Federal Grid Company has a risk management system that is regulated by organizational and administrative documents on two levels:

  • Risk management policy (outlines requirements, principles and approaches to the risk management system);
  • Usage procedure for the risk management policy (stipulates procedures on risk management system functioning, risk identification and evaluation methods, risk reporting and risk response procedures).

The aim of the risk management system: to ensure the Company’s sustainable undisrupted performance and growth through early identification, evaluation and effective management of risks that can compromise the efficiency of the Company’s business operations and reputation, employee health, the environment and the property interests of shareholders and investors.

Participants of the risk management system:

  • Management Board
  • Deputy Chairmen of the Management Board
  • Heads of structural sub-divisions
  • Branch heads
  • Internal Control Division

The risk management system involves the following procedures:

  1. Risk identification methods
    Risk identification involves methods based on the ISO/IES 31010 and COSO standards (analysis, evaluation of threats, expert evaluation and an event tree).
  2. Risk evaluation criteria
    Risk evaluation criteria include: the possibility of the risk being realized; the risk’s financial impact; risk manageability. Risk possibility and financial impact define its importance. The risk importance estimate can be increased if the Company is intolerant to the risk or if a number of departments of the Company’s Executive Bodies, branches or SDCs are subject to this risk.
  3. Risk response methods
    Risk response methods are carried out as one of the following strategies: risk acceptance; minimization of consequences; risk assignment to a third party; risk avoidance; combined measures. The strategy selection is discussed with the Internal Control Division and is approved by the Management Board.
  4. Risk reporting procedures and timeframes
    Risk owners submit their risk reports to the Internal Control Division on a quarterly basis. If necessary, the Internal Control Division amends the reports and approves changes with the risk owners. The amended submitted reports are used as the basis for the Risk Matrix and the Set of Risk Minimization Measures, which are submitted to Federal Grid Company’s Management Board for approval.

Risk identifi cation and evaluation, reporting on risks and providing information about realized risks
Analysis of risk reports, amendments to risk reports, the discussion and approval of changes with risk owners
Discussion and approval of reports with corresponding heads of the EO Departments and directors
Amendments to reports following discussion and approval with Heads of the EO Departments and directors
Preparation of the Risk Matrix and the Set of Risks and Minimization Measures, their submission for Management Board approval, including control over the implementation of already approved risk-infl uencing measures and risk evaluation of performance analysis
Approval of the Risk Matrix and the Set of Risks and Minimization Measures
Distribution of approved risk minimization measures
Implementation of approved risk minimization measures

Main Risks and Measures Aimed at Minimizing Them

Global (Strategic) Risks

Considering the special importance of undisrupted performance and the UNEG development, risks deemed to be global (strategic) are the risk of accidents and performance disruptions for the UNEG, which involves the risk of incorrect performances of RPA and ECA and poorer quality and/or disruptions in electricity supplies. Detailed information on these risks is available in the Production Risks section.

Country-Specific Risks

Federal Grid Company does not view country-specificand regional risks as important in its operations.

Industry-Specific Risks

Considering the specifis of Federal Grid Company as a natural monopoly, the main industry-specific risks are tariff risks, for example, risks that affect the cost of services provided. Tariff risks include, above all, the risk related to the state regulation of tariffs, the risk of the non-implementation of the investment program financing plan and the risk of the non-implementation of plans for an increased number of assets.

Risks Associated with the State Regulation of Tariffs

As a result of the growth containment policy for tariffs on products and services of natural monopolies, which is currently being implemented by the Russian Government, there are risks that regulatory bodies will introduce tariffs far below economically-justified levels.

On 28 December, 2010, Resolution No. 486-e/3 of the FTS approved tariffs for the UNEG electricity transmission services provided by Federal Grid Company for 2010-2014. Under the resolution, the increase in the average tariff for the UNEG electricity transmission services provided by Federal Grid Company (over the long-term regulatory period) will be 32.8% in 2011, 27.0% in 2012, 21.1% in 2013 and 15.2% in 2014. Tariff growth rates for 2011 will remain unchanged. Previously, the Russian Ministry of Economic Development had said that tariff growth rates already approved for 2011 can be revised downwards. This was due to the Government’s decision to limit the growth in electricity tariffs for consumers in 2011 to 15% and below. In particular, the tariff for Federal Grid Company was planned to be reduced by smoothing the tariff in the transition to the five-year regulatory period.

Managing risks associated with tariff regulation involves effetive interaction between Federal Grid Company and power industry regulatory bodies to develop economically-grounded tariffs, and for interactions with electricity market players within the membership of the Market Council.

Non-Implementation of Investment Program Financing Plans The risk of the non-implementation of the investment program financing plan is caused by the possibility of service tariffs being set (or amended for future periods) at a level that is insufficient to cover the Company’s actual expenses.

These risks may be realized if the investment program is not implemented, as a result of not meeting planned timeframes for providing financing to facilities additionally included in the investment program and facilities previously not planned for in the investment program, and also if the actual cost of investment program facilities exceeds the target level when raising funds in the amount needed to implement Federal Grid Company’s investment program is impossible.

Considering that the investment program financing amount is used in calculations of Federal Grid Company’s electricity transmission tariff, non-implementation of the investment program, for any reason, can result in a commensurate reduction in the tariff in later periods.

To ensure financing for the investment program by improving operational efficiency, the Company approved the Comprehensive Cost-Cutting Program with the following principal aims:

  • Reducing informational service costs;
  • Optimizing site maintenance expenses, including utility expenses;
  • Reducing office rent expenses;
  • Cutting business trip expenses;
  • Decreasing insurance expenses by tender procedures;
  • Reducing production program costs by using internal resources for part of the work targets, reducing the price of work and material acquired by the Company, without reducing actual work amounts, and by partially dropping target repair programs.

To reduce the risks of higher actual project costs, compared to those planned for and included in the tariff, the Company developed a system to discuss, approve and control changes in agreements with suppliers and contractors and introduced regular reporting on results of the capital expenditure financing plan and the planned work schedules. The risk of the inability to raise monetary funding in the amount needed to finance the investment program is minimized by diversifying financing sources: the Company signed agreements with several lending organizations to open up credit lines and successfully completed a bond issue.

Non-implementation of the Plan for an Increased Number of Assets A factor that contributes to the non-implementation of the plan for an increased number of assets is the late inclusion of facilities in the investment program (due to incorrectly identifying facilities that limit the grid’s output amid a strong increase in electricity consumption). Consequences of realizing this risk is a possible reduction in the tariff for later periods in accordance with amounts not used as a result of late facility commissioning. There is also the possibility of damages represented by lost profits due to the inability to provide electricity transmission services and a reputation loss due to the non-implementation of important projects.

To minimize the risk realization possibility Federal Grid Company works to include new facilities in the investment program (on schedule) and to amend the investment program when possible.

Legal Risks

Federal Grid Company believes that there is a significant risk of lawsuits and claims filed by third parties over disputable situations, as well as for lawsuits and claims filed by Federal Grid Company against third parties.

To minimize the consequences of legal risks the Company uses different mechanisms aimed at reaching agreement with contractors and defending its views (through pre-court settlement procedures and amicable agreements during court litigation) and at defending the Company’s interests in court actions.

Information about ongoing lawsuits in 2010:

  • The Company faced court claims worth a total of RUR10,540 – in debt claims;
  • The Company faced court claims worth a total of RUR3,303,822,347.24 (including RUR3,132,956,842.24 in debt claims and RUR170,865,505.50 in sanctions).

Production Risks

Risk of Accidents and Disruptions in the UNEG Federal Grid Company believes that the most important production risk is the risk of the UNEG accidents and disruptions. The risk is affected by numerous factors, including all errors (failure to act) of the operational staff, the incorrect performance of relay protection and automatic equipment and emergency control automatics (hereinafter, the RPA and ECA) and poorer quality of and disruptions in electricity supplies.

Corporate efforts to reduce the possibility and consequences of the risk of accidents and disruptions in the UNEG are aimed at fighting risk factors.

Incorrect RPA and ECA PerformanceŔ

To reduce this risk Federal Grid Company upgrades algorithms for its ECA hardware and software complexes and replaces morally outdated and depreciated RPA sets. Additionally, the Company works to upgrade its employees’ skills, monitors RPA and ECA performance and regularly analyzes technological violations to identify reasons and develop measures to eliminate them.

Poorer Electricity Quality

To reduce the risk implementation possibility the Company develops respective regulations on quality control, adjusts and expands agreements on electricity transmission services and implements technical measures aimed at electricity quality control.

Disruptions in Electricity Supplies

Disruptions in electricity supplies, which are caused by outdated equipment, can be minimized by implementing the Company’s investment program and meeting technical maintenance targets. To minimize natural factors the most effective measure is to apply the approved Procedure for Normative Maintenance of Overhead Transmission Line Routes, which, among other things, stipulates the procedure for removing trees and bushes from routes. Special attention is paid to enhanced control over sub-contractors.

Risks Related to Innovative Development and Improving Energy Efficiency

Federal Grid Company views implementing innovative development and energy efficiency improvement programs as highly important. Implementation violations may be the result of changes in requirements set by regulatory bodies and by the insufficient efficiency of third parties involved in program implementation. Realization of these risks can lead to penalties being imposed on Federal Grid Company and negative reputational consequences, which in turn can lead to higher funding costs.

To reduce the possibility or consequences of risks related to upgrading energy efficiency Federal Grid Company has developed and introduced regulations on interactions between structural departments about program implementation and has also intro a data retrieval and analysis system to characterize program implementation.

The Innovative Development Program was discussed by the Company’s Board of Directors and the Strategy Committee of the Board of Directors. There are plans to complete a technical and technological audit of program results, which will later be considered by the Russian Ministry of Energy.

The funding needed to implement the programs in a timely manner has been included in the budget of Federal Grid Company.

Environmental Risks

Environmental safety and the rational use of natural resources are prominent on the agenda of Federal Grid Company. For legislative violations the Company can face high fines (based on Russian legislation). The possibility of these risks is evaluated as insignificant with insignificant consequences for Federal Grid Company’s operations.

Of special importance are risks related to Federal Grid Company’s equipment that contains trichlorodiphenyl. A contributor to realizing this risk is strong equipment wear and tear.

Consequences of this risk include potential environmental pollution and trichlorodiphenyl -poisoning for the Company’s personnel and/or general population. Additionally, if there are violations in maintaining, storing or utilizing procedures for trichlorodiphenyl-containing equipment, Federal Grid Company can face sanctions from state regulatory bodies.

The tool to reduce environmental risks is the Company’s Environmental Policy (as approved by the Company's Board of Directors). The Company implements it E in accordance with the Environmental Doctrine of the Russian Federation, its own Environmental Policy and the opinions of leading environmental protection groups. When new facilities are designed, the environmental aspect is developed as a stand-alone part of the project and takes into account all requirements of Russian environmental legislation. All construction and reconstruction projects of the electric grid facilities are subject tostate environmental examination.

In 2H 2010 the Company approved the 2011-2013 Environmental Policy Implementation Program, which outlines numerous organizational and technical measures aimed at risk reduction, minimization of environmental pollution, introduction of an environmental management system, environmental auditing and development of normative and technical documents related to the environment.

In order to reduce the risk of damages from using and storing potentially hazardous equipment, the Company developed and approved the target program for decommissioning equipment that contains trichlorodiphenyl, introduced efforts to collect and update information about equipment that contains trichlorodiphenyl and exerts ongoing control over decommissioned equipment.

Financial Risks

Currency Risks

Federal Grid Company’s revenues from electricity transmission services are calculated in the Russian national currency – the Russian rubles (RUR). The Company’s current loan and debt obligations are also ruble-denominated. Thus, risks are negligibly low. In terms of exchange rate fluctuations for foreign currencies, these fluctuations affect the Russian economy as a whole and can therefore indirectly influence corporate operations.

Liquidity Risks

Considering the current liquidity level, the Company runs a negligibly low risk of failing to fulfill its obligations in full within the set timeframe. The Company services its previously raised loans in strict accordance with approved schedules.

In order to reduce potential consequences of this risk, the Company controls its debt burden and creditworthiness. The Company’s creditworthiness criteria and their target levels are stipulated by Regulations on the Credit Policy and are approved by the Board of Directors (Minutes No. 116, as of 29 September, 2010).

Interest Rate Risk

The risk of higher interest rates on loans can prove to be significant for the Company if its debt burden shows strong growth. As a result, the risk of higher interest rates can affect the Company’s expenses on debt re-payment. To ensure borrowed financing and minimize the risk of changes in interest rates the Company aims to diversify its borrowing portfolio tools.

Inflation Risks

The current inflation rate has no significant effect on the Company’s financial standing. A critical inflation rate is a level exceeding 30%.

Risks Related to a Possible Increase in Accounts Receivable

Federal Grid Company’s economic risk factor is the increase in accounts receivable, which can be triggered by the poorer performance of the Company's contractors and their inability to pay for the Company’s services within a set timeframe. The possibility of these risks arising can be linked to a downturn in Russia’s economic situation as a whole.

The impact of these factors is minimized by introducing a program to optimize expenses, monitor the market and enact tougher payment discipline for consumers, among other measures.

Risks Related to the Company’s Investment, Which Has an Anticipated Yield of More than 10 Percent Per Annum

ÂIn 2010 as a result of the completed restructuring of promissory note debt of FC Otkrytie and Otkrytie-Finans (which began in 2009 due to the companies’ inability to fulfill their obligations), the Company’s balance sheet received six promissory notes of ENERGO-Finans worth a total of RUR12 billion, with a yield of 13% per annum. The restructuring was in line with the Russian Ministry of Energy’s instructions.

In order to upgrade the liquidity of securities and minimize the risk of non-redemption, promissory notes were secured by a guarantee of a bill by the Rusenergo Limited Fund.

The Company made no other investment with a yield of more than 10% in 2010.