Internal Control and Risk Management System

• 4.1 Main Documents Regulating the Internal Control and Risk Management System
• 4.2 Participants of the Internal Control and Risk Management System. Delineation of Responsibilities
• 4.3 Enhancement of the Internal Control and Risk Management System
• 4.4 Key Risks and Actions for their Minimization
• 4.5 Organization of Internal Control and Risk Management

Key Risks and Actions for their Minimization

As JSC "Lenenergo" activity is influenced by a considerable quantity of factors, the primary goals of the integrated system of internal control and risk management are identification, estimation and risk management of financial and economic activity, as well as provision of information on risks when approving administrative decisions.

Strategic risks

Country and regional risks

JSC "Lenenergo" performs its activity in the territory of two subjects of the Russian Federation (the city of St. Petersburg and the Leningrad Region) which are among the most developed regions of the country. The considerable quantity of industrial enterprises of St. Petersburg and agricultural enterprises of the Leningrad Region stimulates steady growth of electricity consumption in the regions of activity of JSC "Lenenergo". Despite the financial crisis of 2008-2009 and the short-term decline in industrial and agricultural production, volumes of output remain steady, which is a factor of stability of power consumption. Nevertheless, in case of slow recovery of the Russian economy after the crisis of 2008-2009, or in case of repeating the crisis, JSC "Lenenergo" can face lower effective demand for its services rendered that will finally affect the financial results and lead to the lower revenue growth rates of the Company. In case of these scenarios, the Company will undertake a number of measures for anti-recessionary management in order to minimize the negative influence on the financial and economic activity of the Company.

Geographical and climatic features of the region located in the Northwest of the Russian Federation, carry the risks of occurrence of accidents on power installations due to adverse natural events (hurricane winds, heavy snow, ice, extreme low temperatures in winter, abnormal summer heat, etc.). For minimization of the given risks, the Company designs power facilities allowing for the regional climate and geography, and implements the insurance program of protection of the power distribution facilities from natural disasters.

To reduce the risks associated with force-majeure circumstances: political instability, strikes, natural disasters, and state of emergency, JSC "Lenenergo" leads its contractual activity taking into account such events. JSC "Lenenergo" contracts contain the clauses "Force majeure" reducing financial losses of the Company upon the occurrence of the described events.

In general, in the medium-term JSC "Lenenergo" considers the possibility of considerable negative impact of country and regional risks on its activity and execution of its obligations to be improbable.

Industry risks

In recent years the electric power industry has undergone significant changes. The reforming of the industry, which started after 2000, bears a number of uncertainties in terms of which the distribution grid complex of the Russian Federation functions.

The major risk factor is the lack of elaboration of mechanisms of functioning of the retail electricity market, including risks associated with disagreements between power network and retail companies concerning the volumes of current electricity consumption, the growth of receivables and the low payment discipline of consumers. To minimize these risks, JSC "Lenenergo" takes steps for elimination of the reasons of conflict with customers to reduce receivables for electricity transmission services, as well as accumulating court practice, and creates positive precedents in cases when the consumer wrongfully disputes the ownership of delivery points.

A no less significant factor is unsettlement at the legislative level relations between distribution grid companies and JSC "FGC UES" regarding "last mile" lease contracts. Despite the legislatively enforceable right to conclude lease contracts of objects of power network economy of JSC "FGC UES" with territorial grid companies, there is no procedure for approving such contracts with the Ministry of Energy of the Russian Federation. Besides, the existing court practice of undertaking direct contracts between consumers and JSC "FGC UES" increases the risk of losses associated with termination of "last mile" contracts between JSC "FGC UES" and JSC "Lenenergo".

To minimize this risk, the Company monitors the compliance with contractual terms with JSC "FGC UES", as well as the timely provision of documentation for the prolongation on "last mile" lease contracts.

Regulatory risks

The Company receives basic incomes from rendering of services on electric power transmission, which are related to the sector of services subject to state regulation and approval in regional executive authorities. The Order of the Government of the Russian Federation as of 19.01.2010 No.30-r establishes the transition from 01.01.2011 on regulation of price control (tariffs) for services in the electric power transmission, rendered by JSC "Lenenergo" in the form of establishment of long-term parameters of regulation of its activity with application of the method of return on investment capital. The specified method of regulation means provision of return on investments, sufficient for servicing of obligations and receiving profit, and stimulates JSC "Lenenergo" to decrease its costs, as the saved funds remain in the Company unlike the method "costs plus" applied earlier. The change of regulation method bears a number of risks associated with non-recognition in full by regional bodies of components, constituting the tariff for services in electric power transmission. It can be associated with restriction of growth of the marginal levels of tariffs on electric power, established on the federal level. The given risk can cause the impossibility of complete compensation of economically reasonable expenses of JSC "Lenenergo", and limit volumes of investments of own funds in the development of the power network complex. For the purpose of minimization of the given risk, the Company performs interaction with regional regulatory bodies for the purpose of establishment of economically reasonable tariffs compensating all costs of the Company and providing realization of the investment program in the necessary volume, and performs a weighed policy on forming of costs.

The Company, being the subject of a natural monopoly, is subject to risks of acknowledgement of antitrust violations in the part of rendering of services in electric power transmission and technological connection. To decrease the given risk, the Company timely handles requests and traces applications of consumers. Besides, JSC "Lenenergo" accurately regulates and traces timely disclosing of information according to the legislation of the Russian Federation.

Financial risks

Risks of a change in interest rates on attraction of borrowed funds

Considering that JSC "Lenenergo" performs attraction of borrowings to implement its primary activity, there are risks of change of interest rates under credits.

The management of the given type of risk consists in monitoring the debt capital market, and in reasonable and economically proved use of borrowings in terms of interest rates and terms of use.

Among expected actions of the Company in case of negative influence on its activity of interest rates change, the following can be identified: optimization of its loan portfolio taking into account the changed market conditions; monitoring of the market of credit resources for the purpose of revealing more favorable credit terms; increase in the share of tools with a fixed rate at the level acceptable for the Company; and possible expansion of banks-partners.

Inflationary risks
Under the conditions of inflation the Company can face depreciation of the real value of expected incomes. Inflationary risks are generally caused by Company possibilities of broadcasting an increase in costs, in case of excess inflation rates, on the price of services in electric power transmission limited by the tariff level established by the regulatory body for a year. The negative influence of inflation on financial and economic activity of the Company can be expressed in debt receivable depreciation at an essential delay or a payment delay, and increase in the cost price of services. As the events are directed at decreased influence of inflationary risk, JSC "Lenenergo" estimates inflationary risks at representation of economically reasonable costs within the limits of the statement by a regulator of tariff-balance decisions, and conducts optimization of costs by means of development and realization of the program of costs management. At increase in inflation rates, the Company will take measures for optimization of management by debt receivable and costs, and increase of turnover of current assets.

Risks of default on obligations on commissioning of objects of investments
The Company performs investments into fixed capital in the form of capital investments including costs for new building, expansion, reconstruction, modernization, etc. The volume of investments increases annually. The risk of non-observance of terms of development of capital investments confirmed by the regulator at accepting BRT, becomes significant both from the point of view of development of sources of financing, and from the point of view of the terms of commissioning of objects of investment building. The basic current events for management of the given risk are: redistribution of the means received from the economy by results of competitive procedures on other objects of the investment program; the control of timeliness of repeatedly carrying out competitive procedures on objects of the investment program on which competitive procedures have not taken place; the control of a building course; the control of adherence to deadlines of the conclusion of contracts, terms of carrying out purchasing procedures; Carrying out of checks of volumes of capital investments which are subject to execution.

Presently the probability of realization of the given risk is insignificant.

Operational and technological risks

Operational risks
An increase in the quantity of incidents and emergencies in the power network distribution complex is significant for the Company, and is associated with ageing of equipment and depreciation of fixed assets, and the possibility of negative changes in the industry.

Production and technical risks
These risks arise from equipment operation. They are connected with possible transition to work in the conditions of forced (emergency admissible), overflow and actual sharp increase in loading over planned on the basis of requests of consumers. Technical risks are associated with equipment operation. They are caused by such factors as possible operation of the equipment with maximum deviations from normative and technical requirements, errors of operation personnel, infringement of the dispatching schedule and discipline.

JSC "Lenenergo" bears the risks associated with the seasonal nature of consumption of electric energy. The consumption peak is necessary for the autumn-winter period, and in this connection the Company has risks of an overload of networks.

To decrease the influence of operational and technological risks the Company carries out reconstruction of acting network facilities and building of new network facilities, modernization of fixed assets, and development of networks for an increase of possibilities for reservation during system accidents. The Company implements the program of insurance protection: property, dangerous production facilities, vehicles, civil responsibility, insurance of personnel upon accidents and illnesses.

Legal risks

The Company performs constant monitoring of changes in the legislation and does not see prospects of the origin in the financial and economic activities of any essential risks associated with changes in the tax and civil legislation in the short term.

Changes in the branch legislation entered last two years the regulating activity on technological connection of power accepting devices and other objects of applicants, activity on preparation to the statement and the reporting on execution of investment programs, and create risks of the origin of disputes with consumers, federal and regional enforcement authorities, and sanctions from supervising bodies.

The risks associated with imperfection of the legislation and acting regulatory legal acts, including, in the field of technological connection, are overcome by forming of JSC "Lenenergo" activity, based on observance and system application of rates of the current legislation, forecasting of legal risks, and protection of the rights and legitimate interests in courts, and forming, thus, of the practice corresponding to the legal court one.

Existing legal procedures in which JSC "Lenenergo" participates do not bear any risks for its normal activity and functioning.