Internal control

The board acknowledges its responsibilities for the group’s system of internal control to facilitate the identification, assessment and management of risk, the protection of shareholders’ investments and the group’s assets. The directors recognise that they are responsible for providing a return to shareholders, which is consistent with the responsible assessment and mitigation of risks.

Effective controls ensure that the group is not exposed to avoidable risk, that proper accounting records have been maintained and that the financial information used within the business and for publication is reliable. The dynamics of the group and the environment within which it operates are continually evolving together with its exposure to risk. The system is designed to manage rather than eliminate the risk of assets being unprotected and to guard against their unauthorised use and the failure to achieve business objectives. Internal controls can only provide reasonable and not absolute assurance against material misstatement or loss.

The directors confirm that there is an ongoing process for identifying, evaluating and managing the risks faced by the group and the operational effectiveness of the related controls, which has been in place for the year under review and up to the date of approval of the annual report and accounts. They also confirm that they have regularly reviewed the system of internal controls utilising the review process set out below.

Standards

There are guidelines on the minimum groupwide requirements for health and safety and environmental standards. There are also guidelines on the minimum level of internal control that each of the divisions should exercise over specified processes. Each business has developed and documented policies and procedures to comply with the minimum control standards established, including procedures for monitoring compliance and taking corrective action. The board of each business is required to confirm annually that it has complied with these policies and procedures.

High level controls

All operations prepare annual operating plans and budgets which are updated regularly. Performance against budget is monitored at operational level and centrally, with variances being reported promptly. The cash position at group and operational level is monitored constantly and variances from expected levels are investigated thoroughly.

Clearly defined guidelines have been established for capital expenditure and investment decisions. These include the preparation of budgets, appraisal and review procedures and delegated authority levels.

Internal audit

The group’s businesses employ internal auditors (both employees and resources provided by Ernst & Young where appropriate) with skills and experience relevant to the operation of each business. All of the internal audit activities are co-ordinated centrally by the group’s Director of Financial Control, who is accountable to the Audit committee.

All group businesses are required to comply with the group’s financial control framework that sets out minimum control standards. A key function of the group’s internal audit resources is to undertake audits to ensure compliance with the financial control framework and make recommendations for improvement in controls where appropriate. Internal audit also conducts regular reviews to ensure that risk management procedures and controls are adhered to. The Audit committee receives regular reports on the results of internal audit’s work and monitors the status of recommendations arising. The committee reviews annually the adequacy, qualifications and experience of the group’s internal audit resources and the nature and scope of internal audit activity in the overall context of the group’s risk management system set out below. The Director of Financial Control meets with the chairman of the committee as appropriate but at least annually, without the presence of executive management, and has direct access to the Chairman of the board.

Risk Management Review

The Company’s risk management process seeks to enable the early identification, evaluation and effective management of the key risks facing the businesses at operational level and to operate internal controls, which adequately mitigate these risks. The key risks and internal control procedures are reviewed by group personnel together with internal audit activities. Each business is responsible for regularly assessing its risk management activities to ensure good practice in all areas. Compliance with group requirements is monitored six monthly, and these assessments are formally reviewed by group personnel at least annually. The Audit committee receives reports on internal financial control issues from management and from the external auditors and regularly reports to the board for the purposes of the board’s annual review.

The principal corporate risks as identified by each business and noted by the board are currently:

1. Food safety

The Company derives over 55% of its turnover from the production and sale of food and has a positive role to play in contributing to the quality of people’s lives by providing wholesome and nutritious foods, food ingredients and animal feedstuffs. Sugar, tea, flour, bread, cereals, meat and dairy products are part of people’s daily lives all over the world and the Company plays an important part in making sure these are produced efficiently and to a high quality.

To manage food safety risks, the Company’s sites operate food safety systems which are regularly reviewed to ensure they remain effective, including compliance with all regulatory requirements for hygiene and food safety. The Company’s food products are made to high standards regardless of where they are manufactured. The group always puts food safety before economic considerations.

2. Supply chain labour standards

Those businesses within the group with global supply chains are at greater risk of controversy relating to breaches, by suppliers, of the International Labour Organisation core labour standards. Since the group uses extensive global supply chains, it takes all reasonable steps to mitigate the risk of damage to its reputation in the case of any breaches by striving to ensure that it does not buy from factories with poor working conditions. Examples of such steps include:

Primark requires all the factories that manufacture its clothes to sign up to its Supplier Code of Conduct which lays out strict guidelines on working conditions. Primark’s buyers visit all factories before they start working with them and will not buy from factories with obviously poor conditions.

Primark is a member of the Ethical Trading Initiative, an alliance of companies, trade unions and non-profit organisations that aims to promote respect for the rights of people in factories and farms worldwide. The business is committed to monitoring and progressively improving the working conditions of the people that make its products.

Primark currently has an extensive and independent audit programme active in all its sourcing countries. Unannounced audits comprise a large percentage of the total, in an attempt to ensure that audits reflect the actual situation within the factory and not the one the owner would like Primark to see. During 2007 Primark will have visited all of its major overseas suppliers.

Where issues are identified, suppliers are asked to commit to corrective actions and timescales for their implementation. These suppliers continue to have Primark’s full commercial support throughout the agreed remediation period, and the suppliers are supported by Primark’s own ethical trade experts where additional guidance is required. Primark has recruited managers based in China and India/Bangladesh to help to progress the findings of the auditors more thoroughly.

Follow-up audits are conducted within a three-month period of the initial audit and progress is recorded. Where progress is not forthcoming the senior buying directors are included in the process. Should co-operation not be forthcoming, Primark will consider its future trading relationship with this supplier.

• Twinings is a member of the Ethical Tea Partnership which requires its suppliers and subcontractors to meet the International Labour Organisation core labour standards, respecting an observance of human rights and fundamental freedoms without discrimination as to race, sex, language or religion.
• Illovo operates a comprehensive set of policies and standards to cover all aspects of its operation, including supply chain labour standards. Performance is measured on a regular basis by mean s of self-assessments and audits by independent consultants.

Many businesses within the group do not rely upon third parties to source their products. However, those that do have ethical sourcing policies in line with the Company’s Corporate Citizenship principles and the requirements of their customers.

3. Competition rules

The penalties for failing to comply with the 1998 Competition Act, the 2003 Enterprise Act, relevant EU law and all relevant competition legislation are recognised as risks to be managed within the group. Clear policy direction, which includes compulsory awareness training and close support from the in-house legal department, has reduced the likelihood of the group breaching these regulations.

4. Environment

The Company recognises the impact that its businesses have on the environment. Therefore, as a minimum, it aims to comply with current applicable legislation of the countries in which it operates and its operations are conducted with a view to ensuring that:

• emissions to air, releases to water and land filling of solid wastes do not cause unacceptable environmental impacts and do not offend the community;
• significant plant and process changes are assessed and positively authorised in advance to prevent adverse environmental impacts;
• energy is used efficiently and consumption is monitored;
• natural resources are used efficiently;
• raw material waste is minimised;
• solid waste is reduced, reused or recycled where practicable;
• the amount of packaging used for group products is minimised, consistent with requirements for food safety and product protection;
• products are transported efficiently to minimise fuel usage, consistent with customers’ demands, production arrangements and vehicle fleet operations;
• accidents are prevented so far as is reasonably practical; and
• effective emergency response procedures are in place to minimise the impact of foreseeable incidents.

The Company gives particular attention to recently acquired businesses, to ensure they operate in accordance with the standards expected of the group’s businesses.

The principal environmental risk is the use of energy and the resultant emissions of carbon dioxide, a gas involved in climate change. The efficient use of energy is a major element of our environmental policy. Indeed, all sites which are subject to the EU’s Pollution Prevention and Control regime are also under a statutory requirement to minimise energy consumption by use of best available techniques.

The Company’s manufacturing operations in the UK participate in the UK Government’s Climate Change Agreement Scheme. The sugar sites in the UK and Poland participate in the EU Emissions Trading Scheme. These schemes allow the sites to reduce energy consumption and therefore reduce emissions of carbon dioxide cost-effectively.

In addition to the consumption of energy the Company generates surplus electricity from highly efficient Combined Heat and Power (CHP) schemes and sells this electricity to other companies. All UK CHP schemes participate in the UK Government’s CHP quality assurance scheme and qualify for a full exemption from the UK’s Climate Change Levy.

Carbon dioxide is emitted both directly from the combustion of fossil fuels at the Company’s sites to create steam, heat and electricity, and indirectly by the power stations from which the Company buys its electricity. The use of bagasse (sugar cane fibre, which is a renewable resource and hence carbon neutral) as a fuel in the cane factories eliminates the need to use coal and other fossil fuels to provide energy to our boilers.

Other significant environmental risks include handling and disposal of waste and the treatment of waste water. The principal legal risk is regulatory action against the Company for non-compliance with licence conditions and statutory requirements. All the group’s businesses have named accountable senior executives and responsible managers and the management of the physical and legal risks, for which they employ specialists, is included in their annual objectives.

The Company employs Environmental Resources Management Ltd (ERM) to continue its rolling programme of audits of the management of environmental risks at a representative range of group companies. The sites audited are selected on the basis of materiality with regard to the range of issues as well as the contribution to the health, safety and environment performance of the group as a whole. ERM also carry out a sample data verification process on the group’s data to check completeness and accuracy. Each year the board reviews the verified results and provides strategic direction. Companies are required to develop action plans as appropriate and progress is monitored by the group health and safety manager.

The Company publishes details of its environmental performance in a separate report on its website: www.abf.co.uk/csr/hse.asp

5. Health and safety

The Company is committed to providing a safe and healthy workplace in line with local regulations to protect all employees, visitors and the public insofar as they come into contact with foreseeable work hazards. The Company considers health and safety as equal in importance to that of any other function of the Company and its business objectives. It requires its businesses to build a culture of sustained improvement.

People’s health and safety at work is a prime responsibility for all those who manage and supervise. All employees and those working on behalf of the Company have a responsibility for the health and safety of themselves and others who may be affected by their actions. The Company ensures that they are well informed, appropriately trained and are consulted on matters affecting their health and safety.

The principal health and safety risks relate to the potential for serious injuries, fatal accidents and regulatory action for non-compliance with statutory requirements.

As with environmental risks, all the group’s businesses have named accountable senior executives who employ specialists to manage these risks, which form part of their annual objectives.

The Company employs ERM to audit a representative sample of its operations to understand how companies manage their risks and to verify the data. Companies are required to develop action plans as appropriate and progress is monitored by the group health and safety manager.

The Company publishes details of its environmental performance in a separate report on its website: www.abf.co.uk/csr/hse.asp

6. Financial and commodity risks

Treasury operations are conducted within a framework of board-approved policies and guidelines to manage the group’s financial and commodity risks. Financial risks essentially arise through exposure to foreign currencies, interest rates, counterparty credit and borrowing facilities. Commodity risks arise from the procurement of raw materials and the exposure to changes in market prices.

Foreign currency risk

The group publishes its financial statements in sterling and conducts business in many foreign currencies. As a result, it is exposed to movements in foreign currency exchange rates which affect the group’s transaction costs and the translation of the results and underlying net assets of its foreign operations into sterling.

Translation exposure

The group does not hedge the translation impact of exchange rate movements on the income statement. A partial hedge of the balance sheet translation exposure is provided by borrowing in the currencies of some of the group’s overseas assets, as well as the designation of certain intercompany borrowings as a further partial hedge.

Transaction exposure

The group’s main transaction exposures are:

• sugar prices in British Sugar UK and Poland to movements in the sterling/euro and Polish zloty/euro exchange rates respectively;
• sugar prices in Illovo to movements in the South African rand/US dollar/euro exchange rates; and
• sourcing for Primark – costs are denominated in a number of currencies, predominantly sterling, euros and US dollars.

Elsewhere, a number of businesses purchase raw materials in foreign currencies but, in all material respects, they operate in their local currency and, as a result, transaction exposure to exchange rate movements is modest.

The group uses derivative financial instruments to hedge its exposure to fluctuations in foreign exchange on its trade receivables and trade payables that are exposed to movement in foreign currencies.

The group does not seek fair value hedge accounting for transaction hedges but marks them to market with the resulting changes in fair value taken through the income statement.

The group hedges forecast foreign currency exposures in respect of a significant proportion of its future sales and purchases on a rolling 12 month basis. The group classifies its forward foreign exchange contracts, used to hedge forecast transactions, as cash flow hedges and states them at their fair value.

Significant foreign currency transactions are generally covered through forward foreign currency sale or purchase contracts, the majority of which have maturities of less than one year.

Interest rate risk

Interest rate risk comprises the interest price risk that results from borrowing at fixed rates and the interest cash flow risk that results from borrowing at floating rates. The group’s policy is generally to maintain floating rate debt for the majority of its bank finance although interest rate swaps are entered into in more volatile markets.

Commodity price risk

The group purchases commodities including wheat, oils, cocoa, tea and energy in the ordinary course of its business. Exposure to changes in the market price of such commodities is managed through the use of hedging instruments including futures and options contracts. The use of such contracts is tightly controlled within set limits.

Credit risk

Our businesses are exposed to counterparty credit risk when dealing with customers, and from certain financing activities. Credit evaluations are performed on all customers requiring significant credit and outstanding debts are continuously monitored by each business. Aggregate exposures are monitored at group level and, where appropriate, limits are set for higher risk counterparties. Concentrations of credit risk are limited as a result of the group’s large and diverse customer base.

Banking relationships are generally limited to those banks that are members of the core relationship group. These banks are selected for their credit status, global reach and their ability to meet the businesses’ day-to-day banking requirements. The credit ratings of these institutions are monitored on a continuous basis.

Liquidity risk

The group has committed bank facilities available to meet its long-term capital and funding obligations and to meet any unforeseen obligations and opportunities.

7. Taxation risks

Tax benefits are not recognised unless it is probable that the position taken is sustainable. Management reviews each material tax benefit to assess whether a provision should be taken against full recognition of the benefit on the basis of potential settlement through negotiation and/or litigation. Any interest and penalties on tax liabilities are provided for in the tax charge.

The group operates internationally and is subject to tax in many different jurisdictions. As a consequence, the group is routinely subject to tax audit and local enquiries which, by their very nature, can take a considerable period to conclude. Provision is made for known issues based on management’s interpretation of country specific tax law and the likely outcome.

8. Loss of a major site

The group operates from many key sites the loss of which, for example as a result of fire, would present significant operational difficulties. Our operations have business continuity plans in place to manage the impact of such an event and group insurance programmes to mitigate the financial consequences.

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