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Annual report 2012

Social report 2012

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Internal Control and Risk Management

INTERNAL CONTROL AND RISK MANAGEMENT SYSTEM MODE

The internal control and risk management system (“IC&RM”) of the Company and its subsidiaries is a component of their corporate governance. IC&RM includes a full range of control procedures, methods, and mechanisms created by the Board of Directors and executive bodies of the Company and its subsidiaries to efficiently control the Company’s financial and economic activities.

In order for the Company’s IC&RM to develop, the Board of Directors approved the following regulatory documents:

  • Concept of Developing and Improving the Internal Control and Risk Management System;
  • Internal Control Policy;
  • Risk Management Policy;
  • Guidelines for Organizing Internal Control and Risk Management;
  • Recommended Guidelines for Risk Management;
  • Code of Corporate Ethics.

Subsidiaries have similar approved standard regulations.

The key goals of IC&RM are to effectively achieve the strategic and shareholder objectives of the Company and subsidiaries, improve the quality of the corporate governance system, and enhance the operating and investment efficiency of the entire Company’s activities.

IC&RM is improved at all management levels of the Company in the following areas of control:

  • Preliminary control: the identification, assessment, and management of risks (threats and opportunities) to effectively achieve the strategic and shareholder objectives, as well as the identification and management of economic and energy security risks;
  • Routine control: the regulation and standardization of business processes with defining control procedures and responsibilities of business process participants by management level;
  • Follow-up control: the auditorial control of reporting reliability; asset preservation; compliance by business transactions with the laws, the Article of Association, and local regulatory documents; internal audits of the organizational efficiency of business processes and IC&RM; the control of compliance with corporate ethics; and the control of anti-corrupt practices.

Regulatory documents of the Company and subsidiaries specify a “distributed” IC&RM model setting forth responsibilities in the following way:

  • The Board of Directors of the Company and each of its subsidiaries defines the development areas of IC&RM;
  • The Audit Committee of the Board of Directors supervises IC&RM effectiveness;
  • The Internal Audit and Risk Management Department audits and directly evaluates IC&RM effectiveness, corporate governance effectiveness, and follow-up control procedures. Additionally, the Internal Audit and Risk Management Department organizes and coordinates the preparation of risk reports and provides stakeholders with information on risks and internal control procedures of the Company and subsidiaries;
  • Executive bodies are responsible for organizing the effective implementation of routine and preventive control procedures and for implementing local IC&RM regulations;
  • Officers (business process owners) are responsible for establishing and implementing control procedures and risk management measures and for identifying and assessing risks in a timely manner.

KEY RISK FACTORS

The performance of the Company’s subsidiaries may be affected by risks that should be taken by investors into account. The key risk factors described below are currently considered by the Company to be the most important.

Country and Regional Risks

Country and regional risks are determined primarily by macroeconomic factors existing globally, nationwide, and at regional level. These factors may impair the Company’s and subsidiaries’ possibilities for borrowing and adversely impact their liquidity, investment and operating efficiency, and, eventually, shareholder value. Additionally, the global economic crisis has a harmful effect on industrial production and electricity consumption, which reduces revenues of the Company and subsidiaries.

The primary factors of macroeconomic risks are the continuing global financial crisis affecting the key indicators of commodity and financial markets: prices of crude oil and other commodities, the cost of capital, world currency exchange rates, and inflation.

As is the case with the other BRICS countries, Russia is a leading emerging economy and is sensitive to global recessionary pressures. This is due to the economy’s dependence on energy prices, the immaturity and volatility of the Russian financial market, and the transitional state of the national banking system.

With the aim of mitigating the macroeconomic risk, the Company and subsidiaries take comprehensive measures to decrease the share of borrowings in their total capital, take out fixed interest rate loans, and enhance the efficiency of operating and investment expenses of the Company and subsidiaries.

Regulatory (Industry) Risks

The core activities of the Company’s subsidiaries, the provision of electricity distribution and network connection services, are subject to regulation by the government. The tariff regulation policy is aimed at keeping down electricity tariffs, which may lead to limiting the tariff-based sources of financing subsidiaries’ investing and operating activities. To minimize these risk factors, the Company and subsidiaries pursue a balanced policy on improving the efficiency of investing and operating activities, aimed at reducing costs and optimally planning the structure of the financing sources.

One of the regulatory risk factors is imperfect operation mechanisms of the retail electricity market, which entails disagreements between electric grid companies and retail companies over the volume of consumed electricity and capacity used in tariff calculations. This leads to contested and overdue receivables related to electricity distribution services provided by subsidiaries, impairing the liquidity and financial stability of the Company’s subsidiaries. The Company and subsidiaries take measures to eliminate the causes of disagreements with customers, reduce contested and overdue receivables for their services provided, cooperate with federal governmental authorities in preparing amendments to the rules for the operation of the retail market, form judicial practice, and set positive precedents. In addition, the Company’s subsidiaries implement the Long-Term Development Programs for Electricity Metering Systems in the Retail Electricity Market in Distribution Grids of the Company’s subsidiaries approved by their boards of directors.

A substantial risk factor is also the cross-subsidy mechanism at the expense of large industrial customers in favor of other customer categories, including households. Several large industrial customers that are directly connected to networks of the Unified National (All-Russian) Electric Grid (UNEG) pay for subsidiaries’ electricity distribution services at the electricity distribution tariffs if, under the last mile agreements between the Company’s subsidiaries and FGC UES, the electric grid facilities are leased to the Company’s subsidiaries. Since there were no laws specifically governing the last mile agreements, some large industrial customers switched in 2010 – 2013 to direct agreements with FGC UES by recourse to court action. As estimated by the Company, the termination of the last mile agreements decreased subsidiaries’ revenues by 12.7 billion rubles in 2012 and may bring about lost income of 9.3 billion rubles in 2013.

In accordance with paragraph 5 of Article 8 of Federal Law No. 35-FZ of March 26, 2003, “On the Electric Power Industry,” the organization responsible for the management of the Unified National (All-Russian) Electric Grid may lease electric grid facilities to territorial grid organizations upon agreement with the authorized federal executive agencies by January 1, 2014. Resolution of the Government of the Russian Federation No. 1173 of December 27, 2010, “On the Procedure for Leasing Electric Grid Facilities Included in the Unified National (All-Russian) Electric Grid to Territorial Grid Organizations” approved the rules for agreeing with the Ministry of Energy of the Russian Federation upon leasing UNEG facilities to territorial grid organizations. Starting from the beginning of 2011, agreeing upon the composition of UNEG facilities leased to territorial grid organizations takes into consideration the opinion of Russia’s authorized regional executive agencies.

Nevertheless, the Resolution states that agreement upon leasing UNEG facilities to territorial grid organizations is dependent on the fact that that the direct electricity distribution agreements between FGC UES and electricity consumers have been terminated and that the head of a constituent entity of the Russian Federation has applied therefor in writing. The Ministry of Energy of the Russian Federation issued Order No. 403 of August 24, 2012, whereby the Company’s subsidiaries and FGC UES entered into lease agreements for UNEG facilities (last mile agreements) for 2013. Electricity distribution using specific UNEG facilities leased by the Company under the last mile agreements is included by federal and regional regulators in the planned volume of electricity distribution services for 2013. In 2012, the President and the Government of the Russian Federation emphasized the importance of tackling the problem of cross-subsidies in the electric power industry. The Ministry of Energy of the Russian Federation was instructed to work out the mechanisms for eliminating cross-subsidy practices The Company plans to take an active part in discussing this problem at the level of federal governmental authorities.

The transition of subsidiaries to regulation based on the return on invested capital method (Regulatory Asset Base, RAB) involves several risks. The most important of them are as follows:

  • Losses may be incurred due to an unreliably predicted breakdown of electricity distribution by voltage and the overestimated volume of declared capacity as compared with actual capacity used for making tariff and balancing decisions;
  • Some income may be lost due to putting it aside in implementing the income-equalizing mechanism: in planning the calculation of RAB-based tariffs.

In order to mitigate these risks, subsidiaries cooperate with regional regulators in defining the amount and sources of financing their investing activities under long-term regional development programs. This work aims to eliminate any subjectivity in making tariff and balancing decisions by formulating and carrying out the cost management program, including as part of implementing the Russian President’s instructions to attain an at least 10 percent annual reduction of per-unit purchase costs related to goods (work, services) within three years in real terms in 2010 prices. In addition, the Company plans to develop and implement in the future the regulatory contracts enabling tariffs to be set subject to the quality of services provided. These contracts should also provide for reciprocal obligations, on the one hand, of grid companies for the quality of services provided (as clearly specified in the contract) and, on the other hand, of regulatory authorities for adjustments to tariff decisions during the long-term period of regulation.

One of the regulatory risks incurred by the Company is the risk of a decrease in the demand for network connection and electricity distribution services as compared with the planned volume used by regulators to make tariff and balancing decisions. In order to reduce this risk, the Company continues work on the monitoring network connection requests and, on the basis of monitoring, predicting the net delivery of electricity, the demand for network connection services for the following year, and an increase in applications submitted to regulatory authorities to set network connection fees for individual projects. At the same time, due to a great number of network connection requests, the Company is not always able to fully satisfy them, which may adversely affect revenues because of the loss of potential customers and lead to a violation of antimonopoly laws as related to electricity distribution and network connection services. To deal with this issue, the Company improves the business process of processing customers’ network connection requests. Simultaneously, the Company explains to customers the process of providing network connection services, including by publishing information on the provision of services and setting up customer service centers.

Die to the enactment of regulatory documents in late 2012 to simplify the procedure for depriving retail companies of the supplier of last resort status, some of the Company’s subsidiaries incur the risks associated with the necessity of assuming the powers and duties of suppliers of last resort that are lost by retail companies. The most important of these risks are as follows:

  • Risks associated with a rise in receivables of ultimate customers and the writing-off of accumulated receivables under electricity distribution services agreements between retail companies and distribution grid companies;
  • Risks associated with the performance of the supplier of last resort functions in the wholesale electricity and capacity market;
  • Risks involved in an increase in subsidiaries’ expenses related to the performance of the supplier of last resort functions in excess of the minimum regulated revenue used for the calculation of retail markups;
  • Organizational risks associated with the loss of competencies and customer databases and with erroneous payments for consumed electricity.

With a view to minimizing these risks, the Company and subsidiaries take measures to cooperate with federal and regional governmental authorities, the mass media, infrastructural organizations of the wholesale electricity market, law enforcement agencies, and organizations deprived of the supplier of last resort status in the performance of the supplier of last resort functions and the settlement of debts. Additionally, the Company formulates legislative initiatives to streamline the procedure for changing the supplier of last resort.

Financial Risk

In their planned financial and economic model, the Company and subsidiaries are exposed to factors that may result in a shortage of funds to finance their investing and operating activities. The most significant financial risk factors are associated with imperfect operation mechanisms of the retail electricity market and disclosed in the “Regulatory (Industry) Risks” section. However, there are some risk factors that may also affect the results of financial and economic activities.

Inflation Risks

The adverse impacts of inflation on financial and economic activities of subsidiaries and the Company can be connected with loss of the actual value of receivables, an increase in loan interest, and higher construction costs related to the capital investment program’s facilities. The current inflation rate does not have a material effect on the Company’s financial condition. In accordance with the plans of the Bank of Russia to curb inflation and the inflation forecasts for the near future, it is unlikely that inflation will substantially affect the financial results of subsidiaries and the Company.

Currency Risks

An adverse change in foreign exchange rates may affect the indicators of the operating and investment efficiency of the Company and its subsidiaries. Currency risks do not have substantial impacts on the Company and its subsidiaries because settlements with counterparties are entirely denominated in the currency of the Russian Federation. Nevertheless, given that the goods and equipment bought by the Company contain imported components, a considerable increase in foreign exchange rates may lead to higher prices of purchased products. In this connection, the Company pursues a policy aimed at import substitution and entering into long-term contracts that do not specify any increase in prices of purchased products.

Interest Rate Risks

Changes in the refinancing rate of the Bank of Russia reflect the macroeconomic situation and affects borrowing costs. A rise in loan interest rates may result in an unplanned increase in debt service expenses incurred by the Company and subsidiaries. To reduce the interest rate risk, the Company pursues a balanced borrowing policy aiming to streamline the loan portfolio structure and minimize debt service expenses.

Liquidity Risks

The activities of the Company’s subsidiaries are exposed to the risk factors that may impair the liquidity and financial stability of the Company and subsidiaries. The most important factors are cross-subsidies of customer groups and low payment discipline in the retail electricity market.

Total cross-subsidies of all the Company’s subsidiaries in 2012 reached at least 200 billion rubles, which is due to the regional government policy aimed at keeping down tariffs for certain customer groups (households, agricultural and state-financed customers, etc.). The most significant component of cross-subsidies is the mechanism for entering into last mile agreements (disclosed in the “Regulatory (Industry) Risks” section). The lost income of the Company’s subsidiaries due to interrupted electricity consumption in 2010–2012 as a result of large industrial customers switching over to direct agreements with FGC UES is at least 30 billion rubles and is expected to continue to grow in 2013.

Total receivables of all of the Company’s subsidiaries in 2012 increased by 37% to 71 billion rubles. Overdue receivables totaled 39,1 billion rubles at the end of the year and grew by 61% on the previous year. The main factors in the low payment discipline leading to a considerable increase in receivables are the absence of effective mechanisms for dealing with nonpayers, the improper use of money received for delivered electricity by retailers deprived of the supplier of last resort status, and disagreements over declared capacity in settlements with retail companies.

If these risk factors materialize, the Company’s subsidiaries may find themselves incapable of fulfilling financial and other restrictive conditions (covenants) contained in loan agreements, specifically total debt to EBITDA, debt to equity, current ratio, and net asset value. In order to minimize this risk factor, the Company monitors subsidiaries’ capital structure, defines the optimum parameters for borrowings, and carries out measures to reduce cross-subsidies and streamline the working capital structure.

Operational Risk

Activities of the Company’s subsidiaries cover a wide geography, subsidiaries operating in areas with different climates. There is likelihood of emergencies caused by natural disasters (hurricanes, heavy and freezing rain, freshets and floods, snowdrifts, etc.), which may result in system-wide failures of the operability and performance of electric grid equipment and in power outages suffered by customers of the Company’s subsidiaries.

Operational and technological risks affecting power supply reliability are associated primarily with the high physical deterioration and obsolescence of electric grid assets, failure to conform to operation conditions and operation modes of electric grid equipment, and failure to implement the required repair program. In addition, operational and technological risks may materialize because of the following factors:

  • Natural and anthropogenic emergencies;
  • A less efficient management system of assets of the Company’s subsidiaries (changed priorities in ensuring the reliability of network operation, incorrect ranking of facilities that should be repaired);
  • Factors related to equipment operation, including extreme deviations from regulatory and technical requirements, failure by the process parameters of electric grid equipment’s operation to conform to permissible values, mistakes made by operating personnel, and failure to comply with operational discipline.

If these risks materialize, this may have material economic and reputational consequences. In addition, these risk factors affect the volume of electricity network losses, increasing expenses incurred by subsidiaries in relation to the purchase of electricity to compensate for losses.

In order to reduce the probability that operational and technological risks occur, the Company and subsidiaries take measures to make the power supply more reliable and prevent process failure risks. The most important of these measures include:

  • Clearing and expanding the pathways of overhead lines rated 0.4–220 kV;
  • Rehabilitating electric grid facilities;
  • Expanding the stock of reserve power supply equipment and the stock of vehicles and special equipment for accident recovery work;
  • Carrying out the comprehensive program to modernize (renew) electric grid assets;
  • Modernizing switching equipment;
  • Modernizing and creating automated process control systems;
  • Improving data exchange systems, analyzing process failures, and forecasting the consequences of process failures, including the implementation of the Automated Management System for Distributed Resources for Accident Recovery Work;
  • Improving the emergency reserve management system;
  • Increasing the number of mobile accident recovery crews and improving the quality of their personnel;
  • Carrying out the program to reduce injury risks of electric grid facilities;
  • Ensuring the training, control, and certification of personnel operating process equipment;
  • Carrying out the insurance program;
  • Implementing energy conservation and energy efficiency enhancement program.

With the purpose of mitigating operational and technological risks, the Board of Directors of the Company resolved (Minutes of the Meeting No. 64 of October 7, 2011) to approve the Regulations for the Uniform Technical Policy of the Company in the Distribution Grid Sector. Furthermore, subsidiaries are in the process of implementing the production asset administration system based on the actual condition index for equipment.

Investment (Project) Risk

The Company’s subsidiaries take an active part in investment aiming to renew and expand grid infrastructure, which brings about risks associated with the decreasing efficiency and value of investments over the course of implementing investment, innovative development, and R&D programs.

The increasing scope of subsidiaries’ investment programs makes it necessary to mobilize both internal and borrowed considerable financial resources conforming to the RAB regulation parameters, which is an investment risk factor. Additionally, some subsidiaries carry out socially important investment projects that are often unprofitable.

Even if financial resources are sufficient for investment program implementation, there is some likelihood of failure to spend investment-related funds on schedule and of the delayed commissioning of facilities covered by subsidiaries’ investment programs, including due to nonperformance or delayed performance by our contractors and suppliers of their obligations.

Resolution of the Government of the Russian Federation No. 159 of February 27, 2013, “On Amendments to the Rules for Approving the Investment Programs of Electric Power Industry Entities Whose Stakes Are Held by the Government and of Grid Organizations” specifies the facilities not included in territorial planning documents should be excluded from the investment program of the Company’s subsidiaries. There is a risk that construction in progress may grow due to excluding such construction-in-progress facilities from the capital investment program as not included in territorial planning documents.

In order to mitigate the investment risk, the Company and subsidiaries plan their capital investment programs taking account of the following key efficiency criteria: raising the affordability of the grid infrastructure, reducing the physical deterioration of electric grid facilities and modernizing them, and achieving a high utilization rate of commissioned facilities. A precondition for including investment projects in the capital investment program is that they should be linked to territorial and regional development plans. In addition, the Company and subsidiaries monitor the implementation of subsidiaries’ investment programs and their financing and analyze the reasons behind any deviations of the actual results of investment program implementation from the plans. Subsidiaries adopt investment project management procedures, which include investment project risk management. The Company takes measures to improve the quality of project implementation, raise the effectiveness of investments in the existing grid, cut specific construction costs, achieve high utilization rates of new facilities, develop and implement a benchmarking system for specific costs of construction and installation and materials, build an innovation management system, and automate the investment management system.

Compliance Risk

Frequent changes in the laws of the Russian Federation under conditions where the industry is subject to governmental regulation, together with a wide range of regulatory requirements and restrictions, are sources of the risk associated with the failure by the Company and subsidiaries to comply with laws and other legal regulations, or the requirements established by regulators and supervisors and set forth in internal documents of the Company and its subsidiaries that determine internal policies, rules, and procedures.

Activities of the Company and subsidiaries are governed and overseen by Russian authorities and agencies, such as the Federal Antimonopoly Service, Federal Tariff Service, Federal Financial Markets Service, Federal Taxation Service, Ministry of Energy, Federal Service for Fiscal Monitoring of the Russian Federation, and the Accounts Chamber. Furthermore, as government-linked companies, the Company and subsidiaries carry out instructions issued by the Russian President and Government. In this connection, the compliance risk factors are of special significance.

As natural monopoly entities, the Company’s subsidiaries are exposed to the risks involved in their being held to be in violation of antimonopoly laws as related to their provision of network connection services, disclosure of information concerning their services, and procurement operations. In order to reduce this risk, subsidiaries monitor how promptly customers’ requests and appeals are handled, clearly regulate and monitor the disclosures required under Russian laws.

The Federal Financial Markets Service governs and supervises activities of the Company and subsidiaries as related to complying with Russian securities laws, including the disclosure of material facts that can substantially affect the value of securities, and combating insider information misuse.

As provided for in law, the Accounts Chamber is responsible for organizing and overseeing the timely implementation of the federal budget and establishing whether federal budget funds are spent and federal property is used efficiently and reasonably.

Amendments to tax law that involve raised tax rates or changed tax assessment procedures may impair the profitability of the Company and subsidiaries and increase their tax burden.

Subsidiaries are in possession of, have the leasehold of, or have the perpetual right to use most plots of land where their distribution assets are located. Nevertheless, some of the plots lack the registration required under law. In addition, laws specify that the deadline for reregistering the perpetual right to use into ownership or leasehold is January 1, 2015. In order to mitigate this factor, subsidiaries are in the process of carrying out the program to obtain the reregistration of the perpetual right to use.

With the aim of minimizing the above-mentioned risk factors, the Company and its subsidiaries take measures to improve compliance control. In 2012, the Board of Directors of the Company approved local documents designed to enhance the efficiency and transparency of financial and economic activities of the Company and subsidiaries and combat corruption. The Company monitors changes in current laws that affect various aspects of financial and economic activities of the Company and subsidiaries.

As of 31 December, 2012, the Company didn’t have any outstanding legal cases, where it would act as a respondent or as a petitioner.

INSIDER INFORMATION CONTROL SYSTEM

The legal requirements applicable to the Company as an issuer with respect to insider information arise out of the placement of the Company’s financial instruments on Russian trading floors: Moscow Exchange MICEX-RTS (shares and bonds).

Following its internal control policy to ensure compliance with laws, the Company focuses its compliance control activities on the following three areas related to insider information: preventive, routine, and follow-up control.

With the aim of establishing preventive compliance control procedures, the Company’s Board of Directors approved in 2011 the Regulations for Insider Information of the Company (Minutes of the Meeting No. 72 of December 29, 2011), satisfying the requirements laid down in Federal Law No. 224-FZ of July 27, 2010, “On Combating Insider Information Misuse and Market Manipulation and on Amendments to Certain Legislative Acts of the Russian Federation.” The Regulations contain the following procedures:

  • establishing the rules for making the Company’s insider list;
  • defining the Company’s insider information list;
  • establishing the rules for spreading insider information;
  • establishing the rules for conducting transactions involving insider-related financial instruments of the Company and its subsidiaries and dependent companies;
  • entering into insider information confidentiality agreements and addenda to employment contracts with the Company’s employees qualifying as insiders.

Additionally, in order to improve preventive control, the Company’s Board of Directors approved the Code of Corporate Ethics, governing the corporate accountability and behavior ethics of the Company’s employees qualifying as insiders.

As part of routine compliance control, the Company follows the control procedures listed below:

  • maintaining the insider list;
  • recording notices of the inclusion on or exclusion from the insider list and of insider transactions involving the Company’s securities;
  • controlling compliance with the rules for conducting transactions involving insider-related financial instruments of the Company and its subsidiaries and dependent companies, using information (notices) about insider transactions;
  • controlling compliance with insider information laws as part of negotiating the terms and conditions of contracts.

Follow-up control includes analyzing:

  • changes in the prices of the Company’s financial instruments in organized markets;
  • the impact of a news background on changes in the prices of financial instruments;
  • transactions involving the Company’s securities as specified in notices sent by insiders to the Company;
  • information on transactions completed by shareholders from the securities registrar.

Shareholder Value (Corporate) Risk

As part of its efforts to pursue the Strategy for Development of the Company until 2015 with Long-Term Plans until 2020, the Company does not miss the opportunities of managing the future growth and profitability of subsidiaries. The shareholder value of the Company and its subsidiaries is influenced by numerous factors of the internal and external environments.

Almost all subsidiaries of the Company are included on the register of natural monopolies subject to governmental regulation in accordance with Russian laws. In this connection, federal and regional tariff regulation agencies set and regulate tariffs of services provided by subsidiaries.

For the purpose of keeping down electricity tariffs for ultimate customers, the government is able to limit the tariff growth parameters and, consequently, the profitability indicators of subsidiaries’ services. Although the transition to RAB regulation reduces the shareholder value risk by mitigating the influence of subjective factors on tariff decisions, this does not eliminates these risk factors completely. To achieve the long-term targets of RAB regulations (including the investment rate of return prescribed by the regulator) is an essential prerequisite for attaining shareholder goals. With the aim of minimizing this factor, the Company and subsidiaries carry out cost management programs, ensure the well-balanced planning of operations in accordance with approved tariff and balancing decisions, supervise the implementation of the approved business plans of subsidiaries, and cooperate with local government authorities in formulating territorial development programs coordinated with subsidiaries’ investments programs in terms of the amount and sources of financing.

In addition, a substantial risk factor is competition for tariff-based revenues on the part of regional territorial grid organizations in each constituent entity of the Russian Federation. With a view to minimizing this risk factor, the Company plans measures to shrink the existing tariff disparities leading to a disproportionate increase in revenues of regional territorial grid organizations.

Another substantial risk factor is that subsidiaries may be held to be in breach of antimonopoly laws. Network connection services provided by subsidiaries are exposed to antimonopoly regulation risks to the largest extent. Appeals filed by customers with territorial offices of the Federal Antimonopoly Service and followed by proceedings initiated by the antimonopoly authority against the Company with respect to failure to comply with network connection laws may be caused by consumer right violations. Specifically, this may result from refused network connection requests, noncompliance with the statutorily set deadlines for network connections, and a number of other factors. An additional negative factor is that the applicable laws empower the Federal Antimonopoly Service to apply broad interpretations to the notion of product market borders. For instance, a justifiable complaint may lead to a turnover-based penalty calculated on the basis of the total revenues received in the region where a subsidiaries has a presence but not limited to the region where a specific branch of this subsidiaries operates.

In order to mitigate the above-mentioned risk factors, subsidiaries improve their network connection business processes by simplifying their internal procedures and adopting new approaches to customer service, for example, online service techniques.

As the principal shareholder, the Russian Federation controls decision making with respect to most issues and has influence over the strategies of the Company and its subsidiaries. Decisions driven by the economic and social interests of the government may be inconsistent with the interest of other shareholders. Among other things, such decisions can concern dividend policies, mergers and acquisitions, and privatization issues of the Company’s subsidiaries. Additionally, as the principal shareholder of subsidiaries, the Company may make decisions that will not be regarded by minority shareholders of such subsidiaries as consistent with their interests. This may result in minority shareholders’ going to court and their contesting decisions adopted by the executive bodies of subsidiaries.

With the aim of minimizing these risks and in compliance with the provisions of the Corporate Governance Code approved by the Board of Directors of the Company, the Company works to maintain the balance of shareholder interests, including respecting and protecting the rights guaranteed to all shareholders under the laws of the Russian Federation.