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 approximately 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. Liquidity constraints in the Chinese property markets raised market concerns in the third quarter. KONE’s customer portfolio is well diversified, limiting individual customer risks. However, a worsening liquidity situation among Chinese property developers could impact construction activity in China, and, consequently, the demand for KONE’s solutions.

Following the COVID-19 outbreak in 2020, many governments across the world took significant measures to contain the pandemic by restricting the movement of people and limiting some business activities. In 2021, construction markets have started to recover in many countries thanks to successful vaccination campaigns, easing restrictions, and government stimulus. However, a deterioration of the situation, e.g. due to new COVID-19 variants, could have an adverse impact on the overall economic environment, construction activity and the demand for KONE’s services and solutions.

Geopolitical tensions and protectionism continue to expose KONE to various business risks. In addition to the potential adverse impacts on 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, the competitiveness of KONE’s offering is a key driver for 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, structural changes in the competitive landscape of the elevator and escalator industry, such as increased competition and customer consolidation in China, 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, the 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. KONE also uses a significant amount of subcontracted installation resources, has outsourced some business support processes and works with partners in e.g. digital services and logistics. These expose KONE to component and subcontracted labor availability and cost risk as well as continuity risk in partnerships. A failure to secure the needed materials, components or resources or quality issues within these could cause business disruptions and cost increases. The recovery in the global economy witnessed over the last few quarters has put pressure on supply chains resulting in, for example, increased prices and component availability constraints. The shortage of semiconductors, in particular, is closely monitored and managed e.g. with detailed planning of delivery execution and active involvement of supply chain partners. Continued challenges in the global supply chains could have an adverse impact on KONE’s financial performance.

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 e.g. 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 cybersecurity 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, cyber-crime, cyber-attacks, computer malware, information theft, fraud, misappropriation, or inadvertent actions from our employees and vendors. Physical damage caused by fire, extreme weather conditions, natural catastrophes or terrorism, among other things, to these operations, could also 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 of revenues and expenses (transaction risk) and from the translation of statement of income and statement of financial position of the foreign subsidiaries from respective functional currencies into euros (translation risk).
Transaction risks
A substantial part of KONE’s operations are denominated in local functional currencies of the subsidiaries and do not therefore give rise to transaction risk. The sales of new equipment and modernizations, including installation, 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. 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 yuan, British pound, Canadian dollar, US dollar and Singapore 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, statement of cash flows 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 2020 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 -173.2 (54.0) million in 2020. 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 arising from operations of foreign subsidiaries are in the Chinese yuan, Hong Kong dollar and US dollar.
Interest rate risks
KONE’s cash and short-term investments were EUR 2,628.3 (2,250.2) million at the statement of financial position date. At the same time, KONE’s interest-bearing debt was EUR 695.8 (721.6) million and consisted of EUR 504.3 (544.3) million of financial debt including lease liabilities, EUR 4.2 (4.4) million of option liabilities from acquisitions, and EUR 187.2 (172.9) million of employee benefit liabilities. Additionally, KONE had an asset on employee benefits of EUR 19.2 (21.7) 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 2020 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, EUR -2,364.8 (-2,130.3) million. For 2021 a 1 percentage point change in the interest rate level would mean a change of EUR -23.6 (-21.3) 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 acquisition.

Refinancing and liquidity risks

KONE’s cash and cash equivalents was EUR 457.9 (662.4) million and financial investments EUR 2,170.4 (1,587.7) million on December 31, 2020.

Cash and financial investments are managed centrally by KONE Treasury. Due to local regulations part of the funds reside 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 flow method using a current borrowing rate (level 2 fair value hierarchy) as the discount rate. KONE has also an uncommitted commercial paper program of EUR 500 million, an existing committed European Investment Bank (EIB) credit facility of EUR 200 million and bank credit facilities of EUR 800 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, 2020				Dec 31, 2019
Interest-bearing debt
Long-term loans	-	-	-	-	-	-160.0	-	-160.0
Lease liabilities	-98.9	-199.8	-44.2	-342.9	-103.7	-210.3	-56.7	-370.7
Short-term loans	-160.0	-	-	-160.0	-	-	-	-
Used bank overdraft limits	-1.4	-	-	-1.4	-13.5	-	-	-13.5
Option liabilities from acquisitions	-4.2	-	-	-4.2	-4.4	-	-	-4.4
Employee benefits	-	-	-187.2	-187.2	-	-	-172.9	-172.9
Non-interest bearing debt
Accounts payables	-890.9	-	-	-890.9	-809.8	-	-	-809.8
Derivatives
Capital inflow	3,676.9	113.4	-	3,790.3	2,425.5	143.9	-	2,569.4
Capital outflow	-3,667.7	-113.8	-	-3,781.5	-2,437.7	-146.3	-	-2,584.0
Interest payments	-7.6	-8.5	-4.6	-20.7	-0.6	-14.2	-4.4	-19.2
Net outflow	-1,154.0	-208.6	-236.0	-1,598.6	-944.2	-386.9	-234.0	-1,565.1

Financial credit risks
KONE has substantial amounts of cash and financial investments. In order to diversify the financial credit risk, funds are invested into highly liquid interest rate funds and 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 assets, 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 receivable is 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 using the expected credit loss model.

During 2020, KONE modified calculation parameters for the receivables aging based allowance as well as recorded impairment charges on certain individual cases to reflect the effect of increased risk for credit losses pertaining to COVID19. Overall the disruption to the business arising from COVID19 has been limited with significant part of KONE's operations being considered essential and as such, allowed even during lockdowns. Increased uncertainty of receivables collection is not expected to continue long-term.

The amount of bad debt provision recorded to cover doubtful accounts was EUR 262.5 (252.9) million at the end of the financial period.


Aging structure of the accounts receivable after recognition of impairment, MEUR	Jan 1-Dec 31, 2020	Jan 1-Dec 31, 2019
Not past due and less than one month due receivables	1,674.5	1,742.3
Past due 1-3 months	277.5	275.9
Past due 3-6 months	134.8	136.6
Past due > 6 months	91.9	77.5
Accounts receivable in the consolidated statement of financial position	2,178.6	2,232.3

Risks related to the reporting of non-financial information

The assessment and analysis of KONE’s most significant risks also covers non-financial 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. In addition, KONE is applying TCFD guidelines on the reporting of climate-related risks. 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.

Climate and environmental risks

We recognize climate and environmental risks as having a potential negative impact on our business in the short to medium term, albeit they are not considered being very significant in comparison to other business risks which are reported under “Most significant risks”. However, we see that climate risks will only keep increasing in relevance and potential impact. Overall, we identify, assess and manage climate and environmental risks as integral part of our company-wide business risk management process and ISO 14001 environmental management system. Certain KONE functions and locations conduct detailed climate and environmental risk assessments, according to relevant business requirements, e.g. in the Supply Chain function or at selected operational sites.

Climate and environmental risks are classified as transition risks and physical risks as well as risks of negative impacts on the climate. Some of the most relevant climate and environmental risks for KONE are physical risks to our supply chain and own operations, for example, as a result of extreme weather events. These risks can materialize, for example, in the form of delivery disruptions or interruptions in our own manufacturing, installation or maintenance activities. KONE’s products are also subject to physical risks and possible damages due to changing environmental conditions or extreme weather events.

To mitigate the physical risks, we engage in several risk mitigation activities related to component availability and interruptions to our own or suppliers’ operations, as described in the risk management table in this text. We use, for example, dedicated location-based software tools to regularly monitor our supply chain locations for risks related to extreme weather events such as fires, floods and hurricanes. In terms of our product development, we apply design specifications and specific procedures that aim to ensure product resilience even in harsh and changing environmental conditions. For example, rigorous environmental testing is a part of KONE’s product development to ensure that our products sustain exceptional and changing weather conditions, such as temperature variations and moisture.

We have equally identified transition risks in the form of changing market demands and emerging regulation for both KONE’s solutions and operations. Not being able to meet the climate-related demands and offer the solutions and services our customers require, could have a detrimental impact on KONE’s business. In addition to potential product-related requirements, emerging climate-related regulation may also impact our operations. For example, the need to transition towards more sustainable mobility solutions is evident for KONE’s current fleet of over 19,000 service and benefit vehicles.

To mitigate the transition risks, KONE constantly evaluates emerging regulation and market demands in our high-level business plans. KONE is an active member in relevant industry forums and research consortiums and proactively monitors the regulatory landscape. As part of KONE’s climate pledge, we have set ambitious greenhouse gas reduction targets for our offering and operations and aim to have carbon neutral operations by 2030. The pledge will guide our work for more climate-friendly products, services and ways of working, and we actively collaborate with our suppliers and partners to achieve our targets.

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. KONE also identifies and assesses risks related to any type of harassment, equal employment practices, working conditions and any form of discriminations. KONE prevents such situations by having adequate policies and processes in place and training its managers. KONE also offers its employees channels for reporting misconduct as there is no tolerance for such behavior. 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 our suppliers are expected to 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. These standards were further clarified in our 2020 Supplier Code of Conduct. On the basis of the 2019 human rights risk assessment we conducted, we have prioritized our work on human rights in the supply chain, set up a human rights network and prepared supplier on-site and online assessment processes and documentation for roll-out in 2021.

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 has continued 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. In addition, in 2020 we began an anti-bribery and corruption risk assessment, which will be completed in early 2021.