audit of the Boards of Directors of companies with the involvement of the Russian government (stipulated by decree no. 86 of the RF Federal Property Management Agency of 20.03.2014)
According to the Company’s Corporate Governance Code, the Board of Directors (Audit Committee) carries out an analysis and assessment of the risk management and internal control system performance at least once a year. The results of this analysis and assessment are reviewed at a meeting of the Board of Directors (Audit Committee).
In 2016, the Audit Committee conducted an evaluation of the risk management system, which includes:
In June 2017, the Board of Directors will review the report on the functioning of the corporate internal control and risk management system.
more details on the stages and methods of risk management .
CORPORATE DOCUMENTS
The Internal Control and Risk Management Policy of the Company is the main document stipulating the goals, purpose, and principles of the corporate risk management control system efficiency of PJSC RusHydro.
More details on internal control and risk management .
Documents stipulating strategic risk management
More details on regulatory documents .
IMPROVEMENT OF INTERNAL CONTROL AND RISK MANAGEMENT SYSTEM
In order to improve the CSICandRM, the Company implements the program for the development of the RusHydro Group’s CSICandRM by 2019 (approved by the Management Board of PJSC RusHydro on November 28, 2014), and the plan for improving the Company’s internal control system for the reporting year is approved annually.
The Company currently focuses on the improvement of the CSICandRM in the following areas of activity:
In 2016, in order to improve the risk management system, the following key actions were implemented:
Corporate level
The implemention of the system of scenarios/indicators of realization of strategic risks of PJSC RusHydro and RusHydro Group will allow to:
Business and operational level:
More information on improving the risk management system.
RISKS CAUSED BY ACTIVITY OF THE COMPANY
The current register of strategic risks associated with the Company’s operations was formed on the basis of the register of the previous period and analysis of external information and approved by the Company’s Board in November 2016.
More details on the formation of the risk register go to the .
The strategic risk register, taking into account their ranking according to the likelihood of implementation and impact on the Company’s and Group’s business, is presented at the Risk Radar. The Radar reflects the Company’s risk profile in 2016-2017. The risk ranking presented in the Radar reflects the priorities of the management to ensure the Company’s readiness for possible negative scenarios for the development of the overall risk environment.
PJSC RusHydro Risk Radar for 2016-2017
PJSC RusHydro strategic risks register
The risk is related to a wide range of investment programs for the next few years, and the complex management and financing structure of a range of products.
Risk factors: At the initiation and design stage:
At the implementation stage:
Other:
The arrangement of data on the designed projects:
The development of the internal expert review of design and detailed design documents:
Control over the quality of work, schedule and cost:
The risk is critical due to overregulation of the electricity and capacity market, highly volatile electricity prices on WECM, variability of fuel prices for PJSC RAO Energy System of the East, decreasing payment capacity of contractors resulting from the effects of financial crisis, unfavourable conditions (dry years), difficulties in forecasting the payload of the equipment.
The critical risk of unfavourable changes/ violations of law is one of the most significant for the power industry not only in Russia, but worldwide.
The safety, insurance, environmental and other regulatory requirements are getting more stringent.
Possible claims of tax authorities, due to the uncertainty of tax legislation.
The risk is mitigated within the red zone due to the implementation of the comprehensive modernisation programme and the respective equipment reliability and safety growth. However, taking into consideration the potential consequences of risk occurrence, which may threat human life and health and lead to the disruption of production and further reduction of the Company’s revenue, the risk remains in the focus of attention of the managers of the Group.
The negative effect on the risk probability of severance of managerial ties is possible in case of Company privatisation and/or restructuring of the management system by cash-generating units and projects under construction. Here the risk factors result from design faults manifesting at the operation stage, equipment deterioration, the violation of operating conditions, untimely repairs, re-equipment and reconstruction, low-quality repair, the low-quality of construction and installation works connected with re-equipment and reconstruction, the human factor, and environmental factors.
All of them may lead to the breakdown of major equipment and deterioration of hydrotechnic structures. As estimated by the Company, the probability of the breakdown of equipment and structures stays within the industry-average level. All main production facilities of PJSC RusHydro are insured.
Against ongoing stagflation and international sanctions, the risk may be slightly mitigated due to the reconsideration of investment priorities. At that, given that international sanctions continue, the risk of the unavailability of borrowed funds on terms favourable for the Company is growing due to the existing covenants set forth in the Group’s loan agreements. Most of the affecting risk factors are represented by the country and external factors of the Group.
The risk of external fund shortage is critical for the Company. It is closely bound with the implementation of capital construction projects. The full or partial reduction of financing sources within the framework of the investment programme may cause the late completion of ongoing projects or the Company’s being forced to suspend construction or even suspend the construction of a number of facilities.
Taking into account high cost of preservation of facilities under construction, which in some cases is comparable with the cost of proceeding with the construction, this fact will affect the economic efficiency of the Company’s investment projects, as well as its financial and performance results.
This risk correlates with the risk of a shortage of funds for investment. There are possible disruptions of competitions, equipment supplies, rendering of services by foreign counteragents, reviews of bank guarantees issued by foreign banks.
In the crisis, the key development opportunity is quality growth and cost reduction at all stages of the life cycle of the Group’s assets, largely due to reduced risks of engineering activities.
At the same time, it is possible to restrict access of engineering companies to credit facilities in the event of long-term international sanctions and difficulties in obtaining funds in freely convertible currency.
The company considers this risk to be significant because of the significant importance of the engineering business within the life cycle of production assets.
This risk is caused by general political and social tensions, the activity of armed groups in the North Caucasus and their attempts to expand their activities to other regions of the Russian Federation, the high probability of local and regional armed conflicts, the growing threat of international terrorism and political instability in a number of developing countries caused by the economic crisis, as well as the activity of extremist organisations, and growing commercial terrorism.
In this context, PJSC RusHydro expects the growth of risks related to terrorist activities aimed at hydroelectric power facilities.
Lack of coordination with international antiterrorist services in the event of tougher international sanctions. The upcoming events (World Cup in 2018, etc.), a large proportion of foreign-made ASIS.
Another risk factor is the growth of cyberterrorism threats (according to the Kaspersky Lab’s research, Russia belongs to the leaders in the rating of susceptibility to cyber threats).
The risk declines, remains significant for the Company. The risk may depend on slumping demand for electric power and capacity due to decline in production, intense competition with independent power supply companies and the development of energy-saving technologies, as well as consumers’ financial insolvency caused by stagflation and the development of energy-saving technologies.
The risk factors include a high level of competition, a threat of losing the last resort supplier status in retail regions and the possibility for construction of alternative electric supply facilities by large consumers.
The internal control department of PJSC RusHydro analyses key business processes in order to improve the Company’s control system and enhance its process efficiency. Civil responsibility of the Company’s officers to any third parties is insured.
PJSC RusHydro introduces corporate management standards in reacquired or established subsidiaries and affiliates, as well as the systems of corporate project management, staff grading (grading means the establishment of a job hierarchy based on the job evaluation, strategy, and corporate culture of the Company), manager certification and implementation of individual personnel development plans.
Risk aggravation is connected with the uncertainty of consequences and difficulties in forecasting such risks. This is one of the most significant risks for fuel and energy companies, according to insurance companies.
Protection procedures are being improved, but there may be the risk of force-majeure events including incidents similar to the flood of 2013. There is the probability of systemic accidents and damages caused by natural disasters.
The growing risk; such incidents are possible due to the conflict of interests in case of restructuring (including privatisation), though the efficiency of risk management is constantly improving.
The growing probability of such risks all over the world, according to the findings of international consulting companies.
The risk growth against stagflation and the toughening of international sanctions is caused by the adoption of new requirements for the elaboration and implementation of innovation development programs by regulatory authorities, the growing gap between the currently used technologies and the best international practices, as well as the lack of financing for design and survey work due to the risk of fund shortage.
However, there arise new opportunities for innovation development, which may increase competitiveness in case of decline in the exchange rate of the Russian national currency.
The risk is mitigated, since it is largely the factor of the risks described above. and its occurrence does not directly lead to damages, but may contribute to the possibility of the risks listed above.
This risk includes the failure to accurately forecast power output in the medium- and long-term perspectives.
Arrangements for management of accounts receivable of the Company and marketing subsidiaries, including initiation of claims and lawsuits, settlements outside the authorized credit institution on the Wholesale Electricity and Capacity Market (WECM) in accordance with the terms of Contract of connection to the WECM trade system.
Foto: Sakhalinskaya TPP-2 main building Frame was built.
The Russian economy is not protected against market decline and global economic recessions. The decline in the volume of foreign investment in the Russian economy, as well as the vulnerability of the Russian economy to changes in world energy prices, can lead to a significant restriction of the Company’s access to capital and adversely affect the purchasing power of consumers of products and services.
Moreover, under the economy stagnation, there is a risk of reduced demand for electricity, which can result in decreased sales and corporate revenues, as well as the risk of growth in accounts receivable due to non-payment by electricity consumers. Vulnerability to a country risk with some allowances can be indirectly measured using the credit rating (not taking into account the political risks for the business).
According to the international rating agency Standard & Poor’s, the long-term credit rating of the Russian Federation on foreign currency obligations remains at the level of «BB +». At the same time, the outlook for the long-term credit rating of the Russian Federation was revised by S&P on September 16, 2016 from negative to stable. According to analysts, external risks for Russia declined, the Russian economy is being adapted to low world prices for raw materials. The downgrade of ratings may occur if geopolitical events lead to stricter sanctions of foreign states against the Russian Federation.
The impact of financial risks (risk of growth rates on bank loans, currency risk, inflation risk, liquidity risk) on the Company’s activities is estimated as insignificant.
Financial metrics, liquidity, financing sources and RusHydro’s performance are not very responsive to changes in the exchange rate and interest rates, because the Company sells energy on the domestic market, as well as settles accounts with resource suppliers, and accrues and receives payments from consumers mainly in the national currency – Russian ruble.
Due to the aggravation of the international situation, economic sanctions and other force majeure circumstances, the risks of access to the funds of foreign counterparts is increased well as the debt cost of PJSC RusHydro and the losses due to the growth of the exchange rate of foreign currencies and interest rates. Control over these risks consists in reducing the limits for counterparty banks with a lowered rating, stress testing of possible losses due to the currency appreciation and interest rates in the framework of the methodology of currency and interest risks managing and legal support of the contractual base, approved by JSC RusHydro.
The credit portfolio of PJSC RusHydro mainly consists of the loans with fixed interest rate. Some of the loans of PJSC RusHydro have been taken at variable interest rates of MosPrime and Euribor. In order to minimize interest risk, PJSC RusHydro concluded a swap contract to fix a floating interest rate for the loan of PJSC Sberbank (~ 836 million rubles as of December 31, 2016).
The rate of inflation directly depends on the political and economic situation in the country.
The inflation rate is associated with the overall dynamics of interest rates.
The negative impact of inflation on the financial and economic activities of the Company manifests in the growth of the following risks:
The significant impact of inflation on the financial performance of PJSC RusHydro is worth mentioning. The increase in inflation may lead to an increase in the costs of PJSC RusHydro and, as a consequence, to a fall in the profit and profitability of the activities of PJSC RusHydro. In addition, the growth of inflation is associated with an increase in the cost of borrowed funds for PJSC RusHydro, which is characterized by a risk of shortage of current assets of the company.
According to Rosstat, annual inflation in the Russian Federation (CPI) in 2016 reached its minimum since 1991 – 5.4 % compared to 12.9 % in 2015. In accordance with the forecast of social and economic development of the Russian Federation for 2017 and for the planned period 2018-2019, published by the Ministry of Economic Development of the Russian Federation, the annual inflation rate in 2017 is estimated to be no higher than 4.5 % for all variants of the forecast.
In case of inflation growth, PJSC RusHydro plans to increase the turnover of current assets due to changes in contractual relations with consumers.
The Company is specifically exposed to industry risks due to possible changes in the electric power industry.
On the one hand, one should note the decrease in the uncertainty of the work of PJSC RusHydro in the wholesale capacity market associated with the transition in 2015 to a long-term competitive power take-off model, which stipulated in the Wholesale Electricity and Capacity Market Rules (approved by RF Government Decree No. 1172 of 27.12.2010). Based on the results of competitive capacity sampling conducted before 2017, prices for capacity for the period up to 2020 (inclusive) were determined. An increase in the price forecast for future periods reduces the level of industry risk.
At the same time, within the framework of the ongoing reform of the electric power industry, there is constant changes of norms of regulating the Russian electricity market, including norms for market liberalization, setting price rates for electricity, functioning of the capacity market and the system of relations between electricity producers and consumers. Since the official launch of the reform (July 2001), the time frame for implementing the stages of the reform and the scope of such stages has changed several times.
Within the framework of industry risks management the necessary measures have been taken to create a favorable for PJSC RusHydro Legal framework for the functioning of the electricity and capacity market. To fulfill this task, PJSC RusHydro participates as an expert in the development of legal acts in the field of electric power industry at the sites of the Ministry of Energy of the Russian Federation, the Association NP Market Council and the Federal Antimonopoly Service.
In addition to the existing risks inherent in the Russian electricity and capacity market, a large number of operational, commercial, technical, managerial, regulatory and other risks can arise which are currently difficult or impossible to foresee and which are beyond the control of JSC RusHydro. These changes and the uncertainty associated with them can have a significant adverse impact on the economic activities of PJSC RusHydro, its revenues and the results of its operations.
The energy retail companies of the RusHydro Group are at risk of increasing competition when working in the retail market due to the intensification of the work of energy retail companies seeking to attract large consumers to their services. To manage this risk, energy retail companies of the RusHydro Group are directed to work with the client base. The measures to neutralize the risk associated with the loss of consumers include:
Risks associated with the region’s geographical features include the risk of losses (for example, the risk related to the decommissioning of fixed assets) due to seismic activity, avalanches and mudslides, possible landslides and rainfall related floods and other adverse weather conditions (hurricanes, heavy snowfalls and frosts).
Most the regions the Company operates in have a developed transportation infrastructure and are not exposed to the risks associated with the disruption of the transportation link. However, some generating assets are located in remote areas with harsh climates, including in the Krasnoyarsk Region and in the areas of the Far Eastern Federal District.
The Company is constantly working to upgrade the technologies of access and work in harsh climatic conditions in these areas. However, one cannot guarantee that no additional costs will be required to overcome technical difficulties associated with the climate and the accessibility of these locations, which may negatively impact overall revenues, financial conditions, and the Company’s performance and prospects.Thus these risks are estimated as insignificant within the foreseeable future.
With a view to the tense political and social situation, the revitalisation of armed groups in the North Caucasus and attempts to move their activities on other Russian Federation regions , the high probability of local and regional armed conflicts in the Russia bordering territories, the increasing threat of international terrorism and political instability in a number of developing countries caused by the economic crisis, the activity of extremist organisations, and developing commercial terrorism, PJSC RusHydro is concerned about possible risks associated with terrorist attacks, in particular at its North-Caucasian facilities.
Security is maintained constantly to reduce such risks. The comprehensive program aimed at ensuring safety and protection of the PJSC RusHydro facilities from terrorism is being implemented. The regular inspections of the antiterrorist security of the Company’s facilities and personnel training, in particular by anti-terrorist drills and trainings, are being carried out.
The plan for strengthening the security of the Company’s facilities is being implemented. The plan amends the existing security program applied to the power plants including sites under construction. The factors affecting the security of facilities are being monitored. Information security audit is being conducted.
The armed security of facilities is being provided by units of private security of Rosgvardia, FSUE «Okhrana» of Rosgvardia and FSTEC Departmental Security Service of the Russian Federation Energy Ministry. Plans for cooperation with law enforcement authorities are being developed to ensure the protection of facilities in case of a terrorist attack or the threat thereof. Access and internal security control has been introduced within the Company’s facilities. Unlawful interference acts in the Company’s facilities activities prevention work is being carried out in cooperation with law enforcement agencies.
The most relevant threats are being evaluated and consequence management plans are being elaborated in cooperation with the local EMERCOM of the Russian Federation regions (at generating facilities). The main equipment of the company is insured, in particular against terror attacks.
At the same time, international experts do not currently attribute the risk of terrorist attacks to the key risks of the Russian business community – according to the global risks report of the annual Global Economic Forum in Davos (Global risks 2017), the risk of terrorist attacks was ranked 17th in the ranking on the significance of risks to the Business in the Russian Federation.
Most of the Company’s facilities are located in seismically quiet regions. However, such facilities as the Pauzhetskaya GeoPP and the Verkhne-Mutnovskaya GeoPP are located in seismic zones, with possible earthquake intensity up to 9 points on the Richter scale. The Company is currently working to create the seismological network of the Dagestan Branch. In 2014, B.E. Vedeneev VNIIG performed seismic monitoring of the Bureyskaya HPP facilities.
The Company has developed an emergency plan in case of earthquakes and is constantly monitoring the situation. There are seismic monitoring stations at the Company’s facilities. Issues relating to the transportation link are refined in good time with a focus on the above-mentioned risk. Cargo and people transportation schemes are optimized. All corporate facilities comply with earthquake resistance standards.
The risk of seasonal floods plays an important role in corporate activities and is regularly included in the list of critical risks. To manage this risk, the Company has implemented a water regime management, i.e.: forecasting and monitoring hydrological regimes within the facilities, reservoir regulation, spillway construction and operation and other measures.
The Company has also established flood commissions in order to prepare for the spring-summer flood discharge at the Company’s branches. They implement numerous measures aimed at ensuring a trouble-free flood season. In particular, they were making a survey of ice conditions in the area of the dam location, inspecting permanent supports to make sure they are ready for work, to conduct readiness checks of back-up power supply units, releasing the gates of the service spillway from icing and ice fringe so that they could be maneuvered, and to perform inspections of hydropower structures, the drainage system of the dam, the power house and the installation site, visual inspection of the dam body abutment to the shores from the upper pool and lower pool.
Company’s facilities operate in accordance with the instructions of the interdepartmental working group of the Federal Water Resources Agency. The control of production assets was strengthened. No accidents at the Company’s facilities have been recorded in 2016.
More details on the insurance protection.
RusHydro’s insurance protection is built based on the normalization principles of the insurance protection system, the optimization of insurance coverage, the unity of approaches to insurance organization, and insurance continuity.
INSURANCE COMPANY SELECTION
The Company annually seeks for an insurer to enter into an insurance on the basis of regulated procurement procedures. To ensure insurance coverage, PJSC RusHydro conducted an open one-stage tender without preliminary qualifying selection for the right to conclude insurance contracts in 2016. Requirements for insurance coverage are formed on the basis of an analysis of the current risk situation of the Company, analysis of the insurance market’s options, social policy and legal requirements.
TYPES OF INSURANCE COVERAGE
In 2016, the insurance coverage of PJSC RusHydro and its subsidiaries was provided for the following types of insurance:
RusHydro imposes strict requirements with regard to insuring its assets (property insurance against all risks and insurance against construction and installation risks), and due to the limited resources of the Russian insurance market also puts forward additional demands and effects control over risk re-insurance. The Company is implementing a policy of openness to foreign insurance community representatives. Each year, the Company organizes insurance engineering surveys for its facilities, and holds road shows, negotiations and follows reinsurers’ recommendations.
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2.3 The financial performance