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email pagePrincipal risks and uncertainties
The Board recognises that any commercial opportunity brings with it a degree of risk and, like any business, Arriva must manage a range of risks in the course of its activities. An impact assessment of the scale and probability of the principal risks affecting the business is reviewed annually.
As part of the ongoing programme of risk assessment and management, the following actual and potential risks have been identified as those which the directors believe could have a material impact on the long-term value generation of the group. The factors described below are not intended to form a definitive list of all risks and uncertainties.
1. Market risks
Changes in national public transport budgets
A considerable proportion of the group’s income is derived directly or indirectly from national public transport budgets. Changes in these budgets can have positive or negative impacts on the group’s prospects. The group continues to monitor national public transport budgetary policies in the countries where it operates, and ensures it is strategically aware in order to understand possible changes and react to them in a timely fashion.
2. Operational risks
Meeting health, safety and environmental standards
The Board recognises the importance to the business, as a public transport operator, of maintaining high standards and the consequences of failing to do so. A Safety Committee of the Board oversees the group’s safety policy and the arrangements of its implementation and reporting (see Corporate responsibility).
Mobilisation of large new rail franchises
We aim to use the knowledge gained in the successful rail mobilisation processes we have been involved in to date for other new rail franchises won by the group. The mobilisation of the CrossCountry contract from November 2007 went smoothly, benefiting from our previous experience both in the UK and abroad.
3. Commercial risks
Franchise / tender / acquisition costing and revenue forecasting
Errors or inaccurate assumptions in tenders or acquisitions represent a risk to the business. A number of procedures are in place to mitigate the risk.
The Board monitors all material new franchise, tender and acquisition submissions across the group’s operations, whilst the executive directors review other bids on an ongoing basis in line with delegated authority limits. Standard tender models are in use across the business. Significant bus and train tender contracts are compared with current experience to identify weaknesses and potential improvements in the tender process. Post-investment appraisals are carried out through quarterly business review meetings.
One of the most significant set of assumptions which may be required in constructing a franchise bid relates to general economic factors influencing the market concerned. Arriva’s balanced portfolio of operations, between bus and rail, and between different countries, minimises its exposure to any downturn in any individual market sector. The revenue risk associated with any potential loss of consumer demand from the travelling public is mitigated by the substantial proportion of the group’s revenues which flow from non-passenger sources (see Spreading our net).
Most tendered net cost contracts (see Hold on tight) require the operator to deliver specified services whilst retaining the income from passengers. In contracts where passenger income represents a significant proportion of total revenue, the group is exposed to the risk of passenger revenue being higher or lower than anticipated. Historically, passenger revenue growth is highly correlated with growth in local economies. The recently started UK CrossCountry rail contract is a particularly large contract with these characteristics; Arriva is committed to reducing government financial support on this franchise to almost zero before the end of the franchise in 2016. To deliver anticipated returns, over eight per cent annual revenue growth in real terms will be required, a considerable proportion of which is dependent on economic growth. However, in the fourth year of the franchise, the financial risk is partially mitigated by a revenue risk sharing mechanism in the contract.
The actual conditions are complex but the principal financial arrangements are:
| Percentage shortfall on target revenue |
Revenue support |
|---|---|
| 0 – 2% | Nil |
| 2 – 6% | 50% |
| 6% and higher | 80% |
These risk mitigating factors are mirrored by potential payments to the UK Government when targeted revenue is exceeded.
Throughout the franchise, revenue support may also be available if the dominant cause of a qualifying revenue shortfall is a ‘Force Majeure’ event, such as severe flooding.
Acquisitions
Arriva has clearly defined guidelines for due diligence work and internal reporting on potential acquisitions, which require the monitoring of such items by the executive directors subject to delegated authority limits. Sale and Purchase Agreements include price adjustment mechanisms and warranties as appropriate.
back to top4. Financial risks
As detailed in the Financial Review, the group’s financial risks are managed by the group treasury function in accordance with a formal Board approved treasury policy.
Interest rate risk
Fluctuations in interest rates are managed through the use of interest rate derivatives and fixed rate debt.
Commodity risk
The group’s policy is to maintain fuel price fixes at least 12 to 15 months ahead, on a rolling basis.
Currency translation risk
The group policy on foreign exchange exposure is that the risk of translating non UK assets and liabilities into pounds sterling should be reduced to insignificant levels.
Retirement benefit obligations
Increased retirement benefit obligations may require additional contributions to be made by companies to state or other schemes. Such contributions could have a material impact on the group. We perform regular pension strategy reviews with the group’s pension advisors, and monitor developments in group pension schemes and state schemes where we operate.
back to top5. Other risks
Changes in transport legislation and/or regulation
This is a risk that faces Arriva in every country in which it operates.
The group has procedures in place to ensure effective liaison with appropriate national and European Union officials and monitoring of developments in this area for timely reporting to senior management.
In the UK, the Government is currently planning changes to transport legislation with an expected implementation date in late 2008 or early 2009. The Government is also considering amendments to the Bus Service Operators Grant. These planned and potential changes could have significant impact on the UK bus industry.
Arriva, alongside other UK operators, is monitoring the development of legislation in this area and representing the best long-term interests of the industry.
Succession planning for key managerial positions
Arriva is a fast-growing company in many markets. The group has a stable senior management population but any inability to fill a significant proportion of senior vacancies could have an adverse impact on the group’s future development. Succession planning is already in place, as is a process for identifying emerging management talent. We are developing an executive development programme.
