taxation or subsidies, aid, grants or allowances could have a direct effect on UPM’s performance and its relative competitiveness, and structurally restrict or exacerbate UPM’s ability to compete for raw material. UPM also operates in industries that are subject to extensive environmental laws and regulations governing, among others, emissions, water quality, energy efficiency, as well as waste handling, recycling and disposal. Environmental laws and regulations have become more stringent and may continue to develop to be even more stringent due to various global, regional and national level regulatory initiatives. As these environmental laws and regulations are amended or as their application or enforcement is changed, additional costs in complying with new and more stringent regulations may be imposed on UPM. UPM’s operations require UPM to obtain multiple environmental permits and other licences from relevant authorities and comply with their terms and conditions. These permits and licences may be subject to modification, renewal or, subject to certain conditions, revocation by the issuing authorities. UPM monitors regulatory changes in order to UPM is a shareholder of Pohjolan Voima Oyj (PVO), which is the majority shareholder of Teollisuuden Voima Oyj (TVO). TVO is in the process of constructing a third nuclear power plant unit, OL3 EPR, at the Olkiluoto site (OL3). When completed, OL3 will supply electricity to its shareholders on a cost-price principle (so called ‘Mankala-principle’) that is widely applied in the Finnish energy industry. Under the Mankala principle, electricity and/or heat is supplied to the shareholders in proportion to their ownership and each shareholder is, pursuant to the specific stipulations of the respective Articles of Association, severally responsible for its respective share of the production costs of the energy company concerned. OL3 is expected to increase UPM’s electricity generation capacity significantly. UPM’s indirect share of OL3 is approximately 31%. According to TVO OL3 was procured as a fixed price turnkey project from a consortium formed by Areva GmbH, Areva NP SAS and Siemens AG (Supplier). Under the plant contract, the consortium companies have joint and several liability for the contractual obligations. Originally commercial electricity production at OL3 was scheduled to start in April 2009. However, completion of the project has been delayed. Supplier has updated the schedule for the commissioning of OL3 several times. In March 2018 TVO announced that it had signed a comprehensive settlement agreement with Supplier and the Areva Group parent company, Areva SA, a company wholly owned by the French state. The settlement agreement concerns the completion of the OL3 project and related disputes and entered into force in late March 2018. According to TVO, pursuant to the settlement agreement, TVO and Supplier jointly withdrew the pending arbitration proceedings under the International Chamber of Commerce (ICC) rules with respect to costs and losses incurred in relation to delays in the construction of the OL3 project. In July 2018, TVO announced that in June 2018 the ICC tribunal had confirmed the arbitration settlement by a consent award, and the arbitration proceedings had been terminated. The parties also withdrew the pending appeals in the General Court of the European Union. According to TVO, the settlement agreement stipulates as follows: • To provide and maintain adequate and competent technical and human resources for the completion of the OL3 project, Areva will source the necessary additional resources from Framatome S.A.S., whose majority owner is EDF. better adapt to the effects of such changes. Shareholdings in Pohjolan Voima Oyj
• The supplier consortium companies undertake that the funds dedicated to the completion of the OL3 project will be adequate and will cover all applicable guarantee periods, including setting up a trust mechanism funded by Areva companies to secure the financing of the costs of completion of the OL3 project. • The turnkey principle of the OL3 plant contract and the joint and several liability of the supplier consortium companies remain in full force. • The agreement also noted Supplier’s schedule at the time the agreement was signed, according to which regular electricity production in the unit would have commenced in May 2019. • The ICC arbitration concerning the costs and losses caused by the delay of the OL3 project is settled by financial compensation of EUR 450 million to be paid to TVO in two instalments by Supplier. • The parties withdraw all on-going legal actions related to OL3, including the ICC Arbitration and appeals in the General Court of the European Union. • In the event that the Supplier consortium companies fail to complete the OL3 project by the end of 2019, the Supplier consortium companies will pay a penalty to TVO for such delay, the amount of which will depend on the actual time of completion of the OL3 project and may not exceed EUR 400 million. In April 2020, TVO announced that it had submitted a permission application to the Finnish Radiation and Nuclear Safety Authority (STUK) for nuclear fuel loading of the OL3 nuclear power plant unit. In August 2020, TVO announced having received an updated re- baseline schedule on the commissioning of OL3 from Supplier. According to the schedule fuel will be loaded into the reactor in March 2021, OL3 will be connected to the grid in October 2021, and regular electricity production will start in February 2022. Realisation of the OL3 EPR nuclear power plant project and preparing the plant unit for production will be continued. Commissioning tests and maintenance work are needed before fuel loading. The coronavirus pandemic may have significantly added uncertainty to the progress of the project. According to TVO significant arrangements have been made at the OL3 site preventing the coronavirus infections. Despite of coronavirus restrictions, work has been able to continue under special arrangements. As announced by TVO, the new management of Areva, the supplier party, is preparing a financial solution to complete the OL3 project until the end of the guarantee period. TVO is also negotiating with Supplier on the terms of completing the OL3 project. Further, as announced by TVO, TVO has recognised receivables amounted to the accumulated compensation by the end of Q3 2020 agreed in the comprehensive settlement agreement from supplier. The compensation decreases the historical costs of property, plant and equipment in TVO’s balance sheet. On 16 December 2020 TVO announced that the shareholders of TVO have signed an additional shareholder loan commitment, comprising a total of EUR 400 million new subordinated shareholder loan agreements. According to TVO with the new shareholder loan commitment, TVO prepares to maintain a sufficient liquidity buffer and equity ratio in order to complete the OL3. As announced by TVO, on 17 December 2020, S&P Global Ratings (S&P) affirmed its long-term corporate credit rating 'BB' on TVO and removed it from CreditWatch Negative, where it had been placed on 4 September 2020, with the outlook being negative. According to S&P, the EUR 400 million shareholder loan recently granted to TVO reduces near-term risk and signals that TVO's owners still support the OL3 project, despite the delays it has suffered.
Further delays to the OL3 project 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 may be higher than the market price of electricity at that time. Climate change UPM is exposed to a variety of risks related to climate change. Strategic risks related to climate change include risks concerning competition, markets, customers, products and regulation. For example, unpredictable regulation and subsidies may distort raw material and final product markets and changing costs of greenhouse gas emissions may influence UPM’s financial performance. UPM believes that forest, wood-based products and low-carbon energy hold significant value creation potential with respect to renewable and recyclable products. Other risks related to climate change particularly concern UPM’s supply chain as well as the availability and price of major inputs, such as wood and electricity. Climate change may cause exceptional weather events, such as severe storms, floods and draughts, which could, for example, result in unpredictable hydropower availability and wood harvesting conditions. Exceptionally mild winter conditions with a reduced period of frozen soil in the Nordics could affect the harvesting and transport of wood, consequently undermining the stability of raw material supply and potentially increasing the cost of wood. These could also increase the risk of production limitations. Loss of major customers and industry consolidation UPM has several major customers, and the largest customer in terms of sales represented approximately 2% of UPM’s sales in 2020, and the ten largest customers represented approximately 14% of such sales. Although UPM is not dependent on any specific customer or group of customers, the loss of its major customers, if not replaced on similar terms, could have a material effect on UPM’s business. Also, as the size of UPM’s customers could increase in connection with industry consolidation, such customers could exert increased bargaining power on all of their suppliers, including UPM. UPM is also exposed to risks related to any deterioration of a major customer group’s financial condition. Product development, innovation and intellectual property rights Research and product development are an important part of UPM’s strategy, particularly with regard to new businesses, such as wood- based biofuels, biochemicals and biomedicals. The return on investment of new or enhanced existing products and solutions may not meet targets or improve UPM’s competitiveness. UPM has a broad patent portfolio that provides value creation potential in the future; however, it also exposes UPM to risks related to the protection and management of intellectual property, including patents and trademarks. Corporate acquisitions and divestments UPM’s strategy is to grow businesses with strong long-term fundamentals and sustainable competitive advantage. This may result in acquisitions of new businesses or divestments of existing businesses or parts thereof. Carrying out corporate mergers, acquisitions and divestments involves risks relating to the successful implementation of a divestment and the ability to integrate and manage acquired businesses, systems, culture and personnel successfully. In addition, the cost of an acquisition may prove high and/or the anticipated economies of scale or synergies may not materialise. Hidden liabilities of an acquired company (e.g.,
competition law liabilities) may also constitute a significant risk in relation to potential acquisitions. UPM may divest operations or assets to focus on strategic areas. Any future divestments may be affected by many factors that are beyond UPM’s control, such as the availability of financing to potential buyers, interest rates and acquirers’ capacity, and divestments may also expose UPM to indemnity claims. Furthermore, divestments may involve additional costs due to historical and unaccounted liabilities. The profitability of corporate acquisitions and divestments may differ from UPM’s expectations. Operational risks Fluctuations in the prices of major inputs as well as changes in their availability The main inputs required in the manufacturing of UPM’s products are wood, fibre, chemicals, energy and water. The prices for many of these major production inputs have been volatile in the recent years and are expected to remain volatile for the foreseeable future, which may have an effect on the general profitability of the industries in which UPM operates. Climate change may contribute to the increase of the price volatility of UPM’s major production inputs. Also, any changes in the current forestry practices and level of harvesting due to negative public opinion towards harvesting could have an effect on the raw material supply and may increase the cost of wood. Governmental protection and trade protection measures could also have an effect on the price and availability of raw materials as countries may, for example, enact export ban policies to protect forests or to bolster their domestic timber industry, which could have a material effect on the cost and availability of wood as a raw material for UPM. It is also uncertain how the EU energy policies may affect the availability and costs of fibre and energy. Significant increases in the prices of UPM’s major inputs could increase UPM’s operating expenses. Supplier and subcontractor network and raw materials procurement UPM’s business operations depend on a large number of suppliers and contractors. The majority of UPM’s need of wood is covered by suppliers, and other production inputs, such as chemicals, fillers and recovered paper, are fully obtained from suppliers. Disruptions in the supply of key inputs or transportation services could have a significant effect on manufacturing operations. This could, for example, result in interruption or downscaling of production, change in the product mix or increased costs resulting from price increases for critical inputs as well as shifts in the availability and price of wood. Supplier consolidation could also limit the number of suppliers from which UPM would be able to source its production inputs and could materially affect the prices paid by UPM for these inputs. The UPM Supplier and Third Party Code defines the minimum level of performance that UPM requires from its suppliers and third-party intermediaries. UPM carries out supplier risk assessments on, for example, operational, financial, quality and responsibility perspectives. Based on the risk assessment, selected suppliers’ activities are evaluated in more detail through annual surveys, supplier audits and joint development plans. If any non-conformities are discovered, the supplier is required to take corrective measures, which UPM follows up on. Some contracts may also be discontinued due to the seriousness of the finding or insufficient corrective measures. Management and execution of large investment projects Investment projects in UPM’s businesses are often large and take one or more years to complete. Participation in large projects involves risks,