OPPORTUNITIES AND RISKS REPORT

As an organisation that operates throughout the world, the KSB Group is exposed to macroeconomic, sector-typical, financial and company-specific risks. Our risk policy is designed to enable us to grow sustainably and profitably. We aim to reduce the risks associated with our business and where possible avoid them completely. At the same time our global alignment and our extensive product range offer a wealth of opportunities. This includes in particular any opportunities that arise on the basis of our research and development activities, as well as any that are linked to the quality and cost effectiveness of our products. Our competitive position is also improved by the expansion of our worldwide sales and manufacturing network. We always review opportunities to expand our global presence and are able to achieve this through start-ups and acquisition projects.

We see opportunities and risks as possible future developments or events that may lead to forecast or target deviation. The deviation can be both positive and negative. In order to manage the varied opportunities and risks professionally and efficiently, we align our actions accordingly and focus upon the respective situation when selecting the persons responsible. In doing so, Controlling, Finance and Accounting as well as Internal Audits perform important monitoring tasks.

RISK MANAGEMENT SYSTEM

KSB has implemented a Group-wide risk management system for identifying and assessing relevant risks and reporting these to Group headquarters. The risk management process of the KSB Group consists of the successive phases of identification, assessment, management, control, documentation and communication of risks. The six phases form a continuous and IT-based closed-loop system. This is documented in our risk management manual as well as the management responsibility and the description of all relevant tasks.

Managers are encouraged to take timely action to define and implement measures to limit or avoid damage that may result from the occurrence of risk events. All corporate and central functions and Group companies, including Group companies that are not consolidated, are included in the risk management system. The responsible managers are required to supply their relevant key business and financial indicators each month. As well as creating quarterly forecasts on business trends, they also twice a year report the recognised risks for the next 24 months from the reporting date for the categories of market and competitive risks, technological risks, project- and product-related risks, financial risks and procurement risks. Other business risks (environmental, human resources, etc.) are also reported in this cycle to the Risk Managers at the Group headquarters. We classify risks as qualitative and quantitative risks:

Qualitative risks are long-term developments that could have a negative impact on the KSB Group and which cannot or cannot yet be thoroughly quantified due to a lack of precise information. In order to still be able to evaluate them, however, we make estimates of the probability of occurrence and scope. With respect to probability of occurrence, the extent to which the information indicating the potential risk is detailed must be determined. The scope describes the potential influence of the individual risk on the EBIT of the KSB Group or the respective Group company.

Quantitative risks are those risks with possible monetary impact on the EBIT of the KSB Group or the respective Group company. They are evaluated taking into account the probability of occurrence in combination with the potential amount of loss.

In order to assess whether qualitative and quantitative individual risks are significant for us, we classify them as acceptable, neutral or significant risks. We consider as material for the KSB Group all individual risks categorised as neutral or significant that are detailed in the “Individually assessed opportunities and risks” section. The relevant classification can be determined from the matrices below:

Qualitative Risks
Quantitative Risks

This approach gives us the necessary transparency to identify risks in their entirety and to manage them effectively, professionally and in an economically responsible manner.

The bodies to which specific responsibilities and competencies have been assigned in KSB’s risk management system are shown and explained in the figure below:

Risk Management at KSB

The overall responsibility for risk management lies with the Board of Management of KSB AG. It reports to the Supervisory Board during regular Audit Committee meetings and is monitored by the latter. The Board of Management is supported by the Chief Compliance Officer and the Group Finance and Accounting department. The latter coordinates the risk management process at Group level and investigates all reported risks to determine whether they are relevant for the financial statements. It ensures that there is a systematic link with the Group accounting process. The Board of Management and the Supervisory Board’s Audit Committee receive at least two risk reports per financial year. These reports include all the risks that are categorised as significant or neutral that exceed pre-defined threshold values individually or collectively, not considering any action that has been taken. Particularly critical topics are reported on an ad-hoc basis by the managers in charge. In contrast, opportunities are not taken into account in this system, but are examined separately in consultation with segment managers and regional managers.

With regard to financial risks we also make use of additional risk identification, assessment, management and communication. The central Finance department is responsible for this task which is described in further detail later in this section.

Compliance risks are dealt with by the Chief Compliance Officer, who is assigned to the Legal and Compliance, Patents and Trademarks staff function. The Chief Compliance Officer is supported by the members of the Compliance Committee and the Compliance Managers of the individual companies.

The Internal Audits department is integrated into the risk management system as part of our internal control system. When planning audits, it prioritises areas according to potential risks and is provided with all the necessary information. The auditors ensure that all audited units adhere to the applicable guidelines, actively participate in the risk management system, and control or avoid their risks. Information obtained by Internal Audits on both the recognised risks and the countermeasures introduced in response forms an integral part of the reporting to the Board of Management and the Audit Committee of the Supervisory Board.

Our risk management system is regularly reviewed and promptly updated where necessary, for example, in the event of relevant legal or organisational changes. In addition, our auditor examines within the scope of the annual audit the early risk detection system, establishing that it is present and checking that it is fit for purpose.

INTERNAL CONTROL SYSTEM AND RISK MANAGEMENT SYSTEM WITH REGARD TO THE GROUP ACCOUNTING PROCESS

The accounting-related internal control system (ICS) contributes towards ensuring proper financial reporting. The aim is to ensure that the consolidated financial statements and group management report comply with all relevant regulations. Key elements of the ICS are – as well as the risk management system described above – guidelines and regulations, which include standard accounting and measurement policies. They must be applied to the full extent by all our Group companies. Functional separation and the principle of dual control are observed; this is ensured by the audits carried out by our Internal Audits department.

In addition, the Accounting department carries out regular analytical plausibility checks using time series analyses and actual / budget variance analyses. This enables us to identify significant changes early on, which we then examine for accounting and measurement discrepancies. The resulting findings are then discussed at management level.

The responsibility for Group accounting lies with the employees in the central Accounting KSB Group department. We employ the services of qualified external reviewers for certain calculations as part of financial reporting (such as the calculation of complex pension obligations using actuarial assumptions).

Binding schedules and guidelines apply to accounting within the KSB Group and to accounting at each individual subsidiary. The accounting methods that must be applied to compile the consolidated financial statements are defined in writing in a manual that we update and revise on a continual basis. This also includes the guidelines for posting intra-group transactions. We continually analyse new accounting principles and other official announcements with regard to their relevance and impact on the consolidated financial statements. To this end we maintain regular contact with our auditors. We adapt our guidelines and manual where necessary and communicate any changes immediately to our companies. Accounting KSB Group monitors compliance with these regulations. This enables us to reduce the risk of compiling inappropriate financial statements or failing to publish them by the defined deadlines.

We automatically process the financial statement information for all Group companies using certified and tested standard consolidation software. Systematic checks are implemented to help us validate the data. Employees in Accounting KSB Group verify any warning signals that arise before using the data. The sequence of the processing steps is strictly specified through the use of the consolidation monitor within our IT system. This ensures the correct processing of data at all times.

To enable a seamless and accurate accounting process, we only assign employees to this task who have the appropriate specialist know-how. These employees are trained on a regular basis to make sure that their expert knowledge remains up to date.

We have defined access authorisations for the accounting-related IT system. This protects the data against unauthorised access as well as improper usage and modification. The data is checked at many stages, helping to ensure the processing quality. Alongside regular system reviews by the auditors, these checks contribute to limiting operational risks.

INDIVIDUALLY ASSESSED OPPORTUNITIES AND RISKS

The categories presented below include the gross risks classified as significant or neutral and the main opportunities for our business development. The main influencing factor remains the economic development. All other opportunities and risks are assessed as secondary.

Markets / Competition

Our business is affected by changes in the economic and political environments. These include the decline in oil prices, which reduces demand in the oil-producing countries. In order to limit the adverse effect on our business, we are addressing this risk by intensifying our customer contacts.

The intensification of the conflict between Russia and Ukraine involves the risk of a further weakening of the local market opportunities, especially for exports to Russia. This requires on our part a close exchange of information with the local KSB company, fast decision-making and increased localisation of our activities.

We continue to take a critical view of the high government deficits in some European countries, including Italy. They harbour the risk of a recession, which would have a negative impact on the demand for our products.

Sectors with long investment cycles impact on the success of our project business. This can cause customers to delay placing orders. The continuing excess capacity on the supply side continues to be reflected in intense competition. The pressure on the selling prices for our products is therefore ongoing. In addition, Asian competitors in particular are increasingly pushing their way into the global market with their products.

We manage the risk of fluctuations in the economy and in demand by remaining active in several market sectors and industries with different economic cycles. Furthermore we are monitoring the development of the economic environment for our market sectors. If necessary, we adjust capacities, relocate production facilities and implement cost-cutting measures.

The energy efficiency of our products plays an increasingly important role. If we were not to achieve the newly defined energy standards, this would have permanent negative effects on the success of our business. Accordingly, we have addressed these requirements at an early stage.

Thanks to our tripartite distribution structure and a modernised system for customer management, we are now able to make better use of the opportunities vis-à-vis our customer base. At the same time, we want to tap growth opportunities, including via intensified customer acquisition. There are opportunities not only where KSB already has a strong market position, but also in industries in which individual or a small number of competitors dominate and customers are actively searching for alternatives, such as in building services. The prerequisite in each case is an attractive and diversified product range, complemented by a good service offer. Regional niche business, too, offers sales opportunities that we can take advantage of.

The efforts made by many customers to reduce the operating costs of their systems by using energy-saving components boost the sale of variable speed pumps and controlled valves, energy-efficient motors, and special analysis and consulting services. Several countries have also, as mentioned, prepared new regulations that make the use of energy-efficient plant components mandatory. This may increase the demand for products with high levels of efficiency and thus improve sales prospects for hydraulically optimised pumps, energy-efficient motors and automatic control systems.

In 2015 for the first time, we will offer our high-efficiency synchronous reluctance motors  to sectors other than the pump sector. The target group will be users of other rotating machinery that require appropriate drives. If we succeed in expanding our customer base for drive sales, this will open up additional prospects for new and replacement business.

How our general business with standardised pumps and valves develops is very closely tied to the economic situation. Should this prove better than forecast in certain economic countries or regions, demand may recover faster than expected. In this case, we will respond accordingly within the scope of our global manufacturing network.

Globally, our prospects in project business very much depend on the willingness of customers to implement major projects, for example this year in the energy sector. We take advantage of any opportunities with a global project management system, which coordinates the contacts with consultants, plant engineering contractors, end users and other stakeholders. In some countries, such as India, decision-makers have been postponing infrastructure measures for a long time. If there is suddenly unexpectedly strong pent-up demand, this could have a positive impact on our business.

Projects / Products

The markets’ requirements for our products are constantly changing. We will only succeed if we meet our delivery deadlines and offer technically advanced products in good quality at affordable prices. To minimise the risk of delivery delays, which can lead to an adverse effect on our reputation with customers and also result in financial penalties, we constantly monitor our sales and manufacturing operations. If we discover that machinery needs to be renewed or capacities expanded, we examine these investment projects as part of a step-by-step approval process. By doing this, we counter the risk of schedule and cost overruns.

Regular market analysis and monitoring minimise the risk that our products will become technically obsolete or that we offer them at prices not acceptable in the market. At the same time, we are exposed to the risk posed by cheap products from Eastern Europe and Asia that compete with KSB's portfolio. This calls for continuous quality management, which we have introduced across the Group.

Instruments for strengthening our product portfolio include the development of new joint ventures and the acquisition of other companies. But there are fundamental risks to this: We need to introduce products into an existing range, harmonise processes, and integrate employees into our organisation. Defined procedures for such projects, opportunity / risk ratings and appropriate analysis methods all help with this.

In our business, there are special requirements when it comes to the processing of large-scale projects with long terms. There are also always associated risks. There may be cost overruns, tighter import regulations, staff shortages, technical difficulties or quality problems – including possible penalties – that reduce our margins. For this reason, we specially train our employees in project management. This enables them to identify the risks associated with longer-term orders at an early stage. Our project managers are provided with appropriate management tools. Decisions are made in conjunction with clearly structured authorisation processes.

There are also technical and financial risks to orders with newly designed products. We limit technical risks to the extent that we define intermediate steps for development work and subject partial solutions to assessments. This also applies to pumps that we provide within the framework of a major contract running over a number of years for the construction of a new type of power plant in China. We minimise financial risks by using appropriate contractual clauses, and ensure that advances cover the costs incurred.

We set aside suitable provisions for warranty obligations and contractual penalty risks. These amounted to € 45 million in the annual financial statements for 2014 compared with € 43 million in the previous year; beyond which there is no other major residual risk (net risk).

In the current year, we will offer a range of technically enhanced products to customers, which may lead to partially improved business in building services, industry, water management and energy generation. In particular, the main coolant pump mentioned in the report on expected developments may result in additional orders for planned nuclear power plants in China. This is subject to the successful completion of tests in accordance with high quality and safety requirements and corresponding investment decisions by customers.

Our two expansion projects in Grovetown (USA) and La Roche-Chalais (France) will help improve the manufacturing base. The new specialist foundry of our US subsidiary, GIW Industries, Inc., will immediately allow us to supply large slurry pumps for mining more quickly, while the new production facility for triple-offset butterfly valves in the west of France will help meet the demand for these liquefied gas valves, which started increasing in 2014. We can already take into account the imminent expansion of our manufacturing facilities when agreeing deadlines with our customers. This may under certain circumstances have a positive effect on our order intake, but requires scheduled construction progress.

To date we have obtained components for our standardised and close-coupled pumps from our German foundry in Pegnitz. We have begun to modernise it, and to focus on the production of higher-value components. In the current year, we will start obtaining standard castings for standardised and close-coupled pumps at more favourable prices from our Indian foundry as well as from an external supplier. This will allow us to respond more flexibly to market requirements and to achieve adequate margins.

Finance / Liquidity

As a group with global operations, we are exposed to a wide variety of currency risks. We counter these with foreign exchange hedges. However, our global manufacturing network also offers us the opportunity to benefit from currency effects and to use this where appropriate in competition with other manufacturers. In addition to uncertainties regarding exchange rates, interest rate developments on the capital markets play a role for us. We use bank loans subject to variable interest rates to counter the interest rate risk by hedging our future interest payment flows accordingly.

Alongside the euro, the most important currencies for the KSB Group are the US dollar, the Indian rupee, the Brazilian real and the Chinese yuan. If the exchange rate deviates from our assumptions, this would have positive or negative effects upon our business volumes and our earnings. Political crises such as the situation in Eastern Europe and the search for solutions for highly indebted nations can also bring about significant currency fluctuations, as the year 2014 has demonstrated.

A strict receivables management system and the use of trade credit insurance helps us avoid situations where receivables cannot be collected from customers.

Acquisitions generally increase the intangible assets. However, delays in integration into the Group organisation or negative changes in the market environment may have an adverse impact on the business and financial development of a new entity. This may lead to goodwill declining or to financing for the development of these companies not being repaid in a timely manner. Therefore we monitor very closely the course that the businesses of our acquired companies take (post-merger phase).

Risks regarding margins and liquidity are typical of the project business. As well as the continued pressure on our selling prices, which is reducing our profit margins, these include unfavourable contract conditions such as reduced advances and tougher contractual penalties. As we comply exactly with our approval processes in the quotation phase and constantly monitor our net financial position, we minimise this risk. At the same time, this enables us to recognise and avoid liquidity shortages. Where necessary, we secure sufficient liquidity by agreeing appropriate credit lines early on.

Persistent recessions or newly emerging crisis may adversely affect the financial situation of our customers. Delayed payments and credit losses as a result of this can place a burden upon our results of operations. The same effect might occur if the foreign exchange regulations become stricter for individual countries. We counter this by means of a strict receivables management system and intensive customer contacts.

As regards tax matters, the global orientation of our activities must be taken into consideration. Based on our operative activities in numerous countries with varying tax laws and administrative interpretation, differentiated assessment is required for measuring our tax obligations. Uncertainty may arise due to different interpretations by taxable entities on the one hand and local finance authorities on the other. These may come to light during audits. By cooperating closely with external local tax specialists, we counteract the risk of having to pay back taxes. As we continually monitor unclear issues, we can generally classify the probability of occurrence. Should a need for subsequent payment arise, we create the corresponding provisions in good time. In the 2014 consolidated financial statements. we set aside about € 3 million for circumstances that are classified as a significant or neutral risk.

Procurement

Commodity prices and procurement times are subject to strong market-related fluctuations. This may adversely affect our earnings situation if we do not manage to make up for cost increases or pass them onto our customers. Delays or bottlenecks in our supply chain for raw materials and components may negatively impact our business operations. If we do not benefit promptly from declining procurement prices, the persistent pressure on the selling price of our products would have a negative effect on our earnings.

In order for our high-quality products to be price-competitive in the long term, we look for suppliers worldwide who will supply us with raw materials and components in the desired quality and quantity, but at advantageous terms. In this context, we focus not only on price and quality, but also consider the materials used from a total cost viewpoint. We maintain a cooperative relationship with the selected suppliers. We are creating a mutually beneficial situation that is underpinned by a high degree of flexibility and reliability. We are therefore in a good position to meet promised delivery times and to comply with defined quality standards and thus maintain and strengthen the bond between us and our customers. However, we are also careful to avoid becoming dependent on individual suppliers. Accordingly, it is important to us to constantly know a sufficient number of alternative procurement sources and be able to use them, if necessary.

Technology / Research and Development

It is essential to our future success that we have a product and service range that is suited to the market in terms of technology, price and delivery time. The changing needs of our customers and new standards and regulations – especially in promising markets such as China – require that we continuously develop and improve our products and services. Research and development for innovations consumes significant financial and human resources, and the resulting products are not always successful.

New dimensions: Slurry pumps are becoming larger, just as mining plants.

To avoid any negative impact on earnings, it is important to recognise the market-related or technical risks early on. To this end, we are constantly updating our development process, which incorporates various control levels. As sales employees are regularly included in this process, risks arising from changes in markets or applications can be taken into account in good time in the evaluation. This close integration also enables us to respond to new market trends more quickly than our competitors.

Changing technical processes offer scope for new products. This includes, for example, ways in which energy can be used more efficiently, water can be treated more effectively and natural resources can be obtained at a lower cost. Our network with technology partners, customers and suppliers as well as representatives from science and politics enables us to identify such developments at an early stage and to adapt our product range accordingly. However, this means we also have to ensure that we safeguard our know-how. We can only succeed in this if we adequately secure our IT systems technically and apply for patents and trademarks early on.

In the current year, we are working on modernising and supplementing our product range using our research and development capabilities. This applies primarily to products that are needed in the chemical and petrochemical industries, as well as to circulators and automation systems. By developing innovative pumps, valves and systems as well as energy-saving special motors, and launching them onto the market, we are improving the chances of getting our range of competitive products to stand out and thus strengthen our image as a technology leader.

Of particular importance for the development of our products is the keyword “Industry 4.0”, used to describe the networking of manufacturing facilities. By enabling our pumps, valves and automation systems to communicate via the Web, we will establish one of the many conditions for the “net worked factory” that partially organises itself. In this way we will position ourselves early on as a company keen to be at the forefront of this development.

Environment

Our business activities, primarily in the area of production, are subject to numerous environmental protection laws and regulations. Environmental damage of any kind (for example, groundwater contamination, renovation needed due to outdated construction materials or unpleasant odours arising from the use of chemicals) may result in losses not covered by an insurance policy. Therefore, at all company sites officers monitor compliance with laws and regulations as well as with internal KSB rules, which in some cases exceed the prescribed environmental standards. If we discover any contamination, we set aside provisions to meet the liabilities for the necessary clean-up work. In the 2014 consolidated financial statements, these amounted to about € 1 million for significant or neutral risks.

As part of acquisition projects, we examine properties for possible contamination before purchase. We take account of critical issues by way of corresponding contractual regulations with the seller and implement appropriate measure in consultation it.

In markets where environmental regulations are becoming more stringent, there is a risk that our products and own or purchased services may cause infringements that lead to us losing our market authorisation and which damage our reputation. A change in rules on liability in environmental protection can also increase the risks for our business success. As a member of national and international professional associations we become aware of imminent changes in environmental law early on. We also continually update the legal frameworks that are in place in our Operational Units, enabling us to ensure that our employees always abide by the applicable law. This is also monitored by external auditors as part of the management certifications.

Based on a global environmental management system, we recognise in good time the hazards for humans and nature that may arise from our activities, and where necessary take protective measures. It gives us great opportunities to prevent damage and the financial consequences thereof. By having our production and service plants checked by auditors and certified according to international standards, we and our customers are both assured that KSB companies respect the environment. This is an important prerequisite for many business relations. It offers KSB the opportunity to present itself to the market as an environmentally sound company. Our commitment to the UN Global Compact  too allows us to meet the expectations of our customers and thus improve our sales prospects.

Other business-related aspects

To achieve our growth and profitability business objectives, we need qualified employees at all our locations, including technical specialists. Due to the demographic change in some countries, the competition for these and other highly skilled professionals is increasing, and will intensify if economic recovery sets in. We counter this risk with demand-oriented measures, systematic human resources planning and international recruitment processes.

Changing market conditions can have a negative impact on the funded status of our pension obligations. Strong fluctuations in the evaluation of capital market interest rates to be paid may have a considerable impact on the Group’s earnings and the equity carried on the balance sheet. To limit this risk, we validate alternative models.

Other potential risks associated with the activities of our employees include dishonest conduct or violations of laws, that could damage the image of KSB. We counter these risks and safeguard our reputation among our customers by organising regular compliance training and through individual initiatives in critical regions.

Legal disputes cannot always be avoided within the framework of our business activities. These are usually disputes arising from operations, generally involving unclear warranty issues. If as a result of these issues we expect negative effects on the success of our business, we set aside corresponding provisions, which cover not only the anticipated amount of loss, but also the costs of proceedings. To rule out a net risk, the 2014 consolidated financial statements include about € 4 million for those cases classified as significant or neutral risks. We have also created provisions for litigation with authorities and for staff matters. These total a further € 4 million to cover any cases we classify as significant or neutral within our risk assessment methodology.

The manipulation and loss of electronic data can lead to serious commercial disadvantages. We limit this risk by means of adequate security systems and access procedures. An increased centralisation of the IT systems of our various operating units assists us in this. In this way, we implement high security standards and thus reduce the risk of data loss or corruption.

Since 2014, we have made more use of online social media as a means of initiating contact with potential employees. These communication channels will increase our chances of finding a suitable selection of candidates and recruiting professionals internationally. At the same time, using these media we can target young people who are interested in apprenticeships, dual work / degree programmes or executive trainee programmes. We give them an insight via online media into the company’s activities including social activities at KSB. This can increase the attractiveness of our company as an employer for key target groups, and improve our chances in the battle for the “best brains”.

In 2015, we will begin to renew our central infrastructure and standardise and automate our IT services further. This will allow us to provide employees with the required services more cheaply and quickly.

IMPORTANT OPPORTUNITIES AND RISKS BY SEGMENT

As in the previous year, the opportunities and risks for the Pumps, Valves and Service segments are most influenced by economic development. The future development of China, for example, is of importance to us. Particularly in Eastern Europe, uncertainty regarding political risk is of great importance to the Pumps and Valves segments, and to a lesser degree to Service. The unclear oil price trend and worsening payment behaviour harbour risk potential for future business transactions. A quicker-than-expected return to political stability, combined with a calming of the currency turmoil, would probably have positive repercussions. We would always expect benefits from an unexpectedly early recovery of the oil price. On the contrary, a continuation of a politically uncertain situation, combined with persistent depreciation tendencies among some currencies, or a permanently low oil price would have a negative impact on our business. Our risk assessment for our most important influencing factor, the economic situation, remains virtually unchanged from the previous year. We nonetheless hope that our measures, intended to foster growth, will provide us with considerable support in achieving our goals. We see positive signs of this and thus better opportunities for our project business, despite possible currency uncertainties. Furthermore, the political crises and future development of the oil price mean both opportunities and risks for all segments. Our customers are also often affected by recessions and more intense competition, which can decrease their ability to pay in individual cases.

Negative currency changes in growth countries could threaten our exports, in particular those from our European plants. But this would also enable our production facilities in the countries affected to benefit from such developments and to increase their export volumes.

RISK REPORT ON THE UTILISATION OF FINANCIAL INSTRUMENTS

Central financial management in the KSB Group performs its duties within the framework of the guidelines laid down by the Board of Management. We base the nature and scope of all financial transactions exclusively on the requirements of our business and do not lend ourselves to business of a speculative nature. The aim is to ensure liquidity at all times and to finance our activities under optimal conditions. With respect to our export business, we hedge foreign exchange and credit risks to the greatest extent possible. We continuously improve our receivables management methods with the goal of settling our outstanding amounts by their due dates.

We are exposed to the following financial risks as a consequence of our business activities:

On the one hand, we are exposed to credit risk. We define credit risk as potential default or delays in the receipt of contractually agreed payments. We are also exposed to liquidity risk, which is the risk that an entity will be unable to meet its financial obligations, or will be unable to meet them in full. In addition, we are exposed to market price risk. Exchange rate or interest rate changes may adversely affect the economic position of the Group. Risks from fluctuations in the prices of financial instruments are not material for us.

We use foreign exchange hedges to reduce the risks from transactions involving different currencies, These are generally currency forwards, which we use both for transactions that have already been recognised and for future cash flows from orders still to be processed. At year end, the notional volume of currency forwards used to hedge exchange rate risks was € 235.0 million (previous year: € 211.9 million). Foreign currency items denominated in USD account for the major volume hedged by forwards. By strengthening our production sites worldwide, we can realise “natural” currency hedging in currency markets that continue to be volatile.

To minimise interest rate risks, we concluded interest rate swaps to hedge cash flows from underlyings amounting to € 60.6 million (previous year: € 70.7 million). Underlyings and hedge transactions share the same variable interest rates and maturities (1 to 3 years).

We limit all these risks through an appropriate risk management system, defining how these risks are addressed through guidelines and work instructions. In addition, we monitor the current risk characteristics and continuously provide the information obtained in this way to the Board of Management and the Supervisory Board in the form of standardised reports and individual analyses.

For more information on the three risk areas and the impact on the balance sheet, see the Notes, section VI. Additional Disclosures on Financial Instruments.

OVERALL ASSESSMENT OF OPPORTUNITIES AND RISKS BY THE BOARD OF MANAGEMENT

The opportunities and risks for the KSB Group are mainly derived from macroeconomic influencing factors and their effects on the global mechanical engineering markets and the competition.

The overall risk situation has not changed materially in comparison with the previous year, but there has been a change in the assessment of various individual risks as a result of our measures and, in part, of other internal and external aspects. Overall, we assume there will be moderate economic recovery over the next year. Our structural measures will afford us additional support in achieving our objectives. However, an economic slowdown in the growth markets as well as negative developments that could stem from the regions in Eastern Europe experiencing unrest, from the future oil price trend or from volatile currencies present risks. This would have a negative effect on our business volumes as well as the planned earnings.

In this environment, the KSB Group continues to rely on its ability to match capacities and resources to the changing market conditions. For us, a solid financial position and an efficient cost structure are vital in order to maintain our long-term competitiveness. We are convinced that we can continue to successfully overcome the risks arising from the above-mentioned challenges.

The introduced risk management system as well as the related organisational measures allow the Board of Management to identify risks in a timely manner and to take adequate measures. In view of the somewhat uncertain situation, the focus of activities in 2015 will continue to be on the management of market risks. The Board of Management states that, based on the risk management system established by the KSB Group, at present there are no risks that could lead to a lasting and significant impact on the net assets, financial position and results of the KSB Group.

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