Corporate governance

Risk management

Risk philosophy

Kumba maintains an integrated, enterprise-wide, risk management programme (IRM). The company applies a logical, systematic and repetitive methodology to identify, analyse, assess, treat and monitor all risks, whether or not insurable.

The effectiveness of the IRM process is measured by how well it aligns the key fundamentals of governance, business objectives, ethics, policies, standards, strategies and compliance. Kumba recognises the complexity and diversity of risks that face all its operational activities and integrates all efforts to maximise opportunities and minimise exposures to risk and to reduce them, where necessary, to levels commensurate with its risk appetite.

Risk culture

Kumba’s policy is zero tolerance for compliance failures and its aim is to identify and rectify any deviation speedily. Promoting a risk-conscious culture is a constant focus throughout the company and this culture proactively supports achieving Kumba’s strategic business objectives. Each risk owner is responsible for continuously monitoring the existing and ever-changing risk profile of Kumba.

Monthly risk reviews that cover internal and external risks take place, with findings reported to the executive committee.

Divisional and business unit risk committees play an important role in identifying operational and strategic risks and in developing and applying generic mitigating strategies. They also have a risk oversight function by virtue of being closer to activities that could have adverse results.

Risk management objectives

The risk management process is continuous, with well-defined steps that support better decision-making by contributing greater insight into risks and their impacts. Risks from all sources are identified and once they pass the materiality threshold, a formal process begins in which causal factors and consequences are identified and the correlation with other risks and the current risk-mitigating strategy is reviewed. One of the challenges is to ensure that mitigating strategies are geared to deliver reliable and timely risk information to support better decision-making.

Reporting

Continuous monitoring of risk and control processes, across headline risk areas and other business-specific risk areas, provides the basis for regular and exception reporting to business management and boards. Headline risks areas for Kumba are shown below.

Headline risk areas

Risk assessment and reporting criteria are designed to provide the executive committee and board, via the audit and risk committee, with a consistent, enterprise-wide perspective of key risks. Reports are submitted monthly to the executive committee and quarterly to the audit and risk committee and board and include an assessment of the likelihood and impact of risks materialising, as well as risk-mitigation initiatives and their effectiveness.

In conducting its annual review of the effectiveness of risk management, the board considers key findings from ongoing monitoring and reporting processes, management assertions and independent assurance reports. The board also takes account of material changes and trends in the risk profile and considers whether the control system, including reporting, adequately supports the board in achieving its risk-management objectives.

Kumba’s Integrated Risk Management (IRM) framework

The model above illustrates the enterprise-wide IRM framework and its key components. The risk management strategies of all Kumba business units operate under this framework, assuring stakeholders that business risks are professionally and consistently managed.

Headline risks

Kumba’s business, financial position, results of operations, growth, strategies and dividend policy could be materially adversely affected by risks, including any of those set out below. These risks could also have an adverse effect on the market price of Kumba shares.

The risks described below are not the only risks faced by Kumba. Currently unknown risks factors and risks deemed less material by directors may also impair operations.

Mining exploration and projects

Kumba seeks to develop new mining properties and expand its existing operations as a means of generating shareholder value. New mining properties are identified through an active exploration programme while current operations are expanded by technological applications to beneficiate medium-grade iron ore.

This capability will cover internal levers (delivery on projects) and external constraints, ensuring that “new tonnes” reach customers on or ahead of schedule. The associated challenge of this opportunity is to bring growth projects on stream, on time and below budget. Skills and resource shortages in the construction and engineering industries as well as increasing regulatory, environmental and social approvals are required which may result in significant increases in construction costs and/or significant delays in construction. These increases/delays could materially and adversely affect the economics of projects and consequently impact on Kumba’s asset values, costs, earnings, cash flows and prospects. Mitigating actions include initiatives to establish project delivery and management practices and capabilities to ensure project delivery ahead of schedule and below projected costs.

Rail and port infrastructure

While Kumba does not own or operate any of its logistical chain assets, it exports iron ore to international customers through a single channel rail and port. Labour and other operational risks associated with managing the rail and port operators’ assets fall outside Kumba’s direct control. Inadequate support facilities, services, installations (water, power, transportation) may affect the sustainability or growth of the business, leading to loss of competitiveness, market share and reputation.

Accordingly, Kumba promotes the early development of integrated strategies and alignment with the infrastructure owner/operator, development of relationships, participation in industry groups and lobbying to ensure effective provision of services by key utility providers.

Commodity price fluctuations

Iron ore prices typically lag the steel commodity cycle by approximately 18 months. Iron ore prices are negotiated annually with major international steel producers. Kumba normally uses international price settlements as a basis for its annual price negotiations with its customers. Commodity prices and demand for Kumba’s products are influenced strongly by world economic growth, particularly in Europe and Asia. The Chinese market has become a significant source of global demand for commodities. While this increased demand represents a significant business opportunity, Kumba’s exposure to China’s economic fortunes and economic policies has increased. If China’s economic growth slows, it could result in lower prices for Kumba’s products. Commodity prices can fluctuate widely and could have a material and adverse impact on Kumba’s asset values, revenues, earnings and cash flows. Mitigating actions include initiatives to establish and maintain a preferred-supplier status in high-margin iron ore markets by differentiating Kumba’s high-quality products, while maintaining consistent quality and superior levels of customer service.

Legal

Litigation may threaten Kumba’s capacity to consummate important transactions, enforce contractual agreements or implement specific strategies and activities.

Mining operations

The mining operations of Kumba are subject to the risks and hazards normally encountered in open-cast mining operations. These risks include environmental hazards, such as unexpected geological pressures and ground subsidence, and operational risks relating to materials handling, industrial accidents, blasting and removing material from open-cast pits. Mining and beneficiation processes also rely on key inputs, for example fuel and electricity. Appropriate insurance can provide protection from some, but not all, the costs that may arise from unforeseen events. If any of these risks should materialise, such an event could result in serious harm to employees and contractors, delays in production, increased production costs and possible increase in liabilities. Disruption to the supply of key inputs, or changes in their pricing, may have a material and adverse impact on Kumba’s asset values, costs, earnings and cash flows. Failure to meet production targets results in increased unit costs. The impact is more pronounced at operations with a high level of fixed costs. Mitigation strategies include efforts to secure strategic supplies at competitive prices, energy reduction, application of group water management guidelines, adoption of lean production principles and practices and business improvement initiatives to reduce unit costs.

Employees

Mining is a hazardous industry and failure to adopt high levels of safety management can result in a number of negative outcomes; harm to employees and communities that live near Kumba’s mines as well as fines and penalties, liability to employees and third parties for injury. Kumba operates in an industry that is subject to numerous safety regulations. Failure to provide a safe working environment may expose the organisation to compensation liabilities, loss of business reputation and other costs. Evolving regulatory standards and expectations can result in increased litigation and costs, all of which can have a material effect on earnings and cash flows. Mitigating actions include improved safety awareness through campaigns, visible leadership, empowerment of people and implementation of safety standards.

Kumba is, to a great extent, reliant on a large number of people employed in its operations. Despite Kumba’s good relations with bargaining unit employees and their trade unions, we remain exposed to risks as a unionised operation posed by organised labour disruptions and disputes. The strong commodity cycle and large numbers of projects being developed in the resources industry have led to increased demand for skilled personnel. This has led, and could continue to lead to, increased capital and operating costs and difficulties in developing, acquiring and retaining skilled personnel. Skills shortages are being addressed by ensuring that incentives and remuneration are market-related and that opportunities are presented for employee development.

The HIV/Aids infection rate in South Africa is high and may adversely impact on the operations of Kumba through reduced productivity, general medical costs and absenteeism. Mitigating actions include VCT, ART and wellness programmes among the workforce as well as awareness programmes in neighbouring communities. Kumba operates globally and may be affected by potential avian flu outbreaks in any of the regions in which it operates. The effects of avian flu may manifest themselves directly on employees, offices and operations or indirectly on customers and markets.

Regulatory

Mining operations, development and exploration activities are subject to extensive legislation and regulations. Changes in this regulatory environment could increase Kumba’s cost of production and failure to comply could result in the revocation of consents, licences and rights it requires to conduct its business. South Africa has enacted legislation that promotes the ownership and control of mining companies by HDSAs as set out in the mining charter.

Conversion applications for all of Kumba’s old-order rights together with several applications for new-order rights, has been submitted to the Department of Mineral and Energy (DME).

The mining charter also stipulates that, by 2009, at least 40% of the managers Kumba employs must be HDSAs. Kumba has a detailed plan in place to ensure this target is reached and exceeded by the end of 2008.

Currency fluctuations

Kumba’s iron ore export prices are determined in US Dollars and the company negotiates iron ore prices in that currency with customers. Strengthening or weakening of the US Dollar against the Rand therefore could have a significant effect on the financial position and results of Kumba. The group undertakes transactions denominated in foreign currencies, hence exposures to exchange rate fluctuations arise which may expose it to economic or accounting losses. Major capital expenditure is hedged while the continuous inflow of US Dollar export proceeds acts as a natural hedge for operating activities.

Community

In considering the needs and quality of life of our community stakeholders, we are in discussions with elected representatives of the Dingleton township, 28km from Kathu, to develop a mutually beneficial solution to issues arising from the community’s proximity to the mining operation at Sishen Mine.

Environmental risks

Costs associated with rehabilitating land disturbed during the mining process and addressing environmental, health and community issues are estimated and provided for based on the most current information available. Estimates may, however, be insufficient and further issues may be identified. Any underestimated or unidentified rehabilitation costs will reduce earnings and could materially and adversely affect Kumba’s asset values, earnings and cash flows. The operations of Kumba are subject to environmental legislation and regulations. If any of the legislation or regulations should be changed, Kumba’s production costs could be increased. Mitigating actions include initiatives to ensure that all operating business units have approved environmental management plans and systems in place to reduce energy and diesel consumption, to reduce water consumption and pollution, to separate and recycle waste where possible, to rehabilitate inactive mining sites and ensure biodiversity preservation and to reduce emissions and effluents.