ANNUAL REPORT 2017

Board committees and reports from their chairs

Severstal’s Board of Directors has the following committees:

– Audit Committee;
– Remuneration and Nomination Committee;
– Health, Safety and Environmental Committee.

The Board Committees serve as consultative and advisory bodies that deal with issues raised by the Board of Directors. Committees may not act on behalf of the Board and are not considered to be management bodies of the Company. They have no powers in relation to managing the Company.

Committee meetings are held as and when necessary, but at least three times a year (except for the Health, Safety and Environmental Committee, which meets at least twice a year). They are held separately from Board meetings so that extra attention can be given to discussing issues, which require preliminary Board consideration prior to approval by the Board of Directors members, and determine the necessity of the Board’s approval for a specific issue.

Decisions of each Committee are taken by a majority vote of all Committee members taking part in the meeting. Each member has one vote and the Committee Chairman has no casting vote in the event of a tie.

The activity of Severstal’s Committees is regulated by the Regulations for Board Committees. Please refer to www.severstal.com for more information.

The Audit Committee

The Audit Committee consists of three Independent Non-Executive Directors. Currently they are:

  1. Alun Bowen (Chairman);
  2. Sakari Tamminen;
  3. Vladimir Mau.

Sakari Tamminen replaced Philip Dayer as a member of the Audit Commitee during the year to ensure compliance with MICEX’s independence rules.

Role

The Audit Committee assists the Board of Directors in monitoring the Company’s risk management processes and control environment, and in reviewing the Company’s annual and quarterly financial statements and overseeing its internal and external audit arrangements.

Composition

The Board considers that each member of the Audit Committee has appropriate knowledge and understanding of financial matters and commercial expertise, sufficient to enable them to consider effectively the financial and accounting issues that are presented to the Audit Committee. Sakari Tamminen has extensive experience of the steel industry. The Board considers Alun Bowen, the Chairman of the Audit Committee to have specific recent and relevant financial experience, further details are available in his biography.

Report by Alun Bowen, Chair of the Audit Committee

I am pleased to report on the work of the Audit Committee.

A key responsibility is to ensure that the financial information presented by Severstal is fair, balanced and understandable. To do this we focus on the quality of financial information, the independence of our external auditors and the assurance provided by internal audit. The Audit Committee also continues to debate and challenge the assumptions and estimates made by management in producing the financial statements.

Financial reporting

The most significant issues regarding the 2017 Annual Report and financial statements and how the Audit Committee dealt with them are set out below:

External audit

The Audit Committee places great importance on the quality and effectiveness of the external audit. In assessing quality and effectiveness, the Audit Committee looks to the audit team’s objectivity, professional scepticism, continuing professional education and its relationship with management.

The Audit Committee carries out an annual evaluation of the independence and objectivity of the external auditor and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. This assessment is based on a specific discussion between the members of the Audit Committee with the input of the Executive Directors and other relevant senior management.

This year KPMG carried out its own client service interview held by a senior member of the firm not involved in the engagement interviewing me after discussion on their views with the other members of the Audit Committee.

The output of the Audit Committee’s assessment and KPMG’s client service review were discussed with the Lead Audit Engagement Partner who developed a plan to implement the review’s recommendations.

In addition to the annual evaluation, the Audit Committee undertakes an ongoing assessment of external audit quality and effectiveness in the following ways:

  • The Audit Committee debates and agrees the key areas of focus for the external audit.
  • The Audit Committee negotiates and agrees the scope of the audit prior to its commencement.
  • The Audit Committee discusses the accuracy of financial reporting (materiality) with KPMG both for accounting errors that will be brought to the Audit Committee’s attention and amounts that would need to be adjusted so that the financial statements give a true and fair view.
  • I discussed with KPMG the output of reviews carried out by Russian and international regulators on its work. No issues arose from these reviews.
  • I meet with Larisa Kiseleva, the audit partner from KPMG who has been the Lead Audit Engagement Partner for the IFRS financial statements since the first quarter of 2015, in her office once a quarter and we communicate regularly by email and telephone between these meetings.
  • The Committee receives at every Audit Committee meeting an update of KPMG’s work, compliance with independence and its findings. There is a detailed discussion of KPMG’s audit findings including audit differences, the work undertaken to support their audit opinion on the financial statements and the consistency of the Annual Report with their work, prior to the approval of the financial statements and Annual Report.
  • Audit differences are also discussed. No uncorrected audit difference was qualitatively or quantitatively material to any line item in either the income statement or the balance sheet. Accordingly, the Audit Committee did not require any adjustment to be made to the financial statements as a result of the audit differences reported by KPMG.

The Board has established a policy setting out what audit services can be purchased from the firm appointed as external auditors. Generally, only assurance services are purchased where it is sensible to use the external auditor from a cost-efficiency or regulatory perspective. The audit fee for the year ended 31 December 2017 was $1.1 million (2016: $1.0 million) and non-audit fees in connection with assurance on bond offerings was $0.1 million (2016: $0.2 million).

During 2017 the Audit Committee commenced preparatory work in relation to the audit tender which will be held in 2018. The Audit Committee reviewed the Russian audit market and discussed the capability and quality of the firms in the market. Deloitte, EY and PwC were asked to participate in the audit tender as they were considered to be the firms having the necessary scale, capability and reputation for audit quality to act as Severstal’s external auditors. Although KPMG has been Severstal’s auditors since 1997, the Audit Committee decided that KPMG would also be asked to participate in the tender process as under the audit rotation rules recently introduced in the EU they would not be required to rotate for a further three-year period.

The Audit Committee members met with prospective lead audit engagement partners from Deloitte, EY and PwC in October to establish whether the individuals had the necessary personal qualities to act in that role. The Audit Committee also met the prospective KPMG audit partner for the year ending 31 December 2020 as Larisa Kiseleva would have to rotate after the year ending 31 December 2019.

The Audit Committee has determined and agreed an appropriate process, timetable and the critical success factors for the process.

Internal Audit

The annual Internal Audit Plan is developed from a consideration of the principal risks facing Severstal, a cycle of audit testing and management requests. The Audit Committee provides its input in advance of approving the plan at an off-site meeting with Nikolay Lavrov, the Chief Audit Executive, attended by members of the Audit Committee. The Audit Committee meets on its own with Nikolay Lavrov, in addition to the off-site session, at least three times a year.

I led the Audit Committee’s formal review of the effectiveness of internal audit this year, which involved the completion of a detailed questionnaire by members of the Audit Committee and Internal Audit’s principal “customers” being the heads of Severstal’s operating businesses and Alexander Shevelev.

The major areas for discussion were:

  • Ensuring management has a better understanding of the internal audit process and has better “buy-in” to the internal audit plan, whilst ensuring the plan is still “owned” by the Audit Committee.
  • Communicating (and clarifying if necessary) the distinction between the roles and responsibilities of the Security Department and that of Internal Audit.
  • Developing a plan to strengthen the relationship between the Head of Internal Audit and business heads.

Management continues to demonstrate increasing willingness to implement internal audit’s recommendations and there has been a reduction again this year in the number of agreed recommendations which have not yet been implemented.

Control environment

The Audit Committee has supported management’s efforts to improve the control environment during the year. In particular ensuring that plans exist to close vulnerabilities in the information technology system from both external and internal actions. The external penetration test carried out during the year was encouraging, but also provided a number of recommendations for improvement.

In addition to the work carried out by Internal Audit, the Audit Committee receives reports from the Head of Security who briefs the Audit Committee on the Security Department’s efforts through psychophysiological screening and other methods to ensure that the risk culture within the organisation is the best it can be. The sharply reducing trends in inventory theft (particularly ferro-additives), drug and alcohol abuse, disclosure of trade secrets and the number of criminal corruption cases are encouraging. As is the number of employees who are compliant with anti-corruption standards and the continuing vigilance through testing of prospective employees for their attitude to safety, risk and corruption. The Head of Security also briefs the Audit Committee on issues of physical and cyber security, his plans and actions to minimise the risk in these areas and his cooperation with Internal Audit.

Whistleblowing and ethics

The Audit Committee carried out a comprehensive review of Severstal’s whistleblowing procedures and other communication channels during the year, which involved changes in the terms of reference of Severstal’s Ethics Committee, Employee Code of Conduct, Code of Business Conduct and Anti-Corruption Policy to ensure this activity remains in line with global best practice.

Audit Committee effectiveness

The Audit Committee reviews its terms of reference and effectiveness annually. An external effectiveness review carried out in December 2016 concluded that there was no significant area for concern in respect of the performance of the Audit Committee or any of its members, accordingly no formal review was carried out this year, although the membership of the Audit Committee changed during the year as commented on earlier.

Looking ahead

In 2018, in addition to its regular work, the Audit Committee will be focusing on:

  • Ensuring a thorough and effective external audit tender process;
  • Overseeing continuing improvements in the Annual Report, the Sustainability Report and Severstal’s website to ensure that stakeholders receive the information they require in the most effective manner;
  • Ensuring that Severstal’s increasing use of “big data” is managed appropriately and does not increase Severstal’s exposure to risk.

The Remuneration and Nomination Committee

The Remuneration and Nomination Committee consists of three Independent Non-Executive Directors. Currently they are:

  1. Sakari Tamminen (Chairman);
  2. Philip Dayer;
  3. Alun Bowen.

Role

The Remuneration and Nomination Committee’s role is to assist the Company engage qualified professionals to manage the Company, create the incentives necessary to ensure they are successful within the Company and ensure there is an appropriate talent pool and oversee succession planning within Severstal. It also reviews the remuneration and compensation for the Company’s senior managers and Board members.

Report by Sakari Tamminen, Chairman of the Remuneration and Nomination Committee

The Remuneration and Nomination Committee, has focused on three principal areas this year:

  • Corporate culture and employee engagement;
  • Succession planning and Severstal’s talent pool;
  • Executive remuneration structure and the long-term incentive plan (LTIP).

A winning corporate culture and talent retention

Severstal pays a lot of attention to developing a unique corporate culture of innovation and continuous improvement. We firmly believe that a strong corporate culture is our unique advantage, with a long-lasting and growing value. It is hard to replicate by peers and helps to promote change faster.

The cornerstone of our corporate culture is the Business System of Severstal which is the logical development of more than ten years of ongoing efforts to optimise production and standardise internal processes, through many projects striving to achieve maximum efficiency of labour, equipment and energy, improve customer service and ensure employee safety. Among industry players, the system is unrivalled in the extent of its integration and EBITDA contribution potential.

It also includes a set of projects for cultural change. We believe this gives us a key competitive advantage, and is crucial for success in the steel and mining industry. Ultimately, its intention is to make Severstal a global efficiency leader in the steel industry.

There are four main lines of development in the Business System:

  • Safety;
  • Customer care;
  • People engagement;
  • Continuous improvement of operational performance.

As a result of our Business System initiatives, we see an increased level of engagement of our employees and higher satisfaction levels of our clients, a trend that we are confident will continue. The improvement in employee engagement has been reflected in the outcome of the fifth annual independent employee engagement survey which, using the AON Hewitt engagement model, gave an engagement percentage of 75%, which is nine percentage points ahead of manufacturing in Russia and thirteen percentage points ahead of employees in global metallurgical companies.

Safety has a major focus and significant activity takes place to ensure that only employees with an appropriate attitude to safety are recruited and retained.

We do not tolerate bullying behaviour or corruption regardless of the executive level. Severstal has an Anti-Corruption Policy focused on ensuring our compliance with both Russian and international anti-corruption laws. This policy sets standardised anti-corruption requirements for all Severstal businesses and regulates activities associated with high corruption risks, such as cooperation with partners, acquisition of corporate securities, establishment of joint ventures, mergers and acquisitions, conflict of interest evaluation procedures, sponsorships and charities, gifts and entertainment, and so on under this programme, we developed and adopted the Severstal Employee Code of Conduct and Severstal Code of Business Partnership propagating our anticorruption requirements into our supply chain. There is also an Ethics Committee in place and a phone/SMS hotline for our staff to anonymously report any wrongdoing.

Continuous demonstration of corporate values is a task going far beyond the responsibility of just the HR function; it is a fundamental requirement for any manager of employees across the organisation. In addition to the Business System we have internal policies in place to observe any violation of our corporate values.

The recruitment of high-potential students and graduates is a priority of Severstal’s HR policy. We work hard to meet our long-term need for young professionals, to improve the quality of training of our future employees and to make the metals and mining industry more attractive for job seekers. Our aim is to make the steelmaking industry and the science behind it exciting for younger generations. I had the pleasure this year of visiting with other Committee member colleagues the Metallurgy Museum in Cherepovets – a great twenty-first century experience and a big attraction for future employees of Severstal.

An ambition to become a global leader in value creation also helps to attract and retain career-oriented professionals seeking challenges and interesting tasks. We intend to achieve this leadership through sustained improvements in operational facilities and lean production, and use of best available technologies. We have a set of ongoing schemes for employee development and training, from induction programmes through to senior professional development. This helps us to create a culture where employees share similar values and work towards achieving similar goals.

Succession planning and Severstal’s talent pool

Part of our effort to create a motivating corporate culture is a focus on growth of a talent pool, establishing remuneration policies which motivate management for long-term performance and are clearly aligned with the business KPIs and objectives, as well as the interests of Severstal’s shareholders. This also includes annual 360-degree feedback, half-year (annual) assessment of top managers by the CEO and the Board of Directors, semi-annual Staff Committees’ reviews and development of a succession pool.

As a result, since Severstal’s IPO all executive director positions at the Company’s Board of Directors have been placed with top managers from Severstal’s internal talent pool. Undesirable executive talent outflow has been minimal and much below the average industry level.

At each meeting, the Committee discusses and reviews Severstal’s existing and emerging talent pool for senior positions and the Company’s plans for development of the individuals and the potential succession plans for each senior position.

As a result of members of the Remuneration and Nomination Committee’s active involvement in Severstal’s Second Opinion programme, where the firm’s talent participates in an interview with a person not known to them and independent of executive management, I am pleased to say that the Committee has a far better collective knowledge of the capabilities of its senior talent pool.

Executive remuneration structure

The executive remuneration structure seeks to strike the right balance between engaging and retaining highly qualified managers and the interests of the shareholders. Though the established remuneration policy has long-term variable pillars like LTIP and KPIs, the fixed salary element undergoes annual revision involving benchmarking using external data to ensure that the Company management’s compensation is fair and is in line with the market trends. We seek to reward our executives in the range between the 50th and 75th percentile of the market average, as defined by external benchmarks. We regularly review these external benchmarks, which are currently provided by members of the Big 4 accounting firms, to ensure that they are relevant and appropriate to our business. In 2017, we adopted Total Shareholder Return as an additional KPI for management to align more closely their reward with those of shareholders.

Annual Remuneration consists of the following two parts: a fixed salary mentioned above and a variable part known as a bonus.

The bonus’ percentage of an individual’s annual salary varies for various executive levels. However, in general the bonus consists of two parts – an individual element and a corporate one:

  • The first 50% is based on performance against individual targets. The individual targets for executive Board members are set by the Company CEO; targets for the CEO are determined by the Remuneration and Nomination Committee and recommended to the Board;
  • The other 50% of the bonus is performance compared with the Company’s financial and operational KPIs set by the CEO at the start of the year and approved by the Remuneration and Nomination Committee. The set of KPIs includes financial targets such as operating cash flow, EBITDA and Total Shareholder Return.

Board of Directors’ remuneration and compensation policy

By the decision of the General Meeting of Shareholders (GMS), Board members may be paid a remuneration during the execution of their duties, and be reimbursed for expenses incurred in connection with their functions as Board members. The amount of such remuneration or compensation is subject to approval by the GMS only. Should any Board member decide to resign before their term of his/her office expires, such a Board member is paid pro rata in proportion to the term of office that expired prior to resignation.

If incurred, Severstal reimburses its Board members’ expenses in connection with the performance of their duties as Board members, including transport, accommodation and mailing costs, as well as costs relating to the translation of company documents or materials that they are provided with.

Long-term incentive programme (LTIP)

For long-term retention of top management and alignment of their interests with those of the shareholders, Severstal has a LTIP programme in place.

The LTIP covers a period of three years and is based on a “phantom” stock plan. This type of stock plan pays a cash award to an employee that equals a set number of Severstal shares multiplied by the current share price. Phantom stock plans contain vesting schedules that are based on tenure. The vesting period for the whole LTIP starts only after the end of the third year of the executive’s participation in the programme. The number of phantom shares attributed to an executive is determined by a proportion of the executive’s salary in the first year of the programme.

The Committee reviews on an annual basis the awards made under the LTIP programme and the individuals who are eligible to receive awards.

Compensation of Senior Managers, Executive Officers and Directors

Key management’s remuneration for the year ended 31 December 2017, consisting of salaries and bonuses, totalled US$11 million (2016: US$10 million; 2015: US$10 million). Additionally, in 2017, a provision for key management’s long-term cash-settled share-based incentive programmes of US$1 million was accrued (2016: US$3 million, 2015: US$2 million). This provision is subject to further adjustments, dependent on a range of the Group’s financial indicators.

Health, Safety and Environmental Committee

The Health, Safety and Environmental Committee currently consists of:

  1. Philip Dayer (Chairman),
  2. Alexey Mordashov,
  3. Alexander Shevelev,
  4. Vladimir Lukin,
  5. Alexander Auzan.

Role

The Health, Safety and Environmental Committee assists the Board in obtaining assurance that appropriate systems are in place to deal with the management of health, safety and environmental risks.

Report of the Chairman of the Committee Philip Dayer on Work Safety, Industrial Safety and Environmental Protection Committee and its work in 2017

Health and safety is the main priority of Severstal. The Company’s goal is to eliminate completely fatal accidents

To achieve this goal, the Company is working on a programme of continuous improvement of safety in all aspects of its activities, strives to follow best practices in the field of work safety, as well as to become the leading Russian company in this sphere.

We are open for cooperation. Senior management of the Company takes part in the meetings of the RUIE Committee on Environmental and Industrial Safety under the auspices of the Russian Steel Consortium, the national professional association of metallurgists. Severstal is an active participant in the World Steel Producers Association, which regularly publishes reports in the sphere of work and industrial safety.

The system of work and industrial safety of five enterprises of the Russian Steel Division (Cherepovets Iron and Steel Works, Izhora Tube Rolling Plant, Severstal Distribution Company, Severstal Project, Severstal-SMC–Vsevolozhsk), and Karelsky Okatysh and Olkon enterprises are certified for compliance OHSAS 18001: 2007 standards.

For the year ended 31 December 2017, the company showed a 47% reduction in injuries compared with 2016.

Projects involving work and industrial safety are integrated into the Severstal Business System, which is a long-term programme for transforming culture and increasing the Company’s efficiency. The main safety initiatives in 2017 were:

1. Hazard identification:

  • Search for hazards by interviewing and questioning workers; development and implementation of measures aimed at eliminating hazards;
  • Investigation of micro-traumas and dangerous events with analysis of root causes to prevent the recurrence of similar incidents.

2. Involvement of personnel in work safety issues:

  • Testing and training of production managers;
  • Conducting “live” briefings with workers;
  • Teaching the basics of safe behaviour, including security in everyday life;
  • Identifying and disseminating best practices in work safety;
  • Organisation of a multi-stage contest “Safety Formula”.

A survey of employees conducted by internal audit in 2017 showed that the involvement of staff has grown: all employees know the basic rules of work safety, that they must use in their work; 95% of employees confirm the availability of the necessary means of protection and the timely conduct of safety briefings. However, the review also demonstrated that although a significant amount of progress has been made, there is some way to go before the employees and the Committee can be fully satisfied.

We moved from supervision to partnership. According to the results of the Corporate survey “Severstal Pulse”, 79% of employees believe that safety requirements are justified, understandable and feasible in their departments, and 84% of employees noted that their immediate supervisor explains how to do the job safely.

3. Work with employees who violate safety rules:

  • Establishment of common principles for dealing with violators;
  • The active support of safety committees in conjunction with labour unions;
  • Identifying employees who are prone to risk, through carrying out psychological testing and working with them.

4. Active work with contractors:

  • Organisation of training, communication;
  • Implementation of Severstal’s corporate instruments in contractor organisations;
  • Implementation of a system of contractors’ corporate certification of motivating contractors’ managers to ensure labour safety.

5. Accident prevention system (APS): conducting audits at all production sites of the company with the aim of assessing and improving the safety system:

  • Introduction of uniform approaches in the application of work safety tools in all business units;
  • Establishment of proactive targets for managers on APS.

The company invested about 1,651 million rubles to ensure labour safety. The largest investments included:

– The programme to reduce the injuries while walking (SRS – 22.8 million rubles);
– Programme to improve the level of protection in emergencies (SRS, Metiz – 25.1 million rubles);
– The acquisition of safety equipment (Karelsky Okatysh – 222.4 million rubles, Olkon – 565.0 million rubles);
– Industrial safety systems in the Vorkutaugol mines – 785.2 million rubles.

Investments in Vorkutaugol include the implementation of technical solutions aimed at creating a new industrial safety system in mines:

  • Explosion-proofing systems – triggered barrier;
  • Introduction of a multifunctional security system;
  • Monitoring and control system for explosion protection in degassing pipelines;
  • The system of explosion-localisation and for monitoring and controlling explosion protection in mines;
  • Provision of an emergency alert system with automatic (delivery control) and manual (awareness control) confirmation of receiving a notification signal by each miner;
  • Improvement of regional and local forecast systems.

In 2017 Vorkutaugol implemented a number of activities aimed at reducing the level of injuries and involving staff in work safety issues:

  • The levels of production control and the division of responsibility of managers for occupational safety has been revised;
  • An assessment of the effectiveness and measures of the results of the investigation of accidents has been performed; correcting activities have been made;
  • A programme to ensure the safety of traffic has been implemented;
  • Competitions: “Work without injuries”, competition of the best idea for the safe installation of arch support have been organised;
  • Implementation of the “Three Steps to Security” methodology.

Severstal is also actively working on environmental protection and promotes social programmes in the regions where we work.

Year of ecology. Lead the charge.

The ecological protection activity of Severstal is based on the belief that improving environmental performance contributes to improving the life quality of people and increases the competitiveness of the Company. Environmental guidelines are taken into account in the construction and modernisation of production. The company purposefully develops programmes to reduce the environmental impact of man-made work, involving all employees in this work.

The Company’s expenses for implementation of environmental measures during 2017 amounted to 2.65 billion rubles.

The most significant events were at Cherepovets:

In July 2017, ahead of schedule, the construction of the combined gas cleaning of the second ladle and the metal finishing unit was completed. The emission of dust from the metal finishing units is directed to a new bag filter, which cleans dusty air from the ladle furnace. By September, the dust concentration at the discharge was less than 10 mg/m3, which corresponds to the best world practice. The expected reduction of dust emissions is some 500 tons/year.

In the framework of accomplishing our long-term obligations on reduction of discharge of pollutants into water sources, during 2017 erection works on technical re-equipment of the section for processing sludge from gas cleaning of blast furnaces were finished. Start-up works are in progress. The new installation will be brought on line in 2018.

In 2017, work began on the construction of an open waste storage site for steelmaking and blast-furnace slurry:
– Project documentation has been completed;
– Public hearings on the environmental impact and project documentation have been organised.