Operational Risk

Dependency on Governmental Clients and Multi-year Contracts

The Group’s business depends significantly on governmental clients and - especially in its transportation solutions business - on large-amount multi-year contracts.

Any delays, changes, revisions or cancellations of one or more large on-going multi-year contracts could adversely affect the business and the Group’s profit, capital and financial situation.

Additionally, the assessment of multi-year contracts using the completion percentage method requires estimates of completion costs and project risks (technical, legal, fiscal and commercial) and of the progress of the activities.
These estimates are based on assumptions regarding the consequences of future events, which - of their nature and given the complexity of the projects to be carried out - could turn out differently from what has been foreseen, thus adversely affecting the economic and financial performance of the project.

These risks can be mitigated by:

  • diversifying markets and monitoring country and legislation risk;
  • adopting risk management processes, both in the offer stage and during execution of the project, and life-cycle management processes

Project Budgeting and Planning

A project team may not be able to execute its project on budget and on time, in particular one in a new market, due to ineffective project controlling processes, which could already be clear in the offer phase. Risk management might be ineffective due to being based on incomplete or inaccurate information, or inadequately defined and monitored. This risk could cause delays in the identification of project execution problems and inaccurate reporting and planning, with an adverse effect on the Group’s profit, capital and financial situation.

To mitigate this risk, there are defined and monitored processes for checking the physical and accounting progress and for risk management, clear assignment of responsibilities to the Project Manager and the contract Controller, managerial reviews of the performance of the project, reviews of the estimates made in the offer phase and independent reviews by the Risk Management function. Further actions are planned to codify and structure controlling processes even more, and to uniform these processes according to current best practices in all the various businesses of the Group and at all levels of responsibility within each business.

Third Parties (subcontractors, sub-suppliers and partners)

In both the Group’s businesses significant use is made of subcontractors for the provision of subsystems or assembly and installation services and of sub-suppliers of goods and services. The Group’s ability to meet its obligations towards its client is therefore subject to fulfilment by both subcontractors and sub-suppliers of their contractual obligations. Failure to do so could therefore cause Ansaldo STS to default on its own obligations, which would adversely affect its reputation and, apart from any compensation obtained by legal action taken against subcontractors or sub-suppliers, the Group’s profit, capital and financial situation.

The Group also executes contracts in association with other firms, especially in its transportation solutions business. In these forms of association, each party is usually jointly and severally responsible to the client for completion of the whole project. In the case of contractual breach or loss or damage caused to the client by an associated firm, Ansaldo STS might be called on to substitute the defaulting or damage-causing party and to pay compensation for the whole loss suffered by the client, while retaining its right to legal recourse against the defaulting associated firm. The inefficacy or protractedness of legal action against a defaulting or loss-causing associated firm might adversely affect the business and the Group’s profit, capital and financial situation.

Additionally, given the Group’s internationalisation strategy, preliminary assessment of partners, subcontractors and sub-suppliers in new markets could be ineffective and adversely affect the order book, our reputation, our profit, capital and financial situation, and the effectiveness of partnership governance (e.g. divergences between partners or misalignment of risk and cost/benefit assessment between individual partners).

To mitigate these risks, there are processes of selection and qualification of subcontractors and sub-suppliers, cooperation with partners that are already known to the Group and of proven reliability, drawing up, signing and managing appropriate contractual and grouping clauses, risk management processes and, where applicable, requesting specific guarantees. In selecting subcontractors and partners in international markets, these processes are followed with even greater attention, involving the legal department when drafting contractual clauses. Further actions have been identified to make the assessment of subcontractors and partners more effective in the offer stage.

Adequacy and efficiency of developments and technical references

The Group may fail to properly assess its innovation and development priorities, with the risk of being out of line with the market’s needs, of a low economic return on the investment in the innovation and in the project and the loss of commercial opportunities. Development projects might not be carried out within the assigned budget or in line with a clear understanding and identification of requirements, negatively impacting our margins, delivery times and customer satisfaction. In certain circumstances the Group could also not have market and use references for certain products with the risk of missing commercial opportunities or failing in compliance during execution of the project, with adverse effects on project profitability and the Group’s reputation.

To mitigate these risks, the Group has recently strengthened and rationalised its product portfolio definition processes, not least in the assessment of opportunities to re-use existing products in offers. Planning and control of development activities have been strengthened to ensure that priorities are correctly assessed and control over timing and costs. The risk of not having sufficient references for certain new products is carefully assessed in the offer phase and managed with recovery plans during execution.

Liability to clients or third par ties for defects in products sold or delayed delivery

The technological complexity and the limited delivery times of the Group’s products and systems could expose the Group to liability for delayed or failed delivery of contractual products or services, or their failure to meet the client’s requirements (due to planning or production faults), failed or delayed commercialisation, and provision of post-sales service and product maintenance and servicing. Moreover, many products and services supplied by the Group are subject to certification or type approval, often involving third parties.

Supplying defective products may require additional activities or the withdrawal of such products from the market; this could occur with new products with which the Group has not yet gained significant experience of use.

These liabilities could arise from causes attributable to the Group or to external third parties, sub-suppliers or subcontractors. If these risks eventuate, the business could be adversely affected as could the Group’s profit, capital and financial situation and its reputation. With regard to possible product faults, even when this is specifically insured, liability limits may be exceeded, by the claim arising out of an event, insurance premiums could be increased, adversely affecting the Group’s profit, capital and financial situation.

To mitigate these risks, the Group takes out specific insurance policies, maintains careful control over its engineering processes, the validation and monitoring of output, and, in accordance with the risk management process, identifies mitigation action for each project and includes contingencies in its contract cost estimate.

Litigation

The complexity of relationships with third parties (clients, subcontractors, sub-suppliers and partners), and of the content of the products and systems we make, as well as the specific risks of the operations of the business, expose the Group to significant litigation risk. Litigation could concern inter alia tender rules. Settlement of litigation could be complex and require a long period, causing delay in the completion of projects with adverse effects on the business and the Group’s profit, capital and financial situation.

To mitigate this risk, there are risk management processes both in the offer stage and during management of the project, careful checking of contractual clauses with the assistance of the legal department and the adoption of a prudent approach to the accounting recognition of project costs and provisions for risks and charges.

Human Resource Management

The Group supplies products and systems with a high technological content. To produce these we need human resources with specific knowledge and skills that are often hard to find in the market. Successful development of the business, especially in new markets depends on our ability to attract, retain and develop the skills of our people, especially for our international operations.

To mitigate this risk, we have drawn up human resource management policies closely related to the needs of the business, particularly in the current phase of integrated management of the business and expansion into new markets. The transfer of knowledge and experience and training programmes are performed increasingly through secondment and coaching programs, by codifying acquired knowledge in an integrated system documenting our processes and mapping available skills against those required in an increasing number of areas of the business.
In 2010 personnel management processes were re-examined with a view to improving them and integrating them with the Group’s businesses. Lastly, transition plans are drawn up and monitored during implementation of organisation and integrated processes, which came into force on 1 January 2010 for all areas of the Group except our US subsidiary, which will be integrated starting from Q2 2011.

Health, safety and environmental compliance

The Group is subject to health, safety and environmental regulations in its countries of operation.
Non-compliance with these rules due to inadequately managed operational processes or, especially in new markets, incorrect assessment of compliance could expose the Group to risks with adverse effects on the business and the Group’s profit, capital and financial situation and reputation.

To mitigate this risk, the Group adopts health, safety and environmental management systems designed to ensure rigorous compliance with best practice monitored both internally and externally. These systems are certified under OHSAS standard 18001 for safety at work and ISO14001 for the environment in the larger Group entities.
The parent company Ansaldo STS has reviewed and strengthened health and safety processes. The compliance required in new markets is assessed right from the offer phase and support is guaranteed if necessary with recourse to outside consultants. Common policies and procedures are being drawn up to ensure standard behaviours across the Group, while bearing in mind local legal requirements.