Risk is an inherent part of any entrepreneurial activity. To meet the expectations of its shareholders, MTU must exploit opportunities, which entails a certain degree of risk.
The Board of Management has set up an integrated opportunity and risk management system
The Board of Management has set up an integrated opportunity and 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.
The systematic consideration of significant risk factors is of vital importance to the MTU group given the long-term nature of its business model, and serves as a fundamental basis for value-oriented controlling functions and continuous business success. Hence, MTU knows the risks it faces, is aware of their effects and can manage them appropriately.
Significant risk factors of MTU
MTU regards a suitable control environment as being essential for a functioning risk management system. The Board of Management and the company’s senior managers have taken measures to create a suitable framework that is supportive of risk management issues.
The following are considered essential elements of such an environment:
- management style and philosophy,
- integrity and ethical values,
- staff training and development.
The concept of learning from mistakes is embodied in MTU’s mission statement, which describes this as a means of facilitating teamwork and promoting constructive behavioral attitudes. The logical consequence of striving for continuous improvement is the establishment of a CIP organization (Continuous Improvement Project), which aims to encourage employees to deal openly with weak points and create a culture that forms the basis of a functioning risk management system.
Integrity and ethical values play a signi?cant role at MTU. This was laid down by the Board of Management in a group-wide code of conduct communicated to all employees and incorporated in the guiding principles. The importance of staff training and development is embodied in the mission statement under the heading of ‘cooperation and leadership’. Employees receive instruction in risk management within the framework of the MTU training program and risk management is an integral part of personnel development.
The risk management manual, which is valid throughout the group and which documents the risk management system in place at MTU Aero Engines Holding AG, Munich, is accessible to all employees as part of the organizational guidelines or via the intranet. The rules contained in the manual form the basis for the uniform and appropriate treatment of risks and for communicating them within the group.
Integration of risk management in control processes
The Board of Management prescribes the strategy for dealing with risks in the form of a set of compulsoryrules. These rules document the
- integration in the MTU management process,
- principles of the risk policy,
- risk management,
- value thresholds.
In line with the rules of the risk strategy, the net loss expectation should not exceed 50 % for the first planning year and 30 % of the planned EBIT in adjusted terms for the five-year period under consideration.
Identification, analysis and management of risks
DMTU regards risk management as a continuous, end-to-end process to ensure responsible behavior when dealing with specific risks at business unit level and 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 risk inventory of the group, which encompasses all the business units and all the risk factors to which MTU is exposed, serves as a basis for risk identification. According to the COSO Framework, it is structured into governance and compliance, strategy and planning, operations and infrastructure, and reporting.
The central risk management department is informed of any risks exceeding an amount of € 1 million
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 three-monthly reports to the central risk management department for risks exceeding an amount of € 1 million over the five-year period under consideration, at dates allowing them to be reviewed together with the quarterly financial results.
Risks are assessed based on uniform definitions of the probabilities of loss occurrence (p)
- Almost Certain: p >= 80 %
- Likely : 50 % <= p < 80 %
- Possible: 20 % <= p < 50 %
- Unlikely: p < 20 %
and, as far as quantifiable, as a possible deviation of the performance indicators EBIT adjusted and cash flow at group level compared with the currently valid operational planning confirmed by the Supervisory Board. Risk officers use generally accepted commercial methods valid at MTU that are also applied at the planning stage. In particular, these methods comprise cost-benefit analyses, scenario analyses and qualified expert appraisals.
Risk officers have defined risk management measures (mitigation actions) for the top risks.
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 and is headed by the Vice President of Controlling OEM & Corporate, meet once a quarter to examine and discuss 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; they then propose appropriate corrective action including any provisions that may need to be set up. The Risk Management Board furthermore examines risks with a potential impact on the whole group, which are difficult to assess at business unit level.
Risk reporting and communication
The Board of Management receives a risk report once a quarter and is informed of the group’s current risk situation at board meetings each quarter. The so-called Top Risk Map (risks above € 5 million) includes:
- top gross risks for the current planning year and the five-year period under consideration,
- top net risks (assessed based on the probabilities of occurrence) for the current planning year and the five-year period under consideration,
- mitigation actions to manage the top risks,
- top gross opportunities for the current planning year and the five-year period under consideration,
- top opportunities (assessed based on the probabilities of occurrence) for the current planning year and the five-year period under consideration.
Opportunities and risks are not offset. Moreover, the Top Risk Map for the group forms part of the regular monthly reports submitted to the Board of Management and Supervisory Board.
Monitoring the risk management process is of crucial importance
Monitoring the risk management process is of crucial importance for ensuring the functioning and continuous development of the risk management system.
In addition to the classical verification of the system employed for the early recognition of risks by the auditor during the auditing of the annual financial statements, the risk management system is monitored and verified by a number of other functions:
- regular checks by the internal auditing department,
- supervision by the Supervisory Board,
- checking in the course of EFQM audits,
- process reviews by the Risk Management Board (self-assessment).
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 decision-making and supervisory bodies.
With its end-to-end risk management system, the company has created the necessary transparency to deal with risks in a responsible manner. The group identifies high-risk developments and potential risks at an early stage and introduces 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 that both risks and future opportunities are taken into account in planning activities and the controlling department can take timely countermeasures if there are signs of any planning deviations. The reflection of risks in the balance sheet in compliance with the underlying accounting standards is also part of this process.
Integrated management of opportunities
MTU has integrated opportunity management into the process of systematically recording, assessing, dealing with and monitoring risks. Besides taking account of strategic opportunities in the strategic planning, also entrepreneurial opportunities are identified, assessed and documented in a risk report and then communicated to the Board of Management and Supervisory Board once a quarter. The statements made concerning strategy and management in this connection apply analogously to the organization of opportunity management. This enables MTU to ensure an end-to-end, standardized opportunity and risk management process. The specific opportunities and forecasts for the future are presented in Section 5. (Forecasts).
6.2. Main features of the internal control system and risk management system related to the accounting process
Legal background and subject of the report
According to Sections 289 (5) and 315 (2) No. 5 of the German Commercial Code (HGB) introduced by the German Act to Modernize Accounting Law (BilMoG) which serve to transpose the requirements of an EU directive into national law, publicly traded companies are required to provide a description of the main features of their internal control system and risk management system relating to the (consolidated) accounting process in their (group) management report. By virtue of a corresponding transitional arrangement regarding these regulations, the information specified in Sections 289 (5) and 315 (2) No. 5 HGB must be incorporated into the (group) management report for the first financial year beginning after December 31, 2008.
Applying the explanatory memorandum to the BilMoG analogously, a report on the main features of our internal control system (ICS) and risk management system (RMS) relating to the (consolidated) accounting process is included in MTU’s risk report so that the risk report presents a unified and integrated picture. We have also taken account of the German accounting standard DRS 5, which is still valid, and the amendment DRÄS 5.
The comments given below apply both to MTU Aero Engines Holding AG, Munich and to all other group companies included in the consolidated financial statements.
MTU attaches the greatest importance to ensuring the regularity, accuracy and reliability of its financial reporting
Objectives and components of the internal control system and risk management system in relation to the accounting process
The Board of Management, Supervisory Board and Audit Committee of MTU attach the greatest importance to ensuring the regularity, accuracy and reliability of MTU’s financial reporting for recipients of MTU’s financial statements. The control and monitoring processes required for this purpose are tailored to the complex business model of the MTU group and are an important part of a comprehensive corporate governance approach that defines the basic framework for creating sustainable values for shareholders, customers, employees and the public. High-quality financial reporting to these and other recipients is regarded as imperative. The organizational, controlling and monitoring structures described below, which ensure that business data are recorded, processed and assessed correctly and in accordance with statutory and financial reporting requirements and are subsequently incorporated in individual accounting instruments, are part of a company-wide risk management system and internal monitoring system. This, in turn, consists of a company-wide internal control system, company-wide controlling and internal auditing. The interaction between these systems ensures that the high expectations placed on MTU’s accounting are met.
The Board of Management and the senior managers are responsible for creating a supportive environment. Management style and philosophy, integrity and ethical values, and staff training and development are important pillars of this favorable monitoring environment. The important role that integrity and ethical values play at MTU is laid down by the Board of Management in a code of conduct that applies throughout the group and has been communicated to all employees in writing, is continuously practiced in training programs and is explicitly described in the guiding principles. The concept of learning from mistakes is embodied in MTU’s mission statement, which describes this as a means of facilitating teamwork and promoting constructive behavioral attitudes. The striving towards continuous improvement is reinforced by the setting up of a CIP organization (Continuous Improvement Project), which is intended to help employees to deal openly with weak points and create a culture that forms the basis of a functioning risk management system.
The internal control and risk management system of MTU relating to the accounting process guarantees an efficient accounting process that avoids errors as far as possible but at least discovers them at an early stage.
MTU integrates risks entailed in financial reporting into the comprehensive risk management system at group level
- Against this backdrop, the accounting-related RMS is an integral part of the group’s comprehensive company-wide risk management system that creates a basis for a uniform and appropriate response to risks and for communicating them within the group. The risks entailed in financial reporting at group level are, in turn, a part of the corporate risks to be monitored as a whole. Managers from all areas of company operations are represented on the Risk Management Board of MTU, such as the heads of the controlling, finance/accounting and internal auditing departments. The work of the Risk Management Board ensures that both risks and future opportunities are taken into account in planning activities to a reasonable extent and that countermeasures can be taken at an early stage if there are signs of any planning deviations. This process also integrates the inclusion of risks in the financial statements in compliance with the underlying accounting standards. The risk management system is examined by the internal auditing department and the management, whilst the system employed for the early recognition of risks is reviewed by the auditor during the audit of the consolidated financial accounts.
The risk management system of MTU 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.).
- The arrangement of the accounting-related ICS at MTU meets the requirements of the German Act to Modernize Accounting Law as set out in the government’s explanatory memorandum, the definition of IDW (Institut der Wirtschaftsprüfer IDW e.V.), and the internationally recognized and established framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO I). It also reflects the specific corporate and group realities at MTU. Based on these requirements, MTU understands an internal control system to be the principles, procedures and measures (regulations) introduced at the company by the company management that are aimed at the organizational implementation of the decisions of the company management to
- safeguard the effectiveness and economic efficiency of business operations (this also includes protecting assets as well as preventing and exposing financial losses),
- ensure the regularity and reliability of internal and external accounting and
- comply with statutory regulations relevant for the company.
- safeguard the effectiveness and economic efficiency of business operations (this also includes protecting assets as well as preventing and exposing financial losses),
This requires a systematic control system based on the functioning of the following elements:
- control environment,
- risk assessment,
- control activities,
- information and communication
- and monitoring the ICS.
The ICS of the MTU group is primarily based on a functioning internal management system (directive controls) based on efficient and effective processes as well as process-integrated organizational security measures incorporated into the organizational structure and the process organization of the MTU group and its group companies (e.g. separation of functions, access restrictions in the area of IT, payment regulations). Checks integrated within processes reduce the probability of errors occurring (error risk) and help to bring to light any errors that have already occurred (e.g. when checking whether data received or forwarded are correct and complete or when checking manual actual/planned comparisons, programmed verification checks in the software).
- The internal auditing system (Corporate Audit), which is process-unrelated, plays an important role in checking the effectiveness of the accounting-related ICS and RMS and in improving them. The corporate audit department of MTU assesses controlling and monitoring systems and contributes to their enhancement. It is also considered to have an advisory function that aims at improving business processes and ultimately the effectiveness of the internal control system. The charter of the corporate audit department complies with national and international requirements of the Institut der Internen Revision and the Institute for Internal Audit. The corporate audit department is also bound by the code of professional ethics. The administrative standards for internal auditing are available to all employees for perusal on MTU’s intranet.
The Audit Committee provides advice on risk management and the auditing work of the corporate audit department.
- The Audit Committee of the Supervisory Board also provides advice on risk management and the auditing work of the corporate audit department. In future it will be explicitly involved in monitoring the effectiveness of the risk management system, the internal control systems, the internal audit systems, the accounting process and the auditing of the financial statements, in particular the independence of each of these systems, based on Section 107 (3) of the German Stock Corporation Act (AktG) as amended by the German Act to Modernize Accounting Law (BilMoG).
Main features of the internal control system and the risk management system related to the accounting process
The main features of the internal control system at MTU in terms of the (consolidated) accounting process can be described as follows:
- MTU has a clear management and corporate structure. Key functions spanning more than one business unit are managed centrally, although the individual subsidiaries have a certain degree of autonomy at the same time. The functions of the main departments involved in the accounting process ‘Finances/Accounting’ and ‘Controlling OEM Business & Corporate’ are distinctly separate. Responsibilities have been clearly allocated in a distinct organizational structure depicted in organigrams, and are accessible to every employee via the intranet at all times.
- The integrity and responsibility of each employee, also in terms of finances and financial reporting, are ensured by each employee undertaking to observe the company’s own code of conduct.
- As a result of employing highly qualified staff, conducting targeted and regular advance training programs, strictly complying with the dual control principle, and consistently separating functions in financial accounting when creating and entering accounting vouchers and in controlling, it is ensured that national accounting rules (e.g. German Commercial Code and national tax laws) and international accounting standards (IFRSs) are strictly observed in annual and consolidated financial statements.
- The IT systems used are protected by appropriate installations in the IT area against unauthorized access. As far as possible, standard software is used in the finance systems area. Within the framework of the comprehensive IT concept and the existing IT architecture, the IT system’s application controls are reviewed internally and externally on a regular basis against a background of a high level of automatic controls and plausibility checks. The IT general controls are also checked during internal and external IT audits.
- All the annual financial statements of group companies included in consolidation are audited by an auditor at least once a year and the condensed consolidated financial statements and interim group management report in the half-yearly financial report are reviewed.
- An adequate system of guidelines has been suitably drawn up and is updated in line with requirements.
- The departments and business units involved in the accounting process are suitably equipped and regularly trained in quantitative and qualititative respects.
- Bookkeeping data received or forwarded are continually checked to see that they are complete and correct, e.g. by random checks. Programmed plausibility checks are carried out with the software used, e.g. in the course of payment cycles as well as during the consolidation process.
Suitable controls are in place in all accounting-relevant processes
- Suitable controls are in place in all accounting-relevant processes (such as dual control, analytical checks).
- Accounting-relevant processes are also checked by the process-unrelated corporate audit department.
- The group accounting department, which is the immediate point of contact for the managing directors of subsidiaries regarding reporting and the annual and monthly financial statements, prepares and draws up the consolidated financial statements compliant with IFRS.
- Due to the obligation of every subsidiary and joint venture to report its business figures compliant both with the local GAAP and with IFRS in a standardized reporting format to the group holding, any planned/actual deviations during the year are identified rapidly, enabling a swift and appropriate response.
- In the course of its monthly reports, group accounting monitors all the processes relating to the consolidated financial statements, such as capital consolidation, debt consolidation, consolidation of expenditures and revenues and the elimination of unrealized results of intra-group transactions, in consultation with the group companies.
- For particular issues in the group and at individual subsidiaries and joints ventures, such as special accounting issues etc., the group accounting department also acts at holding level as a central point of contact and controlling body for reporting. Special evaluations are also carried out during the year at the request of various management levels. If a need for support arises at short notice in connection with special, complex IFRS issues or company acquisitions requiring examination, this demand is met by qualified staff or by employing the services of external auditors.
With its end-to-end risk management system, MTU has created the necessary transparency, also in its financial reporting, to deal with risks in a responsible manner. The MTU risk management process is integrated into the existing control systems and coordinated with them. This ensures that opportunities and risks are appropriately taken into account in planning activities and that regular bookkeeping and monthly and quarterly financial statements take account of risks in the balance sheet in compliance with the underlying accounting standards.
Risks arising from general economic trends
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 commercial market depends heavily on the volume of air traffic, and is subject to cyclical fluctuations which depend on the general economic situation. The volume of commercial air traffic in both the passenger and the freight sectors showed a negative trend in the last financial year; however, the latest forecasts are showing signs of this situation leveling off. 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.
Risks inherent in the aerospace industry
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 its level of cutting-edge technology that it constantly protects and advances.
MTU operates in various sectors of the market and in different thrust ranges, thus spreading risks in line with the market
Since 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 many airlines. As MTU operates in various sectors of the market and in different thrust ranges, it spreads 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. In the commercial sector, many years often 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 analysis 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.
Significant investment decisions recently were
- the set-up of the location MTU Aero Engines Polska Sp. z o.o., Rzeszów, Poland and
- participation in the GEnx and GE38 engine programs
which, from today’s point of view, do not entail any risks to the substance of MTU.
Generally, MTU has not identified any strategy risks at the present time 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.
MTU sells most of its products under risk- and revenuesharing arrangements
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. It 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.
Risk diversification across programs MTU engine portfolio by life cycle (illustration)
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 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.
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.
Cooperative ties further collaboration as partners and effectively spreads risks
Procurement and purchasing risks
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 initially finances 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.
MTU has taken precautions to a greater extent than previously due to the additional requirements which have arisen in recent months, in particular regarding the software, and the termination of the South Africa export contract. Thus, all previous expenses of the program and the provision for possible obligations have already been taken into account in the 2009 financial statements. It is not possible to take account of effects arising from potential changes to contracts.
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.
MTU minimizes the personnel risks by means of fast-track professional training and development programs, and performance-related compensation
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. This is associated with a corresponding fluctuation risk. 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. One of the main elements of succession planning is the Campus Potential & Succession personnel development process, in the course of which employees with potential in the long term are identified for filling key positions in the future and their potential deployments are regularly assessed and discussed by managers and the human resources department.
The new engine programs will require the requisite development capacity in the coming years. 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.
In contrast, the slight decline in business volume following the economic crisis is presenting MTU with the challenge of managing capacities appropriately. The company has responded by flexibly deploying and training employees in other business units; but MTU is also taking advantage of natural fluctuation rates and the flexible working hours by having employees reduce their flexitime credit.
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 through espionage or system failures are the risks in the IT area. Due to its business with military customers, MTU is particularly sensitive about how confidential data are handled and has a very advanced data and security system. When new IT systems are launched, there is a possibility of workflows being disrupted. MTU minimizes these risks by employing qualified experts and using professional project management. MTU regards the risks in this area as being manageable.
Currency risk, credit risk and hedging transactions
More than 80 % of MTU’s revenues are generated in U.S. dollars (USD) (translated amounting to approximately € 2,100 million in 2009). On the other hand, a large proportion of expenses is likewise invoiced in U.S. dollars, providing a ‘natural hedge’. Most other expenses 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 the corporate 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
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. 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 long as the actual gross inflow of a foreign currency (per month) exceeds the hedged amount, postponements or cancellations of underlying transactions (cash inflows) do not affect the hedging relationship. Forward foreign exchange contracts are used principally as hedging instruments.
At December 31, 2009, MTU held forward foreign exchange contracts for a contractual period up to 2011 to sell a nominal volume of U.S. $ 700.0 million (which translates to € 485.9 million at the exchange rate prevailing at the balance sheet date) at futures rates for a total of € 491.6 million. Changes in the fair value of the forward foreign exchange contracts amounted to a gain of € 14.2 million in 2009 (2008: a loss of € 29.1 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 to ever 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.
Compliance risks exist in all areas of the company. These are risks which, in essence, are if managers and employees of the company fail to observe valid laws and regulations or internal rules. Particularly critical areas are purchasing and the sales organization in the commercial MRO business. Employees deployed in areas where the protection of confidential documents and information plays a significant role are generally affected.
MTU has established a number of measures to minimize risks and to safeguard compliance
To minimize risks and to safeguard compliance, MTU has laid down a number of measures:
- globally binding rules of conduct valid throughout the group,
- online compliance training of all business units and employees affected,
- setting up an appropriate point of contact if illegal action is suspected,
- setting up a Compliance Board,
- continual security checks of employees.
Generally, the occurrence of compliance-relevant circumstances can never be completely ruled out, whether this be due to the lack of knowledge on the part of individual employees or intentional criminal conduct.
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.
Risks arising from general and tax legislation
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 energy-intensive 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.
A certified environmental management system minimizes relevant risks
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 Section 1.5.3 (Environment). 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.
The company has not identified any risks arising from controlling and monitoring systems or relating to organization and management.
Dependence on joint ventures
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.
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, 2008. 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.
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