MOST SIGNIFICANT RISKS

KONE is exposed to risks that may arise from its operations or changes in the operating environment. The most significant risk factors described below can potentially have an adverse effect on KONE’s business operations and financial position and, as a result, on the value of the company. Other risks, which are currently either unknown or considered immaterial to KONE may, however, become material in the future.

Strategic risks

Demand for KONE’s products and services and the competitive environment are impacted by the general economic cycles and especially the level of activity within the construction industry. As China accounts for close to 30% of KONE’s sales, a sustained market decline in the Chinese construction industry, in particular, could have an adverse effect on KONE’s growth and profitability.

Geopolitical tensions and protectionism continue to expose KONE to various business risks. In addition to the potential adverse impacts on the general economic activity, geopolitical tensions and protectionism could impact the competitiveness of KONE’s supply chain, and lead to increased costs from trade and customs tariffs. A significant portion of KONE’s component suppliers and global supply capacity is located in China.

In addition to the level of market demand, competitiveness of KONE’s offering is a key driver of the company’s growth and profitability. A failure to anticipate or address changes in customer requirements and in competitors’ offerings, ecosystems and business models or in the regulatory environment could result in a deterioration of the competitiveness of KONE’s offering. Furthermore, ongoing structural changes in the competitive landscape of the elevator and escalator industry and customer consolidation in China, for example, could affect market dynamics and KONE’s market share.

Operational risks

Engaged employees with relevant competencies and skills are key to the successful execution of our strategy. With the business models and ways of working changing in the elevator and escalator industry, KONE needs new organizational capabilities and new competencies on the individual employee level in the field of, for example, digitalization. At the same time, competition over skilled field workforce is increasing and securing the needed field resources and their competence management is critical. A failure to develop and retain the needed capabilities or obtain them through recruitment could have an adverse impact on KONE’s growth and profitability.

The majority of components used in KONE’s supply chain are sourced from external suppliers. In addition to this, KONE uses a significant amount of subcontracted installation resources, has outsourced some business support processes and collaborates with partners in digital services. These expose KONE to component and subcontracted labor availability and cost risk and continuity risk in partnerships. A failure to secure the needed components or resources or quality issues within these could cause business disruptions and cost increases.

As one of the leading companies in the industry, KONE has a strong brand and reputation. Issues that impact the company’s reputation or brand could have an effect on KONE’s business and financial performance. Such reputational risks could materialize; for example, in the case of an incident, a major delivery issue or a product or service quality issue. Matters concerning product integrity, safety or quality could also have an impact on KONE’s financial performance and affect customer operations.

Hazard, security and incidental risks

KONE’s business activities are dependent on the uninterrupted operation, quality and reliability of its manufacturing facilities, sourcing channels, operational service solutions and logistics processes. KONE’s, its suppliers’ and customers’ operations also utilize information technology extensively and KONE’s business is dependent on the quality, integrity and availability of information. Thus, KONE is exposed to IT disruptions and cyber security risks, as operational information systems and products may be vulnerable to interruption, loss or manipulation of data, or malfunctions which can result in disruptions in processes and equipment availability. Any breach of sensitive employee or customer data may also result in significant penalties as well as reputational damage. Such cyber incidents could be caused by, including but not limited to, cybercrime, cyber-attacks, computer malware, information theft, fraud, misappropriation, or inadvertent actions from our employees and vendors. Also physical damage caused by fire, extreme weather conditions, natural catastrophes or terrorism, among other things, to these operations, could cause business interruption for KONE or its suppliers.

Financial risks

The majority of KONE’s sales and result are denominated in currencies other than the Euro, which exposes KONE to risks arising from foreign exchange-rate fluctuations. KONE is also exposed to counterparty risks related to financial institutions, through the significant amounts of liquid funds deposited with financial institutions, in the form of financial investments and in derivatives. Additionally, KONE is exposed to risks related to the liquidity and payment schedules of its customers, which may impact cash flow or lead to credit losses. Significant changes in local financial or taxation regulation could also have an impact on KONE’s financial performance, liquidity and cash flow.

Foreign exchange risks
KONE operates internationally and is thus exposed to risks arising from foreign exchange rate fluctuations related to currency flows from revenues and expenses (transaction risk) and from the translation of statement of income and statement of financial position items of foreign subsidiaries into euros (translation risk).
Transaction risks
A substantial part of KONE operations are denominated in local functional currencies and do not therefore give rise to transaction risk. The sales and installations of new equipment and modernizations typically take place in the local currency of the customer. Component and material expenses may occur in other currencies than the sales currency, which exposes KONE to transaction risks. The KONE policy is to hedge the foreign exchange exposure of the order book and other highly probable future sales and purchases with foreign exchange forward contracts. The business units are responsible for evaluating and hedging the transaction risks in their operations according to the foreign exchange policy. The most significant transaction risk exposures arising from business operations are in the Chinese renminbi, Singapore dollar, British pound, US dollar and Canadian dollar. The majority of the currency forward contracts expire within one year.
Hedge accounting is applied in business units, where there are significant revenues or expenses in foreign currency. When hedge accounting is applied the gains and losses from the hedges are recognized in the statement of income at the same time as the exchange rate gains and losses for the hedged items are recognized.
KONE’s internal loans and deposits are primarily initiated in the local currencies of the subsidiaries in which case the possible foreign exchange risks are hedged, by the parent company, using foreign exchange swap contracts.
Translation risks
Changes in consolidation exchange rates affect KONE’s statement of income, cash flow statement and statement of financial position, which are presented in euros. As approximately 75% of KONE’s revenues occur in functional currencies other than euro, the translation risk is significant for KONE. A change of 10% in the annual average foreign exchange rates would have caused a 7.6% (7.6%) change in 2019 in the consolidated sales in euros. Such a change would have had a higher impact on KONE’s operating income and therefore also some impact on KONE’s relative operating income. The translation of the subsidiaries’ balance sheets into euros caused translation differences of EUR 54.0 (13.8) million in 2019. The translation risk is not hedged as a rule as KONE’s business consists of continuous operations in various currency areas. However, in individual cases, KONE can also hedge translation risk related to net assets of subsidiaries. The most significant translation risk exposures in the subsidiaries are in the Chinese renminbi, Hong Kong dollar and US dollar.
Interest rate risks
KONE’s cash and short-term investments were EUR 2,250.2 (2,040.2) million at the statement of financial position date. KONE’s interest-bearing debt was EUR 721.6 (369.0) million at the statement of financial position date and consisted of EUR 544.3 (240.6) million of financial debt including lease liabilities, EUR 4.4 (10.4) million of option liabilities from acquisitions, and EUR 172.9 (147.0) million of employee benefits. Additionally, KONE had an asset on employee benefits, EUR 21.7 (29.0) million.
As KONE’s financial investments are mainly invested in tenors of less than one year, changes in the interest rates do not have any significant impact on their market values. Changes in the interest rates may however impact future interest income.
When calculating the interest rate sensitivity analysis the interest-bearing net financial debt, excluding foreign exchange forward contracts, is assumed to remain on the level of the closing balance of 2019 during the following financial period. The sensitivity analysis presents the impact of a 1 percentage point change in the interest rate level on the net interest income for the financial period by taking into account the net financial debt tied to interest periods of less than one year, -2,130.3 (-2,014.7) million euros. For 2020 a 1 percentage point change in the interest rate level would mean a change of EUR -21.3 (-20.1) million in net interest income. The interest rate sensitivity is calculated before taxes.
A change in interest rates does not have a material impact on the net interest on employee benefits, on financial debt or option liabilities from acquisitions.

Refinancing and liquidity risks

KONE’s cash and cash equivalents was EUR 662.4 (636.0) million and financial investments EUR 1,587.7 (1,404.2) million on December 31, 2019.

Cash and financial investments are managed centrally by KONE Treasury. Due to local regulations part of the funds are located in local investments and on decentralized bank accounts in a number of KONE countries. A substantial part of the funds is nevertheless accessible to KONE Treasury. Changes in the local regulations can also in the future have an impact on the location of the cash and financial investments.

KONE has a credit facility from European Investment Bank (EIB) of EUR 160 million. The credit facility is a 5-year fixed interest rate loan which will be used for R&D purposes. The loan will mature in 2021. The fair value of the loan is estimated based on discounted cash flows using a current borrowing rate (level 2 fair value hierarchy). KONE has also an uncommitted commercial paper program of EUR 500 million and existing committed credit facilities of EUR 1,000.0 million to ensure sufficient liquidity.

**Maturity analysis of financial liabilities and Interest payments**
MEUR	<1 year	1-5 years	>5 years	Total	<1 year	1-5 years	>5 years	Total
	Dec 31, 2019				Dec 31, 2018
Interest-bearing debt
Long-term loans	-	-160.0	-	-160.0	-	-160.0	-	-160.0
Lease liabilities	-103.7	-210.3	-56.7	-370.7	-15.6	-32.6	-1.1	-49.3
Used bank overdraft limits	-13.5	-	-	-13.5	-2.3	-	-	-2.3
Option liabilities from acquisitions	-4.4	-	-	-4.4	-10.4	-	-	-10.4
Employee benefits	-	-	-172.9	-172.9	-	-	-147.0	-147.0
Non-interest bearing debt
Accounts payables	-809.8	-	-	-809.8	-786.7	-	-	-786.7
Derivatives
Capital inflow	2,425.5	143.9	-	2,569.4	2,562.1	206.9	-	2,769.0
Capital outflow	-2,437.7	-146.3	-	-2,584.0	-2,565.3	-206.8	-	-2,772.0
Interest payments	-0.6	-14.2	-4.4	-19.2	-0.2	-0.3	-	-0.6
Net outflow	-944.2	-386.9	-234.0	-1,565.1	-818.3	-192.9	-148.1	-1,159.3

Financial credit risks
KONE has substantial amounts of cash and financial investments. In order to diversify the financial credit risk, KONE invests its funds into highly liquid interest rate funds and into deposits with several banks. Global counterparty limits are approved by the Board of Directors. All open exposures such as cash on bank accounts, investments, deposits and other financial transactions, for example derivatives contracts, are included when measuring the financial credit risk exposure. When selecting counterparty banks and other investment targets, only counterparties with high creditworthiness are approved. The size of each limit reflects the creditworthiness of the counterparty. Counterparty creditworthiness is evaluated constantly and the required actions are considered case by case if significant changes in the creditworthiness of a counterparty occur. The fair values of interest rate funds are measured based on market information (fair value hierarchy level 2).

Customer credit risk management

Customer credit risks relate to advance payments receivable from customers or to accounts receivable related to equipment deliveries or to services rendered. This risk is managed by defining the rules for tendering, payment terms, authorizations and credit control as well as project management controls. Advance payments, documentary credits and guarantees are used in payment terms to minimize customer credit risks. KONE proactively manages its accounts receivable in order to minimize the risk of customer defaults.

KONE’s customer base consists of a large number of customers in several market areas. The management considers that there are no significant concentrations of credit risk with any individual customer or geographical region.

The credit quality of advance payments receivable and accounts receivableis evaluated according to KONE’s credit policy. According to this policy, the rules for credit quality evaluation are set separately for the new equipment business and the service business. The credit quality is evaluated both on the basis of the aging of the receivables as well as on the basis of individual case by case customer analysis in order to identify customers with a potential higher credit risk due to individual customer specific reasons. The bad debt provision for the accounts receivable is recognized on the basis of this credit quality evaluation and using the expected credit loss model. The amount of bad debt provision recorded to cover doubtful accounts was EUR 252.9 (226.6) million at the end of the financial period.


Aging structure of the accounts receivable after recognition of impairment, MEUR	Jan 1-Dec 31, 2019	Jan 1-Dec 31, 2018
Not past due and less than one month due receivables	1,742.3	1,553.2
Past due 1-3 months	275.9	253.9
Past due 3-6 months	136.6	122.2
Past due > 6 months	77.5	59.0
Accounts receivable in the consolidated statement of financial position	2,232.3	1,988.3

Risks related to the reporting of non-financial information

The assessment and analysis of KONE’s most significant risks also covers nonfinancial risks. In line with the requirements of the Finnish Accounting Act, KONE has identified the most significant non-financial risks regardless of their materiality for KONE as a whole. The typical impact of the non-financial risks materializing would be reputational damage. In addition to the risk mitigation actions described below, KONE aims for transparent and reliable communication in order to prevent reputational risks and to enable proactive management and learning from incidents, should they occur.

Environmental risks

KONE actively identifies, assesses and monitors the development of existing and emerging environmental risks. Continuous environmental risk assessment process is included in KONE’s ISO 14001 environmental system requirements and management activities. For example, environmental risks are managed by conducting internal and external audits, by regularly tracking compliance requirements and our environmental performance and by actively participating in different environmental research and discussion forums.

Although environmental risks related to KONE’s business are overall not very material, the most significant identified environmental risks relate to climate change. Preparing for extreme weather conditions and minimizing potential damages or interruptions to our operations and delivery chain is an ongoing activity. Climate-related risks can also materialize due to introduction of new environmental legislation potentially causing increases in our cost base.

Social and employee related risks

Safety is a top priority at KONE and potential safety incidents are among the most significant social and employee related risks. Incidents are mitigated through, for example, extensive training and communication, consistent safety management practices, standardized maintenance and installation methods and regular process audits. Major repairs or retrofits in public infrastructure locations may also affect the daily life of many people and therefore, may have a reputational impact. Both safety and quality have a key role in product design, supply, manufacturing, installation and maintenance and they involve strict quality controls. KONE also follows globally implemented principles in how to manage potential incidents and implement improvements.

Human rights related risks

The most significant human rights related risks are in the supply and delivery chain and are related to terms and conditions of work. All new suppliers must sign KONE’s Supplier Code of Conduct which sets out our ethical business practice requirements, including the standards we require in terms of labor and human rights. On the basis of the a risk assessment conducted in 2019, we are prioritizing our work on human rights in the supply chain and have set up a human rights network and are preparing a pilot project for supplier assessments.

Anti-corruption and bribery related risks

KONE requires its employees and partners to adhere to high ethical standards and to comply with its Code of Conduct, Distributor Code of Conduct and Supplier Code of Conduct. These codes cover numerous compliance topics, including competition law, trade sanctions compliance, and labor and human rights issues, as well as prohibiting corruption and bribery. Unethical business practices among KONE’s employees or various stakeholders could cause reputational damage for KONE as well as a possible financial impact. The risks of such behaviors and practices materializing are included in the scope of KONE’s regular audit programs. In addition, processes introduced under our Global Delegation of Authority policy help to mitigate the risk of unauthorized payments, donations and sponsorships. We have introduced more stringent disclosure requirements in China for conflicts of interest and this work will continue worldwide in 2020. The most important action for internal mitigation continues to be the development of KONE’s corporate culture through training and awareness building.