Risk management

The key innovations introduced by the new Organisational Model include the establishment of the Central Risk Management unit, which reports directly to the Chief Executive Officer and assists top management with the control of risk management activities in accordance with national and international standards and best practices, in order to strengthen the Group's governance and ensure the definition, update and circulation of the methodologies, metrics and tools to properly identify, analyse, assess, manage and monitor risks.


The Central Risk Management unit is based on two main areas: Enterprise Risk Management (ERM) and the Project Risk Management (PRM), overlooking to the related processes.

 

In 2016 Activities were carried out to further enhance the integration of risk management into business processes and to spread the "culture of risk" in a pervasive and homogeneous way both in business and operating functions as well as in the technical and staff support functions. The unit operates in close collaboration with the other central units for efficient and coordinated control of all risk areas.


 

Operational Risks

RISKS

ACTIONS

Cuts in public budgets could affect grants from the Government for the Research and Development activities of the Group and, as a consequence, also the Group ability to successfully compete in global markets

The tensions on public budgets could further reduce public grants for R&D activities. A noncompliance of the granting levels with those of the other European competitors could negatively influence the Group capacity of being successfully competitive,due to a lower self-financing ability caused by the complex economic scenario; this would increase the risk of inadequate time-to-market of the products being developed .

The Group pursues a strict policy as regards the assessment and selection of the investments through which it focuses the resources available on the most efficient programmes with the highest potential of return. Moreover, the Group is focused on steadily strengthening synergies among the corporate functions involved in the development of new products, especially with reference to products marked by high levels of technology innovation.

During the current activity, the Leonardo Group is exposed to liability risks tocustomers or associated third parties in connection with the proper performance of contracts, also because of activities pertaining to sub suppliers

As part of its activities, the Group may be held liable in connection with (i) the delay in or non-supply of the products or the services indicated in the contract, (ii) the non-compliance of these products or services with the customer’s requests, due to design and manufacturing defects of products and services, for example, and (iii) defaults and/or delays in marketing, rendering of after-sale services and maintenance and revision of products. These liabilities might arise from causes that are directly ascribable to Group companies or due to maintaining the specialist expertise of the company resources or causes that are ascribable to third parties outside the Group that act as suppliers or sub-suppliers for the Group.

The Group continuously monitors the performance of programmes using the Lifecycle Management techniques. In connection with these programmes the Group is committed to improving its industrial efficiency and its ability to precisely perform to customer specifications, also through managing the development and succession of the core competencies.

The Group operates significantly on long-term contracts at a given price

In order to recognise revenues and margins resulting from medium- and long-term contracts in the income statement of each period, the Group adopts the percentage-of-completion method, which requires: (i) an estimate of the costs necessary to carry out the contract, including risks for delays and additional actions to be undertaken to mitigate the risk of nonperformance and (ii) checking the state of progress of the activities. Given their nature, these are both subject to management’s estimates and, as a result, they depend on the ability to foresee the effects of future events. An unexpected increase in the costs incurred while performing the contracts might determine a significant reduction in profitability or a loss, if these costs exceed the revenues deriving from the contract.

Leonardo’s goal is to regulate within the Group the process of preparing and authorising major contracts by issuing a special Directive. In fact, starting with the business proposal stage, Leonardo controls the main performance and financial parameters including the Economic Value Added (EVA), which is one of the aggregates used to evaluate the major contracts of directly controlled and strategic companies. Moreover, the Group reviews the estimated costs of contracts regularly, at least quarterly. In order to identify, monitor and assess risks and uncertainties linked to the performance of the contracts, the Group adopted Lifecycle Management and Risk Management procedures, aimed at reducing the probability of occurrence or the negative consequences identified and at timely implementing the mitigation actions identified. Under these procedures, all significant risks must be identified from the offering stage and monitored while the programme is being carried out, by constantly comparing the physical progress and the accounting status of the programme. Top management, programme managers and the risk management quality, production and finance departments are all involved in making these assessments. The results are weighted in determining the costs necessary to complete the programme on an at least quarterly basis.

 

The Group operates in particularly complex markets, where disputes are settled after a considerable period of time and following extremely convoluted procedures.

The Group is party to judicial, civil and administrative proceedings; for some of these, the Group has established a specific provision for risks and charges in the consolidated financial statements to cover any potential liabilities. Some of these proceedings in which the Leonardo Group is involved – for which a negative outcome is unlikely or that cannot be quantified – are not covered by the provision.

The Group regularly monitors potential and existing disputes, taking the necessary corrective actions and adjusting its provisions for risks on a quarterly basis.

The Group also operates numerous industrial facilities and is therefore exposed to environmental risks or risks arising from the effects of the climate change, in addition to occupational health and safety risks

While carrying out its production activities, the Group is exposed to the risk of accidental contamination of the environment and may be required to bear the costs of restoring any sites that may be contaminated. Moreover, the Group is exposed to risks regarding the workers’ health and safety, also with reference to third party work sites where workers operate.

As to environmental risks or risks linked to unforeseeable climate events, the Group has established an environmental monitoring and assessment programme and has insurance coverage to limit the impact of any event. Occupational health and safety risks are managed through specific training and other work plans focused on a zero-tolerance policy, supported by an accurate system of delegated and other powers, with the aim of ensuring that action is aligned with corporate policies.

The Group operates in Particularly complex markets which require compliance with specific regulations

The Group designs, develops and manufactures products in the Defence sector. These products are particularly important to the protection of national security interests and, therefore, their exportation is subject to the receipt of special authorisations from the relevant authorities. The prohibition, limitation or withdrawal, if any (in the case, for example, of embargoes or geopolitical conflicts), of the authorisation to export the products might have significant negative impacts on the Group’s operations and financial situation. Moreover, non-compliance with these regulations could result in withdrawal of authorisations.

The Group monitors, through specific structures, the constant updating of the relevant regulations. Commercial actions are subject to regulatory restrictions and receipt of the necessary authorisations.

Financial Risks

RISKS

ACTIONS

The Group’s debt shows high level and could have an impact on the Group’s operational and financial strategies

This Group’s debt was previously affected by the acquisition of DRS and by the negative performance of the Transportation sector. Such debt level, beside impacting the Group’s profitability as an effect of the related borrowing costs, could affect the Group’s strategy, limiting its operational and strategic flexibility. Potential future liquidity crises could also restrict the Group’s ability to repay its debts.

Following the acquisition of DRS Leonardo reduced its level of indebtedness through a successful capital increase and the selling off of assets, with particular reference to the Transportation and Energy businesses. Moreover, Leonardo seeks to continually reduce its debt by keeping a close eye on cash generation. In 2015 the Group also renegotiated the contractual terms of its revolving credit facility. This credit line is an important source of medium-term liquidity and, given its amount and that it is a revolving facility, it meets the Group’s working capital requirements, in which collections are highly seasonal in nature. The amount of this credit facility is adequate and meets the Group’s financial requirements.

The Group’s credit rating is also linked to the opinions of the rating agencies

All Group bond issues are given a medium-term financial credit rating by the three international rating Agencies The downgrading experienced from 2011 and 2014 was attributable to the deterioration in the Group’s financial and economic performance, to the delays in the execution of the expected disposal plan of the Transportation and Energy sectors and, in part, to the downgrade in the rating for the Italian Republic. A further downgrade in the Group’s credit rating, even with no effect on the existing loans, could severely limit its access to funding sources, as well as increase its borrowing costs for existing and future loans, which would have a negative impact on the Group’s business prospects and its performance and financial results.

The Group is actively engaged in implementing actions identified under the industrial plan for reducing its debt. Moreover, the Group’s financial policies and careful selection of investments and contracts involve being constantly alert to maintaining a balanced financial structure. In seeking out strategies to pursue, the Group always takes into account the potential impact such could have in the indicators used by the rating agencies.

The Group realises part of its revenues in currencies other than the currencies in which costs are incurred, exposing it to the risk of exchangerate fluctuations. A part of consolidated assets are denominated in US dollars and pound sterling

The Group reports a significant portion of revenues in dollars and pounds, while costs can be denominated in other currencies (mainly euros). Accordingly, any negative changes in the reference exchange rate might have negative effects (transaction risk). Moreover, the Group made significant investments in the United Kingdom and in the United States. Since the reporting currency of the consolidated Group financial statements is the euro, negative changes in the exchange rates between the euro and the dollar and between the euro and the pound sterling might have a negative impact on the Group balance sheet and income statement due to the translation of the financial statements of foreign investees (translation risk).

The Group continuously applies an organized hedge policy to combat transaction risk for all contracts using the financial instruments available on the market. Changes in the dollar and pound sterling exchange rates also give rise to translation differences recognised in Group equity that are partially mitigated through the aforementioned pound and dollar issues. Moreover, in intercompany financing activities denominated in currencies other than the euro individual positions are hedged at the Group level.

The Group is a sponsor of defined-benefit pension plans in the UK and the US and of other minor plans in Europe

Under the defined-benefit plans, the Group is required to ensure a specific future retirement benefit level for employees participating in the plan; in the UK and the USA the pension funds in which the Group participates invest resources in the plan assets (stocks, bonds, etc.) that might not be sufficient to cover the agreed-upon benefits. If the value of plan assets is less than the agreed-upon benefit level, the Group duly recognizes the amount of the deficit among  liabilities; If the value of plan assets falls significantly, for example due to high volatility in the stock and bond markets, the Group must make good this loss to plan participants, which therefore has a negative effect on its own performance and financial position.

The Group keeps a close eye on plan deficits and investment strategies and takes immediate corrective action when necessary.

 

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