Major Risk Map

Aircraft fleet modernisation with government support, aggressive pricing by air carriers alongside rapid expansion of intercity bus service — all these factors lead to harsher competition.

The risk of losing a share of the long-distance passenger service in Russia is becoming especially relevant as the government is expanding its support to regional air carriers, including through stimulation of subsidised regular regional air services and introduction of direct subsidies to carriers working on specific routes.

To strengthen the position in the passenger service market, the Company took the following steps in 2013:

• Increased the average speed of its passenger trains
• Improved the quality of service
• Used innovative rolling stock (Lastochka, double-deck trains)
• Increased the share of daytime trains and minimised travel time
• Introduced a dynamic pricing system
• Attract new passengers through promotions on some routes and in some trains
• Worked actively on promotion of JSC FPC’s products through information and advertising campaigns

In 2014, the Company is going to continue working on the implementation of the above initiatives. In addition, it is planning to expand the scope of the dynamic pricing system, launch large-scale promotions and use Talgo, a brand-new train, on the Moscow-Kiev service*.

JSC FPC is a natural monopoly; hence, fares for long-distance travel in second-class sleepers and standard cars are subject to state regulation. Passengers carried at regulated rates account for about 60% of the total number of passengers served by the Company. To keep the fares affordable, the government is regulating the rates, setting them below economically viable levels. For that reason, the government supports JSC FPC by compensating the income it loses due to the tariff regulation in the form of annual subsidies. This lost income compensation is paid from the federal budget.

Yet, the amount of compensation allocated in the federal budget is less than the one calculated in accordance with the guidelines and recommendations of the Federal Tariff Service. So, JSC FPC is exposed to the risk of receiving fewer subsidies than it might need to ensure that the government’s obligations to citizens of the Russian Federation with regard to fares for travel in second-class sleepers and standard cars are fully met.

Initially, the amount of compensation allocated in the federal budget for 2013 was almost three times lower than the estimate (13.2 billion roubles). JSC FPC and RZD holing’s management took steps to ensure effective collaboration between all members of the inter-agency taskforce on railway transport development under the chairmanship of A.V. Dvorkovich, Deputy Prime Minister of the Russian Federation, helping them make the necessary decisions, such as:

• A 20% increase in the fares for travel in second-class sleepers and standard cars on the 2012 level
• Amendments to the federal budget providing for additional subsidies of RUB 10 billion to JSC FPC
• A RUB 5 billion contribution to the charter capital of JSC FPC by JSC RZD

In addition, it was decided to reduce Company’s costs by RUB 3 billion, including through cancellation of trains that do not generate enough profit.

Carriage services at regulated rates are a social policy tool used by the government to ensure transport mobility of the population.

The decision to establish JSC FPC was based on the assumption that 100% of income losses would be compensated by the government.

Yet, the Company has been experiencing funding shortfalls over the last two years due to lack of subsidies from the federal budget.

In order to minimize the risk, the Company and JSC RZD took a joint initiative to prepare a draft Plan for the Development and Deployment of a Mechanism for the Provision of Long-Term Subsidies as Compensation of Long-Distance Passenger Service Fares. That plan was approved by A.V. Dvorkovich, Deputy Prime Minister of the Russian Federation (No. 4696p-P9 of August 6, 2013).

The plan includes the following steps:

• Development of the methodological basis for a mechanism of the provision of long-term subsidies as compensation of long-distance passenger service fares for various kinds of transport
• Development of a register and specifications of passenger service routes to be subsidised for various kinds of transport
• Development of a comprehensive financial and economic model of subsidised carriage by various kinds of transport in order to ensure maximum efficiency in the use of budget funds
• Comprehensive assessment of the social and economic consequences and the regulating effect of the long-term subsidy management mechanism as well as to determine the behavioural conditions for parties involved in the passenger service process

Overall, the development model of JSC FPC has been updated so as to shift the focus to decreasing the degree of dependence on government’s decisions regarding allocation of funds for compensation of lost income; for that end, the Company is going to reduce its operations on lossmaking routes and introduce contractual relations with the government when dealing with socially important routes.

In applying the mechanism of contractual relations with the government to long-distance passenger service, the Company is going to rely on the Federal Law On Organisation of Regular Passenger Railway Service in the Russian Federation and Amendments to Some Laws of the Russian Federation.

JSC FPC is taking an active part in the work on the draft law.

Proliferation of extremist ideas and political instability in some regions in the world might result in unlawful acts against railway infrastructure, passengers and Company’s assets aimed at destabilisation of the public order.

In 2013, the Company implemented a range of measures to ensure closer cooperation with law enforcement agencies dealing with transport.

Steps were taken to improve security and the number of guards travelling in passenger trains was increased with the help of private security firm. The Company is continuing to equip its facilities and rolling stock with alarm and security systems.

The Corporate Security Department started to work on the implementation of the Comprehensive Programme of Passenger Security Protection Measures adopted by the Government of the Russian Federation.

As a result of the measures taken, the total number of offences registered in 2013 at the facilities and in passenger trains of JSC FPC decreased by 10.4%; the number of offences classified as crimes fell almost by a third.

In 2014, JSC FPC is going to implement the first stage of an information system deployment project which will allow it to minimize the risk of critical information leakage.

The safety and security of JSC FPC’s passenger trains is a top priority for the Company.

To ensure prompt exchange of information regarding service safety, fire safety, passengers and staff’s injuries and health problems requiring immediate intervention, JSC FPC has been running a special Situation Centre since 2012. Among other things, the Centre provides exchange of information with the Monitoring and Emergency Management Centre of JSC RZD.

The following steps were taken over the reporting year:

• Fire-prevention systems were modernised in 1,344 cars that underwent a major overhaul and 14 cars that underwent renovation
• The Industrial Safety programme was implemented in order to ensure accident-free operation of car depots as well as to prevent incidents and production process stoppages
• In repair shops of Company’s divisions, shock absorber diagnostics facilities were installed
• 14 X-ray baggage scanners were installed
• More than half of all passenger trains had representatives of transport police or private security companies on board

Protection of the life and health of the Company’s employees is one of the priorities that JSC FPC focuses on in implementing its labour protection policy.

The Company is putting a lot of efforts in labour protection and accident prevention. The Company spent RUB 0.6 billion on labour protection-related measures, including RUB 0.3 billion on reduction of job-related injuries and relocation of employees from hazardous areas.

JSC FPC’s exposure to interest rate risks is due to its long-term loans carry floating interest rates.

Interest risk management is based on the Guidance on Interest Risk Management of JSC FPC No. 1-R/FPCFin of March 02, 2012.

The Company calculates the value of its interest rate risk appetite, i.e. an estimation of the interest rate risk that JSC FPC is ready to cope with.

In order to hedge the interest rate risk under loan contracts with floating interest rates, JSC FPC is entering into interest rate swap deals to get fixed long-term interest rates.

The currency risk results from existing contracts in foreign currency, including contracts with foreign contractors for the provision of services of admission of special trains and trains made up by JSC FPC to the infrastructure of foreign railways, contracts for the development and delivery of passenger trains by foreign manufacturers.

Currency risk management is based on the Guidance on Currency Risk Management of JSC FPC № 2-R/FPCFin of May 11, 2012.

With the volume of liabilities in foreign currency being insignificant as of December 31, 2013, JSC FPC estimates the currency risk as moderate.

Liquidity risks result from the fact that the Company has to make payments to the budget, employees and contractors in a timely manner.

JSC FPC manages its liquidity risks by optimizing the equity to debt ratio based on its budget resources. This approach allows JSC FPC to maintain an appropriate level of liquidity and funding resources so as to minimize borrowing costs and optimize the structure of debt and its repayment schedule.

At the moment, JSC FPC has adequate access to financing sources as well as has both credit resources that are already in use and credit resources that have not been used, being able to satisfy its expected borrowing demands.

JSC FPC estimates the risk of having to refinance its debt as insignificant.