Risk report
Increasing the value of the company, securing its existence and countering individual risks appropriately – these are the tasks of our risk management system. In the reporting year, all risks were contained and manageable. The future existence of the company is secured.
Efficient organization of risk management
Risk policy
As part of corporate strategy our risk policy is directed at systematically and continuously increasing the value of the company. The existence of the company has to be secured. In addition, the name and reputation of the Group and the "ThyssenKrupp" brand are of key importance for the Group.
The particular risk strategy applied always begins with an evaluation of the risks and the opportunities associated with them. In the Group's core competency areas we consciously take on reasonable, manageable and controllable risks if they are expected to deliver an appropriate increase in value. Risks in processes which support our core activities are transferred – where economically appropriate – to other risk carriers. Risks not connected with core and/or support processes are not accepted. Overall the aggregate risk volume must not exceed the risk coverage potential available at ThyssenKrupp AG.
ThyssenKrupp has set out rules for dealing with risks in Group policies and guidance notes. Numerous training and monitoring programs ensure these rules are observed. Speculative transactions or other measures of a speculative nature are inadmissible. Conduct towards suppliers, customers and society must be fair and responsible at all times.
Risk management system has proven itself
The risk management system installed by the Executive Board of ThyssenKrupp AG has proven itself to be efficient. All employees of the Group must consider the possible risks of their actions. Direct responsibility for early identification and management of risks and for communicating them to the next reporting level lies with the operating managers. The next organization level up in each case is responsible for risk control.
Within the framework of risk inventories the occurrence, status and significant changes of major risks are reported by the Group companies using tiered threshold values. The segments inform the Executive Board of ThyssenKrupp AG about the current risk situation on a bi-weekly basis. In addition, risks occurring at short notice and urgent risks with an impact on the entire Group are communicated directly to ThyssenKrupp AG outside the normal reporting channels.
Once again in 2006/2007 Corporate Internal Auditing examined whether the Group companies in Germany and abroad are observing the rules of the risk management system. The findings made helped further improve the early identification and management of risks. In addition we have continuously enhanced the tools for identifying and managing risks in the Group.
Risk transfer to insurers
As central service provider, ThyssenKrupp Risk and Insurance Services GmbH in consultation with the Executive Board of ThyssenKrupp AG handled the transfer of risks to insurers through the conclusion of Group insurance policies. To counter the risk from increased deductibles the Group regularly prepared and evaluated loss analyses. Under property and business interruption policies significant deductibles exist for some production units of the Steel and Stainless segments. There is a risk that one or more claims on these policies could materially impair the Group's assets, liabilities, financial position and results of operations.
Several working groups have developed joint binding standards for risk prevention. Compliance with the standards as part of a property insurance risk management system was monitored regularly by internal and external audits.
Central risk areas
Financial risks
Central responsibilities of ThyssenKrupp AG include resource allocation and securing the financial independence of the Group: in this connection ThyssenKrupp AG also optimizes Group financing and controls financial risks.
As in previous years, the procurement of funds in 2006/2007 was effected 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 regular communication of the results of the interest rate analyses is part of our risk management system.
To contain the risks of the numerous payment flows in different currencies – in particular in US dollars – Groupwide regulations exist for the centrally organized foreign currency management of the ThyssenKrupp Group. All companies of the ThyssenKrupp Group are required to hedge foreign currency positions at the time of their inception.
Among other things, derivative financial instruments are used to hedge the risks. The Group's centralized foreign currency management, centralized management of interest rate risks as well as hedging against commodity price risks are described in detail in Note 29.
Translation risks arising from the conversion of foreign currency positions are generally not hedged.
Risks associated with disposals and restructurings
Transaction risks may arise from the disposal of real estate, companies or other business activities and from restructuring programs in the Group. Where the occurrence of the particular risk is at least probable, adequate provision has been made in the balance sheet.
Risks associated with information security
The information technologies used in the Group are continually reviewed and updated to guarantee secure handling of IT-supported business processes. In addition, we continually enhance our information security measures and systems; in this way we eliminate or at least contain the risks associated with IT-based integration in business processes between Group companies and with customers, suppliers and other business partners.
Risks associated with pension and healthcare obligations
The fund assets used to finance pension liabilities are exposed to capital market risks. 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.
Legal risks
A report on pending litigation and claims for damages can be found in Note 28.
Environmental risks
Some of our real estate is subject to risks from past pollution and mining subsidence. These risks are managed by preventive measures and scheduled remediation work. Adequate liabilities were recognized in 2006/2007 if the corresponding measures were not carried out during the reporting year.
The demands on environmental protection and resource conservation have also risen in other areas. We take extensive measures to minimize environmental impact. This includes the use of modern facilities which are environment-friendly and also reduce charges and energy costs. In addition, the increasing number of Group companies with certified environmental management systems has reduced the risk of environmental risks occurring. More details on environmental protection at ThyssenKrupp are provided in the section Group review.
Procurement and selling risks
Movements in steel prices and developments in the auto industry can have a significant impact on the performance of the Group. However, the broad product and geographic spread of our business portfolio has a stabilizing effect.
In the electricity and gas markets the Group is affected by rising prices. A structured procurement policy on the electricity market and the conclusion/continuation of long-term natural gas contracts help limit risks.
Personnel risks
ThyssenKrupp attaches central importance to securing and strengthening the skills and commitment of its staff and managers. That is why we continued to position ourselves as an attractive employer and promote the long-term retention of executive staff in the past fiscal year. Systematic management development includes offering executives career prospects and attractive incentive systems. It also includes targeted mentoring to promote identification with the company at an early stage. You can read more on these subjects in the section Employees.
General economic risks
We expect the world economy to continue to grow in the next two years. We forecast growth of 5.2% in 2007 and just under 5% in 2008. The growth trend should also continue after 2008, but at a slower pace. These forecasts are based on a series of assumptions. In particular it is assumed that the geopolitical and economic situation will remain largely stable. This includes stable capital, currency and raw material markets.
Risks to global growth may result from the liquidity bottlenecks triggered by the US real estate crisis. Weaker spending by US consumers would impact the growth prospects of the US economy and dampen international trade. A weakening of the US economy would have negative effects on economic growth in the rest of the world.
In the medium term we expect the US dollar/euro exchange rate to stabilize. This forecast assumes among other things that the policy of the central banks will not lead to a further reduction in the interest rate differences between the USA and the euro zone. Interest rate and exchange rate risks would also ensue if the capital markets were to significantly change their positive attitude towards the financeability of the US trade deficit. A depreciation of the US dollar versus the euro would have negative consequences for the competitiveness of businesses producing in the euro zone.
We believe that raw material and oil prices will stay at a high level. We expect supplies of energy and other raw materials to remain secure. However, a significant rise in oil prices in particular could increase the economic risks and slow global economic growth. Protectionist measures could impair the availability of raw materials on the international markets.
Decentralized management of segment-specific risks
In the Steel segment, market risks exist regarding the development of selling prices and volumes. Disproportionately rising raw material, freight and energy prices represent risks on the cost side which cannot be fully offset by using alternative procurement sources or passing on price increases. Developments and influencing factors are therefore permanently monitored to allow the early introduction of mechanisms to alleviate the effects. In addition, possible losses within the deductibles agreed with insurers could have a negative impact on our operations even though organizational and technical measures – e.g. preventive maintenance – are being carried out on a permanent basis to counter this. Despite hedging of all transactions denominated in foreign currency, exchange rate variations may also result in risks.
As a result of the new strategic positioning of the Steel segment with the construction of a steel mill in Brazil and the installation of new capacities in the NAFTA region we see only minor local risks in North America with regard to successful market entry from 2010.
There remains a general, global risk that overcapacities will be created in the coming years, especially in China, which will lead to an imbalance on the world markets and could disrupt the price structure. In such a scenario, the profitability of the Steel segment and of competitors could drop sharply. We are therefore monitoring developments in Asia closely and will move early to introduce corresponding measures.
The segment counters the risks associated with steel industry cycles through cost optimization, prompt production adjustments and a concentration on high-end market segments subject to less cyclicality. Quality and delivery risks are minimized by constant optimization of the value chain.
Despite the Groupwide emissions trading strategy, the segment may face volume and price risks in connection with emission allowances in the second trading period from 2008 to 2012.
In addition to the usual cyclical risks the Stainless segment faces risks associated with the way the markets respond to existing or anticipated overcapacities at stainless producers in Asia. The supply and demand situation in China in particular represents a risk.
Stainless is countering the risks in the market by extending its value chain towards the higher-margin end-customer business, intensifying its customer relationships through local service offerings and further improving its quality and delivery performance. We are countering increasing competitive pressure by developing new applications for stainless steels and nickel alloys, by developing innovative products made from these materials and by using modern, cost-saving process technologies.
The risks associated with the availability and prices of raw materials, particularly nickel, chromium and alloyed scrap, are minimized by corresponding contracts and hedging mechanisms.
In the Technologies segment, the Plant Technology and Marine Systems business units manage the risks associated with long-term contracts and technological innovations through close project controls and increased use of project management measures. Notwithstanding these, the increasing complexity of contracts can result in unplanned earnings impacts in individual cases. In the past fiscal year this risk became acute in the construction of mega yachts. We are working to offset the earnings impacts through the swift implementation of efficiency measures and organizational improvements. At the same time processes are being optimized with the aim of substantially improving earnings. In the civilian shipbuilding sector competitive disadvantages versus Asian competitors are to be offset by a concentration on niche markets and by action programs to improve performance and reduce costs.
Our automotive operations, concentrated in the business units Mechanical Components and Automotive Solutions, continue to face a variety of risks. Rising steel prices, which experience shows cannot be passed on to customers in full, represent a major risk to earnings. Extensive cost reduction programs are being implemented to offset rising cost pressure on the procurement side and increasing price pressure from auto manufacturers on the selling side.
We are countering the risk associated with falling demand in our traditional markets by building or expanding production capacities in growth regions such as India and China. This includes the planned construction of a crankshaft factory in China. In the field of production equipment for the auto industry, extensive restructuring measures and capacity adjustments are needed to counter market-related and structural problems.
In the Transrapid business unit, a concrete follow-up project for the line in Shanghai and the trialing of an already delivered prototype vehicle under the further development program are expected to further reduce the existing market risk. In addition there is the prospect of the realization of the Munich project following clarification of the financing situation.
In individual business areas earnings may be impacted by the need for further restructuring measures. In addition, exchange rate movements again impacted sales and earnings in the past fiscal year, for example in the case of US dollar-denominated deliveries from Brazil to the USA.
In the Elevator segment, risks are mainly determined by the different activities in the elevator and escalator businesses and by their regional spread.
The new installations business is closely linked with activity in the building industry and can therefore be subject to volatility. The use of project management measures helps contain risks in the processing of major projects. We are countering rising material prices, which cannot be passed on to customers in all regions, through continuous efficiency improvements in production and by ongoing optimization of purchasing.
The service and modernization business is comparatively unaffected by cyclical developments. We counter the risks associated with the loss of maintenance units through high service quality and customer retention strategies. Local branch offices and a close-knit service network help increase efficiency, for example through lower costs for trips to customers.
The segment's global presence provides an internal risk balancing mechanism as individual markets move through different growth cycles. The resultant impact of exchange rates is limited by financial hedges and by the fact that sales and costs in the respective currency areas are largely congruent.
The Services segment is mainly engaged in materials trading and services. It counters the associated risks with an extensive action program. This includes in particular the systematic improvement of logistics and logistics management tools, especially the expansion of the centralized warehousing concept to optimize inventories. At the same time, expanding the service business, which is independent of material prices, will make the segment less sensitive to cyclical price movements. General economic risks are reduced by the segment'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.
The measures taken by Services to minimize risks associated with exchange rate fluctuations or raw material price changes comply fully with the policy for commodity hedges.
The Industrial Services unit faces risks from competition and price pressure. We counter these by means of continuous capacity adjustments and new sector- and customer-specific service offerings and sales initiatives. Adequate provision has been made to cover risks associated with strategic decisions. Risks from the final completion of projects are managed by ongoing project controls.
Corporate faces risks from the past industrial use of real estate. Potential risks in the construction of the ThyssenKrupp Quarter in Essen are systematically identified and efficiently managed by a project control system to minimize time, cost and liability risks. A dedicated project compliance unit guarantees maximum transparency with regard to adherence to standards.
No threat to existence of company
In the overall analysis of Group risks, the most important are risks associated with major contracts and markets. As well as cyclical price and volume developments we are also dependent on the performance of major customers and industries. Business risks associated with the handling of orders are well managed and therefore contained. Overall, the risks in the Group are manageable and there is no threat to the existence of the Company.