Risk management system

Risk Report

The global business operations of the FUCHS PETROLUB Group and its operating companies in the field of lubricants and related specialties are confronted with a large number of risks that can arise from their business activities. However, along with the risks, the business activities present numerous opportunities that are to be utilized as a way of securing and building on the company’s competitiveness.

The Group’s risk management system
The FUCHS PETROLUB Group’s risk management system (RMS) is a comprehensive, traceable system that covers all company activities and processes. It incorporates all organizational regulations and measures for both detecting and handling the risks associated with the Group’s business. It is also part of the FUCHS planning, control and reporting processes in all operating units and central functions. The Internal Control System (ICS) is integrated in the risk management system. The following is a summary of the key aspects of both systems.

The company-wide risk management and internal control system has been set up on the basis of a generally recognized framework (COSO model – Committee of Sponsoring Organizations of the Treadway Commission). The scope and alignment of the risk management system are laid down and, if necessary, adjusted by the Executive Board, taking into account company-specific requirements. Yet even appropriately selected and fully functional systems cannot offer absolute security with regard to identification and controlling of risks.

The risk management system employs the following elements: strategic planning, mid-term planning and budgeting, reporting and permanent controlling, risk reporting, the Internal Control System of the operational and organizational structure and internal audit. To avoid risks wherever possible, deal with any risks as quickly as possible and be able to introduce counter measures, risks are systematically identified, assessed, monitored and documented early on. Regular risk inventories are an important instrument in global risk governance. These are performed by the management of the operating companies (every 6 months) and in the central functions (annually), and serve to detect risks where they occur or where the risk elimination specialists operate. In addition to this, ad hoc reporting is provided should any significant new risks occur. The risks are identified and assessed, applying suitable risk categories, in terms of their likelihood of occurrence and both gross potential loss (i.e. before counter measures are implemented) and net potential loss (i. e. after counter measures have been implemented). The assessment of potential loss is generally performed on the basis of the effects on EBIT. The expected value of the loss is calculated for evaluation and analysis purposes. The risk data is recorded using an intranet-based system.

The FUCHS PETROLUB Group’s Internal Control System consists of a three-tier control hierarchy and incorporates controls at company level for controlling and monitoring the entire company, individual business processes, and individual business transactions. Instruments such as a Code of Conduct, Corporate Governance Report and Group guidelines, as well as routines and institutions such as risk reporting, the audit committee and the internal audit department are all in place at company level. The details of these regulations and instruments are laid down in the lower tiers of the control hierarchy. The monitoring of individual business processes takes place via appropriate and prompt reporting, which alongside financial reporting also includes other Group-relevant reports such as forecasts, budget reports and compliance reports. To secure compliant financial reporting, organizational arrangements are in place both locally in the individual companies and centrally at the company’s headquarters in Mannheim (e. g. compliance with the “four eyes” principle, approval procedures, segregation of duties, IT access control, etc.).

The Internal Control System is periodically audited by the internal audit department based on a selection of key issues (including the internal controls over financial reporting). This takes place within the scope of the annual audit plan and the performance tests of the individual areas / departments. Alongside this, Group accounting and the internal audit department perform a followup of the results of the annual audits. Both of these departments report directly to the Chief Financial Officer of FUCHS PETROLUB AG. The Supervisory Board receives regular reporting on the results of the risk inventories and the audit results.

The risk management system with regard to the (Group’s) accounting processes works specifically to the goal of promptly detecting and indicating all effects that might impair or otherwise negatively influence proper and accurate preparation of the (consolidated) annual financial statements. To regularly check detected risks, the Group-wide Internal Control System should ensure with sufficient reliability that:

- the accounting records properly and accurately present all transactions and use of assets of the FUCHS PETROLUB Group;
- transactions are recorded in accordance with the International Financial Reporting Standards ( IFRS) and are made available for preparing the (consolidated) annual financial statements based on IFRS; and
- any misappropriation of assets is prevented or securely detected early on.

The FUCHS PETROLUB Group’s accounting has a decentralized organizational structure. On the basis of largely standardized IT systems, financial reporting not only covers the annual financial statements, but also incorporates monthly and quarterly statements, whose results are regularly analyzed and checked within the Group for completeness, accuracy and plausibility.

A uniform disclosure of transactions in financial reporting is secured by a range of Group-wide specifications, such as the FUCHS Accounting Manual, the Financial Guideline, Investment Guideline, Receivables Guideline and the Guideline for Inter-Company Payments. Any amendments with regard to existing regulations on reporting are timely analyzed, taking into account the  ffects on the annual financial statements of the FUCHS PETROLUB Group, and if applicable they are communicated to the Group companies for implementation.

KPMG confirmed within the scope of the (Group) annual audit that the early risk detection system applied by FUCHS PETROLUB is suitable for early detection of risks that threaten the going-concern of the Group. KPMG detected no significant weaknesses with regard to the Internal Controls over Financial Reporting within the scope of its audit.

Individual risks
Macroeconomic risks
The global business operations of the FUCHS PETROLUB Group require to examine the economic and / or political opportunities and risks in those countries in which FUCHS operates. Significant risks exist in the volatility of raw material costs, potential increases in geopolitical tensions and the continuing uncertainty with regard to the further effects of the global financial crisis on the real economy. Since we are represented in 43 countries with 54 operating companies, manufacture a large number of lubricants and related specialties for a wide range of applications, and supply more than 100,000 customers in over 100 countries, the FUCHS PETROLUB Group has a well diversified structure. This minimizes the risk of dependency on individual companies, products, customers, sectors or regions.

Sector risks
Technological advances and innovative power are two key instruments that can be used to counteract sector-typical risks, such as intensive competition in the sales markets. The company is the technological leader in strategically important niches and business segments. Continuous research in developing new products, as well as further development of existing products, forms the basis for anchoring and expanding our market position. Application support stimulates cooperative research and development work directly on site with customers, whereby lubricants for new machines, components, units and production processes are constantly being developed. The Group’s profitability
will continue to be backed in the future by this innovation and niche strategy, global presence, a high degree of specialization and ongoing cost management.

Preregistration for the European chemical regulation REACH (Registration, Evaluation, Authorization of Chemicals) is now complete and all staff-related and organizational measures have been implemented to comply with the regulations and monitor further development.

The aim of the GHS (Globally Harmonized System) legislation, which came into force on January 20, 2009, is to introduce a uniform worldwide system for classifying and labeling chemicals. This leads to reevaluation of the toxicity properties of materials and formulations. Products from the FUCHS range could then become subject to special labeling requirements or a ban on sales. Where it was foreseeable that the implementation of GHS would lead to changes that may impede a particular product’s marketability, counter measures were taken in the form of preparing alternative formulas. Structures have also been created to support the implementation of GHS worldwide.

Procurement risks
The increase in prices of raw materials – in particular base oils and additives – represents a particular risk due to the availability, changes in the market and the oligopolistic position of suppliers. The Headquarters’ purchasing department is carefully and continuously monitoring any detectible volatilities in the procurement markets, allowing immediate reaction to any developments. Base oil supply continues to be secured through a broad range of sources.

Inventory risks
The large number of customers and the broad portfolio of products in connection with short delivery times require to maintain a broad base of inventories in terms of raw materials, finished products and packaging materials. Inventory management is efficiently organized, ensuring that these requirements can be met throughout the entire Group. The significantly greater volatility we are seeing, both in terms of procurement prices and customer demand, is leading to valuation risks, which are taken into account appropriately through a loss-free valuation.

Risks from receivables
The uncertainty being sensed due to the worldwide financial crisis and its effects on the real economy also require constant monitoring in connection with the liquidity situation of our customers. The individual companies and the controlling department in the FUCHS PETROLUB Group have therefore introduced early warning systems, which are used to check and monitor the aging structure, compliance with payment terms for trade receivables per customer / company and their creditworthiness. During the periodically performed audits, the implementation of the measures is additionally
checked.

Risks from research and development
The sustainable market success of the FUCHS PETROLUB Group is based on the capacity for fast innovation and the high degree of specialization. Yet the high level of complexity and limited predictability of research and development projects lead to risks. Here, we pursue a strategy of risk minimization by developing most products in cooperation and coordination with our customers. Joint research in a network together with universities and research institutes is another step taken to spread risks, while also making an important contribution to promoting innovation and the high degree of specialization.

Financial risks
Detailed guidelines and stipulations, approved by the Executive Board and both monitored and controlled by the central Treasury department at FUCHS PETROLUB AG, are in place for the key financial risks, such as currency and interest risks. Currency risks are reduced (where necessary) by entering into term and currency-matched financing and by making use of Der ivat ives . We employ these instruments for hedging purposes only. There are currently no significant interest rate risks. The refinancing risk is also low, due to the creditworthiness of FUCHS. There is sufficient liquidity.

Currency risks consist of (operating) transaction risks (income and expenditures in foreign currency) which, among other things, result from the procurement of raw materials, as well as translation risks (conversion of balance sheets / income statements outside the Eurozone in euros) that come about from currency translation for individual companies on various reporting dates.

Transaction and translation risks counterbalance each other at Group level and have a compensatory effect.

Pension risks
The pension risks essentially result from defined benefit plans, which lead to long-term payment obligations that themselves depend on the development of biometric factors as well as salary and pension level trends. Changes in the discount rate also lead to valuation changes in pension obligations. Defined benefit plans are essentially in place in Germany, the US and England, where the defined contribution system has now been introduced for new commitments.

Existing defined benefit obligations in the US were frozen in 2009 and transferred to a defined contribution system. The UK pension obligations for pensioners will be transferred to a life insurance company in 2010. In Germany the pension fund was basically closed back in 1983.

The covering funds (plan assets) reserved for covering the benefit obligations in the US and England are invested in the capital market and subject to corresponding investment risks, which are limited through various measures. Investment management is performed by professional fund managers, who work according to our specifications.

Legal, regulatory and location risks
The regulations and legislation affecting the Group include legal risks against which FUCHS protects itself through comprehensive legal and insurance advice, as well as through its own expert staff. Appropriate insurance coverage is in place. The continued uncertainty caused by the economic and financial crisis could also have a negative impact here due to the collapse of insurers.

There are currently no pending or threatened court cases likely to have a significant effect on the companies in the FUCHS PETROLUB Group. However, the legal position of shareholders at one of our two joint ventures in the Middle East is unclear. The economic consequences of this are currently difficult to assess. However, the contribution of the joint venture to the earnings before interest and tax (EBIT) of the FUCHS PETROLUB Group is below 5 %.

The international business transactions carried out by the FUCHS PETROLUB Group include local tax liabilities. In the case of taxation risks, sufficient provisions have been made. There are no known taxation risks with a significant impact on the Group. Other risks associated with international business include risks in the areas of product liability, competition and cartel legislation, recalls, workplace safety, patent law, trademark law, tax law and environmental protection. To this end, the FUCHS PETROLUB Group has set up a compliance organization, including a compliance committee and corresponding reporting lines, as well as training measures to be able to deal with any risks resulting from this in the appropriate manner. There are no known significant risks in this arena. Further counter-measures have been established through the continuous improvement of the operational and organizational structure, the quality management system and in ensuring suitable insurance coverage.

Certain national and location risks occur due to our global presence. Potential risks in this context include forces of nature, pandemics, terror, nationalization or confiscation of assets, legal and regulatory risks, capital transfer embargoes, war and other turbulence. The security measures in such locations are constantly reexamined, assessed and adjusted accordingly. The political risk is taken into account for individual investment projects. The risk of damage to property, liability risks, transport risks, as well as risks posed by potential interruptions in business, are sufficiently covered throughout the Group by existing insurance policies.

Risks from acquisitions and investments
Risks can also result from the complexity of acquisition and investment projects. The FUCHS PETROLUB Group employs stipulated procedures and processes to control and minimize risks of this nature.

There are currently no risks from acquisition and investment activities.

IT risks
The organizational and IT-based networking of sites and systems includes further risks. These lie in the increasing complexity of electronic communication technology, which can lead to data loss / theft, operational interruptions and malfunctions, or even to a complete system failure. To this end, processes, guidelines and measures have been developed to be able to meet these risks in an appropriate manner. Furthermore, regular investments are made in modern hardware and software, implementation of detailed backup and recovery procedures and the consistent use of virus scanners and firewalls. Comprehensive training sessions for all employees enable them to keep up-todate with the latest developments.

There are currently no discernible IT-relevant risks for the FUCHS PETROLUB Group.

Human resources risks
HR risks result from the fluctuation of employees in key positions as well as the acquisition and development of specialist staff and managers. The FUCHS PETROLUB Group counters these risks through intensive programs of further training, as well as performance-related compensation packages, substitution plans and early succession planning.

There are currently no significant, discernible risks from the HR department.

Product and environmental protection risks
Manufacturing chemical products involves risks associated with the production, filling, storage and transport of raw materials, products and waste. A failure can lead to personal injury, damage to the environment or production downtime.

To counter potential risks in these areas, high technical (safety) standards are applied when constructing, operating and maintaining production plants. In addition to the rigorous monitoring of quality standards for preventing business interruptions, FUCHS is taking concerted action to maintain soil and water conservation. As is standard in the industry, FUCHS is also insured against any potential damage that may result from this set of risks.
From today’s perspective, sufficient provisions have been made for all known product and environmental risks.

Other risks
There are currently no other significant risks.

Overall risk
The uncertainty resulting from the worldwide financial and economic crisis can continue to place a burden on the economic development and continue to lead to sales revenue and income risks at FUCHS. From today’s perspective, however, there are no discernible risks that threaten the Group’s going-concern existence.

We believe we have made provision for all typical business risks capable of having a major impact on assets, finances and profits in the Group.

The FUCHS PETROLUB Group’s solid financial position, in connection with its global presence, broad customer basis and comprehensive range of problem-solving solutions that it offers its customers, also provides opportunities to further reinforce and expand the Group’s market position and thereby ensure continued growth in sales revenues and earnings.