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6. Risk management

Risk policy

The ThyssenKrupp Group's risk policy is aimed at systematically and continuously increasing corporate value and achieving the mid-term financial key performance targets within the scope of value-oriented management with active portfolio management. We knowingly accept reasonable and manageable risks, in particular when they are associated with the establishment and utilization of the success potential of our core competencies and the opportunities they present can be expected to provide an appropriate increase in value. If this is not the case, the risks are assessed to see whether they may be transferred to third parties. Apart from this, the Group has a code of conduct which is set out in policies and other directives, compliance with which is supported by training and monitoring measures. Speculative transactions or other measures of speculative character are inadmissible. Our conduct toward suppliers, customers and society is marked by fairness and a sense of responsibility. Overall, our measures are aimed at avoiding damage to the ThyssenKrupp brand.

Risk management system

On the basis of its bearing full responsibility for risk management within the Group the Executive Board of ThyssenKrupp AG has laid down the framework for systematic and efficient risk management by defining requirements to be met throughout the Group. This risk management system supports the identification and optimization of risks as well as perception of opportunities. Direct responsibility for early identification, control and communication of risks lies with the operating management of the risk holder; responsibility for monitoring lies with the next highest level.

As part of the risk management system and within regular reporting the occurrence, status and significant changes of major risks are communicated by the group companies bottom up, in line with the multi-layered corporate structure and with tiered threshold values. Apart from this, the segments also inform the Executive Board of ThyssenKrupp AG about the current risk situation on a bi-weekly basis.

The external auditors and Internal Auditing have examined in Germany and abroad the adherence of the group companies to the risk management system and their risk control measures. The consequent findings serve to further improve early risk identification and control.

Risk transfer

In agreement with the Executive Board of ThyssenKrupp AG, the central service provider ThyssenKrupp Versicherungsdienst GmbH controls the transfer of risks to insurers using global insurance programs.

Prevention measures have been further intensified in order to maintain affordable insurance coverage of major risks and reduce the costs in cases of loss or damage. Damage analyses are regularly created and evaluated, with the Group thus countering the risk of increased deductibles.

Financial risks

Central responsibilities of ThyssenKrupp AG include optimizing Group financing and containing financial risks. Thus also this year we succeeded to reduce financial payables.

In order to counteract risks arising from foreign currency transactions, commodity price volatility and interest rate changes, ThyssenKrupp uses derivative financial instruments. Generally, hedging of translation risks arising from currency conversion for subsidiaries with non-euro accounting does not take place. Interest rate risk management is disclosed in detail and interest rate sensitivity and hedging against commodity price risk in Note 28 to the consolidated financial statements.

Sale of real estate, companies, etc.

The disposal of real estate, companies or other business activities may entail certain processing risks. We have appropriately accounted for such risks that are likely to arise.

Information security

Assuring the safe processing of business transactions requires continuous evaluation and adjustment of the information technologies in use. The threat potential is also growing, e.g. due to the extensive integration of IT-supported business processes among subsidiaries and with customers, suppliers and business partners. To eliminate or at least minimize the risks related thereto, measures used to improve information security are being developed continuously.

Pension and health care measures

Our North American subsidiaries in particular have been unfavorably impacted by the weak international stock markets due to the system of fully funded pension plans; this has led to a significant rise in expenses. In addition, expenses for health care measures have increased considerably. With unchanged prevailing conditions, these burdens on income are expected to continue in subsequent years.

Pending lawsuits and claims for damages

Pending legal actions and compensation claims are disclosed in detail in the note 27 to the consolidated financial statements.

Real estate and environmental protection

ThyssenKrupp counteracts risks arising from the ownership of real estate, particularly risks from contaminated sites and mining subsidence, with appropriate preventive measures and the accrual of liabilities. Rising standards in environmental protection and conservation of resources are also causing increased expense in other areas. On the other hand, the use of modern plant and equipment has reduced rates and energy costs. The growing number of subsidiaries with certified environmental management systems has reduced the likelihood of environmental risks being realized.

Volatility of steel prices and dependency on the automotive industry

The volatility of steel prices and the dependency on the economic situation in the automotive industry may have a significant influence on the economic development of the Group. However, the widespread business portfolio, both product-wise and geographically, has a stabilizing effect. Therefore, from the Group's point of view, risks arising from individual subsidiaries or segments concentrating on specific industries, customers or countries are limited.

Personnel risks

The competencies and commitment of the management within the Group represent decisive factors for the development of ThyssenKrupp as well as for the recognition and successful management of risks. We shall continue to position ThyssenKrupp as an attractive employer and strive for long-term retention of senior executives in the Group to assure and consolidate these factors. In particular, the creation of perspectives, target group-oriented mentoring, the early identification and promotion of potential executives and an attractive incentive system for senior executives are elements of systematic management development.

Risks of future developments

For 2005 we expect real global growth of around 4%. The global economy therefore continues to perform robustly, albeit no longer as dynamically as in 2004. The forecast is based principally on the assumption that the oil price will gradually fall again, that there will only be a moderate increase in interest rates and that there will be no distortions on the currency markets.

Should raw material prices, and in particular oil, continue to rise e.g. due to geopolitical developments, this would lead to an appreciable slowdown in the momentum of the world economy. An appreciable rise in procurement costs could be expected, while on the sales side negative effects on demand in the Group's important customer markets cannot be ruled out.

Risks may also arise from currency market developments. A sustained increase in the euro against the US dollar would lead to a reduction in sales opportunities. In addition to the rising trade imbalance and federal deficit, a stronger than expected weakening of the US economy could also be seen as the cause of a strengthening of the euro.

Risks may also arise from developments in China. A sharp additional surge in demand from China may lead to further significant increases in raw material and energy prices. On the other hand, a major slow-down in the momentum of Chinese growth would have adverse effects on world trade.

The strongly export-dependent German economy in particular would be adversely affected by a greater than expected slow-down in the world economy, all the more so as domestic demand in 2005 will only see moderate growth, meaning that there can still be no talk of a self-supporting upward trend. With regard to economic policy, there is a risk that the reform efforts to strengthen Germany's competitiveness will lose momentum.

Segment risks

The Steel segment counters the risks arising from cyclical trends in the steel business by optimizing costs, adjusting production in a timely manner and concentrating on exacting market segments. To counteract financial risks through increased insurer's premiums, the Steel segment has integrated property insurance-related economic and technical risk monitoring into the risk management process. To further optimize preventive fire safety, common minimum standards have been defined for the entire segment.

Quality and delivery deadline risks are minimized through the optimization of the value chains. The segment counteracts currency risks arising from procurement and sales transactions through hedging.

The main risks for the Carbon Steel business unit include market risks regarding sales and procurement, risks from loss of production and increased expenditure for repairs following equipment breakdowns, as well as currency exchange rate fluctuations.

The business unit reduces the risk of limited core markets through globalization of manufacturing in downstream activities and enhanced internationalization of sales. The business unit counteracts the high competitive intensity in the market for carbon flat steel products through its innovation strategy, allowing competitive advantages to be attained, at least temporarily. The risk of rising raw material prices - caused by the growth in demand on the Chinese market - particularly for coke, ore and scrap, can only be counteracted to a limited extent by alternative procurement sources and/or by passing the prices on. Preventive maintenance, modernization and investments work against the risk of an unplanned production standstill.

The Stainless Steel business unit is confronted with risks arising on the one hand from market developments, particularly in Europe and China, and on the other hand due to expected overcapacity in stainless production, exacerbated by changes in worldwide supply flows through existing or new access barriers to major markets outside Europe. The companies of this business unit curtail such risks through measures of distribution, capacity and production control. Rising competitive pressure is countered by the development of new applications for stainless steels and nickel-base materials and innovative products from these materials, as well as modern and cost-saving process technologies. Beyond this, all subsidiaries of the business unit are strengthening their customer relationships through customer-centric service offerings, further quality improvements and better delivery performance.

The risks arising from the availability and the price development of raw materials, especially for nickel and alloyed scrap, are minimized by means of adequate contracts and assurance mechanisms.

The Automotive segment is lowering its dependence on regional markets by an increasing global presence, in particular in growth regions such as Asia and Latin America. Regardless of this, due to the current sales structure, further developments in North America are particularly important for the segment.

An ambitious segment-wide cost reduction program has been introduced to compensate for increasing price pressure from automotive manufacturers. The effects of these measures will be strengthened by improvements in earnings from restructuring measures introduced in the previous years.

Sales and earnings in the past fiscal year were affected by the strengthening of the euro against the US-Dollar and the Brazilian Real.

The structural market development was characterized by concentration trends on the part of automobile manufacturers and competitors. ThyssenKrupp Automotive counteracts such trends through dynamic internal and external, quantitative and qualitative growth.

Automotive is countering possible risks arising from the discontinuation of existing manufactured automotive products through research and development, and, if necessary, cooperation with partners or acquisition of investments, as well as the strengthening of its position as a system vendor. Major consideration is given to the increased use of alternative materials and the use of electric/electronic systems to replace mechanical solutions. At the same time, however, the increasing complexity of products as well as underlying production processes in some cases carry the risks of higher start-up costs and a strained income situation.

The international steel market is currently strongly influenced by China's expanding steel and primary material needs. The major price rises for scrap resulting from this have had a significant impact on earnings for the segment's North American foundries as price increases can only be passed on to customers with a time delay. A continuation of the development in steel prices also carries significant risks for earnings at the steel-processing companies.

While the operating performance of the Elevator segment's new installation business is dependent on the situation in the construction sector, this is not the case with the modernization, service and repair business, which therefore has a stabilizing effect on earnings.

In this regard, regional weaknesses in the international construction sector are impacting further segment growth. However, the segment is profiting from the stable growth, particularly in construction activities, which can currently be observed in Asia. The further expansion of Elevator's service business is relatively independent of the regional variations in the development of new installation business as the expansion of the service portfolio is not based only on new installations.

The operating risks are seen as relatively low due to the strongly decentralized organization of the segment with over 800 branches worldwide and the associated high level of diversification.

Although approx. 45% of business volume is realized in US-Dollar, the currency risks are limited as sales and costs are largely accounted for in the same currency, due to the highly regional nature of activities. The remaining transaction risks are minimized through consistent hedging.

Part of Elevator's strategy for successful business expansion is to acquire new companies. The risks associated with the integration of new acquisitions are minimized through comprehensive business integration measures and close support of the acquired activities.

The Technologies segment has a differentiated risk structure due to the vast diversity of product ranges. Project controlling as a form of early identification system based on available instruments and systems is further optimized through monthly summary reporting on the status and changes of key major projects.

The risk at the Production Systems business unit of over-dependence on only a few large customers is being counteracted by a broadening of the customer base and a reorganization of sales. Risks from changes during project processing will be countered with greater flexibility and further development of product ranges.

Plant Technology curbs risks arising from the processing of long-term contracts through more efficient contract management and intensive project controlling as well as concentration on mastered technologies.

In the Marine business unit, risks in order processing shall be limited by greater project management and controlling. Merchant shipbuilding, concentrating on small and medium-sized container ships (up to 2,700 TEU (container storage spaces)), fast ships (ferries) and mega-yachts, contributes to the compensation of capacity fluctuations in naval shipbuilding.

At the Mechanical Engineering business unit, leading market positions will be consolidated and expanded through further restructuring and cost reduction measures, range extensions and by developing new sales markets.

Now that the Shanghai route has successfully commenced commercial operations, worldwide market penetration for the Transrapid will be supported by the government-financed development program. At the same time, the development program is improving the chances of realizing the Munich project.

The companies of the Services segment chiefly involved in materials trading are mainly exposed to price and inventory risks and those of uncollectible receivables, none of which, however, jeopardize their existence. Further expansion of the centralized warehousing concept as well as constant advancement of the logistics control systems reduce inventories, thus buffering the effects of short-term price volatility even further.

In order to further lower the dependency on cyclical price developments, the segment has been expanding its service business, which does not depend on the price development of materials. The risks from potentially uncollectible receivables are relatively insignificant. Apart from the use of hedging instruments, a broad customer portfolio and worldwide business activities ensure a wide spread in this area of risk. This also applies to the Industrial Services business unit to a great extent. In part, the considerable competition and price pressure has been countered by capacity adjustments at all levels on the one hand and targeted sales initiatives on the other. Business losses have been largely compensated through the acquisition of new customers.

No risks are discernible which could jeopardize the continued existence of the Real Estate segment; this applies in particular for risks which could arise from structural or legal changes or external influences. The risk of vacancy will be limited for residential property in particular through targeted modernization programs and optimized customer service. Improved project management is facilitating risk limitation for industrial property. Beyond this, an integrated sales and maintenance program, together with optimized inventory management, supports the segment's ongoing portfolio optimization.

Summary

The overall evaluation of the risks shows that the Group is affected principally by market risks; this includes economic price and volume developments in particular, as well as the dependency on the development of major customers and industries. Performance processes are well controlled in general and, therefore, less subject to risks. Overall, it can be noted that the risks in the ThyssenKrupp Group are contained and manageable and do not pose a threat to the existence of the company. Nor are any risks discernible that may jeopardize the existence of the Company in the future.