Review from the group risk officer

The group further refined its risk management by enhancing its risk-bearing capacity model. In current markets it is crucial to price contracts competitively – but profitably.
	Guy Mottram

The risk officer’s function within the group encompasses the disciplines of safety, health, risk, environment, quality, commercial, legal, regulatory compliance and secretarial.

• Introduction

  During the year, the group focused on further refining its established approach to risk management by enhancing our risk-bearing capacity model. This will ensure an advanced methodology with which to identify risks, rate and measure them and be able to make more informed decisions on the group’s capacity to take on and manage risk.

  As part of this process, key indicators were identified within four core focus areas. These indicators were weighted according to their agreed contribution to the group’s risk-bearing capacity. Each indicator has a tolerance level which guides the group’s risk appetite at any given time. These indicators are consistently monitored to assess the status of the group against assessed tolerances.

  To identify the group’s risk-bearing capacity, four core focus areas which govern the group’s performance were identified. These are financial, commercial, management and operational.

  Financial

  Financial capabilities encompass the maximum amount of risk the group can bear before it becomes financially unable to recover to “business as usual”.

  An integral part of the group’s ability to grow sustainably rests on its ability to obtain guarantee facilities required for its construction contracts. Free cash flow, liquidity and the group’s credit rating are also central to operations.

  Commercial

  Commercial capabilities entail the key qualities required by Group Five to ensure it can conduct business. Due to the nature of the current construction market, it is crucial to price contracts competitively – but profitably – and on acceptable commercial terms to ensure quality of delivery.

  Management

  Management capabilities comprise the most essential management skills which are required to ensure effective operations.

  Group Five’s core management capabilities are situated in the depth of leadership of its businesses, where critical technical, commercial and operational knowledge resides, its supporting technical experts who are responsible for quality deliverables and the group executive committee where critical corporate memory, financial knowledge and commercial capabilities resides.

  

  Although we anticipated poor conditions in our Construction Materials business and continued difficulty in the Middle East, the extent of the materials downturn was underestimated and the impact of holding costs in the Middle East was larger than anticipated.

  Operational

  Operational capabilities relate to the core processes and procedures which need to be in place to ensure Group Five can function and continue with normal business activities.

  The adherence to discipline and processes is a prerequisite for Group Five to deliver contracts timeously. Risks are therefore managed as critical business processes and mitigated optimally.

• Material issues during the year and how these were managed

  The group had to manage several material risks during the year. Fortunately, none of these were unanticipated as our established risk management system had identified these threats. However, although we anticipated poor conditions in our Construction Materials business and continued difficulty in the Middle East, the extent of the materials downturn was underestimated and the impact of holding costs in the Middle East was larger than anticipated.

  The continued recessionary pressures and the uncertainty of the timing around an eventual market recovery were obviously key focus areas for management. As this is covered in the review from the CEO and in the review from the chairperson of the risk committee, I will not address it here, but will focus on the company-specific material issues identified.

  Construction Materials

  The Construction Materials cluster has operated under very difficult market conditions in which both volumes and prices have declined materially. This cluster also experienced a number of operational inefficiencies. The market conditions, combined with internal issues, had a severe impact on results, which included a large impairment of the cluster’s asset value. Against this, management acted to rightsize the cluster both in terms of people and mothballing certain underperforming and uneconomical plants and quarries.

  The extent of the measures required to reduce losses and marginalise cash outflows within the business were extremely invasive and difficult on employees, which in itself became a risk to manage. Another area which required significant management attention was compliance. South Africa is a highly regulated environment and the group has spent an extensive amount of time and resources to ensure that we adhere to the various regulations that govern the cluster, including stringent mining, environmental, safety and health regulations. We have appointed a specialist team to ensure full compliance at all sites.

  Middle East

  As communicated previously to stakeholders, we have contract resolution risks to resolve in Dubai following the market collapse. There are two main exposures from contract terminations by our clients Meraas and the Department of Civil Aviation (DCA). We have now concluded and signed a formal settlement agreement with Meraas with a payment schedule spanning five years commencing in June 2011. No amendment to the previously certified value of the debt was required in the year although a discounting adjustment to record the debt in present date value was done. We increased engagement with DCA in terms of the commercial resolution of legacy contracts, with constructive steps towards finalisation. The group is satisfied with its progress in this regard.

  Furthermore, our strategy of accessing new markets in the region to replenish order books has been done with a strong awareness of the recent political uncertainties of some territories in the broader Middle East and North Africa (MENA) region. We have approached new territories with due care and consideration. Although we have had some successes in terms of new contracts, this has been at a slower than expected pace and hence in the short term, the group has had to support an overhead in the region to attend to the close out of legacy contracts and to bid for new work without an immediate return on this investment.

  Competition Commission

  About two years ago management made a decision to proactively cooperate with the Competition Commission in its anticipated investigation into the construction sector. This decision was made in line with the group’s zero tolerance to unethical behaviour, its culture of transparency and to proactively manage the potential impact of fines and penalties which could be levied against offending companies. As a consequence, we approached the Commission with a view to mitigate the financial and reputational risk by utilising its leniency policy on companies willing to first report non-compliance. We have spent the last two years cooperating with the Commission in submitting a record of our findings. We have recently been granted conditional leniency pending the finalisation of the broader industry investigation. We are confident that our decision to proactively manage this risk will have the best possible outcome for the group.

  

  Safety

  Despite having maintained our lost time injury rates and other health and safety statistics at low levels, we unfortunately had six fatalities this financial year. The losses of life have been exclusively within our sub-contractor base. Although the sub-contractor employees are not employed by Group Five, they operate within our sphere of responsibility. Therefore, to reverse this trend, we are implementing a more vigorous sub-contractor selection and management programme which will assist our sub-contractors to align to our values and standards to ensure the protection of people.

• Looking forward

  Key focus areas for F2012	Desired results
  Risk-bearing capacity (RBC) model.	The board and executive team will focus on further refining the RBC model to fully entrench the management of the business against the group’s tolerance levels and its appetite for risk
  Sub-contractor management.	To ensure we manage this stakeholder base more effectively, we will revisit the terms and conditions on which we interact with our sub-contractors. We will also ensure the alignment and monitoring of their health and safety standards on our sites
  International expansion.	As we expand our international footprint, it is critical that we maintain our focus on regulatory compliance within these new territories
  Middle East and North Africa.	Despite having made progress in minimising our recovery of debt exposure in Dubai, there is still considerable commercial closure required in the next financial year
  Competition Commission.	Having secured conditional leniency, the group needs to convert this into a confirmed final leniency position to eliminate exposure to penalty and fines

• Appreciation

  I thank the risk, legal and regulatory compliance, commercial and safety, health, environment and quality (SHEQ) teams, as well as our company secretary, for the tireless effort this year in trying times and with limited resources. To the board, thank you for your continued support and vision in our quest to establish best practice in the broader risk management arena.

  GD (Guy) Mottram
  Group risk officer

  5 August 2011