As a major transport company, NCSP Group is subject to numerous and varied risks. The Group’s management pursues a focused policy to minimize potential risks, working to improve production potential, expand the Group’s presence on the port services market and build strong partnerships with companies in related industries. The ongoing work to develop a risk management system allows the Group to perform a comprehensive analysis of various types of risk, to gauge, assess and control these risks, and to
take timely measures to reduce their effect on operations.
The Group’s risk management efforts are aimed at introducing highly efficient technology and equipment, increasing the productivity of cargo handling, improving financial planning, improving cost control systems, conducting an effective price policy, and expanding the range and improving the quality of services offered.

INDUSTRY RISKS

The majority of NCS P Group’s income comes from the transshipment of goods, demand for which is sensitive to changes in the economic conditions on global markets. Demand for these goods could fall in the event of a deterioration of the economic climate, which would lead to a reduction in the volume of exports and, consequently, in
the amount of the Group’s operations with these goods. A global economic crises could reduce demand for many exported goods, causing a drop in Group revenue in certain areas. The Group’s policy of diversifying cargo turnover reduces these risks.

Government Price Regulation
NCS P Group is listed as a natural monopoly in the transport business, so its prices are regulated by the Federal Tariff Service (FTS). The Group’s profitability depends on the maximum tariffs allowed by the FTS for stevedoring and related services, and the Group’s ability to obtain approval to raise the maximum rates in response to higher costs or the expense of investment projects to expand and modernize transshipment capacity. The FTS has the right to review the tariffs at its own discretion, but generally does so following a request by the Group to review current rates. A delay in approval for higher tariffs following an abrupt rise in costs can affect the Group’s profitability.

Deterioration of Transport Infrastructure
Most of the cargo handled by the Group is delivered by train, truck or pipeline. The deteriorating state of Russian transportation infrastructure could lead to irregularity in the amount of cargo, which could have a negative effect on the Group’s financial performance and its operating prospects.

Congestion of Turkish Straits
NCSP Group’s operations depend on shipping lines, most of which travel through the Bosporus, Sea of Marmara and the Dardanelles (together, the Turkish Straits). The Bosporus and Dardanelles are narrow and quite congested. Ships often have to wait for a long time to pass through them due to inclement weather conditions, inspections by the Turkish authorities and other delays. There are also certain restrictions on the volume and size of the ships passing through the Turkish Straits, as well as special safety requirements on the transport of some cargo. The introduction of new or a tightening of existing restrictions, an increase in congestion, any maritime or
environmental accidents, oil spills and similar events could negatively affect our financial position, performance results and operating prospects.

Inclement weather conditions on the Black Sea
The Group is periodically forced to suspend loading and unloading work at Novorossiysk Port due to inclement weather conditions. Poor weather conditions can lead to delays in loading and unloading of ships moored at Novorossiysk Port, despite the fact that the port continues to unload cargo from arriving rail cars and store it in its warehouses. Protracted spells of bad weather could lead to delays and a shortage of available warehouse space and cargo ships, which could, in turn, lead to delays and stoppages in the Group’s operations or negatively affect NCSP Group’s financial position.

Risk of accidents and emergencies
An accident or oil spill in the port could lead to an interruption in operations and work for the period of time needed to repair the consequences or damage to production facilities and the environment, which could have a negative effect on NCSP Group’s financial performance. To prevent accidents and eliminate their consequences, the Group has a fleet of specialized ships designed, among other things, to ferry ships to shelter and to clean up and contain oil spills and spills of other liquids into the harbor waters. If the technological risks related to the breakdown of production equipment come to pass, this could also lead to a stoppage of operations and a failure to
reach set production and financial goals.

COUNTRY RISKS
The risks associated with operating in the Russian Federation, a country with a rapidly changing political landscape, economy and financial system, could adversely affect the Group’s business. The instability of the Russian economy, which was exacerbated by the global financial crisis, heightens the risks of a slump in industrial production, and therefore a drop in demand for the Group’s services; the risk of changes in guarantees for investors in port infrastructure; and the risk of changes in tariff policy for sea and rail transport, as well as tariffs for electricity, among other things.

FINANCIAL RISKS

The Group pursues a balanced financial and borrowing policy and holds corporate ratings from Moody’s and Standard & Poor’s. At the end of 2010, the Group’s foreign and local currency rating from S&P was BB + (CreditWatch negative), and its foreign currency rating from Moody’s was Ba1 (on review for downgrade).

Interest rate risk
NCS P Group borrows on the domestic and foreign capital markets. At the end of 2010 the Group’s debt portfolio did not include any loans or other borrowing with a floating interest rate, which significantly reduces interest rate risk.

Currency Risk
Currency risk is associated, first and foremost, with unfavorable changes in currency exchange rates. The tariffs for NCS P Group’s stevedoring services are calculated in US dollars, but invoices are issued to Russian clients in Russian roubles at the exchange rate of the Central Bank of the Russian Federation on the date of provision of the services. The Group incurs most of its direct costs, including wage and transportation costs, in roubles. Our revenue and cost structure is such that the appreciation of the rouble against the US dollar usually leads to an increase in the ratio of our costs to revenue, while the depreciation of the rouble against the US dollar leads to a decrease in the ratio of our costs to revenue. Accordingly, a significant appreciation of the rouble against the US dollar could have a negative effect on our financial results, and a significant depreciation of the rouble against the US dollar could have a positive effect. The Group tries to maintain an even ratio of assets and liabilities denominated in a foreign currency.
Given the current balance in NCSP Group’s foreign currency revenues and liabilities, the Group was not using any additional instruments to hedge currency risks as of the end of 2010.

Credit Risks
Credit risks are risks associated with the inability of counterparties to execute their contractual obligations, leading to financial losses. To minimize this risk, NCSP Group uses an internal credit rating system to check the creditworthiness of each potential buyer, and focuses on partnership with clients that have a high credit rating. We take active and diverse measures to reduce our credit risks, like mandatory prepayment of some Group's services.

Liquidity Risks
Liquidity risks are risks associated with NCSP Group’s inability to settle its obligations. The Group’s liquidity level is watched very closely, and kept at the necessary level during planning and budgeting. NCSP Group has a steady cash flow from operations, which enables it to pay its obligations in a timely manner. Another risk associated with a reduction in cash flows is the risk of restricted access to financing on international currency and capital markets. To reduce the risks of outside financing, NCSP Group continues to cultivate its mutually beneficial relations with its main partner banks.

LEGAL RISKS

Changes in Tax Legislation
The government of the Russian federation has commenced a revision of the Russian tax system and passed certain laws implementing tax reform. The new laws reduce the number of taxes and overall tax burden on businesses and simplify tax legislation. However, these new tax laws continue to rely heavily on the interpretation of local tax officials and fail to address many existing problems.
Many issues associated with practical implication of new legislation are unclear and complicate the Group’s tax planning and related business decisions. In terms of Russian tax legislation, authorities have a period of up to three years to re-open tax declarations for further inspection. Changes in the tax system that may be applied retrospectively by authorities could affect the Group’s previously submitted and assessed tax declarations.
While management believes that it has adequately provided for tax liabilities based on its interpretation of current and previous legislation, the risk remains that the tax authorities in the Russian Federation could take differing positions with regard to interpretative issues. This uncertainty may expose the Group to additional taxation, fines and penalties that could be significant.

Changes in currency legislation
Part of NCSP Group’s assets and liabilities are denominated in a foreign currency, which means that changes to currency regulations could affect the Group’s financial and business activity. The currency legislation of the Russian Federation has been significantly liberalized, with regulation of various types of currency operations related to capital movement and the creation of reserves for currency operations having been abolished. However, due to the financial crisis and the resultant depreciation of the rouble, the risks of a tightening of currency regulation and control over the circulation of foreign currency have increased significantly, which, in turn, could lead to the risk of late performance of financial obligations by and to foreign partners.

Changes to environmental legislation
Due to the specific nature of its operations, NCSP Group is governed by multiple environmental norms and requirements, established at both the federal and the regional levels. The introduction of new regulatory acts or changes to existing ones may have a negative impact on the operating activity of Group enterprises. At present the Group is in full compliance with the requirements and prescriptions of Russian law in this field. However, at the same time NCSP Group does not rule out the possibility of a further tightening of environmental protection regulations, or the possibility of judicial claims from the state and third parties, which may result in additional costs to bring operating activities into compliance with the new requirements, eliminate violations, and pay restitution for environmental or material damages.

Changes in other areas of legal regulation
In order to minimize the negative effect of legal risks, we constantly monitor changes in legislation, assess and forecast the possible effects of such changes on our operations, and take them into account during planning and budgeting processes.

INTERNAL CONTROL AND AUDITING

Internal control is part of NCSP Group’s corporate governance system and is aimed at the timely identification and analysis of risks arising from company operations. It is also intended to ensure the implementation of the Group’s financial and commercial plans, compliance with laws and the company’s internal procedures, and the authenticity and reliability of all reporting.

The Internal Control Service and the Internal Audit Commission are the key units of the internal control system. Management bodies and certain other divisions of the Group also participate in the internal control process in accordance with the authority granted to them by the founding and internal documents.
The Audit Committee of PJSC NCSP’s Board of Directors reviews the effectiveness of the internal control system.

Internal Audit Commission
The Internal Audit Commission monitors the financial and commercial activities of PJSC NCSP, its divisions, services, affiliates and offices. The five member Internal Audit Commission is subordinate to the General Shareholder Meeting and is elected by shareholders for a term ending at the next annual General Shareholder Meeting.
The powers of the Internal Audit Commission are defined by the federal law On Joint Stock Companies, the PJSC NCSP Charter, and the Regulation on the PJSC NCSP Internal Audit Commission.
The Internal Audit Commission is responsible for reviewing financial and commercial activities and documentation, analyzing the company’s financial health, reviewing the competence of decisions made by management bodies, and other functions. The Internal Audit Commission conducts one mandatory audit of financial and commercial activity for the year as well as spot audits. It prepares a report stating its conclusions on compliance with or violation of laws, regulations, the Charter and internal documents, and an evaluation of the authenticity of the information in reports and other financial documents.
The Internal Audit Commission and the Internal Control Service verify the quality of reports and make necessary changes at each stage of the preparation of financial statements, first to Russian accounting standards and then to international standards. The Internal Audit Commission and Internal Control Service work closely with the external auditor in preparing and disclosing financial statements.
PJSC NCSP’s Internal Audit Commission, as of the end of 2010, included:
• Tatiana Vnukova, Vice President for Consolidated Planning and Analysis of financial and business activity at PJSC NCSP’s Moscow office
• Yulia Maslova, Planning Director, Deputy Director of Project Development for the Stevedoring Division at PJSC NCSP’s Moscow office
• Tamara Stretovich, Chief Analyst, ground transport, water transport and fisheries, in the infrastructure sectors and military-industrial complex department of the Federal Property Management Agency
• Tatiana Chibinyaeva, Senior Vice President for Finance, PJSC NCSP
• Marina Yazeva, Chief Accountant, Director of Accounting, PJSC NCSP Moscow office

Internal Control Service
The Internal Control Service is an independent division of PJSC NCSP that is governed by the Regulation on Internal Control of PJSC NCSP Financial and Commercial Activity, the Method for Auditing Financial and Commercial Activity, and the work plan approved by the PJSC NCSP Audit Committee.
The Director of the Internal Control Service reports to the Audit Committee of the Board of Directors.
The Internal Control Service focuses on four key areas under the Procedures for Internal Control adopted by the Audit Committee in 2008:
• Review of consolidated budgets, income and expense budgets submitted for approval by the boards of directors of PJSC NCSP and its subsidiaries
• Review of the implementation of investment projects
• Review of compliance with corporate regulations and laws governing the activities of joint stock companies
• Review of administrative issues
Under a decision made by PJSC NCSP’s Chairman of the Board, as of March 2008 the members of the Internal Control Service serve as experts and develop relevant recommendations on all matters considered by the Boards of Directors of Group companies.
The Internal Control Service conducted 54 audits in 2010 of the financial and business activities at Group companies, finding 144 issues in accounting records.
The Service also reviewed 1,537 contracts concerning financial and business activities worth more than 3 million rubles each.
The Internal Control Service had 23 employees from January to November 2010, when its staff was expanded to 25.

Manag ing IFRS risks
In preparing consolidated financial statements in accordance with IFRS, the NCSP Group currently uses an approach based on converting financial statements prepared on
the basis of Russian Accounting Standards (RAS), into IFRS. However, there are also elements of parallel accounting, including accounting for non-current assets. While preparing for conversion, records in RAS are checked for completeness and continuity. Then, based on an analysis of the differences between IFRS and RAS, adjustments are made and draft accounts are compiled including all the key modules of the financial statements. All material aspects are analyzed for integrity of the statements and the notes.
Every quarter, prior to the approval of the IFRS statements, the Financial department and Internal Control Service compare IFRS data with management reporting. All differences are analyzed. Comparing consolidated planned indicators with actual data and describing the reasons for discrepancies increases the reliability of the data presented in accounts.
The financial department also analyzes major differences between accounts for the current period and the two previous periods, and prepares detailed explanations for all differences, both for consolidated statements and individual IFRS restatements of subsidiaries. In order to control working capital, cash flow statements prepared on the basis of management reporting data are compared against those prepared in accordance with IFRS .The completeness of information disclosure is verified using a checklist of information that must be disclosed in accordance with IFRS requirements. This list includes requirements and recommendations for disclosure of information, developed by the IFRS Committee in regard to standards in effect on the reporting date. If there are mandatory disclosure items for which requirements have not been met, explanations are made (for example, the amount is considered non-material) or the necessary corrections are made to the Group’s consolidated IFRS statements. In addition, educational seminars are held with consultants from the Big Four accountancy firms to clarify the application of new and amended standards. Carrying out the above key procedures gives NCSP Group management the confidence that the consolidated financial statements are reliable and fully reflect the actual business activities of the Group as a whole. The statements are approved by PJSC NCSP’s Chief Executive Officer.
In addition to the procedures performed internally, the independent auditors plan and perform audit procedures to obtain reasonable assurance as to whether the consolidated financial statements are free from material misstatement and present fairly the consolidated financial position, financial performance, and cash flows of the Group. In planning such procedures, the auditors consider internal controls relevant to the Group’s preparation and fair presentation of the consolidated financial statements.

External Audit
PJSC NCS P hires an independent auditor to the consolidated and financial statements. The Audit Committee gives preliminary approval of the external auditor and the Board of Directors submits the candidate for confirmation by the General Shareholder Meeting. PJSC NCSP shareholders at the Annual General Meeting approved ZAO Deloitte & Touche CIS as the independent auditor of the company’s accounts for 2010. The firm has been PJSC NCSP’s independent auditor since 2007 (for statements prepared in accordance with to IFRS).
The cost of reviewing the interim consolidated financial statements as of June 30, 2010 was $236,000. The cost to audit the consolidated financial statements (NCSP and subsidiaries) under to IFRS and Russian Accounting Standards as of December 31, 2010 was $508,000 and $384,000, respectively.



 

Key operational Risks of the Group

 

NCSP Group's operations are exposed to a significant number of risk factors and uncertainties that are impossible to gauge reliably, but which are capable of having a material effect on the Group's performance results. NCSP Group management is constantly working to ensure that the existing uncertainties and risks are fully accounted for when preparing forecasts and plans, to prevent the appearance of unexpected adverse situations and to mitigate their impact. The ongoing work to develop a risk management system allows the Group to perform a comprehensive analysis of various types of risk, to gauge, assess and control these risks, and to take timely measures to reduce their effect on operations.

 

Internal Control

 

Internal control is an ongoing process at all governance levels of the Group, aimed at reducing the risks taken on, ensuring that operations and transactions comply with statutory requirements, and providing full and reliable reporting to shareholders and other interested parties. Key elements in the internal control system of NCSP Group are the Audit Commission and the Internal Control Service. Management bodies and certain structural divisions of the Group also participate in the internal control process, in accordance with the authorities assigned to them by the foundation documents and in-house statutes.

 

Audit Commission

 

The Audit Commission carries out its activities in the form of reviews: one mandatory review (audit) of financial and business activity based on annual performance results, and also extraordinary reviews. Decisions on issues assigned to the competence of the Audit Commission are taken at meetings that are conducted before the start of the internal audit (review) and after it, to consider its results. Based on the internal audit results, the Audit Commission prepares an opinion that states its conclusions on compliance with or violation of legislation, regulatory legal

acts, the charter and in-house statutes, and also an assessment of the reliability of the data contained in reports and other financial documents.

 

Internal Control Service

 

The Internal Control Service was created by decision of the Board of Directors of NCSP Group with the aim of analyzing and assessing the internal control system, and is an independent structural division, whose activity is monitored by CEO and the Audit Committee. The Internal Control Service performs its duties in accordance with the Regulations on Internal Control over the Financial and Business Activity of NCSP Group and the Methods for Performing Reviews of Financial and Business Activity. The main function of the Internal Control Service is to give an objective and independent assessment of the processes of risk management, internal controls, and corporate governance, in order to make them both more reliable and more efficient. In accordance with the Procedure for Applying Internal Control Procedures, approved by the Audit Committee in 2008, the activities of the Internal Control Service are organized into four main areas:

· expert analysis of consolidated budgets, income budgets and expense budgets submitted for approval to the Board of Directors;

· expert analysis of the execution of investment projects;

· expert analysis on issues of compliance with corporate legislation, and legislation concerning the activity of joint stock companies;

· expert analysis of administrative issues.

 

The structure, personnel, and the size of the Internal Control Service are determined by the Board of Directors on the basis of recommendations made by the Audit Committee. The Service is overseen by the Director of the Internal Control Service. To ensure that the Internal Control Service has sufficient independence to perform its assigned functions, the Internal Control Service Director reports directly to the Chief Executive Officer of NCSP Group and is subordinate to the Audit Committee of the Board of Directors.

Audits are performed by the Internal Control Service in accordance with the annual audit plan approved by decision of the Audit Committee, and the assignments of the boards of directors of NCSP and subsidiaries. Audit results are recorded in a report prepared by the Internal Control Service, which contains a description of the area of financial and business activity that was audited, a list of violations and shortcomings identified, and recommendations on eliminating them and preventing them in future.

Since March 2008 the Internal Control Service have also performed the duties of experts and issued relevant opinions on issues submitted for discussion by the boards of directors of Group companies and working meetings with the Chairman of the Board of Directors of NCSP.

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