Risk Report

TUI Group subsidiaries operate in tourism markets characterised until last year by moderate growth rates. The TUI Group’s Tourism Division again showed an overall positive development in the short financial year 2009, in particular because TUI Travel launched capacity adjustment measures in time to prepare for declines in customer volumes. Container Shipping recorded significant year-on-year declines in volumes and freight rates in the short financial year 2009, causing losses which also affected Group earnings. The contributions by the shareholders and the state loan guarantee granted on 6 October 2009 stabilised the financial situation of Container Shipping operations in the short financial year under review.

In terms of turnover, TUI is Europe’s market leader in tourism, above all due to its stake in TUI Travel PLC. Any company wishing to seize market opportunities and leverage the potential for success must inevitably accept risk to a reasonable degree. The purpose of a risk management system is to identify risks early on, assess them and contain them so that the economic benefit outweighs the threats.

The Executive Board and operative management employ multi-stage integrated reporting systems for risk management purposes. Within the planning and auditing system, deviations of actual from projected business developments are analysed on a monthly basis so that risks that might jeopardise the Company’s performance are quickly recognised. 

In addition, special independently organised reporting systems have been introduced for the early identification of risks threatening the existence of the Company. These risks are reported through a separate system, organised with its own distinct structure alongside operational risk management. Early risk identification aims to provide reports, both regular and case-by-case, in order to identify potential risks within the Group companies, assess these risks with the aid of uniform parameters and summarise them in an overall Group-wide system. The risk management measures to be taken are implemented within the operative entities and mapped and supported by means of operational systems. Nevertheless, there is a feedback loop between early risk identification (German Act on Control and Transparency in Business, KonTraG) and operational risk management.

The Supervisory Board is involved in this process by means of regular quarterly reports from the Executive Board and, where necessary, ad hoc reports at its regular meetings.

Risk management is supported by the Group-wide auditing departments, which examine transactions and operational workflows both regularly and on a case-by-case basis, checking that they function properly and are safe and efficient.

The methods and systems used in risk management and the frequency of controls is tailored to reflect different types of risk and are continually checked, modified and adjusted to changing business environments. The systems for early identification of risks threatening the Group’s existence were verified by our auditors while they were auditing our annual financial statements for the short financial year 2009.

The regular risk reporting system did not identify any specific risks threatening the continued existence of individual subsidiaries or the entire Group, neither during the 2009 short financial year nor at year-end.
 

Demand for tourism products hinges in particular on macroeconomic development. Tourism therefore faces risks if unemployment rates in the relevant source markets, including Germany and the UK, should rise significantly. Special risks in container shipping may arise if world trade only witnesses weak economic growth in the medium term or if it is hampered by protectionist tendencies.

These risks may, inter alia, result in weaker economic growth rates in countries of importance to the TUI Group’s activities. This may have an adverse effect on demand for services in tourism and container shipping and entail cost increases in the procurement of purchased materials and services or essential products.

Risks from acquisitions and divestments
In financial year 2007, the TUI Group’s tourism entities, excluding the hotel companies, were merged with First Choice to form the new company TUI Travel. In a first step, significant synergies were delivered, exceeding planned values. In the meantime, as a second step, additional synergy potential has been identified and supported by appropriate programmes and processes. There is nevertheless a risk of the actual synergy effects not matching the targets.

The acquisitions effected as part of the TUI Group’s realignment have created goodwill. Should cash flows fall below expected levels due to a business downturn, impairments (e.g. amortisation of goodwill) might be required and would thus impact Group earnings.

In financial year 2009, TUI AG sold its stake in Hapag-Lloyd AG and acquired a 43.33% stake in Albert Ballin Holding GmbH & Co. KG. TUI AG also granted a finance facility to container shipping. The planned reduction of this stake and the associated shareholder loan is proving difficult in the current market environment. TUI will therefore continue to be exposed to a financial risk from the business of Hapag-Lloyd AG, which has, however, been countered by the selective initiation and implementation of restructuring measures and the state loan guarantee in October 2009.

A substantial business risk in Tourism relates to the seasonal planning of flight and hotel capacity. In order to plan ahead, tour operators must forecast demand and anticipate trends in holiday types and destinations. The TUI business model underlying operations in TUI Travel and Hotels & Resorts is well suited to countering the ensuing capacity utilisation risks:

• The Group’s own airline and hotel capacity is considerably lower than the number of customers handled by its tour operators. This enables the Group to keep its product portfolio flexible by sourcing third-party flying capacity and hotel beds and concluding contractual agreements accordingly.
• The Group’s presence in all major European countries allows it to limit the impact of regional fluctuations in demand on the take-up of capacity in the destinations.
• Additional opportunities are offered by multi-channel distribution and direct and modular online marketing of capacity.

In the wake of the merger of TUI’s tourism activities with First Choice to form TUI Travel in 2007, a division of labour was introduced for the central cash management system, previously managed exclusively by TUI AG, and the central financial risk management system. TUI Travel PLC performs these functions for the TUI Travel Group, while TUI AG continues to hold this function for all other business operations in the Group.

Policies exist to define financing categories, rules, competences and workflows as well as limits on transactions and risk items. Trading, settlement and controlling functions are segregated in functional and organisational terms. Compliance with the policies and limits is constantly monitored. As a matter of principle, all hedges entered into by the Group must be supported by underlying recognised or future transactions. Recognised standard software is used for recording, evaluating and reporting on the hedges entered into.

Financial instruments
In the TUI Group, financial risks mainly arise from payment transactions in foreign currencies, the need for fuel (aircraft fuel and bunker oil), and financing via the money and capital markets. In order to limit risks arising on changes in exchange rates, market prices and interest rates for underlying transactions, TUI uses derivative financial instruments not traded on stock markets. These are primarily fixed-price transactions (e.g. forward transactions and swaps) and, to a lesser extent, options. These transactions are concluded at arm’s length with first-rate companies operating in the financial sector whose counterparty risk is regularly monitored. Currency translation risks from the consolidation of Group companies not reporting in euros are not hedged.

Detailed information about hedging strategies, risk management and the scope of financial transactions at the balance sheet date is provided in the section on Financial instruments in the notes on the consolidated financial statements.

Liquidity management
In the course of the annual Group planning process, TUI draws up a multi-annual finance budget. In addition, TUI produces a monthly rolling liquidity plan covering a period of one year. The liquidity plan covers all financing categories within the Group.

Liquid funds, money and capital market instruments as well as bilateral bank loans and syndicated credit facilities are used to meet the Group’s financing requirements. Besides TUI AG, TUI Travel PLC in particular has separate access to banks and the capital market and is able to independently secure the liquidity of the tourism companies allocated to it.

In order to meet its long-term financing requirements, TUI had issued bonds worth a total of €2.6bn in the capital market as at the balance sheet date, comprising a total of five bonds including a hybrid bond shown as equity. The bonds had different structures and maturities. Future repayment or refinancing risks were limited by optimising the maturities and volumes of these bonds.

In the completed financial year, TUI AG repaid a bond worth €0.4bn maturing in August 2009 as scheduled and further financial debt worth €0.2bn due to market opportunities before the due date. On the other hand, TUI Travel PLC issued a five-year convertible bond worth £0.4bn sterling at the end of September 2009. TUI Travel PLC received the issuance proceeds in October 2009. Besides, TUI AG has issued a five-year convertible bond in October 2009. The proceeds of €0.2bn were received by TUI AG in November 2009. In addition, TUI Travel PLC signed a syndicated bank credit line worth £0.1bn sterling maturing in June 2012 at the end of September 2009. This credit line had not been drawn by the balance sheet date. This programme helped stabilise TUI’s liquidity position, as did the syndicated bank credit line of TUI Travel PLC from 2007 maturing in June 2012 worth £0.8bn sterling, of which £0.1bn sterling had been drawn by the closing date.

Due to the economic situation in container shipping, assets invested in the Hapag-Lloyd Group cannot be repaid within the planned timeframe. In order to enhance financial flexibility TUI has launched an asset streamlining programme aiming to generate inflows from the refinancing of assets and the sale of non-core assets not required for operating or strategic purposes.

TUI AG’s financial liabilities taken up via the capital market, the financing trans-action in connection with the exchangeable bond with an option for shares in TUI Travel PLC issued by a non-Group third party and TUI Travel’s syndicated credit facility comprise a number of obligations.

In the case of TUI Travel PLC’s syndicated credit facility, for instance, the obligations comprise the duty to comply with financial covenants covering (a) compliance with an EBITDAR-to-net interest expense ratio measuring the Group’s relative charge from the interest result and the lease and rental expenses; and (b) compliance with a net debt-to-EBITDA ratio, calculating the Group’s relative charge from financial liabilities. The covenants also restrict TUI Travel PLC’s scope for encumbering or selling assets, acquiring other companies or shareholdings and effecting mergers.

The capital market instruments, the financing transaction in connection with the exchangeable bond for shares in TUI Travel PLC as well as the syndicated credit facility also contain additional contractual clauses typical of financing instruments of this type. Non-compliance with these obligations awards the lenders the right to call in the facilities or terminate the financing schemes.
 
TUI AG’s and TUI Travel PLC’s business transactions and the expected business trend are continually checked for compliance with contractual provisions.

More detailed information on financing and financial debt is provided in the section Financial situation in the management report and under Liabilities in the notes on the consolidated financial statements.

Risks from pension obligations
Pension funds have been set up to finance pension obligations, in particular in the UK. These funds are managed by independent fund managers who invest part of the fund assets in securities. The performance of these funds may thus be adversely affected and impaired by developments on the financial markets.

The present value of the TUI Group’s fully or partly funded pension obligations for its Continuing Operations totalled €1.6bn, while the fair value of external plan assets amounted to €1.2bn. At the balance sheet date, the funded pension obligations thus exceeded plan assets by €0.4bn. Combined with the present value of pension obligations not covered by funds of €0.5bn, this resulted in pension obligations with a present value of €0.9bn, fully covered by pension provisions. Detailed information on the development of pension obligations is provided under the item Provisions for pensions and similar obligations in the notes on the consolidated financial statements.

Other financial liabilities
At the balance sheet date, the TUI Group had other financial liabilities of €3.1bn (€5.1bn at 31 December 2008). These liabilities mainly related to order commitments for investments. Around 22% of the total amount had a remaining term of up to one year.

At the balance sheet date, financial liabilities from operating lease, rental and charter agreements amounted to €2.9bn (€5.3bn at 31 December 2008). At €1.4bn, aircraft accounted for the largest proportion of financial liabilities from operating lease, rental and charter agreements, with €0.7bn relating to hotels, €0.4bn to travel agencies, €0.2bn to administrative buildings and €0.2bn to yachts, motorboats and Other. Around 24% of the total amount had a remaining term of up to one year.

Detailed information on other financial liabilities is provided in the corresponding section in the Notes on the Consolidated Financial Statements.
 

The TUI Group’s internal control system consists of internal controls and the internal monitoring system. The Executive Board of TUI AG, in exercising its function to manage business operations, has entrusted responsibility for the internal control system in the TUI Group in particular to the Group Controlling, Group Accounting & Financial Reporting, Group Finance and Group HR units based within TUI AG.

The elements of the internal monitoring system in the TUI Group consist of both process-related and non-process-related measures. Besides manual process controls, e.g. the ‘four-eyes principle’, another key element of process-related monitoring are the automated IT process controls. Process-related monitoring is also secured by bodies such as the working group on the German Act on Control and Transparency in Business (KonTraG), and by specific Group functions such as Group Tax or Group Legal.

The Supervisory Board, in particular the Audit Committee, of TUI AG, like Group Auditing at TUI AG and the decentralised auditing departments within Group companies, are incorporated into the TUI Group’s internal monitoring system through their non-process-related audit activities.

The Group auditors and other auditing bodies such as the tax auditor are involved in the TUI Group’s control environment through their non-process-related activities. The audit of consolidated financial statements by the Group auditor and the audit of the individual financial statements from Group companies included in the consolidated financial statements, in particular, constitutes the key non-process-related monitoring measure with regard to Group accounting.

With regard to Group accounting, the risk management component of the internal control system addresses the risk of misstatements in Group bookkeeping and external reporting. Apart from operational risk management, which includes the transfer of risks to insurance companies by creating cover for damage and liability risks and also hedging transactions to limit foreign currency and fuel price risks, the TUI Group’s risk management system also embraces the systematic early detection, management and monitoring of risks across the Group. In order to ensure systematic early risk detection throughout the Group, the TUI Group has installed a ‘monitoring system for the early detection of risks threatening the existence of the Company’ in accordance with section 91(2) of the German Stock Corporation Act, permitting the prompt identification, control and monitoring of all risks, over and above the requirements of this legislation. The Group auditors assess the proper functioning of the early risk detection system in accordance with section 317(4) of the German Commercial Code. The TUI Group adjusts this system swiftly to any changes in the respective environment. Group Auditing also performs regular system checks as part of its monitoring activities to ensure that the system is functional and effective. More detailed explanations of the risk management system are provided in the section on Risk Management in the Risk Report.

Controls implemented to secure proper and reliable accounting include, for instance, analysis of facts and developments on the basis of specific indicator analyses. Separation of administrative, execution, settlement and authorisation functions and implementation of these functions by different persons reduces the potential for fraudulent operations. Organisational measures also aim to capture corporate or Group-wide restructuring or changes in sector business operations in Group accounting in a rapid and pertinent manner. They also ensure, for instance, that bookkeeping transactions are completely recognised in the period in which they occur in the event of changes in the IT systems used by the accounting departments of Group companies. The internal control system likewise ensures that changes in the TUI Group’s economic or legal environment are mapped and that new or amended legal Group accounting provisions are applied.

The TUI Group’s accounting provisions, including the provisions on accounting in accordance with the International Financial Reporting Standards (IFRS), govern the uniform accounting and measurement principles for the German and foreign companies included in TUI’s consolidated financial statements. Specific provisions must, in addition, be met when preparing sub-group financial statements. Besides general accounting principles and methods, provisions concerning the statement of financial position, profit and loss statement, notes, management report, cash flow statement and segment reporting have been established in compliance with EU legislation.

TUI’s accounting provisions also govern specific formal requirements for the consolidated financial statements. Besides defining the group of consolidated companies, they include detailed stipulations for the components of the reporting packages to be prepared by Group companies. Formal requirements govern, inter alia, the mandatory use of a standardised and complete set of schedules. TUI’s accounting provisions also include, for instance, specific provisions on the reporting and settlement of intercompany pricing and the associated transactions for balance reconciliation or determination of the fair value of shareholdings.

At Group level, specific controls to ensure proper and reliable Group accounting include the analysis and, where necessary, correction of the individual financial statements submitted by the Group companies, taking account of the reports prepared by the auditors or any meetings to discuss the financial statements held for that purpose. Based on the control mechanisms already established in the PCE consolidation system or plausibility checks implemented through the system, erroneous financial statements based on TRACE schedules are selected and corrected, if necessary, at Group level. The central implementation of impairment tests for the specific cash-generating units (CGUs) from a Group perspective secures the application of uniform and standardised evaluation criteria. The scope of regulations also extends to the central definition of the parameters applicable in the measurement of pension provisions or other provisions at Group level. The preparation and aggregation of additional data for the preparation of external information in the notes and management report (including subsequent events) is also effected at Group level.

5. Disclaimer
With the organisational, control and monitoring structures established by the TUI Group, the internal control and risk management system enables company-specific facts to be captured, processed and recognised in full and properly presented in the consolidated financial statements.

However, due to the very nature of business activity, discretionary decision-making, faulty checks, criminal acts and other circumstances cannot be ruled out and will restrict the efficacy and reliability of the internal control and risk management system, so that even Group-wide application of the systems cannot guarantee the accurate, complete and timely recording of facts in Group accounting.

Any statements made relate exclusively to those subsidiaries included in TUI AG’s consolidated financial statements where TUI AG is able to directly or indirectly determine their financial and business policies such as to obtain benefits from the activities of these companies.