UPM Annual Report 2017

Accounts

In brief

Strategy

Businesses

Stakeholders

Governance

Risks Risk management UPM regards risk management as a systematic and proactive means to analyse and manage opportunities and threats related to its business operations. This includes also risks avoided by careful planning and evaluation of future projects and business environment. UPM seeks to transfer insurable risks through insurance arrangements if the risks exceed the defined tolerance. UPM strives to ensure compliance with the UPM Code of Conduct and other corporate policies. To enhance compliance and mitigate

Operational risks

TYPE OF RISK

RISK DESCRIPTION

risks, UPM performs risk assessments, training and monitoring at regular intervals. The main risk factors that can materially affect the company’s business, financial results and non-financial performance are set out below. They have been classified as strategic risks, operational risks, financial risks and hazard risks. Risks may also arise from legal proceedings incidental to UPM’s operations.

Earnings uncertainty

The main short-term uncertainties in UPM’s earnings relate to sales prices and delivery volumes of the group’s products, as well as to changes in the main input cost items and exchange rates. Most of these items are dependent on general economic developments. UPM's business operations depend on a large number of suppliers and contractors. Majority of UPM’s need of wood is covered by suppliers. Other production inputs, such as chemicals, fillers and recovered paper, are obtained from suppliers. Disruptions in the supply of key inputs would impact upon manufacturing operations, for example, by interrupting or resulting in the downscaling of production or a change in the product mix. They could also cause price increases for critical inputs or shifts in the availability and price of wood. It is also uncertain how the EU energy policies may impact upon the availability and costs of fibre and energy. Investment projects in UPM's businesses such as energy, pulp, paper or biofuels are often large and take one or more years to complete. UPM has experience in such projects in various businesses and locations around the world, and applies vigorous planning, project management and follow-up processes. Participation in large projects involves risks such as cost overruns or delays, as well as non-achievement of the economic targets set for the investment. UPM currently works together with many partners without control over strategic direction and operational output. The highly competitive market situation and, for example, new developments in biofuels, bioenergy or biochemicals are likely to increase the importance of partnerships in the search for higher efficiency or new products and businesses. Partnerships, however, may create risks to the profitability, for example, through changes occurring within the partner entity or changes in how the partnership operates. UPM's success requires a skilled workforce and diversity in thinking. UPM is continuously developing its leadership culture, evaluating its recruitment, compensation policies and career development opportunities and taking measures to attract and retain diversely skilled personnel, thereby seeking to avoid shortages of appropriately competent and diverse personnel in the future. UPM's production and business operations depend on the availability of supporting information system and network services. Unplanned interruptions in critical information system services can potentially cause a major damage in UPM's businesses. UPM has implemented numerous administrative and technical improvements to mitigate the availability and security risks and to reduce the service interruption related recovery time to acceptable level. Climate change exposes UPM to variety of risks. Unpredictable regulation and subsidies may distort raw material and final product markets, and costs of greenhouse gas emissions may influence UPM’s financial performance. It may cause exceptional weather conditions and more severe storms, floods and draughts resulting in e.g. unpredictable wood harvesting conditions. However, transition to low-carbon economy should bring business opportunities to UPM's renewable and recyclable products. Breach of applicable laws and regulations or corporate policies by UPM employees may lead to legal processes or serious reputational damages impacting the value of the company. The UPM Code of Conduct sets the standards of responsible behaviour. These standards apply to every UPM employee. The Code covers topics relating to legal compliance and disclosure, anti-corruption, competition law, HR practices, human rights, responsible sourcing and environmental matters. UPM’s environmental performance and social responsibility play a significant role in UPM’s ability to operate and influence the long-term success of its businesses. UPM strives to ensure that employees are aware of the legal requirements, the Code and corporate policies by regular trainings and communication. The company maintains a Report Misconduct channel on its website. Non-compliance in the supply chain may also lead to legal processes or serious reputational damages impacting the value of the company. The UPM Supplier and Third Party Code defines the minimum level of performance that UPM requires from its suppliers and third party intermediaries. UPM performs due diligence on third party intermediaries and carries out regular audits in its supply chain.

Supply chain management, availability and price of major inputs

Project execution

Strategic risks

TYPE OF RISK

RISK DESCRIPTION

Partnerships

Competition, markets, customers and products

Energy, pulp, timber, paper, label, plywood and biofuels markets are cyclical and highly competitive. In all of these markets, the price level is determined as a combination of demand and supply, and shocks to either demand (decrease/increase in end-use demand, change in customer preferences, etc.) or supply (e.g. new production capacity entering the market or old capacity being closed) may impact both the volume and price level. Also competitor behaviour influences the market price development. UPM's performance is also impacted by the performance of substitute or alternative products. Most notably, the demand in graphical papers in the mature markets is forecasted to continue to decline, due to the shift away from print media to digital media. Similarly, several raw materials used by UPM have competing end uses. Consumers’ environmental awareness has also increased, and depending on the product area this may have either a positive or negative impact on the consumption of UPM’s products and may impose further requirements for those products. UPM sells a proportion of its products to several major customers. The largest customer in terms of sales represented approximately 3% of UPM’s sales in 2017, and the ten largest customers represented approximately 15% of such sales. UPM’s strategic direction is to grow in businesses with strong long-term fundamentals and sustainable competitive advantage. This may result in acquisitions of new businesses or divestments of existing businesses. Participation in M&A involves risks relating to successful implementation of a divestment and the ability to integrate and manage acquired operations and personnel successfully, as well as to achieve the economic targets set for an acquisition/divestment. UPM is exposed to a wide range of laws and regulations globally. The performance of UPM's businesses, for example the biofuels business, the paper businesses and the energy business, are to a high degree dependent on the current regulatory framework, and changes in regulation, direct and indirect taxation or subsidies would have a direct impact on the performance of UPM and its relative competitiveness. In addition, regulation may structurally restrict or exacerbate UPM’s ability to compete for raw material. UPM has significant production locations in Finland, Germany, the UK, France, Poland and the US. In these countries, the slow development of the individual economies and/or of Europe as a whole may influence adversely UPM’s performance. Furthermore, policies (on European and/or national level) that hamper economic growth or lower the competitiveness of UPM (for example through adverse regulation or increase in direct or indirect taxation) may have an adverse impact on UPM’s performance. In the developed countries, the unpredictability of regulation may lead to an increasing uncertainty and risk level when investing in or operating in these countries. UPM has significant production operations also in a number of developing economies, such as China, Uruguay and Russia. In the emerging market countries, the lack of transparency and predictability of the political, economic and legal systems may lead to an increasing uncertainty and risk level when investing in, or operating in these countries. These uncertainties may materialize as unfavourable taxation treatment, trade restrictions, inflation, currency fluctuations and nationalisation of assets. Teollisuuden Voima Oyj (TVO) is in the process of constructing a third nuclear power plant unit, OL3 EPR, at the Olkiluoto site (OL3). UPM participates in OL3 through its shareholding in Pohjolan Voima Oyj (PVO), which is the majority shareholder in TVO. UPM’s indirect share of OL3 is approximately 31%. The OL3 plant supplier, a consortium consisting of AREVA GmbH, AREVA NP SAS and Siemens AG (the Supplier), is constructing OL3 as a turnkey project. The start of regular electricity production, originally scheduled for April 2009, has been revised several times by the Supplier. According to a public statement by TVO in October 2017, TVO received information on the Supplier’s schedule rebaseline review for OL3 project completion, according to which the start of regular electricity production at OL3 will take place in May 2019. Furthermore, TVO has expressed concerns regarding the pending restructuring of AREVA Group, involving a transfer of the operations of AREVA NP to a new company, the majority owner of which is going to be EDF, and the potential consequences for the performance of the OL3 contract. According to public statements by TVO, no assurance can be given that further delays, which could have a material adverse effect on TVO’s business and financial position, will not occur prior to completion of the OL3 project. As a consequence, further delays could have an adverse impact on PVO’s business and financial position, the fair value of UPM’s energy shareholdings in PVO and/or the cost of energy sourced from OL3 when completed. It is possible that the cost of energy sourced from OL3 at the time when it starts regular electricity production will be higher than the market price of electricity at that time.

Ability to recruit and retain diversely skilled employees

Availability and security of information systems

M&A and changes in the business portfolio

Climate change

Regulatory changes

Risks related to non-compliance in own operations and supply chain

Political and economical risks

Shareholdings

CONTENTS

ACCOUNTS

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103

UPM Annual Report 2017

UPM Annual Report 2017