Risk Report
Our extensive risk management system proved its worth even in the difficult economic climate of the past fiscal year. The transparent presentation of individual risks allows us to manage our risk situation appropriately. From the present perspective all risks are contained and manageable. The future existence of the company is secured.
Efficient organization of the risk management system
Risk policy as part of corporate strategy
Formed on the basis of our corporate strategy, the risk policy at ThyssenKrupp is directed at safeguarding the existence of the company and continuously increasing its value.
Our risk strategy takes into account the risks and the opportunities associated with them. In areas where the Group has core competencies, we consciously take on manageable and controllable risks if they are expected to deliver an appropriate reward. Risks in other areas, however, are transferred where appropriate to other risk carriers. Beyond this we avoid risks wherever possible. Overall we ensure that the Group can cover in full any risks taken.
ThyssenKrupp has documented the framework conditions for orderly and forward-looking risk management in its risk management principles and "Group Risk Management" manual. These contain binding specifications and rules for the identification and management of risks. For example, conduct towards suppliers, customers and other business partners must be fair and responsible. Speculative transactions or other measures of a speculative nature are inadmissible. We check whether these principles are being observed by carrying out regular control measures. In addition, numerous and regular training programs help ensure that all employees are constantly aware of the rules.
Risk management system established in the Group
The risk management system introduced by the Executive Board of ThyssenKrupp AG for the Group has proven itself to be efficient. All employees of the Group are required to be aware of the risks in their area of responsibility. Direct responsibility for early identification and management of risks lies with the operating managers. The next organization level up in each case is responsible for risk control.
In a well-established bottom-up process, the Group companies report on the status of major risks using risk maps with tiered threshold values. The risks are evaluated and classified according to probability of occurrence and loss amounts. For each risk, risk reduction measures are reported; the early warning indicators are regularly updated and discussed with the responsible officers. The information on material risks to the Group is communicated in a systematic and transparent report to the Executive Board of ThyssenKrupp AG. The current risk situation is on the agenda of the Executive Board's bi-weekly meetings. In urgent cases, ad hoc risks and losses incurred are communicated directly outside the normal reporting channels.
In the past fiscal year we again conducted internal audits in Germany and abroad to check compliance with the rules of the risk management system at the Group subsidiaries. The findings from these internal audits helped further improve the early identification and management of risks.
In addition, we continuously enhance the tools and methods for identifying and managing risks. This allows us to manage risks in the Group on a more standardized and structured basis, reduce the number of manual activities in the risk management process and enhance the quality of the information generated. The decision made in connection with the reorganization of the Group to allocate centralized risk management to Corporate Center Controlling at ThyssenKrupp AG will permit closer interaction with the planning and reporting processes.
Opportunities and risks in balance
All risks taken by us are balanced by appropriate opportunities which we systematically identify, evaluate, manage and control. More details can be found in our opportunities report. We make the necessary provision to cover risks from strategic decisions.
Risk transfer by central service provider
As central service provider, ThyssenKrupp Risk and Insurance Services handled the transfer of risks to insurers and concluded the necessary Group insurance policies in 2008/2009, as in previous years. Regular loss analyses are carried out to evaluate the potential risks, and the insurance cover is determined on this basis. Under property and business interruption policies, significant deductibles exist in particular for some carbon and stainless steel production units, so that there is a risk that a claim on these policies could materially impair the Group's assets, financial position and earnings situation. To substantially limit the risk of insurers collapsing, we spread the risk over numerous insurers and only select insurers with a rating of at least A-.
To further develop and optimize risk prevention, binding standards are in place for all Group companies. Experts from all areas of the Group under the leadership of ThyssenKrupp Risk and Insurance Services are involved in these processes. Internal and external audits are conducted regularly to check compliance with these standards.
Central risk areas
Financial risks
Central responsibilities of ThyssenKrupp AG as parent company include the coordination and management of financial requirements within the Group and securing the financial independence of the Group. To this end we optimize Group financing and limit the financial risks. Risks in the individual financial risk areas are minimized through an ongoing process of monitoring and intensive controls.
Credit risk (default risk): We conclude financial instrument transactions in the financing area only with counterparties who have a very high credit standing and/or are covered by a deposit guarantee fund. To further minimize risks, transactions are concluded only within specified counterparty risk limits. Outstanding receivables and default risks are constantly monitored by the Group subsidiaries; in some cases they are additionally insured under commercial credit policies. The credit standing of key account customers is monitored particularly closely.
Liquidity risk: To secure the solvency and financial flexibility of the Group at all times, we maintain long-term credit facilities and cash funds on the basis of a multi-year financial planning system and a liquidity planning system on a rolling monthly basis. The cash pooling system and external financings are concentrated mainly on ThyssenKrupp AG and specific financing companies. We use the cash pooling system to allocate resources to Group subsidiaries internally according to requirements.
Market risk: Various measures are used to mitigate or eliminate the risk of fluctuations in the fair values or future cash flows from non-derivative or derivative financial instruments due to market changes. These mainly include off-exchange-traded foreign currency forward contracts, interest rate/ foreign currency derivatives and commodity forward contracts with banks and commercial partners. To hedge against commodity price risks we also use exchange-traded futures. The use of derivative financial instruments is extensively monitored, with checks being carried out on the basis of policies in the framework of regular reporting.
Currency risk: To contain the risks of the numerous payment flows in different currencies - in particular in US dollars - we have developed Groupwide policies for foreign currency management. All companies of the Group are required to hedge foreign currency positions at the time of their inception; companies based in the euro zone are required to hedge via our central clearing office. Translation risks arising from the conversion of foreign currency positions are generally not hedged.
Interest rate risk: As in previous years, we procured funds in 2008/2009 on the international money and capital markets in different currencies - predominantly in euros and US dollars - and with various maturities. The resulting financial liabilities and our financial investments are partially exposed to risks from changing interest rates. To manage these risks, regular interest rate risk analyses are prepared, the results of which are used in our risk management system.
Commodity price risk: Depending on the market situation, purchasing prices for raw materials and energy can fluctuate significantly. We minimize this price risk firstly through long-term supply contracts - e.g. for ore, coal and coke. Secondly, some Group companies use derivative financial instruments – mainly commodity forward contracts – to hedge against the risk of commodity price fluctuations, in particular for nickel and copper. Hedging via such financial instruments is subject to strict guidelines.
Details of these risk areas are provided under Note 30.
Risks associated with acquisitions, disposals and restructurings
Risks may arise from restructuring programs as well as from the disposal or acquisition of real estate, companies or other business activities. Where the occurrence of risks is probable, we have made adequate provision in the balance sheet.
Order and sales risks
The handling of major orders entails risks. Technical problems and quality problems with sub-suppliers can lead to higher-than-planned costs and cause schedule delays. Here, too, we continuously improve our management instruments to contain these risks. We minimize the risk of default by selecting customers carefully, keeping in contact with them and collecting progress payments.
As a globally active Group, ThyssenKrupp is particularly dependent on the international cyclical situation. We counter these market risks with a number of measures. We closely and continuously monitor the economic trend in individual countries and trade flows in order to minimize sales risks. For example, if necessary we cut back our production and adjust capacities. Our international presence makes us largely independent of regional crises. Our widely differentiated product and customer structure limits our sales risks in individual markets.
ThyssenKrupp is affected by the severe weakening of the worldwide automotive industry, one of our main customers. The reduced credit rating of key account customers harbors the risk of bad debt, which we are countering with effective receivables management. The sales risks are described in detail in the section headed "Specific risks for our operations".
Procurement risks
Rising prices on the procurement side are countered at ThyssenKrupp by passing on the higher prices in our product prices as far as possible. In addition, our purchasing departments are constantly searching for alternative low-cost suppliers worldwide. A structured procurement policy on the electricity market and long-term natural gas contracts reduce the risks on the energy markets.
To limit the risks of supply failures, we select our suppliers carefully. The geographical distribution of orders makes us independent of regional supply bottlenecks and helps us find alternative sources in the event of local supply problems. More details on our procurement management can be found in the section "Group Review".
Legal risks associated with third-party claims
Legal risks can result from claims in the areas of antitrust law and environmental law. Equally conceivable are claims for damages under product liability law, though we minimize these through the high quality of our products.
In addition, contractual partners have lodged claims against ThyssenKrupp under plant construction, supply and service contracts. Where it is probable that individual claims will lead to payment obligations, we have made provision.
Our strict compliance program reduces the risk of violations of antitrust and corruption law and the associated internal policies at all levels of the Group. We monitor and regularly update our internal rules and in-house compliance organization. In extensive training programs and online courses, we inform our employees about compliance requirements, infringement risks and potential sanctions. In 2008/2009 more than 2,500 ThyssenKrupp employees worldwide took part in classroom training sessions. To supplement the compliance training program, we have developed a Groupwide interactive e-learning program which is available in numerous languages. In the reporting year alone, e-learning courses on competition law were completed by 22,000 employees and anti-corruption e-learning courses by around 28,000 employees worldwide. ThyssenKrupp does not tolerate violations of statutory provisions and internal policies.
A report on pending litigation and claims for damages can be found in Note 29.
Regulatory risks
Changes to the legal framework can result in risks to our business, increase our costs and restrict our sales opportunities. Changes to competition rules in individual sections of the markets can also bring disadvantages for us. By intensively gathering information, we ensure that we can respond to such changes in good time. Through close working relations with the relevant institutions we also endeavor to prevent changes to the legal framework from distorting competition.
For the Renewable Energy Sources Act hardship clause, the criteria for defining an independent part of an enterprise have changed and this could lead to an increase in electricity costs.
Environmental risks
Due to our production processes, we are exposed to process-related risks of air and water pollution. Intensive and continuous pollution control measures and investment in environmentally friendly facilities in our production operations help minimize environmental impact and conserve resources. In addition, the large number of Group companies with certified environmental management systems reduces the risk of environmental damage. More details on environmental protection at ThyssenKrupp are provided in the section "Sustainability and environmental protection".
Some of our real estate is subject to risks from past pollution and mining subsidence. We counter these risks with preventive measures and scheduled remediation work, for which we again recognized adequate liabilities in the reporting year.
Emission allowance risks from EU proposals
The plans of the European Commission to increasingly auction CO2 emission allowances from 2013 pose risks for our production costs. We are closely monitoring the political debate on this. As an energy-intensive industrial and services group operating in a competitive international market, we would likely be unable to pass on all or any of the additional costs from increased auctioning to our customers. This would entail risks for our earnings situation.
The allocation system benchmarks yet to be determined and the capping of free certificates will probably lead to a significant reduction in allocations in the next emissions trading period (2013 – 2020).
We are closely following the political developments concerning the introduction of a US emissions trading system so that we can implement strategic plans in good time and compete successfully in the USA on the basis of our know-how and experience.
Risks associated with information security
We continually review our information technologies to assess whether they guarantee secure handling of IT-supported business processes. If necessary, the systems are updated and optimized, because information security is not a status but a work-in-process in which risks and associated protective measures are assessed. The IT-based integration of business processes is subject to the condition that the risks involved for our Group companies and also for our customers, suppliers and other business partners are minimized. Internal policies are therefore in place under which all Group companies are obligated to ensure that information security measures are implemented to the maximum extent possible. In the reporting year we carried out extensive measures to systematically develop our information security management system in accordance with ISO / IEC27001. In addition, at selected Group companies business processes and data centers have security certification.
In view of the increasing risks we took the precautionary measure back in fall 2008 of setting up an Information Security Competence Center to make our IT centers and computer networks even more secure and protect them more effectively from attacks and other external interference. Added to this is the work of our "IT Compliance" team at corporate headquarters, who provide the Group companies with advice and support on all information security matters. Furthermore, e-learning modules on the secure handling of business information are available on the intranet to all employees worldwide. In addition, we organize information security awareness training courses for employees and managers. In parallel with this the ThyssenKrupp Information Security Forum set up in 2004 is now successfully established.
Together with the Group's data protection officers, our information security experts ensure that personal data are processed only in accordance with the rules of the German Data Protection Act. All these measures will allow us to continue to protect the Group's business data as well as the privacy of our business associates and employees through preventive action and to respond appropriately to potential new risks.
Risks associated with pensions and healthcare obligations
The fund assets used to finance pension liabilities are exposed to capital market risks. To minimize these risks, the individual investment forms are selected and weighted on the basis of asset liability studies by independent experts. The aim is to adjust the investments to ensure that the associated pension liabilities are permanently fulfilled in respect of the current and future income from the investments. Pension obligations are subject to risks from increased life expectancies of beneficiaries and from obligations to adjust pension amounts on a regular basis. In addition, the cost of healthcare obligations in the USA and Canada may increase. Furthermore, in some countries there is a risk of significantly higher payments having to be made to finance pension plans in the future due to stricter statutory requirements. In individual cases, the premature cancellation of a pension plan may necessitate an additional allocation. More details are provided in Note 23.
Personnel risks
Committed and competent staff and managers are a central factor in the success of ThyssenKrupp. We have a number of measures in place to counter the risk that key personnel cannot be found to fill vacancies in our Group or that they cannot be retained. We position ourselves as an attractive employer and promote the long-term retention of employees in the Group. We continue our systematic management development program offering executives career prospects and attractive incentives. We are intensifying the targeted mentoring of our employees to promote identification with the company at all levels.
We adhere to our high-quality training system even in difficult economic times. By establishing contact with interested young people from an early age, we can inform them about career opportunities at ThyssenKrupp and secure the young talent we need for our workforces. We also systematically continue our intensive cooperation with key universities to establish contact with talented students early on. More information on these matters is provided in the section entitled "Employees".
General economic risks
The global economy will stabilize only gradually. After a 1.4% fall in global GDP in 2009, we expect growth of only 2.7% in 2010. This forecast is based on a number of assumptions – for example that the geopolitical situation remains largely stable and the risks arising out of the international financial crisis do not grow more severe but gradually recede.
However, economic downside risks remain. Unless the financial crisis is overcome to a large extent in 2010, there could be a negative rebound. With the monetary and fiscal latitude having been narrowed, there is less scope for further government stimulus programs. The assumed low-level economic recovery would also be at risk if key countries were to initiate fiscal consolidation too quickly. Tax increases, premature interest rate increases by the central banks and stronger than expected rises in unemployment could also strongly impact growth prospects.
For 2010 we expect a largely stable euro exchange rate and only moderate increases in energy and raw material prices. However, the balance of payments deficit in the US harbors the risk of an increasingly weak US dollar/strong euro, which could curb export opportunities in particular for German industry. A weaker US dollar could lead to a surge in prices on the energy and raw materials markets.
Specific risks for our operations
Carbon steel flat products sucked into the economic crisis
For our European carbon steel flat-rolled operations, which effective October 01, 2009 now form the Steel Europe business area, risks to future growth include in particular risks on the sales and procurement markets and risks from emissions trading. Should the difficult economic situation continue, the already existing risk of customer insolvencies will increase. We counter the risk of a continued economic crisis through cost optimization in all areas, prompt production adjustments, and a concentration on high-end market segments subject to less cyclicality. To contain the increasing risk of customer insolvencies, we have set internal limits for each individual customer.
In view of the risk of rising raw material and energy prices, we constantly seek out alternative procurement sources and wherever possible pass on price increases to our customers. We minimize our quality risks by continuously optimizing our value chains.
To be able to insure against major risks and reduce costs in the event of damages claims, it is especially important to avoid losses by taking preventive action. For this reason, a business and technical risk controlling system for property insurance is an integral component of our risk management process. In the event of business interruptions, we have business continuity plans in place with concrete measures for remedying damages.
The volume and price risks for emission allowances in the second trading period from 2008 to 2012 have been minimized through a Groupwide emissions trading strategy.
Intensive project controls for major projects in America
Our major carbon steel investment projects in America – which have been combined in the Steel Americas business area since the beginning of the new fiscal year – remain at risk of further implementation problems such as delays and budget overruns. Thanks to intensive project controls, tighter project management and weekly project meetings and reports, we are able to identify and communicate all risks relevant to the realization of these projects in good time. In addition, our efficient claims management system ensures that all claims from our contractual partners are properly handled and managed. Furthermore, ThyssenKrupp is involved in legal, arbitrational and out-of-court disputes in connection with the construction of the melt shop and coke plant in Brazil which could lead to compensation payments.
Risks associated with the startup of future production are minimized by extended ramp-up periods and the careful selection and training of new employees. To contain potential sales risks, we began work on establishing and expanding a customer base from an early stage. Furthermore, the ramp-up of the two major projects is being staggered in line with the economic situation. More information is provided in the section "Business management – goals and strategy". The procurement risk for iron ore is reduced through long-term contracts and our close relationship with the Brazilian iron ore mining company Vale, which is a shareholder in our Brazilian steel facility.
Extensive measures to counter market risks at Stainless
In addition to the usual cyclical risks, our stainless operations – which have now been combined in the Stainless Global business area – face risks associated with the way the markets respond to existing and growing overcapacities at stainless producers in Asia.
Numerous measures are in place to counter these risks. We have extended our value chain towards the higher-margin end-customer business, further intensified customer relationships, expanded our custom services, and improved our quality and delivery performance. These measures are supported by newly developed applications for stainless steels and nickel alloys, innovative products made from these materials and modern, cost-saving process technologies.
To counter the risks of the current economic crisis, an extensive program of measures has been initiated and in part already implemented in the stainless plants which includes significant production cutbacks, administrative cost savings and further cost-reduction and efficiency-enhancement measures in all areas.
In the construction of the stainless plant near Mobile in Alabama/USA, further delays and budget overruns are possible. As with the construction of Steel Americas' neighboring processing plant, an intensive system of project controls, meetings and reports has therefore been installed here, too, to secure a detailed assessment of risks. All risks are identified and communicated.
To safeguard against nickel price risks, we have introduced a sliding-scale model which represents a sustainable hedging strategy. Under this strategy nickel futures are used to hedge some of the unhedged volumes which are exposed to the risk of commodity price changes due to fluctuations in the nickel price on the London Metal Exchange. The maximum hedged volume is 80% of the nickel volume subject to price risks calculated each month.
Action program to counter prices risks for materials services
Our trading and services business is mainly engaged in materials services for customers throughout the world. These activities have now been combined in the Materials Services business area. To counter the associated risks, our comprehensive action program includes a continuously improved system of net working capital management aimed in particular at optimizing inventories. In addition, extensive cost-reduction programs and corresponding capacity adjustments have been implemented. Ongoing project controls are in place to limit risks from the final completion of projects.
Cyclical risks are countered by the business's worldwide presence, broad customer base and high degree of diversification. The resultant wide spread of risks also applies to the bad debt risk, which is additionally limited by the use of hedging instruments.
Regional risks at Elevator largely balanced
The risk structure of our elevator activities – allocated to the Elevator Technology business area since the start of the new fiscal year – is mainly determined by two factors: the different business activities and the different regions in which we operate.
In respect of the business activities, the service and modernization business is comparatively unaffected by cyclical risks. To counter the loss of service units from an early stage, we employ marketing strategies aimed at retaining customers over the long term. In addition, ongoing efficiency-enhancement programs are carried out to offset frequent procurement cost increases, such as rising fuel prices, where these cannot be passed on in full to customers.
The situation is different in the new installations business, which is closely linked to the construction sector and therefore more vulnerable to cyclical fluctuations. The targeted use of project management measures helps contain risks in the processing of major orders. Furthermore, rising material prices are for the most part offset by efficiency improvements in production and optimized purchasing.
With regard to the regional distribution of business activities, the risks are largely balanced within the company, because Elevator is present in very different markets which are generally in different cyclical phases. The exchange-rate risks caused by operating in so many different regions are reduced by the prompt recognition of costs and sales.
However, the economic crisis has led to increased risks in connection with customers' solvency and financing options. This could result in bad debts and the postponement or cancellation of projects. Also, increasingly intense competition on all key markets is placing further pressure on prices. We counteract these trends with professional project management and by carefully monitoring the credit standing of customers. In addition, strong customer loyalty, high-quality services and effective efficiency enhancement programs help cushion the increasing price pressure.
Plant construction: Risk of financing problems for customers
For our plant construction companies, which have been combined in the Plant Technology business area effective October 01, 2009, the general risks lie in the future development of the global economy and the uncertain sales expectations in all relevant customer sectors. Financing problems for customers and decreasing raw material prices could lead to project deferrals or cancellations. Alongside these risks, attention also has to be paid to risks from the political situation for example in the Middle East. The additional specific risks associated with large long-term contracts and technically complex orders are contained through close project controls and increased use of project management measures.
Market risks in components business
For the activities which have been combined in the Components Technology business area since the beginning of the new fiscal year, the main market risks stem from a continued recession in the automotive industry. In automotive components we must continue to expect in some cases drastically reduced orders from the OEMs. To contain the risks, we have cut back production and reduced sales and administrative costs. The market risks are mitigated by our production capacities in China, where we are profiting from sales increases bucking the worldwide trend.
Risks at shipyards
Due to the global economic crisis and a decline in new orders, there is a capacity utilization risk for our shipyards. A sharp drop in freight rates and financing problems for customers have led to postponements and cancellations of newbuild contracts, in particular for container vessels and yachts.
To counter the resultant risks we have introduced concrete optimization measures which also extend to our operating processes. Effective October 01, 2009, our shipyard operations are now combined in the Marine Systems business area.
A further risk has resulted from the decision of the EU Commission in the Hellenic Shipyards (HSY) state aid case. The Commission investigated undertakings given to HSY by the Greek government before and during privatization in the period 1997 – 2002. On this basis it decided that some of the state undertakings in the catalogue investigated did not comply with the requirements of EU state aid law. ThyssenKrupp has claims under its rights of recourse in the event that the implementation of the ruling at national level leads to financial losses. Nevertheless in the event of an unfavorable outcome, financial losses cannot be ruled out. Furthermore, HSY and Howaldtswerke – Deutsche Werft GmbH (HDW) have cancelled the two submarine programs with the Greek government under which four class U-214 submarines were to be built and three class U-209 submarines modernized. Files for arbitration are to be made immediately to enforce claims against the Greek government arising out of the cancellation.
Corporate: Risk management through project controls and compliance
For Corporate, the construction of the ThyssenKrupp Quarter in Essen holds the risk of building cost increases and schedule delays. We systematically and continuously observe and analyze the construction project in a project control and compliance system. From the present perspective the buildings are expected to be completed on schedule. In addition there are risks of ground contamination from the past industrial use of real estate.
No threat to existence of company
No risks exist which threaten the existence of ThyssenKrupp. The efficient and tailored management of all risk categories helps contain the overall risks in the Group. Overall, the risk situation continues to be manageable.