Managing risks – a part of conducting business
Swedish Match strives to ensure that the risks taken are deliberate. It is important for us to understand the risks to which our business is exposed and make informed decisions. Risks need to be managed efficiently in order for the Group to be competitive, to operate safely, and to maintain financial stability and growth.
Risk management within Swedish Match
Swedish Match applies a systematic risk management model, which includes risk reviews as well as loss prevention, continuity planning, crisis management and insurance programs.
The Swedish Match Board of Directors determines the Group’s strategic plans and associated risks based on recommendations from the Group Management Team (GMT). The Board of Directors oversees the Group’s risk management processes and on a recurring basis is informed about the existing and emerging risks as well as on related mitigation activities. Each division, as well as Corporate functions, is responsible for managing the risks associated with their plans, and if required, coordinating risk management activities with other units. Appropriate competencies in the organization and a governance structure with clear responsibilities set the prerequisites for risk management at the local level. The Code of Conduct further ensures an organizational culture that helps to prevent taking those risks deemed to be unacceptable.
To efficiently manage risks, existing and potential risks need to be known. Swedish Match strives to establish a broad understanding among its employees of the concepts and importance of risk management. Employees in all parts of the organization are encouraged to identify and report events and circumstances which are indications of risks. Existing and potential risks are regularly discussed within the divisional management teams and the GMT. A framework of policies is in use to ensure that the responsibilities are communicated and understood and that the management teams have the right tools to drive risk management.
Annual ERM process
To identify and assess the major risks to which the Group is exposed, an annual Enterprise Risk Management (ERM) process is conducted and consolidated at division level. This is part of the strategic planning process. The resulting risks, including probability, impact, interrelations with other risks, mitigation activities and monitoring, are presented to the GMT. The GMT presents risks identified at division level, alongside a consolidated picture for the entire Group, to the Board of Directors. This process helps to ensure that appropriate actions are taken to reduce, prevent or mitigate undesired risks. Based on ERM results, strategies are developed to manage new or changed risks. Risk responses include risk avoidance, risk reduction, risk sharing or risk acceptance.
Integration of sustainability risks into ERM process
Swedish Match addresses sustainability risks with the same priority as financial and operational risks. During 2020, in conjunction with the updated materiality assessment, key sustainability risks have been identified and incorporated into the ERM process at division level. The central coordination responsibilities for sustainability risk assessment are designated to the same function as for the ERM process. This facilitates the sustainability risks to follow the same management approach as the rest of the key risks for the organization.
Important risks to address arise in the areas of competition, production, regulation, and finance among other areas.
Swedish Match operates in highly competitive markets, which require an agile organization in a continually changing environment. There is a risk to both customer purchases and the ability to realize pricing in the event that Swedish Match cannot provide a better offering to the consumer than competitors.
Swedish Match continuously monitors the competitive environment and assesses changing consumer needs. To meet these consumer needs, the Company conducts consumer and market research and closely follows market trends. This insight forms the basis for product positioning, product portfolio decisions and product development and ensures consumers are offered high quality products that meet their needs.
Production facilities are exposed to risk of various harmful incidents such as fires and machinery breakdown, as well as potential natural disasters or global health crises such as a pandemic and other catastrophic events, along with effects related to climate changes. Such incidents may affect both production facilities and employees. Production interruptions could cause quality or delivery problems.
In order to avoid delivery problems or other production interruptions, Swedish Match has implemented a loss prevention and continuity planning program. Periodic inspections are conducted by an independent third party at production facilities that have been identified as critical. These inspections assess to what level the production facilities meet the risk management standards of Swedish Match and determine whether there are investments or actions required to reduce risk. The purpose of the continuity planning is to minimize any negative impact of an incident. By having multiple facilities producing core products, Swedish Match strives to reduce the potential impact of harmful incidents to any single facility.
A loss of a key supplier or a supplier’s non-compliance with regulations or unethical behavior could be harmful to the Group. Potential consequences are delivery or quality problems or difficulties in the interaction with other stakeholders including sales to consumers.
Selected suppliers of production inputs are reviewed by the procurement departments on a recurring basis. The suppliers’ own financial stability and risk management systems are an important consideration for Swedish Match. As a complement to the internal reviews, at times an independent third party conducts risk inspections at suppliers identified as critical.
Swedish Match strives to work with suppliers who have a healthy, long term financial position and who support our values. Our Supplier Code of Conduct specifies what we expect and require from our suppliers in terms of employment and labor practices, workplace practices, ethical business practices and environmental management practices. The Supplier Code of Conduct forms the basis for our relationship with suppliers and is an integral part of our significant business agreements. Risk assessment forms the basis for our efforts to identify and mitigate specific risk in dialogue with prioritized suppliers. We have procedures in place, and under continuous development, to further emphasize sustainable supply chain management.
Swedish Match is exposed to a high degree of regulation from various authorities. Regulations could have restricting impact on how the Group can operate its business and interact with its stakeholders or direct financial impact in the form or increased taxes or imposed fees. Regulations, many related to the Group’s involvement in the tobacco industry, concern among other issues, tobacco excise taxes, marketing, packaging, warning labels, ingredients, reporting to authorities, product approvals, and introduction of new products. Many authorities have and continue to implement various forms of restrictions on sales and usage of tobacco and other nicotine containing products.
Swedish Match closely monitors the development of tobacco regulation and regularly shares information and opinions with governments and other regulatory agencies on issues that affect the Group’s operations.
Most importantly Swedish Match needs to continue to provide consumers with less harmful alternatives to cigarettes and strive toward the vision of a world without cigarettes, with evidence based regulations for our products. A critical activity is to educate and inform decision makers about Swedish Match’s portfolio of smokefree products and their relative health characteristics compared to cigarettes. The differences in relative risk among different tobacco and other nicotine-containing consumer products and the potential to migrate consumers to less harmful products are often referred to as harm reduction.
Currency and interest rate risks
The dynamic financial market conditions are continuously changing with fluctuating currency exchange rates, interest rates and availability of funds.
Currency rate risks
A weakening of certain major currencies, such as the USD versus the SEK, could cause lower financial results presented in SEK from the translation of foreign operations. The transaction exposure is relatively low as most production is located in the country where sales are conducted.
Interest rate risk
Higher interest rates could have a negative impact on net finance expense.
Swedish Match has a large part of its business being conducted outside Sweden with a significant part in the US. The currency exchange rate development is not in the control of Swedish Match. Acknowledging that there is a speculative element in hedging the currency translation exposure, Swedish Match has decided to normally not hedge this exposure. However, Swedish Match is mindful of the cash impact from currency rate changes and strives to regularly distribute dividends from its foreign subsidiaries to the Swedish parent company.
Swedish Match is a highly cash generative company with a stable financial policy. Swedish Match is optimizing its cost of capital by ensuring an appropriate leverage. In order to manage interest rate risk and refinancing risk, the Group strives to have an even spread of maturities and to tie nearly all of its borrowings to fixed interest rates. In addition, Swedish Match shall as a general rule secure financing for the coming twelve months before any share repurchases are executed. More information on financial risks can also be found in the Note 27 Financial instruments and financial risks to the Group Consolidated Financial Statements in the annual report for 2020.
Tobacco is the most important agricultural commodity for Swedish Match business operations. Changes in precipitation patterns, soil content and heat patterns could negatively affect the yield, quality and availability of the tobacco crop. This could result in shortage of supplies and increasing raw material costs. Our direct operations are also exposed to acute physical risks caused by extreme weather events such as cyclones, hurricanes, or floods which could disrupt the manufacturing and distribution in the affected areas.
Our operations are subject to potential transition risks triggered by for instance new carbon-related regulations and shift in consumer preferences. These risks might impact how the Company can operate its business and interact with its stakeholders. This could imply direct financial impact in the form of increased compliance costs, or decreased revenue due to reduced demand for our products.
In response to physical risks, Swedish Match sources raw materials from a broad geography, therefore reducing its risk of exposure to climate change which may occur in any single geographic area. We also mitigate the risk through various activities such as climate impact assessment for our tobacco suppliers through the Sustainable Tobacco Program (STP) and a commitment to Science Based Targets initiative (SBTi) to do our part in reducing greenhouse gas emissions in our entire value chain. For our production facilities that have been identified as critical, periodic inspections are conducted by an independent third party. These third party assessments address, among other aspects, the potential risk exposure related to natural disasters and whether a business continuity plan is in place to prevent and recover from such acute situations.
With regard to transition risks, the Company closely monitors the regulatory and policy development related to for instance packaging and enhanced emissions-reporting obligation. We also continuously monitor market trends and changing consumer needs by conducting targeted market research. This insight forms the basis for our product development decisions.
During 2020, to better manage the climate risk, we have integrated climate risk assessment into our annual ERM process and aligned the methodology with the recommendations of TCFD.
Child labor risk
The risk of child labor has been identified as one of Swedish Match main sustainability risks and therefore is included in one of our focus areas. According to estimations from ILO, as of 2019, 152 million children are engaged in child labor, about 70 percent of the children involved in child labor are primarily concentrated in agriculture.
Swedish Match sources its raw tobacco primarily from global suppliers. These suppliers have their own strict policies with regard to human rights, child labor and farming practices and are audited by other large international tobacco companies as well.
The Company also engages in various programs aiming at mitigating child labor issues, such as raising awareness and educating contracted tobacco growers, as well as reducing the volume of tobacco purchased from suppliers who do not interact directly with individual farmers. We have systems and procedures in place to monitor adherence to our Supplier Code of Conduct.
The major due diligence tools for the raw tobacco supply chain are the STP and associated procedures, of which Swedish Match has been a key contributor in their development.
The Company evaluates risk and tailor the continued dialogue on the basis of self-assessments, third party reviews and resulting action plans for improvement. Suppliers and farmers are visited regularly by Swedish Match to strengthen relationships and to pursue a proactive dialogue, including follow-up on action plans. The Company is also a member of and represented on the board of the Eliminating Child Labour in Tobacco Growing Foundation (ECLT).