Risk management system
Aeroflot Group’s risk management policy is aimed at building up a comprehensive system that helps promptly identify risks that affect the Company, assess their materiality, and take measures to minimise both the likelihood of risks being realised and losses they can lead to.
Aeroflot Group’s risk management procedures are governed by the Regulations on Aeroflot Group’s Risk Management System approved in 2015 and updated in 2017.
The document lays down the framework for a unified risk assessment and management methodology: goals, tasks, principles of organisation and operation of the corporate risk management system (CRMS), and approaches to, and principles of, the distribution of rights, obligations and responsibilities of participants of the risk management system at PJSC Aeroflot and its controlled entities.
Risk management is applied across all management levels and functional and project areas. The respective functions are distributed among the Board of Directors, the Audit Committee of the Board of Directors, the Management Board, and business units of PJSC Aeroflot. A standalone unit (Risk Management Department) has been set up in the Company to:
- generally coordinate risk management processes
- develop guidelines to govern risk management processes
- arrange personnel training in risk management and internal control
- review the risk portfolio and develop proposals on response strategy and reallocation of resources to manage respective risks
- prepare consolidated risk reports
- perform day-to-day monitoring of the risk management process in the Company’s business units and in its controlled entities, as prescribed
- prepare information and inform the Board of Directors and executive bodies as to the efficiency of the risk management process.
PJSC Aeroflot’s business units and the Risk Management Department make comprehensive efforts to identify and assess risks, as well as prepare the Risk Register and Risk Map. In 2017, PJSC Aeroflot’s CEO approved the Risk Management Standard to implement the concept of a unified risk management and internal control methodology. The Board of Directors of PJSC Aeroflot annually reviews and approves the Risk Register, Risk Map, and Risk Appetite Statement of Aeroflot Group.
Control over PJSC Aeroflot’s financial and business activities is exercised by the Audit Committee of the Board of Directors, Revision Committee, Internal Audit Department, and Risk Management Department. An independent auditor is engaged to audit PJSC Aeroflot’s accounting statements prepared under the Russian Accounting Standards (RAS) and the International Financial Reporting Standards (IFRS).
Officers responsible for interaction with PJSC Aeroflot on the implementation of the CRMS have been designated in controlled entities, with controlled entities taking measures to identify and assess risks.
Risk management flow chart
Risk management structure
Enhancement of the risk management system
Selected activities implemented in 2017 to enhance integrated risk management in PJSC Aeroflot:
- The Board of Directors of PJSC Aeroflot approved the updated Aeroflot Group’s Risk Register and Risk Map prepared in line with the Risk Management Standard
- The Board of Directors of PJSC Aeroflot approved the Risk Appetite Statement of Aeroflot Group
- PJSC Aeroflot’s employees were trained in risk management and internal control
- Implementation of the Risk Management Standard in controlled entities was launched
In order to improve risk management performance, Aeroflot Group carries out regular CRMS performance assessments both as part of day-to-day operations and in the form of in-house or independent third-party assessments. The management, Audit Committee of the Board of Directors, and Board of Directors receive regular reports on risk management and the CRMS performance across Aeroflot Group.
Principal risks and mitigation measures
FINANCIAL RISKS
| Risk |
Description |
Mitigation |
| Market risks |
Risks of underperformance against targets (financial, operating, strategic, etc.) due to FX rate, commodity price, or market interest rate fluctuations |
To reduce market risk implications for financial performance, PJSC Aeroflot seeks to balance out revenues and liabilities in each currency. In light of the limits of operational (or natural) hedging, we diversify debt across currencies and instruments, and regularly consider financial hedging options involving derivatives on aviation fuel and FX rates. We review the use of interest rate hedges on a regular basis. No transactions were undertaken in 2017 to hedge FX risk or fuel price risk.
See below an overview of the impact the realised risk may have on the Group. |
| Credit risk |
Risk of incurring losses from a potential failure by a counterparty to meet its contractual obligations to Aeroflot Group companies |
A systemic approach is used to manage credit risk, aimed at preventing the risk occurring or minimising financial losses should it occur. The approach involves:
- use of financial coverage clause in service contracts with deferred payments
- capping agent sales volumes, prepayments, and receivables from counterparties
- regular credit quality assessments of counterparties (based on credit ratings and probability of default ratings)
- regular recalculation of financial coverage for credit risk
- regular monitoring of credit risk indicators that warn of potential defaults and give the Company time to respond in advance
- credit risk limits assigned to banks and financial companies.
|
| Liquidity risk |
Risk of incurring losses from the inability of an organisation to fully meet its obligations as they fall due |
To mitigate liquidity risk, we:
- plan cash inflows and outflows to identify and promptly eliminate potential gaps by raising short-term loans from partner credit institutions
- have established controls over the use of working capital by launching an operational system to enable early warnings of cash gaps, building a sufficient liquidity cushion, prompt raising of funds in the money market, and maximize the use of free cash
- regularly review limits for credit, deposit, and FX transactions with financial institutions.
|
| Capital markets access risks |
Risks of incurring losses from the Group’s inability to raise debt for its financial and business activities on acceptable terms |
The market situation is monitored, a competitive environment for credit institutions is set up, measures to enhance the Group’s equity story are taken, and relationships with credit rating agencies are managed. |
BUSINESS RISKS
| Risk |
Description |
Mitigation |
| Strategic risks |
Risks of incurring losses from errors (flaws) made when making decisions on the Group’s business and growth strategy |
Efforts are taken to minimise risks related to the Aeroflot Group’s Development Strategy including making decisions to improve operating performance, cut costs, and increase resource efficiency. |
| Risk of terrorism or armed conflicts |
Risks of incurring losses from armed conflicts, terrorist attacks, or threats of attacks |
PJSC Aeroflot cooperates with airport security services, airlines, and law enforcement authorities to implement an aviation and transportation security action plan to prevent unlawful interference in the Company’s operations and ensure passenger and staff safety. |
| Risks of epidemics, and man-made or natural disasters |
Risks of losses that have external (beyond the control of the Company) causes and are due to epidemics, or man-made or natural disasters. |
Necessary response measures, including flight suspension, route changes to avoid hazardous regions, extra measures to increase flight safety and to ensure aviation security are taken, and sanitary and epidemiological control is strengthened. |
| Industry risks |
Risks of incurring losses from changes in the air transportation industry |
Industry risks are mitigated by:
- operating a high-frequency route network
- using a hub model at the base airport
- maintaining Europe’s youngest aircraft fleet
- targeting the premium passenger segment (convenient departure and arrival times, high-quality service)
- driving innovation across all areas of the business
- maintaining a high level of flight safety
- promptly adjusting existing fares, running marketing campaigns and various promotions
- matching aircraft capacity to the passenger traffic on a given route
- expanding the route network to countries popular among tourists year-round
- requesting slots in advance and forecasting constraints
- applying a flexible, seasonally adjusted pricing policy to maximise revenue including the use of non-refundable fares.
|
| Environmental risks |
Risks of negative changes in the environment or long-term negative implications of these changes caused to anthropogenic impacts |
Aeroflot Group is fully aware of its responsibility to society and future generations and strives to ensure sustainable environmental balance across all areas of business. The key focus area is improving the aircraft fleet’s fuel efficiency. Aeroflot’s environmental policy is aimed at improving the levers and tools ensuring high energy efficiency and environmental performance of its end air products:
- A CO2 calculator has been developed and implemented, required data is collected and analysed, and reports on GHG emissions and revenue tonne-kilometres (Aeroflot’s entire fleet is compliant with ICAO’s noise and emissions standards) are prepared
- A waste management system is in place to minimise environmental impact with a focus on recycling as the most effective method of waste disposal
- Regular inspections of waste storage sites are performed, waste generation and movement are tracked, and contracts for waste disposal and landfill are signed
- Instrumental control and fine-tuning of ground vehicle fuel systems is performed, and performance of ventilation systems is monitored in operational and office premises
- Regular water protection and water resource management activities are carried out
|
| Service quality risk |
Risk of incurring losses from potential refusal by consumers to buy goods or services of the Group companies or outsourced services as a result of products and services offered by the companies failing to meet the quality requirements of consumers |
A process to obtain feedback from customers through a number of channels and ensure timely and full consideration of all incoming communications and complaints has been put in place. The demand for services offered is also tracked, and measures to enhance service quality, improve consumer loyalty and experience, and monitor employee compliance with regulations are taken. |
| Reputational risks |
Risks that an organisation would incur losses as a result of reduced brand value or negative perceptions of the organisation’s image by customers, counterparties, shareholders, business partners, regulators, and others |
Aeroflot Group takes pride in its reputation as a high-quality, safe carrier and a reliable business partner; therefore, it takes all necessary steps to protect its reputation, ensure management integrity and effectiveness, and maintain a positive image among customers, counterparties, shareholders, and business partners.
A strong focus is maintained on analysing and improving customer experience, and on deploying cutting-edge customer service technologies.
The information environment around Aeroflot Group is continuously monitored and analysed, communications with NGOs are maintained, and procedures to monitor compliance with process flows and regulations are set up. |
OPERATIONAL RISKS
| Risk |
Description |
Mitigation |
| Aviation security risks |
Risks of incurring losses from unlawful interference with aviation activities |
The situation is monitored and analysed and remedial measures to ensure safety at the base airport and destination airports are taken, airports are audited on a regular basis, the level of aviation security at destination airports and compliance with regulations are monitored, independent experts are engaged, and the state of external and internal access control systems is monitored on a 24/7 basis. |
| Flight safety risks |
Forecast likelihood and severity of implications of one or several threats being realised with respect to aviation activities related to aircraft operation or directly supporting such operation (flight and ground, commercial and technical) |
Aircraft condition, aircraft maintenance, and the operation of the corporate healthcare unit in terms of medical examination of flight crews are monitored, medical equipment is replaced; operations and operating processes are continuously monitored. |
| IT risks |
Risks of incurring losses from the use of information technologies by the company |
Relations with IT vendors and developers have been established, channel redundancy and data backup procedures are implemented, skilled personnel are recruited and trained, and the causes of IT failures are investigated. |
| HR risks |
A group of risks that arise from, or affect, the Group’s personnel (or an individual employee), including the lack of required/appropriate number of employees as determined based on the current and forward-looking business plans and existing business processes. |
An effective recruitment process has been put in place, training and professional development courses for employees are organised. Also, staff pay levels are monitored in order to remain in line with the market, and a range of social benefits and guarantees is offered to employees. |
| Risks of quality of purchased spare parts, units, components, and materials |
Risks of losses due to quality and authenticity (originality) of spare parts and units purchased by Aeroflot Group, as well as components and materials to support its core business |
Quality of supplies and suppliers’ operations is monitored and analysed, and procurement and supplier selection procedures are improved. |
| Economic and information security risks |
Risks of losses related to changes in the corporate internal and external environment that may lead to the relevant item losing its economic value |
An effective system to monitor, identify, localise and prevent threats and vulnerabilities has been put in place, and steps are taken on an ongoing basis to monitor employee compliance with economic and information security requirements, and to identify and prevent offences. |
| Occupational safety risks |
Risks of incurring losses from factors related to the Group’s financial and business activities which may cause injury or death of employees at workplaces |
Local occupational health regulations have been developed, compliance with, and conformity to, applicable laws are monitored. |
COMPLIANCE RISKS
| Risk |
Description |
Mitigation |
| Tax risks |
Risks of incurring losses from possible misinterpretation of laws with respect to financial and business activities, resulting in financial uncertainties of such activities after tax |
To prevent non-compliance with tax laws, changes in tax laws are regularly monitored in Russia and other countries in which the Company operates, court practice on tax disputes is analysed, contracts to be signed are analysed to remove provisions that might lead to errors or inaccuracies when taxing relevant transactions, and a regular independent audit of the applied taxation procedures is performed during annual auditing process. |
| Legal and regulatory risks |
Risks of incurring losses from failure to comply with laws, changes in laws that may adversely affect financial and business activities of the Company, as well as risks of incurring losses from direct or indirect implications of potential legislative restrictions imposed by regulators on Aeroflot Group |
In its air transport operations, Aeroflot considers local legal requirements in every destination country, as well as the requirements and recommendations of aviation regulators, along with multiple and frequent changes to immigration policy, customs and foreign exchange laws, and licensing requirements.
An action plan is implemented to reduce the probability of adverse impacts on the continuity of Aeroflot’s operations, including legal monitoring, summarising and analysing court practice, and monitoring of practice for signing and executing contracts and agreements with counterparties.
Aeroflot is actively involved in government and international organisations, and in drafting regulations that may impact the way the air transportation industry is regulated. |
| Corruption risks |
Potential corruption offences by employees |
Aeroflot Group does not tolerate any form of corruption, and is committed to the principles of transparency, openness, and fairness in its business and procurement activities, and rejects illicit benefits. Aeroflot continuously improves its corporate regulations, develops and introduces new rules and procedures to prevent corruption offences, raises awareness among employees and educates them on anti-corruption practices, and has in place effective feedback channels. In 2014, PJSC Aeroflot joined the Anti-Corruption Charter of the Russian Business, and actively promotes anti-corruption activities under the Charter. Aeroflot Group has in place the corporate Anti-Corruption Policy and the Committee on Preventing Corruption and Conflict of Interest Resolution. |
Impact of key financial risks realised in 2017
Aeroflot Group’s key financial risks are associated with changes in foreign exchange rates (EUR/RUB, USD/RUB, EUR/USD), jet fuel prices (in the Russian and international markets), and market interest rates (primarily LIBOR). These risk factors are interlinked, most notably changes in the EUR/RUB and USD/RUB exchange rates and jet fuel prices affected by oil prices.
Effect of changes in FX rates and other macroeconomic factors on EBITDA of Aeroflot Group
RUB MILLION
Significant changes in the above risk factors had a major impact on the Group’s performance in 2017 primarily due to sharp changes in FX rates and fuel prices.
In 2017, the average RUB/USD exchange rate appreciated by 13.1% year-on-year. The rouble rose by 11.2% against the euro, and the average EUR/USD exchange rate appreciated by 2.1%. These factors put pressure on Aeroflot’s FX-denominated revenue but changes in USD/EUR exchange rate had a positive impact on the Company with its foreign currency expenses mostly denominated in USD and FX revenues mostly denominated in EUR.
Global oil prices showed a strong growth in 2017, with the year-average price of Brent crude benchmark rising by 21.3% while the rouble appreciated against the US dollar only by 13.1%, as mentioned earlier. Thus, rouble oil prices grew by 5.6%, pushing jet fuel prices by 7.6%.
Currency and price risks
Aeroflot Group’s exposure to currency risk results from the vast share of the Company’s income and expenses being affected by changes in the EUR/RUB and USD/RUB exchange rates:
- Sales revenue from international flight tickets is collected in foreign currency (in foreign markets or from transit passengers), or in roubles based on euro prices, with fares across the Group’s core markets priced mostly in euros
- Fuel costs, lease payments, and maintenance costs (key foreign currency expenses accounting for 24.9%, 13.4%, and 7.4% of the Group’s operating costs, respectively) are denominated in US dollars with some operating expenses denominated in euros and roubles
Our currency risk management primarily focuses on reducing the Group’s exposure to currency risk factors. Aeroflot Group pursues a policy of balancing out revenues and liabilities in each currency.
USD/RUB, EUR/RUB, and EUR/USD dynamics in 2017
Oil price and USD/RUB rate dynamics in 2017
Aeroflot Group’s price risk arises from fuel purchase contracts, as the contractual pricing formula is linked to global oil prices. The Group traditionally uses hedging instruments to manage price risks. In 2016–2017, no such transactions were executed, and no risks for 2018 were hedged as at 31 December 2017.
Interest rate risk
The Group’s exposure to interest rate risk results from changes in the debt market interest rates affecting the costs of borrowings and loans, and driving operating lease costs escalation. Specifically, costs under lease agreements of Aeroflot Group are linked to LIBOR 6M and 3M market interest rates. In 2017, the 6M rate went up from 1.31% to 1.83%, while the 3M rate increased from 1.00% to 1.69% year-on-year (as at 31 December).
Interest rate swaps are a common instrument to mitigate interest rate risk. This risk factor has a limited materiality for the Group, and no transactions to convert the floating rates into fixed rates were undertaken.
Insurance against operational risks
Aeroflot Group uses insurance as an effective tool to manage risks. Aeroflot Group’s underlying approach is to take out, whenever practically possible, full coverage for all types of risks.
The Group’s key operational risks are insured, with coverage for aviation risks, such as actual or constructive total loss, disappearance or damage of aircraft, its components and/or units, risks of airline/operator liability for injury, death, or property damage to passengers or third parties, and war risks accounting for 60% of the total insurance costs.
As part of its efforts to provide insurance protection, PJSC Aeroflot has signed an agreement for liability insurance of PJSC Aeroflot, its directors and officers with a liability limit of USD 100 million.
Aeroflot Group also uses various insurance programmes covering a wide range of non-aviation operational risks of support operations, including all types of compulsory and most types of voluntary civil liability insurance, motor insurance, property insurance (real estate, flight simulators, IT equipment), personal insurance (voluntary medical insurance for employees, their families, and retired employees of Aeroflot Group, accident insurance, disability insurance for flight crews, and travel insurance).
In 2017, all insurance contracts were renewed as scheduled. Given that all insurance policies are purchased as part of the consolidated procurement process, insurance rates and premiums of the Group companies were reduced for many types of policies.
Subsidiary airlines of PJSC Aeroflot were included in consolidated reinsurance coverage, which helped reduce the aviation risk insurance rates by 10%. Thus, despite the growing fleet, the overall aviation risk insurance premium remained almost flat versus the previous insurance period.
Outlook and plans for 2018
Aeroflot group consistently improves its corporate risk management. As part of efforts to enhance the corporate risk management system and improve its performance, special focus will be placed in 2018 on improving approaches to quantitative risk assessment, roll-out of key risk indicator system, and streamlining information flows, infrastructure, and communication channels enabling early risk identification, analysis, and mitigation follow-up.
