Risk governance

The current macroeconomic situation, financial market instability, management processes complexity and continuous legislative and regulatory evolution entail a renewed capacity to protect and maximise tangible and intangible sources of value and the strategic objectives that characterise the corporate business model. Pirelli adopts a pro-active risk management system. It uses a systematic process of identifying, analysing and assessing risk-prone areas to provide the Board of Directors and management with decision-making tools so that they can anticipate and manage the effects of these risks, guided by the awareness that the assumption of risk is a fundamental part of business management.

Strategic objectives are not only economic but also social and environmental, reflecting full integration of the sustainability model in corporate development plans. In accordance with this philosophy, Pirelli has implemented an integrated risk management system (Enterprise Risk Management) aimed at:

  • managing risks in terms of prevention and mitigation;
  • pro-actively seizing opportunities;
  • disseminating inside the Company the “culture” of the value at risk, particularly in strategic and operating forecast and planning processes and in the most important corporate choices;
  • assuring transparent disclosure of the assumed risk profile and implemented management strategies, through periodic and structured reporting to the Board of Directors and top management, and adequate disclosure to shareholders, as well as to all stakeholders in general.

Consistently with these aims, the Pirelli Enterprise Risk Management is characterized by being:

  • enterprise-wide, i.e. extended to all potentially significant types of risk/opportunities;
  • value-driven, i.e. focused on the most significant risks or opportunities according to their capacity to prejudice attainment of the strategic objectives of Pirelli or to impair critical corporate assets (“Key Value Drivers”).
  • top-down, insofar as top management establishes the guidelines for identifying the priority risk areas and events having the greatest impact on business;
  • quantitative, insofar as it is based, wherever possible, on exact measurement of the impact of risks on expected financial results according to the likelihood of their occurring;
  • integrated in decision-making and business processes and, in particular, in the strategic and operating planning process.

The Pirelli Risk Model systematically assesses three categories of risks: external risks, strategic risks and operating risks. These risk families guide the objectives of risk management, the control system and governance bodies (see the next section). The Board of Directors Internal Control, Risks and Corporate Governance Committee is supported by two Managerial Risk Committees in managing the various risk macrofamilies, with each committee monitoring specifically assigned areas of risk. The Internal Control, Risks and Corporate Governance Committee analysed the results of risk assessment during four meetings held in 2013.

risks and uncertainties

The principal areas of risk to which the Company may be exposed are also illustrated in detail in the section “Principal Risks and Uncertainties” included in the Directors’ Report on Operations – Volume 01: Annual Financial Report at December 31, 2013, to which reference is made for an extended discussion of these risks. The three risk macro-families, the risk management objectives, and the dedicated Control Model are described as follows.

Risks related to the external context in which the company operates, whose occurrence is beyond the Company’s control.

This category includes the risks related to macroeconomic trends, changes in demand, the strategy of competitors, technological innovation, new regulations, and country risk (and specifically economic, security, political and environmental risks).

The aim of risk management is to monitor risks and mitigate their impact if they materialise. The Control Model is based on the adoption of internal and external tools to identify and monitor risks, stress tests to assess the robustness of plans, identification of alternative scenarios, business case studies to assess the impact of material changes in context, etc.

After a year, 2013, dominated by a high degree of uncertainty, Pirelli expects – consistently with forecasts by leading analysts – that the global economy will gradually accelerate in 2014.

In mature economies, a partial relaxation of austerity measures in the public sector and a lower level of indebtedness in the private sector (especially in the United States) should sustain growth on both sides of the Atlantic. Improvement in the economic fundamentals of the United States and, to a lesser extent, in Europe, should also permeate emerging economies in terms of greater exports and further improvement in financial market confidence.

Elements of uncertainty will remain and might derive, inter alia, from the tapering of quantitative easing in the United States, possible political tensions in the more economically fragile emerging countries and, last but not least, geopolitical tensions in the Middle East.

Although subject to impact by the exogenous factors indicated above, the automotive market is forecast to expand at an average annual rate of 3.7% until 2017, with a steady increase in the impact of the premium segment. Even during economic crisis, the performance of the tyre market confirms the wisdom of the choice made by Pirelli to focus its activities on the premium segment. Even in the face of a situation caused by the difficult international business cycle, the premium segment will continue to grow at a rate three times faster than the non-premium segment, with a forecast annual average global increase of 7.3% between 2013 and 2017, as compared with a 2.4% rate in the non-premium segment (+3.6% overall growth). In regard to the evolution of demand over the longterm, some social and technological trends might have a material impact on the automotive sector and indirectly on the tyre market. On the one hand, these are represented by growing urbanisation (according to United Nations estimates, about 70% of the global population will live in urban areas in 2050) and, on the other hand, by changes in the values and behaviour of younger generations (increase in the average age when a driver’s license is obtained, loss of importance of owning a car, increased recourse to various types of car sharing). These factors will be complemented by the spread of information technologies, with a concurrent expansion of e-commerce and/or telecommuting, and frequent regulatory changes in both mature and emerging economies to limit the presence of polluting vehicles within and near metropolitan areas.

These dynamics might be followed by an evolution in automotive sector demand (from changes to vehicle dimensions or type of propulsion system to possible resizing of cars to satisfy the transportation preferences of citizens), with contingent impact on tyre sector dynamics. Pirelli constantly monitors the evolutionary changes in automotive sector demand by actively participating in international working groups, such as the one engaged in the Sustainable Mobility 2.0 (SMP 2.0) project sponsored by the World Business Council for Sustainable Development (WBCSD). The principal aim of SMP 2.0 is to study the possible long-term evolution in urban mobility and promote solutions that might improve the social, environmental and economic well-being of the urban population.

Strategic risks, that are typical for a specific business sector. Proper management of these risks is a source of competitive advantage or, on the contrary, a cause for failure to achieve plan targets (annual and multi-year targets).

This category includes market risk, product innovation and process risk, raw material price risk, production process risk, financial risk, organisational risk, and M&A risk. Risk management aims to manage risk by means of specific tools and protections designed to reduce its likelihood or limit its impact should it materialise in a risk – yield perspective.

The Control Model is based on identifying and measuring PBIT/Cash Flow@Risk when strategic management plans are prepared, defining risk appetite and risk tolerance for principle risk events, introducing Key Risk Indicators in Group reporting, monitoring of mitigation plans associated with material risks in the absence of specific, previously implemented and operational business protection measures. Specific analysis, as reported in Volume 1: Annual Financial Report at December 31, 2013, to which reference is made made for an extended discussion of these risks, has been performed on:

  • transaction exchange rate risk;
  • currency translation risk;
  • liquidity risk;
  • interest rate risk;
  • price risk associated with financial assets; credit risk;
  • credit risk.

The identification of priority risk areas and their measurement in terms of their contingent impact and likelihood of occurrence is guided by the business regions on the basis of the objectives and strategic policies outlined in the industrial plan (key value drivers).

Central corporate functions coordinate the analysis of centrally monitored risks, such as raw materials and currency rates. The use of quantitative metrics of impact permits the aggregation of risks and representation of the Group’s comprehensive risk exposure (“Profit@ Risk”), which the Board of Directors assesses before approving plan targets. In regard to strategic risks, commodities (natural rubber, synthetic rubber and petroleum based raw materials – especially chemicals and carbon black) and exchange rates (especially South American currencies) will continue to represent a factor of uncertainty in the structure of Group costs.

Operational Risks, that are the risks generated by the organisational structure, processes and systems of the Group and do not attribute any competitive advantage if they are assumed.

The principal areas of risk in this category are information technology, security, business interruption, legal & compliance, and health, safety & environment risk.

The aim of risk management is to manage these risks through prevention measures and internal control systems integrated in corporate processes. The Control Model is based on the development of ad hoc methods for measuring risk, defining mitigation and prevention plans, and continuous monitoring of their implementation. Specific analysis, as reported in Volume 1: Annual Financial Report at December 31, 2013, to which reference is made made for an extended discussion of these risks, has been performed on:

  • environmental risks;
  • employee health and safety risks;
  • product defect risk;
  • litigation risks;
  • risks associated with human resources;
  • business interruption risks;
  • risks associated with information systems;
  • corporate criminal liability risks.

The analysis of operational risks is an integral part of the Group internal control system. Ad hoc methods are developed for each area of riskto measure the vulnerability of control systems and their possible impact on the Group. The vulnerable areas revealed by this analysis are the object of continuous follow-up activity by the Operational Risk Committee.

In 2013 the Group to undertook a series of mitigation actions to reduce the vulnerability of the supply chain.

In particular, this involved extending the portfolio of approved plants by individual supplier, approval of alternative materials/suppliers, increase in the levels of safety stocks of critical materials, supplier audits, etc.

A joint effort was launched in 2013 with certain of the Group’s principal suppliers to agree on areas for improvement of the principal business interruption risks at their production sites, including the sharing of Pirelli best practices applicable to loss prevention.

In regard to the impacts from climate change, no significant risks have been found in relation to production processes. Instead, in terms of opportunities, Pirelli Green Performance tyres exhibit growth potential, given the relevant lower environmental impact and the possible regulatory evolution in many countries as it was in Europe with European labelling standards.

In 2013 the ESG (Environmental, Social, Governance) risk assessment and monitoring system was refined and reinforced in terms of the number of monitored Key Risk Indicators.

In 2014 a new control panel will be used for constant monitoring of the evolution in the environmental, social and governance Key Performance Indicators linked to the targets defined during strategic planning and for prompt identification of possible risk factors that might slow down achieving them.

Moreover, since 2013 Pirelli has decided to develop an ad hoc method to identify and measure reputational risks, construed as the present or prospective risk of lost profits or lower share price resulting from negative perception of the Company by one or more stakeholders. While on the one hand reputational risk has to be construed as the contingent occurrence of a negative event tied to one of the three macro-families of risks mentioned above, on the other hand it must be managed as an independent event precisely because its scope depends on the expectations of stakeholders and the impact of the negative event.

The method that will lead to identification of reputation risks in 2014 will consider a series of internal and external drivers, such as: negative events with an impact on reputation that occurred in the industry worldwide over the last ten years; interviews with external Key Opinion Leaders on sector trends, particularly mobility and sustainability; interviews with internal Key Opinion Leaders. The identified risk events will be measured by the stakeholders general public in the key countries for the Group and will lead to definition of the governance and management structures, as well as the preparation of any mitigation and/or crisis management plans.

For more details on risk governance, reference is made to Volume 02: Annual Report on Corporate Governance and the Structure of Share Ownership 2013.