MTU’s long-term market success depends on the company’s ability to recognize and manage the risks inherent to its day-to-day business. This is why the Board of Management has set up an integrated risk management system, which is linked to the group’s value-oriented performance indicators and its present organizational structure. The system ensures compliance with statutory requirements and is based on the internationally recognized COSO II Enterprise Risk Management (ERM) Framework and on the recommendations concerning opportunity and risk management standards issued by COSO’s German counterpart RMA (Risk Management Association e.V.). In accordance with the stipulated requirements, opportunities are dealt with in a separate section of the Annual Report: Please refer to the earlier section entitled “Opportunities”.

The risk management policy of MTU Aero Engines Holding AG is documented in a risk management manual that is valid throughout the group and in which the Board of Management’s prescribed strategy for dealing with risks is described in the form of a set of compulsory rules. These rules form the basis for uniform and appropriate treatment of risks and for communicating them within the group.

MTU regards risk management as a continuous, end-to-end process to ensure responsible behavior when dealing with:

• specific risks at business unit level,
   
• general risks affecting several business units or the entire group, or risks which need to be assessed on a wider scale (projects, U.S. dollar, changes in commodity prices).

The affiliates and business units are responsible for identifying, assessing, controlling and monitoring the risks in their specific areas and documenting them in risk maps. They submit reports to the central risk management department once a quarter, at dates allowing them to be reviewed together with the quarterly financial results.

The central risk management department aggregates and consolidates the reported risks and evaluates the overall risk position at group level.

The members of the Risk Management Board, which is made up of managers from all functional departments, meet once a quarter to verify the details of aggregated risks which could potentially raise or lower the performance indicators EBIT adjusted or free cash flow by at least € 5 million at group level, and to discuss and propose the appropriate corrective action. The Risk Management Board furthermore examines risks with a potential impact on the whole group, which are difficult to assess at business unit level.

The Board of Management receives a risk report once a quarter informing its members of the group’s current risk situation. The so-called Top Risk Map for the group is included once every three months in the regular monthly reports submitted to the Board of Management and Supervisory Board.

A systematic approach to risk management is of vital importance to the MTU group given the long-term nature of its business model, and serves as a fundamental basis for valueoriented controlling functions and continuous business success.

With its end-to-end risk management system, MTU has created the necessary transparency to deal with risks in a responsible manner. It enables the group to identify high-risk developments and potential risks at an early stage and introduce targeted measures for dealing with and minimizing these risks. The MTU risk management process is integrated into the existing control systems and coordinated with them.

This ensures firstly that balanced measures to reduce exposure to risks can be integrated in planning activities, taking into account both risks and future opportunities, and secondly that the controlling department can take timely countermeasures and arrange for provisions to be allocated by agreement with the treasury department where appropriate.

The internal auditing department and management review the risk management system at regular intervals. Additionally, the system employed for the early recognition of risks is verified by the auditor during the auditing of the annual financial statements. From an organizational point of view, MTU has put in place all the instruments required to manage risks on a proactive basis and communicate the necessary information to the group’s decisionmaking and supervisory bodies.

Significant risks to the MTU group’s business development are presented by the U.S. dollar exchange rate, the level of commodity prices, and general economic factors. MTU generates a high proportion of its revenues in the commercial engine business and in commercial MRO. This market depends heavily on the volume of commercial air traffic, and is subject to cyclical fluctuations which depend on factors such as the general economic situation. The volume of commercial air traffic in both the passenger and the freight sectors is following a distinctly negative trend, which shows no signs of leveling off at the present time. The slowdown in economic growth and the difficulties being encountered by certain companies is moreover changing patterns of use in the existing fleet of business jets and reducing the quantity of orders for new air transportation capacity. Other risks affecting industry in general include rising energy costs, the unavailability of suppliers, and delays in deliveries from suppliers. Overall, from the present point of view, there are no identifiable risks to the substance of MTU arising from general economic trends.

Because engines have long product lifecycles, extending from development through volume production to the supply of spare parts, MTU’s spare parts business is increasingly exposed to competition from companies that manufacture parts under the FAA’s system of Parts Manufacturer Approval (PMA). These companies are able to sell FAA-approved parts at lower prices than the original engine manufacturer because they have not had to bear the financial burden of high development costs and the loss-making early stages of volume production. MTU counters the risks inherent to the aerospace industry with a constantly advancing level of cutting-edge technology.

Because air traffic is so dependent on economic factors – but also due to crisis situations – airlines frequently encounter financial difficulties. The already strained situation may be further exacerbated by escalating fuel prices and by an intensification of the difficult financial situation of the airlines. MTU operates in various sectors of the market and in different thrust ranges, thus spreading the risk in line with the market.

At the present time, MTU does not expect any significant negative impact on the group’s operating results, financial situation or net assets.

 

The main forms of strategy risk are misjudgments when taking decisions concerning investments in engine programs, the establishment of new sites, and possible M&A activities. MTU’s business model, particularly in the OEM segment, is based on long-term processes. Many years may pass between the decision to invest in a new engine and the breakeven point, separated by a long period of development and the preparatory phases leading to volume production. The risk is that the original economic and technological parameters on which the decision was based might change substantially over the course of time, and also that the customers, i.e. the airlines, might change their mind and choose a different engine at a later stage of the project. MTU counters such strategy risks by engaging highly qualified specialists at the decision-making stage and by using documented processes to perform cost-benefit analyses, which make it compulsory to carry out the appropriate risk assessment on the basis of a variety of different scenarios. The company’s wide product portfolio – comprising engines in all thrust classes – helps to spread the risk and minimize the dependency on individual engine programs. At the present time, MTU has not identified any strategy risks that might endanger the substance of the company.

The customers in the military engine business are national and multinational agencies whose budgets vary widely with the level of public spending. When they are faced with budgetary constraints, there is a risk that contracts might be rescheduled or canceled. In the military engine business, the company is firmly embedded in international cooperative ventures. This tends to have a limiting effect on risks because the partners work together to protect their common interests. Because government offices more and more frequently attempt to settle accounts for military engines on the basis of negotiated fixed prices, new military programs face an increasing risk that the technical, economic and market-related assumptions on which the contract is based may deviate from the actual conditions, thus also affecting the attainable return on investment. The terms of existing contracts in the military sector are generally defined to cover a prolonged period of time, thus effectively excluding the possibility of modifying prices.

The commercial engine market has an oligopolistic structure. MTU sells most of its products under risk- and revenue-sharing arrangements. The lead partners in the consortium determine the prices, conditions and concessions. MTU, as a consortium partner, is bound by these conditions. MTU is involved in the leading engine programs of the major engine manufacturers in the context of these partnerships. The customers of these risk- and revenue-sharing partnerships in the commercial engine and MRO business are airlines. Various types of concessions to customers are common practice in the marketing of commercial production engines. MTU is obliged to absorb these concessions to the extent of its program share in risk- and revenue-sharing arrangements. The fact that the cooperation partners share a common interest helps to prevent excessive concessions during contract negotiations. Furthermore, risks are spread across the various programs. Concessions to major customers during the launch phase of a program are largely offset by a decline in the marketing expenses for older programs.

Overall, from the present point of view, there are no identifiable market risks to the substance of MTU.

In the commercial and military engine business, MTU undertakes to perform development work during which unplanned delays and additional costs may arise. The company nevertheless ensures strict adherence to time schedules and budgets by permanently monitoring project management (see earlier section headed “Risk report”) and applying appropriate corrective measures where necessary. Furthermore, through its involvement in collaborative ventures, it works in partnerships that extend beyond corporate boundaries and thus spreads the risk.

Moreover, MTU products are subject to extremely stringent safety requirements. The company requires numerous official certifications, particularly from the German Federal Office of Civil Aviation (LBA) and the U.S. Federal Aviation Administration (FAA), in order to carry out its activities. These certifications are valid for limited periods; they can only be renewed after further tests have been carried out. The production and repair processes are documented in detail to ensure compliance with all regulations.

As a general rule, MTU’s business plans for new engines are drawn up to cover a long period. They tend to assume long repayment terms, with the result that the investments in the development phase and the production run-up are only gradually amortized over a long period of time. Due to the long period under consideration, the actual conditions may deviate from the technical, economic and market-related assumptions on which the calculations were based, thus also affecting the attainable return on investment.

For some raw materials, individual parts and components and for the provision of specific services, MTU is dependent on suppliers and third-party vendors. Risks can arise in the form of the unavailability of suppliers, problems with quality, and price increases. MTU strives to reduce its reliance on individual suppliers by securing the services of several, equally qualified vendors for materials, parts and services. In the case of single-source suppliers, MTU enters into long-term agreements as a hedge against unforeseen shortages and to reduce the risk of sudden price hikes. The risks involved are manageable thanks to the broad diversity of the links in the supply chain.

Besides the general business risks, MTU has specifically identified risks in the TP400-D6 engine program for the new Airbus military transporter A400M. MTU is a member of a consortium comprising four European companies. Each partner is required to finance unexpected additional development and manufacturing costs using its own resources, in proportion to its share in the program. A provision has been allocated for anticipated contractual obligations to cover part of this possible future expense.

More than 80 % of MTU’s revenues are generated in U.S. dollars (USD) (translated amounting to approximately € 2,250 million in 2008). On the other hand, a large proportion of costs is likewise invoiced in U.S. dollars, providing a “natural hedge”. Most other costs are incurred in euros (€) and, to a lesser extent, in Polish zloty (PLN), Chinese yuan renminbi (CYN) and Canadian dollars (CAD). Consequently, earnings are dependent on changes in the exchange rate parity between the U.S. dollar and the cited currencies from the order date to the delivery date, in the measure to which MTU does not make use of financial instruments to hedge against its current and future net exposure. In line with MTU’s policy of generating profit solely on the basis of its operating activities and not through currency speculation, MTU makes use of hedging strategies for the exclusive purpose of controlling and minimizing the effect of U.S. dollar exchange rate volatility on EBIT.

The financial instruments employed by MTU cover the greater part of the net exposure to currency risk, leaving only a small proportion of the U.S. dollar surplus exposed to this type of risk. The unhedged portion of forecast transactions is calculated at the euro cash rate on the date payment is received

MTU holds a long-term hedge portfolio comprising financial instruments with terms to maturity stretching over several years, used to hedge U.S. dollar cash flows. The net risk is calculated by subtracting the part of the currency risk balanced by costs invoiced in U.S. dollars (the “natural hedge”) from the total currency risk (i.e. revenues denominated in U.S. dollars). The hedge portfolio accounts for the majority of the group’s hedging transactions.

For accounting purposes, MTU prudently only designates a portion of its hedged future cash flows (forecast transactions) as hedged items to reduce the expected net currency risk exposure. As a result, postponements or cancellations of underlying transactions (cash inflows) do not affect the hedging relationship as long as the actual gross inflow of a foreign currency (per month) exceeds the hedged amount. Forward foreign exchange contracts are used principally as hedging instruments.

At December 31, 2008, MTU held forward foreign exchange contracts for a contractual period up to May 2011 to sell a nominal volume of U.S. $ 880.0 million (which translates to € 632.3 million at the exchange rate prevailing at the balance sheet date) at futures rates for a total of € 619.9 million. Changes in the fair value of the forward foreign exchange contracts amounted to a loss of € 29.1 million in 2008 (2007: a gain of € 2.1 million). Further explanatory comments concerning financial instruments are provided in Note 42. to the consolidated financial statements (Risk management and derivative financial instruments).

The unsteady fluctuation in the exchange rate parity between the euro and the U.S. dollar makes it impossible at the present time to predict with any certainty how the exchange rate is likely to develop in the near future. Exchange rate disparities amplify currency risk, with a possible adverse impact on MTU’s earnings. The company’s long-term hedging strategy makes currency risks manageable.

In the commercial engine business and commercial MRO, airlines are indirect and direct customers of MTU. These carriers may find themselves facing financial difficulties, with the result that they may plan or carry out restructuring measures or mergers, or apply to be placed under bankruptcy protection. Their situation affects the receivables management processes of MTU and its partners. The consortium leaders in the commercial engine and spare parts businesses have extensive receivables management systems in place. In the commercial MRO business, MTU tracks its open accounts receivable in short cycles in cooperation with the sales department. Before a deal is finalized, potential risks are assessed and any necessary precautions are taken. Wherever possible, the company takes advantage of export credit guarantees (Hermes coverage) to protect itself against political and credit risk. As a matter of principle, the group avoids signing contracts for which the parameters cannot be calculated. Hence MTU considers nonpayment risks to be transparent and manageable.

In the aviation industry, accidents can never be completely ruled out despite strict compliance with manufacturing quality standards and utmost diligence in performing maintenance work. In the military engine business (excluding exports), MTU is largely exempt from product risk liability through government agency indemnification. The remaining liabilities, especially in the commercial engine business, are covered by comprehensive insurance policies; this includes aircraft liability insurance. Other risks that could threaten the continued existence of the company, such as fire and interruption of business operations, are covered as well. No insurance cover has been taken out for the risk of terrorist attacks because of the excessively high premiums. By limiting liability risks and taking out insurance cover, the risks are transparent and manageable.

In the commercial maintenance business, MTU’s interests in the Asian market include a 50:50 joint venture, MTU Maintenance Zhuhai Co. Ltd., Zhuhai, China. In jointly controlled entities where decisions have to be made jointly, there is always a risk of differences of opinion when the company’s own interests do not coincide with those of its partners.

MTU has drawn up guidelines and a code of conduct that are valid for all of its employees throughout the world, by means of which the company strives to establish binding rules for internal and external communication. Employees who are entrusted with confidential or insider information make a solemn commitment to abide by the applicable regulations, such as those laid down in the German Investor Protection Improvement Act (AnSVG), and to exercise the appropriate integrity when handling such information.

The commitment, motivation and skills of the company’s employees are major contributory factors to its business performance. There is considerable rivalry in the recruitment market for the aerospace sector, as companies compete to find the best-qualified employees to work on the development, manufacture and maintenance of cutting-edge technical products. MTU minimizes the associated risks by means of fast-track professional training and development programs, performance-related compensation, mentoring schemes and early preparation for promotion. In view of the development challenges facing the company as it embarks on new engine programs, there is a need to build up the corresponding human resources to provide the requisite development capacity.

MTU is meeting this challenge by setting up new development centers in Munich and at its new site in Poland, and by collaborating with universities. Insurance policies are in place to limit potential liability risks that might be caused by individuals employed by the company. The overall level of personnel risk is estimated to be low.

The loss of confidential data due to espionage or to system failure is the principal risk in the realm of information technology. Because it conducts business with military customers, MTU takes an especially precautionary approach in the way it handles and protects restricted data, operating a highly advanced system for the protection of data and classified information. The introduction of new IT systems is a further occasion on which interruptions in the workflow can occur. Particularly in the commercial MRO business, with its complex workflows, the introduction of new IT systems represents a special challenge. MTU keeps such risks to a minimum by employing highly trained experts and a professional project management system. The risks in this area are manageable.

MTU’s business activities are subject to numerous laws and regulations on the protection of the environment. Any tightening of the applicable environmental requirements may give rise to additional investment costs, particularly in connection with the use of chemicals in manufacturing and test rig emissions. Further information can be found in the section “Environmental report”. MTU requires special certification in order to operate certain production facilities such as test rigs and electroplating plants. The regulations must be strictly observed and all procedures fully documented. An environmental management system certified to DIN EN ISO 14001 minimizes the risks in this area.

In June 2007, the European Commission approved Germany’s request to prolong the period during which tax reductions could to be granted to particularly energy-intensive businesses to the end of 2009. This concerns the capping of the German ecotax for the most energyintensive users (the so-called “Spitzenausgleich”). The Commission’s decision makes provision for the application of the tax cap to be further extended to the end of 2012 on condition that German industry meets the agreed voluntary environmental targets. If the further extension beyond 2009 is not approved, German industry will face the burden of additional energy taxes, which could have an adverse effect on the international competitiveness of MTU’s domestic production facilities. MTU estimates the resulting additional tax expense to be of moderate proportions. Other than this, there are no important risks arising from (tax) legislation that could have a significant impact on the company’s net assets, financial situation or operating results.

The company has not identified any risks arising from controlling and monitoring systems or relating to organization and management.

The results of an analysis of the main strengths, weaknesses, opportunities and threats (SWOT) presented by MTU’s corporate structure and market environment can be summarized as follows:

There have been no substantial changes in MTU’s risk exposure compared with December 31, 2007. The group is of the opinion that it would serve no purpose to aggregate the most important individual risks, on the grounds that it is improbable that hypothetical risks would arise simultaneously. The unsteady fluctuation in exchange rates and the global financial market crisis make it impossible at the present time to predict with any certainty how exchange rates and general economic trends are likely to develop in the near future.

Overall, the level of risk exposure is manageable; from the present point of view, the MTU group’s continuing existence as a going concern is not endangered. MTU does not anticipate any fundamental changes in its risk exposure at the present time. MTU has taken every possible organizational measure to ensure early awareness of potential risk situations.