Risk management report

Enterprise Risk Management (ERM)

The ERM process is one of the best processes implemented by Sri Lanka Telecom PLC amongst a host of others that add value to the company and its stakeholders including it's investors. ERM has been practiced at SLT since 2010 when the process was first introduced with the necessary framework. From then, it has taken a few years for the ERM process to be adopted into Business As Usual (BAU) at SLT when making business decisions at functional, operational and strategic levels. By incorporating risk management in BAU, the company has been able to identify and escalate business critical risks to appropriate management forums. The year 2013 was remarkable in that the ERM process was used as a driving force in making business decisions. During the year, a series of reports indicating business critical risks were escalated to Board of Directors (BOD) for their review, consideration and direction. With the guidance of the BOD, appropriate decisions were taken on investments, diversification and direction for operational activities. Measures were also taken to use the ERM process to drive the company to a profitable business entity while effectively managing costs in a rapid dynamic business and industry environment.

Principal Risks and uncertainties

Communications industry regulation

SLT conducts its activities in accordance with the law and its regulatory obligations. This is achieved through, a comprehensive programme-based approach to compliance.

This programme-based approach at a corporate level is supported by a group of lawyers appointed to perform the functions of Business Unit Compliance. They are supported by business unit personnel who implement the compliance programmes within their business unit. The Audit Committee assists the Board in discharging its responsibilities by overseeing SLT’s approach to achieving compliance with legal and regulatory requirements. This oversight is facilitated by the preparation of regular compliance reports which are presented to the Audit Committee.

Regulatory requirements and constraints can directly impact our ability to compete effectively and earn revenues. Telecommunication Regulatory Commission of Sri Lanka (TRCSL) requires us to provide services at regulated prices. It can also require us to make retrospective repayments to other operators where we are found to have set prices outside regulatory requirements, and can impose fines on us for non-compliance with the regulatory rules

Regulatory decisions made during the year also contributed adversely to our risk profile, revenue and profits. These decisions failed to address imbalances in the competitive playing field. This means that some of our competitors in the consumer space continue to benefit from a combination of limited regulation on their core business combined with extensive sector-specific regulation being applied to our fixed-line business.

The role of the regulator in the telecom industry in Sri Lanka has become prominent in today’s dynamic environment created by the significant increase in competition. TRCSL, the regulator has been issuing new polices and guidelines more frequently than before to manage the industry to which SLT needs to comply with even if it is not necessarily favourable to the company.

Mitigation:We employ a team of regulatory specialists who, together with legal experts and external advisors, continuously monitor and review the scope for regulatory changes and potential future disputes. This team maintains a dialogue with regulators and with other key influencers to ensure our positions are understood and to drive for fair and proportionate regulation. We are also able to appeal any regulatory decisions where we believe errors have been made.
We believe risks can be mitigated by seeking changes in regulation to level the playing field so that we can compete effectively, and for the benefit of our customers.

National Backbone Network (NBN)

As per the license, NBN operations which commenced in June 2013 is to be developed with a roll out target to be achieved annually over five years from commencement. At the end of 5 years, NBN should be capable of providing services from 329 access points covering all Divisional Secretariats in the country.

Risks: A penalty charge of Rs.500,000 per access point is applicable if SLT fails to achieve the target. A performance bond worth of US$ 2,000,000 has also been imposed as a performance security of NBN.

Mitigation: SLT is working diligently with high performing teams assigned to meet these conditions of the NBN license. Further, SLT is working closely with the regulator, keeping them informed of any deviations from the target as stated in the license.

Regulation of Tariffs

Despite the unhealthy competition created due to backbone network developments being carried out by competitors, the tariffs of the NBN services are regulated. With the commencement of NBN, the tariffs of the Wholesale services were revised to meet the regulatory requirement as the regulator anticipates an increase in demand for wholesale services from NBN.

Risks: The retail market is already feeling the competition in the international voice and broadband markets which has challenged the sustainability of the revenues resulting in eroding margins for retail products. Application of the revised tariffs to the services already being provided might have a negative impact on the wholesale revenue if the demand is not increased as expected due to existence of duplicate backbone networks in the market. Negative impact on the wholesale revenue will only add to a further eroding of the bottom line.

Mitigation: SLT is carrying out regular communications with TRCSL, highlighting and emphasising the disadvantage position of NBN in the current market while requesting TRC’s active intervention to promote NBN as a national asset.

Quality of Service measurements (QoS) by TRCSL

TRCSL carries out measurements of QoS of the broadband products of service providers and publishes the results in the TRC web site. Further, TRC has published a consultation paper requesting comments with regard to the QoS measurements of Voice services as a means of providing additional guidelines to the industry.

Risks: As the QoS of products are published as a comparison with other operators, a competitive disadvantage may be created due to degradation of the QoS of SLT products.

Further, as an outcome of the consultation paper, TRC will issue a policy with regard to the QoS of voice services despite the practical difficulties of measuring some of the parameters as stated in the consultation paper.

Mitigation: SLT works diligently with high performing teams to manage the best QoS of SLT broadband products and measures are being taken to carry out frequent testing with TRC while complying with the guidelines issued by TRC. In response to the consultation paper, SLT has already notified the limitations in measuring some of the parameters stated in the consultation paper and have forwarded to the TRC suggestions/proposals to be considered when formulating policy.

Regulatory policy on Cable Landing Stations

Several operators have been issued with licenses to operate cable landing stations in Sri Lanka.

Risks: Despite the decision made by SLT to invest on submarine fibre cable SEA ME WE 5 of tera byte capacity which is going to be the superhighway for global communication, implementation of another cable landing station is in progress by a competitor. This will now open access to other cable landing operators to participate in similar initiatives. Therefore competition created from duplicate cable landing stations will have a negative impact to SLT cable landing stations.

Mitigation: SLT is continuously communicating to TRC regarding these developments and of SLT’s role in protecting national interest in order to seek maximum support from TRC.

Other policies of TRC

It is expected that new policies will be introduced in order to regulate the telecom industry in Sri Lanka including the introduction of a new Broadband Policy that is expected to be released in the near future. In accordance with the Regulatory Framework for NGN issued by TRCSL, new guidelines related to NGN operations might also be issued for operators to comply with. In addition, a review of the Telecommunication Act 25 of 1991 was initiated by TRC where SLT has already submitted suggestions.

Risks: New policies, until issued and studied by SLT could have either a positive or negative impact on SLT which unfortunately cannot be determined in advance.

Mitigating: SLT is in constant watch over developments in the Telecom industry in Sri Lanka and is in regular dialogue with TRC. SLT is also expecting that the revised Telecommunication Act will have due consideration to the suggestions made by SLT.

HR Related Risks

Employee skill development, employee retention, aging workforce and escalation of employee cost are common HR related risks faced by SLT and the industry. Therefore in the rapidly changing Telecom business models, SLT needs to ensure that human capital is aligned to face emerging challenges. SLT has recognised that developing skills and enhancing the knowledge on new technologies is exceedingly important and we have been successful in moulding existing employees according to future requirements, while improving employee satisfaction through their active involvement in SLT operational activities.

Risks: Managing the permanent employee base including retaining critical staff is imperative to SLT continuing to be the market leader with the most critical requirement being to provide the best customer service at all times. SLT took many initiatives to improve employee satisfaction in order to improve customer satisfaction as there is a direct correlation between happy employees and happy customers. SLT created an environment for employees to generate new ideas to bring about changes to improve SLT’s efficiencies where the best ideas were then implemented while giving employees their due recognition for the suggestions. Internal programmes were also arranged to assist staff members to further their career development goals.

Mitigation: SLT has taken steps to maintain healthy relations with trade unions and employees through fair and professional HR practices to enhance industrial harmony. Many initiatives were also introduced to enhance employee satisfaction. Most of the grievances have been resolved by improving internal communications to employees. SLT has also arranged skill development programmes for employees to attend at future dates.

Revenue leakage and fraud exposure

Risk : Revenue leakage is a fact of life, given the technical and business challenges in this complicated environment. It is an inherent risk in the telecom revenue cycle, irrespective of the region of operations. Companies worldwide take a 1.5-2% leakage in revenue as normal. Operators and their IT vendors have taken significant efforts to limit theft and fraud however it is a concern for the telecommunication sector.

Mitigation: The implemented Revenue Assurance system is designed to proactively monitor and audit revenue chains across the entire network, eliminating losses due to network inefficiencies, unexpected changes to key systems and poor billing and decrementing platform performance. Through this SLT also seeks to improve inter-carrier reconciliation through a deeper analysis of cost and usage metrics, so that one does not pay more than what is required, while assuring ones trading partners are paying what its owned.

A phase by phase implementation of Revenue Assurance and Fraud Management system is in progress where Mega voice, CDMA voice, Broadband, IPTV and Data products will be subject to RA analysis and several reconciliations and exceptional reports are considered in the scope , targeting the capture of revenue leakages.

Financial Risks

Liquidity Risk

When the company finds it unable to fulfil due payment obligations in a timely manner mainly due to a mismatch in the timing or maturity of cash flows, it is considered a liquidity risk. The liquidity of a company will depend on several factors such as - Company’s short-term need for cash, cash in hand, available lines of credit, the liquidity of the company’s financial assets, the trust the company has built up in the market place (i.e. how willing counterparties will be to transact with or lend to the company) etc.

Risks: SLT could face difficulties in obtaining loans or requiring financing on unfavourable terms and/or counterparties avoiding transactions

Mitigation: SLT, through the use of regular financial planning and monitoring systems, ensures that sufficient cash flows are available to meet future financial commitments when they fall due. The Company also ensures that adequate credit lines are in place with Banks for emergency financing in addition to investment of excess funds in highly liquid instruments such as Government Securities, Repos and short term Fixed Deposits. Also through the use of credit rating agencies (current Fitch rating of AAA on SLT), the company is able to borrow at competitive interest rates.

Credit Risk

The diminution of credit quality of debtors and other counterparties caused by statement of financial position items as well as off-statement of financial position items such as financial guarantees is considered credit risk. A company has to consider the following three main factors when assessing the credit risk: Default probability – the likelihood of the customer/counterparty defaulting on its obligations; Credit exposure – in the event of a default, how large will the outstanding obligation be; and Recovery rate – in the event of a default, what fraction of the exposure may be recovered Risk: The possibility of a loss being incurred by SLT due to the inability of a debtor or counterparty to honour its contractual obligations.

Mitigation: SLT monitors and evaluates debtors/counterparties and recoveries by way of using comprehensive systems and procedures. Further, pre-paid sales are used as a means of mitigating credit risk.

Interest Rate Risk

This risk is inevitable for a company having interest sensitive assets and liabilities and would arise mainly due to the maturities of all interest sensitive assets that cannot be identically matched with liabilities and changes in market interest rates in response to market forces.

Risks: SLT risks a negative impact to the Company’s financials in the event of adverse interest rate fluctuations

Mitigation: Debt and investments at SLT are maintained in a mix of fixed and variable interest rate instruments with caps and floors where possible. In addition, periodic maturity gap analysis is carried out to take timely action in order to mitigate possible adverse impact due to volatility of interest rates.

Foreign Exchange Rate Risk

Also known as currency risk, this is a major source of market risk and is unavoidable in any entity where re-pricing of foreign currency assets and liabilities are not identically matched. This risk represents the current or prospective risk to earnings and capital arising from adverse movements in currency exchange rates.

Risk: The company is exposed to foreign exchange risk whenever it transacts in any other currency other than SLT’s base currency, Sri Lankan Rupees (LKR) due to the fluctuations of the foreign currency rates in the global market. The risk impacts the foreign currency denominated assets and liabilities at SLT

Mitigation: SLT manages its foreign exchange exposure by maintaining foreign currency accounts for related inflows and for paying off some of its liabilities as it works as an effective hedging mechanism against foreign currency exposure. Furthermore, only optimum amounts are maintained in foreign currency accounts and any excesses are converted to SLT’s base currency (LKR) after carefully studying the future currency movements.

Legal Risks

SLT is subject to a comprehensive range of legal obligations in the country and as a result SLT is exposed to many forms of legal risk, which may arise in a number of ways including:

• Business not being conducted in accordance with applicable laws.
• Contractual obligations not being enforced as intended or enforced in an adverse manner.
• Intellectual property not being adequately protected.
• Liabilities for damages being incurred by third parties due to harm caused by the conduct of business by SLT.
• A defective transaction.
• A claim (including a defence to a claim or a counterclaim) being made or an event which results in a liability or loss for SLT.
• Failure to take appropriate measures to protect assets owned by SLT.
• Change in laws after executing agreements.
• Failure to correctly document, enforce or adhere to contractual arrangements.
• Inadequate management of non-contractual rights or failure to meet non-contractual obligations.

Legal Risk is owned and managed by the Legal department with the head of legal overseeing the adequacy and effectiveness of the controls operated in the business units. Heads of department for each business unit is responsible for management and reporting of legal risk with specific risks relating to legal risk being reported on a monthly basis to the Board.

Risks: Foreseeing the outcome of any particular case or the financial impact thereof is an impossible task.

Mitigation : SLT was a party to several court and out-of-court proceedings. A summary of the material litigations during 2013 and the outcomes mentioned if known are listed on page 175 [note 33].

Security, network and systems failure leading to non-availability of services.

Risk : SLT has a responsibility to many customers, both business and consumer, to safeguard their electronic information and to maintain continuity of services. This requires high levels of operational security and resilience, which can be threatened at any time by incidents such as malicious cyber-attacks, theft of copper cable and equipment, sabotage, extreme weather, component overload, loss of power and human error causing temporary disruptions to Company’s services.

The volume of traffic through SLT’s systems and networks is increasing, and customer tolerance of interruptions reduces as the world becomes ever more dependent on information technology.

Mitigation : The Company follows steps such as consistently investing in business continuity plans and disaster recovery initiatives, which enables minimum disruption and speedy restoration of services. The Company is also focusing on quality improvement to eliminate network congestion and other causes of technical failures.

SLT’s security defences range from physical protection of assets, access controls and continuous monitoring for intrusion and anomalies, through to rapid modification of firewalls and automated blocking of malicious data traffic as well as a governance process to manage Information Security within the organization. Together, these measures increase the likelihood that any potential incidents can be contained and dealt with as quickly as possible.

Major contracts

SLT has a number of complex and high-value national and multinational contracts with some customers. The revenue arising from and the profitability of these contracts are subject to a number of factors including: variation in cost; delays in the delivery or achievement of agreed milestones owing to factors either within or outside of the Company’s control; changes in customers’ requirements, budgets, strategies or businesses; and the performance of suppliers. Any of these factors could make a contract less profitable or even loss making.

The degree of risk generally varies in proportion to the scope and life of the contract and is typically higher in the early stages of the contract. Some customer contracts require investment in the early stages, which is expected to be recovered over the life of the contract. Major contracts often involve the implementation of new systems and communications networks, transformation of legacy networks and the development of new technologies. The recoverability of these upfront costs may be impacted by delays or failure to meet milestones. Substantial performance risk exists in these contracts. Unexpectedly high costs associated with the delivery of contracts could also negatively impact profitability. SLT could lose revenue due to the merger or acquisition of customers, business failure or contract termination and contracts may become loss-making.

Mitigation : SLT has in place business processes that support each stage of a major contract’s lifecycle - renewal and termination. Our programme of “on the job” reviews is designed to validate financial and non-financial controls over delivery of the contract. It incorporates tiered levels of defined reviews according to the scale and complexity of the contract. Controls are applied and regularly monitored across the major contracts. All major contracts are subject to regular management review and many are subject to independent review as part of that governance. SLT’s independent review programme helps in applying lessons learned and promoting best practice through the business.

Growth in competitive markets

SLT operates in markets which are characterized by high levels of change, strong competition, declining prices, technology substitution, market and service convergence, customer churn, new competitors, and regulatory intervention to promote competition and reduce wholesale prices.

A significant proportion of SLT’s revenue and profit is generated locally with strong volume growth in new services. Revenue from SLT’s calls and lines services to consumers and businesses has historically been in decline though new broadband and connectivity markets have been growing. SLT’s ability to deliver profitable revenue growth in a responsible and sustainable manner depends on the company delivering on its strategic priorities.

Failure to achieve profitable revenue growth from the strategic priorities may lead to a continued decline in revenue, erosion of the current competitive position and might also lead to a reduction in profitability and cash flows in the future.

A number of competitor-related developments have contributed to the increase in risk. These include, but are not limited to acquisitions and other developments increasing competitive activity.

Mitigation : The mitigation of this risk centres on successfully executing SLT’s strategy. SLT believe that delivering this strategy, with its focus on customer service delivery, and investing for the future, as well as investing in existing businesses and offering new services in adjacent markets, will together help drive profitable revenue growth.

Supply chain

The integrity and continuity of the supply chain is critical to SLT’s operations. The aim is to harness the capability, diversity and innovation of the global supply market to add value to SLT’s business and customers. The Company is committed to ensuring that all dealings with suppliers, from selection and consultation to contracting and payment, are conducted in accordance with SLT’s stringent policies.

The failure of a critical third party supplier to meet its obligations could cause significant harm to SLT’s business and the SLT brand, as well as potentially impact strategies and efficiency plans.

A failure in our supply chain to meet legal obligations or ethical expectations could adversely impact our reputation or possibly lead to censure, legal action and financial loss.

Mitigation : SLT conducts supplier risk analysis as part of the sourcing strategy and where possible, take actions to reduce risk, such as through dual sourcing where appropriate. The Company operates a comprehensive on-the job risk mitigation programme that classifies suppliers into an appropriate risk category and then aims proactively to build risk mitigation plans and detect potential supplier failures before they happen.

For the critical suppliers of SLT this mitigation strategy considers a range of risks including: financial failure; supplier capability and capacity; business continuity, security; location; and the overall supplier relationship. This approach has been complemented by a programme specifically looking at the low spend suppliers, to ensure that maximum business benefit are achieved but at the same time they do not contract with too many suppliers, exposing us to unnecessary risk. SLT does a vendor ranking and those who get higher levels in ranking order are given more marks in evaluation of potential vendors. Also vendor black-listing is done to eliminate troublesome vendors who disturb the supply chain.

By adopting this approach, SLT seeks to minimize the risk of not being able to meet customer and legal commitments or comply with ethical policies. This helps to minimise SLT’s exposure to loss of revenue, financial penalty and any adverse impact on the brand and reputation.

Operational Risks

Being in the Telecom industry has its inherent operational risks in the form of system failures resulting in the inability to provide services on time, loss of customers due to competition, inadequate infrastructure etc.

Service interruptions and service delays

Interruptions to certain services such as Broadband or PEO TV in the case of SLT due to technical issues or the inability to provide service calls on time delaying the response time for customers are detrimental to the existence of a company in the Telecom industry.

Risks: The company could lose its valued customers to competition given that the market in Sri Lanka has internationally recognized players providing services in par with that of SLT.

Mitigating Factors: Adequate backup systems are in place with 24 x 7 monitoring by technical staff to avoid any major service interruptions. All field staff and all customer touch points have gone through extensive training and are provided continuous training on providing customer service in a timely manner.

Inadequate IT systems

Globally the Telecom industry is continuously evolving with introductions of “latest” technologies that enhance the customer experience.

Risks: The company could lose market share if the infrastructure is not up-to-date with latest technologies, IT systems and IT security especially given that this industry in Sri Lanka has internationally recognized players who have access to such technologies.

Mitigating Factors: The IT policy at SLT reflects the need to stay up-to-date with dynamic changes that are taking place in the global Technological environment and therefore makes it a priority for SLT’s technical staff to undergo training on a regular basis. In addition, SLT has enhanced and expanded server space to handle volume and introduce new technologies as and when needed.

Inability to meet the growing needs of customers

When competing with international players that are exposed to unique and novel consumer products and services, it is imperative that SLT is able to keep up with the competition.

Risks: Meeting customer needs and introducing the right product mix at the right time is essential for SLT to maintain its market share.

Mitigating Factors: SLT carries out market research on a regular basis to keep abreast of the growing needs of its customer base.

Loss of Revenue from International incoming traffic

The industry has been experiencing the existence and increasing trend in bypassing traffic to SLT network.

Risks: SLT loses a significant amount of revenue each month and the trend is expected to continue resulting in increased losses.

Mitigating Factors: SLT is monitoring and controlling illegal terminations with the assistance of the revenue assurance team. SLT is also in constant dialogue with TRCSL to bring about strict laws to mitigate the risk.

If the resources are not allocated appropriately, the company could be faced with a situation where it is unable to provide the right product mix to the customers, or not having the latest technologies to provide better service, or not being able to provide critical training to staff members etc.

Risks: Return On Investment (ROI) may not be optimal if there is a gap in resource allocation and could cause a loss in market share/reputation as well as financial losses due to operational inefficiencies.

Mitigating Factors: All investments at SLT are evaluated by cross functional teams through the recently established Strategic Governance Boards thus ensuring that resources are allocated appropriately.

A company’s long term success is dependent on anticipating unexpected glitches -technical or human error, natural or man-made disasters etc and being prepared to face them at any given moment.

Risks: Adequate controls and business continuity plans are essential to survive in today’s environment and without which a company’s going concern can be challenged by its stakeholders.

Mitigating Factors: SLT has introduced a disaster recovery systems and sites that are monitored and tested on a regular basis. The company also has stringent Internal controls and systems as well as a comprehensive risk management process in place to identify and proactively control any gaps.