1.5.

Key risks and opportunities

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1.5.1. Internal control and risk management system

Risk management activity of RusHydro facilitates the Strategy implementation and ensures business efficiency.

RusHydro adheres to the definition of risk mentioned in ISO 31000-2010 «Risk management — Principles and guidelines» Standard. According to the Standard, risk is the impact of the uncertainty on the goals, it can have different aspects and can apply at different levels. Risk is often characterized by reference to potential events and consequences, or a combination of these.

Internal Control and Risk Management System

Internal Control and Risk Management System

Internal Control and Risk Management Corporate System of PJSC RusHydro (hereinafter IC&RMCS) covers all companies of the Group. It provides management of potential impacts in order to decrease possibility and negative consequences of risk occurrence.
The main body of RusHydro risk management system is the Risk Control and Risk Management Department (hereinafter – RC&RM), a part of the Internal Control and Risk Management Unit. It ensures an efficient operation of the IC&RMCS, an effective operational control and interacts with external control bodies.

The main document, which regulates risk management activities of the Group, is the Internal Control and Risk Management Policy (approved by the Board of Directors of PJSC RusHydro on 16.11.2015). It defines goals, objectives and principles of the IC&RMCS and is based on

ISO 310000:2009 «Risk management – Principles and guidelines» Standard and methodological know-how of the best international practices. The methods of risk identification, measurement and response used by RusHydro take into account the principles of COSO ERM and risk management standards ISO 31000 and ISO 31010.

For detailed information on risk management system see PJSC RusHydro Annual Report 2016.

1.5.2. Sustainable development risks management

PJSC RusHydro annually updates the Strategic risk management plan, which includes the list of key risks and response actions, and takes into account all material aspects as for sustainable development. In 2016, RusHydro elaborated and implemented the indicator system of strategic risks realisation, based on scenario approach.

The Governance of PJSC RusHydro annually adopts the Register of strategic risks where the risk owners are defined. The Register discloses information about RusHydro’s risks for shareholders, rating agencies, auditors and other stakeholders, and helps to elaborate and control risk management activities in terms of realization of the Company’s strategy. The risks and opportunities are prioritized based on their level of impact on key financial, social and ecological aspects, taking into account the strategic goals, development priorities and mission of the Group.

In 2016, the Board of Directors of JSC RusHydro adopted a five-year program to optimize RusHydro’s expenses, which includes measures to optimize operation, administrative and management expenses, and investment activities.

A key condition of this program is to ensure safe and reliable operation of production assets.

The implementation of the program allows reducing the debt burden and the risks of a shortage of funds, increasing the financial stability of the RusHydro Group companies and ensuring the growth of the RusHydro’s business margins while strictly observing high safety standards at generating equipment operation, which is ultimately aimed at increasing the RusHydro Group capitalization.

Current procedures of risk/impact management in terms of sustainable development are classified based on three aspects in terms of sustainable development: economic, ecological, social risks. RusHydro Group also defines the stakeholders that are subject to the potential impact in case of a particular risk occurrence. Risk Radar is presented in PJSC RusHydro Annual Report 2016.

Management of sustainable development risks in 2016

Impact on KPIs of RusHydro Group and PJSC RusHydro14StakeholdersRisk management measures

Economic aspect

Capital construction project risks
Direct:
  • Compliance with the schedule of the capacities commissioning at the core facilities of new construction, %
  • Fulfilling capacity commissioning timetable and the finance and disbursement plan, %
  • Return on equity (ROE), %
  • Limitation on the debt burden (Net Debt/Ebitda)
  • Leverage ratio (coefficient)

Indirect:
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Employees
  • Federal authorities
  • Regional authorities and local government authorities
  • Suppliers and contractors
Systematisation of data on the designed projects:
  • Development of the corporate project management system for classification of data on the existing and designed projects

Development of the internal expert review for design and detailed documentation:
  • Improvement of the efficiency of design institutes operation and procurement activities to strengthen the role of its own design institutes to conduct internal review of design and working documents;
  • Regulation of the activity on conducting internal review of design documentation.

Quality, terms and cost of works control:
  • Maintenance of the list of disreputable designers, participation in subdesigners selection process;
  • Development of regulatory documents for performance of individual types of work, implementation of an authorisation system allowing the employees to perform such types of work, and adapted to suspend individual employees from the works performance in case of any substantial breaches;
  • Development of the supplied equipment quality control system (including equipment manufacture and shipment/delivery);
  • Creation of the schedule and cost monitoring and control system for new construction projects based on the SAP capital construction management information system;
  • The 2017-2021 Investment Program materials to be reviewed contain assessment of the cost-effectiveness of investment capital construction projects with the account of risks.
Reduction of electric power and capacity sales income compared to the business plan
Direct:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/Ebitda)
  • Current liquidity ratio (coefficient)

Indirect:
  • Leverage ratio (coefficient)
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Employees
  • Suppliers and contractors
  • Preparation of proposals for amendments to the normative legal acts in the field of electric power industry;
  • Regular revision of the sales policy of PJSC RusHydro;
  • Implementation of a commercial dispatch system.

Fund shortage including the shortage of external funds for planned investments
Direct:
  • Compliance with the schedule of the capacities commissioning at the core facilities of new construction, %
  • Fulfilling capacity commissioning timetable and the finance and disbursement plan, %

Indirect:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/Ebitda)
  • Leverage ratio (coefficient)
  • Total shareholder return (TSR)

  • Shareholders and investors
  • Federal authorities
  • Suppliers and contractors
  • Maintenance of the sufficient amount of funds and availability of financial resources through credit lines;
  • Implementation of a balanced model of working capital financing by using short-term and long-term sources;
  • Monitoring of the compliance with credit agreements in order to avoid breaches of the Company’s financial covenants;
  • Placement of temporarily available funds in short-term financial instruments (bank deposits);
  • Execution of contracting agreements in accordance with standard financial provisions
  • Introduction of interest rate and currency exposure management procedures with due regard to the credit policy of RusHydro
  • Preparation of the flood zones of power plants under construction using the funds of the federal budget and the budgets of the subjects of the Russian Federation;
  • In order to reduce the debt burden of RusHydro Holding, an additional issue of shares was made and an agreement was concluded on the purchase of 55 billion shares of the Company by PJSC VTB Bank.

As part of the Company’s approved interest rate and currency exposure management procedures, the Company calculated the risks of currency and interest rate fluctuations for 2017 for the open foreign currency position and the portfolio of liabilities of the Company, respectively, for the purpose of evaluation and formation of the reserve to cover foreign currency and interest rate risks in the Company’s budget for 2017.
Terrorism risk
Direct:
  • Reliability criterion
  • Compliance with the schedule of the capacities commissioning at the core facilities of new construction, %

  • Fulfilling capacity commissioning timetable and the finance and disbursement plan, %
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/Ebitda)

Indirect:
  • Leverage ratio (coefficient)
  • Reduction of the operating costs
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Employees
  • Suppliers and contractors
  • Federal authorities
  • Regional authorities and local government authorities
  • Provision of the facilities’ armed security by the private guard of Rosgvardia, FSUE Okhrana of Rosgvardia and FSUE Departmental security of the Ministry of Energy of the Russian Federation;
  • Development and maintenance of up-to-date plans for interaction with law enforcement agencies to protect the Company’s facilities when committed or threatened to commit a terrorism act;
  • Maintenance of security pass regime at the Company’s facilities;
  • Application of measures to identify, prevent and suppress acts of unlawful interference in the activities of the Company’s facilities together with law enforcement agencies;
  • Assessments of the most likely threats and development of plans for mitigation, together with the territorial bodies of EMERCOM of Russia in the constituent entities of the Russian Federation at the location of the Company’s facilities;
  • Equipment of the Company’s facilities with engineering and technical means of protection;
  • Organization and control over the access to information on the composition and condition of engineering and technical means of protection;
  • The Company’s fixed assets insurance package includes insurance against Terrorism and Diversion;
  • Increase in the number of equipment certified by FSTEC of Russia, and equipment of domestic production;
  • Audits of information and technical security;
  • Organization and control over the mode of access to software and hardware of control systems and information systems.
Failure to achieve targets by the sales companies
Direct:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA)
  • Reduction of the operating costs

Indirect:
  • Leverage ratio (coefficient)
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Employees
  • Suppliers and contractors
  • Monitoring of the compliance of the sales companies controlled by PJSC RusHydro with the criteria for financial stability in accordance with the rules of retail markets;
  • Work with consumers to form mutually beneficial relationships, including the work aimed at preserving the market share of the sales companies of PJSC RusHydro;
  • Introduction of the PJSC RusHydro’s corporate risk management system into subsidiary sales companies.
Delays and errors in management system improvement
Direct:
  • Compliance with the schedule of the capacities commissioning at the core facilities of new construction, %
  • Fulfilling capacity commissioning timetable and the finance and disbursement plan, %
  • Share of purchases from small and medium-sized business entities

Indirect:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA)
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Employees
  • Suppliers and contractors
  • Improvement of the activities regulation and business process management system;
  • Optimization of procurement timing and coordination;
  • Improvement of the communication with the stakeholders;
  • The internal control department of PJSC RusHydro analyses the key business processes in order to improve the Company’s control system and enhance its process efficiency. Civil responsibility of the Company’s officers to any third parties is insured.

PJSC RusHydro introduces corporate management standards in reacquired or established subsidiaries and branches, as well as the systems of corporate project management, staff grading (grading means the establishment of a job hierarchy based on the job evaluation, strategy, and corporate culture of the Company), manager certification and implementation of individual personnel development plans.
The risk of the low efficiency of innovation activity
Direct:
  • Integral KPI of innovation activity, %
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA)

Indirect:
  • Leverage ratio (coefficient)
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Employees
  • Suppliers and contractors
  • Alteration/elaboration of work methods and infrastructure in order to ensure the implementation of the innovation programme;
  • Update of the innovative development programme;
  • Regular benchmarking of currently used technologies.

Environmental aspect

Adverse changes / breaches of legislation
Direct:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA)
  • Current liquidity ratio (coefficient)
  • Reduction of the operating costs

Indirect:
  • Leverage ratio (coefficient)
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Consumers
  • Employees
  • Trade unions
  • Federal authorities
  • Regional authorities and local government authorities
  • Local communities
  • Environmental organizations
  • Mass media
  • Suppliers and contractors
  • Monitoring of initiated and pending changes in legislation, which could potentially have an impact on the Company’s activities;
  • Monitoring and review of the existing standards and regulations in the field of technical regulation;
  • Participation of the PJSC RusHydro’s representatives in the important law changing events held by legislative, executive and judicial bodies, public associations, professional legal organizations and associations;
  • Regular environmental audits and implementation of the recommendations received;
  • Participation in working groups of the Russian Ministry of Energy (on technical regulation) and the Technical Committee No.330 (on national standards).
Anthropogenic accidents
Direct:
  • Reliability criterion

Indirect:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA)
  • Leverage ratio (coefficient)
  • Current liquidity ratio (coefficient)
  • Reduction of the operating costs
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Consumers
  • Employees
  • Trade unions
  • Federal authorities
  • Regional authorities and local government authorities
  • Local communities
  • Environmental organizations
  • Professional communities and higher education institutes
  • Mass media
  • Suppliers and contractors
  • Non-profit organizations
  • Performance of the full scope of repairs and implementation of the Retrofitting and Upgrading Program;
  • Development of the quality control system for supplied equipment including its manufacturing and shipment/delivery, construction, installation and commissioning, as well as increasing the scope of contractual liability of suppliers/contractors for the manufacture and supply of equipment and materials;
  • Filing claims against disreputable suppliers/contractors;
  • Observance of the recommendations provided during inspections of the facilities owned by PJSC RusHydro;
  • Strengthening of on-site control over contractors / sub-contractors in terms of reducing accident rates, fires, unethical behaviour, thefts;
  • Development of regulatory technical documentation aimed at improving the quality of design and construction management processes;
  • Introduction of up-to-date equipment troubleshooting procedures, advanced control technologies for business assets including appropriate information technologies;
  • Refinement of the structure and amount of replacement parts;
  • Development of equipment lifecycle management systems at operating hydroelectric power plants;
  • Industrial environmental control and monitoring;
  • Control over the officials’ compliance with the regulations, instructions, etc. in the course of operations, service, etc.
Damage in the result of natural disasters and anthropogenic accidents outside the Company’s facilities
Direct:
  • Reliability criterion
  • Compliance with the schedule of the capacities commissioning at the core facilities of new construction, %
  • Fulfilling capacity commissioning timetable and the finance and disbursement plan, %
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/Ebitda)

Indirect:
  • Leverage ratio (coefficient)
  • Reduction of the operating costs
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Consumers
  • Employees
  • Federal authorities
  • Regional authorities and local government authorities
  • Environmental organizations
  • Non-profit organizations
  • Modernisation in accordance with modern requirements of the centralized emergency control system;
  • Research and development of methods for remote monitoring of the condition of facilities and operating modes of HPPs;
  • Compliance with the Russian legislation in the field of industrial safety and the use of a production control system functioning on its basis;
  • Industrial environmental control and monitoring;
  • Property insurance.
Incorrect water-content and output forecasting
Direct:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA

Indirect:
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Consumers
  • Optimization of the use of water resources within the framework of the Energy Saving Program of PJSC RusHydro;
  • Development of the industry system of hydro-meteorological observation and protection of the interests of HPPs in interagency working groups of the Federal Agency for Water Resources;
  • Integration of the medium-term water-content forecasting model.

Social aspects

Risks of interaction with stakeholders
Direct:
  • Total shareholder return (TSR)

Indirect:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA)
  • Shareholders and investors
  • Consumers
  • Employees
  • Trade unions
  • Federal authorities
  • Regional authorities and local government authorities
  • Local communities
  • Environmental organizations
  • Professional communities and higher education institutes
  • Mass media
  • Compliance with the Rules of information activities, the Rules of participation in public events, the Rules of information disclosure;
  • Preparation of explanatory press releases and media materials;
  • Organization of interaction with stakeholders on the basic areas of the Company’s activity, including through organization of joint public events;
  • Preparation of regular press releases with the Company’s official opinion on the activity issues;
  • Holding of press tours and special events for the media.
Unethical or illegal actions of the employees
Indirect:
  • Return on equity (ROE), %
  • Limitation on the debt burden (NetDebt/EBITDA)
  • Total shareholder return (TSR)
  • Shareholders and investors
  • Consumers
  • Employees
  • Trade unions
  • Mass media
  • Suppliers and contractors
  • Non-profit organizations
  • Introduction of the integrated automated control system over distribution of the commercial secret information;
  • Monitoring of the compliance of the employees with the Regulation on Insider Information;
  • Restriction of the right of access to the insider information for the Company’s employees;
  • Organization of mandatory notifications from the insiders about transactions they enter into with the Company’s securities.

1.5.3. Risk management in subsidiaries

The Company currently focuses on the IC&RMCS improvement in the following areas of activity:

  • implementation of regular assessments of the effectiveness of risk management measures, automation of management procedures as for collection of the information on risks, activities and risk indicators for the Group;
  • regulation of risk management processes in the Group’s subsidiaries based on the approaches implemented in PJSC RusHydro;
  • integration of risk management systems into planning and decision-making processes in the Group’s companies;
  • development of an end-to-end system for collecting reports on the risk management of the Group’s companies and aggregation of the information on risk management at the parent company level using the automated risk management system of PJSC RusHydro;
  • type assignment of risk control procedures in all companies of the Group;
    annual reassessment of the levels of development of risk management systems in the Group’s companies to update the integrated systems’ assessment, as well as development of the to improve the RusHydro Group’s risk management system based on the assessment.

In 2016, in order to improve the risk management system, the following key actions were implemented:

  • Branches and subsidiaries were assessed and prioritized according to the level of risk and the status of implementation of risk management procedures in order to form a risk-oriented internal audit plan for PJSC RusHydro for 2017-2018;
  • In the key subsidiaries of PJSC RusHydro (design and research institutes, construction organizers and contractors, repair and service companies, sales companies), risk management plans for 2016-2017 were approved;
  • As part of the risk management activities of the RAO ES of the East, the measures provided by the Strategic Management Plan for the Holding Company RAO ES of the East for 2015-2016, as developed for the strategic risks of RAO ES of the East, as well as strategic risks Subsidiaries of RAO ES of the East: JSC FEGC, JSC FEDC, PJSC FEEC and PJSC Yakutskenergo were undertaken.

1.5.4. Influence of R&D and research development on the key risks

The RusHydro Group’s innovative activities are mainly aimed at reducing the costs of maintenance, repairs, technical support, TP&R and new construction. In addition, the effectiveness of innovation activity directly affects the competitiveness of RusHydro’s engineering companies in international markets.

The Company’s management specify a separate strategic risk of the low efficiency of innovation activity taking into account the scale of the RusHydro Group’s operations and the significance of the possible impact of R&D and research work on RusHydro’s financial performance.

Among the risk factors, the Company sees a possible widening of the gap between the applied technologies and international best practices, an underinvestment of planning and surveying works due to occurrence of the risk of shortage of funds, as well as emergence of new requirements of the supervisory bodies for the formation and implementation of Innovation Development Programs.

In 2016, the key event in this risk management was the revision of the RusHydro Group’s Innovation Development Program for 2016-2020 with a prospective for up to 2025 (Minutes No. 244 of November 23, 2016). The implementation of this Program will increase efficiency of the main technological cycle of the HPPs (including by reducing costs for own needs), economic and operational efficiency of the activity through the introduction of innovative technical and management solutions aimed at:

  • Increase of the service life and productivity of equipment;
  • Development of technologies to improve reliability and operating economy of the equipment;
  • Improvement of the equipment diagnostics quality and a proactive identification and elimination of operating risks;
  • Reduction of dependence on imported equipment and import substitution;
    Environmental impact reduction.

Read more about the Company’s innovation activity in part 3.3 of 2016 Report on Corporate Social responsibility and sustainable development of RusHydro Group.

1.5.5. Internal control and audit

There is a system of control over the proper use of funds in PJSC RusHydro. The main mechanism for the implementation of control is the internal control and risk management system aimed at ensuring:

  • efficiency and rationality (economy) of operations,
  • reliability of financial and management reporting,
  • compliance with laws and regulations.

The principles and approaches to the organization of internal control and risk management are defined in the Internal Control and Risk Management Policy. In accordance with the provisions of the Policy, the following internal control procedures are applied by the Company’s authorized control bodies and officials:

  • coordination of documents;
  • approval of documents;
  • reconciliation of data;
  • monitoring of the key performance indicators (analysis of the actual budget indicators compliance with planned ones);
  • monitoring of compliance with disclosure regulations (aimed at identifying deviations in routes and traffic schedules of reporting documents in order to carry out appropriate corrective actions);
  • sharing of access rights;
  • automation of the procedure for input and transformation of information.

In 2014-2016, the Company carried out a comprehensive work to improve the internal audit, control and risk management system, including the update of this system in accordance with the current requirements and recommendations of the Ministry of Finance of the Russian Federation, the Bank of Russia, and the Federal Agency for State Property Management.

Internal control is executed at all levels of the Company’s management, in all its divisions. IC&RMCS is a multilevel body, which assumes a continuous exchange of information between its subjects (management bodies and structural divisions of the Company).

The Internal Control and Risk Management Departments analyse available risks, test (evaluate effectiveness of) the control procedures aimed at reducing existing risks. Their activity is based on the information provided by the Company’s functional divisions. This information contains data about the Company’s business processes and the availability and implementation of internal control procedures. Taking into account the results of the data-analysis, the Internal Control and Risk Management Departments formulate recommendations for the improvement of risk management procedures and control procedures.

The interaction of risk management departments, internal control and internal audit departments was organized. As part of this interaction Risk Management Department submits relevant information on the Company’s risks to the internal control and internal audit units in order to ensure the risk-based planning of the control activities.

Based on the results of the control activities, the Internal Audit Department informs on the identified risks and residual risks of the IC&RMCS management, as well as about the revealed «defects» in the internal control system of the internal control unit with a view to taking measures to improve the effectiveness of the internal control system.

Internal control is executed at all levels of the Company’s management, in all its divisions. This system allows to implement all forms of control: preliminary, current and subsequent ones, as well as promptly interact and respond in a timely manner to emerging risks.

Based on the results of 2016, the internal audit service carried out an internal independent evaluation of the effectiveness of corporate governance, internal control and risk management of PJSC RusHydro in accordance with the valuation Methodology of the Company. The results of the evaluation were reviewed by the Board of Directors of PJSC RusHydro.

The main development directions of the internal audit function are:

  • development of a Program of quality guarantees and improvement of the internal audit system;
  • update of local regulatory acts that that determine the principles for building the group function of the internal audit of RusHydro Group;
  • update of programs and methodologies for ongoing control activities, annual independent evaluation of corporate governance, evaluation of the effectiveness of the internal control system and risk management.

1.5.6. Control over the proper use of funds

RusHydro has implemented an internal system of control for the proper use of funds. It represents a special reporting system before the RusHydro’s Management Board (quarterly, in the framework of investment sessions), as well as a number of standards and control regulations that allow to monitor the subsidiaries’ work at all stages of project implementation. These measures ensure maximum transparency and enable the state, other shareholders and other interested parties to control the implementation of strategically important infrastructure projects.

Please, see 3.1.2. Procurement for more information on preventing unauthorized and inefficient use of funds in the procurement process.

Please, see 3.1.3. Investment activities for the details on the monitoring of the targeting funds for investment projects and repair work and on the monitoring of the proper use of budgetary funds.

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