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Internal control and approach to risk management

The Board confirms in accordance with principle C.2 of the Code that it has maintained a sound risk management and internal controls systems, seeking to safeguard shareholders’ investment and the Group’s assets. The Board is responsible for seeking to determine the nature and extent of the significant risks that it is appropriate for the Group to take to achieve its strategic objectives and it is the responsibility of the Executive Directors and senior management to implement and maintain the Group’s internal control and risk management systems within the governance and policy framework approved by the Board. The risk management and internal controls systems have been in place throughout the year ended 30 June 2011 and up to the date of this report, and their effectiveness is regularly reviewed by the Board. The risk management and internal controls systems and their effectiveness accord with the Turnbull guidance.The Group’s system of internal control is designed to manage risks that may impede the achievement of the Group’s business objectives rather than to eliminate those risks entirely. The system of internal control therefore provides only reasonable, not absolute, assurance against material misstatement or loss. The system of internal control does, however, provide reasonable assurance that potential issues can be identified promptly and appropriate remedial action taken.

The Group operates internal controls to ensure that the Group’s financial statements are reconciled to the underlying financial ledgers. A review of the consolidated accounts and financial statements is completed by management to ensure that the financial position and results of the Group are appropriately reflected.

To enhance the internal control framework, a senior executive Risk Committee was established in the 2009/10 financial year. The Risk Committee consists of standing members comprising the Group Finance Director, Group General Counsel and Company Secretary, an Operational Executive Director and/or a Regional Managing Director and the Chief Internal Auditor. Other members of the Executive, heads of function and senior managers attend meetings by invitation having regard to the business areas to be explored. Subject to the general supervision of the Audit Committee, the Risk Committee reviews the effectiveness of the Group’s internal control policies and procedures for the identification, assessment and reporting of risks and to assess individual key risks on a rolling basis.

The key aspects of the Group’s system of internal control and risk management framework are as follows:

i) a clear organisational structure with defined levels of authority and responsibility for each operating division;
ii) financial and management reporting systems under which financial and operating performance is consistently reviewed against budget and forecasts at divisional, regional and Group level on a monthly basis;
iii) identification and review of principal operational risk areas are embedded in the Group’s monthly management reporting system, so that risk identification and the control of risk are a routine aspect of management responsibility. Amongst other matters, the risks reviewed include:

the land and housing markets, including changes in the macroeconomic environment, sales and quality of product;
liquidity, including the availability of sufficient borrowing facilities;
people, including the development of a skilled and experienced workforce;
subcontractors and suppliers;
land buying;
Government regulation, including obtaining planning permission;
construction, including achieving key milestones and the impact on the environment and social surroundings;
health and safety; and
failure of the Group’s IT systems; and

iv) compliance with internal control and risk management systems are supported by the Group’s internal audit team which is responsible for undertaking an annual audit plan and ad hoc audits and reporting to the Audit Committee, and, if necessary, the Board on the operation and effectiveness of those systems and any material failings with them. The planned programme of audit appraisals across Group operations is approved by the Audit Committee and includes full divisional audits and targeted audits of key risk areas such as the land viability process, land acquisition control and monitoring, work in progress and subcontractor payment controls. Where the internal audit team does not have the expertise or resources required to conduct complex audits they use external expertise.

The Group’s operations and financing arrangements expose it to a variety of financial risks that include the effects of changes in debt market prices, credit risks, liquidity risks and interest rates. The most significant of these to the Group is liquidity risk and, accordingly, there is a regular, detailed system for the reporting and forecasting of cash flows from the operations to Group management to ensure that risks are promptly identified and appropriate mitigating actions taken. These forecasts are further stress tested at a Group level on a regular basis to ensure that adequate headroom within facilities and banking covenants is maintained. In addition, the Group has in place a risk management programme that seeks to limit the adverse effects of the other risks on its financial performance, in particular by using financial instruments, including debt and derivatives, to hedge interest rates and currency rates. The Group does not use derivative financial instruments for speculative purposes. The Board approves treasury policies and has delegated certain day-to-day treasury activities to a centralised Treasury Operating Committee, which in turn regularly reports to the Board. The treasury department implements guidelines that are established by the Board and the Treasury Operating Committee.

In accordance with principle C.2.1. of the Code the Board regularly reviews the effectiveness of the Group’s system of internal controls, covering all material controls including financial, operational and compliance controls and risk management systems. A risk framework has been developed for all business processes by the internal audit function and approved by the Audit Committee. This framework forms the basis of the internal control audit plan for the year ahead, which tests if controls are being applied effectively in each operating division. Material issues identified during internal audits and follow-up action plans are reviewed by the Executive Directors and by the Board on a quarterly basis, and necessary actions are immediately taken to remedy any failings in the internal control system.

During the course of its review of systems of internal control, the Board has not identified nor been advised of any failings or weaknesses which it has determined to be significant. Therefore, a confirmation of necessary actions has not been considered appropriate.

In addition, the management teams of all operating divisions identify key risks in their monthly management reports to the Executive Committee and complete a control self assessment twice a year in which they confirm that they have applied appropriate levels of control. The Audit Committee, as a standing agenda item every six months, reviews the risk framework to determine if the system of internal control remains effective and report on their findings to the Board. During the year under review, the Executive Committee prioritised the risk framework by identifying the risks considered most significant to the Group. For each of the risks identified, an assessment has been made of the probability and potential impact on the business and these risks are reported on internally and reviewed during internal audits and control self assessments.