Risk Management System

The Risk Management System is the set of organizational measures, methods and procedures created and used for effective implementation of the risk management. However, the risk management is understood as the process carried out by the Board of Directors of the Company, collective and sole executive body of the Company, heads and employees of the Company, including identification and an assessment of risks, their ranging, as well as impact on risks in order to provide a reasonable guarantee of achievement of the Company’s goals.

The purpose of the risk management system in the Company is ensuring reasonable confidence in achievement of the Company’s goals.

The information below specifies the risks inherent to the Company, the main measures aimed at the risk management implemented in 2015, as well as estimation of risks significance and their dynamics in comparison with 2014 and during 2015. Risk Significance means a combination of the probability of the risk and the size of its consequences for the Company in monetary and other terms. The following scale is applied:

Level of significance

Dynamics

Critical

No change (or insignificant dynamics)

Significant

Increase

Moderate

Decrease

Risks of the Company


Item No.

Risk name

Risk Description

Measures aimed at minimization of risk consequences implemented in 2015

Risk significance assessment and dynamics

Industrial risks:

1.

Tariff risks

The Company is a natural monopolist and its activities are subject to state regulation. Due to the limited increase in tariffs for power transmission to customers at the level of the Government of the Russian Federation, the possibility of establishing tariffs below the economically justified level is estimated as high.
Besides, the Company is exposed to the risk of decline in revenue due to changes in the actual structure of power transmission as compared with that adopted when approving the tariffs as well as the risk of changes in tariff legislation.

  • Cooperation with the tariff regulation bodies on justification of expenses within the framework of review of tariffs for electric power transmission services for 2015:
  • participation in working meetings and Management Board of REC-PTD KT with regard to revision of tariffs for electric power transmission services for 2015 in relation to modification of the current legislation and correction of NGP for electric power transmission services through Company’s grids for 2015.
  • Cooperation with tariffs regulation authorities on justification of expenses within approval of tariffs for electric power transmission services for 2016:
  • submission of a statement on adjustment of necessary gross proceeds for electric power transmission services through Company’s grids for 2016 with attachment of supporting materials, sending letters in addition to the statement;
  • submission of letters to FAS of Russia on Company’s individual opinion on formation of summary forecast balance of electric energy and power for 2016 (the Krasnodar Krai and the Republic of Adygea), on Company’s individual opinion on limits of tariffs for electric power transmission services for 2016;
  • participation in working meetings and Management Board of REC-PTD KT concerning approval of tariffs for electric power transmission services for 2016 (Order of REC-PTD KT No. 94/2015-e of December 31, 2015 (as amended) sets unified (boiler) tariffs for electric power transmission services through grids of the Krasnodar Krai and the Republic of Adygea);
  • submission of Company’s statement to FAS of Russia on pre-judicial consideration of dispute with REC-PTD KT related to non-inclusion of expenses into NGP for 2015, as the result of which the requirements of PJSC Kubanenergo are met according to the decision of FAS of Russia.

    Besides, for the purpose of formation of economically reasonable tariffs for electric power transmission services for 2016, PJSC Kubanenergo again sent an application to the Administration of the Krasnodar Krai on amending Decree of the |Government of the Russian Federation No. 1178 of December 29, 2011 regarding revision of limit amount of cross subsidizing.

2

Technological connection risks

The key risk of the Company in terms of technological connection (TC) is a risk of shortage of funding for the implementation of TC agreements. The consequence of this risk includes regulatory approval of TC rates below the economically reasonable level.

  • development of design and estimate documentation for TС projects;
  • interaction with tariff regulation authorities on justification of the payment, supporting the cost of individual projects;
  • improvement of the TC process.

3

Risk of a shortfall in income due to cross-subsidization

In connection with the termination of lease agreements for “last mile” facilities in most constituents of the Russian Federation from January 1, 2014, the Company retains a significant risk that the shortfall in income will not be compensated. This is due to the fact that the Pricing basics in the area of controlled prices (tariffs) in the electric power industry approved by Decree of the Government of the Russian Federation No. 1178 of December 29, 2011, do not envisage a fixed compensation mechanism for the shortfall in income of grid companies, including the possibility of additional growth of tariffs for electric power transmission services.
In addition, in connection with approval of the value of cross-subsidization at level of 2013 (in accordance with Decree of the Government of the Russian Federation No. 750 of July 30, 2014 On amendments to certain acts of the Government of the Russian Federation on reducing the amount of cross-subsidization in the electric grid complex), there is a risk of an increase in the uncompensated shortfall in income of the Company.
According to Federal Law “On Electricity Production” No. 35 of March 26, 2003, Article 8, “Lease by the organization managing the unified national (All-Russia) electric grid to territorial grid companies of power grid facilities and (or) their parts, having technologically connected power receivers of electricity customers, may be subject to preliminary conclusion of agreements between such customers and territorial grid companies”.

  • submission of Agreements to extend “last mile” agreements to customers directly connected to the grids of PJSC FGC UES and indirectly connected to the grids of the UNEG;
  • submission of an offer under the agreement to extend the “last mile” agreement between PJSC FGC UES and PJSC Kubanenergo, taking into account the Agreements received;
  • conclusion of an agreement in order to avoid shortfall in volumes of the planned performance of the Company for 2015.

4

Risks of growth of overdue and uncollectible receivables

To a greater degree, the risk applies to the debt for electric power transmission, as the revenue from power transmission services constitutes a large portion of the revenue structure of the Company. Thus, the growth of overdue / uncollectible receivables for electric power transmission has the greatest impact on Company’s solvability and causes increase in need for borrowed funds.

  • analysis of the causes of disagreement between amounts of power transmitted;
  • execution of a schedule of activities to reduce receivables for electric power transmission services;
  • claims-related work;
  • accumulation of judicial practice and creation of positive precedents in cases where a customer unduly contests the use of supply points (e.g., refusal of utility service providers to record the amount of electricity consumed in for household needs or that determined using common metering device);
  • installation of collective metering devices.

Country and regional risks:

5

Risks associated with the political and economic situation in the country and region

Major risk factors in this group may include: decrease in the ratings of the country, changes in exchange rates and the key rate, inflation. These factors may lead to an increase in the cost of purchased power grid equipment, industrial decline, reduced purchasing power, complicated attraction and increase in the cost of borrowed capital. 
In the event of a significant political instability, which may negatively affect the activity and revenues of the Issuer, the Issuer shall promptly take crisis management measures and reduce costs as soon as possible.
The social and political situation in the regions where the Company is assessed as stable and the risk of occurrence in these regions, for internal reasons, of a military conflict or a state of emergency is minimal.
The risks of terrorism and subversive activities are assessed as minimal.

  • implementation of state programs on import substitution to reduce the cost of purchased equipment;
  • implementation of the program for decrease in operating expenses;
  • improvement of energy efficiency and introduction of energy-saving technologies;
  • implementation of measures to protect power facilities against sabotage and terrorist acts.

6

Risks associated with the geographical features of the country or region, including increased risk of natural disasters, possible interruption of transport communications

Risks related to military conflicts, introduction of a state of emergency and natural disasters may have the following consequences:

  • deterioration of the national economy and, as a consequence, deterioration of the financial situation of the Company;
  • damage/loss of the Company’s property, which may adversely affect its ability to timely and fully meet its obligations to customers and partners.

Given the development of the transport infrastructure in the region, the risks of disruption of transportation due to inaccessibility and remoteness are minimal.
According to the Company, the situation in the region will have a positive impact on activities of the Company; there is no reason to expect that a change of situation in the region may result in a failure to fulfill its obligations.

  • property insurance;
  • cost management;
  • crisis management measures.

Financial risks:

7

Risks associated with changes in foreign exchange rates

The Company has no investments in foreign companies the net asset value which is exposed to changes in exchange rates, has no revenue and expenses denominated in foreign currencies (has no foreign currency settlement or deposit accounts). Risks associated with exchange rate fluctuations do not directly impact the financial and economic activity, but may lead to higher prices for power equipment. At the moment, the risk is assessed as moderate

  • purchase of power equipment of Russian manufacturers;
  • implementation of the program for decrease in operating expenses;
  •  monitoring of the dynamics of exchange rates, analysis of the possible impact.

8

Risks associated with changes in interest rates

The Company attracts short-term and long-term borrowings from the Russian financial market. The main factor in the growth of interest rates may be as well the increase of the key rate, but the Central Bank of Russiahas reduced it several times.
A significant increase in interest rates may lead to higher debt servicing costs.

  • the Company’s Activity Performance Management Program is developed and executed;
  • effective management of a credit portfolio is exercised;
  • use of reserves of operating and investment activities for reduction of the need for debt financing is carried out;
  • effective placement of temporarily free money for obtaining the additional income under conditions favorable to the Company is carried out;
  • the work with creditor banks aimed at depreciation of the loan capital of PJSC Kubanenergo for decrease in operating expenses is carried out.

 

9

Risks associated with the effect of inflation

It is impossible to estimate a critical rate of inflation for the Company, as except the level of customer prices, it is necessary to consider change of real purchasing power of ruble, price environment in the Russian and international markets of energy carriers and further policy of the state for tariffs for electric energy.
Rising inflation rates may increase the cost of procurement. The Company assesses the risks associated with the effect of inflation as moderate.

  • a comprehensive analysis of financial risks is conducted;
  • a business plan is prepared in accordance with the scenario;
  • procurement procedures are carried out in order to reduce the cost of procurement.

Legal risks:

10

Legal risks

Since the Company has no arrears on taxes and duties to the budgets of all levels, its tax risks are considered to be minimal. In addition, the Company does not expect the emergence of any significant consequences associated with changes in the tax law and civil law in the short term.
Changes in currency and customs legislation of the Russian Federation do not affect Company’s operations and, therefore, do not entail any legal risks.
Company’s exposure to the risk of suspension, modification or revocation of licenses is insignificant.
The risks of compliance with the legislation and internal regulatory documents are identified by the results of internal and external audits of the Company, with subsequent compilation and implementation of corrective action plans.

  • extension of the necessary permits for business activities;
  • compliance with legal and internal regulations;
  • monitoring of the legislation of the Russian Federation;
  • planning of the Company’s financial and economic activities with account of all changes in the legislation.

Risks associated with the Company’s activities:

11

Operational and technical risks

Risks of the industrial activity:

  • systemic customer power supply failures due to accidents and damage of grid sections and substation equipment;
  • violation of the requirements of GOST 13109-97 on electric power quality assurance;
  • violations of power transmission conditions and reduced quality of services rendered;
  • failure to perform timely maintenance (including diagnostics) and repairs;
  • poor quality of repairs;
  • methodological errors in planning of maintenance programs;
  • incorrect ranking facilities to be repaired;
  • accidents in related networks, leading to failures of the equipment of the Company;
  • abnormal power losses.
  • scheduled and unscheduled repairs and maintenance of electric grid equipment;
  • upgrade, reconstruction and new construction;
  • technical control;
  • regular optimization of the structure and amount of components and spare parts in stock, etc.;
  • ensuring industrial safety and production control;
  • implementation of a program to reduce losses;
  • planning emergency measures (based on the analysis of technological violations) in order to mitigate the risk and to prevent occurrence of similar cases in the future.

12

Investment risk

The main risks for the Company’s investment activities are the risks of incomplete disbursement of capital investment, increased construction in progress, and reduced investment program (both in volume and funding). The latter risk arises in connection with changes in macroeconomic conditions.

  • formation of the investment program in accordance with the scenario conditions;
  • adjustment of the investment program to changes in macroeconomic conditions;
  • reallocation of funds received from the savings as the result of tender procedures to other facilities of the investment program;
  • implementation of measures to reduce the amount of construction in progress;
  • control of compliance with the terms of the procurement procedures and agreement conclusion.

13

Risks associated with current litigations of the Company

In 2015, the Company participated in judicial proceedings regarding its core activities that could significantly affect its financial situation. Judgments were passed both in favor of the Company and in favor of the plaintiffs against the Company.

  • supporting the interests of the Company in court;
  • monitoring the judicial practice to ensure positive court decisions in favor of the Company.

14

Risks associated with possible Company’ liability for of third parties, including subsidiaries

In 2015, the Company bore no liability for debts of the third parties since it provided no enforcement to their obligations.
The Company has affiliated joint-stock companies with 100 % participations in their authorized capital and can become responsible for their debts. These obligations can have a certain negative impact on results of financial and economic activity of the Company.

  • annual checks of subsidiaries by audit commissions of companies;
  • consideration of  the most significant issues and decision-making on them by corporate governance bodies of subsidiaries.

15

Risks associated with possibility of customers loss, which share of a turn over amounts at least 10% of total sales revenue (products, works, services) of the Company

The Company cooperates with its main customers for a long time. Possibility of loss of the main customers is considered as minimum.

  • conclusion of agreements with key customers according to the legislation and on mutually advantageous conditions.

Distribution of risks by areas of significance

Distribution of risks by areas of significance