Principal risks and uncertainties Our risk management approach We have a well-established risk management methodology which we use throughout the business to allow us to identify and manage the principal risks that could: adversely impact the safety or security of the Group s employees, customers and/or assets have a material impact on the financial or operational performance of the Group impede achievement of the Group s strategic objectives and financial targets; and/or adversely impact the Group s reputation or stakeholder expectations. The Board has overall responsibility for the Group s systems of internal control. Following publication of the revised UK Corporate Governance Code and the recent Financial Reporting Council Guidance on Risk Management, Internal Control and Related Financial and Business Reporting, a review of the Group s risk management framework will be undertaken in 2016. Risk management structure Whilst some risks such as fuel costs and treasury risk are managed at a Group level, all of our businesses own and manage the risks they face with appropriate assistance from the Group functions as necessary. The current structure is as follows: Board and Audit Committee Responsibility The Board has overall responsibility for the Group s systems of internal control and their effectiveness. The Audit Committee has a specific responsibility to review and validate the systems of risk management and internal control. Process Review and confirmation of Group and divisional risks presented to the Board and Audit Committee. Internal Audit Risk Group The Risk Group has oversight of the Group s risk management processes. Internal Audit provide assurance on the key risk mitigating controls and ensure that the audit plan is appropriately risk-based. The Risk Group and Internal Audit review and challenge Group and divisional risk submissions. Business divisions Business division and Group function management have responsibility for the identification and management of risks, developing appropriate mitigating actions and the maintenance of risk registers. Facilitated by the Risk Group, divisional and Group risk champions maintain and update risk registers for their function or division. Risks and mitigating actions are monitored through normal business management processes. 44 FirstGroup Annual Report and Accounts 2015
Strategic objectives 1 Focused and disciplined bidding in our contract businesses 2 Driving growth through attractive commercial propositions in our passenger revenue businesses 3 Continuous improvement in operating and financial performance Strategic report 4 Prudent investment in our key assets (fleets, systems and people) 5 Maintain responsible partnerships with our customers and communities Principal risks and uncertainties The Group s principal risks are set out below. These risks have been assessed taking into account their potential impact, the likelihood of occurrence and any change to this compared to the prior year and the residual risk after the implementation of controls. Each risk is linked to the relevant strategic objectives, which are detailed on page 14. Further information on our risk management processes is contained in the Corporate governance report on pages 58 to 75. Economic conditions 1 2 3 Economic conditions affect our businesses in different ways. A downturn could have a negative impact on our businesses in terms of reduced demand and reduced opportunities for growth or to retain or secure new business. The same factors could also affect our key suppliers. An improving economic climate, particularly when combined with lower fuel prices, may result in reduced demand for public transportation in our Greyhound business as alternative modes of transport become relatively more affordable. Improving economic conditions may also result in a tightening of labour markets resulting in employee shortages or pressure to increase pay. Political and regulatory issues 2 3 4 5 Our businesses are all subject to numerous laws and regulations covering a wide range of matters including health and safety, equipment, employment (including working time, wage and hour, mandatory breaks and holiday pay), competition and anti-trust, data protection and security, bribery and corruption, environmental (including carbon and air emissions), insurance coverage, consumer protection, and other operational issues. Failure to comply could have financial or reputational implications, could result in increased litigation and claims and have a negative impact on the Group s ability to bid for new contracts. These laws and regulations are constantly subject to change, the impact of which could include increased compliance costs and/or a reduction in operational flexibility or efficiency. Political risk remains an issue, particularly in the UK where the new Government is proposing to devolve powers for cities to regulate bus services in their area. Any such regulation could impact the profitability of our operations or impose additional costs or operating constraints. Whilst economic conditions have generally improved in our markets, in some areas economic recovery has been varied, for example in some of our local UK Bus markets. Our businesses are at risk from further political and regulatory change. To an extent, our UK Bus and Greyhound operating companies are able to modify services to react to economic impacts. An applicant tracking system has been introduced in our UK divisions to streamline the recruitment process and assist in providing a suitable pool of drivers to help manage any shortages in an efficient and cost-effective way. A similar system is being rolled out in our North American divisions. The Group has embedded operating policies and procedures in all of our businesses to ensure compliance with existing legislation and regulation. The Group has dedicated legal teams in the UK and North America who oversee the Group s compliance and training programmes and advise on emerging issues. The Group actively engages with the relevant government and transport bodies and policy makers to help ensure that we are properly positioned to respond to any proposed changes. FirstGroup Annual Report and Accounts 2015 45
Principal risks and uncertainties continued Contracted businesses 1 3 5 The Group s First Student, First Transit and UK Rail divisions are contracted businesses dependent on the ability to renew and secure new contract wins on profitable terms. Failure to do so would result in reduced revenue and profitability and incorrect modelling or bid assumptions could lead to greater than anticipated costs or losses. Failure to comply with contract terms could result in termination, litigation and financial penalties and failure to win new or non-renewal of existing contracts. Competition 1 2 3 All of the Group s businesses (both contracted and non-contracted) compete in the areas of pricing and service and face competition from a number of sources. Our main competitors include the private car and existing and new public and private transport operators across all our markets. Increased competition can result in lost business, revenue and reduced profitability. Information technology 2 3 4 5 The Group relies on information technology in all aspects of our businesses. Any significant disruption or failure, caused by external factors, denial of service, computer viruses or human error could result in a service interruption, accident or misappropriation of confidential information (including credit card and personal data). Process failure, security breach or other operational difficulties may also lead to revenue loss or increased costs, fines, penalties or additional insurance requirements. Prolonged failure of our sales websites could also adversely affect revenues. Continued successful delivery and implementation of the Greyhound IT transformation plan is required to improve yield management and drive future growth. Failure to manage the implementation of new IT systems properly may result in increased costs and/or lost revenue. Rail franchises/bidding 1 3 5 Competition for new rail franchises is intense. We bid against operators of current UK rail franchises and rail operators from other countries, principally from within the European Union. Whilst our current UK rail franchises have been extended, failure to win franchises in the future will result in a lower UK Rail division contribution and profitability. Rail franchises are large and complex arrangements and incorrect modelling or bid assumptions could lead to greater than anticipated costs or losses. Breach of the Group s existing franchise agreements could potentially result in their termination causing loss of revenue and cash flow as well as some or all of the amounts set aside as security for performance and season ticket bonds. The new First Great Western franchise will cover a period during which there will be significant change in the franchise including major infrastructure work, electrification and re-signalling as well as the introduction of new trains, which will require careful planning and management. Failure to manage these risks adequately in accordance with our plans could result in financial and reputational risk to the Group... Web and mobile sales channels are of increasing importance across many of our businesses. Direct awards have been made in the year to extend the First TransPennine Express and First Great Western rail franchises. The relevant divisions have experienced and dedicated bid teams who undertake careful economic modelling of contract bids and, where possible, seek to negotiate risk sharing arrangements with the relevant customer or contracting authority. The Group continues to focus on service quality and performance as priorities in making our services attractive to passengers and other customers. In our contract businesses, contract compliance, a competitive bidding strategy and a strong bidding team are key. In addition, wherever possible, the Group works with local and national bodies to promote measures aimed at increasing demand for public transport and the other services that we offer. As a result of the continuing threat of cyber-attacks, our operations are implementing new threat detection systems. The Group has also increased its focus on asset management and further enhanced its IT security processes and procedures. The Group has further strengthened its IT project management capability, particularly within Greyhound. The Group has an experienced and dedicated rail bid team which will continue to compete for franchises as they are re-let. The Group also has a comprehensive review process for bids as they are developed and finalised involving a number of divisional and Group functions as well as final Board sign off. Compliance with our rail franchise agreements is closely managed and monitored on a monthly basis by senior management and procedures are in place to minimise the risk of non-compliance. 46 FirstGroup Annual Report and Accounts 2015
Strategic objectives 1 Focused and disciplined bidding in our contract businesses 2 Driving growth through attractive commercial propositions in our passenger revenue businesses 3 Continuous improvement in operating and financial performance Strategic report 4 Prudent investment in our key assets (fleets, systems and people) 5 Maintain responsible partnerships with our customers and communities Treasury risks 1 3 4 As set out in further detail in note 23 to the financial statements on pages 136 to 140, treasury risks include liquidity risks, risks arising from changes to foreign exchange rates and interest rates and hedging risk. Foreign currency and interest rate movements impact profit, balance sheet and cash flows of the Group. Ineffective hedging arrangements may not fully mitigate losses or may increase them. The Group is credit rated by Standard & Poor s and Fitch. A downgrade in the Group s credit ratings to below investment grade may lead to increased financing costs and other consequences and affect the Group s ability to invest in its operations. Pensions 3 4 The Group sponsors or participates in a number of significant defined benefit pension schemes, primarily in the UK Future cash contribution requirements may increase or decrease based upon financial markets, notably investment returns/valuations, the rates used to value the liabilities and through changes to life expectancy and could result in material changes in the accounting cost and cash contributions required. Fuel costs 1 3 4 Fuel is a significant component of the Group s operating costs. Fuel prices and supply levels can be influenced significantly by international, political and economic circumstances. Volatility in fuel prices or supply restrictions, shortages or interruptions could adversely impact the Group s operations, cash flow and profitability. For example, Greyhound s passenger revenues were adversely affected during the year by the rapid decline in oil prices. The Group may be unable to pass fuel cost volatility on fully to customers and hedging arrangements may not fully mitigate losses or may increase them. Oil prices may also adversely affect the economic activity of those customers which are dependent on oil and gas revenues, reducing demand for our services. No change in the year.. No overall material change. The Group s treasury policy and delegated authorities are reviewed periodically to ensure compliance with best practice and to control and monitor these risks appropriately. The Group is continuously focused on improving operating and financial efficiency as part of our strategic objectives as outlined on page 14. Through diversification of investments, hedging of liabilities, amendment of the defined benefit promises and the introduction of a defined contribution scheme for new starters in UK Bus and Group, the Group has reduced these risks. Under the UK Rail franchise arrangements, the Group s train operating companies are not responsible for any residual deficit at the end of a franchise so there is only short term cash flow risk within a particular franchise. The Group has a forward hedging programme providing fixed fuel prices and cost certainty. Some of the Group s contracts also enable us to pass on fuel cost increases to customers. The Group s businesses may have the opportunity to limit the impact of unexpected fuel price rises or revenue reductions caused by lower oil prices through efficiency, pricing and cost control measures. First Student s DriveSMART and the purchase of new fuel efficient buses in our UK Bus division are initiatives aimed at reducing fuel usage in our businesses. Terrorism 5 The threat from terrorism is enduring and continues to exist in all of our markets. Public transport has previously been subject to attack and across our businesses, we take all reasonable steps to help guard against such activity on the services we operate. An attack or threat of attack could lead to reduced public confidence in public transportation, and/or specifically in the Group s security and safety record and could reduce demand for our services, increase costs or security requirements and cause operational disruption.. We continue to develop and apply good practice, and train our employees so that they can identify and respond effectively to any potential threat or incident. Our focus is enhanced through close working relationships with specialist government agencies both in the UK and North America. FirstGroup Annual Report and Accounts 2015 47
Principal risks and uncertainties continued Customer service 2 3 5 The Group s revenues are at risk if we do not continue to provide the level of service expected by our customers. Failure to provide acceptable levels of customer service could lead to non-renewal of contracts, reductions in passenger revenues and/or have negative reputational impact. Litigation and claims 3 The Group has three main insurable risks: third party injury and other claims arising from vehicle and general operations, employee injuries and property damage. The Group is also subject to other litigation, which is not insured, particularly in North America, including contractual claims and those relating to employee wage and hour and meal and break matters. A higher volume of litigation and claims can lead to increased costs, reduced availability of insurance cover, and/or reputational impact. A large single claim or a large number of smaller claims may negatively affect profitability and cash flow. Attraction and retention of key management 2 3 4 5 Attracting and retaining key members of senior management is a vital part of ensuring that the Group continues to have the necessary expertise and continuity to execute its strategy and turnaround plans. Employee costs and relations 1 2 3 4 5 Employee costs represent the largest component of the Group s operating costs, and political or union pressure to increase wages could increase these costs. Improving economic conditions resulting in labour shortages or decreasing unemployment rates could hinder our ability to recruit and retain qualified employees. Our employees are key to service delivery and therefore it is important that good employee relations are maintained. High employee turnover could lead to higher than expected increases in the cost of recruitment, training and employee costs and operational disruption. Similarly, industrial action could adversely impact customer service and have a financial impact on the Group s operations. No overall material change in the year. The claims environment, particularly in our North American businesses, remains a challenge despite our continued focus on safety. Our defined business plans have enabled us to attract and retain high quality management.. Our commitment to our customers is embedded in our values (see page 12). The relevant employees undertake intensive training programmes to ensure that they are aware of, and abide by, the levels of service that are required by our customers in each business. Ongoing engagement with customers and community stakeholders takes place across the Group, including through meet the manager events, customer panels, consultations and local partnerships. The Board also monitors customer service KPIs to ensure that strict targets are being met. The Group has a very strong focus on safety and, as described on page 12, it is one of our five values. The Group self-insures third party and employee injury claims up to a certain level commensurate with the historical risk profile. We purchase insurance above these limits from reputable global insurance firms. Claims are managed by experienced claims handlers. Non-insured claims are managed by the Group s dedicated in-house legal team with external assistance as appropriate. Our Group-wide succession planning process and performance development approach is designed to identify talented individuals, set development goals for progression to other roles and to assess the depth of talent and any gaps throughout the leadership of FirstGroup. The Group also offers market-based compensation packages consisting of an appropriate mix of long and short term incentives. The Group seeks to mitigate these risks via its recruitment and retention policies, training schemes and working practices. An applicant tracking system has been introduced in our UK divisions to streamline the recruitment process and assist in providing a suitable pool of drivers to help manage any shortages in an efficient and cost-effective way. A similar system is being rolled out in our North American divisions. Our working practices include building communication and engagement with trade unions and the wider workforce. Examples of this engagement include regular leadership conferences, employee surveys and the presence of Employee Directors (Directors voted for by the employees to represent them) on many of the Group s UK divisional boards and the Board. 48 FirstGroup Annual Report and Accounts 2015
Strategic objectives 1 Focused and disciplined bidding in our contract businesses 2 Driving growth through attractive commercial propositions in our passenger revenue businesses 3 Continuous improvement in operating and financial performance Strategic report 4 Prudent investment in our key assets (fleets, systems and people) 5 Maintain responsible partnerships with our customers and communities Environmental 3 4 5 The Group s operations store and manage large quantities of fuel which presents a potential regulatory, reputational and financial risk in the event of significant loss or spillage. As a leading transport provider, we face the challenge of addressing climate change, both through managing its impact and reducing emissions. The Group s businesses are at risk from future changes in the regulatory regime which could increase compliance costs or impose operational constraints. Severe weather and natural disasters 3 Greater and more frequent adverse weather could lead to interruptions or disruption to service performance and reduced customer demand with consequent financial impact, potential increased costs and accident rates. Severe weather can reduce profits, for example through lower demand for our services, increased costs, business disruption and increased accidents. overall. Whilst the Group s North American operations were not as badly affected by severe weather as they were in the prior year, adverse weather in the north eastern US in the last quarter still had an impact. To mitigate these risks, the Group s storage facilities are subject to regular inspection and we have detailed fuel handling procedures which are regularly audited. Robust environmental policies, strategies and management systems are maintained across the Group. The Group continues to target reductions in our emissions, including through behaviour change initiatives and investment in new technology. The geographic spread of the Group s businesses offers some protection. In addition, some of our contract-based businesses have force majeure clauses in place. We have severe weather action plans and procedures to manage the impact on our operations. The risks listed are not all of those highlighted by our risk management processes and are not set out in any order of priority. Additional risks and uncertainties not presently known to us, or currently deemed to be less material, may also impact our business. Indication of a movement in a risk may not indicate a change in the overall net risk position after taking into account risk mitigations. FirstGroup Annual Report and Accounts 2015 49