Annual report 2014

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Risk management

Lenenergo has an effective system of internal control and risk management, which includes all the necessary range of procedures, practices and controls. The structure of the system consists of the Board of Directors, the Audit Commission, the executive bodies of management and all employees of the Company.

The principles of internal control and risk management:

  • efficiency and effectiveness;
  • compliance with legal requirements and local regulations;
  • prevention of illegal actions of employees and third parties in respect of the Company’s assets;
  • the accuracy, completeness and timeliness of all types of reporting.

In its activities in the area of risk management the Company is guided by the requirements of the legislation, as well as the following internal documents:

  • Internal Control Policy (Minutes of the Board of Directors #6 of 9 September 2014);
  • Risk Management Policy (Minutes of the Board of Directors #6 of 9 September 2014);
  • Internal Audit Policy (Minutes of the Board of Directors #6 of 9 September 2014).
Improving the IC and RMS are carried out at all management levels of the Company in the following areas of control
Preliminary (pre-emptive) monitoring Current monitoring Follow-up monitoring
Pre-emptive monitoring of procedures are carried out within the framework of the risk management system (RMS) and include:
  • monitoring,
  • identification and assessment of risks,
  • development and implementation of risk management measures
Business process-embedded monitoring procedures aimed at achieving the goals of business-processes
  • Internal Audit,
  • Monitoring of accurate reporting, the safeguarding of assets,
  • Compliance control,
  • External audit
  • Self-assessment

The structure of the internal control and risk management system

RISK MAP OF LENENERGO

The risks faced by the Lenenergo

Industry-specific risks
# Name of risk Description Measures to minimize the consequences of the risk Assessment of the significance risk and dynamics compared to 2013
1. Tariff risks
  • Electricity transmission to electric networks, as well as technological connection to electric networks are regulated by the state. Regulatory approval of tariffs for services directly influences volumes of the received proceeds.

Thus, according to the decision of the Government of the Russian Federation on June 11, 2014 #542, executive bodies on subjects of the Russian Federation in the field of state regulation of tariffs, was entrusted to take decisions on the establishment of (revised) from July 1, 2014 united (boiler) tariffs for electric power transmission if these tariffs are set from July 1, 2014 at a level exceeding the specified level of tariffs as of June 30, 2014, in order to ensure the establishment of united (boiler) tariffs from July 1, 2014 for the second half of 2014 at a level not to exceed the level of these tariffs as of June 30, 2014.

In connection with the need to execute the decision of the Government of the Russian Federation, the Company’s revenue from electric power transmission services was decreased.

Also, to a shortfall of revenue as a result of the choice of the two-part tariff type by consumers conducts overestimate by the regulator of capacity of declared power, applied in the calculation of tariffs, over the actual capacity.

  • Implementation in conjunction with the Federal Tariff Service and the bodies of regulation of tariffs of the Russian Federation measures to amend the current legislation of the Russian Federation in the field of pricing on services of natural monopolies, aimed to protect the interests of distribution grid companies at establishment of tariffs for electric power in the retail market.
  • Conducting systematic work with regional regulators to establish economically justified tariffs that include all possible costs.
  • Work on pre-trial settlement of the dispute with the Committee on Tariff on how to apply the level of the declared capacity to calculate the joint-operations tariff for the maintenance of electric networks in St. Petersburg.
  • Increase the operating efficiency of the Company by implementing programs to reduce production costs.
  • Approval of volumes and sources of financing of the investment program with the authorities in view of territorial development programs.
Critical
2. Technological connection risks
  • Due to the large amount of applications for technological connection (TC), the risks of breaching the antimonopoly legislation in terms of the provision of services on technological connection and initiating by applicants of legal actions.
  • The risk of profits loss on non-fulfillment of the contract properly on the implementation of the TC.
  • Failure to comply with the obligations by the applicants, including the rejection of TC leads to non-use of newly constructed equipment and the potential revenue shortfall from electricity transmission services.
  • There is a risk of reducing the volume of connected capacity in applications on TC to the electric networks.
  • The risk of source deficiency of funding for the implementation of the TC contracts consequence of the approval by regulator of rates for TC below economically reasonable level.
  • Implementation of the plan of execution of accumulated liabilities.
  • Optimization of the processing of consumers applications on TC using information technology and standard solutions, the development of interactive services.
  • Reduce the stages and timing of the TC.
  • Work with claims in respect of the applicants in terms of cost recovery for the TC.
  • Conducting work to monitor the dynamics of the volume of the maximum power at the request of applications on TC, forming the correct amount of obligations under contracts on the implementation of the TC, providing other supporting materials to the regulatory bodies.
  • Work in a working group under the Government of St. Petersburg “Improving accessibility of energy infrastructure,” elaboration of measures aimed at reducing the time and stages of the TC realization, oriented, including amending in regulations on land use and construction of network objects.
Critical
3. Risks of growth of overdue and bad accounts receivable
  • Disagreements between the electric grid and power supply companies in respect of the volume of consumption of electricity and power applied in the calculation of tariffs. The consequence of this is the appearance of the disputed and overdue receivables for transmission services, which leads to lower liquidity and financial stability of the Company.
  • Company performs an analysis and systematization of the reasons of disagreement on the volume of electricity transmitted, implemented a set of measures for the settlement of disputes, debt collection and claims work.
  • Implementation of comprehensive Program of energy saving and increase of power efficiency, including the installation of metering devices and activities to identify of non-contractual consumption.
Meaningful
Country and regional risks
# Name of risk Description Measures to minimize the consequences of the risk Assessment of the significance risk and dynamics compared to 2013
4. Risks associated with political and economic situation in the region
  • Economic sanctions against Russia, inflation, decrease in volumes of the financial market, the prices on fuel and energy and other raw materials, the increase of the ruble against foreign currencies and impact on decrease in volume of industrial production and electricity consumption (decrease in productive supply in 2014 amounted to 1.7% compared to tariff setting) and as a result, contributed to the decline in revenue.

    These factors may adversely affect the ability to attract debt capital, on liquidity indicators, on investment and operating efficiency and, ultimately, on shareholder value of the Company.

  • Monitoring of the current economic situation in the region.
  • The implementation of set of measures aimed at optimizing the share of loans in total capital structure.
  • Attracting long-term loans at fixed interest rates.
  • Improving the efficiency of operational and investment costs.
Meaningful
5. Risks associated with the geographical features of the country or region, including increased risk of natural disasters, possible interruption of transport communication
  • The geographical features of the region in which the Company operates, assume the risk of natural disaster (hurricane, torrential rains, floods, snow, snow drifts and etc.), resulting that power supply can be interrupted in the region and caused material damage to the Company’s assets.
  • Implementation of set of measures on preparation of the grid complex for autumn-winter period.
  • Works to reduce the time period required for the liquidation of consequences of floods in autumn-winter period.
  • Engineering of energy facilities taking into account the characteristics of the regional climate and geography.
  • Expansion of the glades with overhead power lines in accordance with the normative legal acts regulating the procedure for determining the protected areas and logging of technological glades near the electric grid facilities.
  • Realization of the program of insurance protection of property. Ensuring the availability and mobilization readiness of the rescue and recovery teams.
Moderate
6. Risks associated with possible military conflicts, introduction of state of emergency and strikes in the country (countries) and region
  • The Company cannot completely eliminate the risks associated with the possible introduction of a state of emergency in the region, in whose territory the Company and in Russia in general are located. Acts of terrorism, both internal, and international which can be also reflected negatively in investments and the cost of securities of the Company can cause damage of activity.
  • In case of possible military conflicts or terrorist acts, the Company can bear risks of removal from a system of their fixed assets.
  • In order to minimize these risks, the Company is taking steps to meet the requirements of the Federal Law “On the safety of the fuel and energy complex” dated July 21, 2011 #256-FZ.
Moderate
Financial risks
# Name of risk Description Measures to minimize the consequences of the risk Assessment of the significance risk and dynamics compared to 2013
7. Risks associated with the monetary policy of the Central Bank of the Russian Federation
  • The Central Bank of the Russian Federation, while conducting monetary policy, indirectly affects financial markets and money supply. Any actions of the Central Bank of the Russian Federation can both decrease and increase the risks of the Company, which, respectively, will be reflected in its financial performance.
  • The Company is taking all possible measures to minimize risk and resolve the situation.
Meaningful
8. Risks associated with changes in foreign exchange rates

The Company is not currently engaged in foreign economic activity, the main customers engaged in the consumption of electric power are residents of the Russian Federation, and the calculations for the transport of electricity are also made in the currency of the Russian Federation.

But considering that the nomenclature of goods and equipment purchased by the Company contain imported components, a significant increase in the exchange rate led to a rise in the cost of purchased products.

  • The Company regularly monitors the prices, holds open competitive procedures, as well as the policy of import substitution.
Meaningful
9. Risks associated with changes in interest rates
  • Energy sector is the one of the most capital-intensive industries in the market resources and so the issuer’s activities require substantial capital and investment investments. As the part of the planned economic and financial policy, the Company attracts borrowed funds. Thus, in the current economic situation there is a probability of increase in interest rates on loans.
  • Constant monitoring of debt capital market and counterparty banks and the possibility of debt restructuring.
  • The conclusion of long-term agreements on revolving credit lines with significant borrowing limit and limitations of the maximum interest rate on the loan depending on the CB RF refinancing rate.
  • Monitoring of loan resources market seeking more favorable credit conditions.
  • The selection of financial organizations for the provision of services through open competitive procedures, that allows to borrow on the most favorable terms for the Company.
  • The search for alternative sources of borrowing.
Meaningful
10. The risks associated with the effect of inflation

Inflation in 2014 exceeded the rate of inflation, founded the end of 2013, at acceptance tariff setting by the regulator.

The negative impact of inflation on the financial and economic activity of the Company may be due to losses in real value of receivables, with an increase in interest payable, as well as the cost of goods, works, services due to rising on energy prices, transportation services, wages, with an increase in construction costs within the implementation of the investment program, etc., with a decrease in the real value of the funds under the investment program. As a consequence, this can lead to a reduction in the overall profitability of the Company and the deterioration of its financial condition.

  • The accounting of inflationary processes and their forecasting when planning activity.
  • Implementation of measures to reduce accounts receivable, and raising level of its turnover.
  • Systematic monitoring, control and analysis of macroeconomic indicators.
  • Implementation of set of measures aimed at obtaining a positive net profitability which cover different types of expenditures.
  • Implementation of measures to reduce costs.
Meaningful
Legal risks
# Name of risk Description Measures to minimize the consequences of the risk Assessment of the significance risk and dynamics compared to 2013
11. Legal risks
  • For the Company, there is a risk of changes in legislation (federal laws and subordinate legislation) regulating shareholder and corporate relations.

    The Company cannot guarantee the absence of negative changes in the Russian legislation in the long term, as the majority of risk factors are beyond the Company’s control.

  • Reducing the negative effects of this category of risk is achieved by monitoring and timely response to changes that are made in the legislation of the Russian Federation, as well as through the active interaction with legislative, executive and non-governmental organizations in the interpretation and improvement of the legislation.
  • To minimize legal risks, that any Company business processes can be subject to risks (e.g., contracts), pass obligatory legal examination.
Moderate
12. Risks associated with changes in tax legislation
  • Tax risk may have a number of implications:
    • the probability of introduction of new types of tax and fees;
    • the possibility of increasing the rates of existing taxes;
    • expanding the taxable base;
    • changing terms and procedure of taxes payment, and submission of tax return.
  • The potential risks of engaging the Company’s tax liability in case of changes in the state fiscal policy concerning separate taxes and fees, as well as changes (not in favor of the taxpayer) of judiciary practice on separate categories of tax affairs.
  • To minimize the risk of wrong calculation and / or payment of taxes due to different interpretations of the legislation, the Company is constantly working to improve the calculation of tax base in strict accordance with the laws of the Russian Federation.
Moderate
13. Changes in judicial practices on issues related with the Company activities
  • Changes in judicial practices on matters related to the Company’s activities may lead to increased costs on attracting highly specialized lawyers and also to pronouncement of judgments not in favor of the Company, which could negatively affect its operating results.
  • Permanent monitoring of arbitration practice.
  • Optimization processes of the legal paperwork and maintenance activities of the Company.
Moderate
14. Compliance-risks
  • The Company’s activity is regulated and supervised by various supervisory authorities: the Federal Antimonopoly Service, the Federal Tariff Service, the Federal Tax Service of Russia, Ministry of Energy, Federal Financial Monitoring Service, Rostekhnadzor, the Accounts Chamber of the Russian Federation and others.
  • The activity of the Company has a natural monopoly character and is subject to the anti-monopoly regulation. Recognition that the Company has violated antitrust laws may result in penalties, including current — estimated in the volume of the Company’s revenues. The greatest risk of antitrust regulation is subject to the activities in the area of technological connection of electro installations of consumers to power grids of the Company.
  • The Company’s activities as it relates to implementation of the requirements of the legislation of the Russian Federation on securities, including disclosure of material facts that could adversely affect the value of the securities, as well as to counter misuse of insider information is subject to supervision by the Bank of Russia.
  • The Company owns leases or has a right for unlimited use the majority of land on which there are distribution assets but, on some of these, property rights are not furnished in accordance with the legislation of the Russian Federation.
  • To reduce the impact of the factors leading to the realization of the risk of antitrust regulation, the Company develops business processes of technological connection, simplifying their internal procedures and reducing their terms, introducing new forms of customer service, in particular related to the interactive methods of service that reduces the impact of errors and factors abuse of staff.
  • In the case of pronouncement of FAS resolutions about imposing of penalties for violations of the current legislation, the Company will challenge their legality in court.
  • In order to minimize compliance-risk factors, actions are realized on improving compliance-control, monitoring changes of the current legislation are carried out that affecting the various aspects of the Company’s activities. Local documents are enacted that are aimed at improving the efficiency and transparency and fighting corruption. By the decision of the Board of Directors of the Company dated 28 December, 2014 the Anti-corruption policy of JSC Rossetti and subsidiaries of JSC Rossetti was approved.
Moderate
Risks associated with the Company’s activities
# Name of risk Description Measures to minimize the consequences of the risk Assessment of the significance risk and dynamics compared to 2013
15. Operational and technological risk
  • Operational and technological risks, influencing reliability of power supply are associated with systemic disorders of efficiency and effectiveness of the equipment of electric distribution complex, and failures in the power supply of consumers of the Company as a result of natural disasters, high physical and obsolescence deterioration of distribution grid assets, violation of operating conditions and operating modes of the electric equipment, non-performance of the program of repairs in necessary volume. These risk factors affect the amount of losses in network grids, increasing the costs of the Company for the purchase of electricity to compensate losses.
  • As a result of realization of the specified risks are possible both essential economic and reputational consequences.
  • As the measures promoting decrease in probability of emergence of operational and technological risks, the Company carries out the actions directed on the increase of reliability of power supply of consumers and the prevention of risks of technological violations including:
  • clearing and extension of the glades and overhead power lines, reconstruction of power grid facilities, the expansion of the park of reserve sources of supply of electricity and motor vehicles for the rescue and recovery operations, a comprehensive program of modernization of the power grid assets, modernization of switching equipment and remote control systems, the improvement of systems for the collection and transmission of information, analysis of technological failures etc.
  • The Company implements a complex of measures on preparation of the grid complex for autumn-winter period (to obtain a Passport of readiness).
  • On a constant basis works on decrease in the temporary period necessary for expeditious elimination of consequences of disaster during the autumn and winter period are conducted.
  • The Program to reduce risks of injury on the power grid facilities, training, control and certification of the personnel is realized.
  • Price monitoring and procurement planning.
  • Realization of the program of energy saving and energy efficiency.
Meaningful
16. Investment risk
  • The implementation of socially important projects for the region, economically inefficient for the Company.
  • Violations of planned terms of development of capital investments and the delay of commissioning of objects of investment programs.
  • Growth of volume of incomplete construction in connection with an exception of the objects that were begun with construction from the investment program.
  • Failure to comply with the parameters of RAB-regulation.
  • Reduce sources of financing of the investment program and the necessary gross revenue of the Company in future periods.
  • Development and planning the investment program aimed at expanding and improving the availability of grid infrastructure, the modernization of the power grid facilities, and the achievement of high load input power, linking with the plans of territorial and regional development.
  • Monitoring of implementation of investment programs and their financing, analysis of deviation causes of the actual parameters of realization of the planned investment programs.
  • Implementation of the management investments project.
  • Automation of investment management system.
  • Reduction of the unit cost of construction, the introduction of a comparative analysis system of the unit cost of construction and materials.
Meaningful