Risk Management System
Aeroflot Group’s risk management policy implies building a comprehensive system that helps us promptly identify risks, assess their materiality, and take measures to minimise both the likelihood of risks being realised and losses they can lead to.
In 2015, PJSC Aeroflot’s Board of Directors approved the Regulations on Aeroflot Group’s Risk Management System. The document lays down the fundamentals of a unified risk assessment and management methodology: goals, tasks, principles of organisation and operation of the corporate risk management system (CRMS), and approaches to the distribution of rights, obligations and responsibilities of participants of the risk management system at PJSC Aeroflot and its subsidiaries.
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 Office) 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 risks 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.
In 2016, PJSC Aeroflot’s Board of Directors approved Aeroflot Group’s Risk Register and Risk Map. PJSC Aeroflot’s business units made comprehensive efforts to identify and assess risks and developed a draft Risk Management Standard implementing the concept of a unified risk management and internal control methodology.
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, Risk Management Office, Financial Risk Management Office of the Corporate Finance 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 corporate risk management system have been designated in subsidiaries, with subsidiaries taking measures to identify and assess risks.
General Meeting of Shareholders tier
- making decisions on matters of the General Meeting of Shareholders.
Board of Directors tier
- determining key parameters of the CRMS (goals, tasks, operating principles, architecture, risk appetite, etc.);
- managing risks within the authority of the Board of Directors;
- making decisions on providing necessary resources to CRMS participants;
- assessing CRMS performance;
- reviewing the risk map.
- operational management and monitoring of CRMS;
- making decisions on management of risks within the authority of CRMS participants at the executive management level;
- making decisions on allocation of resources among CRMS participants;
- making decisions on identifying instruments and parameters for financial risk hedges.
Line management tier
- executing, following up, and continuously improving risk management procedures;
- making decisions on management of risks within the authority of line management.
To further improve risk management across key business processes within Aeroflot Group, the CEO, the Audit Committee, and the Board of Directors regularly receive reports on the Company’s key risks, including a report on the actual realisation of financial risks (market and credit risks), submitted by the Audit Committee on a monthly basis. In addition, at least once a month the Management Board receives a report on the steps taken to mitigate identified risks relating to flight safety, based on the results of the implementation of the flight safety management system.
First Deputy CEO for Aviation Safety also receives a quarterly review of the results of monitoring and assessment of potential unlawful interference in the Company’s operations across the route network, and the risk matrix for the airline’s network for the next quarter. This information is also presented to members of the Management Board who have authorised access to confidential information.
Risks and Risk Management Measures
|Currency and commodity price risk||Currency risk is the risk of incurring losses from potential adverse fluctuations of exchange rates. Commodity price risk is the risk of incurring losses from potential adverse changes in prices of commodities purchased.||Aeroflot Group has a policy aimed at balancing receivables and liabilities across each currency. In light of the limits of operational (or natural) hedging, we consider financial hedging options: to balance out the income structure and the cost structure we may use derivatives on oil and on FX rates.|
|Interest rate risk||Risk of incurring losses from potential fluctuations in market interest rates.||We regularly analyze and implement, as necessary, measures to hedge interest rate risk.|
|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 including:
|Liquidity risk||Risk of incurring losses from inability of the company to fully meet its obligations as they fall due.||To mitigate liquidity risk, finance units carefully plan cash inflows and outflows to identify and promptly eliminate potential gaps by raising short-term loans from credit institutions, analyse and follow up the execution of the Cash Flow Budget, monitor identification of foreign exchange proceeds, monitor compliance with payment deadlines, etc.|
|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 mitigate the implications and/or the likelihood of these risks being realised, changes in Russian tax laws are monitored, tax systems in foreign jurisdictions and agreements signed by the companies are reviewed, etc.|
|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.||To mitigate the implications and/or the likelihood of these risks being realised, the market situation is monitored, a competitive environment for credit institutions is set up, and measures to enhance the Group’s equity story and upgrade and/or maintain our credit rating are taken.|
|Other financial risks||Other risks that may affect financial performance.||To mitigate the implications and/or the likelihood of these risks being realised, the market environment is analysed, the terms of service offered by financial institutions are monitored, payments for outstanding invoices are followed up, etc.|
|Strategic risks||Risks of incurring losses from errors (flaws) made when making decisions on the Group’s business and growth strategy.||To mitigate the implications and/or the likelihood of these risks being realised, the market situation is monitored, market players and analysts are consulted, judgements and opinions by leading global experts are used, necessity to upgrade the fleet is analysed, and specialised business units are involved in strategic planning.|
|Route network planning risks||Risks of incurring losses from wrong decisions made when planning the route network.||To mitigate this risk such methods as requesting slots in advance when interacting with airports, providing standby aircraft, forecasting constraints, monitoring flight loads and the market situation are applied.|
|Service quality risks||Risks of incurring losses from potential refusal by consumers to buy goods or services of the Group’s companies as a result of products and services offered by the companies failing to meet the quality requirements of consumers.||To mitigate the implications and/or the likelihood of these risks being realised, a process to obtain feedback from customers through a number of channels and ensure timely, full consideration of all incoming communications and complaints has been put in place. The demand for services offered by Aeroflot Group 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 negative perceptions of the organisation’s image by customers, counterparties, shareholders, business partners, regulators, and others.||To mitigate the implications and/or the likelihood of these risks being realised, procedures to monitor compliance with process flows and regulations are set up; the information environment around Aeroflot Group is continuously monitored and analysed; and communications with NGOs are maintained.|
|OPERATIONAL RISKS (CORE BUSINESS)|
|Aviation security risks||Risks of incurring losses from unlawful interference with aviation activities.||To mitigate the implications and/or the likelihood of these risks being realised, 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).||To mitigate the implications and/or the likelihood of these risks being realised, aircraft condition, aircraft maintenance, and the operation of the corporate healthcare unit in terms of medical examination of flight crew are monitored, medical equipment is replaced; operations and operating processes are continuously monitored.|
|Other operational risks (core and non-core business)||Operational risks (core business) are risks of losses that are explicitly due and directly related to air transportation of passengers, baggage, cargoes, and mail. Operational risks (non-core business) are risks of losses that are due, but not directly related, to air transportation of passengers, baggage, cargoes, and mail.||To mitigate the implications and/or the likelihood of these risks being realised, aircraft maintenance processes are monitored and coordinated in line with existing process flows for pre-flight management by the Group’s business units and third parties, existing technologies are improved, as well as processes for personnel selection, training, and provision with advanced equipment and special machinery; other necessary procedures are put in place. Key operational risks of the Group are insured.|
|OPERATIONAL RISKS OF SUPPORT ACTIVITIES AND OTHER RISKS|
|IT risks||Risks of incurring losses from the use of information||technologies by the company. To mitigate the implications and/or the likelihood of these risks being realised, relations with IT vendors and developers have been established, channel redundancy and data backup procedures are implemented, skilled personnel is 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. HR risks may be viewed as any action or omission by personnel (human resources).||To mitigate the implications and/or the likelihood of these risks being realised, 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. To mitigate the implications and/or the likelihood of corruptionrelated HR risks being realised, compliance with anti-corruption procedures and their conformity to anti-corruption (corruption prevention) laws are monitored, and safe, confidential and easyto- use whistle-blowing procedure to report violations of the law or internal procedures has been put in place.|
|Legal risks||Risks of incurring losses from failure to comply with laws; non-conformity of internal local regulations to laws; delays in bringing local regulations in compliance with laws; default on agreements; risks connected with inconsistency or ambiguity of legislation or changes in laws that may adversely affect financial and business activities of Aeroflot Group.||To mitigate the implications and/or the likelihood of these risks being realised, a system for timely communication of legislative changes to the Group’s business units has been put in place, and contracts are reviewed for compliance with applicable legislative requirements.|
|Process risks||Risks of incurring losses from errors in internal processes of Aeroflot Group.||To mitigate the implications and/or the likelihood of these risks being realised, business processes are analysed and improved, compliance with regulatory requirements is monitored, and personnel is provided with training.|
|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.||To mitigate the implications and/or the likelihood of these risks being realised, 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.||To mitigate the implications and/or the likelihood of these risks being realised, 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.|
|Legal risks of corporate executive bodies||Risks of losses related to potential civil or administrative prosecution of individuals that act as sole executive bodies or are members of collective executive bodies for action or omission committed by them when managing the Company.||Aeroflot Group has launched a number of insurance programmes covering a broad range of operational risks of support operations, including motor insurance, comprehensive civil liability insurance, hazardous industrial facilities insurance, liability insurance for temporary storage owners, liability insurance for the Board of Directors and the Management Board, and property insurance.|
|Risks of impact by external factors||Risks of losses that have external (beyond control of the company) causes and are inherent to any type of activities (natural risks (natural hazards), risks of man-made disasters, etc.).||To mitigate the implications and/or the likelihood of these risks being realised, necessary response measures, including flight suspension, route changes, extra measures to increase flight safety and to ensure aviation security are taken, and sanitary and epidemiological control is enhanced.|
|Investment risks||Risks of incurring potential unexpected losses from investment uncertainties.||To mitigate the implications and/or the likelihood of these risks being realised, a due diligence procedure has been set up, progress of project implementation is monitored, results are assessed, budget performance is monitored, etc|
|Occupational safety risks||Risks of incurring losses from factors related to the Group’s financial and business activities which may damage the health and life of employees at workplaces.||To mitigate the implications and/or the likelihood of these risks being realised, working conditions are improved and environmental management guidelines have been drafted in line with the requirements of ISO 14000 and approved. The fleet is upgraded by adding last generation aircraft that offer enhanced fuel efficiency and lower harmful emissions, requirements of Directive 2008/101/EC are implemented, and other measures are taken.|
|Other operational risks||Other operational risks.||To mitigate the implications and/or the likelihood of these risks being realised, the operation of systems is monitored, measures to enhance efficiency and control performance are taken, relations with aviation authorities are maintained, and the reporting system is improved.|
Impact of Key Financial Risks Realised in 2016
Aeroflot Group’s key financial risks depend on the market environment and are primarily represented by currency, price, and interest rate components. Factors that influence the Company’s operations comprise currency exchange rates (EUR/RUB, USD/ RUB, EUR/USD), fuel prices, and interest rates (mainly LIBOR).
Effect of changes in FX rates and other macroeconomic factors on EBITDA of Aeroflot Group
Significant changes in the above risk factors had a major impact on the Group’s performance in 2016. This was mainly due to sharp changes in currency exchange rates and fuel prices, as well as highly volatile foreign exchange and commodity markets. The market risk management system primarily aims to minimise the Group’s exposure to the above factors.
In particular, in 2016, the Russian rouble appreciated against the US dollar by 16.8% y-o-y (as at 31 December). Growth against the euro was even stronger, with the rouble gaining 19.9% over the same period. The euro also depreciated by 3.2% against the US dollar. However, on average RUB vs USD and EUR was circa 10% weaker in 2016 vs 2015. The latter trend has negative implications for the Group, as its US dollar-denominated costs outpace the eurodenominated revenue.
Global oil prices grew strongly in 2016, with the price of Brent crude going up 52.2%. The negative impact of these changes on fuel prices in rouble terms was offset by the positive trend in the rouble exchange rate.
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.
- the Group receives revenue from ticket sales, and tickets for most international flights are priced in euros;
- costs of fuel, lease payments, and maintenance (key foreign currency expenses) are denominated in USD and in EUR.
Our currency risk management primarily focuses on reducing the Group’s exposure to currency risk factors. Aeroflot Group pursues a policy of balancing proceeds and liabilities in each currency and also uses currency hedges. In 2016, just one crosscurrency hedge was in place; however, it had a zero financial effect at the end of the year due to market conditions. On top of that, Aeroflot Group is exposed to currency risk from revaluation of assets and liabilities in USD and EUR. The Group does not hedge this risk, as it does not affect its actual cash flows.
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, no such transactions were executed, and no risks for 2017 were hedged as at 31 December 2016. In 2017, risks may be hedged during the year based on regular risk assessment and testing of potential hedges using the Financial Hedging Methodology.
Interest Rate Risk
The Group’s exposure to interest rate risk results from changes in interest rates in the money market, which affects the borrowing costs of the Group. Specifically, costs under lease agreements of Aeroflot Group are linked to USD LIBOR 6M and 3M market interest rates. In 2016, the former rate went up from 0.6117% to 0.9979%, while the latter increased from 0.8423% to 1.3177% y-o-y (as at 31 December).
Interest rate swaps are a common instrument to mitigate interest rate risk. According to a hedging report prepared by the Group’s advisor, this risk factor has a relatively low materiality for the Group, and converting the floating rates into fixed is not considered at the moment.
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 insured risks.
The Group’s key operational risks are insured, with coverage for aviation risks, such as aircraft destruction, disappearance or damage, and risks of liability related to the property and health of third parties to whom the Company provides transportation services, accounting for 65% of the total insurance costs.
The Group also uses various insurance programmes covering a wide range of non-aviation operational risks of support operations, including motor insurance (compulsory motor third party liability, motor hull insurance), comprehensive civil liability insurance, and hazardous industrial facilities insurance.
In 2016, all insurance contracts were renewed as scheduled. Subsidiary airlines of PJSC Aeroflot were included in consolidated reinsurance coverage, which helped reduce the insurance rates. Stabilisation of the global aviation insurance market has also contributed to the rate reduction. Insurance rates declined on average by 20%. Thus, despite the growing fleet value, the overall aviation risk insurance premium decreased versus the previous insurance period.
Risk management development plans include improvements to the corporate risk management system both for individual and unit risks, as well as across Aeroflot Group in general.
In February 2017, PJSC Aeroflot’s CEO approved the schedule of actions to improve CRMS performance in 2017, comprising the following actions:
- approving and adopting Aeroflot Group’s Risk Management Standard implementing the concept of a unified risk management methodology;
- training the Company’s and subsidiaries’ staff in risk management and internal control;
- updating the risk register and risk map, including analysis of identified risks.