Elements of risk and uncertainty

The main risks identified and monitored by Snam as part of the Enterprise Risk Management process are described below.

Market risk

Interest rate risk

Fluctuations in interest rates affect the market value of the company’s financial assets and liabilities and its net financial expense. Snam aims to optimise interest rate risk while pursuing the objectives defined and approved in the financial plan, and the Snam Group has adopted a centralised organisational model. In accordance with this model, Snam’s various departments access the financial markets (capital markets and banking channels) and use funds to cover financial requirements, in compliance with approved objectives, ensuring that the risk profile stays within the defined limits.

At 30 June 2015, 70% of financial debt was fixed rate (69% at year-end 2014) and the remaining 30% was floating rate (31% at year-end 2014).

At 30 June 2015, the Snam Group used external financial resources in the form of bonds and bilateral and syndicated loans with banks and other financial institutions, in the form of medium- to long-term loans and bank credit lines at interest rates indexed to benchmark market rates, in particular the Europe Interbank Offered Rate (Euribor), and at fixed rates.

Exchange rate risk

Snam’s exposure to exchange rate risk relates to both transaction risk and translation risk. Transaction risk is generated by the conversion of commercial or financial receivables (payables) into currencies other than the functional currency and is caused by the impact of unfavourable exchange rate fluctuations between the time that the transaction is carried out and the time it is settled (collection/payment). Translation risk relates to fluctuations in the exchange rates of currencies other than the consolidation currency (the euro) which can result in changes to consolidated shareholders’ equity. Snam’s risk management system aims to minimise transaction risk through measures such as the use of derivatives.

As at 30 June 2015, Snam’s foreign currency items consisted essentially of a bond worth ¥10 billion, maturing in 2019, which was worth around €75 million as at the issue date and was fully converted into euros via a cross-currency swap. Snam does not have any cross-currency swaps in place for speculative purposes.

Natural gas price risk

Since 1 January 2010, the Authority has defined methods of payment in kind, by users of the service to the leading transportation firm, for the quantities of gas covering fuel gas²⁴, network losses and gas not accounted for (GNC). Consequently, the change in the price of natural gas covering fuel gas and network losses is no longer a risk factor for Snam.

Since 1 January 2014, at the start of the fourth regulatory period (1 January 2014 - 31 December 2017), the Authority has changed the procedure for payment in kind, by users of the service to the leading transportation firm, of the quantities of gas covering GNC. Specifically, with Resolution 514/2013/R/gas, the Authority defined the permitted level of GNC based on a fixed amount for the entire regulatory period, in order to encourage the leading transportation company to deliver further efficiency improvements. In view of the aforementioned mechanism for the payment in kind of GNC, there is still uncertainty about the quantities of GNC withdrawn over and above the quantities paid in kind by the users of the service.

Credit Risk

Credit risk is the company’s exposure to potential losses arising from counterparties failing to fulfil their obligations. Default or delayed payment of fees may have a negative impact on the financial balance and results of Snam.

For the risk of non-compliance by the counterparty concerning contracts of a commercial nature, the credit management for credit recovery and any disputes are handled by the business units and the centralised Snam departments. Guidelines and methods for quantifying and controlling client riskiness are drawn up at corporate level.

The rules for client access to the services offered are established by the Authority and set out in the Network Codes. For each type of service, these documents explain the rules regulating the rights and obligations of the parties involved in providing said services and contain contractual clauses which reduce the risk of non-compliance by the clients. In certain cases, the Codes require guarantees to be provided to partly cover obligations where the client does not possess a credit rating issued by one of the leading international agencies. The regulations also contain specific clauses which guarantee the neutrality of the entity in charge of balancing, an activity carried out from 1 December 2011 by Snam Rete Gas as the major transportation company. In particular, balancing gives Snam Rete Gas an obligation to acquire, according to criteria of financial merit, the resources necessary to guarantee the safe and efficient movement of gas from entry points to withdrawal points, in order to maintain a constant balance in the network, procure the necessary storage resources to cover imbalances for individual users and adjust the relevant income statement entries.

Snam provides business services to a small number of operators in the gas sector, the largest of which by revenue is eni S.p.A. It cannot be ruled out, however, that Snam may incur liabilities and/or losses due to its customers’ failure to honour payment obligations, including as a result of the current economic and financial situation, which makes the collection of receivables more complex and critical.

Liquidity risk

Liquidity risk is the risk that new financial resources may not be available (funding liquidity risk) or that the company may be unable to convert assets into cash on the market (asset liquidity risk), meaning that it cannot meet its payment commitments. This may affect profit or loss should the company be obliged to incur extra costs to meet its commitments or, in extreme cases, lead to insolvency and threaten the company’s future as a going concern.

Snam’s risk management system aims to establish, under the financial plan, a financial structure that, in line with the business objectives, ensures sufficient liquidity for the Group, minimising the relative opportunity cost and maintaining a balance in terms of the duration and composition of the debt.

As shown in the section “Interest rate risk”, when implementing the debt refinancing programme, the company had access to a wide range of funding sources through the credit system and the capital markets (bond loans, bilateral contracts, pool financing with major domestic and international banks, and loan contracts with the EIB).

Snam’s objective is to maintain a balanced debt structure, in terms of the composition of the bonds and the bank credit and the availability of usable committed bank credit lines, in line with its business profile and the regulatory environment in which Snam operates.

At 30 June 2015, Snam had unused committed long-term credit lines worth approximately €3.9 billion. At the same date, in addition to the funding from the banking system, the renewal of the Euro Medium Term Notes (EMTN) programme²⁵, approved by Snam’s Board of Directors on 22 June 2015, permitted the issue, by 30 June 2016, of additional bonds worth up to €1.3 billion, to be placed with institutional investors.

Rating risk

Moody’s confirmed a Baa1 rating with a stable outlook for Snam’s long-term debt on 19 February 2015.

On 9 December 2014, the rating agency Standard & Poor’s downgraded Snam’s long-term credit rating by one notch, from BBB+ to BBB, with a stable outlook.

This followed the one-notch downgrade of Italy’s sovereign debt rating on 5 December 2014 from BBB to BBB-, with a stable outlook.

On 23 July 2015, Fitch has assigned Snam BBB+ rating with a stable outlook.

Snam’s long-term rating from Moody’s and S&P’s is a notch higher than that of Italian sovereign debt.

Based on the methodology adopted by the rating agencies, the downgrade of the current rating of Italian sovereign debt would probably trigger a downward adjustment of Snam’s current rating.

Risk of default and the debt covenant

The risk of default consists of the possibility that the loan contracts concluded contain provisions that provide the lender with the ability to activate contractual protections that could result in the early repayment of the loan in the event of the occurrence of specific events, thereby generating a potential liquidity risk.

As at 30 June 2015, Snam has unsecured bilateral and syndicated loan agreements in place with banks and other financial institutions. Some of these contracts provide, inter alia, for the following: (i) negative pledge commitments pursuant to which Snam and its subsidiaries are subject to limitations concerning the pledging of real property rights or other restrictions on all or part of the respective assets, shares or merchandise; (ii) pari passu and change-of-control clauses; and (iii) limitations on certain extraordinary transactions that the company and its subsidiaries may carry out.

For only some of the loans granted by the EIB, for a total principal amount of €848 million at 30 June 2015, and in relation to the information flows required under Article 34, paragraph 8 of Legislative Decree 159/2011 (judicial control), provided by the Court of Palermo in connection with the revocation of the judicial administration order imposed on Italgas, the bank has the power to request early repayment by Snam, making use of and in compliance with contractual provisions relating to early voluntary repayment within 60 days of any request.

The bonds issued by Snam as at 30 June 2015 as part of the Euro Medium Term Notes programme provide for compliance with covenants that reflect international market practices regarding, inter alia, negative pledge and pari passu clauses.

Failure to comply with these covenants, and the occurrence of other events, some of which are subject to specific threshold values, such as cross-default events, may result in Snam’s failure to comply and could trigger the early repayment of the relative loan. Exclusively for the EIB loans, the creditor has the option to request additional guarantees if Snam’s rating is downgraded to BBB- (Standard & Poor’s) or Baa3 (Moody’s).

Operating risk

Snam is required to comply with rules and regulations at EU, national, regional and local level.

The expenses associated with the actions required to fulfil its obligations constitute a significant cost item now and for the years ahead.

In addition to minimising the risks from its activities, compliance with rules and regulations is required in order to obtain authorisations and/or permits relating to health, safety and the environment. Violation of current regulations may result in criminal and/or civil sanctions and, in specific cases where safety and environmental rules are violated, companies may be liable on the basis of a European model of corporate social responsibility adopted in Italy by Legislative Decree 231/01. The possibility of Snam incurring significant costs or liability cannot be entirely ruled out.

Current regulations highlight the value of organisational models aimed at preventing offences in the event of the violation of environmental and workplace health and safety laws, specifying corporate liability.

Snam uses organisational tools and internal regulations to establish the responsibilities and procedures to be adopted within the Group when planning, constructing, operating and disposing of all corporate assets, thereby ensuring compliance with laws and internal regulations on health, safety and the environment.

Snam and the companies it controls have implemented environmental and workplace health and safety management systems based on the principles of its own Health, Safety, Environment and Quality Policy, which has been consolidated in the company for several years.

The documentation and application of the Snam Management Systems are certified according to international regulations.

During the year, regular visits were made by the certification body, leading to the confirmation of all the certifications already held by the Group companies.

By adopting management systems and procedures that take into account the specific characteristics of its business, and by continually improving and modernising its facilities, Snam ensures that it can identify, assess and mitigate risks as part of a cycle of continual improvement.

Snam pays the utmost attention to all its operational processes worldwide: from designing and constructing plants to operating and maintaining them. For the purposes of business management and operational control, the company uses specific techniques that are continually being updated and are developed in compliance with international best practices.

Snam develops and maintains technical regulations and management systems for the environment and workplace health and safety based on an annual cycle of planning, implementation, control, reviewing results and setting new objectives.

Management system control is conducted by monitoring health, safety and environmental indicators, periodic reporting and inspections of operating sites and the registered office, which involve:

• a technical audit, designed to ensure that the management systems are applied correctly in compliance with the Code of Ethics and Organisational Model 231;
• management system checks on certification, maintenance and renovation (conducted at least annually by an external certifying body);
• health, safety and environment checks on outsourced activities.

The findings are examined together with the results of the operating checks, providing basic information for planning future activities and setting new objectives, in accordance with Snam principles.

Snam has adopted organisational and regulatory measures for preventing (availability, goods and services contracts, training, etc.) and managing any operational crises which may impact assets, people and the environment, identifying the actions required to limit damage.

Snam participates in national and international working groups engaged in benchmarking activities, the drawing up of guidelines, legislative proposals and research, in order to improve processes relating to the gas industry from a technical, health and safety, environmental and quality point of view.

In addition to the risk response, monitoring and management system and the HSE measures adopted across the Group, Snam has taken out insurance to limit the possible negative effects on its assets of damage caused to third parties and to industrial property, whether onshore or offshore (Messina strait, Offshore LNG Toscana (OLT) connection at Livorno), that could occur during operations and/or investment works. The insured amount varies according to the type of event and is determined by current market best practice in risk assessment.

Risks connected with failing to meet infrastructure development objectives

Snam’s effective ability to develop its infrastructure is subject to many unforeseeable events linked to operating, economic, regulatory, authorisation and competition factors which are outside of its control. Snam is therefore unable to guarantee that the projects to upgrade and extend its network will be started, be completed or lead to the expected benefits in terms of tariffs. Additionally, the development projects may require greater investments or longer timeframes than those originally planned, affecting Snam’s financial position and results.

Risks arising from the malfunctioning of plants

Managing regulated gas activities involves a number of risks of malfunctioning and unforeseeable service disruptions due to factors which are outside of Snam’s control, such as accidents, breakdowns or the malfunctioning of equipment or control systems; the underperformance of plants; and extraordinary events such as explosions, fires, earthquakes, landslides or other similar events. These events could also cause significant damage to people, property or the environment.

Any service interruptions and subsequent compensation obligations could lead to a decrease in revenue and/or an increase in costs. Although Snam has taken out specific insurance policies to cover some of these risks, the related insurance cover could be insufficient to meet all the losses incurred, compensation obligations or cost increases.

Risks arising from the need to manage a significant flow of information to operate regulated services

The regulatory framework in which Snam operates involves continually collecting and processing a significant flow of information from its service clients. The information received by Snam includes, inter alia, capacity bookings, details of where gas is coming from and going to each day, physical and commercial balancing mechanisms and forecasts on demand and transportation capacity usage. This flow of information, partly managed by the extensive use of IT systems, is broad and complex. Therefore Snam cannot guarantee that its management will not lead to operating and planning difficulties which could affect its business.

Risks arising from the seasonal nature of the business

Based on the current regulatory framework, Snam’s overall business is not affected by seasonal or cyclical factors which could have a significant impact on its annual or interim financial position and results.

Risks specific to the sectors in which Snam operates

Risks related to regulatory changes

Snam operates in the regulated gas sector. The relevant directives and legal provisions issued by the European Union and the Italian government and the resolutions of the Authority and, more generally, changes to the regulatory framework, may have a significant impact on Snam’s operating activities, financial position and results. Considering the specific nature of its business and the context in which Snam operates, changes to the regulatory context with regard to criteria for determining reference tariffs are particularly significant. To this end, it should be noted that, by means of Resolutions 438/2013/R/gas, 514/2013/R/gas and 573/2013/gas, the Authority defined the criteria for determining benchmark tariffs for liquefied natural gas regasification, natural gas transportation and natural gas distribution services respectively for the fourth regulatory period (1 January 2014 - 31 December 2017). In 2014, by means of Resolution 531/2014/R/gas, the Authority defined the criteria for determining reference tariffs for the natural gas storage service’s fourth regulatory period (1 January 2015 - 31 December 2018).

In addition, Decree-Law 138 of 13 August 2011, converted into Law 148 of 14 September 2011, extended the application of additional corporate income tax to the natural gas transportation and distribution business segments, with a tax rise of 10.5% for 2011-2013 and 6.5% as at 2014. It also prohibited companies from passing on the tax rise to customers via tariff increases and mandated the Authority to enforce this rule. The Constitutional Court declared the additional corporate income tax to be unconstitutional in Ruling 10/2015 of 9 February 2015. As laid down by the ruling, the tax was unconstitutional with effect from 12 February 2015.

Future changes to European Union or Italian legislative policies, which may have unforeseeable effects on the relevant legislative framework and, therefore, on Snam’s operations and results, cannot be ruled out.

Risks associated with the end of gas distribution concessions held by Italgas and its subsidiaries and associates

Risks relating to tenders for new gas distribution concessions

As at 30 June 2015, Snam, through Italgas, managed 1,472 natural gas distribution concessions throughout Italy. In accordance with the provisions of the legislation applicable to Snam’s concessions, tenders for new gas distribution concessions will no longer be issued by each municipality but exclusively by the minimum geographical areas known as ATEMs. As the tender process unfolds, Snam may not be awarded one or more of the new concessions, or it may be awarded them on less favourable terms than is currently the case. This could have a negative impact on Snam’s operations, results, balance sheet and cash flow, notwithstanding, should the company not be awarded concessions for municipalities it currently manages, the reimbursement to the outgoing operator.

Risks relating to quantifying repayment to the outgoing operator

With regard to the gas distribution concessions where Italgas also owns the networks and plants, Legislative Decree 164/00, as subsequently supplemented and amended on several occasions, provides that the amount reimbursed to the outgoing service operators in possession of the ongoing contracts and concessions is calculated based on what has been established in the agreements or contracts, provided that these were entered into before the date on which the regulation pursuant to Ministerial Decree 226 of 12 November 2011 came into effect (i.e. before 11 February 2012), and, for the portion that cannot be inferred from the will of the parties, as well as the aspects not governed by the aforementioned agreements or contracts, based on the guidelines on the operating criteria and methods for measuring the repayment amount, which were subsequently made available by the Ministry of Economic Development in a document dated 7 April 2014 and approved by a Ministerial Decree of 22 May 2014²⁶. In any case, private contributions relating to local assets, as valued according to the current tariff regulation methodology, shall be subtracted from the amount to be reimbursed.

Where there is a disagreement between the local authority and the outgoing operator with regard to the reimbursement amount, the public notice contains a reference amount to be used for the purpose of the tender. This reference amount is the estimate of the contracting local authority or the RAB, whichever is greater.

Decree 226 of the Minister of Economic Development of 12 November 2011 on tender and offer evaluation criteria stipulates that the incoming operator will acquire ownership of the system by paying the outgoing operator the reimbursement amount, with the exception of any parts owned by the local municipality.

Eventually, i.e. in subsequent periods, the reimbursement to the outgoing operator shall be the value of local net fixed assets, net of government grants for capital expenditure and private contributions relating to local assets, calculated on the basis of criteria used by the Authority to determine distribution tariffs (RAB).

In light of new legal provisions, it therefore remains possible that the reimbursement amount will be less than the RAB.

Risks relating to gas storage concession ownership

Through Stogit, Snam holds ten gas storage concessions. Of these, eight (Alfonsine, Brugherio, Cortemaggiore, Minerbio, Ripalta, Sabbioncello, Sergnano and Settala) will expire in December 2016, one (Bordolano) will expire in November 2031 and the other (Fiume Treste), which was extended for a decade for the first time in 2011, will expire in June 2022. Each Stogit concession issued before Legislative Decree 164/2000 came into force may be extended by the Ministry of Economic Development no more than twice for a duration of ten years at a time, pursuant to Article 1, paragraph 61 of Law 239/2004. Pursuant to Article 34, paragraph 18 of Decree-Law 179/2012, converted by Law 221/2012, each Stogit concession issued after Legislative Decree 164/2000 came into force (Bordolano) has a duration of 30 years and can be extended by 10 years. If Snam is unable to retain ownership of one or more of its concessions or if, at the time of the renewal, the concessions are awarded under terms less favourable than the current ones, there may be negative effects on the company’s operations, results, balance sheet and cash flow.

Risks connected with certain socio-political situations in natural gas production and transit countries

A large part of the natural gas which travels through the Snam transportation network does, or may, come from or travel through countries which present risks arising from certain socio-political situations. Importing and transiting natural gas from or through such countries may present risks such as: higher taxes and excise duties; production, export or transportation limits; enforced contract renegotiations; nationalisation or renationalisation of assets; changes to national political and governing systems; changes to commercial policies; monetary restrictions; and loss or damage owing to the actions of rebel groups. If shippers are unable to access the natural gas available in these countries as a result of the aforementioned or similar situations, or if they are damaged in any other way by said situations, there may be a risk of the shippers being unable to fulfil their contractual obligations to Snam or there may be a reduction in volumes of gas transported. Such events may therefore have a negative effect on operations, results, the balance sheet and cash flow.

The European Community, through Regulation (EU) No 994/2010 of the European Parliament and of the Council of 20 October 2010 (“Regulation SOS”), established an obligation for each Member State to identify, through predetermined guidelines, measures intended to guarantee the security of its gas supply or to meet demand for gas. In implementation of the aforementioned Regulation, in accordance with the provisions of Legislative Decree 93 of 1 June 2011, (Legislative Decree 93/11), the Ministry of Economic Development shall carry out a risk assessment every two years on the security of the domestic natural gas system, and define a preventive action plan and an emergency and monitoring plan for the security of natural gas procurement.