RISK ANALYSIS AND MANAGEMENT Home Investors Risk Analysis and Management Share On the basis of international best practices, we identify, define and analyse risk scenarios capable of damaging or undermining the achievement of corporate goals At Terna, risk analysis and management is done on an annual basis and takes into account the deadlines for planning and reviewing the corporate strategy and performance monitoring. This process involves the entire corporate scope based on two macro activities: Enterprise Risk Analysis and Management, using a top-down approach, or rather focused on the main risks which could compromise achievement of the Group objectives. Process Risk Analysis and Management, using a bottom-up approach, or rather focused on risks associated with individual company processes The risk analysis and management conducted by the various control functions within their areas of remit are integrated accordingly in order to guarantee an organic view of the Group’s overall risk profile which takes into account the risk assessments and intervention priorities which emerged. RISK MANAGEMENT SYSTEM COMPANY GOALS (strategic and recurring) GROUP RISK ASSESSMENT Guide by the Risk Observatory Enterprise Risks (TOP DOWN) Process Risks (BOTTOM UP) Cybersecurity Healr & Safety Fraud management Environment Compliance Privacy Management systems Monitoring Law 262/05 Other functions Control functions Risk Management allows for systematic and iterated risk identification, evaluation, handling, monitoring and reporting. Identification: An important reference for Management in identifying risk events is the corporate objectives framework, which is indicative of the value sought and which could be compromised. They are divided into Strategic (linked to the Industrial Plan) and Recurring (continuous, linked to concession business, the corporate mission, codes of conduct). For each of these objectives, potential risk events—sometimes emerging—applicable to the various companies and which could affect the achievement of the objectives themselves are identified. Evaluation: An Impact assessment is associated with each risk event, evaluating the probability of occurrence over the plan’s time horizon. The Age of the existing Risk Management System completes the assessment. The priority in which risks are handled is based on these elements. Handling: The risk management strategy is defined, identifying any specific interventions with the respective implementation deadlines. Monitoring: Objectives and associated risks can change over time. Even implemented mitigation and corrective actions can undergo changes in cost and effectiveness. Consequently, the steps in the previously described process are repeated regularly (at least annually). Reporting: The results of risk analysis and management performed by the 1st and 2nd level control functions are gathered in a report prepared annually and presented to the Audit and Risk, Corporate Governance and Sustainability Committee by the Chief Risk Officer and given to Management. Information about the Risk Management System and the main results of Risk Analysis and Management are also reported in the Annual Financial Report. The Main Risks In 2020, the Risk Assessment cycles involving Terna’s Middle and Top Management were completed. The Risk Assessment made it possible to identify 64 risk events which were evaluated in terms of impact, probability of occurrence in the plan’s time horizon, and age of the existing Risk Management systems, allowing for their further analysis and the implementation of further containment actions. Their evaluation revealed 12 priority risks associated with the objectives and main mitigation and control actions in order to contain them. OBJECTIVE RISK EVENT CATEGORY MANAGEMENT ACTION Increased severity of weather events The risk connected with the intensification of extreme weather events (tornados, heavy snowfall, ice, flooding) with a resulting impact on the continuity and quality of the service provided by Terna and/or damage to equipment, machinery, infrastructure and the grid. Natural human- induced events New investment to increase the resilience of the electricity grid and identify mitigation strategies. Separation of the European transmission grid CONTINUITY AND QUALITY OF SERVICE The risk connected with extreme weather events/incorrect setup of the structure of the grid in accordance with n-1 security criteria for the European transmission grid, with the potential for cascading failures triggering overloads/line failures, critical events and major incidents on the interconnected European transmission grid with separation of the grid and widespread blackouts. Operational risk - Control processes and systems to defend the electricity system - Involvement in working groups and programmes analysing security / defence scenarios at European level, with the aim of improving the security and coordination of the interconnected grid. Cyberattack The risk connected with a cyberattack, using for example ransomware, that could cause: - the loss of visibility of infrastructure - the temporary shutdown of systems - data loss and/or additional costs for recovery. Natural/human induced events - Internet and perimeter security systems and the segregation of IT and OT networks - Consolidated IT monitoring processes (CERT - Computer Emergency Response Team) - Awareness campaigns. Enhancement and oversight of internal competencies Enhancement and oversight of adequate specialist knowledge to enable achievement of the challenging goals contained in the Plan. Operational risk - Expansion of the workforce - Training and skills development. HUMAN RESOURCES Workplace injuries/incidents The risk connected with serious/fatal injuries and/or incidents that may have consequences for the health of employees and/ or contractors and sub-contractors, as well as impeding the Company’s efforts to achieve goals relating to safeguarding people’s health and having a serious impact on the Group’s reputation and credibility. Operational risk A strategic steering committee with the aim of achieving continuous overall improvements throughout the Group (procedures, technologies, working practices, etc.) with a specific focus on HSE issues. Evolution of rates of return REGULATORS AND OTHER GOVERNMENT STAKEHOLDERS The risk connected with the introduction of new frameworks and changes to the parameters used in determining revenue from regulated activities carried out under concession. External/ market risk Focus on output-based regulation linked to investment in projects providing major benefits for the electricity system. Timing of the issue of consents for projects with an impact on the investment programme The risk connected with delays or missed deadlines in obtaining the necessary consents for the construction of infrastructure, resulting in delays to the entry into service of infrastructure and an impact on the investment programme. External/ market risk Identification of back-up projects to start work on in the event of delays to certain projects. Extended consents processes due to opposition from local bodies/environmentalists The risk connected with the possibility that opposition from local bodies, environmentalists, the public and local authorities may lead to major delays in concluding the agreements necessary in order to complete projects involved in the development and security of the national grid. External/ market risk As regards the impact on the landscape, assessment of the need to expand and encourage the use of underground/submarine cable in place of overhead lines, when this is compatible with the security and operation of the national grid. Delays in obtaining consents due to the imposition of conditions prior to granting consent DEVELOPMENT OF THE NATIONAL TRANSMISSION GRID The risk connected with the presence, in intermediate opinions and/or Environmental Impact Assessments and/or landscape assessments, of conditions resulting in the need to "make changes to projects for which consent has been applied for" or to change parts of the project, thus lengthening the consents process in order to ensure compliance. External/ market risk Planning of back-up projects to start work on in the event of delays to certain projects. Timing of compliance and implementation of environmental restrictions imposed following the receipt of consents, specialist advice and environmental controls of construction sites The risk connected with possible delays during construction in order to comply with restrictions imposed as a condition for granting consent, and to comply with and monitor all the environmental requirements (archaeological, wildlife, geology, environmental engineering and green engineering); in order to engage with the entities responsible for inspection and involved in compliance with the restrictions imposed (e.g., dialogue with entities and third parties regarding the Environmental Monitoring Plan); in order to arrange specialist technical support for environmental matters so as to ensure full compliance with the restrictions imposed prior to and during the works and checks on construction sites to verify compliance with the law. Operational risk Conduct of coordinated activities designed to reach agreement with the various parties as part of a structured process for managing the issues in question, with well-defined internal procedures and roles. Suppliers operational capacity reaches saturation point, resulting in delays in the construction and maintenance of infrastructure The risk connected with the ability of suppliers to follow a demanding programme and/or their inability to rapidly adjust their supply chain to meet Terna’s increased demands, resulting in delays to the construction of infrastructure included in the Plan. Counterparty Risk Steps to boost capacity in key supply chains. CUSTOMERS, SUPPLIERS AND BUSINESS PARTNERS Changes to the strategy or priorities of major key suppliers, resulting in delays and additional costs in the construction of infrastructure The risk connected with changes in the strategy of key suppliers as they shift their focus to other, more attractive sectors (e.g., renewable energy, industrial automation), geographical markets (e.g., India) and/or changes to priorities resulting in delays/additional costs in the construction of infrastructure included in the Plan. Counterparty risk Initiatives designed to pre-empt any such changes (the inclusion of "notices to proceed"), within the limits imposed by the Tenders Code, in order to tie up key suppliers’ operational capacity so that they can meet Terna’s requirements on time Market and financial risks Terna is exposed to various financial risks in its daily business. Market risk This is the risk that the fair value or the future cash flows of a financial instrument will fluctuate following changes in the conditions of the financial markets. Market risk comprises three types of risks: exchange rate risk: exchange rate risk must be managed with the objective of defending the profitability of the business against the risks of changes in currencies through continual checks on the markets and constant monitoring of the existing exposures. Terna selects financial hedging instruments with structural and duration characteristics in keeping with the group’s exposure to foreign currencies. The instruments used have limited complexity, high liquidity and easy pricing. The exposure of the Group’s Income Statement to exchange rate risk is, however, residual and attributable to the foreign currency flows deriving from equity investments in Latin America and Switzerland; interest rate risk: this is represented by the uncertainty associated with the trend in interest rates. It is the risk that a change in market rates may produce effects on the fair value or future cash flows of financial instruments. In performing its business, the Group is exposed to the risk of interest rate fluctuation. The main source of the risk derives from the components of net financial debt and of the related hedging positions in derivative instruments that generate financial expense. The Group’s financial debt strategy has been directed towards long-term debt instruments that reflect the useful life of the corporate assets, and an interest rate risk hedging policy has been pursued with the aim of guaranteeing at least a portion of debt at a fixed rate of 40% as provided for in the corporate policies inflation risk: we can note that the tariff set by the Regulator to remunerate Terna S.p.A.’s activity is determined so as to enable coverage of the recognised costs of the sector. These cost components are updated annually to take into account the inflation accrued. Having had recourse to an inflation-indexed bond issue in 2007, the Company has put in place a partial protection of the net Income Statement result. In fact, any decrease in the portion of expected revenues, following a decrease in the inflation rate, is offset, in part, by lower financial expenses. Liquidity risk This is the risk that the Terna Group will have difficulty in fulfilling its obligations associated with financial liabilities and in the operating cycle. Management of liquidity risk ensures adequate coverage of financial needs through opening suitable credit lines and appropriate management of any surplus liquidity. Credit risk Credit risk is the risk that a customer or one of the counterparties of a financial instrument will cause a financial loss in not fulfilling an obligation. It derives mainly from trade receivables and the Group’s financial investments. Credit risk originated from open positions on transactions in financial instruments is considered marginal, as the counterparties selected, observing what is established by the financial risk management policies, are highly rated, leading international credit institutions. As regards the risks associated with the insolvency of dispatching customers, the application of ARERA Resolution no. 111/06 introduced three instruments to protect the electricity market: the system of guarantees (sureties issued by the single users of the dispatching in relation to their turnover), the possibility of terminating the dispatching contract (in the event of insolvency or failure to replenish guarantees called in) and the possibility of recovering receivables not collected through a specific fee which, when needed, is defined by ARERA. Default risk and covenants on the debt This relates to the possibility that loan contracts or the regulations of bond loans, to which the Parent Company is a party, contain provisions that allow the counterparties to ask the debtor, on the occurrence of certain events, for the immediate repayment of the amounts lent, generating consequently a liquidity risk. However, the provisions on default events in the Parent Company’s contracts follow the market standard. As regards covenants on the debt, some of the long-term financial debts of the Parent Company Terna S.p.A. contain commitments (“covenants”) typical of international practice, none of which, as of today, is unfulfilled. Emerging risk The transition to an electricity system based on production from renewable sources opens up new scenarios and poses new challenges for the operation of the transmission grid. The most significant emerging risks for Terna originate from the changes connected with the progress of the transition, of which the effects have not yet been fully felt, but definite trend lines have been established. Amongst these, the following are of particular importance: growing widespread generation by both energy producers and consumers, which entails an emerging risk linked to the difficulties of maintaining complete grid observability within a real time grid management framework; the sudden decrease in solar production in the evening, which (as solar production increases) will require adequate availability from other programmable sources, in particular storage sources; the increasing use of the Internet of Things, for example in substation equipment, which increases the system’s exposure to cyber risks. In addition to these risks, there are also risks of inefficiencies resulting from the increasing frequency of extreme weather events. EMERGING RISK DESCRIPTION POTENTIAL IMPACT MITIGATION INITIATIVES PROSUMER Traceability of grid input from distributed generation plants The “prosumer” market model increases the complexity of measuring grid input and withdrawals Dispatching: real-time grid management Innovative data management & analytics solutions RESIDUAL LOAD CURVE Rapid and significant reduction in the supply of energy from renewable sources at sundown with simultaneous increase in consumption. Excess of production from renewable sources in central hours Increased steepness of the residual load curve in the evening compared to that covered by renewables, which requires a rapid response with other forms of flexible inputs Dispatching: adequacy of demand coverage, real-time grid management Investments in storage (pumping, electrochemical storage); development of demand response systems, including experimental studies on the use of car batteries for grid services. Equigy Platform Related contents INTERNAL CONTROL AND RISKS CORPORATE GOVERNANCE SYSTEM STRATEGY TERNA IS THE FIRST GRID OPERATOR FOR ELECTRICITY TRANSMISSION IN EUROPE. WE PROMOTE THE ENERGY TRANSITION AND SUSTAINABLE DEVELOPMENT BY FOCUSING ON PEOPLE AND INNOVATION. 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