OJSC Kubanenergo
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Internal Control and Risk Management

The System of Internal Control and Risk Management (SIC&RM) of OJSC Kubanenergo is an element of the Company’s corporate governance, which includes the full range of procedures, methods and controls created and used by the Board of Directors and executive management bodies, senior management and all employees of the Company in order to provide reasonable guarantees of achievement of goals set in the following areas:

  • efficiency and effectiveness of activity arrangement;
  • compliance with the laws applicable to the Company’s activities as well as with the requirements of the Company’s local regulations;
  • prevention of misconduct of the Company’s employees and third parties with respect to the Company’s assets;
  • reliability, completeness and timeliness of all types of reporting.

The effectiveness of the control function and internal control system as a whole is ensured suing the following three constituent relationship management processes:

  • organization of effective internal control of business processes to achieve the maximum effect of all activities of the Company: control procedures implemented at the level of business processes promote timely and effective identification of deviations and improve the efficiency of the operating environment and reliability of financial reporting (monitoring);
  • risk management, forming part of the internal control system, helps reduce the risk of failure by the Company in reaching its objectives, creation of protective barriers and prevention of abuse (preventive control);
  • audit and independent evaluation: internal audit provides independent and objective judgment about the reliability and effectiveness of internal control and risk management (follow-up).

For the development and improvement of the system of internal control and risk management and the internal audit function, in the reporting year the Board of Directors approved (Minutes of 12.09.2014, No.196/2014):

  • Internal Control Policy, as amended;
  • Risk Management Policy, as amended;
  • Internal Audit Policy.

The Policies are available on the Company's website; all employees of the Company have read and understood the Policies.

System of Internal Control and Risk Management

System of Internal Control and Risk Management

Members of the internal control and risk management system

Members of the internal control and risk management system

Powers and responsibilities of the main participants of SIC&RM

Name of the participant

Basic powers and responsibilities in the field of SIC&RM

Board of Directors

  • to ensure the creation, operation management and establishment of the overall development strategy of SIC&RM in the Company;
  • to review of reports and making decisions on systemic and key issues of internal control

Revision commission

  • to exercise control over financial and economic activities of the Company;
  • to perform independent assessment of the data contained in the annual report and annual financial statements of the Company;
  • to interact with the Department of Internal Audit and Control

Audit Committee of the Board of Directors

  • to ensure the selection of the external auditor and assess the results of its work;
  • to provide an assessment of the reliability of accounting (financial) statements of the Company (including the external auditor's opinion);
  • to evaluate the effectiveness of the SIC&RM and prepare proposals for its improvement

General Director, Management Board

  • to ensure the creation and daily operation of an effective and reliable SIC of the Company

Heads of units and divisions

  • to organize an effective control environment for supervised processes (activities), be responsible for the effective achievement of operational goals in supervised processes (activities), risk management in supervised processes (activities) and execution of control procedures

Employees of Company's divisions performing control procedures as part of their official duties

  • to perform control procedures in the functioning of the SIC in accordance with the job descriptions and established regulations;
  • to ensure timely notification of supervisors if the performance of control procedures and risk management measures is rendered impossible for some reason and/or requires a change in the design of control procedures/risk management measures due to changes in internal and/or external conditions of functioning of the Company, including to ensure the development and submission to supervisors of proposals on introduction of control procedures and risk management measures in their respective fields of activity

Internal Audit and Control Department

  • to ensure methodological support and coordination of risk management processes and regulatory control environment of the Company, perform independent follow-up and evaluation of the effectiveness of the control environment within the Company, and ensure notification of the Board of Directors and executive bodies of significant trends and shortcomings in the activities of the Company
  • to interact with the Revision commission

In order to ensure the efficiency of the SIC and its compliance with the objectively changing requirements and conditions, the Company evaluates the effectiveness of the SIC in terms of its compliance with the target condition and level of maturity.
Information on risks presented below contains the names of the risks inherent in the Company, a brief description thereof, main risk management measures implemented in 2014, as well as a graphic representation of the significance of risks and its dynamics against 2013 and throughout 2014. Significance of a risk refers to a combination of the probability of the risk and the magnitude of its consequences for the Company in monetary and other terms with the application of the following scale:

Level of significance Dynamics
Critical

No change (or insignificant dynamics)

 

Significant

Increase

Moderate

Reduction

Information on Risks of the Company

Item No.

Risk

Description

Measures to minimize the risk taken in 2014

Risk significance assessment and dynamics

Industrial risks

1

Tariff risks

The Company is a natural monopoly; its activities are subject to state regulation. Due to the limited increase in tariffs for consumers at the level of the Russian Government, the possibility of establishing tariffs below the economically justified level is estimated as high.
In addition, 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 at the approval of tariffs, as well as the risk of changes in tariff legislation.
FTS of Russia approved the conversion of the Company to the regulation of tariffs for power transmission with the use of the method of return on invested capital (RAB-regulation), the use of which shall help to attract long-term investments in the industry and reduce the influence of subjective factors on tariff decisions. Due to the increase in interest rates both in the existing and new loans, the approved rates of return on invested capital created after the transition of the Company to RAB-regulation, as well as the rate of return on invested capital for the calculation of tariffs for electric power transmission under UNEG, in accordance with Order No.1981-e and No.2049-e of the FTS of Russia of 17.11.2014 and 21.11.2014, do not cover the cost of return and maintenance of borrowed funds, which may lead to an increase in the debt burden of the Company.

  • interaction with tariff regulation bodies on the justification of expenditure in the framework of approval of tariffs for electric power transmission services;
  • interaction with REC DPT KT and FTS of Russia for the adoption of the highest possible level of tariffs for electric power transmission services in 2015, as a result of which tariffs for power transmission services for 2015 were approved (by agreement with the Federal Tariff Service of Russia) in excess of the limit maximum tariffs approved by the Federal Tariff Service of Russia;
  • pre-trial work was conducted on the consideration of the dispute on the shortfall in income not included by REC DPT KT in NGR in 2014. As a result of this work, the claims of OJSC Kubanenergo were granted (Order No.1837-d of the FTS of Russia of 27.10.2014);
  • uncompensated costs were recognized as economically justified and subject to reporting by the Company within NGR (based on Judgment No.A32-23152/2014 of the Arbitration Court of the Krasnodar Territory of 19.12.2014).

2

Technological connection risks

The key risk of the Company in terms of technological connection (TC) is 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 estimates for ЕС projects;
  • interaction with tariff regulation authorities on the 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 from 01.01.2014, of lease agreements for "last mile" facilities in most constituents of the Russian Federation, 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 (rates) in the electric power industry approved by Decree No.1178 of the RF Government of 29.12.2011, do not envisage a fixed compensation mechanism for the shortfall in income of grid organizations, 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 No.750 of the Government of the Russian Federation of 30.07.2014, 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 No. 35-FZ dated 26.03.2003, On Electricity Production, Article 8, "Lease by the organization managing the unified national (All-Russia) electric grid to territorial grid organizations of power grid facilities and (or) their parts, having technologically connected power receivers of electricity consumers, may be subject to preliminary conclusion of agreements between such consumers and territorial grid organizations".

  • submission of Agreements to extend "last mile" agreements to consumers directly connected to the grids of OJSC UES FGC and indirectly connected to the grids of the UNEG;
  • submission of an offer under the agreement to extend the "last mile" agreement between OJSC UES FGC and OJSC Kubanenergo, taking into account the Agreements received, conclusion of a agreement in order to avoid shortfall in volumes of the planned performance of OJSC Kubanenergo for 2014.

4

Risks of growth of overdue and uncollectible receivables

Overdue and uncollectible receivables may arise in such areas of activity as transmission of electric power, capital construction, and technological connection.
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. One of the major factors affecting the growth of overdue and uncollectible receivables for electric power transmission is the difficulty of matching the amounts of services rendered (due to the use of different algorithms for the formation of productive supply by distribution and power grid companies).

  • 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;
  • accumulation of judicial practice and creation of positive precedents in cases where a consumer 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 equipment);
  • installation of collective metering equipment.

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;
  • improvement of energy efficiency and introduction of energy-saving technologies;
  • cost management;
  • 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 property of the Company, 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;
  • monitoring of the dynamics of exchange rates, analysis of the possible impact.

8

Risks associated with changes in interest rates

The issuer attracts short-term and long-term borrowings from the Russian financial market. The main factor in the growth of interest rates was the increase of the key rate used by the Central Bank of Russia to provide credits to commercial banks in debt.
A significant increase in interest rates may lead to higher debt servicing costs.

  • the use of borrowed capital with fixed interest rates;
  • raising long-term credits in order to prevent the negative impact of short-term fluctuations in interest rates, diversification of funding sources.

9

Risks associated with the effect of inflation

The Company is assesses the risks associated with the effect of inflation as moderate. Rising inflation rates may increase the cost of procurement subject to state limitation of the growth of tariffs.

  • 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 in the short term the emergence of any significant consequences associated with changes in the tax law and civil law.
Changes in currency and customs legislation of the Russian Federation do not affect Company's operations and, therefore, do not entail any legal risks.
The exposure of the Company 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;
  • 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;
  • compliance with legal and internal regulations.

Risks associated with the Company's activities

11

Operational and technological risk

Risks of the industrial activity:

  • systemic consumer 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 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 (in terms of volume and funding). The latter risk arises in connection with the state tariff regulation and the resulting changes in economic conditions, including due to increased procurement prices related to investment activities.

  • formation of the investment program in accordance with the scenario conditions;
  • adjustment of the investment program to changes in economic 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 (Order No.999 of the Company dated 27.11.2014);
  • monitoring compliance with the terms of the procurement and agreementing procedures.

13

Risks associated with current litigations of the Company

In 2014, 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. The most significant cases were related to the settlement of disputes under the agreements for electric power transmission services with OJSC Kubanenergosbyt, OJSC Oboronenergosbyt, and Maykopskaya CHP LLC

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

Risks by Areas of Significance

Risks by Areas of Significance