HOCHTIEF deploys integrated planning, control and monitoring systems and fine-tunes them on an ongoing basis to ensure that risks are detected at a sufficiently early stage, assessed and appropriately managed.
Risk management is a key success factor for HOCHTIEF and as such forms an integral component of our management system. To promote risk awareness throughout the workforce, we nurture a continuously evolving risk culture at all levels. This risk culture is sustained by organizational processes, IT systems and open communication.
Risk inventories and forecasts are compiled at all operating locations three times a year and the resulting information is aggregated to Group level. This approach involves managers at all tiers of the corporate hierarchy, ensuring that risk awareness is all-pervasive – from project managers all the way through to divisional heads and holding company executives.
HOCHTIEF compiles the Steering Committee's findings in a risk situation analysis. This details all major risks in tabular form. The commented analysis forms an integral part of reporting and is finalized by the Executive Board.
In addition to the Risk Management Steering Committee, the Investment Committee is also a key part of our early warning system. As a rule, investments and equity stakes must be approved by the Investment Committee. The Committee ensures that all investment projects are assessed using uniform and recognized principles. Along with strict profitability standards, operational, financing and country risks are also material factors used by the Committee to make decisions.
Opportunities are inventoried simultaneously with risks Group-wide and are included in planning and forecasting reports submitted to the Executive Board. Opportunities are individually quantified and additionally weighted by probability of occurrence. There is no offsetting of risks and opportunities.
At just under 50 percent, project and contract risk accounts for the largest share of overall risk. This category is followed by market, financial and equity investment risks, which together make up about 45 percent of quantifiable overall risk. Personnel and internal risk jointly add up to less than a five percent share. In the sections that follow, risks are described by risk category.
Alongside acquisitions, real estate investments, development projects and decisions to enter new business segments, all routine projects are systematically scrutinized once their volume or risk level touches a certain threshold. This allows potential contract and project risks to be detected and minimized at an early stage. The processes used for this purpose are chosen for empirical relevance and effectiveness. In the case of real estate development projects, for example, pre-lease or pre-sales rates commensurate with the type of project must be attained before the green light is given for construction to start and in certain cases before the site is purchased.
Our Australian subsidiary Leighton stipulates a wide range of project-specific requirements for processing and approving bids. A special committee analyzes all projects and their risk structure. The committee decides whether an implicit risk premium should be calculated or whether the project should be declined. The decision-making bodies of our US subsidiaries Turner and Flatiron base their decisions on similar criteria taking into consideration marketspecific conditions.
All prospective acquisitions and bids are also subjected to risk classification in the HOCHTIEF Europe division. At the same time, all bids must be reviewed and approved by a centralized Contract Review Committee made up of qualified specialists. The Risk Management department ensures that risks are identified, managed and reported according to uniform standards in the HOCHTIEF Europe division. Risk management was improved substantially in 2008 by introducing additional criteria for assessing the risks of projects. Risk auditors manage projects with identified risks from bid preparation through contract award to handover to the client. The Contract Administration
department, risk managers, the CIP team* and Legal corporate
center support the project teams in all contracting matters
under the auspices of the Risk Management department.
In addition, the internal auditing function regularly analyzes
domestic and international projects for technical, commercial
and legal risk.
In 2008, earnings from German building construction contracts were negatively impacted by the completion of lossmaking projects already underway and expenses for approved restructuring projects in particular. Our new contracts feature improved margins and significantly fairer risk distribution. Projects are now only approved if there are binding offers from subcontractors for key trades and materials. Escalator clauses additionally reduce the risk of price increases. Despite this approach, cost risk cannot be entirely eliminated now or in the future, particularly in largescale projects spread out over several years.
We aim to further reduce risk in the mainstream construction business by using partnership-based contracting
While HOCHTIEF generates a high volume of sales with individual trading partners, it does not depend directly on any one client or supplier. Default risk is reduced through customer credit checks and by obtaining guarantees for amounts owed.
HOCHTIEF's centralized procurement management** ensures that capable operating partners are selected. By maintaining a constant watch over the market and close contact with suppliers and institutions, we can quickly spot changes on the procurement market and respond accordingly.
We address warranty risks from the construction business by requiring subcontractors to post surety or guarantees and, where applicable, by entering into service contracts and setting up regular monitoring. In 2008, we also launched the new "Subguard" insurance product in order to cover liability risks and claims arising from the insolvency risk of subcontractors. Where HOCHTIEF is required to cover a certain contingent of risk itself – in other words, where use is made of captive insurance arrangements the Group's exposure is kept in check by enforcing appropriately scaled liability limits.
Earnings from a project can also be adversely affected in the execution phase, for instance, by geological difficulties encountered in tunneling. Under the terms of contract, these risks are generally agreed to lie with the client. The commercial success of such contracts often depends on the extent to which claims for supplementary work can be billed on to project owners. Risks arise if the value of change orders cannot be recouped.
Moreover, the project execution phase also poses the risk of ambitious completion dates not being able to be met. This can result in penalties due to schedule overruns if the delay is down to HOCHTIEF.
One major court case is the lawsuit pending since late 2003 in connection with the construction of the Sony Center in Berlin. A subcontractor employed in building the Center is suing us for payment for supplementary work. We petitioned to have the entire suit dismissed and also filed a counterclaim. Due to considerable delays in the proceedings, it is not possible to foresee how long the case will continue.
Other legal disputes relate to two projects by our US subsidiary Turner: a sports stadium near Washington, DC and a school building in Cincinnati. The cases involve enforcing claims against project owners and insurers through the courts.
The profitability of our subsidiaries has not been adversely affected to date by the generally difficult economic situation in the United States. Numerous new orders ensure a stable order backlog for our US subsidiaries. Traditionally, Turner has not been involved to any significant extent in the residential construction market, which has declined precipitously due to the mortgage crisis. A drastic drop in building construction projects is not anticipated currently. In addition, Turner builds a substantial percentage of its
The HOCHTIEF Asia Pacific division – along with our subsidiary Leighton – benefits in particular from its diversified activities in the Australian market and various Asian markets. Future developments in Australia depend materially on demand for raw materials. In our contract mining operations, we cannot completely rule out a decrease in the number of new orders or a paring down of investments by mine operators. The cooling of the overheated construction market is being felt keenly in the Gulf region. Payment patterns have deteriorated, particulary in Dubai. Nonetheless, we expect the division's performance to be positive because of the large order backlog and the continued need for infrastructure investments in Australia and the Gulf region.
International air transport sustained its positive trend in 2008. Our airport holdings in Athens, Budapest, Düsseldorf, Hamburg, Sydney and Tirana reported passenger growth of 1.5 percent on average. HOCHTIEF AirPort"s planning indicates stable passenger figures at these airports. In the long term, we anticipate sustained growth in this segment.
As a consequence of its broad regional positioning, HOCHTIEF Real Estate has been able to successfully balance out weaknesses in individual markets to date. The lease rates of our projects are currently high. However, demand for leased space in the markets in which HOCHTIEF Real Estate operates could be adversely affected by the strained overall economic situation. In the project development segment, we will leverage market opportunities by selecting new projects with even more care and focusing on promising business segments. The financial crisis has had a negative effect on the real estate investment market. In 2008, the volume of transactions in European real estate markets has decreased considerably while profitability requirements have been rising simultaneously. Due to the dependence of the investment market on the smooth functioning of the credit markets, 2009 will again see risks
The German construction market stabilized in 2008. The commercial and public-sector construction sectors saw marked growth in new orders and sales while the residential construction market continued to contract. The level of new orders received by HOCHTIEF Construction's German building construction operations was lower than in the previous year due to greater selectivity in order taking. HOCHTIEF Construction is also holding its strategic course of focused expansion in Central and Eastern Europe and by carefully choosing international projects. In addition, promising market segments will be developed further using profitable business models. These include renovating or refurbishing schools based on PPP contracts in conjunction with other Group units.
We cannot rule out that further turbulence on sales and procurement markets might adversely affect our business.
All financial activities in the HOCHTIEF Group are conducted on the basis of a Group-wide financial framework directive. This is fleshed out by individual, function-specific operating directives on issues such as currency and collateral management. These lay down principles for dealing
In the event that this unwillingness to lend continues for a longer period, a strained liquidity situation for our company cannot be ruled out altogether.
HOCHTIEF Aktiengesellschaft's cash resources include adequate growth and liquidity reserves. We also have sufficient short-term revolving credit facilities available for daily drawing as part of our cash pooling arrangements. These credit facilities are broadly diversified. In July 2008, we augmented our long-term borrowing with the issuance of EUR 250 million in promissory note loans (Schuldscheindarlehen) with tenors of five and seven years. Furthermore, we also have a EUR 600 million revolving credit facility running until November 2012 and sufficiently large guarantee facilities for securing bank guarantees and other collateral. The most important of these arrangements is a longterm internationally syndicated guarantee facility in the amount of EUR 2 billion.
On the whole, we have ensured that all Group companies in Germany and abroad possess sufficient credit and guarantee facilities to successfully finance both their operating activities and new projects. As a precaution, we have supplemented our liquidity reserves and are reviewing all investments very carefully, taking this into consideration. Our planning is based on the assumption that the credit and capital markets will normalize again starting in 2010.
We minimize the risk of interest rate changes by locking in interest rates for the longest available terms. Any variable interest-rate borrowing that may be necessary is hedged in each instance by targeted use of interest rate derivatives with congruent maturities. Project finance is hedged as needed according to term and volume. A sustained contraction of liquidity in the financial markets could lead to a widening of credit spreads. This could increase our refinancing costs when existing project and investment financing matures and thus raise our capital requirements. The resulting pressures could materially affect our earnings and liquidity situation.
Derivative financial instruments such as interest-rate swaps and currency options are never used for speculative purposes. They are used solely to hedge potential risks from existing transactions. To minimize intrayear fluctuations of derivatives, utmost care is taken to ensure that all hedging instruments qualify for hedge accounting.
Price risk also arises at HOCHTIEF from investments in stocks and funds. These investments are managed by ongoing monitoring. In the event of impairment of these investments, writedowns can impact earnings.
With the exception of our subsidiary Leighton, the HOCHTIEF Group does not currently have an external rating because it has not so far been apparent that such a rating would bring any financial benefit.
As in previous years, the annual impairment tests to verify that the market value of goodwill still matches or exceeds book value indicated no need to recognize goodwill impairment charges in 2008.
Risks from equity holdings relate primarily to our airport holdings, stakes in concession companies and other equity holdings in which HOCHTIEF companies hold less than 50 percent of the capital either directly or indirectly.
The possibility of airlines defaulting on amounts owed to HOCHTIEF's airport holdings cannot be ruled out.
Concessions generally have a very long contract term and pose specific risks, among other things due to the need to estimate future business growth as well as to cost operation and maintenance expenditure. On infrastructure concessions, HOCHTIEF either guarantees a stipulated level of availability or itself takes on the risk relating to future utilization levels. If HOCHTIEF takes on the risk and utilization levels prove to be less than assumed, this can have a negative impact on the value of the concession.
If unforeseen events were to occur, other subsidiaries and associates could also have an adverse effect on our earnings due to the need to recognize impairments.
In fiscal 2008, impairments were recognized for Australian companies in the Leighton business portfolio mainly due to a drop in share prices. This relates principally to three toll roads, the project development company Devine and the contract mining company Macmahon.
We cannot rule out the possibility that impairment losses may have to be recognized for our subsidiaries and associated companies in isolated cases in the future.
Succession planning is a further key issue for HOCHTIEF. Integrated employee development activities ensure that managerial vacancies are largely filled from within the Group. We secure the enduring loyalty of managerial employees by providing variable compensation components with a long-term incentive effect.
Employee and workplace safety is very important to HOCHTIEF. Occupational safety, health and environmental protection are coordinated centrally by the OSHEP Center. Focused safety management aims to reduce to a minimum accident and health risks for employees and third parties.
No material risks are currently apparent with regard to HOCHTIEF's company pensions. Actuarial reports are prepared in order to ensure that all pension liabilities are covered. The switch from defined benefit pension plans to defined contribution arrangements that place predictable demands on the company has already been effected in Germany in recent years. Pension obligations in Germany are fully covered by HOCHTIEF Pension Trust e.V. and pension liability insurance, and are backed by sound assets.** All new pension commitments at Leighton and Turner follow the defined contribution model. Existing commitments from closed defined benefit pension funds at Turner, which are largely covered by other investments, will run out over the long term.
If, however, the capital markets were to follow a sustained downward trend, it would not be possible to rule out the necessity of top-up contributions to meet pension commitments.
Our internal auditing function additionally reviews and evaluates the proper functioning and cost-effectiveness of the installed systems and processes. Identified scope for improvement is presented in the Risk Management Steering Committee and incorporated in refinements to the risk management system.