Opportunities and Risks Report

As an organisation that operates throughout the world, the KSB Group is exposed to macroeconomic, sector-typical, ­financial and company-specific risks. Our risk policy is designed to enable us to grow sustainably and profitably. We aim to ­reduce the risks associated with our business and where possible avoid them completely. At the same time our global alignment and our extensive product range offer a wealth of opportunities. This includes in particular any opportunities that arise on the basis of our research and development activities, as well as any that are linked to the quality and cost effectiveness of our products. Our competitive position is also being strengthened by optimising our global sales and production network. We always review opportunities to expand our global presence and are able to achieve this through start-ups and acquisition projects.

We see opportunities and risks as possible future developments or events that may lead to forecast or target deviation. The deviation can be both positive and negative. In order to manage the varied opportunities and risks professionally and efficiently, we align our actions accordingly and focus upon the respective situation when selecting the persons responsible. In doing so, Controlling, Finance and Accounting as well as ­Internal Audits perform important monitoring tasks.

RISK MANAGEMENT SYSTEM

KSB has implemented a Group-wide risk management system for identifying and assessing relevant risks and reporting these to Group headquarters. The risk management process of the KSB Group consists of the successive phases of iden­tification, assessment, management, control, documentation and communication of risks. The six phases form a continuous and IT-based closed-loop system. This is documented in our risk management manual as well as the management ­responsibility and the description of all relevant tasks.

Managers are encouraged to take timely action to define and implement measures to limit or avoid damage that may result from the occurrence of risk events. All corporate and central functions and Group companies, including Group companies that are not consolidated, are included in the risk management system. The responsible managers are required to supply their relevant key business and financial indicators each month. As well as creating quarterly forecasts on business trends, they also twice a year report the recognised risks for the next 24 months from the reporting date for the categories of market and competitive risks, technological risks, project- and product-related risks, financial risks and procurement risks. Other business risks (environmental, human resources, etc.) are also reported in this cycle to the Risk Managers at the Group headquarters. We classify risks as qualitative and quantitative risks:

Qualitative risks are long-term developments that could have a negative impact on the KSB Group and which cannot or cannot yet be thoroughly quantified due to a lack of precise information. In order to still be able to evaluate them, how­ever, we make estimates of the probability of occurrence and scope. With respect to probability of occurrence, the extent to which the information indicating the potential risk is detailed must be determined. The scope describes the potential influence of the individual risk on the earnings before interest and taxes (EBIT) of the KSB Group or the respective Group company.

Quantitative risks are those risks with possible monetary ­impact on the earnings of the KSB Group or the respective Group company. They are evaluated taking into account the probability of occurrence in combination with the potential amount of loss.

In order to assess whether qualitative and quantitative individual risks are significant for us, we classify them as acceptable, neutral or significant risks. We consider as material for the KSB Group all individual risks categorised as neutral or significant that are detailed in the “Individually assessed opportunities and risks” section. The relevant classification can be determined from the matrices below:

Qualitative Risks

Quantitative Risks

Evaluation of the amount of loss is based on just three possible classifications: low, medium and high. The following criteria apply.

Classification of amount of loss
Amount of loss in € thousands
Magnitude Sales revenue Low Medium High
Small companies Up to € 20 million 50 – 125 125 – 250 > 250
Medium-sized companies € 20 to € 80 million 75 – 250 250 – 500 > 500
Large companies, holding companies, organisational units From € 80 million 100 – 500 500 – 1,000 > 1,000

This approach gives us the necessary transparency to identify risks in their entirety and to manage them effectively, professionally and in an economically responsible manner.

The bodies to which specific responsibilities and competencies were assigned in KSB’s risk management system in the reporting year are shown and explained in the diagram below.

Risk Management at KSB

The Board of Management of KSB AG had overall responsibility for risk management. It reported to the Supervisory Board during regular Audit Committee meetings and was monitored by the latter. The Board of Management was supported by the Chief Compliance Officer and the Group Finance and Accounting department. The latter coordinates the risk management process at Group level and investigates all reported risks to determine whether they are relevant for the financial statements. It ensures that there is a systematic link with the Group accounting process. The Board of Management and the Supervisory Board’s Audit Committee received at least two risk reports per financial year. These reports include all the risks that are categorised as significant or neutral that exceed pre-defined threshold values individually or collectively, not considering any action that has been taken. Particularly critical topics are reported on an ad-hoc basis by the managers in charge. In contrast, opportunities are not taken into account in this system, but are examined separately in consultation with segment managers and regional managers applying a different assessment system.

With regard to financial risks we also make use of additional risk identification, assessment, management and communi­cation. The central Finance department is responsible for this task which is described in further detail later in this section.

Compliance risks are dealt with by the Chief Compliance ­Officer, who is assigned to the Legal and Compliance, Patents and Trademarks staff function. The Chief Compliance Officer is supported by the members of the Compliance Committee and the Compliance Managers of the individual companies.

The Internal Audits department is integrated into the risk management system as part of our internal control system. When planning audits, it prioritises areas according to po­tential risks and is provided with all the necessary information. The auditors ensure that all audited units adhere to the applicable guidelines, actively participate in the risk management system, and control or avoid their risks. Information obtained by Internal Audits on both the recognised risks and the countermeasures introduced in response forms an integral part of the reporting to the Board of Management and the Audit Committee of the Supervisory Board.

Our risk management system is regularly reviewed and promptly updated where necessary, for example, in the event of relevant legal or organisational changes. In addition, our ­auditor examines within the scope of the annual audit the early risk detection system, establishing that it is present and checking that it is fit for purpose.

INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT SYSTEM WITH REGARD TO THE GROUP ACCOUNTING PROCESS

The accounting-related internal control system (ICS) contributes towards ensuring proper financial reporting. The aim is to ensure that the consolidated financial statements and group management report comply with all relevant regulations. Key elements of the ICS are – as well as the risk management system described above – guidelines and regulations, which include standard accounting and measurement policies. They must be applied to the full extent by all our Group companies. Functional separation and the principle of dual control are observed; this is ensured by the audits carried out by our Internal Audits department.

In addition, the Accounting department carries out regular analytical plausibility checks using time series analyses and actual / budget variance analyses. This enables us to identify significant changes early on, which we then examine for ­accounting and measurement discrepancies. The resulting findings are then discussed at management level.

The responsibility for Group accounting lies with the employees in the central Accounting KSB Group department. We ­employ the services of qualified external reviewers for certain calculations as part of financial reporting (such as the calculation of complex pension obligations using actuarial assumptions).

Binding schedules and guidelines apply to accounting within the KSB Group and to accounting at each individual subsidiary. The accounting methods that must be applied to compile the consolidated financial statements are defined in writing in a manual that we update and revise on a continual basis. This also includes the guidelines for posting intra-group transactions. We continually analyse new accounting principles and other official announcements with regard to their relevance and impact on the consolidated financial statements. We adapt our guidelines and manual where necessary and communicate any changes immediately to our companies. Accounting KSB Group monitors compliance with these regulations. This enables us to reduce the risk of compiling inappropriate financial statements or failing to publish them by the defined deadlines.

We automatically process the financial statement information for all Group companies using certified and tested standard consolidation software. Systematic checks are implemented to help us validate the data. Employees in Accounting KSB Group verify any warning signals that arise before using the data. The sequence of the processing steps is strictly specified through the use of the consolidation monitor within our IT system. This ensures the correct processing of data.

To enable a seamless and accurate accounting process, we only assign employees to this task who have the appropriate specialist know-how. These employees are trained on a regular basis to make sure that their expert knowledge remains up to date.

We have defined access authorisations for the accounting-­related IT system. This protects the data against unauthorised access as well as improper usage and modification. The data is checked at many stages, helping to ensure the processing quality. Alongside regular system reviews by the auditors, these checks contribute to limiting operational risks.

INDIVIDUALLY ASSESSED OPPORTUNITIES AND RISKS

The categories presented below – unless stipulated otherwise – include the qualitative and quantitative gross risks classified as significant or neutral and the main opportunities for our business development. The main influencing factor remains the economic development. All other opportunities and risks are assessed as secondary.

Markets / Competition

Risks

Our business opportunities are again affected by changes in the economic and political environments in the current reporting year.

We manage the risk of fluctuations in the economy and in demand by remaining active in several market sectors and industries with different economic cycles. Furthermore we are monitoring the development of the economic environment for our market sectors. If necessary, we adjust capacities, relocate production facilities and implement cost-cutting measures.

Asia remains our most important sales market for power plant equipment, including pumps and valves. However, competition in China intensified further. For the KSB Group, this has created increased pricing pressure and thus represents a “significant” risk. Political decisions too, such as the postponement or even abandonment of energy projects in several Chinese provinces, have impacted negatively on our business performance. In order to tap into the Asian market more widely, we have agreed a strategic alliance with our long-term partner, the Chinese SEC Group, in late 2015. This aims at closer cooperation so that KSB can achieve success in Asian power plant projects outside of China.

The risk from the political situation in various parts of this world, however, lost some significance year on year. According to our assessment, the framework conditions in the countries of the Region Middle East / Africa, which were presented in the 2016 annual report as risks, are no longer material risks in the financial year. However, the East / West relations that are under considerable strain given the political differences between Russia and the USA, and between Russia and most European countries, continue to be significant. This also becomes apparent in the Russian government’s import substitution programme, which constitutes a “significant” risk. Russian companies are to increasingly order products that have been made in Russia or involve a high proportion of local value added. Our KSB company in Moscow has prepared for this development, setting up a local assembly site for industrial and water engineering pumps in leased premises. In addition, an own production site is being established, which will start operations in 2018 according to our plans. Our company almost doubled the domestic value added share ­already in the reporting year.

We considered the risk of a fall in demand in the petrochemical industry in China in our sales strategy. It is therefore no longer material for our expected business development, contrary to the previous year.

Opportunities

Whereas business in the field of fossil-source energy generation remains weak, there is a trend towards growing demand for technical equipment from energy supply companies operating nuclear power stations. Here, KSB sees opportunities as a provider of high-safety components to participate in the supply of equipment, but also to provide maintenance and repair services for such plants with its specially qualified staff.

In China business prospects are arising in the retrofitting  of coal-fired power plants, which are upgraded to become more efficient and environmentally friendly. In addition, KSB Shanghai Pump Co., Ltd. can contribute its expertise to the construction of fossil-fuelled power plants, which Chinese plant engineers are planning and installing in selected countries within the framework of the One Road, One Belt policy.

In China and India with their strong need to catch up with environmental protection requirements, ongoing action plans offer good opportunities for waste water pumps, which are required in sewage treatment plants and the requisite infrastructure. In India, in particular, which is suffering from serious air pollution, tackling the causes may also increase demand for flue gas desulphurisation pumps from our portfolio.

Projects / Products

Risks

The markets’ requirements for our products are constantly changing. We will only succeed if we meet our delivery deadlines and offer technically advanced products in good quality at affordable prices. To minimise the risk of delivery delays, which can lead to an adverse effect on our reputation with customers and also result in financial penalties, we constantly monitor our sales and manufacturing operations. If we discover that machinery needs to be renewed or capacities expanded, we examine these investment projects as part of a step-by-step approval process. By doing this, we counter the risk of schedule and cost overruns that is rated as “significant”.

Regular market analysis and monitoring minimise the risk that our products will become technically obsolete or that we offer them at prices not acceptable in the market. At the same time, we are exposed to the risk posed by cheap products from Eastern Europe and Asia that compete with KSB’s portfolio. This calls for continuous quality management, which we have introduced across the Group.

In our business, there are special requirements when it comes to the processing of large-scale projects with long contract terms. There are also always associated risks. There may be cost overruns, tighter import regulations, staff shortages, technical difficulties or quality problems – including possible contractual penalties – that reduce our margins. We therefore train our employees in project management and equip them with specialist knowledge. This enables them to identify the risks associated with longer-term orders at an early stage. With this in mind, our project managers are also provided with appropriate management tools. Decisions are made in conjunction with clearly structured authorisation processes.

There are also technical and financial risks to orders with newly designed products. We limit technical risks to the extent that we define intermediate steps for development work and subject partial solutions to assessments. This also applies to pumps that we provide within the framework of a major contract running over a number of years for the construction of a new type of power plant in China. We minimise financial risks by using appropriate contractual clauses, and ensure that advances cover the costs incurred. We set aside suitable provisions for warranty obligations and contractual penalty risks. These amounted to € 51 million in the consolidated ­financial statements for 2017 compared with € 50 million in the previous year; beyond this there is no other major resid­ual risk (net risk).

The protection of intellectual property is also becoming ever more significant in our increasingly interconnected world. We are addressing a growing risk by registering patents early, monitoring Internet platforms for the sale of pumps and valves and taking legal action against anyone violating our rights.

Opportunities

Digital transformation enables us to better fulfil customer ­requirements with new products and services and to generate competitive advantages. A new pump monitoring system to be launched in the market in the current year serves this aim. It sends values measured by sensors into a cloud for analysis and increases transparency for operators of machinery. As a result, deterioration and damage can be identified early on and appropriate measures be initiated. This can result in a higher number of service orders in the medium term. The introduction of the new SAP C4C  cloud software enables us to better control service processes and to plan assembly assignments precisely.

There are also good chances that our customers will increasingly ask for products newly launched in 2017, such as high-­pressure pumps and pressure booster sets, oil pumps to API  standards, waste water pumps with high efficiencies and submersible borehole pumps. This also applies to new valves for use in water pipelines, ANSI  valves for power plants and­ diaphragm valves with improved pneumatic actuators.

New high-efficiency waste water pumps open up opportunities for KSB BRASIL LTDA. to improve its market position in the waste water market compared with competitors.

The expansion of our range of mechanical seals to more than 30 type series provides added options for fitting pumps for the most varied applications with this core component or for supplying such seals as spare parts. By intensifying the sale of these components produced in-house, we are increasing the value-added depth and thus our pumps business profit.

Finance / Liquidity

Risks

As a group with global operations, we are exposed to a wide variety of currency risks. We counter these with foreign exchange hedges. However, our global manufacturing network also offers us the opportunity to benefit from currency effects and to use these where appropriate in competition with other manufacturers. In addition to uncertainties regarding exchange rates, interest rate developments on the capital markets play a role for us. We use bank loans subject to variable interest rates to counter the interest rate risk by hedging our future interest payment flows accordingly.

Alongside the euro, the most important currencies for the KSB Group are the US dollar, the Indian rupee, the Brazilian real and the Chinese yuan. If the exchange rate differs from our assumptions, this would have positive or negative effects on our business volumes and our earnings. A strict receivables management system and the use of trade credit insurance helps us avoid situations where receivables cannot be collected from our customers.

Risks regarding margins and liquidity are typical of the project business. As well as the continued pressure on our selling prices, which is reducing our profit margins, these include ­unfavourable contract conditions such as reduced advances and tougher contractual penalties. As we comply exactly with our approval processes in the quotation phase, we minimise this risk. At the same time, this enables us to recognise and avoid liquidity shortages. Where necessary, we secure sufficient liquidity by agreeing appropriate credit lines early on.

Persistent recessions or newly emerging crises may adversely affect the financial situation of our customers. Resulting ­delays in payment and bad debts which were rated as “significant” in the financial year would weigh on our results of op­erations. The same effect might occur if the foreign exchange regulations become stricter for individual countries. We counter this by means of a strict receivables management system and intensive customer contacts.

Changing market conditions mean that our business models need to be fundamentally reviewed time and time again. This can also mean that we adjust our product range accordingly.

As regards tax matters, the global orientation of our activities must be taken into consideration. Based on our operative ­activities in numerous countries with varying tax laws and administrative interpretation, differentiated assessment is ­required for measuring our tax obligations. Uncertainty may arise due to different interpretations by taxable entities on the one hand and local finance authorities on the other. These may come to light during audits. By cooperating closely with external local tax specialists, we counteract the risk of having to pay back taxes, which is rated as “significant”. As we ­continually monitor unclear issues, we can generally classify the probability of occurrence. Should a need for subsequent payment arise, we create the corresponding provisions in good time. In the 2017 consolidated financial statements, we set aside € 0 million (previous year: € 1.3 million) for circumstances that are classified as a significant or neutral risk. In addition, there are contingent liabilities in the expected amount of € 1.6 million (previous year: € 7.4 million).

Procurement

Risks

Commodity prices and procurement times are subject to strong market-related fluctuations. This may adversely affect our earnings situation if we do not manage to make up for cost increases or pass them onto our customers. Delays or bottlenecks in our supply chain for raw materials and components may negatively impact our business operations. If we do not benefit promptly from declining procurement prices, the persistent pressure on the selling price of our products would have a negative effect on our earnings.

In the context of our procurement strategy, we are also careful to avoid becoming dependent on individual suppliers and thereby counteract the risk of a supplier default. If local conditions mean that it is impossible to ensure sufficient diver­sification in this regard, we make use of additional foreign business partners. In selected cases, we also integrate ex­ternal expertise into our company, not least to make the best possible use of our capacity.

Our suppliers are also further developing their product ranges. In some cases, this results in changes to the specifications for the materials that we require. We consistently monitor any potential impact on the quality of our products. Should risks emerge, we reserve higher volumes based on the original material structure, where possible, and assess alternative procurement sources.

Opportunities

Process improvements and new forms of the global procurement of materials and services are key elements of our Efficiency Improvement Programme. A reduction in costs is increasingly served by online auctions, which help to achieve favourable purchase prices thanks to the strong competition. The processes, which can be controlled with comparatively few members of staff, reduce the indirect procurement costs and offer the opportunity of a high level of transparency in supplier selection, which we can base on a large number of providers.

Technology / Research and Development

Risks

It is essential to our future success that we have a product and service range that is suited to the market in terms of technology, price and delivery time. The changing needs of our customers and new standards and regulations – especially in promising markets such as China – require that we continuously develop and improve our products and services. Research and development required for adjustments consumes signi­ficant financial and human resources, with no guarantee of success in either the medium or the long term.

To avoid any negative impact on earnings, it is important to recognise the market-related or technical risks early on. To this end, we are constantly updating our development process, which incorporates various control levels. As sales employees are regularly included in this process, risks arising from changes in markets or applications can be taken into account in good time in the evaluation.

Opportunities

At our Business Innovation Lab  we develop new business models on the basis of digital technologies. The aim is to offer customers smart solutions to problems in liquid transport ­using plant-based data and to simultaneously ensure a high level of security and transparency of their processes. In a test phase, we check these models for functionality and market­ability in order to tap new business opportunities.

For example, we deal with application software (apps) for the remote control of our products, the electronic change of fixed speeds – as an alternative to mechanical adjustments – as well as the miniaturisation of power electronics and its integration in the motor. New cooling concepts and loss-reduced semiconductors serve precisely this purpose. In the current year, we will be launching a cloud-based system for pump monitoring into the market for the first time, which will provide ­users with structured information and early warnings. We see opportunities of receiving orders in a noteworthy volume for this new development as early as in 2018.

With a view to serving our customers in the oil and gas industry, we focused on the development of pumps to API 610  standards in 2017 and enhanced our range of products for downstream  applications. This opens up opportunities for winning additional orders. Initial order successes for new API  pumps were recorded already in 2017.

As far as pumps for energy engineering are concerned, a focus of our development work was on product adjustments in order to supply combined-cycle power plants in North America with the technical equipment needed. To this end, we expanded our portfolio with new variants of boiler feed and condensate pumps. On the basis of these technological developments, we expect to boost sales in this application area.

We have established a dedicated development team to provide large tubular casing pumps meeting the required specifications. This enables us to produce customised variants of this product for the project business in a narrow time frame. We ­received orders for this type of pump in 2017 for cooling water supply and for flood control. The latter will increase in sig­nificance on account of global warming. Aiming to expand the business with tubular casing pumps, we are currently driving the development of fish-friendly propellers. They will expand the potential uses of these pumps.

Rapid manufacturing  will have an impact on the availability of parts. Using CAD data, it is today possible to manufacture the components of pumps and valves anywhere in the world. We achieved further progress in the use of additive manu­facturing  processes in 2017 and will install a large stainless steel powder bed 3D plant in the current year. The use of this technology allows offering customers new production alternatives and receiving corresponding orders.

Other business-specific risks – Environment

Risks

Our business activities, primarily in the area of production, are subject to numerous environmental protection laws and ­regulations. Environmental damage of any kind (for example, groundwater contamination, renovation needed due to outdated construction materials or unpleasant odours arising from the use of chemicals) may result in losses not covered by an insurance policy. Therefore, at all company sites officers monitor compliance with laws and regulations as well as with ­internal KSB rules, which in some cases exceed the prescribed environmental standards. If we discover any contamination, we set aside provisions to meet the liabilities for the necessary clean-up work. In the 2017 consolidated financial statements, these amounted to just under € 0.2 million for significant or neutral risks.

As part of acquisition projects, we examine properties for possible contamination before purchase. We take account of critical issues by way of corresponding contractual regulations with the seller and implement appropriate measure in consultation it.

In markets where environmental regulations are becoming more stringent, there is a risk that our products and own or purchased services may cause infringements that lead to us losing our market authorisation and which damage our reputation. A change in rules on liability in environmental protection can also increase the risks for our business success. As a member of national and international professional associations we become aware of imminent changes in environmental law early on. We also continually update the legal frameworks that are in place in our Operational Units, enabling us to ensure that our employees always abide by the applicable law. This is also monitored by external auditors as part of the management certifications.

Opportunities

At KSB, environmental awareness is combined with an active and forward-looking approach as well as internal processes that enable permanent cost reductions. This applies, for instance, to all measures that reduce energy consumption in production, service and in the administrative areas. Inversely, we offer the users of our products the opportunity to reduce their electricity costs by selecting energy-efficient KSB products.

Hazards to people and nature may emanate from the production and processing methods of manufacturing companies. Our global environmental management system helps us to identify these risks early on and to initiate protective measures in good time. We thereby not only prevent pollution, but also its financial consequences.

Drawing on a functioning and certified environmental management system, we fulfil a requirement of numerous public-­sector customers, large companies and entire industries such as the automotive sector. For them, evidence of an environmental management system is an increasingly important criterion in the selection of suppliers. By having our production and service plants checked by auditors and certified to international standards, we and our customers are both assured that KSB companies respect the environment. Our commitment to the UN Global Compact  also meets the expectations of our customers and improves our order opportunities with companies that pick their suppliers with a view to their responsi­bility for the environment and society, among other things.

Other business-specific risks – Human resources, legal aspects and IT

Risks

To achieve our growth and profitability business objectives, we need qualified employees at all our locations, including technical specialists. Due to the demographic change in some countries, the competition for these and other highly skilled professionals is increasing, and will intensify if economic recovery sets in. We counter this risk with demand-oriented measures, systematic human resources planning and international recruitment processes.

Changing market conditions can have a negative impact on the funded status of our pension obligations. Strong fluctuations in the evaluation of capital market interest rates to be paid may have a considerable impact on the Group’s earnings and the equity carried on the balance sheet. To limit this risk, we validate alternative models.

Like all companies, KSB has to adapt to new market conditions. We are currently implementing a global efficiency improvement programme, which also encompasses staff reduction measures. By seeking out socially responsible solutions in the areas of the company concerned and by keeping our employees up to date at all times, we are aiming to keep motivation high and to avoid the departure of employees from key positions.

Changes to our processes and organisational structure, such as the introduction of shared services centres, require clearly defined project responsibilities and valid project plans, as well as the selection of suitably qualified external partners. This helps to avoid teething troubles when changes are introduced to structures and processes, as such problems could impact on the expected cost benefits.

Other potential risks associated with the activities of our ­employees include dishonest conduct or violations of laws, that could damage the image of KSB. We counter these risks and safeguard our reputation among our customers by organising regular compliance training and through individual initiatives in critical regions.

We address maintenance and repair risks, which could result in production downtime or health hazards for persons, by monitoring them permanently. As soon as necessary refurbishment work is identified, we implement the requisite measures in good time. For instance, we are currently overhauling our heating systems and planning structural measures regarding roofing at the Frankenthal site.

Legal disputes cannot always be avoided within the framework of our business activities. These are usually disputes arising from operations, generally involving unclear warranty issues. If as a result of these issues we expect negative effects on the success of our business, we set aside corresponding provisions, which cover not only the anticipated amount of loss, but also the costs of proceedings. To rule out a net risk, the 2017 consolidated financial statements include about € 1 million (pre­vious year: € 3 million) for those cases classified as significant or neutral risks. We have also created provisions for litigation with authorities and for staff matters. These amount to just under € 3 million overall (previous year: € 2 million) to cover any cases we classify as significant or neutral within our risk assessment methodology. Overall, we rate the risk from legal disputes in the financial year to be significant.

The manipulation and loss of electronic data can lead to serious commercial disadvantages. We limit this risk by means of ­adequate security systems and access procedures. An increased centralisation of the IT systems of our various operating units assists us in this. In this way, we implement high security standards and thus reduce the risk of data loss or corruption.

Opportunities

To remain successful, we need to keep seeking opportunities to optimise our services for customers, simplify processes and reduce costs. In this context, ideas and improvement suggestions by employees provide key impulses. With a view to translating such ideas into innovations, we launched an Internet-based ideas management portal in 2017. Its aim is to generate more employee ideas and to have other portal users provide their comments on or expand them. We will globalise the tool, which was initially rolled out in Germany, in order to use the ideas potential of our employees worldwide.

IMPORTANT OPPORTUNITIES AND RISKS BY SEGMENT

As in the previous year, the opportunities and risks for the Pumps, Valves and Service segments are most influenced by economic development. The future development of China ­remains important to KSB. Particularly in Eastern Europe, uncertainty regarding political risk is of great significance to the Pumps and Valves segments, and to a lesser degree to Service. Compared with the previous year, we rate the poli­tical situation in some countries in the world to be no longer material for the business of the KSB Group. However, political decisions on energy projects in China and the considerable strain on East / West relations continue to be significant risks for us. Worsening payment morale also bears corresponding risk potential for future business. As regards our most signi­ficant influencing factor, the economic development, our risk assessment compared with the previous year has changed in that the development of the oil price is no longer a significant risk for the KSB Group. We now assume that the oil price will not recover fully in the coming years, and we have implemented this factor in our strategy. If the oil price were to ­develop better than expected, however, this would likely have positive effects on our business. The economic development in general continues to be the most significant risk for us due to the difficulty of assessability. By contrast, we continue to hope that our measures intended to foster growth will provide us with considerable support in achieving our goals. Our customers are also often affected by recessions and more intense competition, which can decrease their ability to pay in individual cases.

Negative currency changes in growth countries could threaten our exports, in particular those from our European plants. But this would also enable our production facilities in the countries affected to benefit from such developments and to increase their export volumes.

RISK REPORT ON THE UTILISATION OF FINANCIAL INSTRUMENTS

Central financial management in the KSB Group performs its duties within the framework of the guidelines laid down by the Board of Management. We base the nature and scope of all financial transactions exclusively on the requirements of our business and do not conduct business of a speculative nature. The aim is to ensure liquidity at all times and to finance our activities under optimal conditions. With respect to our export business, we hedge foreign exchange and credit risks to the greatest extent possible. We continuously improve our receivables management methods with the goal of settling our outstanding amounts by their due dates.

We are exposed to the following financial risks as a consequence of our business activities:

On the one hand, we are exposed to credit risk. We define credit risk as potential default or delays in the receipt of contractually agreed payments. We are also exposed to liquidity risk, which is the risk that an entity will be unable to meet its financial obligations, or will be unable to meet them in full. Finally, we are exposed to market risk. The risk of exchange rate or interest rate changes may adversely affect the economic position of the Group. Risks from fluctuations in the prices of financial instruments are not material for us.

We use foreign exchange hedges to reduce the risks from transactions involving different currencies. These are generally currency forwards, which we use both for transactions that have already been recognised and for future cash flows from orders still to be processed. At year end, the notional volume of currency forwards used to hedge exchange rate risks was € 276.5 million (previous year: € 269.8 million). Foreign currency items denominated in US dollars account for the major volume hedged by forwards. By strengthening our ­production sites worldwide, we can realise “natural” currency hedging in currency markets that continue to be volatile.

To minimise interest rate risks, we concluded interest rate swaps to hedge cash flows from underlyings amounting to € 0.0 million (previous year: € 39.5 million). Underlyings and hedge transactions share the same variable interest rates and maturities (1 year).

We limit all these risks through an appropriate risk management system, defining how these risks are addressed through guidelines and work instructions. In addition, we monitor the current risk characteristics and continuously provide the information obtained in this way to the Board of Management and the Supervisory Board in the form of standardised reports and individual analyses.

For more information on the three risk areas and the impact on the balance sheet, see the Notes, section VI. Additional Disclosures on Financial Instruments.

OVERALL ASSESSMENT OF OPPORTUNITIES AND RISKS

The opportunities and risks for the KSB Group are mainly derived from macroeconomic influencing factors and their effects on the global mechanical engineering markets and the competition.

The overall risk situation improved a little compared with the previous year. The reason for this is that we no longer rate the oil price to be a significant risk. Overall, we expect an economic performance in line with the IMF  forecast for next year. Our structural measures will afford us additional support in achieving our objectives. The weakening economic momentum in the growth markets as well as political developments, however, continue to constitute risks, as described in the risk situation by segments. The same applies to geopolitical instabilities, decisions on sanctions and volatile currencies. Such circumstances would have a negative effect on our business volumes as well as our budgeted earnings.

In this environment, the KSB Group continues to rely on its ability to match capacities and resources to the changing market conditions. For us, a solid financial position and an efficient cost structure are vital in order to maintain our long-term competitiveness. We are convinced that we can continue to successfully overcome the risks arising from the above-mentioned challenges.

The risk management system in place as well as the related organisational measures allow the Board of Management to identify risks in a timely manner and to take adequate measures. In view of the somewhat uncertain situation, the focus of activities in 2018 will continue to be on the management of market risks. The Board of Management states that, based on the risk management system established by the KSB Group, at present there are no risks that could lead to a lasting and significant impact on the net assets, financial position and ­results of the KSB Group.

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