The H&M group carries out regular risk analysis for both operational and financial risks. Operational risks are mainly associated with the business and the external risks that affect the group. Some can be managed through internal procedures, and in some cases the group can influence the likelihood of a risk-related event occurring. Other risks are determined to a greater extent by external factors. If a risk-related event is beyond the company’s control, work is aimed at mitigating the consequences.
There are risks and uncertainties affecting the H&M group that are related to the shift in the industry, fashion, weather conditions, macroeconomics and geopolitical events, sustainability issues, foreign currencies, taxes and various regulations, but also in connection with expansion into new markets, the launch of new concepts and how the brand is managed. A description of the H&M group’s operational and financial risks is given in the section operational risk, with more detailed information concerning financial risks being given in the annual report 2019, note 2, Financial risks.
The H&M group’s approach to risk management and internal control is described in more detail on pages 22–35 of the corporate governance report. The description includes how the H&M group works according to the COSO framework, which is issued by the Committee of Sponsoring Organizations of the Treadway Commission and has five components: Control Environment, Risk Assessment, Control Activities, Information and Communication, as well as Monitoring Activities.
MAJOR SHIFT IN THE INDUSTRY
Society is being increasingly influenced by growing digitalisation, as a result of which many sectors such as the retail trade are undergoing significant structural changes – a shift in the industry, with rapidly changing customer behaviour. The H&M group sees many opportunities arising from this shift since the group has the capacity and the resources to seize these, but there are also risks for those that are not fast and agile enough during this transitional period. Since more and more shopping is taking place online, mainly via mobiles, the shift is bringing challenges for physical retail stores throughout the sector. The H&M group is therefore integrating its physical stores more and more with its online store, to make the shopping experience as convenient and easy for the customer as possible. This shift also means that the competitive landscape is being redefined, that there is increasing focus on creating sustainable solutions, that new operators are coming in with new business models and that profitability in the industry is being squeezed by the fierce competition.
As one of the world’s leading fashion companies H&M attracts great interest and is constantly in the spotlight. To safeguard and manage the brands it is important that the H&M group continues to be developed and run according to its strong values, which are characterised by high business ethics.
It is of the utmost importance that the H&M group lives according to the high aims set out in its policies and guidelines on business ethics and has good knowledge, insight and procedures in respect of the production of its products. It is also of the utmost importance that the H&M group lives up to the high ambitions that it has set itself in the area of sustainability. Should the H&M group fail in these respects, there is a risk that the group’s reputation and brands could be damaged. Accurate, transparent and reliable communication can prevent occurrences of reputational risk, and can also help mitigate the consequences of any incidents.
Operating in the fashion industry is a risk in itself. Fashion has a limited shelf-life and there is always a risk that some part of the collections will not be sufficiently commercial, i.e. will not be well received by customers. Fashion purchases are often emotional and may therefore be negatively affected by unforeseen geopolitical and macroeconomic events. Purchasing decisions are also increasingly influenced by customers’ desire to live more sustainably.
Within each concept it is important to have the right volumes and the right balance in the mix between fashion basics and the latest trends. In summary, each collection must achieve the best combination of fashion, quality, price and sustainability.
To optimise fashion precision, the H&M group buys items on an ongoing basis throughout the season. Fashion is becoming increasingly global, but shopping patterns vary between different markets and sales channels.
The start of a season and the length of that season can vary from country to country, for example. Delivery dates and product volumes for the various markets and channels are therefore adjusted accordingly. Greater accuracy will also help reduce overall resource consumption and create a more sustainable business model.
The H&M group’s products are purchased for sale based on normal weather patterns. Deviations from normal weather conditions affect sales. This is particularly true at the transition between two seasons, such as the transition from summer to autumn or from autumn to winter. If the autumn is warmer than usual it may have a negative effect on sales of weather-related garments in particular, such as outerwear and chunky knitwear. The increasingly clear effects of climate change mean that these variations are likely to increase in the future.
NEGATIVE MACROECONOMIC CHANGES AND GEOPOLITICAL RISKS
One or more markets may be affected by events that have a negative effect on the macroeconomic situation or geopolitical environment in the country. These changed macroeconomic or geopolitical circumstances, such as political instability and sudden negative events, e.g. virus outbreaks, in one or more countries, may result in rapid changes in the business environment and in economic downturn, which is likely to change consumer purchasing behaviour and thus negatively impact the group’s sales.
Uncertainties also exist concerning how external factors such as foreign currencies (see the following section), raw materials prices, transport costs and suppliers’ capacity will affect buying costs for the group’s products. There are also risks associated with social tensions in sourcing markets, which may lead to instability for suppliers and in manufacturing and deliveries. The climate risk analysis that the company has carried out according to TCFD guidelines has shown that climate change may have further effects on the conditions for producing and distributing products in certain regions/countries (see also page 48 in the annual report 2019).
The group therefore needs to monitor such changes closely and have strategies in place to deal with fluctuations as advantageously as possible for both the company and external stakeholders.
The H&M group has a highly ambitious sustainability strategy which aims to lead the change towards a more sustainable fashion industry. This gives rise to both opportunities and risks. Some of the main risks identified by the company include shortage of natural resources, climate change and its impact, failure to uphold human rights along the supply chain, corruption, political and social instability in production and sourcing markets and changed consumption patterns and customer attitudes. This last factor could ultimately have major effects on the H&M group’s sales – both positive and negative – and the outcome will depend on how successful the company is in its work on the sustainability strategy, including how well the company meets customers’ expectations concerning sustainability.
For a more detailed description of risks related to sustainability see the statutory sustainability report on pages 46–51 in the annual report 2019, and particularly pages 48–49 for the climate risk analysis according to TCFD.
Nearly half of the group’s sales are made in euros, while the most significant currencies for the group’s purchasing are the US dollar and the euro. Fluctuation in the US dollar’s exchange rate against the euro is the single largest foreign currency transaction exposure for the group. Large and rapid exchange rate fluctuations, particularly as regards the US dollar as a sourcing currency, may also have a significant effect on purchasing costs – even if this may be regarded as relatively competition-neutral over time.
To hedge flows of goods in foreign currencies and thereby reduce the effects of future exchange rate fluctuations, payments for the group’s flows of goods – i.e. the group’s purchases of goods and in the majority of cases also the corresponding foreign currency inflows from the sales companies to the central company H & M Hennes & Mauritz GBC AB – are hedged under forward contracts on an ongoing basis.
In addition to the effects of transaction exposure, translation effects also impact the group’s results. These effects arise due to changes in exchange rates between the local currencies of the various foreign sales companies and the Swedish krona compared to the same period the previous year. The underlying profit/loss in a market may be unchanged in the local currency, but when converted into SEK may increase if the Swedish krona has weakened or decrease if the Swedish krona has strengthened.
Translation effects also arise in respect of the group’s net assets on consolidation of the foreign sales companies’ balance sheets. For more information on currency hedging see the annual report 2019, note 2, Financial risks.
Purchasing costs may be affected by decisions at a national level on export/import subsidies, customs duties (see more below), textile quotas, embargoes etc. The effects primarily impact customers and companies in individual markets. Global companies with operations in many countries are affected to a lesser extent, and among global corporations trade interventions may be regarded as largely competition-neutral. In the event of a major trade war between two countries this would affect not just sourcing costs but generally also the entire flow of goods from production to the customer, which the companies would need to mitigate.
Related party customs valuation continues to attract attention at a global, regional and national level, from both authorities and importers such as the H&M group. It will therefore continue to be important for the H&M group to proactively monitor and manage future developments in this area. One challenge is that customs authorities around the world are not taking a consistent approach to the assessment of pricing between related parties, despite the fact that the rules on customs valuation are based on the same global customs valuation rules.
For multinational companies today’s global environment involves complex tax risks, such as the risk of double taxation and tax disputes. As a large global company, the H&M group closely monitors developments in the field of tax. The H&M group is present in many countries and through its operations contributes to the community via various taxes and levies such as corporate tax, customs duties, income taxes and indirectly via VAT on the clothes sold to consumers.
The H&M group complies with national and international tax legislation, and always pays taxes and levies in accordance with local laws and regulations in the countries where the H&M group operates. The H&M group’s tax policy, which can be found at hmgroup.com, reflects and supports H&M’s business. The H&M group follows the OECD Transfer Pricing Guidelines, which means that profits are allocated and taxed where the value is created. Up until mid-2019 the H&M group was ISO certified for direct taxation and transfer pricing.
The H&M group works continually to ensure that its tax strategy is designed to limit any distortion arising from differences in tax legislation in different parts of the world.
The OECD guidelines on transfer pricing can be interpreted in various ways, and consequently tax authorities in different countries may question the outcome of the H&M group’s transfer pricing model even though the model complies with the OECD guidelines. This may mean a risk of tax disputes in the group in the event that the H&M group and the local tax authorities interpret the guidelines differently..