10 - Main risk areas
Risk is inherent to any business venture and the risk to which the Group is exposed is not unusual or different from what is considered acceptable in the industry. The Group’s risk management system is designed to identify and manage risks. Effective risk management enables BAM to capitalise on opportunities in a carefully controlled way.
Risk profile and appetite
The focus areas of BAM’s strategy Building the present, creating the future have a positive impact on the risk profile of the Group. In the current project and business portfolio, BAM has a more disciplined focus on market segments and projects where the company can use either scale or expertise as a critical success factor. For the future business portfolio, BAM is rationalising its propositions and developing of new solutions for clients and is investing in digitalisation to be an industry leader in how and what BAM builds. The new strategy also places a stronger emphasis on cultural values, to further support the brand and the strategy of BAM.
Risk appetite is defined as the level at which BAM is willing to accept risk in the ordinary course of business in order to achieve its objectives. The general willingness of the Group to run risks in rather low, taking into account the sector in which managing risk is a necessary core competence to survive and to carry out sustainable business.
Key factors in determining risk appetite are the risk categories:
Strategy: Based on knowledge and experience in the home markets, BAM participates in tenders for complex multidisciplinary projects, in which the risks are distributed in a controlled manner between the customer and BAM. Outside the home markets, BAM operates worldwide in niche areas, provided they are in line with the Group’s business principles. In PPP investments, BAM only invests in Design Build Finance Maintain Operate contracts in home markets where payments are based on availability of the asset, excluding volume related risks. BAM invests in property development projects on condition that they are profitable and have a clear and profitable exit strategy that has been defined in advance.
Operations: BAM seeks to limit the risks that may jeopardize the execution of its business activities.
Finance: BAM strives to maintain a solid financial position for ensuring access to the financial markets and retaining its customers, supply chain and other partners. BAM has a low risk appetite in relation to financial reporting risks.
Compliance: Compliance with all applicable laws and regulations including BAM's code of conduct is of fundamental importance for the Group.
Risk appetite statements are further underpinned by our strategic agenda, governance, core values, code of conduct and policies and procedures.
Improvements to the risk management framework
In 2017 BAM further strengthened its enterprise risk management. The enterprise risk management is embedded in different levels of the organization and has various areas of attention. The core of BAM's risk management at project level covers the full life cycle of the project, from opportunity to tendering, and from execution to handover. BAM has further strengthened the risk management tools and business intelligence in these areas to improve predictability. In addition, the Group has further structured corporate risk management at strategic and management level by more indepth risk focus and assessment. BAM continues to improve its risk management capabilities in order to realise the strategic agenda and guarantee value creation in the long term.
11 - BAM’s risk management framework
BAM’s risk management framework
At Group level, the BAM strategy is the starting point. The group’s strategy offers guidance on focusing the project portfolio (Doing Things Better), shaping the business portfolio (Doing Better Things) and the creation of the future portfolio (Doing New Things).
These areas and underlying strategic objectives and initiatives form the basis for the focus on enterprise risk management, taking into account BAM’s risk appetite. The Supervisory Board supervises and advises the Executive Board, which has the overall responsibility for enterprise risk management within the Group. There is an annual risk assessment for the Group in relation to the strategic agenda and operating plans.
BAM’s risk management framework, which is based on COSO (Committee of Sponsoring Organisations of the Treadway Commission, version 2017), addresses strategic, operational, financial and compliance risks. Risks are assessed and prioritized on their impact and probability and on effectiveness of the controls. The cycle is concluded with a risk response and monitoring of effectiveness in the organisation. The Executive Board receives progress updates on the status of the strategic objectives, initiatives and leading indicators through dashboards in periodic reports and in management meetings. This is also periodically shared with the Supervisory Board.
At the operating company level, management of the portfolio and tender management is essential for a healthy order intake and supervises a tender in various phases. BAM focuses on data-driven tendering where there is a close link between the sales funnel, tendering and execution. Lessons learned during the implementation are used for tender selection and for improving the stage gate database. The management of the operating companies closely monitors the progress of projects, the risks and the opportunities and actions goning forward in periodic reports and in project and management meetings.
At project level, the project team wants to manage the contract and the expectations of customers in the most effective and efficient way, by forming the right team that can make this possible and choosing the right tools and capabilities to support them. Digital construction is one of the means to minimise risk and cost. In addition, project teams manage risks and opportunities, both qualitatively and quantitatively, developed in the tendering phase as input for the periodic reporting of project performance. The periodic reporting also includes a bandwidth for the best and worst case scenarios to be reported to senior management.
The risk management and control system provides a platform for the structured sharing of knowledge and expertise between the operating companies, so that risk management plays a key role in achieving the strategic objectives. Business functions and topics across the Group accelerate the process of acquiring and sharing knowledge and expertise through a consistent language and approach to risk management.
Governance, Risk and Compliance (GRC)
Since 2017, enterprise risk management and the interconnected pillars related to governance and compliance have been further enhanced by establishing a new Governance, Risk and Compliance (GRC) function. The main responsibility for this role is to further evolve the GRC areas in line with the strategy 2016-2020. The GRC areas relate to the implementation and periodically recalibrating of BAM’s governance structure in line with market trends and strategic development of the Group, enhancing the enterprise risk management (ERM) programme and further develop compliance (including privacy) in accordance with social standards and relevant laws and regulations.
Insurance management is part of the risk management strategy of the Group. Insurance management is identifying insurable risks and buying the right insurance cover, with a balance between cover, cost and certainty of cover. The focus is on high impact events, and not on insuring frequent losses with low impact. All insurances are placed via professional insurance brokers and results are monitored at Group Level. All insurers have a minimum rating of S&P A-. Within the operating company dedicated insurance management teams assess and insure the risks associated with the construction of projects. The Group sets the minimum requirements for insurances to be secured by the operating company.
Within BAM, the Operational Audit Department has been established as an objective, independent function to assess the effectiveness and efficiency of the control environment. The capacity of the audit function is focused on the main risks the company faces in the project business it is involved in. Operational audits are an important and powerful tool in the mitigation of project-related risks at an early stage. In 2017, high-risk projects throughout the Group were visited shortly after contract award to assess the effectiveness of the project control system.
Operating model supporting internal control framework
The BAM strategy is supported by the BAM operating model that creates clarity and uniformity in the way the company operates. All key processes are identified around strategic enablers and are aligned with existing core processes in accordance with these enablers. BAM has derived its internal control framework from this operating model and underlying core processes and uniform guidelines and policies (for accounting, treasury, legal, compliance, information security, and so on). The internal control framework ensures insight in the effectiveness of internal risk management and control systems, as well as the reliability of the financial reporting and compliance with laws and regulations. Moreover, the internal control framework uses COSO as an external reference framework.
Comfort on the effectiveness of the internal control framework is obtained by a semi-annual assessment of the requirements in the framework. The Group and operating companies carry out self-assessments and the results are reported to the Group Governance Risk & Compliance function. No significant deviations are identified and improvement areas are defined. Most important improvement areas are finance, IT, procurement and project executionThe results of these self-assessments are challenged by the Group and improvement actions are discussed and monitored.
In control statement process
BAM has a structured 'in control statement process', resulting in an end-of-year 'in control statement' in the integrated report. The underlying assessments on operating company level form the basis for management’s accountability for the effectiveness of the internal control framework, together with the formal issuance of a statement and letter of representation to the Executive Board. Any deviations from the minimum requirements are highlighted, including identified follow-up actions to resolve these deviations. The Executive Board report is included in this integrated report.
Core values supporting the right risk culture
BAM’s risk management and internal control system is supported by BAM’s core values. These elements are instrumental in steering the behaviour of BAM’s people and help to ensure that BAM’s risk profile remains in line with the risk appetite. The Group’s culture is further strengthened by scalable learning from tenders and projects, more predictable performance, working together in open collaboration and ownership of challenges and opportunities. BAM’s people are fundamental to its success. This is why project and business careers are being aligned. A stronger culture will be promoted to make the Group more attractive as an employer and a partner par excellence.
Main risk areas
Several risk areas and measures have been identified with respect to BAM’s strategic objectives. Follow-up and feedback are part of the regular management reporting cycle. The main risk areas are specified on the following pages.
The markets in which BAM operates are subject to macro-economic volatility and are affected by government investment programmes, economic recession and political developments. There is fierce competition in most of the Group's home markets.
Limited availability of capital may lead to cancellation and postponement of property development, construction and PPP projects, putting the value of BAM's portfolio under pressure. Intense competition may lead to a buyer’s market, which influences margins, causes a shift in design and contract risks for the contractor and endangers the pre-financing of projects by customers.
Because the market conditions differ per country, BAM strives for a diversified geographical footprint. Based on the Group's strategy, BAM applies a more disciplined focus on market segments and projects, where it can use either scale or expertise as a critical success factor. For its future business portfolio, BAM rationalises its propositions, and thus develops new solutions for customers and invests in digitization to be a market leader in how and what BAM builds. BAM invested in the required capabilities to support the achievement of the strategic objectives, for example by creating or strengthening corporate functions in the areas strategy, digital construction, innovation and governance, risk and compliance, but also by harmonising processes and procedures.
The re-focus within BAM following the 2016-2020 strategic programme Building the present, creating the future has influenced the way the Group wants to work. The transition to a new organisation involves the rationalisation of business models and businesses. This should involve a greater role for cooperation and more harmony and agility, so that BAM can follow the developments in the sector and be a leader in the selected markets.
BAM may not realise a successful and agile implementation of the Group’s strategic (One BAM) agenda, together with other strategic initiatives and targets.
The Executive Board is closely steering and monitoring the progress of the transformation activities as defined in the strategic agenda and translated in the yearly operating plans. Furthermore, there is extensive attention for leadership to embed BAM’s core values and behaviour.
The nature of BAM’s business can pose safety risks to its people. The well-being and safety of the people of BAM are of vital importance to the company.
Safety incidents may lead to serious injuries or even fatalities and may lead to project disturbance. Incidents may lead to loss of time, additional costs and as a result impact BAM’s performance.
The chapter ‘Stakeholder engagement and material themes’ describes BAM’s management measures as part of section Health and Safety.
The trust of customers, shareholders, lenders, construction partners and employees in the Group is vital to ensure the continuity of the company.
BAM’s reputation may be damaged if it fails to successfully mitigate the main reputational risks, such as fraud, bribery and corruption.
The chapter ‘Stakeholder engagement and material themes’ describes BAM’s management measures as part of section Business conduct and transparancy.
Attracting, training and retaining talented people is crucial for BAM, because it enables the Group to respond more effectively to changes in the market by exploiting its full potential. It is essential that BAM remains a preferred employer.
The inability to keep the right talent, expertise and human capital within BAM will have a negative effect on success.
BAM strives for an open culture of learning and exchanging knowledge in the form of training and education, building on the available knowledge and expertise. To attract top talent,
BAM has a professional recruitment team that works together with recruitment agencies through advertisements, but also with various training institutes. BAM increases the mobility of employees between the core businesses. The Group invests in the further development of employees through various training programmes, including a program for management trainees, project directors and project managers, and prepares candidates for key positions to improve (inclusive) leadership.
BAM is active in thousands of projects where the company is exposed to a wide variety of risks, in a sector known for its asymmetrical risk profile. Selecting the right projects against balanced contractual conditions is crucial.
Failure to achieve a healthy order intake and flawless project execution leads to fluctuations in the project results, possible claims and litigations and ultimately to the failure to achieve BAM's strategic objectives.
BAM implemented several measures to manage the project risk. The starting point is a selective tender with a focus on portfolio management, a robust tender stage gate procedure and peer reviews. The results of projects are largely determined during the tendering phase, and work is constantly being done to strengthen this process. Moreover, in projects that exceed €300 million, BAM basically makes bids together with partners. This usually involves the establishment of a general partnership – a legal form in which all parties are jointly and severally liable for mutual obligations in connection with the implementation of the project. The Group only enters into joint agreements with solid and solvent partners. If the risk to which a partner is exposed nevertheless is judged to be too high, BAM requires other securities in the form of, for example, a bank guarantee or the investment by the partner of sufficient cash in the joint agreement. During the implementation phase, much attention is paid to achieving operational excellence with, among other things, the right composition of the project team, design management, schedule management, contract management, working capital management and project monitoring.
Supply chain risk
On an annual basis, the Group purchases more than 70% of its turnover from suppliers and subcontractors. These companies have a major impact on the projects, both financially and technically.
Failure to manage the cost of the supply chain (subcontractors, materials) and insufficient acces to qualified and cost-effective vendors has impact on succesful and profitable execution of the projects.
The chapter ‘Stakeholder engagement and material themes’ describes BAM’s management measures as part of section Procurement.
The Group’s industry is at the brink of major technological changes. Digital technology is beginning to change value creation within the construction industry where traditional capabilities may become commoditised.
Competitors or newcomers on the market can marginalize BAM's distinctive capabilities and thus jeopardize the existing business model.
The chapter ‘Stakeholder engagement and material themes’ describes BAM’s management measures as part of section Innovation.
Information technology risk
Digitalisation, data, communication and connectivity are essential for BAM. A global presence also leads to cyber security challenges, which require the Group to have the flexibility to continually adapt.
Information technology is crucial in supporting and protecting the core and supporting processes. BAM increasingly relies on digital communication, connectivity and the use of technology. The Group has to remain alert to prevent the use of compromised data and the unavailability, loss or theft of critical strategic, financial and operational data.
BAM aims to improve the maturity of the IT function to keep up with external developments. In addition, BAM increased its security efforts to remain resilient to growing cyber risks. This includes implementing and testing of confidentiality and continuity measures as well as the integrity of data. Training and communication increase familiarity with safe IT use among BAM people and partners, as this is considered essential.
The construction industry relies heavily on natural resources, which will be depleted as soon as the consumption goes faster than the natural supplement. Global warming and climate change cause more frequent extreme weather conditions, such as storms, heat waves, droughts, heavy rainfall with flooding and heavy snowfall.
Failure to deliver more sustainably and innovatively could disrupt BAM's position vis-à-vis customers and chain partners. Extreme weather events and material shortages can lead to disruption of the building process.
BAM has a strong corporate team to support continuous improvement and makes considerable efforts to reduce the impact on the environment with the ambition to achieve a net positive result. To reduce the impact of BAM on resource use, the company works with partners in the supply chain and customers to explore circular economic business models.
The attractiveness of BAM as a trusted partner to cooperate with or to invest in is strongly influenced by its financial position and the ability to manage financial risks.
Failure to achieve the status of trusted partner may prevent BAM from working with preferred parties and lead to restrictions on access to financial markets.
BAM's financing strategy is based on long-term relationships with reputable financial institutions and a well-spread debt maturity schedule. A strong centralised focus on cash and working capital, including financing by clients and suppliers, limits the need for extra capital. The company enters ‘equity-light’ in property development projects and in PPP investments. It is the intention of the company to sell these projects to investors.
Specific financial risk management measures, including those in the area of interest rate risk, foreign exchange risk, price risk, credit risk and liquidity risk are disclosed in note 3 of the financial statements.
Property development risk
BAM is involved in property development for its own account. The level and timing of both income (sale/rent) and costs (site acquisition and building costs) of these projects may deviate from the initial expectations as a result of divergent market and process (planning/permits) conditions. BAM’s capital employed position is important to adequately finance the projects.
Property development projects can be postponed or completed at higher costs than budgeted. Furthermore the realisable value of our land bank and property development positions may be lower than book value. This again has consequences for the financial results (level and duration of the capital employed, profit).
If the Group intends to take on property development risks, this requires the prior consent of the Executive Board. The latter takes a decision on the basis of project proposals from the relevant operating company and associated analyzes carried out by the Group’s Property Investment function. The general rule is that construction does not start before a significant number of properties have been sold or, for non-residential buildings, a large part of the project has been rented out or sold. However, the United Kingdom – where BAM only operates in the non-residential property sector – is an exception to this. There, the inventory risk is mitigated by a system of phased project execution.
Data driven tendering
BAM has further strengthened its data driven decision process by linking sales, tendering and project execution data with each other. During 2017 BAM completed its project management database covering financial data of projects. This information is used as input for our sales and tender decision making process. Additionally, BAM started with the development of a BAM wide sales funnel to track projects leads from all operating companies in an integrated manner. In the meantime, BAM has created extensive tender data over the years to make better data-driven decisions. Lessons learned from these tenders are shared with the management of the operating companies, focusing on product type, client relationship, geographical location, contract type and preferred partners for the tender at hand. Combining this data with project execution data ensures even better focus on business development and selective tendering.
Fundamental behind managing a healthy order intake is BAM’s tender stage gate procedure (see scheme below). Material tenders are guided through various stage gates based on the complexity and size of the tender (tender category). Through the process, qualitative and quantitative risks and opportunities that may impact the success of the tender are considered. Areas considered include client, contract, team, work schedule, finance, partners, safety, location et cetera.
The stage gate procedure also includes several approval rounds depending on the risk profile. The procedure follows a governance structure based on tender categories to ensure tenders are reviewed and approved by the right level of management. Bids for major projects or projects involving exceptional risk are submitted and presented to the Executive Board and – if necessary – the Supervisory Board for prior approval.
Peer reviews and Tender Assessments are performed by experts from other operating companies in the Group during the tender phase of major projects. These reviews mobilise the full knowledge of the Group and contribute in robustness of the proposal made to the client.
12 - Tender stage gate procedure
What impacted BAM in 2017?
Some risks and uncertainties related to the nature and complexity of the business environment but also opportunities had an impact on BAM in 2017. Some examples are given in this section.
The United Kingdom is BAM’s second largest home market after the Netherlands. BAM’s UK activities are split between three operating companies: BAM Construct UK in non-residential construction and property development, BAM Nuttall in civil engineering and the UK operations of BAM PPP. They are widely diversified by location (strong regional presence across the United Kingdom), client base (public and private) and market (retail, office and industrial construction, and across all civil sectors.) The operating companies are among the leaders in their markets.
The impact of Brexit remains uncertain, which is why BAM will continue to monitor developments closely, maintain tender discipline and adapt its organisation and operations if required.
BAM’s performance in 2017 was impacted by an asymmetric risk profile. There was a considerable project loss on the sea lock in IJmuiden. The loss mainly related to the redesign of the two caissons (the construction holding the lock doors) to prevent torsion and cracking during ummersion. The new design specified reinforced caissons and heavy temporary structures, which lead to significantly higher costs for specialist materials, equipment and personnel. The redesign is expected to be finalised in April 2018. There have been changes in the management of the project and there will be close monitoring on the progress of the project. The project is still in an early stage. Furthermore, there has been additional attention for improvements in the design management process within BAM.
Although the focus on safety remains high, the company still faces incidents at project sites. Besides having the knowledge and tools to work safely, it is crucial that employees can always communicate openly about unsafe situations with each other and their managers.
Collapse of parking garage
There was a partial collapse of the P1 parking garage under construction at Eindhoven Airport on Saturday 27 May 2017. Investigations have shown that the shear strength of the interface between the precast concrete floor slabs was insufficient to convey the traction. As a result, the structural capacity of the floor was compromised. Further discussion among all parties involved will have to determine who can be held responsible for the incident. BAM and Eindhoven Airport agreed to rebuild the parking garage in 2018. In addition, BAM performed a review of other buildings constructed by BAM with a similar production method. Based on this review the financial impact is considered to be limited.
Digital and sustainable solutions
A positive impact is BAM’s progress with its development and implementation of digital and sustainable solutions that ensures our leadership in the construction sector. BAM has been awarded international prizes in the area of digital construction. BAM sees a growing number of circular and energy neutral opportunities, which BAM also won because of our innovative construction methods. Some examples are Circl and Bijlmer prison facility in Amsterdam and the gravity based foundations for Blyth Offshore Demonstrator wind farm in the northeast of England.
Executive Board statement
The Executive Board is responsible for the design and operation of the internal risk management and control systems. In discharging this responsibility, the Executive Board has made an assessment of the effectiveness of the design and operation of the internal control and risk management systems. Furthermore, the Executive Board determined the outlook based on market developments, orderbook, cash flow and financing.
On the basis of this management report and in accordance with best practice 1.4.3 of the Dutch corporate governance code as adopted on 8 December 2016, and article 5:25c of the Financial Supervision Act (‘Wet op het financieel toezicht’), the Executive Board confirms that, to the best of its knowledge:
- the management report provides sufficient insights into any significant failings in the design and operating effectiveness of the internal risk management and control systems of Royal BAM Group;
- the aforementioned systems provide reasonable assurance that the financial reporting does not contain any material inaccuracies;
- based on the current state of affairs, it is justified that the financial reporting is prepared on a going concern basis; and
- the management report states those material risks and uncertainties that are relevant to the expectation of Royal BAM Group’s continuity for the period of twelve months after the preparation of the management report.
It should be noted that the above does not imply that these systems and procedures provide absolute assurance as to the realisation of operational and strategic business objectives, or that they can prevent all misstatements, inaccuracies, errors, fraud and non-compliances with legislation, rules and regulations. Nor can they provide certainty that we will achieve our objectives.
In view of all of the above, the Executive Board confirms that, to the best of its knowledge:
- the financial statements give a true and fair view of the assets, liabilities, financial position and profit or loss of Royal BAM Group and of companies included in the consolidation;
- the management report provides a fair review of the position at the balance sheet date, the development and performance of the business during the financial year of Royal BAM Group; and
- the management report describes the principal risks and uncertainties that Royal BAM Group faces.
13 - Linkage between BAM’s strategy, material themes and performance indicators