Risk management report

IAN HENSTOCK COMMERCIAL EXECUTIVE

GROUP INTEGRATED ASSURANCE FRAMEWORK

The Group Integrated Assurance Framework governs and co-ordinates the overall approach to Group risk management. This entails understanding, identifying, reporting, managing and mitigating Group risk, and includes the process of independently auditing Group polices, plans, procedures, practices, systems, controls and activities to ensure that the Group achieves the level of operational efficiency and compliance required by the Board.

The Board approved the Group Assurance Policy, which establishes and mandates the risk management, regulatory compliance and internal audit functions; effectively as the three building blocks of the Group Integrated Assurance Framework.

The Group Integrated Assurance Framework can be depicted graphically as follows:

Risk Management

Although a level of risk awareness and response is embedded in daily management and operational activities, a large and complex Group faces corresponding risks. This in turn requires of management to design and implement a planned and structured approach to understand, identify, report, price, manage, mitigate and close out the Group’s large and complex risks. This includes governance structures (such as the Board risk management committee, the executive committee and operating platform risk structures), organisational leadership, strategic planning and effective management to ensure that the appropriate operational and functional capacities, controls, systems and processes are in place to manage risk. Underpinning this is the Integrated Assurance Framework.

The Group Risk Management Framework, which was approved by the Board, comprises one of three building blocks that make up the Integrated Assurance Framework, and aims to:

	Align strategy with risk tolerance
	Improve decision making which improves the Group risk profile,
	Promote the strategic and coordinated procurement of quality order book
	Ensure equitable commercial terms and conditions are contracted, and the rational pursuit of commercial entitlement
	Promote rigorous project review, and timeous response to contracts in distress
	Promote continuous improvement through the application of key lessons learnt
	Reduce operational surprises, improve predictability and build shareholder confidence
	Build robust organisational risk structures and facilitate timeous interventions, to promote long term sustainability
	Promote the efficient and proactive utilisation of opportunities

REGULATORY COMPLIANCE

With the growth of the Group over time, in new geographies and disciplines, regulatory compliance has become a large and complex area to understand. This in turn requires a structured approach to evaluate exposure and ensure adequate responses are initiated timeously to mitigate and avoid any negative impact on the Group’s performance through regulatory non-conformance. The regulatory compliance function provides specific focus on regulatory compliance risk within the context of the Integrated Assurance Framework.

The implementation of a regulatory compliance Framework focuses on the seamless integration of regulatory compliance in conjunction with risk management and internal audit into business planning, execution and management.

The key imperative to be derived from the implementation of regulatory compliance is to ensure material compliance across the Group with every law, rule, code, standard and policy where non-compliance could be materially injurious to the Group’s performance and/or continued existence, whether from a financial, legal or reputational perspective.

Internal Audit

Internal audit is a key element of the Group’s assurance structure, and constitutes the third building block of the Group Integrated Assurance Framework. Internal audit has established a robust, risk-based systems approach to identify the significant risk management processes and responses which are to be tested and evaluated (i.e. effort is focused on providing assurance that the key strategic and operational risks are being effectively understood, identified, managed, mitigated and closed out). Internal audit follows a planning and execution process through which the risk-based systems approach is delivered in a consistent manner, which is followed by detailed reporting and issue tracking processes.

It is through the Group Integrated Assurance Framework that the major element of critical risk processes and responses to be included in the internal audit plan are developed. These include interactions with the Group risk executive and the Group regulatory compliance executive, and with specific reference to their respective mitigation strategies and plans. The audit plan also encompasses governance areas for assessment, the assessment of internal financial controls and risk management policies and procedures, as well as specific areas highlighted by the audit & sustainability committee, Group executive committee and by executive and operational management for separate and dedicated review.

GROUP RISK MANAGEMENT FRAMEWORK

The context within which the Group identifies, assesses and responds to risk and opportunity is described below in terms of its prevailing strategic, corporate, operational and project environments:

Recovery & Growth

Our strategy for Recovery & Growth is aimed at establishing Murray & Roberts as the leading construction and engineering group in its selected markets. The year to June 2012 was defined as the recovery year and the following two years as the growth years.

The recovery objectives included amongst others an improvement in the Group’s liquidity position.

This improvement was achieved by the following five key initiatives: driving cash generation from operations, the sale of non-core operations and assets, the restructuring of the Group’s debt, a successful rights issue and the resolution of project claims. Cost containment and capital preservation form a key imperative in this plan.

Growth plans for the operating platforms have been defined and will be vigorously pursued by the executive teams leading each platform. The Growth strategy focuses on the commodity boom, engaging Africa more proactively and leveraging the Group’s footprint in the growing oil and gas market.

Strategic Risk

	Trend		Risk		Mitigation
			Continued market volatility in developed economies
			Demand for commodities is driven by economic growth in China. This in turn is leading to strong pipeline and order book for Cementation. A slowdown in the Chinese economy could dampen the commodity run. Europe’s stagnation has forced Europe based contractors into new markets, with an increased appetite for risk in Africa and the Middle East.		1. Further diversify in terms of geographies, clients and disciplines. 2. Utilise a “Growth through Acquisition” strategy to accelerate capacity building in strong diversified commodity markets and emerging geographies. 3. Establish a strong position in key areas of Africa that support the beneficial and profitable delivery of new projects. 4. Leverage further the Group’s footprint in the growing oil and gas markets. 5. The Group has adopted and implemented a stringent cost containment and capital preservation programme to strengthen its balance sheet.
			Public sector clients introduce additional risk to delivering infrastructure projects
			The Group has exposure to public sector clients, particularly in South Africa and the Middle East. The public sector has a limited capacity to absorb the cost of scope changes and drawn out dispute resolution processes create pressure on working capital. The public sector also has a limited capacity to meet delivery obligations.		1. Apply key lessons learnt and commercial guidelines to new opportunities, and contract out of risk issues. 2. Understand the public sector’s capacity/or lack thereof to meet its contractual responsibilities prior to concluding agreements. 3. Focus strongly on pricing approach, design completion, implementation planning and change management.
			SA business environment
			Declining business confidence in South Africa, as a result of the political and mining environment, could lead to reduced foreign investment and further constrain opportunities in the local infrastructure and mining markets.		1. Continue to seek growth opportunities in Africa, the Middle East, Australasia and the Americas. 2. Target acquisitions in growth geographies.
			Transformation
			Lack of transformation (Employment Equity) and a low BBBEE rating could reduce Murray & Roberts' chances of being successful with public sectors tenders or incurring client sanction or penalties on current projects if contractual BBBEE obligations are not met.		1. Focus on improving transformation (implementation of Transformation Policy) and BBBEE rating. 2. Growth in international markets will lead to proportionately lower levels of domestic revenue, which will improve the BBBEE rating. 3. Invest in capacity that is scalable into Africa and other growth geographies.
			Construction Products Africa Operating Platform
			The construction products business in South Africa is highly sensitive to local market conditions, and generally is not able to adapt product ranges, or relocate plant to meet changing markets dynamics.		1. Invest in capacity that is scalable into Africa and other growth geographies.
			New growth markets
			Oil and gas is needed to fuel energy demands from global urbanisation. Clough is strategically placed to benefit from the oil and gas outlook and could become a meaningful player and facilitator in the growing Africana gas market, in addition to its traditional Australasian markets.		1. Develop strategies to leverage the Group further into the oil and gas markets.
			Group liquidity
			Losses and severe working capital demands from projects, in particular GPMOF, Dubai International Airport and Gautrain, created significant liquidity stress for the Group.		1. Disposal of a number of non-core businesses has brought in approximately R0.9 billion. 2. Successful debt restructuring has been concluded with the first covenant measurement in December 2012. 3. A heads of agreement has been signed with Eskom on Medupi Civils, averting cash flow pressure. 4. Settlement of claims on GPMOF, Dubai International Airport and Gautrain are in progress.
			Leadership capacity to support growth strategy
			The Growth strategy is placing increasing demands on leadership capacity. The Construction Africa and Middle East platform has performed poorly over the past number of years, and suffered from high staff turnover. With the global scarcity of skilled technical talent, Murray & Roberts risks the loss of key talent, including project managers, contract managers and senior executives.		1. Experienced COOs have been appointed for the Civils and Buildings companies, with new MDs appointed to the Middle East and Marine. 2. Jerome Govender has been appointed to lead the Construction Africa and Middle East platform. 3. A new remuneration policy is being developed to focus on performance and retention of key talent. 4. Performance management and development is receiving appropriate attention. 5. Regular succession reviews are held to identify potential talent retention risks and apply appropriate strategies to individuals.

Key
Colours:	Black – High, Dark grey – Medium, Light grey – Low
Risk trend:	Arrow up – increasing, Arrow down – decreasing, Arrow right – stable
Object:	- Opportunity, - New risk

Operational Risk

	Trend		Risk		Mitigation
			Delay in South African infrastructure programme
			Delays in the planned rollout of the Government’s infrastructure plan in South Africa are impacting negatively on a number of areas within the Group, in particular the Construction Africa and Middle East, Engineering Africa and Construction Products Africa platforms.		1. Africa strategy to reduce dependence on contracts and projects within the South African environment. 2. Invest in capacity that is scalable into Africa and other growth geographies.
			CIDB and the Competition Act
			The Construction Industry Development Board (CIDB) has said that once the Competition Commission pronounced the outcome of its investigation, the CIDB had the option, in terms of its code of conduct, to remove guilty companies from its grading system database for up to 10 years, precluding such contractors from working for the South African public sector. This is however unlikely under the current fast track process, but poses a significant risk for future transgressions.		1. Rigorous focus on becoming the lowest cost producer. 2. Proactively enforce the Group’s Statement of Business Principles. 3. Proactively enforce signing of the unethical and unlawful practices declaration with tender finalisations. 4. Full co-operation with the Competition Commission.
			Decline in Genrec order book
			Genrec’s reduction in scope under the Hitachi contract and loss of market share during the focus on the power programme has placed strain on the Company’s medium term outlook.		1. Rigorous focus on becoming the lowest cost producer.
			Health, safety and environmental exposures
			The Group has made significant progress in managing safety risk, with the LTIFR of 1.14, just above the target of 1 and fatalities at a decade low of 4. However, anything more than Zero Harm is a concern.		1. The majority of operating entities in the Group are OHSAS 18001 (Health and Safety) certified, with a significant number achieving ISO 9001 (Quality) and ISO 14001 (Environmental) certification. 2. The Zero Harm through Effective Leadership project aims to strengthen the STOP.THINK.ACT brand, build a leadership engagement programme, align HSE structures across the Group, establish Centres of Excellence, develop lead indicators and capacitate effective leadership.
			Order book
			The termination of the Aquarius contract reduced the Group order book by R7,5 billion at year-end. The scope reduction by Hitachi on the Medupi and Kusile Boiler contracts has reduced the order book by a further R6,2 billion. The Middle East business has not been able to secure new orders for more than 18 months. The Building markets in South Africa are flat and oversupplied, with new building contracts secured at very low margins. There has also been delays in bringing civil contracts to market under the South African Government’s infrastructure programme.		1. Africa strategy to reduce dependance on contracts and projects within the South African environment.

Key
Colours:	Black – High, Dark grey – Medium, Light grey – Low
Risk trend:	Arrow up – increasing, Arrow down – decreasing, Arrow right – stable
Object:	- Opportunity, - New risk

Project Risk

	Trend		Risk		Mitigation
			Risk at tender stage and commercial close
			Compromises during the tender stage due to pressure to win work may introduce risks which are outside the defined risk tolerance.		1. Rigorously apply the lessons learnt register and schedule of contracting principles. 2. Murray & Roberts Limited risk committee reviews high risk bids, and sets formal negotiating mandates. 3. Managing directors to confirm that contracts were closed in full compliance with the mandates given. 4. Group legal services reviews all contracts for red rated projects.
			Lack of formalised project management discipline
			Internal Audit findings indicate a general lack of formalised project management discipline such as risk registers, cost control and forecasting, as well as schedule and change management on projects. This introduces risk of cost overruns, late delivery and unpredictable profitability on projects.		1. Operating platforms actively implementing formalised project management processes, systems and controls, with the necessary skills capacity. 2. Internal Audit ensures the Framework for Standardised Project Delivery is implemented correctly and applied for all critical and high-risk projects.
			State procurement process
			Recent bid adjudication by some State entities/ departments has not been strictly in line with the Request For Proposal (RFP) evaluation criteria, raising concerns around procurement processes.		1. Engage directly with relevant State entities/departments to ensure consistency and transparency.
			Mafraq Hospital
			The late delivery of permanent power, delayed medical equipment procurement and design coordination issues is leading to substantial delay. The client has agreed to a 10 month extension of time, but associated costs still need to be negotiated.		1. Plans are to reach amicable settlement with the client, including likely cost overruns.
			Lonmin opencast mine
			Actual costs on the project are escalating above what the cost recovering mechanism is allowing.		1. Discussions are being held to increase the contract price, alternatively to terminate the contract.

Corporate Risk

	Trend		Risk		Mitigation
			Uncertified revenues
			Uncertified revenues taken to book on Gautrain, Dubai International Airport and GPMOF must still be realised through protracted claims processes. This creates the risk of a write-back of revenues accounted for in prior financial years, if the outcomes are less favourable than anticipated.		1. Gautrain delay and disruption claim formulation is progressing. An alternative negotiated settlement is no longer being pursued. 2. Favourable arbitration ruling on design changes for GPMOF. Formulation of the claim is progressing. 3. Tribunal has ruled the ultimate respondent on the Dubai International Airport Claim is the Dubai Government. UAE Supreme Court will determine the responsible department, following which claim arbitration will commence.

Key
Colours:	Black – High, Dark grey – Medium, Light grey – Low
Risk trend:	Arrow up – increasing, Arrow down – decreasing, Arrow right – stable
Object:	- Opportunity, - New risk