Risks arising from the economic environment
As a company with global operations, we are dependent on cyclical trends in the world economy. Furthermore, the fact that markets are competitive means that we are exposed to the risk of losing market share and experiencing a decline in the level of market awareness.
The Linde Group operates in a number of different industry sectors in order to avoid dependence on one particular sector. We are constantly conducting analyses of our market environment and competitive situation. We obtain vital information about our customers’ needs by maintaining regular contact with customers, which enables us to stay close to the market. We use the information we receive to develop and supply products tailored to suit the needs of the market and to enhance our competitive position and level of market awareness.
Risks in politically unstable countries
The Linde Group is a global group operating in around 100 countries. Potential risks we might encounter in different countries include the nationalisation or expropriation of assets, legal risks, the prohibition of capital transfers, war and other unrest. To manage these risks, we employ risk assessment tools to evaluate our exposure to risk and the impact of risk on the net assets, financial position and results of operations of the Group and to ensure cross-border financing at optimal levels of risk. Individual capital expenditure projects are evaluated so as to identify any political risks which might be associated with them.
Financial risks
Due to its global operations, The Linde Group is exposed to a number of financial risks. In particular, these include counterparty risk and risks arising from movements in interest rates and exchange rates.
Interest rate risk arises as a result of fluctuations in interest rates caused by the markets. On the one hand, they have an impact on the level of the interest expense borne by The Linde Group, and on the other hand they affect the fair values of financial instruments.
In the case of exchange rate risk, it is important to distinguish between operational transaction risks, which are the result of supply contracts for individual projects spread across different currency zones, and translation risks, which arise from currency translation relating to individual companies at different cut-off dates. As a result of the acquisition of The BOC Group plc, our interest rate risk and exchange rate translation risk have increased significantly.
To manage counterparty risk, we rely mainly on the credit ratings of the counterparties and we limit the extent and duration of any financial transactions to be concluded accordingly. Regular reviews are performed by a supervisory unit which is independent of the trading entity to ensure compliance with all the limits set.
Within Treasury (Glossary), the principle of segregation of duties between the front, middle and back offices must be observed and monitored throughout the risk management process. This means that there is a strict personal and organisational separation between the dealing and the processing and verification of a financial transaction. We use a treasury management system to implement, record and evaluate our transactions. The operations within Treasury are subject to regular reviews by our internal and external auditors, generally once a year.
The basic risk strategies for interest, currency and liquidity management, and the objectives and principles governing our financing are determined by the Treasury (Glossary) committee led by the member of the Executive Board responsible for finance. This committee usually meets once a month.
We make financing and hedging decisions on the basis of the financial information which we receive from the treasury management system and from our financial and liquidity forecasts.
Business and financing activities which are not in the local currency inevitably lead to foreign currency cash flows. The Group guideline states that the individual business units must monitor the resulting transaction risks themselves and agree appropriate hedging transactions with the Group Treasury, based on predetermined minimum hedging rates, provided that no country-specific restrictions or other reasons not to hedge internally apply. Specific risks are aggregated by currency at Group level and the resulting net foreign currency position (Glossary) per currency for The Linde Group is determined in each case. Furthermore, we regularly run value at risk (Glossary) scenarios on the net position using the variance-covariance method (Glossary) , assuming a one-year holding period and a confidence level of 95 percent.
Hedging decisions are made according to the risk strategies of the Treasury committee. Forward exchange deals, currency swaps (Glossary) and simple currency options are all used here. The main currencies are the US dollar (USD), the British pound (GBP), the Australian dollar (AUD) and some Eastern European, South American and Asian currencies. Since 2006, translation risks have also been hedged as, following the acquisition of The BOC Group, the focus of our currency management has shifted from currency transactions to currency translation.
In our Gases Division, we also use financial instruments to hedge against exposure to electricity price changes. In our project business in the Engineering Division, foreign currency risks are reduced as much as possible by natural hedges, for example by purchasing supplies and services in the currency of the contract. Any foreign currency amounts over and above this are immediately hedged fully when they arise, generally by entering into forward exchange transactions.
Interest rate risks are also centrally managed. We evaluate potential interest rate risks, ascertain the interest risk exposure in the major currencies and conduct sensitivity analyses. The Treasury committee then determines the range for the hedging rates and the Group Treasury concludes the transactions with the banks. Interest rate risks are hedged using long-term fixed-interest bonds, loans and interest rate derivatives. At 31 December 2007, around 32 percent of the Group’s exposure was financed at variable rates.
Personnel risks
An important feature of Linde AG’s corporate culture is that it is based on trust. We place special emphasis on our employees assuming personal responsibility and thinking and acting in an entrepreneurial way.
Linde will continue to position itself as an attractive employer and will seek to ensure the long-term loyalty of its management team by developing the strengths of the Group’s executives and fostering their commitment. Our rigorous management development programme includes the provision of development opportunities and offering support and advice to target groups, the early identification and advancement of high achievers and those with potential, and attractive management incentive schemes which are tailored to suit the needs of the market.
The success of our company depends on the commitment, motivation and skills of our employees. We are addressing the issue of the shortage of qualified personnel in some fields by ensuring that we offer a range of personnel development schemes and extensive opportunities for gaining qualifications and for professional development. This strengthens our position as an attractive employer in the competitive market for qualified employees, especially in the field of engineering.
Risks arising from acquisitions and investments
Acquisition and investment projects are vital for the growth of The Linde Group, because they look to the future. Such projects, however, are associated with complex risks. We manage and reduce these risks by designing tailor-made procedures and processes for our acquisition and investment projects.
Right at the beginning of each project, we use internal and external experts to assess the risks associated with that project, while acquisitions and divestments are regularly discussed at committee meetings or meetings of the Executive Board.
In the course of the past financial year, Linde AG has completed a variety of acquisitions and sales. Most of the sales were made because of conditions imposed by the competition authorities following the acquisition of The BOC Group plc in 2006. The acquisitions made by Linde AG in 2007 are the result of deliberate measures taken by the company to strengthen our core business. We monitor the performance of our acquisitions by examining movements in specific financial variables.
Environmental risks
The Linde Group stands not only for quality management, but also for environmental management on a large scale. Our aim is to identify environmental risks at an early stage and to take appropriate countermeasures. In this way, we also reduce any liability risk arising from excessive environmental pollution. We have a holistic approach to environmental protection, involving the entire life-cycle of our products. We even consider the potential impact on the environment at the development and planning stages.
The tightening of legal regulations may lead to increased development costs, product identification requirements and production costs. In the course of our risk identification and management process, we monitor any legislation which applies to our markets and our research and development teams look at alternative production materials.
Legal risks
With its international operations, The Linde Group is exposed to numerous legal risks. These may include, in particular, risks relating to product liability, competition and antitrust law, patent law, tax legislation and environmental protection. The outcome of any current pending or future proceedings can often not be predicted with certainty. It is therefore possible that legal or regulatory judgements or agreed settlements might give rise to expenses which are not covered, or not fully covered, by insurance benefits and which might have an impact on our earnings and on our business.
Legal proceedings currently considered to involve material risks are outlined below. This does not necessarily represent an exhaustive list.
Certain companies in The Linde Group are parties to various legal proceedings in the ordinary course of business, including some in which claims for damages in large amounts have been asserted. The outcome of the litigation to which Linde Group companies are party cannot be readily foreseen, but the Company believes that such litigation should be disposed of without material adverse effect on the Company’s financial condition or profitability.
Certain subsidiaries of the Company are parties to lawsuits in the United States for alleged injuries resulting from exposure to manganese, asbestos and/or toxic fumes in connection with the welding process. In these cases, the Company’s subsidiaries are typically one of several or many other defendants. The subsidiaries of the Company named in these cases believe that they have strong defences to the claims asserted in the various cases and intend to defend vigorously such claims. Based on the litigation experience to date, together with current assessments of the merits of the claims being asserted and applicable insurance, the Group believes that the continued defence and resolution of the welding fumes litigation will not have a material adverse effect on its financial condition or profitability. Nonetheless, the outcome of these cases is inherently uncertain and difficult to predict. The Company’s subsidiaries have insurance that covers most or part of the costs and any judgements associated with these claims.
IT risks
In a modern working environment, companies rely on information technology to ensure a secure and effective infrastructure. To minimise the risk of business processes being interrupted as a result of systems failure, numerous security measures have been implemented. These include access control systems, contingency plans, an uninterrupted electricity supply for critical systems, back-up systems and data mirroring. In addition, we use firewall systems and virus scanners to counter data security risks arising from unauthorised access to the IT systems. We also ensure the confidentiality, availability and integrity of the data.
Project risks
Complex major plant construction projects make specific demands on risk management. In our Engineering Division, we handle major contracts which may be worth several hundred million euro and may extend over a number of years. Typically, the division is involved in the planning and construction of turnkey plants. Potential risks may arise as a result of costings of complex projects which are subject to uncertainties. Risks may include unexpected technical problems, bottlenecks in the supply of major components, unforeseen developments during on-site assembly and problems with our partners or subcontractors. To manage the risks in plant construction, we employ tried and tested methods even in the tendering phase, to assess the impact on the profitability of a large-scale project of potential variances from budgeted cost for individual components. We conduct simulations of the opportunities and risks associated with each project with the aid of numerical methods of analysis. By continually monitoring changes in the parameters alongside the progress of the project, we are able to identify potential project risks at an early stage and to take appropriate measures to counter them. These risk management tools are constantly being updated and modified to meet the increasing demands of the market.
Another important aspect of risk management is the planning, assembly and commissioning of the projected plants, while at the same time taking account of safety and environmental issues. To ensure that this is indeed the case, the Engineering Division has defined clearly-structured management standards and procedures and has set up a panel of experts with a wide-ranging remit.
Strategy risk
The Linde Group has developed a long-term growth strategy. At regular meetings, the Executive Board and Supervisory Board, as well as Linde AG management personnel, evaluate the Group’s growth strategy and implement any corrective measures required.
External risks
A fundamental risk for Linde, as for all companies, is posed by potential radical changes in the political, legal and social environment. A theoretical risk to the financial position and results of operations of the Group also exists, in the form of terrorist acts or natural disasters. These risks are covered in some cases by insurance.
Risk transfer
In selected risk areas, with the agreement of the Linde AG Executive Board, the risk is managed by transferring the risk to insurance companies, i.e. by entering into Group insurance contracts with our central service-provider, Commercium Versicherungsvermittlung GmbH.