SSE
Annual Report 2017

Plain-text annual report

S S E p l c A n n u a l R e p o r t 2 0 1 7 Strategic Report About SSE Welcome to the SSE Annual Report 2017 At SSE we provide the energy people need in a reliable and sustainable way. We’re involved in producing, generating, distributing and supplying electricity and gas, as well as other energy-related services, across the UK and Ireland. This gives SSE the broadest range of energy businesses of any company listed on the London Stock Exchange. Our performance in 2016/17 demonstrates the value of a business built on core strengths and a commitment to providing long-term value for our shareholders and meeting the needs of our customers. This Report, addressed to SSE’s shareholders, details SSE’s performance in 2016/17 and looks ahead to 2017/18 and beyond. Strategic Report About SSE Our story About our business Chairman’s introduction Our role in society Executing our long-term strategy Questions to the Chief Executive Our strategy Performance in 2016/17 and future plans Financial and non-financial performance indicators Reducing our carbon emissions Our people and our values Risk Management Framework Working in partnership with our stakeholders Our financial and business performance Financial overview The weather Wholesale – producing energy Networks – delivering energy Retail – supplying energy Enterprise – providing energy services 2 4 6 8 10 12 14 16 18 20 24 28 30 39 40 44 48 52 Directors’ Report Chairman’s introduction Board of Directors Leadership Effectiveness Accountability Stakeholder engagement and responsible stewardship Remuneration Other statutory information Statement of Directors’ responsibilities 54 56 58 64 70 76 80 98 100 Financial Statements Alternative Performance Measures 101 Consolidated income statement 106 Consolidated statement of comprehensive income Consolidated balance sheet Consolidated statement of changes in equity 107 108 109 Consolidated cash flow statement 110 Notes to the consolidated financial statements Accompanying information Company balance sheet Company statement of changes in equity Notes to the Company financial statements Independent Auditor’s Report Shareholder information 111 159 187 188 189 199 IBC CDP has again recognised SSE as a leader for its actions and disclosure on climate change. SSE was awarded a score of A- in recognition of its significant reduction in carbon emissions in 2015/16. This score is expected to be updated in October 2017. For the third year in a row SSE has been awarded the Fair Tax Mark for its transparent tax disclosures, it is the only FTSE-listed company to have this accreditation. SSE is an accredited Living Wage company and extends this commitment to its supply chain. Full year dividend per share SSE believes its first responsibility is to give shareholders a return on their investment through the payment of dividends, that are at least equal to RPI inflation. SSE has delivered a dividend increase every year since 1999. 25.7 27.5 30.0 32.4 35.0 37.7 60.5 55.0 42.5 46.5 80.1 75.0 66.0 70.0 84.2 86.7 88.4 89.4 91.3 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Adjusted profit before tax Reported profit before tax £1,545.9m +2.1% £1,776.6m £593.3m in 2015/16 Total recordable injury rate per 100,000 hours worked 0.22 -4.4% compared with 2015/16 Total carbon emissions (carbon dioxide equivalent – 000’s tonnes) See page 18 for more 19,395 -14% compared with 2015/16 Adjusted capital and investment expenditure £1,726.2m +6.6% Reported capital and investment expenditure £2,387.3m £2,248.1m in 2015/16 Economic contribution to the UK £9.3bn +5% compared with 2015/16 Adjusted earnings per share Reported earnings per share 125.7p +5.2% 158.4p 46.1p in 2015/16 This symbol donates the use of an Alternative Performance Measure (APM). Read more about Alternative Performance Measures on page 104. 1 3.1. Strategic Report2.Strategic Report – About SSE Our story Building on a proud past; creating a smarter, low-carbon future Our heritage Preserving our heritage Pitlochry Dam Visitor Centre At the heart of the post World War Two hydro-electric revolution in the north of Scotland was the Tummel-Garry project, known as the Grand Scheme because of the vast area of the project. While Perthshire has abundant rainfall and many hills and mountains, the scale of these mountains was not comparable to the hydro schemes that were developing in North America. Therefore the Scottish schemes needed to think more creatively and capture more water from a wider area. Across the north of Scotland 54 main hydro-electric power stations were built, 30km of tunnel and a construction workforce that reached 12,000 at its peak. This was a feat of incredible vision, engineering and effort. The social history that was created by these hydro pioneers is something that does not simply belong to SSE and there is a responsibility to preserve and promote that heritage for future generations. That’s why in 2015 a final investment decision was taken to invest £4m in a brand new visitor centre in Pitlochry – the very heart of the Tummel- Garry hydro scheme. It opened to the public on 30 January 2017, is free entry and tells the story of Scotland’s hydro heritage. Furthermore, the visitor centre allows visitors to learn more about the importance of newer forms of renewable energy for a low carbon future. Taking inspiration from a rich heritage SSE’s roots are firmly planted in the hydro-electric revolution that took place in the north of Scotland shortly after the Second World War. Bringing power to the islands, glens and crofts of the north of Scotland was transformative to life in the north and established, at the time, a public corporation whose aim was to harness abundant natural resource for public benefit. It was the privatised Scottish Hydro-electric that merged with Southern Electric to create Scottish and Southern Energy, now known as SSE. The two regions in the most extreme north and south of the British Isles could not have been more different geographically, economically or socially. The electricity network in the south of England had expanded quickly: the challenge was to provide electricity reliably to a booming population. The relative strengths complemented each other and provided the basis from which SSE grew rapidly through the 2000s. 1933 The National Grid started operating across GB 1990 Central Electricity Board broken into three parts and privatised 1991 Scottish electricity industry privatised 1943 The Hydro Electric (Scotland) Development Act 1956 Calder Hall, the world’s first nuclear power station of industrial scale opened in Cumbria 1989 The Electricity Act provided for the privatisation of the electricity industry 1986 The Gas Act provided for the privatisation of the gas industry 1998 Scottish Hydro Electric and Southern Electric merge and become Scottish and Southern Energy 2 SSE plc Annual Report 2017 Working to deliver a clean, digital electric future One hundred years ago, electricity revolutionised the way in which people lived their lives and today it is an essential service that we take for granted. It powers the daily commute, how we interact with friends and family and as a sector electricity is central to economic growth. This century, a new electric revolution is under way, driven by the imperative to cut carbon emissions, and create an electricity system that is flexible, dynamic and clean. SSE aims to take a leading role, supporting the transition towards this low carbon future. Central to this are SSE’s plans to continue to invest in renewable energy, and reaffirm its position as a leader in renewable sources of energy. SSE, alongside its joint venture partners, is investing in the Beatrice offshore wind farm, a £2.6bn, 588MW windfarm in the Moray Firth. The scale of the Beatrice wind farm is as awe inspiring as the hydro schemes of the 1950s. 7MW turbines with individual blades almost as long as a football pitch being constructed in the deep, difficult waters of the Moray Firth, providing enough electricity to power 450,000 homes. A smarter future is also in prospect for homes and businesses. The installation of smart meters in homes and businesses throughout the UK marks the beginning of a digitalised industry. SSE is working hard to install smart meters in its customer homes, with the programme ramping up significantly in 2016/17 with a total of 500,000 smart meters installed as of 31 March 2017. The transport sector is also on the cusp of transformation. Two hundred years since the internal combustion engine was invented, electric motors may provide a clean alternative to the future of transport. Providing transformative opportunities to improve air quality reduce carbon emission providing significant opportunity to electricity companies ready to respond. Electricity generators, suppliers and distribution network companies must be ready to deal with the challenges a mass take-up of electric cars will have on the system. SSE’s Scottish and Southern Electricity Networks has taken a leading role in considering the impacts and the ways to manage the system more efficiently. 2008 Irish wind developer Airtricity acquired, expanding SSE’s capabilities in renewable energy 2008 UK’s Climate Change Act sets legal target to reduce CO2 emissions by 80% on 1990 levels by 2050 2007 All Ireland single electricity market created 2006 SSE’s Hadyard Hill wind farm became first in the UK to generate over 100MW of electricity 2013 Ofgem introduced the RIIO (Revenue = Incentives + Innovation + Outputs) framework for energy network regulation 2017 First 24-hour period since 1880s that Britain did not use coal to generate electricity 2020 SSE’s capital investment programme from 2016 is expected to result in renewable energy capacity increasing to 4.3GW and the Regulated Asset Value of its Networks businesses increasing to close to £9bn 3 1. Strategic Report2.3.Strategic Report – About SSE About our business A balanced range of energy businesses 2 1 3 Gas Electricity SSE provides the energy people need in a reliable and sustainable way. It has three principal business areas: Wholesale, using turbines to convert energy from gas, oil, coal, water and wind to generate electricity; trading in wholesale energy markets; and managing energy contracts. Networks, transmitting and distributing electricity and gas to homes and workplaces. Retail, supplying electricity and gas and related services to households and organisations. Each business area works within SSE’s strategic framework and enables SSE to fulfil its financial objective. It is the only company listed on the London Stock Exchange with such a balance of energy businesses. 4 SSE plc Annual Report 2017 Wholesale Sustainably sourcing and producing energy SSE provides energy and related services for customers in wholesale energy markets in Great Britain and the island of Ireland. It delivers this through Energy Portfolio Management and Electricity Generation, Gas Production and Gas Storage. Amongst other things, it is a leading generator of electricity from renewable sources across the UK and Ireland. Read more information see pages 40 to 43. 1 2 3 Gas production Extracting natural gas from fields in the North Sea and west of Shetland for use onshore. Energy portfolio management and electricity generation Using turbines to convert energy from gas, oil, coal, water and wind to generate electricity and managing energy contracts. Gas storage Using caverns to store large volumes of natural gas under ground for use at a future date. Market-based 5 6 7 8 4 Networks 9 Retail Safely delivering energy to homes and businesses SSE has an ownership interest in the energy networks businesses in electricity transmission in the north of Scotland, electricity distribution in the north of Scotland and southern central England and in gas distribution in Scotland and southern England. These ‘regionally-defined’ businesses are subject to economic regulation by Ofgem. Supplying energy and essential services to customers SSE supplies electricity, gas and related services such as telecoms in markets in Great Britain and the island of Ireland. It aims to become a market-leading retailer by digitalising and diversifying its business and consistently excelling in customer service. It also incorporates SSE Enterprise, which brings together key SSE services for industrial, commercial and public sector customers. Read more information see pages 44 to 47. Read more information see pages 48 to 51. 4 5 6 Gas distribution Using pipes to distribute gas from the transmission network to homes, work places and other premises. Electricity transmission Using higher voltage lines and cables to transmit electricity from generating plant to the distribution network. Electricity distribution Using lower voltage lines and cables to distribute electricity to homes, work places and other premises. 7 8 9 Energy supply Retailing gas and electricity to household, small business and industrial and commercial customers. Energy-related services Providing energy-related products and services to households and small businesses. Enterprise Bringing together key SSE services for industrial, commercial and public sector customers. Economically-regulated Market-based 5 3.1. Strategic Report2.Strategic Report – About SSE Chairman’s introduction Providing the energy people need This Strategic Report sets out our performance over 2016/17, and looks at our future strategic priorities. 6 SSE plc Annual Report 2017 I’m pleased to introduce this year’s Strategic Report. Since becoming Chairman of SSE in July 2015 I’ve had the privilege of seeing first hand a business made up of talented and committed people who are focused on exceeding the expectations of customers; building, owning and operating assets that power our low-carbon energy future; working constructively with stakeholders; and making a positive contribution to the communities and wider society it serves. There is more detail about all of these areas in this Strategic Report. Energy underpins modern society: it’s at the centre of economic growth and industrial strategy, and it powers the daily commute to work and how our customers engage with friends and family. Yet the energy sector never stands still and 2016/17 brought further changes and challenges. In all of this SSE is a business built for the long term. The fundamentals of the business are strong and our proposition to shareholders, to increase annually the dividend payable to shareholders by at least RPI inflation, remains firm. A business investing, building and operating long-term assets SSE is a business that focuses on what it does well. As well as efficiently operating our assets that provide energy to the UK and Ireland’s homes and businesses, in 2016/17 we invested over £1.7bn as part of plans to invest around £6bn in the four years to March 2020 of which around two thirds is investment in regulated networks and government mandate renewables. This investment adds to the diversity of SSE’s operations and the balance of our business. It also helps to stimulate sustainable economic activity, principally by supporting around 120,000 people’s employment. The sheer scale and impact of the Caithness-Moray transmission link and the engineering feats at the Beatrice offshore wind farm, SSE’s two largest projects to date, can not fail to leave a positive impression. The projects are on track for completion in 2018 and 2019 respectively. Of course, SSE’s assets are not confined to plant and machinery; SSE is a people business. The stable, experienced and increasingly diverse team are committed to adding to the ‘human capital’ of the organisation. This stretches from our engineering apprentices helping to deliver an efficient distribution network whatever the weather; those who operate our diverse portfolio of power stations; through to the teams dedicated to making energy fair and simple for customers. Our highly skilled teams cover the length and breadth of the UK and Ireland and their commitment to their roles has formed the basis of SSE’s success to date, and will drive it to succeed in the future. A changing energy sector Change is a theme running throughout all aspects of SSE’s businesses. Some political uncertainty is a fact of life for the energy sector. It is again evident with the UK’s decision to leave the European Union, political parties in the UK considering possible intervention in the Retail energy market and the calls for a second Scottish independence referendum. This is something on which the Board is clearly focused, not only to manage any risks from politics and regulation but also to foster constructive working relationships with government and regulators, to best represent customers’ interests and identify opportunities that may emerge. Politics is just one factor driving change. Energy markets are now changing at a rapid pace as competition changes market dynamics and the costs of some low-carbon technologies falls rapidly. This brings notable changes to every part of SSE’s operations. SSE has shown before it can respond and adapt when market conditions change, from becoming a leading investor in renewable energy to spearheading calls for tax transparency on the part of large business. The Board held several discussions this year to help the SSE team pursue emerging opportunities, whilst mitigating risk. Putting customers at the heart of everything we do Almost everything SSE does is paid for by consumers. It must therefore put their interests and needs at the heart of its activities. We can’t control the underlying cost of energy, particularly wholesale prices or many of the costs associated with the low-carbon transition, and it was with regret that we announced an increase in our GB domestic electricity tariffs, which took effect at the end of April 2017, and increases for customers in Northern Ireland also. While we have been able to hold gas prices at their current levels, and we protected customers from an increase in energy costs during the preceding winter, the fact is that the costs of programmes to upgrade and decarbonise our ageing energy infrastructure are ultimately borne by the bill payer. At SSE, we do everything we can to keep the impact of that on customers to a minimum. We are very aware that energy is an essential service and energy suppliers have to treat their customers fairly. We have taken action, be it investment in smart metering or outlining a proactive programme to engage with our customers to ensure they are on the right products for them. There is always more to do, particularly as the regulatory environment evolves, following the UK General Election. The Board is committed to fostering constructive relationships with governments and regulators as they pursue their priorities; and to ensuring that SSE is as well-placed as possible to respond to the challenges and opportunities that those priorities represent. Creating a culture for long-term success In July 2016, the Financial Reporting Council (FRC) published a report on the importance of corporate culture to long-term business success. SSE’s Board endorsed the FRC’s definition of culture and the active management and oversight of SSE’s culture has been a growing theme for the Board throughout 2016/17. There are, of course, distinctive responsibilities between Board and Executive in relation to corporate culture: it is the role of the Board to agree a healthy culture and for ensuring there is an appropriate framework of control with regard to culture-related issues; and it is the role of the Executive team to ensure that the attitudes and behaviours demonstrated in day-to-day operations are consistent with an appropriate culture. I have been pleased with early progress in a more systematic and methodical approach to defining, nurturing and monitoring SSE’s internal culture. From a new code of ethics for employees to the development of ethical training packages, SSE made a good start in 2016/17 with much to do in the years to come. Acting in the interests of stakeholders Over the last year, there has been significant debate about the UK’s strategy for economic growth. Creating an Industrial Strategy and giving greater importance to the voice of the stakeholder in business decision making are increasingly coming into focus. Stakeholder interests are explicitly outlined in Section 172 of the Companies Act 2006, as is the impact of a company’s operations on the community and the environment. SSE has always sought to live by the spirit and the letter of Section 172 of the Act. Fulfilling its duty to act in the interest of all stakeholders should make a significant contribution to a healthy organisational culture. As well as our commitment to reduce carbon emissions from our electricity generation output, the achievement of the Fair Tax Mark for the third year in a row, supported by more accessible tax disclosure, and SSE’s four year commitment to the accredited Living Wage are symbols of fairness that are valued by stakeholders, customers and shareholders. I have no doubt that continuous improvement in openness and transparency at the same time as recognising the strategic role of the stakeholder voice will benefit SSE in the short, medium and long term. Achieving our first financial objective At SSE our financial objective is to increase annually the dividend payable to shareholders, by at least RPI inflation. SSE has delivered a dividend increase every year since 1999. I’m pleased that the Board is recommending a final dividend that will take the full-year dividend for 2016/17 to 91.3 pence per share. In all, SSE provides the energy people need in a reliable and sustainable way. We made a £9.3bn contribution to the UK economy this year and we know we have a unique role in the energy sectors in the UK and Ireland which comes with responsibilities and the need to earn the right to make a sustainable profit over the long term. There are complex issues to manage and additional challenges facing us in 2017/18 yet SSE has the strategy, culture, and a team of talented people required to succeed in 2017/18 and beyond. The Strategic Report was approved by and on behalf of the Board of Directors on 16 May 2017. This Strategic Report provides you the shareholder with an update on our approach and performance. Richard Gillingwater CBE Chairman May 2017 7 3.1. Strategic Report2.Strategic Report – About SSE Our role in society Providing the energy people need to create and share value SSE does not operate in isolation; it has a deeply interconnected relationship with the society it serves, operates within and is part of. SSE relies on society to be able to serve its customers in a reliable and sustainable way, and in return puts back into society through paying tax, creating sustainable employment and investing in national energy infrastructure. By creating and sharing value with the communities in which it operates SSE fulfils its role as a responsible member of society. Supporting and creating sustainable jobs Investing in infrastructure Paying a fair share of tax Society Providing public services 8 SSE plc Annual Report 2017 Giving the right to pay dividends Lending human capital Investing in infrastructure Supporting and creating sustainable jobs Paying a fair share of tax SSE helps maintain and invest in the energy infrastructure society needs. In 2016/17 SSE invested around £1.7bn in energy assets and services, part of the £9.3bn and €779m contribution SSE made to UK and Irish economies in the same year. As a responsible member of society, SSE believes in supporting and creating high quality long-term jobs. In 2016/17 SSE employed 21,157 people directly and supported a total of 108,440 jobs across the UK and Ireland. SSE believes it should contribute to the cost of the services on which it depends. It does this through the payment of tax. SSE seeks to be transparent and open about its tax disclosures. It has been an accredited Fair Tax Mark company since 2014. Capital investment 2016/17 Employees 2016/17 Total tax paid including on profits, property, and employment and environmental taxes £1.7bn +6.6% 21,157 +0.2% £385m -15.2% Society Providing public services Lending human capital Giving the right to pay dividends The public services society provides are crucial for SSE to function and thrive. SSE relies on emergency services, public infrastructure, health and education services to fulfil its core purpose of providing energy in a reliable and sustainable way. SSE’s success depends on its employees and their innate abilities and learned knowledge. It depends on society to make the first investment in that human capital, through education and training. Energy was once owned and operated by central government in the UK and so SSE depends on society for the right to pay dividends to shareholders. To attract and support investment in energy infrastructure, SSE has paid increasing dividends each year since it was formed. Contribution to the UK economy 2016/17 Investment in people development 2016/17 Full-year dividend price per share 2016/17 £9.3bn +5% £18.9m +9.8% 91.3p +2.1% 9 3.1. Strategic Report2. Strategic Report – Executing our long-term strategy Questions to the Chief Executive Managing change for the long term SSE Chief Executive Alistair Phillips-Davies answers questions on SSE’s performance in 2016/17 and looks ahead to 2017/18 and beyond. 10 SSE plc Annual Report 2017 How would you describe SSE’s performance in 2016/17? The best word is robust. I’m pleased that we met our financial objective and took some major steps to prepare the business for the future, whilst not losing sight of the need to deliver the efficient and safe operations that customers rely on. The operating context continues to present challenges and it’s clear that a combination of political uncertainty and technology will change our energy sector in the years ahead. That’s why SSE’s focus is on what it does well: building, owning and operating assets and providing energy safely and efficiently for customers. We are a business that is focused, adaptable and resilient and this has formed the basis of our solid performance and forms the foundations for sustainable growth. What aspect of SSE’s performance in 2016/17 has disappointed you the most and, what has pleased you the most? I’m pleased with the progress at our major investments, notably the Caithness-Moray transmission link and our portfolio of renewable energy developments. We invested around £1.7bn over the year, part of a £6bn programme to 2016-20, in strategic assets that will grow and diversify our business. I’d also note the discipline we showed in asset disposals and capital recycling. The sale of a 16.7% stake in SGN, for a headline consideration of £621m, confirmed our ability to deliver value for shareholders by reshaping SSE. But safety comes first at SSE. In some ways, our performance may have been better than in the previous year but this was completely overshadowed by the death last October of a contractor working on an SSE project. The loss of life at work is why the safety and wellbeing of our team must be the top priority. In a year in which SSE increased its electricity tariffs in GB, and energy affordability is the priority for regulators and governments, how is SSE factoring this into decision making? I’ve said before that everything that SSE does is ultimately paid for by customers. As a group of energy businesses we must always remember how important it is that people can afford to pay their bills. The energy sector in general, and the cost of energy in particular, will always be under political and regulatory scrutiny. So we have to ensure energy affordability is central to our decision making in each business, and that’s why our focus on controlling costs and operating efficiently is so important. It’s also why we engage constructively with governments and regulators to ensure a balance in delivering reliable and low carbon energy as cost- effectively as we can for customers. The energy market continues to change at a rapid pace, and innovation and competition are driving this change. Is SSE’s strategic framework still the right one in this rapidly- developing sector? Sector changes mean that to succeed in the future SSE will have to evolve and adapt, as it has in the past. Our strategic framework is consistent over the long term and allows us to exploit opportunities, as well as mitigate risk. It has also seen us undertake some innovative projects, including our distribution business trialling more active network management on Orkney, to prepare it for an increasingly distributed and flexible energy system. Our Wholesale business is involved in the testing of wind turbines that are larger, more efficient and capable of supporting offshore wind projects in deeper waters, such as the Beatrice offshore wind farm. Our strategic framework gives us the foundations from which to innovate, whilst providing great service to our customers, and invest for the future. How are SSE’s capital expenditure and investment plans to 2020 progressing? We’re pleased with our investment portfolio. Central to our strategy is building, owning and operating assets that bring scale, diversity and balance to the business and any final investment decisions for such assets are determined by the need to secure returns that are clearly greater than the cost of capital, enhance earnings and support the delivery of annual dividend increases that at least keep pace with inflation. We invested around £1.7bn in 2016/17. Over the four years 2016-20 we’re on course to invest around £6bn. This strategic investment is largely in assets that are either economically-regulated or government mandated, such as renewables. This will further transform the SSE Group and support earnings and our commitment to dividend growth. Has the macro-economic and regulatory risk to SSE escalated due to Brexit and calls from the Scottish Government for a second independence referendum? Politics, regulation and compliance is one of SSE’s principal risks. Whilst these events don’t present an immediate risk to how we serve customers or our investment plans, the level of risk could increase if political uncertainty leads to a prolonged period of legislative or regulatory volatility. Whenever I speak to government I always advocate for as much stability in the operating environment as can be achieved. Our balanced business model is designed, amongst other things, to provide underlying resilience when there is regulatory uncertainty. I do think as well as risks there will be opportunities emerging in this changing environment and we need to identify them. What do you expect to be the consequences for the energy sector of the UK General Election? Energy was a prominent issue when the election was called. During it, SSE issued a five-part ‘manifesto’ with a series of proposals for building a productive and sustainable UK economy and an energy sector that works for customers. Our balanced business model is designed to ensure SSE is resilient to political changes – for example, operating profit from GB household energy supply comprised around 15% of overall operating profits in 2016/17. We clearly recognise the role of government and regulation in the energy sector, but I’d caution that intervention in a changing market requires a clear objective with broad support and careful consultation on the principles and the detail. This belief will form the basis of our approach to working with the UK government and members of Parliament in the years ahead. How has SSE invested in the people and culture for future success? This is a critical area for us. Our sector is facing challenges in terms of its diversity, age profile and skillset. We have to therefore respond. I was pleased that we were the first major UK company to measure the economic value of the skills and capabilities of the people we employ; and are updating this. We did this principally to give us the insights our team needs into how to manage our most critical resource – the people who work for SSE. We’ve put considerable thought into our people and getting the right culture at SSE. This is about attracting talent, investing in a pipeline of apprentices and young people, and building an inclusive and diverse workforce who will achieve our strategic aims. Is the commitment to the dividend sustainable in the years ahead? Yes. Annual dividend increases, in line with RPI inflation, remains our first financial objective. Our strategic framework and opportunities for growth mean we can deliver a full-year dividend increase that keeps pace with RPI in 2017/18 and in the subsequent years. What are your personal priorities for 2017/18 and the period to 2020? We know that 2017/18 will present challenges and changes. But that’s a fact of life in the energy sector. Our focus will be on doing what we do well and building on our core strengths. Our long-term approach is to maintain focus, be resilient and ensure we can adapt to external change. So in the coming years, we’ll focus on securing maximum value from our portfolio of Wholesale assets and investments, achieving further efficiencies and customer service improvements in our Networks businesses and giving our Retail and Enterprise customers the products and services they need. In all this our commitment will be to provide long-term value for customers and shareholders. Alistair Phillips-Davies Chief Executive May 2017 Our strategic priorities to 2020 The safe and efficient operation of assets and providing the energy products and services that customers rely on. The disciplined investment in new assets, or the upgrading of existing assets, to support and maintain the balance of the business. Constructive engagement with regulators and legislators to advocate for clarity and stability, where possible, in the regulatory framework for all three business segments. 11 3.1. Strategic Report2.Strategic Report – Executing our long-term strategy Our strategy Creating value for the long term SSE’s strategy outlines not only what we do but how we do it. It outlines our strategic priorities, our values and the financial objective that we work towards, to increase annually the dividend payable to shareholders, in line with RPI inflation. Strategy SSE provides the energy people need in a reliable and sustainable way. Its strategy is to deliver the efficient operations of, and disciplined investment in, a balanced range of energy-related businesses, focusing on the UK and Ireland. Read more about our highlights in delivering our strategy this year on pages 14 and 15. Efficient operations Efficient operations means putting safety first and putting the current and future needs of customers at the heart of everything SSE does. At the heart of SSE’s business are its core operations. In 2016/17, total generation output was 26,296GWh; it safely delivered electricity to 3.7 million homes and businesses through its distribution networks; and supplied electricity, gas and related services to over 8 million customer accounts in the UK and Ireland. An operational focus for SSE means: – a focus on the safety of its people; – operating its assets safely and using resources effectively, efficiently and sustainably; and – putting the current and future needs of customers at the heart of everything it does. Finance Our financial objective is to increase annually the dividend payable to shareholders by at least RPI inflation. See pages 30 to 38 for more information. Dividend SSE’s financial focus is not on maximising short-term profits but on delivering an annual dividend increase to shareholders, of at least RPI inflation, as shareholders’ objective for investing capital into companies is to secure a return. Responsibility SSE believes that to be successful over the long term, companies must operate responsibly. For this reason, SSE operates under a set of core values known as the SSE SET. Safety All accidents are preventable, so we do everything safely and responsibly or not at all. Service We put the current and future needs of customers at the heart of everything we do. 12 SSE plc Annual Report 2017 Disciplined investment Balanced businesses Disciplined investment means identifying assets that complement SSE’s business and securing returns which are clearly greater than the cost of capital and enhance Adjusted earnings per share. Balanced businesses means operating and investing both in economically-regulated and market-based energy-related assets and businesses and avoiding over-exposure to any one part of the energy sector. In 2016/17 SSE invested around £1.7bn across the UK and Ireland. SSE’s strategy seeks to avoid becoming over-exposed to any one part of the energy sector but pursues investment opportunities where most appropriate. SSE has reportable segments covering Wholesale, Networks and Retail businesses (including Enterprise, which provides services for commercial and public sector organisations). This gives SSE a diversity of business activity across the energy sector. SSE’s investments are: – in line with its commitment to strong financial management; – complementary to its existing portfolio of assets; and – governed, developed and executed in an efficient and effective manner. SSE’s balance is maintained by: – operating and investing in a balanced range of energy assets and businesses; – maintaining a range of opportunities to develop new assets and customer propositions; and – developing a balanced range of future investment options. Dividend cover Dividends are paid out of earnings and, over the long term, earnings should increase to support dividend growth. Over the three years to 2019/20, and subject to the ongoing factors that influence earnings and material changes to sector regulation, SSE is on course to achieve dividend cover within a range of around 1.2 times to around 1.4 times. Balance sheet SSE believes it should maintain a strong balance sheet, illustrated by its commitment to robust ratios for retained cash flow and funds from operations/debt. A strong balance sheet enables it to borrow money from debt investors at competitive rates and therefore take long-term decisions. Efficiency We keep things simple, do the work that adds value and avoid wasting money, materials, energy or time. Sustainability We are ethical, responsible and balanced, helping to achieve environmental, social and economic well-being for current and future generations. Excellence We strive to get better, smarter and more innovative and be the best in everything we do. Teamwork We support and value our colleagues and enjoy working together as a team in an open and honest way. 13 3.1. Strategic Report2.Strategic Report – Executing our long-term strategy Performance in 2016/17 and future plans Delivering our strategy and looking ahead 2016/17 was another year of delivery against SSE’s strategic priorities. Looking ahead, 2017/18 and beyond will bring challenges, but also new opportunities which will support SSE’s focus on delivering annual increases in the dividend that at least keep pace with inflation. Efficient operations Performance highlights Putting safety first and putting the current and future needs of customers at the heart of everything SSE does Disciplined investment Identifying assets that complement SSE’s business and securing returns which are clearly greater than the cost of capital and enhance Adjusted earnings per share Total recordable injury rate 0.22 per 100,000 hours worked, an improvement on 2015/16 SSE broke company records with the best ever complaints score of 20.5 per 100,000 customers from October to December 2016 in the Citizens Advice Supplier Performance Report Performance highlights Investment of £1.73bn took the total since 2010 to almost £11bn, significantly in renewables and networks, including the £1.1bn Caithness-Moray transmission link SSEN’s investment in reinforcements, upgrades to automation and tree cutting will improve customer’s experience of the electricity network Balanced businesses Performance highlights Operating and investing both in economically-regulated and market- based energy-related assets and businesses and avoiding over-exposure to any one part of the energy sector 14 SSE plc Annual Report 2017 Investing for the future at the Ferrybridge Multifuel 2 project which can generate 70MW, powering 170,000 homes Investment into our Business Energy products continued with the launch of a 100% renewable energy proposition for commercial customers Outlook to 2020 – Continue an ‘if it’s not safe, we don’t do it’ culture – Respond constructively to regulatory change in the Retail market and advocate for changes that benefit customers – Provide an excellent service to all customers who rely on their energy networks – Continue to build on SSE’s strong culture of customer service with new products, services and efficiently delivering smart metering – Retain and gain domestic and business energy customer accounts, with a lower net loss than in recent years Outlook to 2020 – Efficiently execute our £6bn investment programme 2016 – 2020, including our two largest projects: the Caithness-Moray transmission link and the Beatrice offshore wind farm, due for completion in 2018 and 2019 respectively – Take the RAV of the networks business to almost £9bn through investment in new assets and timely connections to our networks – Continue progress with onshore wind projects in construction which are on track to take our total renewable electricity capacity to 4.3GW – Explore strategic generation development options in new gas, offshore wind and multi-fuel to diversify and bring flexibility to our portfolio – Further investment in digital customer service platforms to improve our customer service Outlook to 2020 – Maintain balance to sources of revenue and ensure balance in our investment options – Continue to operate a diverse and balanced portfolio of electricity generation and gas production assets – Diversify the Retail business by building a range of connected products and services and expanding energy-related services – Further growth in Business Energy based on meeting business customers’ core energy needs and enhancing our engagement with key customers and partners – Build on strong foundations and new leadership to grow the Enterprise business to further balance SSE’s revenue and market exposure 15 A step change improvement in customer contact and experience in Distribution led to a 74% rise in performance against the RIIO-ED1 customer satisfaction measure Further investment in our renewable energy portfolio, including construction of Ireland’s largest wind farm in Galway SSE Retail expanded its customer base in energy-related services including boiler cover and home broadband to 0.5m, from 0.4m previously 3.1. Strategic Report2.Strategic Report – Executing our long-term strategy Financial and non-financial performance indicators Measuring the results of SSE’s strategy We assess our performance in delivering our financial objectives, executing our strategy and fulfilling our core purpose in a reliable and sustainable way through a series of financial and non-financial indicators. Financial Dividend per share – pence Dividend cover – times Adjusted earnings per share – pence 88.4 89.4 91.3 1.40 1.34 1.38 124.1 119.5 125.7 2015 2016 2017 2015 2016 2017 2015 2016 2017 SSE’s financial objective is to increase annually the dividend payable to shareholders, by at least RPI inflation. SSE believes that the dividend should be covered by Adjusted earnings per share at a level that is sustainable over time and it believes that sustainability is based on the quality of the operations and assets from which earnings are derived and the longer-term financial outlook. Dividends are paid out of earnings and SSE’s Adjusted EPS measure provides an important and meaningful measure of financial performance. For more detail on Adjusted items see Alternative Performance Measures on pages 101 to 104. Strategic Adjusted capital and investment expenditure – £m 1,618.7 1,726.2 1,475.3 Networks Regulated Asset Value – £bn 7.35 7.96 7.68 Renewable energy generation capacity – MW 3,394 3,275 3,309 2015 2016 2017 2015 2016 2017 2015 2016 2017 Central to SSE’s strategic framework is efficient and disciplined investment in building a balanced range of economically-regulated and market-based assets. SSE’s economically-regulated energy networks businesses provide index-linked RAV and relatively stable returns, which brings opportunities for investment and balance to SSE as a whole which underpins our financial objective for dividend growth. Renewable energy generation capacity in the UK and Ireland is supported by government-mandated targets and mechanisms. SSE’s Wholesale business seeks to grow SSE’s renewables portfolio as the investments provide balance and opportunities for investment in strategic assets. Responsibility Total recordable injury rate per 100,000 hours worked UK employee productivity (direct contribution to GDP per capita) – £000 0.23 0.23 0.22 172.0 139.9 129.7 Carbon intensity of electricity generated (Emissions Relative to MWh output (kg CO2e per MWh)) 474 397 304 2015 2016 2017 2015 2016 2017 2015 2016 2017 Safety is a core SSE value. We measure it by assessing the Total Recordable Injury Rate for employees and employees of other companies working on SSE sites per 100,000 hours worked. 16 SSE plc Annual Report 2017 Combining SSE’s direct contribution to GDP and the size of its workforce implies SSE’s average employee productivity as shown above. SSE aims to use resources responsibly and be transparent in its reporting of this. SSE is committed to reducing the carbon intensity of its overall electricity generation by 50% (compared to 2006) by 2020. Financial Strategic Responsibility Reported earnings per share – pence Adjusted profit before tax – £m Reported profit before tax – £m 158.4 1,564.7 1,513.5 1,545.9 1,776.6 55.3 46.1 735.2 593.3 2015 2016 2017 2015 2016 2017 2015 2016 2017 Reported results for 2016/17 were significantly higher than those for 2015/16 due to the impact of significant exceptional charges incurred in the previous year compared to lower asset write downs and a gain on sale in 2016/17, plus a movement in mark-to-market valuations on forward purchase contracts for commodities over both years. SSE’s objective is not to maximise profit in any one year but to earn a sustainable level of profit over the medium term. Reported results for 2016/17 were significantly higher than those for 2015/16 due to the impact of significant exceptional charges incurred in the previous year compared to lower asset write downs and a gain on sale in 2016/17, plus a movement in mark-to-market valuations on forward purchase contracts for commodities over both years. Adjusted capital and investment expenditure composition 8% 14% 32% Wholesale Networks Retail Corporate Adjusted operating profit composition Adjusted operating profit composition (five year average) 23% 27% Wholesale Networks Retail Corporate 0% 23% 28% Wholesale Networks Retail Corporate 0% 46% 50% 49% Central to SSE’s strategy is disciplined investment in a balanced range of energy business across the energy sector. To provide balance to the SSE group of businesses, SSE seeks to earn a sustainable level of operating profit from each of its three segments, covering economically- regulated and market-based sectors. This prevents it from becoming over exposed to any single part of the energy sector. Central to SSE’s strategy over the long term is a balanced range of energy businesses. This balance seeks to avoid exposure to one single part of the energy sector and derive operating profits from economically-regulated activities and market-based businesses. UK tax paid (profit, property, environment and employment taxes) – £m All employees gender diversity – male/female 506 454 385 68.6% Female Male 31.4% For information on the performance of SSE’s Wholesale, Networks, Retail and Enterprise businesses in 2016/17, see pages 40 to 53. 2015 2016 2017 As a responsibly-minded Company, SSE believes in being transparent in its tax affairs and that this is important to shareholders and other stakeholders. SSE has been targeting a series of actions around gender diversity and chose to be an early adopter of the draft gender pay gap regulations, publishing its full disclosure in 2015/16. 17 3.1. Strategic Report2. Strategic Report – Executing our long-term strategy Reducing our carbon emissions Managing our environmental impacts Managing the issues of climate change, resource use and waste is gaining significant interest from stakeholders interested in the impacts of these issues on business performance and long term viability. SSE has an important role to play in driving a low carbon transition as well as improving its environmental performance and disclosure. CO2 Emissions (000’s tonnes) Generation    1 Other Scope 1 Scope 1 Total   2 Distribution Network Losses Other Scope 2 Scope 2 Total   3 Scope 3 WTT Fuel Purchased Scope 3 Gas Sold Scope 3 Transmission Other Scope 3 Scope 3 Total  4 Total Emissions  5 Scope 2 emissions (net) Net Emissions Intensity Ratios Emissions relative to MWh output (kg CO2e per MWh) 6 1 April 2016 to 31 March 2017 1 April 2015 to 31 March 2016 CO2 7,915 40 7,955 971 63 1,034 969 9,086 286 16 10,357 19,346 0 19,346 CO2e Total CO2 CO2 CO2e Total CO2  38 12 49 0 0 0 0 0 0 0 0 49 0 49 7,953 10,889 51 39 8,004(A) 10,928 971 63 1,079 60 1,034(A) 1,138 969 888 9,086 9,139 286 16 329 19 10,357(A) 10,375 19,395(A) 22,441 0 47 19,395 22,394 77 16 92 0 0 0 0 0 0 0 0 92 0 92 10,966 54 11,021(A) 1,079 60 1,138(A) 888 9,139 329 19 10,375(A) 22,534(A) 47 22,486 304 397 Notes 1 2 3 4 The figure for generation emissions adjusts the figure from SSE-owned generation (in GB and Ireland) to include energy bought in under power purchase agreements. Scope 1 comprises electricity generation, operational vehicles and fixed generation, sulphur hexafluoride emissions and gas consumption in buildings. Scope 2 comprises electricity distribution losses and electricity consumption in non-operational buildings and substations – transmission and distribution. Scope 3 comprises emissions that occur outside of the organisation in support of its activities. Scope 3 emissions have been extended to include emissions from SHE Transmission losses and gas sold. As a result, scope 3 emissions have been restated for the previous year. 5 GHG emissions from SGN’s activities are excluded (SGN reports these separately). GHG emissions from other Joint Ventures are also excluded. 6 Emissions intensity relative to MWh is calculated against scope 1 emissions only, rather than total emissions. (A) PwC has provided limited assurance against ISAE 3000 (Revised) and ISAE 3410 standards for selected key data in 2016/17. Where you see the (A) ‘Assurance symbol’ in this report, it indicates data has been subject to assurance. For the limited assurance opinion and SSE’s reporting criteria, see www.sse.com/beingresponsible/reporting-and-policy/. 18 SSE plc Annual Report 2017 A sustainable climate change strategy SSE’s most material environmental impact is the carbon it emits when generating electricity. Its strategy is to transition to a low carbon energy system by reducing the carbon intensity of the electricity it generates. To do this it is undertaking a strategic shift away from carbon intensive fossil fuel generation towards electricity generation from more efficient thermal generation and renewable sources. At its core is a long-standing commitment to reduce the carbon intensity of its electricity generation by 50% by 2020, using 2006 performance as its baseline. SSE’s performance in managing climate change impacts led CDP to award SSE an A- in 2016 and include it in the global Climate Disclosure Leadership Index. Risks and opportunities to SSE’s business from climate change Climate change, and the imperative to decarbonise energy systems, creates both risks and opportunities for SSE. In response to a heightened awareness from investors and other stakeholders, SSE has considered the way in which climate change is best reflected in its assessment of Group Principal Risks. The framework for managing these risks is outlined on pages 24 to 27. Furthermore, SSE’s Sustainability Report 2017 and CDP submission 2017 outline in more detail the risks and opportunities associated with climate change for the SSE Group. Taking action on climate change To bring about a change in carbon performance, SSE has: – invested significantly in renewable energy (£3.2bn since 2010) and has the largest renewable energy capacity in the UK and Ireland at 3,309MW; – switched from thermal (primarily coal) to renewables generation with coal output contributing 3.4% of output and renewables contributing 30% of output in 2016/17 (22% and nearly 35% respectively in 2015/16); and Generation output (GWh) and carbon scope 1 emissions (000’s tonnes CO2e) 50,000 40,000 ) h w G ( t u p t u O 30,000 20,000 10,000 0 2011/12 2012/13 2013/14 2014/15 2015/16 2016/17 Gas output Coal output Renewables output Scope 1: Carbon emissions 30,000 20,000 10,000 0 ) e 2 O C s e n n o t s 0 0 0 ( s n o i s s i m e n o b r a C tree cutting along networks; resilience funds for local communities to support climate adaptation initiatives; and emergency response procedures to ensure the lights are kept on. Responding to other environmental challenges: using resources responsibly Managing water use SSE’s enhanced disclosure of water is detailed in its Sustainability Report 2017. In 2016/17 SSE’s operations in GB abstracted a total of 22.7 billion m3 of water (28.9 billion m3 for 2015/16). The vast majority was abstracted by SSE’s hydro generation operations and is therefore returned almost immediately to the environment – only 0.005 billion m3, of this water was consumed in 2016/17 (0.008 billion m3 for 2015/16). None of SSE’s operations have an impact on ‘water stressed areas’. Water abstraction, consumption and return (billions m3) Water consumption 2014/15 2015/16 2016/17 – enabled more renewable generation to connect to the electricity network by investing close to £1.9bn since the Transmission price control period began in 2013 in new electricity infrastructure that has allowed the connection 500MW of new renewable generation capacity in 2016/17. SSE’s carbon intensity falling by 23% between 2015/16 and 2016/17 to 304 kgCO2e/MWh. While this means that SSE’s carbon intensity target was met for the first time in 2016/17, there is an ongoing imperative to bring about a year-on-year contribution for supporting the UK and Ireland transition to a low carbon economy. Total water abstracted Total water consumed Total water abstracted & returned 27.1 28.9 22.7 0.019 0.008 0.005 27.1 28.8 22.7 In addition, SSE has been advocating for carbon pricing by engaging with government officials, the Committee on Climate Change and collaborated with partners to publish an open letter in the Financial Times in September 2016. The decision by the UK Government to maintain the Carbon Price Floor up to 2021 at the current carbon price support level, as well as the tightening of the EU ETS to close the global emissions gap to keep global temperature changes to well below 2°C of pre-industrial levels, was welcomed by SSE. Improving carbon emissions performance In 2016/17 SSE achieved a 14% reduction in its total carbon emissions (scope 1, 2 and 3) from 2015/16. The main contributor was the significant reduction in total scope 1 carbon emissions which fell by 27% between 2015/16 and 2016/17. The reduction in gross scope 1 emissions was mainly a result of significantly lower output from SSE’s coal- fired generation plant from 6,141GWh to 901GWh between 2015/16 and 2016/17. SSE’s renewable generation assets (including hydro pumped storage) generated 7,955 GWh of electricity in 2016/17, 30% of SSE’s entire generation output. This resulted in SSE has enhanced and improved its disclosure on reporting its scope 3 emissions. These emissions now cover SHE Transmission losses and gas sold to customers. Resilience to different climate change scenarios SSE has been collaborating with stakeholders to understand the impacts of carbon reduction ambitions on the resilience of its business. From the scenario analysis it was found SSE’s balanced and mixed assets in distribution, transmission and generation were found to be vital to the UK’s electricity system over the long term. The important conclusion from the review was that the long term viability of SSE’s existing portfolio of assets is secure in every scenario it assessed. Climate adaptation While SSE plays its part to mitigate climate change, it must also adapt its business to the impacts of rising global temperatures. Extreme weather events are a material climate adaptation risk that impacts the resilience of SSE’s transmission and distribution network. As a result SSE has invested in maintenance and emergency response solutions. This includes new technology that identifies faults on lines; Managing air emissions SSE is reducing air emissions as a result of the change in its energy generation mix (reducing coal), the increased use of renewable energy and the use of operating practices and technologies that reduce or remove air pollutants. In 2016/17 SSE’s thermal generation sites in GB emitted 1,564 tonnes of sulphur dioxide and 5,555 tonnes of oxides of nitrogen. This compares to 6,704 and 10,685 tonnes in 2015/16. Emissions will be lowered further through continued investment in improvements in combustion processes and renewable energy. Air emissions from SSE’s thermal generation plant ) s e n n o t ( s n o i s s i m E 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 2014/15 2015/16 2016/17 Nitrogen oxide Sulphur dioxide Total thermal output 30,000 20,000 10,000 ) h w G ( t u p t u O 0 19 3.1. Strategic Report2. Strategic Report – Executing our long-term strategy Our people and our values Investing in a diverse team, built on core values SSE’s current and future success depends upon the talents, skills and motivation of the people it employs. The strategic development of human capital value is therefore critical to SSE’s long-term success. Key workforce metrics Total number of employees 1 Number 21,157 21,118 2016/17 2015/16 Retention rate 2 Total recruitment 3 Employee gender (female) Average age Employee engagement index 4 Learning and development expenditure % Number % Years % £m 86 3,227 31.4 40 n/a 18.9 89 2,763 30.9 40 77 17.2 Total number of training interventions 6 Number 103,688 63,052 Investment in pipelines 7 UK Productivity (GVA per capita) 8 Productivity compared to UK average 9 £m £ n:n Whistle-blowing cases raised 10 Number 9.4 12.7 172,000 129,670 3.1:1 88 2.4:1 41 Total headcount at 31 March 2017, including employees within Windtowers Ltd. 1 2 Excludes end of fixed term contracts and internal transfers. 3 External recruitment only. 4 Total expenditure in learning and development, internal and external, including talent pipelines. 5 Externally facilitated company-wide employee engagement survey, not available until July 2017. 6 7 The total cost of providing apprentice, graduate, technical skills and employability training programmes. 8 Based on SSE’s direct contribution to UK GDP and directly employed employees, analysis undertaken by PwC. 9 Ratio of SSE’s UK labour productivity to the UK’s national productivity (source: PwC). 10 Number of cases reported to SSE’s independent whistle-blow line. Including targeting courses, workshops, seminars on e-learning packages. Talent pipeline 1,277 trainees Development training 103,688 interventions Apprentices (436) Technical skills trainees (64) Business graduates (25) Engineering graduates (26) IT graduates (13) Employability programme participants (Barnardo’s and Career Ready) (31) Customer service apprenticeships (682) Craft (3,969) Development (7,712) Legislation and policy (1,421) Safety rule authorisations (2,284) Safety, health and the environment (4,997) Sales and service (74,051) Misc (9,254) 20 SSE plc Annual Report 2017 Responding to strategic challenges: skills shortages and greater diversity The strategic human capital challenges SSE has articulated regularly in recent years remain key. The strategy is to anticipate the skills gaps that are looming in the early 2020s by attracting a wide and diverse range of entry level talent into SSE’s pipeline programmes. These pipelines include employability programmes, apprenticeships, higher level technical skills trainees and engineering graduates. The solution to the second strategic challenge, a lack of diversity, is complementary to the first. Because of the skills gap SSE has a unique opportunity to become a more inclusive employer, improve its attractiveness to a diverse set of applicants and to build a pipeline of new talent that more closely reflects the communities SSE serves. Creating a workforce for the future SSE offers a range of structured programmes designed for school leavers, apprentices, trainee engineers and graduates. These pipelines introduce hundreds of young people into SSE every year and represent the single most important way SSE builds its future workforce. While the financial investment in its pipeline programmes in 2016/17 was £9.4m, representing a fall in investment since 2015/16, the number of individuals participating increased to 1,277 from 859 in 2015/16. The increase is dominated by a concerted effort to develop existing employees working in customer service, progressing from Level 2 to Level 3 qualifications, supporting SSE’s strategy to continue to differentiate itself on the basis of sector leading customer service. Talent pipelines There were 1,277 trainees on a pipeline programme in 2016/17. See pie chart on page 20. Beyond this focus on pipelines of new talent, SSE invests in its people through talent development, management training, technical training, customer service development and the delivery of particular issues based knowledge and skills through electronic learning techniques. This development activity is predominately delivered internally, ensuring the skills and knowledge learnt are bespoke and designed for SSE’s particular circumstances. Development training 103,688 training interventions were delivered internally in 2016/17. See pie chart on page 20. 2016/17 saw a step change in the way SSE delivers continuous learning and development across its workforce. The establishment of a new Learning Management System has provided the opportunity to deliver significantly more training opportunities online. There has been greater focus on training for compliance, and significantly more individual interventions supporting higher quality customer service. The ability to track and monitor employee participation and the efficacy of training programmes has also improved. Furthermore, the momentum in delivering SSE’s Smart Meter programme increased significantly in 2016/17. The nature and demand of the programme means there is a shortage of smart meter operatives in the labour market; therefore SSE is both redeploying existing meter reading employees and recruiting individuals with the aptitude to be skilled smart meter operative installers and putting them through a comprehensive training and assessment programme. In 2016/17 583 smart meter operatives were recruited to SSE’s Smart Meter programme. Inclusion and diversity SSE’s efforts to improve its inclusiveness have prioritised gender representation in the short term. Further disclosure relating to other protected characteristic contained within the Equalities Act, including disability, can be found in the Sustainability Report 2017. In relation to gender diversity, the proportion of women within SSE has, once again, risen marginally from 30.9% to 31.4%. SSE chose to be an early adopter of the draft gender pay gap regulations in 2015/16 and published its full disclosure in its Sustainability Report 2016. The full disclosure for 2016/17 is published, once again, in its Sustainability Report available on see.com. This exercise proved to be very instructive to SSE’s strategy to improve inclusion and diversity and supported the formation of its strategy of ‘in, on and up’. In: The first level of the inclusion and diversity programme is to attract more women applicants into SSE. Some progress was made in 2016/17. The proportion of women being recruited externally has risen from 33% in 2014/15, to 37% in 2015/16 and to 39% in 2016/17. It is worth noting that the short term impact of attracting higher proportions of entry level women, may actually influence the gender pay gap in a negative direction. Nevertheless, SSE believes the longer term prize of an organisation more reflective of the society it serves is more important. Furthermore, SSE understands that the barriers to a career in the energy industry are deep and cultural, therefore SSE has a role to encourage non-traditional entrants into the industry and has a partnership with Teach First to influence the uptake of STEM subjects by girls in schools in England and Wales. On: Retaining women within the organisation is particularly important given the relative success, so far, of efforts to attract more women entrants. There are many initiatives targeting this group from enhanced flexible working practices and investment in connected working technology to the development of STEM and senior women networks. Most recently maternity, adoption and paternity benefit offerings have been significantly enhanced. Whilst this includes a substantial increase in the level of paid leave, it also sees the introduction of a gradual phasing in the return to work for maternity and adoption leavers, with no reduction in salary. New ways of flexible working are being piloted for employees moving to SSE’s new Forbury Place development in Reading, with a view to this being rolled out across the wider organisation. Up: Creating the conditions whereby more women are present in the highest levels of the organisation is expected to take time. A number of initiatives are in place, in particular, the establishment of a ‘Shadow Board’ of diverse emerging talent for SSE’s Wholesale business has proved to be an interesting pilot due to be rolled out in new areas of the SSE group in the year ahead. The first target set is a simple one, where the proportion of women earning over £40,000 will rise to 25% by 2025. In 2016/17 the proportion was 12.8%, representing a rise of 8% since 2015/16. Sustainable employment ethos At the centre of SSE’s human capital strategy is an ethos about the way in which the talents and abilities of people flourish. This approach gives a signal to its employees that they are valued and that worthwhile, rewarding careers can be built with SSE. In return, SSE looks to its employees to be engaged, motivated and committed, delivering for both customers and shareholders over the long term. A focus on career progression and recruiting senior positions from within A preference for direct employment as opposed to out-sourcing core work A preference for direct employment and a presumption against offshoring work outside of the UK and Republic of Ireland Career progression Through 2016/17, 3,826 employment vacancies were filled across SSE. Of those 3,826 vacancies, 16% were filled from internal applicants. However, at the most senior levels, where talent and succession is managed closely, 34 vacancies were filled. Of those, nearly 60% were awarded to internal applicants. Out-sourcing There is a clear preference to directly deliver core work in house. On the occasions where it is necessary to use external contractors to support peak demand or transitional change, SSE insists on a number of core standards in relation to health and safety and conditions of service. In 2016/17, SSE took the decision to extend its Living Wage commitment in its supply chain. Rather than simply ensuring that regular contractors working on SSE’s sites receive the real Living Wage, (as required by the Living Wage Foundation) from 1 April 2017 every new contract will include a requirement to ensure that everyone UK based providing regular services to SSE’s customers will receive the Living Wage. 21 3.1. Strategic Report2.Strategic Report – Executing our long-term strategy Our people and our values continued Redeployment Change is an ongoing feature of the energy market and SSE must be able to respond to changing conditions and markets. To remain competitive and efficient SSE has had to review and either restructure or cease several operations in 2016/17. In all instances, it has sought to fully consult with those employees impacted and to offer opportunities for retraining and redeployment where possible. One such example of this is the Retail shops in the north of Scotland. To ensure opportunities are available to employees affected by change in the organisation, a number of vacancies are advertised internally only. In 2016/17, 306 vacancies were opened to internal applicants only. An engaged workforce Teamwork is one of six enduring values that guide employees in their day-to-day working lives in SSE. It is underpinned by an ethic of mutual respect and is defined as: Teamwork: we support and value our colleagues and enjoy working together in an open and honest way. SSE has undertaken an annual survey of employee opinion for many years. A review of the survey in 2016/17 considered feedback and decided to adjust the frequency of the survey to every two years to allow sufficient time to understand, plan and report back on progress with action plans to all employees. The next survey is being run in the early summer of 2017. The objective of the new survey is to gather instructive data on SSE’s business culture, as well as gather signals on issues such as inclusiveness, engagement and strategy. Headline results from that survey will be published on sse.com/beingresponsible in the summer of 2017. Rewarding employee contribution Performance management is undertaken comprehensively throughout SSE. Its objective is to create a framework for continuous feedback and improvement in line with business goals. Above all, this approach is designed to ensure the safe operation of SSE’s businesses and the reliable provision of service to customers. Alongside assessing performance against agreed objectives, the process assesses the extent to which each individual, including the senior management team, demonstrate their support for SSE’s core values of Safety, Service, Excellence, Sustainability, Efficiency and Teamwork. The opportunity to grow and develop a career has the greatest impact on employee 22 SSE plc Annual Report 2017 commitment but it is also understood that employee benefits make an important contribution to both employee engagement and the attractiveness of SSE as a place to choose to work. – Employee benefits: a significantly enhanced package of employee benefits was established in 2016/17. A more flexible and family friendly package includes significant improvement to parental benefits, more flexibility for unexpected situations and a new ‘gradual return to work’ offer for returning mothers. This package has been deliberately designed to reflect modern lives and support SSE’s efforts to become a more inclusive and diverse organisation. There has also been a strong focus on delivering additional health related benefits to support employee wellbeing. – Sharing success: SSE actively encourages it employees to own SSE shares, offering both an employee Share Incentive Plan (SIP) and a Sharesave scheme, with participation rates at 73% and 41% respectively. – SSE pension schemes: SSE has taken measures to help employees plan and save for their financial future and has proactively enrolled new employees onto its pension schemes since 2005. 97% of SSE’s employees in 2016/17 chose to save for their future through one of SSE’s pension schemes. Recent supplier negotiations have improved the value that employees get from these schemes, with affinity benefits and reduced management charges. Fairness at work SSE’s Human Rights policy specifically respects the right of its employees to join a trade union. SSE recognises four trade unions and a Joint Negotiating and Consultative Committee (JNCC) continue to provide the structure by which industrial relations are conducted. 66% of SSE’s employees are covered by the negotiating arrangements under the JNCC. SSE has a range of employment policies in place to ensure that all people, including those with disabilities, are dealt with fairly during the recruitment process, and that all people have access to training and development opportunities with SSE. Believing that its employees deserve at least to earn a rate of pay that enables them to live a decent life, SSE continues to be an accredited Living Wage employer in the UK and pays its employees in Ireland the Irish Living Wage. Reinforcing an ethical business culture Code of ethical business conduct In 2016/17 SSE published a new code: Doing the right thing: A guide to ethical business conduct for SSE employees. The new code is a development from the previous version as it more explicitly outlines the steps employees should take to ensure that their day-to-day actions and decisions are consistent both with SSE’s values and rules. SSE engaged proactively with the Institute of Business Ethics to ensure the new code reflected best practice. The implementation of the code is ongoing, with regular issue driven awareness raising campaigns alongside the delivery of a range of training packages. Creating a culture of speaking up Building on the establishment of a new whistleblowing policy in 2015/16, SSE worked throughout 2016/17 to actively promote the Speak Up policy, alongside awareness raising of Doing the right thing: A guide to ethical business conduct for SSE employees. As a result, the number of whistle-blowing reports has more than doubled between 2015/16 and 2016/17 from 41 to 88. This increase is welcome as it confirms that the efforts to promote Speak Up are having an impact. Analysis is being undertaken to carefully track trends and an aftercare process is being introduced to get feedback on the experience from those reporting issues through this approach. Human rights SSE’s Human Rights Policy outlines the fundamental principles that guide SSE, recognising that in both its direct employment and through its supply chain, human rights must be actively respected and protected. The policy also outlines SSE’s commitment to meeting the provision of the UK’s Modern Slavery Act and SSE’s second Modern Slavery Statement is published on sse.com. More information: SSE is committed to the ongoing development of workforce metrics and works with a number of stakeholders to provide more data that supports its human capital strategy. More information and disclosure can be found in SSE’s Sustainability Report 2017. Creating a workforce for the future SSE offers a range of structured programmes designed for school leavers, apprentices, trainee engineers and graduates. These pipelines introduce hundreds of young people into SSE every year and represent the single most important way SSE builds its future workforce. In 2016/17 the number of individuals participating in SSE’s talent pipelines was 1,277. 23 1. Strategic Report2.3.Strategic Report – Executing our long-term strategy Risk Management Framework Supporting the achievement of SSE’s strategic objectives The Group’s objectives are set through the Strategic Framework. To support the achievement of these over the past 12 months the Board has sought to further mature and embed the Risk Management Framework (as detailed below) that has been developed over the past three years. For further information on how SSE manages risk, please see the supplementary Group Risk Report. The Executive Committee and its sub- committees have responsibility for overseeing SSE’s Principal Risks. During the third quarter of SSE’s financial year, a self assessment is completed for each of SSE’s Principal Risks by an assigned oversight committee. This assessment requires committee members to provide commentary on contextual changes in the risk and whether they consider it to have become more or less material during the course of the year. These individual responses are consolidated into a report, one for each Principal Risk. The end reports are then presented back to the committees, along with the results of provisional viability testing and analysis of relevant and current Management Information. Following presentation of the assessment information, the committees discuss and reach a consensus regarding risk trend (more, less or equally material), overall effectiveness of the risk control and monitoring environment, and whether any additional actions are required to improve the control environment. The outputs from the committee assessments are then presented to the Executive Committee for full review, with any material changes resulting from this being proposed to the Board for approval. Following the 2016/17 review process, the number of Principal Risks to the Group was increased from nine to ten with the pre-existing “Cyber and Networks Failure” risk being split into two separate risks – Cyber Security and Resilience and Energy Infrastructure Failure. In addition, the “Human and Relationship Capital” risk has been expanded and renamed, becoming People and Culture. The diagram below details SSE’s wider System of Internal Control and how the Risk Management Framework is aligned with the other elements of it. System of internal control Corporate Governance Framework Strategic Framework Risk Management Framework Assurance Framework Standards and Quality Framework Board Board Committees Executive Committee Executive Sub-Committees Divisions Corporate Support Functions 24 SSE plc Annual Report 2017 Strategic Objectives Financial Objective Responsibility Framework Group Risk Management and Internal Control Policy Review of the Effectiveness of the System of Internal Control Principal Risk Self-Assessment Risk Appetite Statement Viability Assessment Key Risk Indicators Divisional Risk Approach Assurance Evaluation Risk Blueprint External Audit Internal Audit Group Policies Group Compliance Group SHE Large Capital Projects Services Governance Manuals Business Assurance Divisional Procedures, Processes and Systems Risk Appetite Statement No business is risk-free and indeed the achievement of SSE’s strategic objectives necessarily involves taking risk. SSE will however only accept risk where it is appropriate, well understood, can be effectively managed and offers commensurate reward. The markets in which SSE operates are inherently subject to a high degree of political, regulatory and legislative risk. Furthermore each of SSE’s business divisions has differing levels of exposure to additional risks. For example, the Networks business is largely regulated and is characterised by stable, inflation linked cashflows whereas the Wholesale and Retail businesses are heavily exposed to energy market and commodity risk. Affordability and industry transformation also particularly affect the Retail business while Enterprise is exposed to the risks that come with growth in a highly competitive market place. The key elements of SSE’s strategic framework – including the diversity of energy businesses within the SSE Group described above, as well as its financial objective – are fully reflective of its risk appetite: – SSE seeks to avoid over-exposure to any single part of the energy sector and therefore maintains a balanced range of economically regulated and market- based energy businesses; – production, storage, transmission, distribution, supply and related services provide a balanced portfolio of business activities whilst keeping the depth of focus on a single sector – energy; and – Great Britain and Ireland gives SSE a geographic markets focus and a clear understanding of the risks and opportunities in those markets. In areas where SSE is exposed to risks for which it has little or no appetite, even though it has implemented high standards of control and mitigation, the nature of these risks mean that they cannot be eliminated completely. In determining its appetite for specific risks, the Board is guided by three key principles: 1. Risks should be consistent with SSE’s strategy, financial objective and core values – safety is SSE’s number one value and it has no appetite for risks brought on by unsafe actions; 2. Risks should only be accepted where appropriate reward is achievable on the basis of objective evidence; and 3. Risks should be actively controlled and monitored through the appropriate allocation of management and other resources. The Board has overall responsibility for determining the nature and extent of the risk it is willing to take and for ensuring that risks are managed effectively across the Group. Corporate Governance Framework Strategic Framework Risk Management Framework Assurance Framework Standards and Quality Framework Board Board Committees Executive Committee Executive Sub-Committees Divisions Corporate Support Functions Strategic Objectives Financial Objective Responsibility Framework Group Risk Management and Internal Control Policy Review of the Effectiveness of the System of Internal Control Principal Risk Self-Assessment Risk Appetite Statement Viability Assessment Key Risk Indicators Divisional Risk Approach Assurance Evaluation Risk Blueprint External Audit Internal Audit Group Policies Group Compliance Group SHE Large Capital Projects Services Governance Manuals Business Assurance Divisional Procedures, Processes and Systems There are five related frameworks which, combined, comprise SSE’s system of internal control. The Corporate Governance Framework is designed to ensure focus on the key components of high quality and effective decision making – clarity, accountability, transparency and efficiency. For further details please see page 58 of the Directors’ report. The Strategic Framework comprises the Group’s strategic objectives, financial objective and our responsibility framework. For further details please see page 12 to 23 of the Strategic Report. The strategic framework forms the basis for all activity within the Risk Management Framework. The Risk Management Framework is underpinned by the fundamental principle that everyone at SSE is responsible for the management of risk. The Risk Management Framework supports each Division in managing its risks and helps to ensure that the Board is able to meet its obligations. The Assurance Framework. Group Audit, Group Compliance, Group SHE and LCP Services work together to provide an integrated programme of audit and assurance activity that is independent of the day to day operations of the Divisions and Corporate Functions. The Standards and Quality Framework sets out the expected standards and guidelines to be followed in the delivery of the Group’s core purpose – providing the energy people need in a reliable and sustainable way. 25 3.1. Strategic Report2.Strategic Report – Executing our long-term strategy Risk Management Framework continued Group Principal Risks Commodity Prices Oversight: Wholesale Risk Committee The risk associated with the Group’s exposure to fluctuations in both the physical volumes and price of key commodities, including electricity, gas, CO2 permits, oil and related foreign exchange values. Key mitigations include the use of VaR monitoring measures and daily assessments of commodity positions by a risk management team which is independent of the trading teams. • Limited level of interconnection with SSE’s other Principal Risks. Cyber Security and Resilience Oversight: Information Security and Privacy Committee The risk that key infrastructure, networks or core systems are compromised or are otherwise rendered unavailable. Key mitigations include significant longer term Security Programme investment and ensuring staff awareness of security issues and their importance. • Highly interconnected with SSE’s other Principal Risks. Development and Change Oversight: Executive Committee The risk of failing to recognise and react appropriately to competition, technological advancements and changes in customer expectations within the energy industry. Key mitigations include the implementation of various strategic change programmes which are governed by SSE’s Transformation and Large Capital Projects and Governance Frameworks. • Moderately interconnected with SSE’s other Principal Risks. Energy Infrastructure Failure Oversight: Executive Committee The risk of national energy infrastructure failure, whether in respect of assets owned by SSE or those owned by others which SSE relies on, that prevents the Group from meeting its obligations. Key mitigations include wide-ranging asset management strategies, and membership and participation in national security forums such as the Centre for the Protection of National Infrastructure (CPNI). • Moderately interconnected with SSE’s other Principal Risks. Major Projects Quality Oversight: Group Large Capital Projects Committee The risk that major assets that SSE builds do not meet the quality standards required to support economic lives of typically 15 to 30 years. Key mitigations include the Large Capital Project Governance Framework which ensures that all material capital investment projects across the Group are governed, developed, approved and executed in a consistent and effective manner. • Moderately interconnected with SSE’s other Principal Risks. Politics, Regulation and Compliance Oversight: Group Governance, Culture and Controls Committee The risk from changes in obligations arising from operating in markets which are subject to a high degree of regulatory, legislative and political intervention and uncertainty. Key mitigations include the maintenance of dedicated Corporate Affairs, Regulation, Legal and Compliance functions that provide advice and guidance regarding the interpretation of political, regulatory and legislative changes to SSE’s operating divisions. • Highly interconnected with SSE’s other Principal Risks. 26 SSE plc Annual Report 2017 Energy Affordability Oversight: Retail Risk Committee The risk that the combination of the cost of providing reliable and sustainable energy and the level of customers’ incomes means that energy becomes unaffordable to a significant number of SSE’s customers. This risk is directly connected to political interventions and commodity price exposure. Key mitigations include maintenance of a diverse generation fleet limiting exposure to a single commodity, as well as public policy lobbying to try to ensure the fair allocation of non-commodity costs related to energy provision. • Limited level of interconnection with SSE’s other Principal Risks. Financial Liabilities Oversight: Tax and Treasury Committee The risk that funding is not available to meet SSE’s financial liabilities, including those to its defined benefit pension schemes, as these fall due under both normal and stressed conditions without incurring unacceptable costs or risking damage to its reputation. Key mitigations include the mandatory maintenance of minimum borrowings and committed facilities to support forecast debt requirements, plus the ongoing de-risking of SSE’s defined benefit pension schemes. • Limited level of interconnection with SSE’s other Principal Risks. People and Culture Oversight: Group Governance, Culture and Controls Committee The risk that SSE is unable to attract, develop and retain an appropriately skilled, diverse and responsible workforce and leadership team, and maintain a healthy business culture which encourages and supports ethical behaviours and decision-making. Key mitigations include clear expectations relating to conduct and accountability, the SSE SET of values, well developed succession and diversity plans, and comprehensive training and learning management across the organisation. • Highly interconnected with SSE’s other Principal Risks. Safety and the Environment Oversight: Group Safety, Health and Environment Committee The risk of harm to people, property or the environment from SSE’s operations. Key mitigations include crisis management and business continuity plans that are in place and regularly tested, which are designed for the management of, and recovery from, significant safety and environmental events. • Moderately interconnected with SSE’s other Principal Risks. Group Principal Risks High s n o i t c e n n o c r e t n I People and culture Politics, regulation and compliance Cyber security and resilience Development and change Safety and the environment* Energy infrastructure failure Major projects quality Energy affordability** Financial liabilities Commodity prices Low Less Potential impact on Group Viability More * ** Safety is SSE’s most important value, and management of this risk remains SSE’s highest priority. It should be noted that Energy Affordability is particularly closely linked to – and therefore impacted by – Politics, Regulation and Compliance and Commodity Prices. SSE operates in fast moving markets that are subject to a high degree of political, regulatory and legislative intervention. It is therefore essential that SSE’s Risk Management Framework is dynamic and flexible, allowing decision makers to focus on material risk information that may have an impact, whether positive or negative, on core objectives. The Board and Executive Committee look to assess the Principal Risks that face the Group from a number of different perspectives, including both individually and collectively. This graphic illustrates SSE’s ten Group Principal Risks positioned on a relative basis against two important metrics – interconnectivity (a highly interconnected risk has more ways to manifest than a less interconnected risk), and potential impact on Group viability based on selected critical risk scenarios developed in conjunction with business experts. In addition, the Principal Risks that were considered by their oversight Committees to have increased in materiality during the year are shown in red, with those whose materiality has not significantly changed are shown in blue. No Principal Risk was deemed to have decreased in materiality. Viability Statement As required within provision C.2.2 of the UK Corporate Governance Code, the Board has assessed the prospects of the Company over the next 3 financial years to the period ending 31 March 2020. The Directors have determined that as this time horizon aligns with the Group’s current capital programme and is within the strategy planning period, a greater degree of confidence over the forecasting assumptions modelled can be established. In making this statement the Directors have considered the resilience of the Group taking into account its current position, the Principal Risks facing the Group and the control measures in place to mitigate each of them. In particular the Directors recognise the significance of SSE’s strong balance sheet, and committed lending facilities of £1.5bn which could be drawn down in most circumstances. The Group also has a number of highly attractive and relatively liquid assets – including a regulated asset base which benefits from a strong regulated revenue stream as well as the operational wind portfolio – which provide flexibility of options. This was demonstrated in the successful sale during the 16/17 financial year of a 16.7% share of Scotia Gas Networks Ltd. To help support this Statement, over the course of the year a suite of severe but plausible scenarios has been developed for each of SSE’s Principal Risks. These scenarios are based on relevant real life events that have been observed either in the markets within which the Group operates or related markets globally. Examples include persistently low commodity prices (for “Commodity Prices”); changes to key government energy policies (for “Politics, Regulation & Compliance”); and, a major incident that results in the loss of a significant volume of customer data (for “Cyber Security and Resilience”). A formal assessment is carried out to stress test the scenarios that most have the potential to adversely affect SSE’s ability to deliver its core purpose of “providing the energy people need in a reliable and sustainable way” against forecast available financial headroom. In addition to considering these in isolation, the Directors also consider the cumulative impact of different combinations of scenarios, including those that individually have the highest impact and those that are most heavily interconnected with SSE’s other Principal Risks. Upon the basis of the analysis undertaken, the Directors have a reasonable expectation that the Group will be able to continue to meet its liabilities as they fall due in the period to 31 March 2020. Long Term Climate Change Risk Exposure In response to the 2015 Paris Agreement on Climate Change, and out with the scope of the Viability Assessment, a number of scenarios have been assessed to consider SSE’s long-term resilience to carbon reductions that would be required to prevent global average temperatures rising by 1.5 °C or 2 °C. Further detail is disclosed in SSE’s Sustainability Report. 27 3.1. Strategic Report2.Strategic Report – Executing our long-term strategy Working in partnership with our stakeholders Collaborating to achieve sustainable outcomes for customers SSE’s success depends on its ability to engage and work constructively with a range of key stakeholders, to improve the outcomes it can achieve for customers, shareholders and society as a whole. For SSE, stakeholders are people, groups and organisations who have an interest in SSE and the energy sector as a whole. SSE and its stakeholders have a common agenda in ensuring the energy sectors in the UK and Ireland are delivering for customers; are reliable and sustainable; and are dealing responsibly with economic, social and environmental issues. Customers: Customers are at the heart of everything SSE does. In addition to engaging with customers through the day-to-day provision of services, ongoing research and surveys and customer forum and consultation events, SSE engages with five other key stakeholder groups: SSE’s principal stakeholders – Government and regulators: SSE recognises the central role of governments and regulators in the energy sector, and its Political Engagement Policy can be viewed at sse.com. – Non-governmental organisations (NGOs): NGOs focus on social, environmental and other energy- and business-related issues which affect energy customers, bringing a specialist, distinctive and influential view to those issues. SSE actively seeks their insight and advice through meetings, consultation and other programmes. Society - g o v e r n mental organisations n o N L i s t ening to t h e views of s p e c i a list bodies Energy Customers d e R m e s o p c r e a c t t i i c n g p r t h e o c e s s G o v e r n m e n t a n d r e g u l a t o r s g to G issues din n o p s e R S E y e k U p o s i n Providing the energy people need g p e ople to r f o r c usto mers a r e h olders h g i n E n g a e i v d e l a n d s w g b e r for good uying ers old h e r a h S S u p p li e r s a n d c ontractors E m p l o y e es 28 SSE plc Annual Report 2017 – Suppliers and contractors: Working with suppliers and contractors can reduce the costs of, and enhance positive economic, social and environmental outcomes from, energy provision. SSE has a structured approach to engaging with its most strategic supply chain partners, with a new framework of category management to ensure a more coherent approach to procurement. – Employees: SSE depends on employees to deal with customers and other stakeholders on a day-to-day basis and to respond first hand the issues that customers face and contribute to how those issues are resolved. SSE’s objective is to create a framework for continuous engagement, feedback and improvement for employees (see Our people and our values on pages 20 to 23). – Shareholders: Shareholders own the Company and have a wider concern to ensure SSE is a responsible company that considers shareholders’ concerns its decision-making, especially on environmental, social and governance matters. SSE has a structured investor relations programme, covering financial, operational and environmental, social and governance issues. All of this means that in making operational, investment and strategic decisions, SSE depends on the knowledge and insight which stakeholders can bring to support robust business decisions that are in the long-term interests of customers and investors alike. This, in turn, means that SSE is better able to fulfil its core purpose of providing the energy people need in a reliable and sustainable way; and it means that SSE acts as a responsibly-minded business in pursuit of its financial and other business objectives. For these reasons, SSE will continue to engage and work constructively with a range of key stakeholders in 2017/18 and beyond. Putting stakeholders at the heart of Networks decision-making At a time in which the energy networks must be more responsive to stakeholder and customer needs, in March 2016 Scottish and Southern Electricity Networks has established an independent Stakeholder Advisory Panel. With membership from charities and external industry bodies, it works alongside the Board for SSE’s Networks business to help scrutinise key areas of business performance, the commitments made under the RIIO-T1 and RIIO-ED1 price controls and future plans. The Panel consists of a Chair and six members, recruited to reflect a broad range of external interests, skills, knowledge and experiences. Through its work, the panel brings stakeholder insight and challenge to SSEN’s decision-making and long-term direction at the highest level, helping to drive improvement in key processes and outcomes for customers. A Sustainability Impact Report found that Galway Wind Park (a joint venture between SSE and Coillte) will add €88.7m to Irish GDP and grant over €150,000 to local community groups during construction. In September 2016, SSE’s three electricity networks businesses adopted a common trading name as Scottish and Southern Electricity Networks (SSEN). This, alongside the Advisory Panel, responds to the RIIO price controls which incentivises all network operators to engage effectively with their customers and stakeholders. Working with communities and assessing our impacts when developing and constructing onshore wind farms Developing and upgrading the energy infrastructure in the UK and Ireland is an essential part of providing the energy people need. As a responsible developer and operator SSE therefore strives to develop projects responsibly, listening to stakeholders and responding in a balanced way. This is particularly the case for SSE’s onshore wind farm developments, as SSE knows that developers must try to minimise the upheaval and associated impacts to local residents. That’s why engagement is a major part of SSE’s development plans and why SSE has always sought to engage constructively and openly with the communities living and working in the vicinity of a project. Its focus is always to understand, and where possible act upon, any issues or concerns raised by the community in order to refine and improve plans and SSE works hard to ensure there is extensive two-way communication between its project liaison team with those living near a project. It also produces several reports to quantify the material economic, social and environmental impacts of its projects. In 2016/17 SSE produced a sustainability impact report for the Galway Wind Park, which found that Ireland’s largest onshore wind development would add €88.7m to Irish GDP and support 1,657 years of Irish employment. Engaging customers to ensure Retail services and products meet their expectations meter rollout. The Forum members and chairs meet regularly with senior managers in the Retail business and, from time to time, with members of the SSE plc Board. Launched in 2012 SSE’s Retail business has four independent Customer Forums that provide honest feedback on the company’s products and services, thereby enabling the business to factor their views into decisions. The Forums are made up of customers and are based in Newcastle, Perth, Cardiff and Havant. Each is chaired by a representative of a leading consumer group, for example Citizen’s Advice. There were 13 meetings in total in 2016/17 and the topics discussed included how to simplify the presentation of new products, how to improve our telephone customer service and what customer’s think of aspects of the smart SSE’s Retail business has taken the guidance and advice from its Customer Forums since 2012. This helps it develop products and services to meet customer’s needs. 29 3.1. Strategic Report2.Strategic Report – Our financial and business performance Financial overview SSE is committed to creating and sustaining long-term value. Its first financial objective is to deliver annual dividend increases that at least keep pace with inflation, whilst ensuring that the dividend is covered by Adjusted EPS at a level that is sustainable over time. A 2.1% increase in the dividend per share to 91.3p demonstrates that despite an increasingly competitive and changing operating environment SSE is focused on responsibly delivering what it says it will for shareholders and this year was no exception. 30 SSE plc Annual Report 2017 Key questions to Gregor Alexander, SSE Finance Director Given the challenges in the operating environment, how committed are you to future dividend increases, in line with RPI? We’re fully committed to meeting our long- standing financial objective of annual dividend increases, at least in line with RPI. The business is geared toward this. Our strategic framework, options for growth, relentless focus on efficiency and index-linked revenues in Wholesale and Networks position us well to deliver our financial objective in 2017/18 and beyond. What is the outlook for capital and investment expenditure? Disciplined investment in building, owning and operating assets is core to our strategy and since 2010 we’ve invested almost £11bn. We are now into a programme to invest around £6bn in the years 2016 to 2020. All investments are intended to complement our asset base and provide balance to the Group. That’s why economically-regulated networks and government mandated renewables, whose revenues are generally index-linked, make up around two-thirds of this investment programme. Going forward our investments will only proceed if they create long-term value with returns greater than the cost of capital, meaningfully contribute to earnings and provide balance to SSE. Financial discipline has always been important for SSE, how confident are you that this will be maintained? Financial discipline, securing a diversity of funding sources and maintaining a strong balance sheet are fundamental to how we run our business. Our credit rating illustrates this, and we are committed to maintaining robust ratios for both retained cash flow and funds from operation to debt. This, alongside a strong balance sheet, gives SSE the capacity to invest to create long-term value. Financial discipline, therefore, will always be part of our plans. How consistent is SSE’s financial focus with its agenda on sustainability? Totally. In addition to being committed to the transparency demanded in tax by the Fair Tax Mark, we are also involved in Accounting for Sustainability. It is aiming to make sure that financial and accounting systems better reflect wider environmental and social factors and help support better business decision-making. As a long-term business in a key sector, this is highly relevant for SSE. Group financial overview The following tables provide a summary of Group financial performance. The definitions SSE uses for Adjusted measures are consistently applied and are explained in the Alternative Performance Measures section of this document, before the Financial Statements. Key Adjusted financial metrics Adjusted operating profit Adjusted net finance costs Adjusted profit before tax Adjusted current tax charge Adjusted profit after tax Less: hybrid equity coupon payments Adjusted profit after tax attributable to ordinary shareholders Adjusted EPS – pence Number of shares for basic and Adjusted EPS – million Shares in issue at 31 March – million Key Reported financial metrics Reported operating profit Reported net finance costs Reported profit before tax Reported tax charge Reported profit after tax Less: hybrid equity coupon payments Reported profit after tax attributable to ordinary shareholders 1 Reported EPS – pence 1 After distributions to hybrid capital holders. Dividend per share Interim dividend – pence Final dividend – pence Full year dividend – pence Increase – % Dividend cover times/SSE’s Adjusted EPS Adjusted operating profit by segment EPM and Electricity Generation Gas Production Gas Storage Wholesale Electricity Transmission Electricity Distribution SGN (SSE’s 50% share reducing to 33% from 26 Oct 2016) Networks Energy Supply Energy-related Services Enterprise Retail Corporate unallocated Total Adjusted operating profit March 17 £m March 16 £m March 15 £m 1,874.0 (328.1) 1,545.9 (157.7) 1,388.2 (119.3) 1,268.9 125.7 1,009.7 1,015.6 1,824.4 (310.9) 1,513.5 (193.4) 1,320.1 (124.6) 1,195.5 119.5 1,000.0 1,007.6 1,881.4 (316.7) 1,564.7 (224.8) 1,339.9 (121.3) 1,218.6 124.1 981.8 993.0 March 17 £m March 16 £m March 15 £m 1,940.5 (163.9) 1,776.6 (57.8) 1,718.8 (119.3) 1,599.5 158.4 785.4 (192.1) 593.3 (8.1) 585.2 (124.6) 460.6 46.1 985.9 (250.7) 735.2 (70.8) 664.4 (121.3) 543.1 55.3 March 17 March 16 March 15 27.4 63.9 91.3 2.1% 1.38x 26.9 62.5 89.4 1.1% 1.34x 26.6 61.8 88.4 2.0% 1.40x March 17 £m March 16 £m March 15 £m 501.2 26.4 (13.0) 514.6 263.7 433.4 239.4 936.5 389.5 16.1 16.7 422.3 0.6 436.3 2.2 4.0 442.5 287.2 370.7 268.7 926.6 398.9 15.4 40.9 455.2 0.1 433.3 36.6 3.9 473.8 184.1 467.7 285.0 936.8 368.7 17.7 70.4 456.8 14.0 1,874.0 1,824.4 1,881.4 31 3.1. Strategic Report2. Strategic Report – Our financial and business performance Financial overview continued Reported operating profit by segment EPM and Electricity Generation Gas Production Gas Storage Wholesale Electricity Transmission Electricity Distribution SGN (SSE’s 50% share) reduced to 33% from 26 Oct 2016 Networks Energy Supply Energy-related Services Enterprise Retail Corporate unallocated Total Reported operating profit March 17 £m March 16 £m March 15 £m 736.1 (201.1) (36.8) 498.2 263.7 433.4 151.7 848.8 313.2 (20.3) 16.7 309.6 283.9 (174.8) (159.6) (146.9) (481.3) 287.2 370.7 175.3 833.2 398.9 (2.4) 40.9 437.4 (3.9) (71.8) (69.4) (160.0) (301.2) 184.1 467.7 153.2 805.0 334.5 33.3 100.7 468.5 13.6 1,940.5 785.4 985.9 A reconciliation of Adjusted operating profit by segment to Reported operating profit by segment can be found in Note 5 (ii) to the accounts. Operating profit reconciliation Adjusted operating profit Movement on derivatives Exceptional items Share of JVs and Associate interest and tax Reported operating profit Profit before tax reconciliation Adjusted profit before tax Movement on derivatives (IAS 39) Exceptional items Interest on net pension liabilities (IAS 19R) Share of JVs and Associates tax Reported profit before tax Tax Adjusted current tax charge Add/(Less): Share of JVs and Associates tax Deferred tax including share of JV and Associates Tax on exceptional items and certain re-measurements Reported tax charge Effective current tax rate based on Adjusted profit before tax – % Total UK taxes paid including taxes on profits, property taxes, environmental taxes and employment taxes 32 SSE plc Annual Report 2017 March 17 £m March 16 £m March 15 £m 1,874.0 203.1 (8.2) (128.4) 1,940.5 1,824.4 (28.8) (889.8) (120.4) 785.4 1,881.4 (61.1) (674.6) (159.8) 985.9 March 17 £m March 16 £m March 15 £m 1,545.9 255.7 (8.2) (3.1) (13.7) 1,776.6 1,513.5 (14.5) (889.8) (22.3) 6.4 593.3 1,564.7 (105.3) (674.6) (14.0) (35.6) 735.2 March 17 £m March 16 £m March 15 £m 157.7 193.4 224.8 (13.7) 19.8 (106.0) 57.8 6.4 80.8 (272.5) 8.1 (35.6) 82.0 (200.4) 70.8 10.2% 12.8% 14.4% 385.0 453.9 506.2 Investment and capex summary (Adjusted) Thermal Generation Renewable Generation Gas Storage Gas Production Total Wholesale Electricity Transmission Electricity Distribution Total Networks Energy Supply and Related Services Enterprise Total Retail Other Total investment and capital expenditure (Adjusted) Debt metrics Adjusted net debt and hybrids Average debt maturity – years Adjusted interest cover (excluding SGN) – times Adjusted interest cover (including SGN) – times Average interest rate for the period (excluding JV/assoc. interest and all hybrid coupon payments) – % Average cost of debt at period end (including all hybrid coupon payments) – % Adjusted net debt and hybrids reconciliation Adjusted net debt and hybrids Less: hybrid equity Adjusted net debt and hybrid debt Less: outstanding liquid funds Add: finance leases Less: non-recourse Clyde debt Unadjusted net debt and hybrid debt Net finance costs reconciliation Adjusted net finance costs Add/(Less): Movement on financing derivatives (IAS 39) Share of JV and Associates interest Interest on pension asset/(liabilities) (IAS 19R) Reported net finance costs Adjusted net finance costs Add/(Less): Finance lease interest Notional interest arising on discounted provisions Hybrid equity coupon payment Adjusted finance costs for interest cover calculation March 17 Share % March 17 £m March 16 £m 6.3 21.2 – 4.2 31.7 29.3 16.5 45.8 10.7 3.4 14.1 8.4 100 108.6 366.4 0.2 72.9 548.1 505.0 284.7 789.7 184.3 58.7 243.0 145.4 90.8 291.8 14.0 56.1 452.7 573.4 258.3 831.7 169.0 48.5 217.5 116.8 1,726.2 1,618.7 March 17 £m March 16 £m March 15 £m (8,483.0) 8.8 6.0 4.7 3.66% 4.10% (8,395.0) 8.9 5.2 4.7 3.73% 3.95% (7,568.1) 9.9 5.3 4.8 4.21% 4.55% March 17 £m March 16 £m March 15 £m (8,483.0) 2,209.7 (6,273.3) (105.2) (276.9) – (6,655.4) (8,395.0) 2,209.7 (6,185.3) (121.8) (300.8) (200.7) (6,808.6) (7,568.1) 3,371.1 (4,197.0) (71.7) (319.7) – (4,588.4) March 17 £m March 16 £m March 15 £m 328.1 310.9 316.7 (52.6) (114.7) 3.1 163.9 (14.3) (126.8) 22.3 192.1 44.2 (124.2) 14.0 250.7 328.1 310.9 316.7 (33.1) (14.2) 119.3 400.1 (34.7) (15.7) 124.6 385.1 (34.2) (14.0) 121.3 389.8 33 3.1. Strategic Report2. Strategic Report – Our financial and business performance Financial overview continued SSE principal sources of debt funding Bonds Hybrid debt and equity securities European investment bank loans US private placement Index-linked debt, long term project finance and other loans % of total SSE borrowings secured at a fixed rate Rating agency March 17 % March 16 % March 15 % 41 33 11 10 5 91 45 25 8 5 17 87 38 37 8 5 12 83 Moody’s Standard and Poor’s A3 Stable outlook A- Negative outlook Mid teens% RCF/net debt 23% FFO/net debt Rating Criteria Date of issue 3 October 2016 26 October 2016 Contributing to employees’ pension schemes – IAS 19R Net pension scheme asset/(liabilities) recognised in the balance sheet before deferred tax Employer cash contributions Scottish Hydro Electric scheme Deficit repair contribution included above Employer cash contributions Southern Electric scheme Deficit repair contribution included above Additional information on employee pension schemes can be found in Note 23 to the accounts. March 17 £m March 16 £m March 15 £m 70.5 36.2 14.0 76.3 41.2 (394.8) 33.7 14.8 68.3 44.6 (664.6) 57.6 29.5 92.0 58.5 Group financial review This Group financial review covers SSE’s financial performance and outlook, capital investment, balance sheet and tax payments. Earnings, dividends and dividend cover Focusing on delivering dividend increases that at least keep pace with inflation The Board is recommending a final dividend of 63.9p per share, to which a Scrip alternative is offered, compared with 62.5p in the previous year, an increase of 2.2%. This will make a full-year dividend of 91.3p per share which is: an increase of 2.1% compared with 2015/16, which is in line with RPI inflation; and covered 1.38 times by SSE’s Adjusted earnings per share. SSE believes that its strategic framework, opportunities for growth and the extent to which its revenues in Wholesale and Networks are index-linked mean it can deliver a full-year dividend increase that at least keeps pace with RPI inflation in 2017/18 and in the subsequent years (measured against the average annual rate of RPI inflation across each of the 12 months to March). Focusing on Adjusted earnings per share and dividend cover To monitor its financial performance over the medium term, SSE consistently reports on its Adjusted earnings per share (EPS) measure. This measure is calculated by excluding the charge for deferred tax, interest costs on net pension liabilities, exceptional items and the impact of certain re-measurements. SSE’s Adjusted EPS measure has been calculated consistently and provides an important and meaningful measure of underlying financial performance. In adjusting for exceptional items and certain re-measurements, Adjusted EPS reflects SSE’s internal performance management, avoids the volatility associated with mark-to-market IAS 39 re-measurements and means that items deemed to be exceptional due to their nature and scale do not distort the presentation of SSE’s underlying results. For more detail on these and other Adjusted items please refer to the Alternative Performance Measures section of this report. In 2016/17, SSE’s Adjusted earnings per share increased by 5.2%, to 125.7 pence, which was ahead of the target of at least 120 pence. Reported EPS was 158.4p, compared to 46.1p in the previous year. The extent of this increase is predominantly explained by the impact on Reported earnings of the significant exceptional charges incurred in the previous year and the relative movement in mark to market valuations on derivative contracts over both years. As stated in its Notification of Close Period Statement on 30 March 2017, SSE is working to keep dividend cover within the expected range of around 1.2 to around 1.4 times in 2017/18, although it is likely to be towards the bottom of it, which also means Adjusted earnings per share is likely to be lower than it was in 2016/17. SSE believes that its dividend should be covered by Adjusted earnings per share at a level that is sustainable over time; and it believes that sustainability is based on the quality of the operations and assets from which earnings are derived and the longer-term financial outlook. 34 SSE plc Annual Report 2017 As a result of its investment over the last five years, the majority of SSE’s asset base and operating profit now relates to economically-regulated, and largely index-linked, Networks and government- mandated renewable sources of energy. Subject to the range of factors that apply in its market-based businesses (see below), and to material political or regulatory change, SSE is working towards achievement of dividend cover a within a range of around 1.2 times to around 1.4 times over the three years to 2019/20, based on dividend increases that at least keep pace with RPI inflation, and to be towards the bottom of that range in 2017/18. Delivering Adjusted profit before tax in 2016/17 and 2017/18 Adjusted profit before tax increased by 2.1%, from £1,513.5m to £1,545.9m during 2016/17. SSE’s Wholesale, Networks and Retail (including Enterprise) segments were profitable. Nevertheless, SSE’s objective is not to maximise profit in any one year but to earn a sustainable level of profit over the medium term. Over 2017/18, SSE’s actual level of Adjusted profit before tax will be determined largely by the range of factors set out in previous years that continue to apply in its market- based businesses, in which energy portfolio management is a major influence, including: – the impact of wholesale prices for energy; – electricity market conditions, the ability of its thermal power stations to be available and to generate electricity efficiently; – the output of renewable energy from its hydro-electric stations and wind farms and the price achieved for the output; – the output from its gas production assets and the price achieved for the output; and – the actual and underlying level of customers’ energy consumption. Summarising the impact of movements on derivatives SSE enters into forward purchase contracts (for power, gas and other commodities) to meet the future demands of its Energy Supply business and to optimise the value of its Generation and other Wholesale assets. Some of these contracts are determined to be derivative financial instruments under IAS 39 and as such are required to be recorded at their fair value. SSE shows the change in the fair value of these forward contracts separately as this mark-to-market movement is not relevant to the underlying performance of its operating segments. It will recognise the underlying value of these contracts as the relevant commodity is delivered, which will predominantly be within the subsequent 12 to 36 months. Conversely, commodity contracts that are not determined to be derivative financial instruments under IAS 39 are accounted for as ‘own use’ contracts, the cost of which is recognised on delivery of the underlying commodity. The favourable movement on derivatives under IAS 39 of £201.0m arose partly from an improvement in the fair value of forward commodity purchase contracts and the unwinding of contracts in 2016/17. The fair value of such contracts is derived by comparing the contractual delivery price against the prevailing market forward price at the balance sheet date. The position at 31 March 2017, primarily electricity and gas, was a liability of £163.3m compared to a liability on similar contracts at 31 March 2016 of £364.3m. Complementing this was a positive movement on the fair valuation of interest and currency derivatives of £52.6m. This movement is primarily due to the impact of the aftermath of the EU referendum on cross currency swaps and forward currency contracts. SSE also reports these fair value re-measurements separately as these do not represent underlying business performance during the financial year. The effect of the contracts will be recorded in Adjusted profit measures when the transactions are settled. Exceptional items In the year to 31 March 2017, SSE recognised a net exceptional charge of £8.2m before tax. The following table provides a summary of the key components making up the net charge position: For a full description of the net exceptional charge see Note 6 of the financial statements. The Clyde fair value uplift of £59.1m relates to the deconsolidation, in May 2016, following a change to the shareholders’ agreement, of SSE’s investment in Clyde Windfarm (Scotland) Limited (‘Clyde’). It is therefore now an equity-accounted joint venture. This change in accounting treatment required the investment to be fair valued and the revaluation to be recorded in the income statement. This has been recorded as an exceptional credit due to both its quantum and the non-recurring nature of the item. The thermal generation credit reflects a reversal of previously impaired coal inventory, resulting from the unexpected improvement in winter 2016/17 ‘dark spreads’, partially offset by impairments at SSE’s oil burning stations at Rhode and Tawnaghmor in the Republic of Ireland due to their age and future competitive prospects. The impairment charges recognised for Gas Production assets are mainly driven by the latest independent Reserves Report, which takes account of all technical and economic variables, and estimates a significant reduction in the Proven and Probable (2P) reserves in the Greater Laggan Area assets that is only partially offset by an increase in those of SSE’s mature asset base in the Southern North Sea. In addition, an impairment charge has been recognised in relation to Bacton field assets, predominantly related to higher than previously assessed decommissioning costs. The Gas Storage asset impairment relates to higher anticipated decommissioning costs. Total net charges By asset class SGN gain on sale Clyde fair value uplift Thermal Generation Gas Production Gas Storage Retail and technology development Other Property, plant & equipment £m Gains/ (losses) on disposals £m – – 31.6 (227.5) (23.8) (120.3) (34.6) 307.3 59.1 – – – – – Total exceptional (charge)/gain (374.6) 366.4 Total £m 307.3 59.1 31.6 (227.5) 23.8 120.3 34.6 (8.2) By segment Wholesale Retail Corporate Total (237.9) (112.7) (24.0) 59.1 – 307.3 (374.6) 366.4 (178.8) (112.7) 283.3 (8.2) 35 3.1. Strategic Report2.Strategic Report – Our financial and business performance Financial overview continued The exceptional charges for Retail and other technology developments reflect impairments of capitalised costs following the decision taken to cease development of a replacement customer service and billing system and related technology development projects. line with SSE’s commitment to strong financial management. During 2016/17, SSE’s investment and capital expenditure totalled £1,726.2m. This included: – a major investment programme in The Other exceptional charges are primarily the impairment of goodwill associated with the purchase of the Energy Solutions Group and offsetting changes in provisions relating to disputes and claims. Reported profit before tax and earnings per share Reported results for 2016/17 are significantly higher than those for 2015/16 due to the impact on Reported profit before tax of the significant exceptional charges incurred in 2015/16. These related mainly to the write down of wholesale generation, gas storage and production assets in 2015/16 compared to the gain on sale of a stake in SGN plus lower asset write downs in 2016/17. This together with the relative movement in mark to market valuations on forward purchase contracts for commodities over both years (which at March 2017 were still ‘out of the money’) contributed to a net Reported gain before tax of £247.5m in 2016/17 compared to a loss before tax on those items of (£904.3m) in 2015/16. This swing is explained in more detail in the relevant sections throughout this report and is the main driver for: – Reported profit before tax increasing to £1,776.6m in 2016/17 compared to £593.3m in 2015/16, due to the movement in non-recurring exceptional items; and – Reported earnings per share increasing to 158.4p in 2016/17 compared to 46.1p in 2015/16, again due to the movement in non-recurring exceptional items. Investment and capital expenditure Central to SSE’s strategic framework is efficient and disciplined investment in building a balanced range of economically- regulated and market-based energy assets that it also generally owns and operates. This means that investment should be in line with SSE’s commitment to strong financial management and consistent with the maintenance of a balanced range of assets within SSE’s businesses. electricity networks: the switching on of the first section of an overhead link between Knocknagael and Kintore represented a key milestone in the Caithness-Moray electricity transmission link project. The project is the largest capital project ever undertaken by SSE and is on schedule for completion in 2018. This investment, alongside continued upgrading of the electricity distribution network to meet the changing needs of customers, will further increase the total Regulated Asset Value (RAV) of SSE’s networks businesses; and – further investment in renewable energy in GB and Ireland: progress was made to increase SSE’s renewable energy portfolio in GB with projects to be delivered through the Renewables Obligation (RO), which also applies in Northern Ireland, Contracts for Difference (CfD) and Renewable Energy Feed in Tariff 2 in Ireland. Progress has been made at projects including the Clyde Extension (173MW); Stronelairg (225MW); the Beatrice offshore wind farm (SSE share 235MW); and Galway Wind Park (SSE share 120MW), which is the largest wind farm in Ireland. These projects, along with further onshore wind projects in construction or pre-construction and the recently delivered Tievenameenta (34MW) wind farm, will add just over 1GW to SSE’s renewable energy portfolio, taking SSE’s total renewable energy capacity 4.3GW including pumped storage. In addition, SSE is fulfilling a regulatory obligation to install smart meters for its Energy Supply customers. At 31 March 2017 SSE had installed over 500,000 smart meters in customers’ homes. Post installation, SSE’s meters will transfer to a contracted Meter Asset Provider, therefore SSE’s investment and capital expenditure excludes the capital cost of installation and meter assets. Subject to the delivery timetable of the critical central infrastructure, and other GB-wide technical constraints affecting the progress of smart metering, SSE intends to ramp up its rollout significantly over 2017/18. Investing efficiently in energy assets that the UK and Ireland need in 2016/17 SSE invests in a balanced range of businesses and invests only in assets for which returns are expected to be clearly greater than the cost of capital. All projects complement SSE’s existing portfolio of assets and are governed and executed in an efficient manner and in SSE is maintaining investment momentum, with capital and investment expenditure of around £1.7bn planned for 2017/18, similar levels currently expected for 2018/19 and around £6bn as a whole over the four years to 2020. Around £5bn of that is already committed, predominantly in building, owning and operating economically- 36 SSE plc Annual Report 2017 regulated electricity networks and government-mandated renewable energy projects. The revenue derived from those assets is generally index-linked. Simplifying and re-shaping the SSE group As part of its long-standing strategic commitment to efficiency and disciplined investment, SSE is maintaining the significant downward pressure on its operating costs that it started in 2014. Also in 2014 SSE commenced what was called a value programme to dispose of assets which were not core to its future plans, which resulted in a disproportionate burden, or which could release capital for future investment – all in the interests of simplifying and re-shaping the SSE group. The sale in March 2017 of its equity holding in the last of 11 PFI streetlighting contracts means the programme is now complete, and over the period between 2014 and 2017 SSE secured disposal proceeds and debt reduction as a result of this value programme totalling over £1.1bn. The sale in October 2016 of a 16.7% stake in SGN for £621m is in addition to the £1.1bn received as a result of the value programme launched in 2014; but the SGN stake sale and the value programme both demonstrate that timely disposals to create value for shareholders should always be an option for SSE where they help to simplify and streamline the SSE group. Financial management and balance sheet Keeping SSE well-financed As a long-term business, SSE believes that it should maintain a strong balance sheet, illustrated by its commitment to robust ratios for retained cash flow and funds from operations/debt. SSE believes that a strong balance sheet enables it to secure funding from debt investors at competitive and efficient rates and take decisions that are focused on the long term – all of which supports the delivery of annual increases in the dividend of at least RPI inflation and the maintenance of an appropriate level of dividend cover. In October 2016, Moody’s Investors Service affirmed SSE’s senior credit rating of A3, changed SSE’s outlook from negative to stable and raised SSE’s threshold for retained cash flow/debt ratio of ‘mid teens’ (previously 13%). In the same month, Standard & Poor’s affirmed SSE’s A-rating and negative outlook, while also raising SSE’s threshold for funds from operations/debt ratio to 23% (previously 20-23%). SSE has a long-standing commitment to maintaining financial discipline and diversity of funding sources and to moving quickly to select financial options that are consistent with this, including issuing new bonds and loans. In line with this, in March 2017, it successfully issued £1.03bn of hybrid debt. The dual tranche issue comprised £300m with a coupon of 3.625% and $900m with a coupon of 4.75%. The $900m tranche has been swapped back to both Euros and Sterling, bringing the all-in rate down to 2.72% and resulting in an all-in funding cost for both tranches to SSE of 3.02% per annum. The intent is to use the proceeds to replace SSE’s hybrid issued in 2012 (at an all-in rate of 5.6%), which has an issuer first call date on 1 October 2017. This will result in an annualised cash saving of around £26m from 2018/19. The combined hybrid coupon and hybrid interest payments in 2017/18 are expected to be £128m falling to around £80m in 2018/19. The new £1.03bn hybrids have a fixed redemption date and are therefore debt accounted and included within Loans and Other Borrowings while the existing £2.2bn of hybrids are perpetual instruments and are therefore equity accounted. SSE has confirmed that the criteria applied by the rating agencies, Moody’s, and Standard and Poor’s, will result in broadly the same value of hybrid equity treatment as that of previous years. During the year the £300m Scottish Hydro Electric Transmission plc facility with the European Investment Bank was drawn into a 10 year fixed rate term loan at a rate of 2.076% while a new £200m facility with the European Investment Bank was secured. The new facility is split evenly between SSE plc and Scottish Hydro Electric Transmission plc and will be drawn during 2017/18 at which point it will convert to 10 year term loans. The first of the one year extension options on the £1.5bn of bank facilities was exercised in 2016 meaning these facilities now mature in 2021 while the second one year option is likely to be exercised during 2017 which will take these maturities to 2022. Maintaining a prudent treasury policy following the EU referendum SSE’s treasury policy is designed to be prudent and flexible. In line with that, cash from operations is first used to finance maintenance capital expenditure and then dividend payments, with further growth in capital expenditure and investment generally financed by a combination of: cash from operations; bank borrowings and bond issuance. As a matter of policy, a minimum of 50% of SSE’s debt is subject to fixed rates of interest. Within this policy framework, SSE borrows as required on different interest bases, with financial instruments being used to achieve the desired out-turn interest rate profile. At 31 March 2017, 91% of SSE’s borrowings were at fixed rates. Borrowings are mainly made in Sterling and Euros to reflect the underlying currency denomination of assets and cashflows within SSE. All other foreign currency borrowings are swapped back into either Sterling or Euros. Transactional foreign exchange risk arises in respect of: procurement contracts; fuel and carbon purchasing; commodity hedging and energy portfolio management operations; and long-term service agreements for plant. SSE’s policy is to hedge any material transactional foreign exchange risks through the use of forward currency purchases and/ or financial instruments. This means that all its major project capex requirements are hedged, including the Stronelairg wind farm that was approved in 2016. Translational foreign exchange risk arises in respect of overseas investments, hedging in respect of such exposures is determined as appropriate to the circumstances on a case-by-case basis. Overall, while SSE has kept its treasury policy under review following the result of the EU Referendum, it has so far identified no need for change. Managing net debt and maintaining cash flow SSE’s Adjusted net debt and hybrid capital was £8.5bn at 31 March 2017, compared with £9.0bn at 30 September 2016 and £8.4bn on 31 March 2016. The overall level of net debt and hybrid capital reflects SSE’s ongoing investment programme however it also includes an accounting increase of around £212m as a result of fair value adjustments. The fair value adjustment relates to marked- to-market movements on cross currency swaps and floating rate swaps that are classed as fair value hedges under IFRS and as a result of Sterling weakness and lower interest rates during 2016/17 these have become more ’in the money’ to SSE therefore increasing the net debt position. This accounting movement in debt is offset by an equivalent movement in derivative financial liabilities held on SSE’s balance sheet. Adjusted net debt and hybrids at 31 March 2017 also includes £369m of the £500m proceeds identified for the share buy back from the sale of a 16.7% stake in SGN. Of this, £65m was deployed during the irrevocable, non-discretionary programme that continued during the close period from 1 April 2017 which means as at 17 May 2017 SSE has directed £196m towards the buy back, re-purchasing around 13.4m shares. It still expects the process to be completed by the end of December 2017. Adjusted net debt and hybrids is forecast to be around £9.5bn at March 2018. Adjusted net debt excludes finance leases and includes outstanding liquid funds that relate to wholesale energy transactions. As noted above SSE’s existing £2.2bn of hybrid equity is accounted for as equity within the Financial Statements but, as in previous years, has been included within SSE’s ‘Adjusted net debt and hybrid capital’ to aid comparability. SSE’s new £1.03bn of hybrid debt issued during 2016/17 is treated as debt. A reconciliation of Adjusted net debt and hybrid capital to Reported net debt is provided in the table headed Adjusted net debt and hybrid capital, due to the different accounting treatments, only the £2.2bn of hybrid equity is part of that reconciliation. The level of Reported net debt also reflects SSE’s ongoing capital expenditure programme along with the impact of movements in foreign exchange rates. Ensuring a strong debt structure through medium- and long-term borrowings SSE’s objective is to maintain a reasonable range of debt maturities. Its average debt maturity, excluding hybrid securities, at 31 March 2017 was 8.8 years, compared with 8.9 years at 31 March 2016. SSE’s debt structure remains strong, with around £8.7bn of medium/long term borrowings in the form of issued bonds, European Investment Bank debt and other loans. This includes £1.03bn of hybrid equity with their first call date on 2 October 2017, which it is intended will be redeemed using the proceeds of the most recent hybrid issuance. The balance of SSE’s Adjusted net debt is financed with short-term bank debt. SSE’s Adjusted net debt includes cash and cash equivalents totalling £1.4bn and around £1.2bn of medium-term borrowings which will mature in the period to March 2018, including the hybrid bonds mentioned above. 37 3.1. Strategic Report2.Group financial overview – conclusion and priorities SSE’s first financial objective is to deliver annual increases in the dividend that at least keep pace with RPI inflation. SSE believes that its strategic framework, opportunities for growth and effective financial management mean it can continue to deliver this in 2017/18 and beyond. Its financial priorities for 2017/18 as a whole include: – delivering an annual increase in the dividend that at least keep pace with RPI inflation; – maintaining dividend cover in a range from around 1.2 times to around 1.4 times, albeit towards the bottom of it; – continuing a disciplined approach to investment in building, owning and operating a balanced range of energy related assets and delivering assets within the established investment programme, especially in economically-regulated Networks and government- mandated renewables; – maintaining a strong balance sheet, with robust ratios for retained cash flow and funds from operations/debt; and – completing deployment of the SGN stake sale proceeds by way of the on market share buy back, a process which could continue until the end of 2017. Strategic Report – Our financial and business performance Financial overview continued Operating a Scrip Dividend Scheme The Scrip Dividend Scheme, approved by SSE’s shareholders most recently in 2015, gives shareholders the option to receive new, fully paid Ordinary shares in the company in place of their cash dividend payments. It therefore reduces cash outflow and so supports the balance sheet. The Scrip dividend take-up: – in August 2016 (relating to the final dividend for the year to 31 March 2016) resulted in a reduction in cash dividend funding of £142.6m, with 9.4 million new ordinary shares, fully paid, being issued; and – in February 2017 (relating to the interim dividend for 2016/17) resulted in a reduction in cash dividend funding of £95.3m, with 6.3m new ordinary shares, fully paid, being issued. This means that the cumulative cash dividend saving or additional equity capital resulting from the introduction of SSE’s Scrip Dividend Scheme in 2010 now stands at £1,289m and has resulted in the issue of 93.4 million Ordinary shares. Managing net finance costs SSE believes Adjusted net finance costs provide the most useful measure of performance and a reconciliation of Adjusted and Reported net finance costs is provided in the table headed Net Finance Costs. SSE’s Adjusted net finance costs in 2016/17 were £328.1m, compared to £310.9m in 2015/16 reflecting the increase in net debt in the year. Reported net finance costs were £163.9m, compared to £192.1m. This reduction reflects a positive movement in finance derivatives of £52.6m in 2016/17 compared to £14.3m in 2015/16. The coupon payments relating to the existing £2.2bn hybrid equity are presented as distributions to other equity holders and are reflected within Adjusted earnings per share when paid. In 2016/17 these totalled £119.3m, compared to £124.6m in the previous year. The coupon payments on the new £1.03bn hybrid debt issuance are treated as finance costs under IFRS and were £1.3m in 2016/17. Tax SSE is one of the UK’s biggest taxpayers, and in the survey published in November 2016 was ranked 14th out of the 100 Group of Companies in 2016 in terms of taxes paid. In the year to 31 March 2017, SSE paid £385.0m of taxes on profits, property taxes, environmental taxes, and employment taxes in the UK, compared with £453.9m in the previous year. Total taxes paid in 2016/17 were lower than the previous year, primarily due to: 38 SSE plc Annual Report 2017 – reduced taxable profits from Gas Production as a result of lower gas prices and capital allowances from the Greater Laggan acquisition in 2015/16; – the reduction in the Petroleum Revenue Tax rate to 0% from 1 January 2016; – a one-off Land & Buildings Transaction Tax liability in 2015/16 on the Greater Laggan acquisition; and – lower Climate Change Levy liabilities through reduced coal consumption. SSE also paid €16.5 million of taxes in the Republic of Ireland, being the only country outside of the UK in which it has any trading operations. SSE considers being a responsible taxpayer a core element of being a responsible member of society. SSE seeks to pay the right amount of tax on its profits, in the right place, at the right time, and continues to be the only FTSE 100 company to have been awarded the Fair Tax Mark. While SSE has an obligation to its customers and shareholders to efficiently manage its total tax liability, it does not seek to use the tax system in a way it does not consider it was meant to operate, or use “tax havens” to reduce its tax liabilities. SSE understands it also has an obligation to the society in which it operates, and from which it benefits – for example, tax receipts are vital for the public services SSE relies upon. Therefore SSE’s tax policy is to operate within both the letter and spirit of the law at all times. For reasons already stated above, SSE’s focus is on Adjusted profit before tax, and in line with that, SSE believes that the Adjusted current tax charge on that profit is the tax measure that best reflects underlying performance. SSE’s Adjusted current tax rate, based on Adjusted profit before tax, is 10.2%, as compared with 12.8% in 2015/16 on the same basis. As would be expected for a Company of SSE’s size, the SSE group has a small number of tax enquiries ongoing with HMRC at any one time. In addition, under Corporate Tax Self Assessment, SSE adopts a filing position on matters in its tax returns that may be large or complex, with the position then being discussed with HMRC after the tax returns have been filed. SSE engages proactively with HMRC on such matters, but where SSE considers there to be a risk that HMRC may disagree with its view, and that additional tax may become payable as a result, a provision is made for the potential liability, which is then released once the matter has been agreed with HMRC. SSE considers this to be in line with the overall prudent approach to its tax responsibilities. +0.7°C temperatures were above the 1981-2010 mean temperature for the UK The weather Managing the impact of the weather on SSE The operational performance of SSE’s businesses is affected by the weather. It impacts the production of renewable energy (Wholesale), the operation of the transmission and distribution lines (Networks) and the amount of gas and electricity used by consumers (Retail). Whilst the weather is not a principal risk to SSE in itself, it is of course an important contributor to business performance that is strongly interconnected to identified Principal Risks such as Energy Affordability and Commodity Prices. Given its impacts, SSE closely monitors short and long term weather conditions so that it is able to manage and respond to conditions in an appropriate manner for the benefit of customers and to support the fulfilment of its business objectives. This includes: – predicting how forecast temperatures may affect customers’ demand for gas and electricity, and whether daily fluctuations in temperature require a response form SSE’s generation assets; – forecasting the temperature to inform how SSE’s energy portfolio managers buy power and gas in advance, thereby improving SSE’s procurement; – determining short-, medium- and long-term wind forecasts and the electricity generation output from renewable generation assets; – assessing how rainfall patterns could impact SSE’s hydro-electric generation output and storage capabilities; and – preparing for how extreme weather, such as high winds or excess rainfall, could impact the resilience of the transmission and distribution assets that SSE’s customers rely on. -13% reduction in average rainfall in the North of Scotland, compared to the 1981-2010 average -0.3m/s wind speeds in 2016/17 were below the long-term average Overall 2016/17 was warmer than the previous year, however winds speeds and rainfall in the North of Scotland were below long-term averages. This has implications for customer demand, renewable energy output and hydro-electric output. Rainfall Wind Temperature Rainfall directly affects hydroelectric generation in the north and west of Scotland. Wind speeds drive renewable generation but excess can limit capacity and damage networks. A total of 1503.4mm of rain fell in the North of Scotland during the year which is 87% of the 1981-2010 average. Over the period October to March rainfall was below average in North of Scotland for 5 of the 6 months. As a result, SSE’s hydro-electric assets saw their output decrease to 3,101GWh compared to 4,074GWh in the previous year. While GB wind speeds in 2015/16 were very close to the long-term average (over 1981-2010), they were 0.3m/s below the average in 2016/17. Wind speeds were down compared with the previous year due to a change in the positions of the high and low weather pressure systems. These less windy conditions resulted in a decrease in output of electricity from SSE’s wind farms. Temperatures can significantly impact total demand for energy. 2016/17 was warmer than the previous year with average temperatures 0.7°C above the 1981-2010 average. The mean temperature in the UK over the year was 9.5°C, which is higher than the 9.2°C in the previous year. Whilst overall it was warmer there were several months in which the temperature was significantly colder. This impacts the trends in household energy demand. 39 3.1. Strategic Report2.618m therms Total output in 2016/17 from SSE’s gas production assets. 588MW The Beatrice offshore wind farm on the outer Moray Firth is expected to be fully operational in 2019. SSE’s share is 40%. Strategic Report – Our financial and business performance Wholesale – producing energy SSE’s Wholesale segment consists of three business areas: Energy Portfolio Management (EPM) and Electricity Generation; Gas Storage; and Gas Production. It operates a balanced portfolio of assets, contracts and investment opportunities. Wholesale Adjusted operating profit – £m Adjusted capital expenditure and investment – £m 514.6 +16.3% 548.1 +21% The businesses in SSE’s Wholesale segment source, produce and store energy through energy portfolio management, electricity generation, gas production and gas storage. Capital expenditure and investment for this business is in strategic assets that enhance, diversify and balance the portfolio. Renewable generation capacity – MW Total generation capacity – MW 3,309 +1.0% Renewable generation capacity covers hydro electric schemes (conventional and pumped storage), wind farms (onshore and offshore) and dedicated biomass plant. 10,643 +0.8% SSE’s generation capacity (including its share of joint ventures) incorporates 5,305MW of gas and oil-fired generation, 3,309MW of renewable generation (including pumped-storage), 34MW of multi-fuel and 1,995MW of coal-fired generation. Renewable generation output – GWh Total generation output – GWh 7,995 -17.9% Renewable generation output covers conventional hydro electric schemes and pumped storage on and offshore, wind farms and dedicated biomass plant. Output is affected by the amount of plant in operation and by weather conditions. 26,296 -5.3% SSE’s generation output covers the amount of electricity generated by the gas-fired, renewable and coal-fired power stations in which SSE has an ownership or contractual interest. The Wholesale business aims to secure maximum value through the flexible provision, storage and delivery of energy for customers in wholesale markets in Great Britain and Ireland. We manage risks, notably volatile commodity prices, by ensuring a balance and diversity in our business. It’s this diversity that positions us well. We are focussed on efficiently and safely operating our assets in an increasingly complex market as well as exploiting new opportunities by maintaining our investment momentum. Martin Pibworth Managing Director, Wholesale 40 SSE plc Annual Report 2017 41 1. Strategic Report2.3.Strategic Report – Our financial and business performance Wholesale – producing energy continued Wholesale key performance indicators Energy Portfolio Management (EPM) and Electricity Generation EPM and Generation Adjusted operating profit EPM and Generation Reported operating profit/(loss) – £m EPM and Generation Adjusted capital expenditure – £m and investment – £m March 17 March 16 501.2 736.1 436.3 (174.8) 475.0 382.6 Generation capacity – MW Gas- and oil-fired generation capacity (GB) – MW Gas- and oil-fired generation capacity (Ire) – MW Coal-fired generation capacity – MW Multi-fuel capacity – MW Total thermal generation capacity – MW Pumped storage capacity (GB) – MW Conventional hydro capacity (GB) – MW Onshore wind capacity (GB) – MW Onshore wind capacity (NI) – MW Onshore wind capacity (ROI) – MW Offshore wind capacity (GB) – MW Biomass capacity (GB) – MW 4,013 1,292 1,995 34 7,334 300 1,150 900 122 456 344 37 Total renewable generation capacity (inc. pumped storage) – MW 3,309 3,961 1,292 1,995 34 7,282 300 1,150 900 88 456 344 37 3,275 Total electricity generation capacity (GB and Ire) – MW Renewable capacity qualifying for ROCs – MW 10,643 10,557 c1,850 c1,800 Generation output – GWh Gas- and oil-fired (inc. CHP) output (GB) – GWh Gas- and oil-fired output (Ire) – GWh Coal-fired (inc. biomass co-firing) output – GWh Total thermal generation – GWh Pumped storage output – GWh Conventional hydro output – GWh Onshore wind output GB – GWh Onshore wind output NI – GWh Onshore wind output ROI – GWh Offshore wind output – GWh Biomass output GB – GWh Total renewable generation (inc. pumped storage) – GWh 14,977 2,463 901 18,341 233 3,101 1,895 251 1,211 1,172 92 7,955 10,160 1,780 6,141 18,081 252 4,074 2,439 235 1,308 1,312 75 9,695 Total Generation output all plant – GWh 26,296 27,776 Notes: 1 Capacity is wholly-owned and share of joint ventures. 2 Output is electricity from power stations in which SSE has an ownership interest (output based on SSE’s contractual share). 3 Capacity includes 1,180MW at Peterhead (while TEC is 400MW and is due to reduce to be zero from 1 April 2018). 4 Keadby TEC increased by 20MW to 755MW and Medway TEC increased by 35MW to 735MW from 1 April 2016. Wind output excludes 309GWh of constrained off generation in 2016/17 and 387GWh in 2015/16. 5 Onshore wind capacity and output at March 2017 excludes 175MW related to the Clyde disposal in March 2016. 6 Waste to Energy GWh not included above as contracted to third party. 7 Slough Heat & Power Biomass Plant’s financial results are reported within SSE Enterprise. Capacity and output included above. – £m Gas Production Gas Production Adjusted operating profit Gas Production Reported operating profit/(loss) – £m Gas Production – M therms Gas Production – Mboe Liquids Production – Mboe Gas Production capital investment – £m Total net proven and probable reserves (2P) – bn therms Total net proven and probable reserves (2P) – Mboe Gas Storage Gas Storage Adjusted operating (loss)/profit Gas Storage Reported operating profit/(loss) – £m Gas Storage customer nominations met – % Gas Storage capital investment – £m – £m 42 SSE plc Annual Report 2017 26.4 (201.1) 618 10.21 1.05 72.9 2.5 43 (13.0) (36.8) 100 0.2 2.2 (159.6) 403 6.55 0.13 56.1 3.6 59 4.0 (146.9) 100 14.0 Building new renewable energy assets SSE’s total wind capacity in operation is 1.8GW which, alongside our extensive hydro assets, makes us one of the largest generators of renewable energy in the UK. We’ve outlined further investment plans and expect to add over 500MW of onshore wind in 2017/18 with the 225MW Stronelairg wind farm to follow in addition to that. We will also continue to make significant progress with the Beatrice offshore wind farm, in which SSE has a 40% stake and a capacity share of 235MW. Beyond this we have the capability and track record to take advantage of emerging opportunities including interests in two further offshore wind joint ventures. Key questions and answers about SSE’s Wholesale business What is the role of the Wholesale business within SSE’s strategic framework? Wholesale makes a significant contribution to overall Group operating profit. It is a business which is impacted by many different changing external factors, from commodity prices, exchange rates, the shift to a low-carbon economy to regulatory and political change. The business has a diverse asset portfolio and investment opportunities. This means that whilst overall there was lower output from renewable sources of energy in 2016/17, due to the weather, and gas storage remains a very challenged business, there was improved financial performance from thermal generation and Energy Portfolio Management. There is also a significant investment programme continuing in a range of technologies including offshore wind, onshore wind and multi-fuel. The energy market is changing – has the Wholesale businesses strategy adapted? Yes. Change is a fact of life for this business and we must embrace it. One of the starkest changes is how lower carbon forms of generation are displacing coal and the scale of the cost reductions in some low carbon technologies is notable. As a business we continue to adapt, review and shape our portfolio of assets, contractual positions and investments in the context of an uncertain market. In doing so diversity and flexibility is important, particularly given the volatility in the electricity market. This business works to ensure it has the options it needs to adapt to changing market conditions and to act as opportunities emerge. In offshore wind or new gas-fired generation investment, for example, SSE has good options for the future. We also have a portfolio of gas production assets including the Greater Laggan area assets acquired in 2015, which now produce significant volumes and contribute to the profitability of the business and will do so for years to come. Renewable energy has been core to SSE’s investment pipeline, but with no available subsidy for new onshore wind in the UK what is the outlook for your generation capital expenditure? Looking ahead we retain a number of options in on- and offshore wind. The Beatrice offshore wind project, which we own 40% of, is one of the largest infrastructure projects ever seen in Scotland. While it remains a complex project to deliver, it is on course to be operational in 2019. Alongside this we have interests in offshore wind projects at Dogger Bank and Seagreen which we are hopeful can progress towards bidding for support contracts. In onshore wind we have sites in construction, including Stronelairg wind farm in Scotland. The future regulatory and policy framework is developing and we will continue to adapt to it, however, we think renewables in the UK has a bright future and, as the sector grows, it brings major industrial and supply chain benefits too. In short, we have plenty of options for the future but, as always with capital investment decisions, will apply our disciplined approach. The decline in coal-fired generation is a major trend across the sector, so what are the implications for your portfolio of assets and investments? SSE operates a balanced portfolio of energy generation assets. This includes the coal-fired power station at Fiddler’s Ferry in Cheshire, hydro, on and offshore wind, and gas generation as well as multi-fuel. Coal output has significantly declined but the UK Government’s commitment to phasing out coal by 2025 means it still has a role to play. Operating the electricity system is an immensely complex task, and over the next few years there will still be points at which coal-fired power stations will be needed to keep it stable and secure for the customers who depend on it. The acquisition of gas production assets in the Greater Laggan area completed in 2015 and has already been subject to impairment charges. Is SSE still positive about these assets? Yes. There has been a significant rise in SSE’s gas production this year primarily due to the ramp up of output from the newly commissioned fields in the Greater Laggan Area (GLA), partially offset by the natural decline in output from the more mature fields in SSE’s gas production portfolio. GLA started in 2016 with production rates peaking at up to 90,000 boe a day. Assets of this type are subject to assessments at least annually by independent reserves auditors who found that the GLA’s Proven plus Probable (2P) reserves are estimated to have reduced, resulting in an exceptional impairment of £180.5m at the 2016/17 year end. While this is clearly disappointing, movement in the technical assessment of 2P reserves is a well-known occurrence, particularly for new fields. This decrease reflects current best, but early stage, understanding of the fields, it now appears there is greater compartmentalisation of gas than expected, which could require some further capital investment to extract. Consequently, this also means the level of Contingent Reserves (2C) has increased. Overall, these gas production assets are long-term assets and are expected to make an important contribution to EBITDA with SSE’s average annual volumes of gas and liquids produced expected to average around 500 million therms of gas per year in the three years to March 2020. What are the Wholesale businesses principal strategic priorities for the year ahead? Our priorities are to operate our assets safely, reliably and efficiently; deliver new assets in construction, as well as develop new opportunities to build, own and operate assets in the future; ensure efficient delivery of gas from the offshore fields in which SSE has a shared ownership; and secure value, where appropriate, through the risk-managed trading of energy- related commodities. For the full analysis of SSE’s Wholesale business in 2016/17, see the Full-Year Results Statement (2016/17) available on sse.com. 43 3.1. Strategic Report2.Strategic Report – Our financial and business performance Networks – delivering energy SSE is the only energy company in the UK to be involved in electricity transmission, electricity distribution and gas distribution. Its five economically- regulated energy network companies consist of a 100% ownership of Scottish Hydro Electric Transmission (SHE Transmission), Scottish Hydro Electric Power Distribution (SHEPD) and Southern Electric Power Distribution (SEPD) and, since 26 October 2016, a 33.3% stake in both Scotland Gas Networks and Southern Gas Networks (SGN). Networks Adjusted operating profit – £m Total Networks RAV – £bn 936.5 +1.1% 7.68 -3.5% Adjusted operating profit for this business covers activity across all the electricity and gas networks SSE has interests in. SSE is on target to take this Regulated Asset Value of its networks business to almost £9bn by 2020. Adjusted Electricity Distribution networks capital expenditure – £m Transmission networks capital expenditure – £m 284.7 +10.2% 505.0 -11.9% SSE owns and invests in two electricity distribution networks companies: Scottish Hydro Electric Power Distribution and Southern Electric Power Distribution. SSE owns and invests in two electricity distribution networks companies: Scottish Hydro Electric Power Distribution and Southern Electric Power Distribution. Electricity Distribution operating profit – £m 433.4 +16.9% Scottish and Southern Electricity Networks (SSEN), operating as Scottish Hydro Electric Power Distribution (SHEPD) and Southern Electric Power Distribution (SEPD) under licence, is responsible for maintaining the electricity distribution networks supplying over 3.7 million homes and businesses across central southern England and north of the central belt of Scotland, the Mull of Kintyre and the Scottish islands. Transmission operating profit – £m 263.7 -8.2% Scottish and Southern Electricity Networks (SSEN), operating as Scottish Hydro Electric Transmission plc under licence, is responsible for maintaining and investing in the electricity transmission network in the north of Scotland. Networks bring balance to SSE and the relative stability of the returns underpins the Group’s financial performance. Through investment in modern energy networks and targeted performance against the incentive-based regulatory framework, we provide a safe, reliable and efficient service that our customers can rely on. We’ll continue to adapt to a changing role for network operators, increasing our RAV through investment delivered in the most disciplined way possible. Colin Nicol Managing Director, Networks 44 SSE plc Annual Report 2017 £1,118m The agreed allowance, in 2013/14 prices, for SSEN’s flagship Caithness-Moray transmission link. The largest single investment undertaken by the SSE group to date. 3.7m homes and businesses Scottish and Southern Electricity Networks is responsible for maintaining the electricity distribution networks supplying homes and businesses across central southern England and north of the central belt in Scotland. 45 1. Strategic Report2.3.Strategic Report – Our financial and business performance Networks – delivering energy continued Networks key performance indicators Electricity Transmission Transmission operating profit – £m Regulated Asset Value (RAV) – £m Capital expenditure – £m Electricity Distribution Electricity Distribution operating profit – £m Regulated Asset Value (RAV) – £m Adjusted capital expenditure Electricity distributed – TWh Customer minutes lost (SHEPD) – average per customer Customer minutes lost (SEPD) – average per customer Customer interruptions (SHEPD) – per 100 customers Customer interruptions (SEPD) – per 100 customers – £m Scotia Gas Networks SSE’s 50% share reducing to 33% from 26 Oct 2016 SGN Adjusted operating profit (SSE’s share) SGN Reported operating profit (SSE’s share) – £m Regulated Asset Value – £m Uncontrolled gas escapes attended within one hour – % SGN gas mains replaced – km – £m 46 SSE plc Annual Report 2017 March 17 March 16 263.7 2,685 505.0 433.4 3,246 284.7 39.3 60 43 68 48 239.4 151.7 1,748 98.7 457 287.2 2,287 573.4 370.7 3,157 258.3 39.5 55 41 66 47 268.7 175.3 2,513 98.5 960 A Distribution business looking to the future Our Distribution business is focused on the future. The role of the network is changing and will be more active and flexible in a decarbonised energy system. In preparing for this change we have to ensure customer’s interests are considered and the network remains reliable and cost-effective. We’ve been involved in some pioneering innovation projects, working with Ofgem and industry partners. For example, the My Electric Avenue project considered how to prepare the network for the possible increase in electric vehicles. The findings are shared across the sector to ensure a cost-effective transition if homes and businesses want to install charging points. For more visit http://myelectricavenue.info Key questions and answers about SSE’s Networks business How would describe 2016/17 for SSE’s Networks business? It was a year of important progress at Scottish and Southern Electricity Networks (SSEN). We have moved forward in areas such as innovation, investment and customer service, as well as continuing to provide a safe and reliable electricity supply to homes and businesses across our networks. We are also undertaking a business-wide change programme to improve the efficiency and capability of our business and set ourselves up well for a successful future. Networks remains central to the fulfilment of SSE’s strategy and underpins SSE’s commitment to annual dividend growth through stable returns and index-linked RAV, which bring balance and investment options to SSE. Excellence in customer and stakeholder engagement is an increasingly important component of the RIIO regulatory framework, so, is SSEN expanding its capabilities in this area? Yes. SSEN is a customer-focused business. We transmit and distribute electricity to over 3.7 million customers and have to be focused on their needs first and foremost. Ofgem also recognise this and the RIIO framework was created to make sure the needs of the customer is considered and our financial incentives or penalties are judged against that. This includes power restoration times, the support for vulnerable customers, efficient connection management and stakeholder involvement in decision making. We’ve significantly invested in this area to ensure we continue to deliver to meet the needs of our customers. In September we rebranded our business to Scottish and Southern Electricity Networks so the business more accurately reflects what we do and where we do it. We have launched several initiatives that have increased our stakeholders’ voice in our business decisions, including stakeholder feedback on the visual impact of our transmission assets in Scotland, which presents an opportunity to look again at the visual impact of our existing infrastructure in Scotland’s National Parks and National Scenic Areas; similar to a scheme for our distribution networks which invites stakeholders to nominate areas for undergrounding of 90km of distribution power lines in National Parks, Areas of Natural Beauty and National Scenic Areas; and the launch of our independent Stakeholder Advisory Panel. How is SSEN preparing for a changing energy market? There is no doubt that technology improvements, decarbonisation of electricity generation and increasing levels of demand-side response and energy storage will further transform the way network operators do business, with distribution companies in particular required to adapt to a new active and flexible distribution system operator role. From SSEN’s perspective, we are well positioned to maximise opportunities from this change, having led the way in innovations such as Active Network Management on Orkney, considering the impact of electric vehicles through our Electric Avenue initiative and the six-year long Thames Valley Vision project. We’ll continue to engage constructively with policy-makers, the regulator and industry to ensure that a phased transition to a flexible role is delivered in the best interests of customers. How is the Caithness-Moray transmission link, SSE’s largest ever construction project, progressing and what’s next for capital expenditure in Transmission? Good progress has been made. The sheer scale of the project is remarkable and with the manufacture of the subsea cable now complete, we expect its installation on the Moray Firth seabed later this year. Progress remains on track with completion expected by the end of 2018. We’ve developed significant construction capabilities and see major opportunities from the low-carbon transition. Our capabilities and opportunities arising mean we expect the RAV of this business to reach around £3bn by 2018. We are now four years into the Transmission Price Control, so is SSE’s Networks business now thinking about the future? Absolutely. The mid-point of Transmission’s price control means that thoughts now turn to the arrangements after 2021. We’re starting to consider our business plan and how we can meet the needs of customers in the north of Scotland in the next decade. We’ll be working with stakeholders to help shape our thinking and ensure that our plan is as robust and customer focused as possible. What is SSEN’s principal priority for the year ahead? SSEN’s core priority is always to provide a safe and reliable supply of electricity to the communities we serve from the Scottish islands to the Isle of Wight. We never lose sight of our role to provide a reliable energy network those homes and businesses can rely on. Our investment plans will also continue and our committed plans mean that the total RAV of SSE’s network businesses is well placed to reach almost £9bn by 2020. Has demand for renewable energy connections in Scotland continued and what is the outlook? In advance of the closure of the Renewables Obligations Scheme, there has been an increased demand for SSEN to provide connections to its transmission network for renewable energy developers. In fact it’s been a record year. Including that connected at distribution level, SSEN connected over 500MW of renewable electricity to its networks in 2016/17, the highest combined capacity to connect to the north of Scotland network in a single year since electricity privatisation. This continues the rapid growth of renewable energy in the north of Scotland, and low-carbon sources now make up 4.5GW of generation capacity in our licence area. Alongside this increase in connections SSEN was able to maintain 99.9% network reliability, giving customers a reliable and safe supply of electricity. Going forward we expect a significant number of new renewable energy projects to connect to the transmission network throughout the remainder of the transmission price control to March 2021, subject to developers reaching financial close. For the full analysis of SSE’s Networks business in 2016/17, see the Full-Year Results Statement (2016/17) available on sse.com. 47 3.1. Strategic Report2.Strategic Report – Our financial and business performance Retail – supplying energy SSE is one of the largest energy suppliers in the competitive markets in Great Britain and Ireland. It also provides other related products and services, including telephone, broadband and boiler care, to homes and businesses. Retail Adjusted operating profit* – £m Retail Reported operating profit – £m 422.3 -7.2% 309.6 -29.2% SSE is involved in the supply of electricity, gas and other energy-related services to household customers and, through its Enterprise business, to industrial and commercial customers. SSE is involved in the supply of electricity, gas and other energy-related services to household customers and, through its Enterprise business, to industrial and commercial customers. 500,000 smart meters installed SSE’s is focused on delivering its obligation to install smart meters in a way that is cost-effective and customer-centric, to maximise the net benefits for customers. Energy customer accounts – m SSE Enterprise operating profit – £m 8.0 -2.6% 16.7 -59.2% SSE supplies electricity and gas to household and business customers in the energy markets in the UK and Ireland. It is the second largest supplier in both markets. Enterprise brings together key SSE services for industrial, commercial and public sector customers. 0.47m Home Services customer accounts (GB) All-Island energy market customers (Ire) – m Energy-related Services Adjusted operating profit – £m 0.79 0.0% 16.1 +4.5% SSE Airtricity is the second largest provider of energy and related services in Ireland (ROI) and Northern Ireland (NI), and the only energy retailer to operate in all of the competitive gas and electricity markets across the island. Energy-related services covers boiler cover, electrical wiring, broadband and telephone. The Retail business operates in an intensely competitive market, and one that is subject to regulatory obligations and political interest. This is a challenging context, yet our focus is delivering for our customers and ensuring they are at the heart of everything we do. This means offering the products, services and value that they are seeking, diversifying our business to provide balance and at all times focusing on what we do well: supplying energy efficiently and providing customers with excellent customer service. Will Morris Managing Director, Retail 48 SSE plc Annual Report 2017 49 1. Strategic Report2.3.Strategic Report – Our financial and business performance Retail – supplying energy continued Retail (including Enterprise) key performance indicators – £m Energy Supply Energy Supply Adjusted operating profit Energy Supply Reported operating profit – £m Adjusted capital expenditure (Energy Supply and Energy-related Services) Electricity customer accounts (GB domestic) – m Gas customer accounts (GB domestic) – m Energy customers (GB business sites) – m All-Island energy market customers (Ire) – m Total energy customer accounts (GB, Ire) – m – £m Electricity supplied household average (GB) – kWh Gas supplied household average (GB) – th Household/small business aged debt (GB, Ireland) – £m Bad debt expense (GB, Ireland) – £m Customer complaints to third parties (GB) 1 1 Ombudsman: Energy Services and Citizens Advice. Energy-related Services Energy-related Services Adjusted operating profit Energy-related Services Reported operating profit – £m Home Services customer accounts (GB) – m Supply customers’ bills based on actual reading – % Smart meters installed – £m Enterprise Enterprise operating profit – £m Capital expenditure – £m SSE Heat network customer accounts 50 SSE plc Annual Report 2017 March 17 March 16 389.5 313.2 184.3 4.06 2.70 0.45 0.79 8.00 3,793 440 80.2 47.9 1,322 398.9 398.9 169.0 4.16 2.79 0.47 0.79 8.21 3,763 426 103.2 44.0 1,416 15.4 (2.4) 0.40 95.1 Over 500,000 Over 180,000 16.1 (20.3) 0.47 95.5 16.7 58.7 Over 6,500 40.9 48.5 Over 5,000 A smarter energy future for our customers SSE has continued to make significant progress in fulfilling its regulatory obligation to offer every customer a smart meter. We’ve installed over 500,000 smart meters and, subject to the delivery timetable for the critical infrastructure, will ramp up our roll-out further still in 2017/18. Our focus will as always be on doing so in a cost-effective way that maximises the net benefits for customers. Alongside investments in our digital, customer-facing services, in time smart meters can lead the way to a smarter energy market in which customers can better engage with their usage and products. This transformation presents both risks and opportunities for established businesses like ours and we are focused on ensuring we not only deliver on our obligations but emerge well-placed to succeed in the smart- enabled market of the future. Key questions and answers about SSE’s Retail business drive further engagement and reduce costs. We are digitalising our business to meet the changing expectations that people have about how they want to engage with products such as energy and essential services. Importantly we also have to get the basics right, listening to, and engaging with, our customers; so providing excellent customer service is critical. Our track record in this, notably complaint handling, remains strong and we want to maintain our leadership position in this area. What are the growth areas for SSE’s Retail business? We see two prominent areas for growth. Firstly, we want to expand our I&C customer base and build upon the progress we’ve made in recent years. Secondly, our business is increasingly focused on diversifying into new markets; that’s why we’re particularly pleased that our Home Services business now has a national presence, and we’ve now grown to nearly 500k non-energy customers across broadband, telephone and home services. We are targeting further growth in this area as we continue with our strategy of becoming more than a retailer of gas and electricity. The price of energy has again risen up the political agenda, with potential government interventions, how is the business managing this risk? Energy is an essential service and customers, and the affordability of energy, are at the heart of every decision we make. We regret having to take the difficult decision to increase electricity tariffs, but without this increase SSE would have been supplying electricity at a financial loss. At the same time, we also have outlined major plans to engage customers with the products, services and rewards we offer, we continue to take costs out of the business and we work closely with the regulator and our stakeholders on issues affecting customers. Governments should be mindful of the progress the market has made in any interventions they make. What does SSE’s Retail business do to help vulnerable customers? As an essential service provider, looking after our vulnerable customers is central to how we operate. That’s why we became the first energy supplier in Great Britain to commit publically to achieving the British Standard for Inclusive Service Provision. This represents the gold standard in recognising and catering for vulnerability. In addition to this, we have a wide range of practical services to help people who are struggling with their energy bills. The key point for any customer who is vulnerable at any time is: if you have any worries or concerns about paying for your energy, get in touch with us. There are many ways in which we can help. One of the initiatives we are particularly proud of is our advisers referring customers for Benefit Entitlements Checks. The outcome of these checks can transform people’s lives for the better. What are Retail’s principal strategic priorities for the year ahead? We are focused on doing the right things to give customers what they are looking for in terms of products, service and value. The net loss of customer accounts in 2016/17 was lower than in previous years, and our service, programmes of engagement, products and investment in digitalising front- end, customer-facing systems will continue. We also need to fulfil our existing regulatory obligations and work with the regulator on the CMA remedies and other reforms from government to ensure the competitive market works in a way that benefits all customers and, critically, make sure we are well positioned to compete successfully for customers in the future market. For the full analysis of SSE’s Retail business in 2016/17, see the Full-Year Results Statement (2016/17) available on sse.com. How would you describe the performance of the Retail business in 2016/17? We have to acknowledge that operating profit fell and that we experienced a decline in household energy customer numbers. We are, however, pleased with the positive aspects of performance this year. We have continued to expand our customer propositions, whilst maintaining our good record in customer service. The net loss of customer accounts was the lowest we’ve seen for a number of years and we showed we can compete successfully for new customers, while also working hard to retain customers in greater numbers. Good progress is being made in our investments in digital, customer-facing systems and in diversifying our products and services. We took the difficult decision to increase standard electricity prices for household customers in GB from April 2017, although were able to hold gas prices. The business faces two prevailing headwinds: regulatory and political scrutiny of energy costs, to which we need to respond as constructively as we can, and the increasingly competitive market. Customer account numbers have fallen, so how are you responding to that? The energy retail market is the most competitive it has ever been and this year switching levels were at their highest rate since Energy UK began its records. There are over 50 suppliers and a range of products and services are available to customers. We don’t have a specific target for customer numbers – the market is too complex and fast moving to allow for that. Nevertheless, winning and retaining customers in a fiercely competitive market is central to this business. That’s why our focus is on ensuring we are doing the right things to treat customers fairly and to give them what they are looking for in products, service and value. Consumer habits and expectations are changing and competition is fierce. How is the Retail business adapting to this? It’s true that the market is changing. Smart metering, faster switching and the increasing connectivity of customers’ homes will have a transformative effect. This also presents us with an opportunity to enhance service levels, 51 3.1. Strategic Report2.Strategic Report – Our financial and business performance Enterprise – providing energy services 1. Strategic Report 2. 3. I joined SSE as Managing Director of this business in January 2017. Already I can see that we’re in a key phase of our development as part of the SSE Group. There are significant opportunities for us in telecoms, rail, utilities and contracting and the team I lead is working extremely hard to capitalise on these. I believe 2017/18 will be a pivotal year to position us as an effective engine of growth in new competitive markets for SSE. Neil Kirkby Managing Director, Enterprise What’s the role of the Enterprise business within SSE? As a group of businesses we provide energy and related services to meet the needs of industrial, commercial and public sector customers across the UK. Our businesses comprise Telecoms, Utilities, Rail and Contracting. This gives us diversity in competitive markets and a broad client base with a collective focus on delivering efficient, reliable and bespoke solutions to meet individual client needs. considerable focus on adopting the best structure to win and deliver work. Therefore I have created a leadership team focused on leaner operations and strategic development and a business transformation programme is underway. Embedding a culture of efficiency will be essential for critical growth in the longer term. We also need to optimise our customer relationship management and deliver a first class service whilst targeting markets where we see opportunities for growth. You joined in January 2017, what are your initial plans for the business? I joined SSE with a clear remit to develop the business to be as efficient as possible and to identify and exploit opportunities for growth. We need to evolve the Enterprise proposition to deliver larger scale projects complementing business as usual and ensuring a positive contribution to the SSE Group. To achieve this there needs to be What does the future look like for the Enterprise business? It promises to be an exciting time for this business. While the financial performance in the last year reflects the challenging markets SSE Enterprise operates in, the business has established strong foundations. There are some compelling new opportunities in the pipeline for each of the Enterprise businesses and we are well-placed to tap into key long-term economic, infrastructure and technological trends. Advances such as the electrification of transport, the move towards distributed generation and the roll out of 5G technology, as well as high speed rail, are all crucial development areas as we look to the future. How will innovation play into the SSE Enterprise growth story? The most successful players in our markets are those who are thinking differently in the way that they operate as a business, how they deliver their services, and how they attract new customers. We have set a significant challenge for Enterprise in terms of improving efficiency and winning new business this year. In order to deliver, we must start to change the way we do things. We have a superb talent base here in Enterprise and I hope that by putting innovation at our core, we will create a leaner, more efficient, and forward looking Enterprise capable of delivering real value back to the wider SSE Group. Innovative District Heating to improve Glasgow’s housing stock SSE Heat Networks is a division of SSE Enterprise, specialising in the design, construction, maintenance and operation of heat infrastructure for homes and businesses. Cube Housing Association partnered with SSE Heat Networks to install the new district heating system at the Wyndford estate in Glasgow with the aim to improve comfort levels and the energy efficiency of almost 1,800 homes; mainly social housing with a small number of privately owned houses. The system uses hot water to heat multiple homes from a central boiler rather than each individual home producing its own heating requirements. It is greener, producing considerably less carbon emissions than more conventional forms of heat, and it is also a more energy efficient way to keep homes warm. This ground-breaking project has significantly improved quality of life for residents at the estate and has been recommended by the Scottish Government as the preferred method for improving the quality of energy provision for high-rise social housing in a sustainable and environmentally friendly way. 52 SSE plc Annual Report 2017 Directors’ Report Chairman’s introduction Board of Directors Leadership Effectiveness Nomination Committee Report Accountability Audit Committee Report Stakeholder engagement and responsible stewardship Safety, Health and Environment Advisory Committee Report Remuneration Other statutory information 54 56 58 64 67 70 70 76 78 80 98 Statement of Directors’ responsibilities 100 53 3.2. Directors’ Report1.Chairman’s introduction The Board is committed to ensuring good corporate governance and effective Board practice in support of SSE’s sustainable success over the long term 54 SSE plc Annual Report 2017 54 SSE plc Annual Report 2017 The UK Corporate Governance Code Through the Listing Rules, the UK Corporate Governance Code (the ‘Code’) underpins the overarching corporate governance framework for premium listed companies within the UK. It contains principles and provisions which set out standards of good practice in relation to Board leadership, effectiveness, accountability, relations with stakeholders and remuneration and this Directors’ Report is structured accordingly. The Code is published by the FRC and is available to view on their website. Each year, through this Directors' Report, we describe how we have applied the Main Principles of the Code and in line with its ‘comply or explain’ model detail any departures from its specific provisions. A departure is only ever made when it is deemed appropriate to do so, and good governance can be achieved by other means. For 2016/17 we are again reporting against the 2014 version of the Code and confirm compliance with its provisions with the exception of C.3.7 – that the external audit contract be put out to tender at least every ten years. This remains unchanged from last year and a full explanation of our reasons for non-compliance, including details of the timeline to address the position are set out in the Audit Committee Report on page 74. Directors’ Report – Corporate governanceDear Shareholder, As outlined in my earlier letter on pages 6 and 7 and as evidenced throughout the Strategic Report, the Board have considered a wide range of matters throughout 2016/17. These have covered current investments in capital projects, to support the maintenance of a balanced portfolio of assets, through to reviewing the risks associated with operating such a diverse range of businesses. We have also considered our people and stakeholders, which has been both explicit – through a review of cultural matters, talent and succession plans; and implicit – when assessing the impact of all our decisions on our customers, society at large and in delivering value for our shareholders. All of these deliberations have been against a backdrop of change, as we acknowledge the existence of some political uncertainty, the move towards a low-carbon future and the impact of changing energy markets on our businesses and customers. In line with our stewardship position, we continually monitor and reflect upon all of these external developments when discharging our role as a Board. Corporate governance The Directors’ Report which follows explains the different elements of our Corporate Governance Framework, which has been designed to ensure that as a Board we fulfil our responsibilities effectively and create value for the longer term. This is achieved by ensuring that we have appropriate oversight of all matters affecting the Group and that all risks and opportunities are identified and considered by the correct individuals, for example by one of our supporting Committees, the Executive Committee or management teams below. The dedicated work of the Board Committees is set out in each of their respective reports which follow. The relationships between the Board and its sub-Committees, and the Executive team and the business, are central to the Group’s effective operation, and we continually nurture these relationships to ensure that all of our decisions are informed and transparent. I believe this is an area in which we have seen continued development throughout the year, as demonstrated through inviting members of senior management to attend and present at Board meetings, and through specific engagements such as site visits, technical teach-ins and the strategy development process. Risk Over the last year, focus has again been given to the iterative development of SSE’s Risk Management Framework, and the wider review of the Group’s system of internal Board members and meetings Member Position Richard Gillingwater Chairman Gregor Alexander Finance Director Jeremy Beeton Independent non-Executive Director Katie Bickerstaffe Independent non-Executive Director Sue Bruce Independent non-Executive Director Crawford Gillies Senior Independent Director (SID) Peter Lynas Helen Mahy Independent non-Executive Director Independent non-Executive Director Alistair Phillips-Davies Chief Executive Member since Attended/ scheduled 2007 2002 2011 2011 2013 2015 2014 2016 2002 7/7 7/7 7/7 7/7 7/7 7/7 7/7 7/7 7/7 control. Further information on our work and responsibilities in these areas can be found on pages 24 to 27 in the Strategic Report and within our section on accountability on pages 70 to 75, which includes a description of the work of the Audit Committee. Talent and succession As outlined in the Nomination Committee Report there have been no changes to the Board this year, as we have continued to benefit from our experienced and diverse membership. Increased focus has however been provided to reviewing the internal talent pipeline, including the work which is being carried out to support inclusion and diversity throughout the Group. During the year I had the opportunity to attend a number of employee events, including one which was held at our new visitor centre in Pitlochry, and these allowed me to meet and understand the issues which are important to our workforce. We have a highly skilled and committed group of people who underpin the operations and future success of the Group and as a Board we have a responsibility to ensure the appropriate opportunities, development and support are available to them. Stakeholder engagement Energy is an essential requirement of everyday life and SSE’s role in its generation, transmission, distribution, and supply means that as a Company, we must interact with, and acknowledge the potential impact of our operations upon a wide range of stakeholders. In our duty as a responsible Company each matter considered by the Board therefore has to be in the context of relevant economic, social and environmental factors, and in order for the Board to understand what these are, constructive engagement is required. The ways in which this is achieved is explained on pages 76 and 77 and includes the use of dedicated advisory panels and customer forums and also meetings with shareholders and the relevant regulatory bodies. Corporate culture Corporate culture within SSE is an area which has received our specific focus this year, although the behavioural aspects and impacts of agenda items have long been an integral part of the Board’s discussion. Our work in this area has included the launch of a new guide to ethical business conduct for SSE employees, as well as updating the Matters Reserved for the Board and the terms of reference of the Board’s Committees, to explicitly consider the impact of decisions on culture and to reinforce our ultimate responsibility to set the tone for the Group. We have agreed that our initial work in this area has formed a platform for further initiatives in 2017/18, with culture being an area which we will continue to monitor and assess, in recognition of its fundamental role in the successful and responsible delivery of our strategic priorities, our values and our financial objectives. I hope you find the report that follows an interesting explanation of our work throughout the year and supportive of our continued commitment to deliver transparent and sustainable value to our shareholders. Richard Gillingwater CBE Chairman 16 May 2017 55 3.2. Directors’ Report1.Board of Directors Career, skills and competencies Richard Gillingwater CBE Chairman Alistair Phillips-Davies Chief Executive Gregor Alexander Finance Director Richard has varied experience with a wide range of organisations giving him an excellent understanding of the policy and regulatory framework within which SSE operates, as well as broad financial skills and City experience. For over 20 years he worked in corporate finance and investment banking, latterly as Chairman of European Investment Banking at CSFB. He served as Chief Executive of the Shareholder Executive and was Dean of Cass Business School, London. He has extensive board experience and was previously Senior Independent Director of Hiscox Ltd and a non- Executive Director of Wm Morrison Supermarkets plc. Alistair is a Chartered Accountant and this together with his operational experience and leadership skills means he brings significant knowledge and commerciality to the Board. Alistair has 20 years’ service with the Group, where he has held leadership roles in the Wholesale, Retail and Enterprise areas, as well as Corporate Finance. In addition, he has led many of the Group’s most significant transactions since the merger in 1998 when SSE plc was formed. Prior to 1997 he worked for HSBC and National Westminster Bank in corporate finance and business development roles in London and New York. Gregor is a Chartered Accountant and has over 25 years’ service with the Group, joining Scottish Hydro-Electric plc in 1990. He therefore has the benefit of experiencing much change in the energy sector and his detailed understanding of the different aspects of the SSE Group and its operating environment is invaluable. He was SSE’s Group Treasurer and Tax Manager before being appointed as Finance Director in 2002. The responsibilities of this role were first expanded in 2010. He has been instrumental in many of SSE’s major investments including SSE’s investment in SGN. Prior to 1990, Gregor worked for Arthur Andersen. Crawford Gillies Senior Independent Director Crawford’s varied career means he brings extensive commercial and governance knowledge to the Board including particular expertise in matters of finance and risk management. Crawford has over three decades of business experience in a variety of organisations and extensive public company board experience, making him an excellent appointment as Senior Independent Director. Crawford’s business experience includes working with major companies in the UK, Europe and North America across multiple sectors. He has also held public sector posts in the UK, including Chairman of Scottish Enterprise for 7 years until 2015. Date of appointment Non-Executive Director since May 2007. Chairman since July 2015. Executive Director since January 2002 and Chief Executive from July 2013. Finance Director since October 2002. Non-Executive Director since August 2015. Committee membership Key current appointments Nomination Committee Audit Committee Safety, Health and Environment Advisory Committee Remuneration Committee Committee Chair Katie Bickerstaffe N/A N/A Chairman of Henderson Group plc. Member of the Accenture Global Energy Board. Non-Executive Director of Stagecoach Group plc. Non-Executive Director of Barclays plc. Senior Independent Director of Helical Bar plc. Vice President of Eurelectric. Chairman of Scotia Gas Networks Ltd. Pro-Chancellor of Open University. Non-Executive Director of The Edrington Group Limited. Crawford Gillies Jeremy Beeton Alistair Phillips-Davies Dame Sue Bruce 56 SSE plc Annual Report 2017 56 SSE plc Annual Report 2017 Directors’ Report – Corporate governance Jeremy Beeton CB Non-Executive Director Katie Bickerstaffe Non-Executive Director Dame Sue Bruce DBE Non-Executive Director Peter Lynas Non-Executive Director Helen Mahy CBE Non-Executive Director Jeremy is a Civil Engineer and brings extensive knowledge of project management and related areas including safety, complex project structures and contractual negotiations. Jeremy’s career comprises over 40 years in managing large, multi-site projects. He has worked with a wide range of organisations including governments, and both private and public companies. Jeremy held various positions at Bechtel Ltd., Haden Maclellan Holdings PLC and Cleveland Bridge Engineering UK Middle East Ltd. He was the Director General of the UK Government Olympic Executive from 2007 to 2012. Katie has experience in a variety of roles in different customer-facing retailers and fast-changing markets and has an invaluable understanding of customers’ needs. This combined with her experience in HR, marketing and other business areas gives her a wide-range of skills relevant to SSE’s business. From 2008 to 2012, Katie expanded and consolidated her varied business experience while serving as Director of Marketing, People and Property (Dixons). In 2012 she was promoted to the role of Chief Executive, UK and Ireland Dixons Carphone plc and also joined the Group Board. Sue’s extensive career in the public sector enhances the diversity of the Board; she held a variety of roles in local government in a career which spanned 40 years. Her operational experience of leading organisations, with large numbers of employees, significant assets, construction projects and an important place in the community they serve, make her an excellent source of knowledge on these matters for the Board. She was Chief Executive at both East Dunbartonshire Council and Aberdeen City Council before taking up the role of Chief Executive at the City of Edinburgh Council. Peter has over 30 years of business experience spanning all areas of finance. He is a Fellow of the Chartered Association of Certified Accountants and brings up to date financial knowledge and experience to the Board as well as general business knowledge and board experience. In 1998 he was appointed Finance Director of Marconi Electronic Systems prior to the completion of the British Aerospace/Marconi merger and also has been Chairman of the trustee Board of a major pension scheme. He has been Group Finance Director of BAE Systems plc since 2011. Helen’s career, including relevant sector experience, puts her in the ideal position to understand the legal, risk, compliance, commercial and governance issues SSE faces. She has significant public company board experience in a number of sectors in the UK and abroad and brings a detailed knowledge of, and interest in, the areas of inclusion and diversity. She was Company Secretary and General Counsel for both Babcock International Group PLC and more recently National Grid plc. Helen was also a non- executive Director of Stagecoach Group plc. Non-Executive Director since July 2011. Non-Executive Director since July 2011. Non-Executive Director since September 2013. Non-Executive Director since July 2014. Non-Executive Director since March 2016. Chairman of Merseylink Ltd. Senior Independent Director of WYG plc. Non-Executive Director of John Laing Group plc. Non-Executive Director of OPG Power Ventures plc. Chief Executive, UK and Ireland Dixons Carphone plc. Chair of the Royal Scottish National Orchestra. Group Finance Director of BAE Systems plc. Chair of Young Scot. Electoral Commissioner, The Electoral Commission. Member of the BAE Systems Inc Board in the US. Gregor Alexander Peter Lynas Richard Gillingwater Chairman of The Renewables Infrastructure Group Limited. Non-Executive Director of Bonheur ASA. Non-Executive Director of MedicX Fund Limited. SVG Capital plc (until approximately 2017). Helen Mahy 5757 3.2. Directors’ Report1.3.2. Directors’ Report1. Leadership SSE’s Corporate Governance Framework The Board, Executive Committee and their respective sub-Committees, together with the relationships between them, make up SSE’s Corporate Governance Framework which is outlined in the diagram below. The Corporate Governance Framework is set by the Board and has been carefully designed to ensure that decision-making within SSE is transparent, well-informed and involves the people with the correct skills and experience. Central to this is a close working relationship between the Board and the senior management team, and a mutual respect for the knowledge held at each level. In recognition of the current pace of change within the energy sector, the Corporate Governance Framework is subject to periodic review to ensure that all matters relevant to the Group’s operations are able to be identified and receive adequate focus. Board role and relationships SSE has a responsibility to meet its objectives and operate sustainably for the benefit of all of its stakeholders, which includes upholding the commitments it has made to its shareholders and customers through its financial objective and core purpose. It is the role of the Board to ensure that these are achieved, and this is supported primarily through setting the Group’s longer term strategy, and providing the leadership and support necessary to ensure that it can be delivered responsibly within accepted levels of risk. Implementation and delivery of this strategy is managed through the careful delegation of authority in line with the Corporate Governance Framework, with oversight being retained through regular reporting, which includes an ongoing dialogue between the Board, the Executive Committee, their respective sub-Committees and other key individuals within the business. The individual and collective powers and duties of the Board of Directors in managing the Company are ultimately determined by a combination of legislation and the Company’s Articles of Association. As outlined above, in order to discharge its duties effectively the Board has the ability to delegate this authority further, which may include to any of its sub-Committees or the Executive Committee. There are however limits to this delegation as determined by a formal Schedule of Matters Reserved for the Board. SSE’s Corporate Governance Framework Board of Directors Responsible to shareholders for the effective leadership and long-term success of SSE, including its overall strategic direction, values and governance. y t i r o h t u a f o n o i t a g e l e D Matters reserved exclusively for Board consideration include: – Group strategy. – Annual budget. – Approval of interim and full year financial statements. – Interim dividend payments and recommendation of final dividend. – Significant changes in accounting policy and practice. – The Group’s corporate governance, risk management and system of internal control. – Changes in capital structure of the Group. – Board and Committee membership. – Succession planning and people strategy. – Major acquisitions, mergers, disposals and capital expenditure. – Approval of key policies. – Significant legal and regulatory matters. Nomination Committee Audit Committee Safety, Health and Environment Advisory Committee Remuneration Committee See pages 67 to 69. See pages 70 to 75. See pages 78 and 79. See pages 80 to 97. Group Executive Committee Responsible for implementing the strategy, values and governance set by the Board, whilst leading the day to day running and operations of SSE. Wholesale Management Committee Networks¹ Management Committee Retail Management Committee Enterprise Management Committee Group Capital Allocation Committee Group Large Capital Projects Committee Group Safety, Health and Environment Committee Group Governance Culture and Controls Committee 1 The Networks Management Committee has dual reporting lines and also reports into the SSEPD Board, which has oversight of the Networks business. 58 SSE plc Annual Report 2017 s g n i t e e m i f o s e t u n m d n a s e t a d p u c i f i c e p s f o n o i s i v o r p h g u o r h t k c a b t r o p e R Directors’ Report – Corporate governance These reserved matters generally involve decisions surrounding the governance, major policies, structure, direction and values of the Group. Both the Schedule of Matters Reserved for the Board and Articles of Association are available to view on the SSE website. The four Committees of the Board support it in its role by providing detailed focus to their specific areas. This support can involve assessing new developments or technical matters, and may be followed by a recommendation to the Board or taking a decision within the relevant delegated levels of authority. The remit and authority of each Committee is determined by its terms of reference; these are set by the Board, reviewed regularly and available in full on the SSE website. Further information on the work of each Committee can be found in the reports that follow. Committee membership is determined by the Board, on the recommendation of the Nomination Committee and in consultation with the relevant Committee Chairman. Prior to a recommendation being made, consideration is given to the role and subject matter of the Committee’s work, such that membership complements any technical expertise required. At meetings of the Board, the Committee Chairman is responsible for providing an update on key matters requiring Board consideration. The Executive Committee The membership of the Executive Committee comprises: the two Executive Directors; and the Managing Directors of Wholesale, Networks, and Retail – all of whom are persons discharging managerial responsibilities. The Company Secretary is Secretary to the Executive Committee, and the Managing Director, Corporate Affairs, is invited to attend meetings. The Executive Committee is collectively responsible for implementing Group strategy through the operational management of each of SSE’s businesses, and meets monthly in line with an agreed meeting calendar. During 2016/17 the Executive Committee reviewed and refreshed its reporting sub-Committee structure to further support effective and efficient decision-making. Board composition, individual roles and responsibilities The composition of the Board has remained unchanged during the reporting year and is set out in the table on page 55. Each appointment to the Board is made on the recommendation of the Nomination Committee, and is the result of a combination of comprehensive succession planning and formal and rigorous Board composition and roles Position Individuals Role and responsibilities Chairman 1,2 Richard Gillingwater r i a h C t n e d n e p e d n I e v i t u c e x E Senior Independent Director 1,3 Non- Executive Directors 1 Crawford Gillies Jeremy Beeton Katie Bickerstaffe Sue Bruce Peter Lynas Helen Mahy Chief Executive 2 Alistair Phillips- Davies Finance Director Gregor Alexander – leadership, operation and governance of the Board; – setting the agenda for Board meetings ensuring that they operate effectively, and provide appropriate opportunity for challenge and debate to support sound decision-making; – ensuring constructive relations exist between the Executive and non-Executive Directors; – identifying individual Director training needs and overseeing the performance evaluation; – meetings with shareholders, analysts and other representatives of institutional investors; and – meeting with managers and employees at various locations throughout the Group. – providing a sounding board for the Chairman; – serving as an intermediary to other Directors when necessary; and – being available to shareholders if they have any concerns which are unable to be resolved through the normal channels of Chairman, Chief Executive or Finance Director, or if contact through these channels is deemed inappropriate. – scrutinising, measuring and reviewing the performance of management; – constructively challenging and assisting in the development of strategy; – providing support to the Executive Committee surrounding the implementation of strategy; – reviewing Group financial information, ensuring systems of internal control and risk management are appropriate and effective; – reviewing the succession plans for the Board; and – serving on various Committees of the Board. – delivering strategy as agreed by the Board; – leading the Executive Committee which oversee the operational and financial performance of, and issues facing the Group; – leading and supporting each of SSE’s businesses and the functions of HR, Strategy and Development and Corporate Affairs; and – representing SSE externally to stakeholders, shareholders, customers, suppliers, regulatory and government authorities and the community. – deputising for the Chief Executive; – leading the finance management teams; – leading and supporting the functions of: Procurement and Logistics; Risk, Audit and Insurance; Investor Relations and Company Secretarial; Corporate and Business Services; Assurance, Supply and Transformation; and IT; and – representing SSE externally to stakeholders, shareholders, customers, suppliers, regulatory and government authorities and the community. Sally Fairbairn y Company Secretary r a t e r c e S – compliance with Board procedures; – advising and keeping the Board up to date on corporate governance developments; – facilitating the Directors’ induction programmes and assisting with professional development; – considering Board effectiveness in conjunction with the Chairman; and – providing advice, services and support to all Directors as and when required. 1 The Chairman, Senior Independent Director and non-Executive Directors are appointed for a fixed term of three years subject to annual re-election by shareholders. This term can be renewed by mutual agreement and the current letters of appointment are available for inspection on the SSE website. 2 The roles of Chairman and Chief Executive are separate and clearly defined. These are set out in writing and were reviewed during the year with the approval of the Board Charter. 3 The Board appoints one of the non-Executive Directors to be the Senior Independent Director, who in addition to the responsibilities of non-Executive Director has specific roles as outlined above. 59 3.2. Directors’ Report1.Leadership continued external searches. Further information on the work of the Nomination Committee, including in relation to succession planning can be found in its report on pages 67 to 69. The individual Directors possess a broad range of skills and insight having been recruited from backgrounds which are diverse in terms of career and experience. Collectively they provide SSE with leadership which is balanced, focussed and supports the creation of value for the Group. In addition to knowledge of business matters, each Director through their individual experience is able to apply independent thought and judgement to decisions surrounding SSE’s range of operations and investments within the energy sector. Further information on the background, competencies, current tenure, Committee membership and other appointments of each Director can be found in the individual Biographies on pages 56 and 57. To ensure the Board functions effectively and in the best interests of the Group, the Chairman, Senior Independent Director, non-Executive Directors and Executive Directors all have individual responsibilities as determined by their role. An overview of each role and details of the individuals assuming each position in 2016/17 is provided on page 59. Signature practices timeline Board relationships The Board as a whole have a collegiate working relationship founded on trust and a mutual duty to promote the long-term success of the Group. In order to effectively discharge their roles, the Chairman and Chief Executive maintain a regular dialogue out with the Boardroom, which recognises and respects the division of responsibilities between their positions. In addition, the non-Executive Directors are provided with direct channels of communication to any of the senior management teams across SSE. This allows them to ask questions, request information and further their understanding of specific areas as required. By fostering strong relationships between the Board and management, the non-Executive Directors can respectfully challenge, support and guide executive decision-making on behalf of the Group. As part of the ongoing process to preserve the integrity of the Board-level relationships, the Chairman meets the non-Executive Directors individually throughout the year and also collectively as a group without the Executive Directors present – in 2016/17 two meetings were held. The purpose of these meetings is to provide the opportunity to discuss matters without executive input and to raise any concerns as required. Board meetings and activity In line with the scheduled meeting calendar, the Board met seven times in 2016/17 with full Director attendance at each meeting as detailed on page 55. In addition, a Board update call is held in most alternate months to ensure that the Directors remain fully informed of any business developments and can consider any new issues or opportunities as they arise. Arrangements are also in place should a Board decision be required to be taken out with the scheduled meetings and calls. Scheduled meetings of the Board adopt a number of signature practices as outlined in the timeline below, and begin with the setting of the annual Board Planner prior to the reporting year. The process which follows ensures that significant focus is given to each of the strategic priorities which have been agreed when setting the Group’s Strategic Framework. As outlined on pages 12 and 13 of the Strategic Report these are: the operation of a balanced range of businesses in core markets; a commitment to efficient operations; and disciplined investment. A number of matters considered by the Board during 2016/17, including in relation to these priorities are set out in the table opposite. Start of reporting year Before the meeting Annual Board Planner The Annual Board Planner is set in support of SSE’s strategic priorities and reporting timeline, and ensures that flexibility is retained. Amongst other matters, each of the Group’s business areas is subject to a deep dive throughout the calendar year. Meeting locations The SSE site at which each Board meeting is to take place is agreed and colleague engagement at both senior management and operational level is arranged. Agenda The final form agenda is agreed by the Chairman, Chief Executive and Company Secretary in alignment with the Group’s reporting timeline and in consideration of: the status of ongoing projects; new investment opportunities; any risks and challenges which have been identified; external developments relevant to the Group; and stakeholder considerations. Meeting pack The meeting pack is issued to all Directors and uploaded onto an electronic Board portal in advance to allow sufficient time to review the matters which are to be discussed. 60 SSE plc Annual Report 2017 Evening before the meeting Board dinner A business dinner at which a range of topics are presented, such as: financial markets; regulatory matters; and the political landscape, is held in advance of each full Board meeting. These may be attended by external guests and key stakeholders. Board Committees One or more of the Board Committees may arrange to meet in the day or evening before a full Board meeting. Any matters requiring Board consideration are then raised during the report back from the Committee Chair the following day. Board meeting Post meeting Standing items Each Board meeting opens by reflecting upon safety performance, and the Directors provide feedback on any site visits which have been conducted. Standing updates include reports from the: Chief Executive; Finance Director; Managing Directors of each business and key support functions. Business attendees One member of the Executive Committee is invited to attend each meeting of the Board in full. In addition, during 2016/17, 42 individuals from within the business presented to the Board. Employee engagement The Board meet with individuals within the business at the respective meeting sites. Feedback Any comments on the administrative or operational aspects of the meeting, and any further information requested by the Board are provided as appropriate. Minutes and actions Minutes and matters arising from the meeting are produced and circulated to the Directors for review and feedback. Directors’ Report – Corporate governanceBoard activity Business areas Group Compliance and Governance Aspects of compliance were considered in relation to all business areas. For example: – the results of internal compliance audits; – various network regulation and compliance Board agenda items in the year included: – a review of Committee membership; – the review and approval of the Board Charter; – an update on the government’s Governance matters including price control reporting, and the commitments made following Ofgem’s investigation into SSE’s Connections business; and – compliance with the CMA’s final recommendations Green Paper; – approval of SSE’s Group Policies; – a review of internal control and risk management; and – updates on the development of a new Group-wide following their competition enquiry into GB energy markets. database documenting relevant legislative and regulatory obligations. Safety, Health and Environment (SHE) As noted in the signature practices above, SHE performance is a standing item at the start of each Board meeting, and feedback from the Safety, Health, and Environment Advisory Committee is also routinely provided. In addition, specific updates were considered by the Board during the year surrounding: case details of the more serious safety incidents which had been reported which included one contractor fatality in 2016/17; SSE initiatives to improve SHE performance including internal SHE communications; and ongoing SHE enforcement actions. Technology A number of business specific technology developments were considered by the Board during the year. – For Wholesale, these focussed on technology The Board received general updates on: – the SSE IT security programme; and – investment in technology to enable advances impacting new generation opportunities. mobile working. Stakeholders Culture Commercial – For Networks, updates were provided on how the business aims to use technology to improve compliance, efficiency and accuracy of data. – For Retail, these included: decisions on system development; connected homes; and investments in digital, as well as updates on the smart meter roll out. The Board considered the range of stakeholders relevant to each business when taking a number of key decisions. – In Wholesale, investment decisions in new projects such as the Beatrice offshore wind farm, considered the impact on employees, the environment and the wider supply chain. – In Networks, the best interests of customers and Ofgem’s principles and objectives were considered when reviewing performance. – In Retail, customers were the focus when considering: the domestic electricity tariff change; reviewing performance against SSE’s treating customers fairly objectives; and reviewing sales-related standards and practices. At a Group level, the Board routinely received shareholder feedback and considered all stakeholders when approving key external reports and statements, including the Annual Report. The Board was also updated on SSE’s engagement with other stakeholders for example: the Rating Agencies; Ofgem; and political representatives. As noted on page 62 this was considered explicitly by the Board during the year. However, implicitly, culture is also a key element within other areas of Board work, which over the period has included: changes in senior management; feedback from the Nomination Committee on inclusion and diversity, and leadership, development and succession; the SSE Group Policy environment; SSE’s guide to ethical business conduct; and the focus on efficiency and effectiveness through improved organisation design and governance. Commercial opportunities, decisions and developments in each business were considered by the Board during the year. These included investment decisions on: – Beatrice offshore windfarm; – Ferrybridge Multifuel 2; – Stronelairg onshore windfarm; – SSE’s bids into the GB Capacity auctions; and – ceasing development of a replacement customer service system. At a Group level, Board activity included: – the decision to sell part of SSE’s equity stake in SGN including the proposal to return £500m in proceeds to shareholders by way of a share buyback; and – a review of efficiency and effectiveness of SSE’s business operations. Finance Financial performance is a standing item on the Board agenda throughout the year. In addition, the following items were considered in the period: approval of the interim and full year financial statements and the Annual Report; approval of the distributable reserves in respect of the interim dividend; approval of the 2017/18 budget; an update on SSE’s pension position; SSE’s funding position and approval of the issuance in March 2017, of new hybrid securities. 61 3.2. Directors’ Report1.Leadership continued Strategy session In June 2016 the Director of Strategy Development and Head of Strategic Projects facilitated a comprehensive strategy session spanning two days, which was attended by the Board and all members of the Executive Committee. The purpose of the session was to enable the Board to refine the focus of the Group’s ongoing strategic development, by using the conclusions which had been drawn from the 2015 strategy session as a platform for review. In conducting its assessment the Board considered: the Executive Committee’s view of the Group’s strategic position; the planned focus of any growth in the year ahead; and the continued validity of any underlying strategic assumptions. Following an in depth debate and discussion of each of these areas, the Board agreed any changes and actions that were required in relation to the Group’s existing strategic priorities, to ensure that the overall Group and business level strategies would continue to support the delivery of SSE’s core purpose and financial objective. Corporate culture in SSE In support of the iterative strategy development process, areas for further Board consideration throughout the year were identified and an annual strategy session for 2017 was again agreed to assess progress. Culture Following the release of the FRC’s report ‘Corporate Culture and the Role of Boards’, the Board took the opportunity during the reporting year to specifically consider the existing culture within SSE and identify the different culture related activities which help to define it. The Board believes that a healthy business culture is one which is inclusive and diverse and which encourages employees to make a positive difference for customers and SSE’s other stakeholders. The Board recognise their responsibility to lead by example and also ensure that there is an appropriate framework of control for culture-related issues. One of the foundations for this is the SSE SET of values, which was adopted by the Board more than 10 years ago and following periodic review, is considered to remain an appropriate driver and commitment to doing the right thing. The SSE SET of values binds attitudes and behaviours and underpins the Employee Rules and the guide to ethical business conduct for SSE employees which must be adhered to. As a platform for ongoing work in this area, the Board endorsed the below depiction of culture recognising that in addition to documented practice, culture is embedded in, and is central to, every aspect of operational performance and decision making within the Group. The Board agreed that whilst many of the existing key performance indicators provide insight in respect of existing values, attitudes and behaviours, future work and assessments based on objective evidence should be carried out with structured and targeted plans to address any shortcomings. A number of actions which centre on reinforcing and reviewing existing culture related activities and initiatives were agreed by the Board, and will be monitored throughout the course of 2017/18. Giving shareholders a return on their investment through paying dividends Meeting the current and future needs of customers Promoting success of the company in line with Section 172 of the Companies Act 2006 Earning returns greater than the cost of capital A combination of values, attitudes and behaviours Safety, Service, Efficiency, Sustainability, Excellence, Teamwork ‘Doing the right thing’ A guide to ethical business conduct Proper and professional performance of duties Lead by example and take a responsible approach 62 SSE plc Annual Report 2017 Directors’ Report – Corporate governanceGovernance case study Decision to sell a 16.7% equity stake in Scotia Gas Networks Limited (SGN) SSE’s acquisition of a 50% share in SGN in 2005 took the total net Regulated Asset Value (RAV) of its economically-regulated businesses to just over £4bn. By 2015, that had increased to almost £7.5bn, with much of that increase attributable to Electricity Transmission, in which a major – and continuing – programme of investment started in 2009, transforming its scale and scope. Against this background of a transformed portfolio of economically-regulated networks businesses, in May 2016, SSE announced its intention to consider options to crystallise some value for shareholders from its long term investment in SGN. This case study sets out the related governance and process. September 2015 The Board supported the potential sale of a stake in SGN and authorised initial discussions with SSE’s Joint Venture partners. It was acknowledged that while Networks remain core to SSE’s strategy of maintaining a balanced range of businesses, disposal of a stake would potentially provide an opportunity to demonstrate value creation and refresh and re-balance SGN’s ownership facilitating more development opportunities. Consideration was also given to: – the possible uses of proceeds, including the potential for a share buy back programme and for investment in value creating projects; and – the potentially positive impact of such a sale on SGN’s strategic opportunities. February 2016 The Board delegated authority to the Executive team to progress options to sell a stake in SGN at or above an agreed premium to RAV. May 2016 The sales process, was outlined to and agreed by the Board. The following narrative was included in the 2015/16 Preliminary Results Statement. June 2016 July 2016 ‘SSE considers disposal of up to one third of its 50% equity stake in Scotia Gas Networks Limited, with any proceeds being used to return or create value for shareholders. Should a sale be completed, SSE would expect to use the proceeds to return value to its shareholders or to invest to create value for shareholders should there be the right opportunity, in a way that would be determined at the time’. Shareholder feedback, post results, was presented to the Board confirming that, SSE considering to sell a stake in SGN was generally well received, as was the intention to return value to shareholders. The 2016 AGM Notice of Meeting included the following wording within the explanatory notes for proposed Resolution 18, Authority to purchase own shares: This resolution renews the authority that was given at last year’s AGM, authorising the Company to purchase its own ordinary shares in the market. In its preliminary financial results statement published on 18 May 2016 SSE stated it has decided to consider the disposal of up to one third of its 50% equity stake in SGN Limited, with any proceeds being used to return capital to, or create value for, shareholders. Should such a disposal take place in the year ended 31 March 2017 one option to return capital to shareholders would be to use this authority, if approved, to purchase SSE’s own shares. Such purchases will only be made if the Directors believe that to do so would result in an increase in the Group’s earnings per share and would be in the best interests of shareholders generally. In this particular instance this method of returning capital to shareholders could have the advantage of offsetting the EPS reduction resulting from the potential disposal and reducing the total dividend outflow in future years. This Resolution was approved by shareholders at the AGM with 99.04% of votes cast in favour. September 2016 The Board were provided with an update on the SGN sale process and confirmed delegated authorities for the potential transaction. October 2016 The agreement to dispose of a 16.7% stake in SGN to wholly owned subsidiaries of the Abu Dhabi Investment Authority (ADIA) was announced on 17 October 2016, with a headline consideration of £621m. The sale was completed on 26 October 2016. November 2016 The Board approved delegated authority to the Finance Director to return around £500m of the proceeds to shareholders by way of an on-market share buy-back, expected to complete by December 2017. The Board approved that the remaining £100m be directed to support the investment in the Stronelairg onshore windfarm development. The Board noted that both uses of proceeds would mitigate the impact of the sale on SSE’s Earnings per Share. The Board approved the announcement of the intended use of proceeds in the Interim Results Statement. 63 3.2. Directors’ Report1.Effectiveness Board evaluation In 2015/16 the effectiveness of the Board was assessed through a formal and rigorous external evaluation process, the results of which were used to develop actions and agree areas for improvement in 2016/17. For this reporting year an internal evaluation was conducted, and was specifically designed to allow any progress made throughout the year to be measured. As well as confirming the areas in which the Board has performed well, or in which improvements have been made, the evaluation identified areas of focus for 2017/18. An overview of the evaluation process is set out below and details of the findings are detailed opposite. During the year each Director also participated in a detailed review of individual performance which was carried out by the Chairman. The process for evaluating the Chairman was managed by the Senior Independent Director, which involved a separate meeting with the non-Executive Directors and included feedback from the Executive Directors. Details of the individual Committee evaluations which were conducted can be found in their respective reports that follow. Director independence and conflicts The continuing independence of each non-Executive Director is considered through: the annual Board evaluation process, which includes the individual Directors’ evaluation; and the Nomination Committee’s review of the Directors’ conflicts of interest. The Board recognises the circumstances as set out in the Code which could compromise the independence of the non-Executive Directors and takes these, amongst others matters, into account when forming their view. Each Director has a duty to disclose any actual or potential conflict of interest to the Board should it arise, which the Board must then review and approve if appropriate to do so. A Director always abstains from authorising his or her own position. The Company Secretary records any notifications made, along with the Board’s response in the Conflicts of Interest Register, which is reviewed annually by the Nomination Committee. This annual review is accompanied by an assessment of the other appointments held by each non-Executive Director. Following their review, the Nomination Committee provide a recommendation to the Board as to any action that is required and a view as to the continuing independence of each non-Executive Director. The Board confirmed all of the non-Executive Directors remain independent, and note that in line with the recommendations surrounding tenure, no non-Executive Director has served on the Board for more than nine years from the date of their first election. The Board also consider that the Chairman was independent on appointment. Knowledge Throughout the reporting year the Directors develop and refresh their knowledge through various training sessions and a number of internally and externally facilitated engagements, with individual development needs being reviewed as part of the annual Board evaluation process. Directors are encouraged to request additional information and support at any time as required, with the necessary resources being made available to them. There is an agreed procedure for the Directors to take independent professional advice at the Company’s expense should it be required, with any advice being obtained made available to the other members of the Board. This procedure was not used during the year. As part of their development in 2016/17, all Board members took the opportunity to participate in site visits and spend time with teams at different locations across each of SSE’s business areas. These visits were either organised in response to an identified training requirement, or due to having been an area of particular interest to the individual Director. Whilst these engagements are primarily to facilitate learning, they also provide the Board with visibility of talent at different levels and insight into the culture within the business. Following any such site visits, feedback is always provided at the next Board meeting. Additional knowledge is also gained through the provision of teach-ins, and updates and briefings which cover areas relevant to the Group. These can involve deep dives into technical business areas, presentations on macro-economic, political and regulatory developments, and training in corporate matters. Board and Committee evaluation process Step 1 A meeting was held with Boardroom Dialogue Review, plan and design Ltd, the Chairman and Company Secretary, at which the scope and format of the The Chairman and Company Secretary evaluation process was decided. reviewed the actions which had been agreed following the external evaluation in 2015/16, in consideration of which, a comprehensive questionnaire was designed. Step 1 Step 4 Boardroom Dialogue Ltd attended the Board meeting Report and agree in January and presented the The Chairman and Company findings of the evaluation process. The recommendations Secretary prepared a report on the made were considered by the findings, which was presented to the Board and actions identified for the coming year. Board along with a number of proposed actions for consideration and approval as appropriate. S t e p 4 64 SSE plc Annual Report 2017 External Evaluation Process S t e p Step 2 Issue questionnaire The questionnaire was issued to each of the Directors for comment and feedback. Individual interviews were held by Boardroom Dialogue Ltd with each of the Directors, the Company Secretary, Deputy Company Secretary and members of the Executive Committee. A review of Board documentation including meeting packs and agendas from the past 12 months was also conducted. 2 Evaluation Process The findings of the evaluation process were compiled and reported to the Board via an in-depth report. Step 3 Compile and analyse The individual responses were compiled by the Company Secretary and an in-depth analysis of the comments provided was carried out. p 3 S t e Briefing and Scope Interview and Review Result Collation Discussion and Objectives Step 1 Step 2 Step 3 Step 4 Directors’ Report – Corporate governance Board evaluation findings Actions for 2016/17 Progress made Actions for 2017/18 Enhancing Board engagement Monitor the agenda setting process to ensure continued linkage to strategy. A dedicated annual strategy session was again held, which received positive feedback surrounding year on year improvement. The time allocated to strategic discussions throughout the year has also increased. Continue to assess the opportunities to enhance strategic discussion and debate throughout the year. Review the allocation of time for site visits including the process for reporting back to the Board. The number of site visits has increased during the year, and each meeting of the Board now includes ‘site visit feedback’ as a standing item. Identify any areas of the business which have not yet been visited by the Board and consider increasing the number of visits centred on safety. Consider increasing the number of meetings of the non-Executive Directors in the Board calendar. In addition to the normal diarised non- Executive meetings, the non-Executive Directors met over dinner as part of the strategy session. Continue to build both dedicated non-Executive and Board engagement time into the formal meeting calendar. Engaging in Board development Identify complex or technical business areas that would benefit from teach-ins and consider increasing the number of one-to-one meetings between the non-Executive Directors and members of the senior management team. Improving meeting administration Explore options for streamlining the format and volume of Board and Committee meeting packs, with continued timely dissemination of all documentation. Considering long-term succession planning This was progressed during the year through non-Executive Director teach-ins covering: Energy Portfolio Management; aspects of Financial Reporting; investing in digital in Retail; and IT security. Opportunities for further Board development, both SSE specific and more generally, will be monitored and progressed as appropriate in 2017/18. Technical presentations in relation to financial reporting were also provided to the Audit Committee. The content and format of the agenda and Board meeting packs was refreshed during the year, with key matters and supplementary information being clearly identifiable. Meeting administration will be continually monitored but no specific actions have been identified in this area for 2017/18. Continue to monitor and develop succession plans at Board level and increase visibility of the talent pipeline below the Board and upper level of senior management. Improvements were made in respect of succession planning and talent development and the Nomination Committee considered these in detail throughout the year, reporting back to the Board. Receive feedback on planned engagement between the Nomination Committee and HR and consider ways in which the visibility of the talent pipeline can be increased. Continue to challenge and strengthen the work on inclusion and diversity. New actions for 2017/18 Focussing on corporate culture Corporate culture is implicit in all areas identified above and runs through all of the Board’s work and considerations. Following specific questioning and feedback through the Board evaluation process, the Board agreed that work in the area of culture should be explicitly supported through the reporting and monitoring of a number of existing and new initiatives including supporting data. 65 3.2. Directors’ Report1.Effectiveness continued Examples of some of the different development opportunities in which the Directors participated throughout the year, including details of specific site visits, teach-ins and updates and briefings are outlined below. The Company also operates performance coaching for the Executive Directors and for other members of senior management, which is designed to develop and enhance individual and Company performance. Director induction On joining the Board, all non-Executive Directors receive an induction tailored to their individual requirements. The comprehensive programme is facilitated by the Chairman and Company Secretary and involves briefings and meetings with key individuals from each business area and supporting Group functions. During the induction programme each Director is invited to identify areas in which they would like additional meetings or further information. Director knowledge and Board engagement Site visits To gain a better understanding of: operational matters; safety considerations; and key performance drivers. Wholesale Site visits included: – the coal fired power station Networks Site visits included: – the Beauly-Denny Fiddlers Ferry; – the gas fired power stations Medway and Peterhead; and – the onshore windfarm sites Clyde and Griffin. and Caithness Moray Transmission projects; – the Networks Control Room in Perth; and – operational depots in Inverness and Portsmouth. Retail Site visits included: – a number of SSE’s call centres; and – customer services sessions in Perth. Enterprise Site visits included: – an on site meeting with one of SSE’s contracting teams in Inverness. Teach-ins and one to one meetings with management To provide a better understanding of: technical matters; areas specific to the relevant Board Committees; and key business initiatives. Engagements included: – an Energy Portfolio Management training session covering commodity markets and energy trading; – a review of the developments in SSE’s digital customer service offering; – an insight meeting with the Business Energy team on location; – sessions with Finance and Internal Audit covering broader Audit Committee matters; and – meetings with HR to review the ongoing inclusion and diversity work. Updates and briefings To provide a better understanding of: external developments relevant to the Group; and specialist corporate areas. Engagements included: – an overview of the political, regulatory and legal landscape following the EU referendum from members of SSE’s legal panel; – a review of recent corporate developments from legal and financial advisors; – an update on the views of the investment community from SSE’s brokers; and – a briefing on changing trends and developments from within the energy sector from SSE’s strategy team. 66 SSE plc Annual Report 2017 Directors’ Report – Corporate governanceNomination Committee Report Members and meetings Member Richard Gillingwater Gregor Alexander 1 Jeremy Beeton Katie Bickerstaffe Sue Bruce Crawford Gillies Peter Lynas Helen Mahy Position Chairman Executive Director Non-Executive Director 2 Non-Executive Director 2 Non-Executive Director 2 SID Non-Executive Director 2 Non-Executive Director 2 Alistair Phillips-Davies 1 Executive Director Member since Attended/ scheduled 2008 2014 2014 2011 2014 2015 2014 2016 2013 4/4 2/2 4/4 4/4 4/4 4/4 4/4 4/4 2/2 The two Executive Directors ceased their membership of the Nomination Committee during the year. 1 2 All non-Executive Directors are considered to be Independent by the Board. Dear Shareholder, It has been another busy year for the Nomination Committee, with four meetings during the reporting period. These meetings covered a number of matters, ranging from Board membership to Group wide people initiatives, which I believe to be both supportive and representative of the broad scope and forward looking nature of our work. In 2016/17 we again reviewed the composition of the Board and its Committees. Following our most recent appointments of Helen Mahy and Crawford Gillies – both of whom have now completed their first full year as non-Executive Directors – we have benefited from an overall increase in the diversity of skills and experience at Board level. As such, no changes to Board membership have been made this year. At sub-Committee level, the membership of the Safety, Health, and Environment Advisory Committee has been refreshed following changes in the SSE senior management team, and the membership of the Nomination Committee has also been updated. This was following discussion with significant US shareholders, and in recognition of the more stringent New York Stock Exchange corporate governance standards surrounding fully independent membership. Specific Nomination Committee focus has been provided to a number of other key areas including: succession; talent development; and the inclusion and diversity of both the SSE leadership team and the Group at large, all of which are highlighted in the report that follows. We also took the opportunity throughout the year to consider and refresh our terms of reference in recognition of the pace of external change in the areas relevant to our work. Throughout 2017/18 we will again monitor the membership and composition of the Board and its Committees, and challenge the senior management team to develop the internal talent pipeline, so that together they continue to support and promote the success of SSE in the longer term. Richard Gillingwater CBE Chairman of the Nomination Committee 16 May 2017 67 3.2. Directors’ Report1.Effectiveness continued Role and responsibilities The Nomination Committee is responsible for reviewing and identifying the leadership needs of the Board, its Committees and SSE’s senior management in order to support the long-term success of the Group. The specific remit of the Committee is set out in its terms of reference, which were refreshed during the reporting year, and details of the Committee’s key considerations, principles and objectives which inform its work can be found in the diagram opposite. Nomination Committee activities in 2016/17 The Nomination Committee had four meetings during the year and an overview of the work carried out during the reporting period is set out in the table below. Nomination Committee responsibility i o n s , t a r e si d n o C External commitments of Directors p rinciples and objectiv e s SSE’s culture and values Group strategy Responsibility: to review the structure, size and composition of the Board and senior management. Potential conflicts of interest of Directors Diversity including gender and ethnicity Balance of skills, knowledge and experience Progressive and well managed change Rigorous and transparent appointment process Oversight of the executive talent pipeline Nomination Committee activity Area of focus Actions Succession planning and talent development – Monitor plans for succession and refreshment of the Board and senior management. – Focus was given to the ongoing assessment of the succession pipeline for Board and senior management positions, including a review of potential successors’ readiness and plans identified for their development. – Reviewed senior appointments, both internal and external hires. – Continued to monitor the acceleration of SSE’s female leadership pipeline. – Out with the meetings a number of Committee members spent time with senior leaders throughout SSE, providing an opportunity to observe the succession pipeline in action. This included attending the SSE Leadership Conference and a senior Wholesale team event. – Updates were received on the HR team’s initiatives on inclusion and diversity. These comprise measures to build a diverse and long-term pipeline of talented individuals from a wide range of backgrounds, and initiatives to improve: social inclusion; female representation; and ethnic representation. – The Committee discussed the findings of a number of externally developed reports including: the Hampton-Alexander Review; the Parker Report: the ethnic diversity of UK boards; and various Government papers. – Confirmed that all non-Executive Directors remain independent in line with the Code. Inclusion and diversity – Support inclusion and diversity throughout SSE. Director independence and conflicts – Review the independence of all non-Executive Directors. – Review of declared and potential – Made a recommendation to the Board for approval. conflicts of interests of the Directors. Committee and Board membership – Review the Board and Board Committee membership. 68 SSE plc Annual Report 2017 – Recommended changes to the membership of the Safety, Health, Environment, Advisory Committee and the Nomination Committee. – Recommended re-appointment of Sue Bruce as a non-Executive Director for a further three years from 1 September 2016, and confirmed continuing membership of the Audit Committee and the Safety, Health, Environment, Advisory Committees. Directors’ Report – Corporate governancePerformance The performance of the Nomination Committee was assessed as part of the internal evaluation process, in which the Board and its Committees participated during the year. The evaluation was conducted using a tailored questionnaire and the responses highlighted positive developments for the year under review. It was noted in particular, that the visibility of SSE’s talent pipeline and succession planning had improved, and that this should continue in 2017/18 with specific focus on diversity, talent development and the wider scope of the HR function. Diversity As well as maintaining an overview of Group initiatives to improve diversity, the Committee has a responsibility to consider diversity in its broader sense when reflecting upon the correct composition of the Board and its Committees. In doing so, the Committee considers the recommendations and findings of external reviews which have been undertaken in areas relevant to their work. The SSE Board Diversity Policy also continues to support the Committee in this area, by setting out SSE’s approach to Board diversity, and the principles which should be applied when recruiting new individuals and considering if any changes are required. The Policy also ensures that recommendations surrounding appointment continue to be made on merit. In 2016/17 the diversity of Board and senior leadership positions within FTSE companies continued to receive significant focus, and the Committee have discussed and will continue to monitor the implementation of any initiatives as appropriate to support any recommendations made. In respect of gender diversity at Board level, the Board and Committee were supportive of the original work of the Davies Review, and recognise the current recommendations of the Hampton-Alexander Review for a minimum 33% women’s representation on FTSE 350 Boards by 2020. Female membership of the Board is currently in line with this at 33%. A number of measures of the current diversity of the Board are highlighted opposite and further detail on the gender mix of SSE’s employees is provided on pages 20 to 22 of this Strategic Report. Composition The membership of the Nomination Committee comprises the five non- Executive Directors and the Chairman of the Board, who is also Chairman of the Committee. The Company Secretary is Secretary to the Nomination Committee. The membership of the Nomination Committee has always recognised and been compliant with provision B.2.1. of the Code, whereby a majority of the members should be independent non-Executive Directors. During the year and following discussion with significant US shareholders, the membership was updated to reflect the New York Stock Exchange listing and corporate governance standards, which require Committee membership to be fully independent. As a result the Executive Directors, Alistair Phillips-Davies and Gregor Alexander, stepped down from their positions on the Nomination Committee. Succession planning During the reporting year, the Nomination Committee continued to discharge its responsibility for ensuring that the balance of skills, knowledge and experience on both the Board and its Committees remains appropriate, such that they are able to carry out their roles effectively. In reviewing the composition of the Board and its Committees, the Nomination Committee has due regard for succession planning and the options for future membership refreshment should it be required. Following the appointment of Crawford Gillies and Helen Mahy in the previous financial year, the Nomination Committee was satisfied that no further changes to Board membership were required in 2016/17. Before a Board appointment is made, the Nomination Committee applies the considerations, principles and objectives outlined in the diagram on page 68, and in addition, when appointing a new non- Executive Director, engages the services of a professional search firm specialising in Board-level recruitment. The process generally involves interviews with a number of candidates and in line with Board policy SSE strives to engage only with firms that have signed up to the Voluntary Code of Conduct for Executive Search Firms. When the Nomination Committee deals with any matter concerning the Chairmanship of the Board, another non-Executive Director chosen by the remaining members chairs the meeting. Members of the Nomination Committee do not take part in discussions when their own performance or continued appointment is being considered. Board diversity Gender of Board Male (6) Female (3) Board – Years of service 0-3 years (2) 3-6 years (4) >9 years (3) Board – Age 41 to 50 years (2) 51 to 60 years (5) 61 to 65 years (2) Board – Experience  1 Banking, corporate finance (4) Large capital projects (3) Retail businesses (3) Regulation & energy utilities (4) Governance & risk (4) Leadership of large organisations (3) Public sector (3) 1 Number of members with relevant experience in this area. 69 3.2. Directors’ Report1.Accountability Audit Committee Report Members and meetings Member Peter Lynas 1 Sue Bruce Crawford Gillies Helen Mahy 2 Position Non-Executive Director Non-Executive Director Non-Executive Director Non-Executive Director Member since Attended/ scheduled 2014 2014 2015 2016 4/4 4/4 4/4 4/4 The Board has confirmed that each member of the Audit Committee is independent and that membership meets the requirements of the Code in terms of recent and relevant financial experience and competence relevant to the sector in which the company operates. 1 Recent and relevant financial experience as the current Group Finance Director of BAE Systems plc and a Fellow of the Chartered Association of Certified Accountants. 2 Energy sector experience through previous role as Company Secretary and General Counsel of National Grid plc. 70 SSE plc Annual Report 2017 70 SSE plc Annual Report 2017 Dear Shareholder, On behalf of the Audit Committee, I am pleased to present the Audit Committee’s Report for the year ended 31 March 2017. Over the following pages we provide insight into the workings and activity of the Audit Committee throughout the reporting year, in support of our role, which is to assist the Board discharge it’s responsibilities in relation to: the integrity of Financial Reporting; the relationship with the External Auditor; the effectiveness of the Internal Audit function; and the effectiveness of the System of Internal Control and Risk Management Framework. The Audit Committee held four meetings in 2016/17 in line with the financial and audit calendars. Amongst a range of matters, the Audit Committee conducted a comprehensive review of the system of internal control and risk management framework, including the related assurance processes. We agreed to recommend to the Board that the number of Principal Risks be increased from nine to ten, following the split of the ‘Cyber and Networks Failure’ into two separate risks. The ‘Human and Relationship Capital’ risk was also expanded and renamed to ‘People and Culture’. We were pleased with the positive progress which has been made in this area, and further details of these changes are set out on pages 24 to 27. Over the next 12 months the Audit Committee will continue to focus on the audit, assurance and risk processes to enhance the overall effectiveness of the System of Internal Control. Peter Lynas Chairman of the Audit Committee 16 May 2017 Directors’ Report – Corporate governanceRole The key matters considered by the Audit Committee during the year are explained in the report that follows, and principally fell under the following areas. Financial reporting – review the integrity of the interim and annual financial statements; – review the appropriateness of accounting policies and practices; – review the significant issues and judgements considered in relation to the financial statements, including how each was addressed; and – review the content of the Annual Report and Accounts and advise the Board on whether taken as a whole, it is fair, balanced and understandable. Internal Audit – review and monitor the effectiveness of the Internal Audit function, including approval of the audit plan. External Audit – review and monitor the objectivity and independence of the External Auditor, including the policy to govern the provision of non-audit services; – review and monitor the effectiveness of the external audit process and the ongoing relationship with the External Auditor; and – review and make recommendations to the Board on: the tendering of the external audit contract; and the appointment, remuneration and terms of engagement of the External Auditor. Risk management and internal control – review and monitor the effectiveness of the risk management and internal control framework; – review the framework and analysis to support the long-term viability statement; and – establish and oversee appropriate whistleblowing and fraud prevention arrangements. which was carried out during the year confirmed that the Audit Committee continued to operate effectively. Meetings and activities in 2016/17 Meetings of the Audit Committee are scheduled at key times in the Group’s financial reporting and audit calendar, and take place in advance of Board meetings. The matters considered at each meeting are guided by an annual plan of business which is designed to ensure the Audit Committee discharges its responsibilities in accordance with its terms of reference which were updated during the year. The Audit Committee met four times during the year, and has met once since the end of the financial year. Meetings of the Audit Committee are also routinely attended by the: Company Chairman; Finance Director; Director of Risk, Audit and Insurance; the External Auditor; and the Deputy Company Secretary who is secretary to the Audit Committee. Throughout the year, a number of other senior finance and business managers were invited to attend certain meetings to provide a deeper level of insight into particular items of business. This gave the Audit Committee the opportunity to meet management and discuss, debate and challenge on a range of matters. The Chairman of the Audit Committee meets separately with the Finance Director, Director of Risk, Audit and Insurance, other senior management, and the External Auditor to ensure the work of the Audit Committee is focused on key and emerging issues. During the course of the year, regular challenge and engagement with management, Internal Audit and the External Auditor, together with the timely circulation of reports and information, has enabled the Audit Committee to discharge its duties and responsibilities effectively. The internal Board and Committee evaluation process Financial reporting and significant financial judgements Financial reporting The Annual Report and Accounts seek to provide the information necessary to enable an assessment of the Company’s position and performance, business model and strategy. The Directors’ statement set out on page 100 recognises and confirms the Board’s responsibility for preparing the Annual Report and Accounts and to present a fair, balanced and understandable assessment of the Group’s position and prospects. The Audit Committee assists the Board with the effective discharge of its responsibilities for financial reporting. During the year, the Audit Committee reviewed: – the integrity of the interim and annual financial statements and accompanying reports to shareholders; – the appropriateness of the accounting policies and practices used; – the clarity of the disclosures, in addition to compliance with financial reporting standards and governance reporting requirements, including Alternative Performance Measures; – the Group’s tax position, including ongoing HMRC enquiries, and areas of potential tax exposure; – regular reports on the status of various accounting projects including: the transition to FRS 101 for subsidiary companies; IFRS15 – Revenue from Contracts with Customers; and IFRS9 – Financial Instruments; – areas in which significant judgements had been applied and other matters raised for discussion by the External Auditor; Fair, balanced and understandable assurance framework The Audit Committee reviewed and the Board approved the assurance framework used to assist the Directors discharge their requirement to state that the Annual Report and Accounts are fair, balanced and understandable. The components of the assurance framework which were used to assist with the preparation of 2017 Annual Report and Accounts included: – comprehensive guidance issued to contributors, including the FRC Letter, ‘Summary of key developments for 2016 annual reports’, which was issued to Audit Committee Chairman and Finance Director in October 2016; – a verification process dealing with the factual content; – comprehensive reviews undertaken independently by senior management in Legal and Regulation to consider messaging and balance; – comprehensive reviews undertaken by the Company’s brokers to ensure consistency and balance; – reporting by the External Auditor of any material inconsistencies; and – comprehensive review by the Directors and the senior management team. The Audit Committee and Board received confirmation from management that the assurance framework had been adhered to for the preparation of the 2017 Annual Report. 71 3.2. Directors’ Report1.Accountability continued – reports from the External Auditor on its audit of the full year results and its review of the half year results; – matters which informed the Board’s assessment that it was appropriate to prepare the accounts on a going concern basis; – letters of representation issued by management to the External Auditor for the full year and half year results prior to them being signed on behalf of the Board; – the content of the Annual Report and Accounts and advised the Board on whether they were fair, balanced and understandable and provide the information necessary for shareholders to assess the company’s performance, business model and strategy; and – the governance arrangements to assist the Directors discharge their responsibilities in relation to: the disclosure of information to the External Auditor; and the fair, balanced and understandable assurance framework. Significant financial judgements In carrying out the review of these matters, the Audit Committee received reports from management and the External Auditor setting out their views on the accounting treatments and judgements included in the Financial Statements. Significant financial judgements In preparing the Financial Statements, there are a number of areas requiring the exercise by management of judgement or a high degree of estimation. After discussion with management and the External Auditor, the significant areas of judgement reviewed and considered by the Audit Committee in relation to the 2017 Financial Statements, and how these were addressed are set out in the table below. Going concern After making appropriate enquiries, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future (12 months). The financial statements are therefore prepared on a going concern basis. Further details of the Group’s liquidity position and going concern review are provided in Note 1 to the Financial Statements. The Directors’ statement of longer term viability can be found on page 27. Internal Audit The Director of Risk, Audit and Insurance has management responsibility for the Internal Audit function. In addition to the normal corporate reporting structure, he has the right of direct access to the Audit Committee, Chief Executive, and Company Chairman. The Internal Audit function operates a risk-based methodology to review internal control and risk management processes and procedures. During the year, the Audit Committee: – reviewed progress against the 2016/17 Internal Audit Plan, including significant findings, the adequacy of management’s response and overdue actions; – received reports on the assessment of the system of internal control, including risk management; Significant financial judgements for the year ended 31 March 2017 How the Audit Committee addressed these significant financial judgements Carrying value of certain non-current assets: The carrying value of certain non-current assets in the Group – including power generation plants and goodwill – are assessed by reference to the recoverable value (value-in-use or fair value less costs to sell) of the asset or the associated CGU (cash generating unit). An annual valuation/impairment exercise is carried out. The assumptions applied in this exercise require judgements on the economic factors associated with the assets under review. Further details are provided in Notes 4.1 (i) and Note 15 to the Financial Statements. Accounting for estimated revenue: Revenue from energy sales in the Retail division include estimates of the value of electricity and gas supplied to customers between the date of the last meter reading and the financial year end. These are based on estimates and assumptions in relation to the consumption and valuation of that consumption. Further details are provided in Notes 4.1 (ii) and Note 18 to the Financial Statements. The basis and outcome of this review is presented to the Audit Committee by management, and includes a description of the assumptions applied in deriving the recoverable values. The Audit Committee reviewed and challenged the assumptions and projections and also considered the findings of the External Auditor. Following this review, the Audit Committee supported the recommendation to recognise exceptional charges of £374.6m in relation to certain assets in the financial year. The Audit Committee reviewed the practical process issues and assumptions applied in determining the basis of recognition of ‘unbilled’ debtors, with particular reference to domestic electricity and gas. The Audit Committee also considered the findings of the External Auditor. Following this review, the Audit Committee supported this judgement. Valuation of receivables: The recoverability of the Group’s billed energy receivables in the Retail division is a key judgement area given the risk of customer insolvency or default. The level of the Group’s aged debt is monitored with allowances for doubtful debt being based on assumptions derived from experience and industry knowledge. Further details are provided in Notes 4.1 (iii) to the Financial Statements. The Audit Committee considered the assumptions impacting doubtful debt allowances and charges, and were updated on the activities of the Retail Debts Committee (whose members include the Finance Director) and the processes for receivables collection and provisioning. The Audit Committee also considered the findings of the External Auditor in this area. Following this review, the Audit Committee supported this judgement. Accounting for Group pension obligations: The assumptions in relation to the cost to the Group of providing future post- retirement benefits are set after consultation with qualified actuaries and can have a significant material impact on the financial position of the Group. Further details are provided in Notes 4.1 (iv) and Note 23 to the Financial Statements. The costs, assets and liabilities of the Group’s defined benefit retirement schemes are regularly reviewed. Advice is taken from independent actuaries on the IAS 19R valuation of the schemes. The Audit Committee were updated on the schemes’ valuation and also considered the findings of the External Auditor particularly in relation to the scheme’s key assumptions relative to market practice. Following this review, the Audit Committee supported this judgement. 72 SSE plc Annual Report 2017 Directors’ Report – Corporate governance – considered the independence, authority and responsibilities of the Internal Audit function and approved an updated version of the Internal Audit Charter; After taking into account all of the above matters, the Audit Committee concluded that it is satisfied with the effectiveness of the Internal Audit function. – assessed the expertise and level of resources available to the Internal Audit function; and – approved the Internal Audit Plan for 2017/18 which comprises both fixed and flexible elements in order to provide capacity to respond to any changing business requirements. The Audit Committee is responsible for reviewing and monitoring the effectiveness of the Internal Audit function. During the year, the Audit Committee considered: – the views of the Director of Risk, Audit and Insurance on the level of resourcing and areas for future development of the Internal Audit function; – progress on delivery of the audit plan, together with post-audit management feedback; – progress of the actions identified in the Quality and Standards Assessment of the Internal Audit function undertaken by KPMG in 2015; – the output of a senior management survey obtaining feedback on the overall value and quality of the service provided by Internal Audit; and – the views of the External Auditor on the effectiveness of the Internal Audit function. External Audit KPMG were appointed as the External Auditor in 1999 through a competitive tender process following the merger which formed SSE. At the 2016 AGM, shareholders re-appointed KPMG as the External Auditor of the Company for the year ended 31 March 2017, and authorised the Audit Committee to fix their remuneration. KPMG has acted as the External Auditor of the Group throughout the year. The External Auditor is required to rotate the lead Audit Partner every five years. The Audit Committee monitors this rotation, and confirms the current lead Audit Partner – Bill Meredith – is in the third year of his term. Objectivity and independence The External Auditor has provided specific assurance to the Audit Committee on the arrangements it has in place to maintain its objectivity and independence, including confirmation of compliance with FRC Auditing and Ethical Standards in relation to the audit engagement. The Audit Committee also considered reports from management which did not raise any concerns in respect of the External Auditors’ objectivity and independence. In addition, the Audit Committee oversees a policy to govern the non-audit services provided by the External Auditor. Details of the policy and fees paid to the External Auditor in 2016/17 are provided below. After taking into account all the above matters, the Audit Committee concluded that it is satisfied with the objectivity and independence of the External Auditor. Effectiveness and ongoing relationship During the year, the Audit Committee reviewed: – the approach, scope, areas of focus, level of materiality and remuneration for the audit of the financial year ended 31 March 2017; – regular reports on progress against the 2016/17 External Audit Plan, significant findings, the adequacy of management’s response and the time taken to resolve; – the competence with which the External Auditor handled and communicated the key accounting and audit judgements; – the effectiveness of the overall external audit process for 2016/17, including meeting with the External Auditor and management separately to get feedback on the relationship and assess the effectiveness of the external audit process; – the quality of the External Auditor’s engagement with the Audit Committee; – the qualifications, expertise and resources of the External Auditor; Non-Audit Services Policy The Non-Audit Services Policy applicable during the financial year recognises that the external audit contract will be subject to mandatory rotation from time-to-time, and provides a safeguard to ensure that potential audit firms are not restricted in their ability to tender for the external audit contract going forward. For the purposes of approval, non-audit services are divided into 3 categories: – Audit-Related Services, where the approval of the Finance Director is needed; – Permitted Non-Audit Services, where approval can be obtained from the Finance Director up to £150,000 and the Audit Committee Chairman above this amount; and – Prohibited Non-Audit Services. The Audit Committee reviews a report at each meeting on the services being provided by the External Auditor. Fees for Audit and Audit-Related Services incurred during the year amounted to £1.2m and £0.7m for Permitted Non-Audit Services. Details of the fees paid to the External Auditor during the year are made in Note 6 to the Financial Statements. Significant categories of engagement for Permitted Non-Audit Services awarded during the year include £0.5m for transaction support in relation to the part disposal of SGN, £0.1m for review of various regulatory returns and information requests arising in the Networks business and £0.1m for tax advisory and compliance services. In line with the Non-Audit Services Policy, in each case the Audit Committee was satisfied that the work was best handled by the External Auditor because of their knowledge of the Group and the skills and expertise brought to the assignment. Fees paid to External Auditor £0.7m £1.2m During the year, the Non-Audit Services Policy was reviewed and updated (with effect from 1 April 2017) to ensure compliance with the changes introduced as part of EU Audit Reform. Audit and Audit Related Services Permitted Non-Audit Services 73 3.2. Directors’ Report1.Accountability continued – the output from a questionnaire – the lead time required to ensure completed by senior management seeking views on KPMG’s capability and performance in providing external audit services; and – the output from a FRC Audit Quality Review of KPMG published in May 2016. After taking into account all the above matters, the Audit Committee concluded that it is satisfied with the effectiveness of both the external audit process and the ongoing relationship with the External Auditor. Tendering of External Audit contract Whilst the Audit Committee has continued to keep under review all aspects of the relationship with the External Auditor, no formal tender of the external audit contract has been carried out since KPMG’s appointment in 1999. Before making a recommendation to the Board on the timing of the external audit contract tender, the Audit Committee considered: – the quality, stability and continuity provided by the relationship with the current External Auditor; – the audit tendering recommendations set out in the Code and the requirements of the CMA Audit Order, EU Audit Regulation and EU Audit Directive; – management of the audit requirement regarding the change in accounting standards at subsidiary level; and potential audit firms are not restricted in their ability to tender for the external audit contract arising from existing contracts for non-audit work. After taking into account the matters outlined above, in addition to the arrangements for monitoring all aspects of the relationship with the External Auditor, upon the recommendation of the Audit Committee, the Board concluded that it was in the best interests of the Company to tender the audit contract in line with the timeline set out below. The matters highlighted in this section constitute the Company’s rationale and explanation for non-compliance with provision C.3.7 of the Code. Resolutions to re-appoint KPMG as External Auditor of the Company for the year ending 31 March 2018, and to authorise the Audit Committee to fix their remuneration, will be proposed to shareholders at the AGM on 20 July 2017. Internal control and risk management The Board is responsible for the effectiveness of the Group’s system of internal control, including risk management and risk appetite. The Group’s system of internal control is detailed on pages 24 and 25. The Group’s risk management framework is designed to manage rather than eliminate the risk of failure to achieve business objectives, and can only provide reasonable and not absolute assurance against material misstatement or loss. During the year the Board has carried out a robust assessment of the Principal Risks facing the Group (as set out on pages 24 to 27), being those that could threaten its business model, future performance, solvency or liquidity. The Directors’ statement of longer term viability can be found on page 27. The Group has in place extensive internal controls to help mitigate the material risks which the business faces and management is responsible for establishing and maintaining these controls, including those in relation to the financial reporting process. This year, the Group implemented an integrated assurance mapping and planning process to ensure coordination of assurance activities across the Group. The Board has delegated responsibility for reviewing the effectiveness of SSE’s system of internal control to the Audit Committee. This covers all material controls including financial, operational and compliance controls. During the year, the Audit Committee reviewed information drawn from a number of sources, including reports from: – Treasury, setting out: strategy; market developments; debt structure; maturity profiles; funding plan; liquidity; going concern; credit rating; foreign exchange; and significant risks and controls; External Audit tender timeline 3 Lead Audit Partner tenures 5 Year term of current Audit Partner New External Auditor 1999 2014 (1 April) 2016 (AGM 21 July) 2017 (AGM 20 July) 2018 2019 (31 March) 2019 (AGM) 2020 (31 March) KPMG appointed as External Auditor KPMG re-appointed as External Auditor Approval sought for the re-appointment of KPMG Competitive external audit tender process begins Completion of final audit by KPMG Approval sought for the appointment of new External Auditor Completion of first audit by new External Auditor The five year rotation of the current lead Audit Partner will end on completion of the audit for the financial year ending 31 March 2019. A tender process will take place in 2018, in accordance with the timeline above which complies with the provisions set out in The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014. There are no contractual obligations with a third party which restrict the choice of External Auditor, and the future tender process will be based on a clear selection and assessment criteria. 74 SSE plc Annual Report 2017 Directors’ Report – Corporate governanceReview of system of internal control The Board and Audit Committee have reviewed the effectiveness of the Group’s system of internal control, including risk management, in accordance with the requirements of the FRC Guidance on Risk Management, Internal Control and related Financial and Business Reporting. The Board confirms that no significant failings or weaknesses were identified during the year and up to the date of this Annual Report. Where areas for improvement were identified, processes are in place to ensure that the necessary action is taken and that progress is monitored. – Internal Audit on cyber security risks and vulnerabilities, including the development of the IT security programme; – Energy Portfolio Management setting out: strategy; market prices and analysis; financial regulation developments; energy portfolio and counterparty credit exposures; and significant risks and controls; – Group Risk on the framework for the identification, evaluation and monitoring of Principal Risks, including assessment of the risk management framework and internal control environment; – Group Risk on the framework and analysis to support the long-term viability statement; – Group Compliance updates on the development and implementation of a comprehensive obligations matrix, documenting legislative and regulatory obligations that govern SSE’s operations; – Company Secretarial on governance developments relating to the work of the Audit Committee; – Internal Audit on the work undertaken to identify Group-level fraud risks, and the development of a focused fraud risk audit plan; – Internal Audit and Human Resources on the review and effectiveness of whistleblowing arrangements; – Internal Audit highlighting investigations into allegations and incidents of fraud across the Group; – the External Auditor, on its assessment of significant risks and the internal control environment in so far as is necessary to form an opinion on the true and fair view of the Financial Statements; and – Group Risk on the information to provide assurance to the Audit Committee and Board on the key areas which form the system of internal control, together with a view from the Finance Director on the overall effectiveness of the system of internal control. These reports provided the Audit Committee with invaluable insights into the risks facing the Group and the management of them, and inform the Board in its review of the effectiveness of the Group’s system of internal control, including risk management. 75 3.2. Directors’ Report1.Stakeholder engagement and responsible stewardship The Board and SSE’s stakeholders In order to agree the strategic priorities for the Group, and apply judgement and challenge to the ways in which these should be delivered, the Board must understand the concerns and needs of both SSE’s shareholders and its wider stakeholders. This is supportive of the Board’s duty to promote the success of the company as set out in Section 172 of the Companies Act 2006, and is achieved in part through a number of engagement activities. These engagement activities include: regular ongoing dialogue with stakeholder groups; promoting the creation of, and attending, dedicated forums, focus groups and advisory panels; and the considerations and work of the Safety, Health, and Environment Advisory Committee. Further information on the role and activities of SSE in relation to the above is detailed on pages 28 and 29 of the Strategic Report and within SSE’s Sustainability Report which can be found on the SSE website. Shareholder dialogue The Board is committed to maintaining constructive dialogue with shareholders – its ultimate owners – to enable communication of the Group’s objectives, strategy and performance, and to develop an understanding of shareholder views. The Board recognise that in their investment decisions, many shareholders consider a range of environmental, social and governance matters and the Board seeks to understand what these are, such that they can be considered and applied as appropriate in their decision making. This constructive shareholder dialogue is achieved through a structured investor relations programme comprising meetings and bi-annual roadshows, as well as ad hoc conferences, discussions and correspondence on a reactive basis. Details of some of these investor relations activities and the related resources are set out in the table below. Shareholder engagement Website and shareholder communications SSE’s website is an important source of information for shareholders, which includes: – share price information; – Stock Exchange announcements; – investor presentations; – shareholder services; and – useful contact details. Shareholder circulars, including the Annual Report and Accounts, and Notice of Annual General Meeting, are sent to all shareholders at the requisite time. These are provided in electronic form by default, however, any shareholder wishing to receive hard copies can contact Capita Asset Services, SSE’s Share Registrar. Roadshows, shareholder meetings and feedback The Executive Directors aim to meet or have calls with SSE’s top 30 shareholders twice annually, as well as attend a number of investor conferences where they typically meet with groups of investors. The Chairman and Senior Independent Director also attend a selection of investor meetings. The Board receives updates on SSE’s shareholder engagement and analyst commentary at each Board meeting, and is provided with independent investor feedback collated by SSE’s Brokers twice a year. This follows investor roadshows which take place in November and May. During this reporting year, the Board also heard directly from one of SSE’s largest shareholders as part of a pre-Board briefing. 76 SSE plc Annual Report 2017 Consultation and engagement Results and routine announcements Annual General Meeting In 2016 the Chairman and the Chair of the Remuneration Committee held meetings and calls to consult with large shareholders on remuneration matters. The same is being offered in 2017. Senior management and the investor relations team engage throughout the year with a range of investors and analysts, which this year included presenting at a Local Authority Pensions Fund Forum Conference. Following publication of interim and preliminary results, in November and May respectively, presentations are held in London and attended by SSE’s large shareholders and energy utility analysts. The results presentation is also available online and by dial-in, both real-time and after the event. The Chairman and Executive Directors attend and present results. Other routine announcements designed to ensure ongoing engagement with investors include: – the Q1 Trading update; – the Q3 Trading update; and – pre-close announcements in September and March. AGM 21 July 2016 – Full director attendance. – 3 Special resolutions passed. – 17 Ordinary resolutions passed. AGM 20 July 2017 – Full Director attendance planned. – 3 Special resolutions proposed. – 15 Ordinary resolutions proposed. At the 2016 AGM attendees included a number of shareholders as well as representatives of shareholder bodies, such as the Aiming for A investor coalition and the Local Authority Pension Fund Forum. The AGM includes time for the Chairman and Board to answer questions from attendees. Directors’ Report – Corporate governanceStakeholder engagement and Board oversight The Board recognises and embraces its responsibility to take account of the interests of stakeholders – people, groups and organisations who have an interest in SSE and the energy sector as a whole – in the course of its deliberations and decision making. The diagram below sets out the different elements of direct Board level engagement, and includes details of the feedback it receives from a range of well established stakeholder engagement activities which take place within each of SSE’s business areas. Taken together, these help to provide insight surrounding the way in which business is being conducted and to ensure that it is both responsible and sustainable. Society In line with their role to promote SSE’s responsibility within society, during 2016/17, the Board approved 24 Group Policies and the revised guide to ethical business conduct for SSE employees, which had received input during development from the Institute of Business Ethics. The Group Policies and the Guide cover the different cornerstones of SSE’s interactions and impacts upon its stakeholders, including amongst others, the areas of: Climate Change; Safety, Health and the Environment; Sustainability and Corporate Responsibility; Inclusion and Diversity; and the SSE Group Taxation policy. Society - g o v e r n mental organisations n o N L i s t ening to t h e views of s p e c i a list bodies Energy Customers d e R m e s o p c r e a c t t i i c n g p r t h e o c e s s G o v e r n m e n t a n d r e g u l a t o r s g to G issues din n o p s e R S E y e k U p o s i n Providing the energy people need g p e ople to r f o r c usto mers a r e h olders h g i n E n g a e i v d e l a n d s w g b e r for good uying ers old h e r a h S S u p p li e r s a n d c ontractors E m p l o y e es Suppliers and contractors In 2016/17, the Safety, Health, and Environment Advisory Committee provided additional focus to the area of sub-contractor safety, and the Board approved the updated SSE Modern Slavery Statement and a revised Procurement policy. Customers The Chairman and the Chief Executive meet annually with the Chairs of a number of Customer Forums, and receive feedback and insight surrounding the areas which have been highlighted as important by SSE’s retail energy customers. The Board also provided oversight and support surrounding SSE’s treating customers fairly commitments for 2016/17, which were developed in consideration of this feedback, and in recognition of SSE’s customer needs. Government and regulators The Board met directly with the energy regulator, Ofgem, during the reporting year, and welcomed the opportunity to engage and allow better common understanding of priorities and areas of concern. The Board also welcomes engagement from policy makers and the opportunity to oversee SSE’s responses to consultations. These can relate specifically to SSE’s different business areas, as well as general governance and business developments, for example, in 2016/17 Board members fed views into the All Party Corporate Governance Group report, ‘The Board’s Role in Determining Culture’. Employees A key aspect of Board member’s site visits, attendance at teach-ins, and one-to-one meetings and briefings, is the opportunity that they provide for engagement with SSE employees. In addition the non-Executive Directors attended the SSE employee safety conferences and a number of employee leadership events. The Chairman also chaired an event which captured views on SSE’s corporate culture from a cross-section of employees. In addition to the ongoing employee engagement, in 2017/18, the Chairman and the Chair of the Remuneration Committee intend to meet directly with employee representatives, which will provide the opportunity for further understanding of the matters relevant to SSE’s workforce. 77 3.2. Directors’ Report1. Stakeholder engagement and responsible stewardship continued Safety, Health and Environment Advisory Committee Report Members and meetings Member Position Jeremy Beeton Non-Executive Director ¹ Sue Bruce Helen Mahy Colin Nicol 2 Jim Smith 2 Non-Executive Director ¹ Non-Executive Director ¹ Senior Executive Senior Executive Mark Patterson Senior Executive Jim McPhillimy 3 Senior Executive Paul Smith 4 Senior Executive Member since Attended/ scheduled 2011 2013 2016 2016 2016 2013 2008 2008 3/3 3/3 3/3 2/2 2/2 3/3 1/1 -/- 1 All non-Executive Directors are considered to be independent by the Board. 2 Colin Nicol and Jim Smith joined the SHEAC on 31 May 2016. 3 4 Paul Smith retried from SSE and as a member of the SHEAC on 31 May 2016. Jim McPhillimy retried from SSE and as a member of the SHEAC on 31 October 2016. Dear Shareholder, On behalf of the Board, I am pleased to present the report from the Safety, Health and Environment Advisory Committee (SHEAC). During this reporting year, members of the SHEAC have taken the opportunity to visit various operational sites throughout the UK and Ireland, which has allowed us to meet a number of front-line employees, and gain insight into the culture relating to safety, heath and environment across SSE’s businesses. These meetings and visits have provided a backdrop for our increased focus on the unique challenges facing each of SSE’s business areas through the framework of the Enduring Goals. The Enduring Goals were rolled out in 2015/16 and subsequently updated in 2016/17. They are designed to improve safety, health and environmental performance across the Group and I am pleased to report that overall performance has improved during 2016/17. Looking forward over the next 12 months, the SHEAC have agreed to continue work in this area, through the review and implementation of, existing and new initiatives to drive improvements in the following Enduring Goals: Contractor Safety; Safety Family; Operational Safety; and Occupational Health and Well-being. I hope you find the report that follows an interesting explanation of our work and SHE performance during the year. Jeremy Beeton CB Chairman of the SHEAC 16 May 2017 78 SSE plc Annual Report 2017 78 SSE plc Annual Report 2017 Directors’ Report – Corporate governanceRole The SHEAC advises the Board on matters relating to safety, health and environment. The remit of the SHEAC is set out in its terms of reference which were updated during the year, and include responsibility for: – ensuring adherence to SSE’s safety, health and environmental policies; – setting Group targets and monitoring performance against these targets; – developing strategy to drive improvements in performance; – promoting a culture, and enhancing the awareness, of safety, health and environmental management; and – making recommendations to the Board where action or improvement is needed. Composition The membership of the SHEAC currently comprises three non-Executive Directors, two Senior Managers with significant operational responsibilities in Wholesale and Networks and the Group Safety, Health and Environment Manager. Members of the SHEAC are appointed by the Board following recommendation by the Nomination Committee. During the year, Colin Nicol and Jim Smith were appointed to the SHEAC and replaced Jim McPhillimy and Paul Smith, both of whom retried from SSE. The Chief Executive routinely attends meetings and the Deputy Company Secretary is Secretary to the SHEAC. The SHEAC provides a leadership forum for the non-Executive Directors to share their knowledge and expertise with senior management. Jeremy Beeton brings a depth of experience from his background in engineering and major construction projects. Sue Bruce provides valuable insights from various senior roles in the public sector. Helen Mahy brings a wealth of knowledge from her career in the energy industry. Meetings and activities in 2016/17 During the year, the SHEAC had three meetings, with one of these being held at Clyde Windfarm. The SHEAC has an annual work plan with standing items covering safety, health and environmental: performance; incidents and trends; risks and priorities. Other matters which the SHEAC has focused on during the year include: strategy to improve SSE’s SHE performance over multiple years; contractor safety; decommissioning and demolition; driving; and SHE-related training. The Board and Committee evaluation process which was carried out during the year confirmed that the SHEAC continued to operate effectively. Performance in 2016/17 Safety SSE’s overall safety goal is 100% injury free working by those working for and on behalf of SSE. SSE’s total recordable injury rate for SSE and Contractors was 0.22 per 100,000 hours worked in 2016/17, compared to 0.23 in 2015/16. way, helping employees make a speedy return to health and to work. During 2016/17, the average number of days of sickness absence from work was 9.8 days per person. In this financial year there have been 102 incidents that have harmed individuals and most tragically this includes a fatality on one of our major construction projects. This compares to 113 incidents for the same period in 2015/16. On balance, this performance shows some progress; but it also still represents a significant number of incidents and accidents. One area of continuing concern is the number of serious incidents involving company vehicles with 19 Class 1 Road Traffic Collision Accountable incidents in 2016/17, compared with 29 in the previous year. Following on from the successful implementation of Project Drive in 2015/16 SSE has continued to improve the management of road risk in 2016/17. This has had a positive impact on driving related safety and the management of road risk will continue to be a key area of focus going forward. Health SSE’s Health and Well-Being Action Plan provides the basis for workplace health programmes and initiatives, all designed to help promote the physical and mental health of employees. SSE deals with sickness absence in a sympathetic and constructive Environment Developing and upgrading the energy infrastructure in the UK is an essential part of providing the energy people need. With the transition towards a low carbon economy, it is increasingly important that this infrastructure has sufficient capacity to deliver ‘greener’ energy. Developing, building, owning and operating this infrastructure can have both positive and negative impacts on people’s lives. It is therefore important to develop these projects responsibly, listening to stakeholders and responding in a balanced way. SSE’s main environmental impact arises from emissions of CO2 associated with electricity generation, and the reporting of greenhouse gas emissions is set out on pages 18 and 19. SSE’s focus remains on minimising the impact of operations and adhering to environmental based permit conditions associated with its operations and minimising the impact of operations and projects. Further information relating to safety, health and environmental performance during 2016/17 is contained on pages 1 to 53 and also included in SSE’s Sustainability Report which is available on the SSE website. The Enduring Goals SSE’s first priority in everything it does is to prevent harm to people or places. In support of that, SSE’s first core value is Safety – we believe all accidents are preventable, so we do everything safely and responsibly or not at all. Due to the diversity of operations across SSE’s businesses, this core Safety value is supported by a set of Enduring Goals, which provide a framework for each business to focus attention on its unique safety, health and environmental challenges. The work of the SHEAC is designed around these Enduring Goals which are set out below. 1 Safety Family Being our brother’s keeper with everyone working to high standards. 2 Driving Creating a company of lower risk drivers. 3 Process Safety Carrying out our duty of care diligently and preventing major incidents. 4 Contractor Safety Working with our contractors to be ‘best in class’ on Safety. 5 Occupational Health and Well-being Protecting our team’s health and promoting their well-being. 6 Environment Protecting the environment and operating in a sustainable way. 7 Crisis Management Staying well prepared and responding brilliantly when things go wrong. 8 Operational Safety Ensuring a robust safe system of work. 79 3.2. Directors’ Report1.Remuneration Remuneration Committee Report Members and meetings Member Position Member since Katie Bickerstaffe Non-Executive Director ¹ Jeremy Beeton Non-Executive Director ¹ Crawford Gillies SID Richard Gillingwater CBE Chairman of the Board 2011 2014 2015 2007 1 All non-Executive Directors are considered to be independent by the Board. Attended/ scheduled 3/3 3/3 3/3 3/3 80 SSE plc Annual Report 2017 80 SSE plc Annual Report 2017 In this section: Chairman’s Statement A snapshot of SSE’s approach to pay Annual report on remuneration Single total figure of remuneration 2016/17 AIP 2014/17 PSP Other remuneration disclosures Pay ratio Governance Implementation for 2017/18 Summary of remuneration policy 80 82 86 86 87 89 89 91 94 95 96 Dear Shareholder, The objective of the Directors’ Remuneration Report for 2016/17 is to set out in a simple and transparent way how SSE pays its Directors (executive and non-executive); the decisions made on their pay and how much they received in relation to 2016/17 performance. The report also describes how this links to the Company’s purpose and strategy; how the Remuneration Committee works, and how it has given due consideration to the perspectives of SSE’s stakeholders. Linking Executive Directors’ remuneration with SSE’s purpose and strategy It is key that our overall remuneration policy is aligned to SSE’s core purpose of providing energy in a reliable and sustainable way; energy is a long-term business requiring effective stewardship. It must also be aligned to SSE’s strategy of efficient operations and disciplined investment, which requires genuine customer focus and strong delivery capability, across a balanced range of energy businesses. In addition, it must be consistent with SSE’s wider commitment to being a responsible company, which, in remuneration terms, means a policy characterised by simplicity to enable effective stakeholder scrutiny and balance to take account of a broad range of considerations. Finally, remuneration policy must be characterised by fairness: fair to the Executive Directors themselves; fair relative to the rest of the SSE team; fair in terms of the value delivered to SSE’s investors by its Executive team; and fair in terms of SSE’s contribution to society as a whole. Together, stewardship, customer focus, Directors’ Report – Corporate governancedelivery, simplicity, balance and fairness provide the pillars of our overall remuneration policy. The Committee is very mindful of the public debate on executive pay and the Company as a whole has sought to maintain a clear and consistent approach to pay, with simple, transparent arrangements which are easily understood and consistent with SSE’s commitment to being a responsible employer. We are also aware of employees’ views on executive pay and general employment issues. As part of this process the HR Director and Head of Reward meet with recognised employee representatives annually and provide feedback to the Committee following the meeting. It is my intention over the next 12 months that I will meet directly with the employee representatives. The extent and impact of their responsibilities means Executive Directors are well-paid; the remuneration policy of SSE is designed, amongst other things, to ensure they are fairly paid but not overpaid. As part of our commitment to transparency, we have again voluntarily disclosed a CEO pay ratio (see page 91). We have also provided detailed disclosure on the gender pay gap (see our Sustainability Report) and the measures we are taking as a Company to understand and address it over the long term. Using these additional reference points and taking a broader view of pay and employment conditions is as important to us as the use of external benchmark data when setting executive pay levels. As part of its responsibilities, the Remuneration Committee regularly reviews the remuneration policy to ensure it remains appropriate for the business and is at the forefront of developments in good corporate governance. The Committee has been following the wide range of investor guidance that has been released in the last 12 months and the consultation process for the UK Government’s Green Paper on Corporate Governance. We accept that this may have an impact on UK market practice over time. Where relevant, we have implemented a number of these suggestions on a voluntary basis. However, the Committee does not believe it is appropriate to make material changes to the policy only a year into the current policy period, although this is an area which will be kept under review to ensure we are best supporting the long-term interests of the business, applying a consistent approach across the senior executive team and developing and retaining the best talent. Performance related pay out-turns in 2016/17 In a difficult trading environment SSE performed robustly against its key metrics with DPS, Adjusted PBT, Adjusted EPS, customer performance and cashflow all at or ahead of expectations as shown on page 83. The PBT target was adjusted to remove the impact of SGN earnings after the part-disposal earlier in the year to ensure consistency of measurement. – Annual Incentive Plan (AIP): The out-turn under the AIP was determined against a range of financial, strategic and personal targets set at the beginning of the year. This resulted in an outcome of 72% of the maximum opportunity. We have set out details of SSE’s performance against the AIP measures and targets on page 87. – Performance Share Plan (PSP): For PSP awards granted in 2014, which were due to vest following the end of the 2016/17 financial year, measurement of performance over the three year period resulted in a 45.5% out-turn against the PSP measures and targets on page 89. This is the first vesting of the PSP, including revised measures from 2014. For both plans the Committee considered in detail, whether any adjustments were merited and decided, taking into account overall performance, to make a downward adjustment to the AIP total, reducing the overall pay out for both Executive Directors from 76% to 72%. The Committee decided to leave the PSP performance unadjusted. Improved performance under both the AIP and PSP means that the level of total remuneration earned by the Chief Executive has increased significantly, by 72% year-on- year. This increase also includes the PSP vesting for the first time in three years together with last year’s approval by shareholders to increase the maximum opportunity under the AIP. To put this into context, however, total remuneration in 2015/16 decreased compared with the previous year, which demonstrates that there is a clear link between business performance and remuneration out-turn in any given year. Implementation for 2017/18 The current Directors’ Remuneration Policy was approved with 99% of votes cast in favour at the 2016 AGM. During the year the Committee reviewed the policy and determined that it remained appropriately aligned to SSE’s strategy. The Committee agreed to base salary increases for the Executive Directors of 2.4% which are in line with those provided to the wider SSE workforce. Next steps In light of the continuing debate on executive pay and our desire to enhance the effectiveness of pay in support of SSE’s strategy, the Committee intends to spend time during 2017/18 considering how we can operate the policy more effectively, which will include amongst other things: – The operation of the PSP and alignment of approach with below board participants to ensure consistency of approach. – Moving the primary AIP financial measure from Adjusted PBT to Adjusted EPS to align with the key measure and general approach SSE take when issuing financial performance guidance. Finally, it is worth noting from SSE’s preliminary results statement in May 2017 and from this Annual Report that SSE expects this to be a challenging year. Taking this into account it is the role of the Committee to continue to set challenging but fair performance measures and targets that incentivise strong performance and delivery by the Executive Directors and the wider SSE team. As always, I appreciate any feedback or comments on this Report. We will endeavour to report remuneration matters with clarity and transparency and welcome any suggestions on how we can improve this. Katie Bickerstaffe Chairman of the Remuneration Committee Summary of activities during the year – Setting of performance metrics for 2016/17 – Review of Committee advisors – Review of performance – Analysis of proposed governance reforms 81 3.2. Directors’ Report1.Remuneration continued A snapshot of SSE’s approach to pay Remuneration principles and strategy Simplicity Pay comprises just four elements – base salary, benefits (including pension), an annual incentive and a long-term incentive. Customer focus Customer service measures are included in both the annual incentive and PSP. Balance A balanced range of measures used to ensure all aspects of Executive Directors’ overall performance is covered. Delivery Dividends and Total Shareholder Return (TSR) measures align Executive Directors’ interests with those of shareholders. Stewardship Executive Directors are expected to look to the long term and build and maintain significant personal shareholdings in the business even after they retire. Fairness Our transparent approach to setting and reporting pay levels which takes into account a range of stakeholder views. A summary of our pay policy in action Element Salary Fixed pay Benefits Pension Variable pay – at risk Annual Incentive Plan (AIP) Additional governance Performance Share Plan (PSP) Share ownership requirement Recovery and withholding Post- employment 82 SSE plc Annual Report 2017 Max 2016/17 2017/18 2020/21 2022/23 Salary paid Benefits paid Pension accrual Increases normally limited to those of wider employee base Market competitive Final salary and top up (with pensionable pay increases capped at RPI+1%) CEO 150% of salary FD 130% of salary 67% cash/33% career shares CEO 200% of salary FD 175% of salary 2 Year holding period AIP cash paid AIP career share award granted PSP awards granted Award vests PSP awards vests Holding period ends 200% of salary Share ownership requirement All incentives Clawback: misstatement, serious misconduct, error in calculation Malus: misstatement, misconduct, serious reputational damage, error in calculation Career shares Holding requirement for career shares until one year after cessation of employment Directors’ Report – Corporate governanceLink between strategy, KPIs and incentive performance measures TSR DPS Cashflow Adjusted EPS Adjusted PBT Customer Teamwork Personal SSE’s performance in 2016/17 Adjusted EPS Adjusted PBT 125.7p +5.2% Total Recordable Injury Rate 0.22 -4.4% £1,545.9m +2.1% Strong performance in the Citizens Advice Energy Supplier Performance Report Ranked 2 out of 22 suppliers Total shareholder return over the last three years Providing the energy people need in a reliable sustainable way Financial objectives Consistent strategy Long-term focus ü ü ü ü ü ü ü ü ü ü ü ü Adjusted capital and investment expenditure £1,726.2m +6.6% Contribution to UK economy £9.3bn +5% Electricity networks estimated incentive performance Total carbon emissions (000's tonnes) £19.52m 19,395 -14% 130 120 110 100 90 80 70 Mar 14 Sep 14 Mar 15 Sep 14 Mar 15 Sep 15 Mar 16 Sep 16 Mar 17 Source: Datastream (Thomson Reuters). SSE FTSE 100 MSCI Europe Utilities 83 3.2. Directors’ Report1. Remuneration continued Performance against AIP targets Performance against PSP targets (2014-17) Adjusted PBT (30%) Actual £1.546m (62% out-turn) Relative TSR 1 (20%) V FTSE100 Actual Ranking at median (27% of max) Threshold £1.449m Target £1.526m Max £1.604m Threshold Median Ranking Max Upper Quartile Ranking DPS growth (10%) Actual RPI (50% out-turn) Threshold Growth at RPI Relative TSR 2 (20%) V MSCI Europe (24) Actual Ranking above median (51% of max) Max RPI + 2% Threshold Median Ranking Max Upper Quartile Ranking Retained cash-flow/debt (10%) Adjusted EPS Growth (20%) Actual 15.7% (100% out-turn) Actual < RPI (0% of max) Threshold 13% Target 13.5% Max 14% Threshold (25%) – RPI+2% Max – RPI+10% Non-financial (50%) Actual 84% DPS Growth (20%) Actual RPI (50% of max) Threshold 50% Max 100% Threshold (50%) – RPI Customer (20%) Threshold (rank 2) – 50% Max RPI+5% Actual rank 1 (100% of max) Max rank 1 84 SSE plc Annual Report 2017 Directors’ Report – Corporate governanceExecutive Directors’ Remuneration for 2016/17 The chart below shows the total remuneration received for 2016/17. For comparison, the chart also indicates, minimum, on target and maximum remuneration levels that could have been earned in the year. Chief Executive – Alistair Phillips-Davies Finance Director – Gregor Alexander 5,000 4,000 3,000 2,000 1,000 ) 0 0 0 £ , ( n o i t a r e n u m e R l a t o T 43% 27% 22% 31% 33% 21% 47% 46% 30% 5,000 4,000 3,000 2,000 1,000 ) 0 0 0 £ , ( n o i t a r e n u m e R l a t o T 42% 26% 32% 23% 28% 49% 31% 20% 49% Minimum Actual Target Maximum Minimum Target Actual Maximum PSP AIP Base salary, benefits, pension The charts above are based on the current Executive Directors’ packages and show the amount of remuneration payable in four scenarios; 1) minimum performance where only base salary, benefits and pension is payable, 2) target performance, 3) maximum performance and 4) actual performance. Underlying assumptions Minimum performance Only the fixed pay elements are included i.e. base salary, benefits and pension calculated as: – Base salary effective from 1 April 2016. – Benefits represent those shown in the single figure table on page 86. – Pension is the annual value shown in the single figure table on page 86. Chief Executive Finance Director Base salary £ 844,104 652,424 Benefits £ 24,752 21,135 Pension £ 501,600 397,600 Total £ 1,370,856 1,061,559 Target performance This is what the Executive Director would receive in addition to the minimum performance elements, if the Committee agreed that target level performance had been achieved: – AIP would be 50% of maximum opportunity. – PSP would be 50% of maximum opportunity and dividends would accrue at the rate of the 2014-17 PSP. Maximum performance This is what the Executive Director would receive in addition to the minimum performance element, if the Committee agreed that the maximum level performance had been achieved: – AIP would be 150% of base salary for the CEO and 130% for the FD. – PSP would be 200% of base salary for the CEO and 175% for the FD and dividends would accrue at the rate of the 2014-17 PSP. Notes: The AIP figures are the gross value of awards before 33% is converted into deferred career shares. The PSP awards do not include any assumptions for share price growth. 85 3.2. Directors’ Report1. Remuneration continued Annual report on remuneration 1. Single total figure of remuneration (audited) Single total figure of remuneration for each director for financial years ending 31 March 2016 and 2017 : Base salary/fees ⁵ £000s Benefits ⁶ £000s AIP ⁷ £000s PSP⁸ £000s Pension⁹ £000s Total 10 £000s Executive Directors Alistair Phillips-Davies Gregor Alexander Non-Executive Directors Jeremy Beeton Katie Bickerstaffe Sue Bruce Crawford Gillies 1 Richard Gillingwater CBE 2 Peter Lynas Helen Mahy 3 Lord Smith of Kelvin 4 2017 844 652 74 78 63 76 369 79 63 35 2016 824 637 71 69 60 47 275 75 5 117 2017 2016 25 21 24 21 2017 910 610 2016 445 344 2017 644 498 2016 0 0 2017 502 388 2016 403 286 2017 2016 2,925 2,169 1,696 1,288 Total 5,094 2,984 74 78 63 76 369 79 63 35 71 69 60 47 275 75 5 117 Overall Total 5,931 3,703 Notes: 1 Crawford Gillies was appointed to the Board on 1 August 2015. 2 Richard Gillingham CBE was appointed as Chairman on 23 July 2015. 3 Helen Mahy was appointed to the Board on 1 March 2016. 4 Lord Smith of Kelvin stepped down as Chairman on 23 July 2015 and was retained by SSE’s Executive Committee for a further year to provide advice and counsel on key business issues relating to Scotland. SSE offers all staff a range of voluntary benefits some of which operate under a salary sacrifice arrangement. The salaries shown above is reported before any such adjustments are made. 5 6 Benefits relate to company car, Share Incentive Plan company contributions and medical benefits. These benefits are non-pensionable. 7 The AIP figures above show the full value of the award before 33% was deferred in shares. 8 The PSP awards due to vest in 2016 lapsed in full. The estimated value shown in the table above is based on the average share price in the three months to 31 March 2017 of £15.19p, as is required by the reporting regulations. The awards remain subject to service until May 2017 and so the prior year comparative will be restated in next year’s report to show the actual value on vesting, as is required by the regulations. 9 The pension value represents the cash value of pension accrued over 1 year x a multiple of 20 (less director contributions) in line with statutory reporting requirements. 10 Directors have not received any other items in the nature of remuneration other than as disclosed in the table. Rationale for 2017 single total figure As indicated on page 83 and shown in specific detail in the following sections, the financial and operational performance of the business has been strong in the context of the overall market conditions. As a result of this and the increases agreed to maximum AIP levels in 2016, the year-on-year increases in the above table are significant. This corporate performance is also reflected in the pay outcomes for wider employees with the average annual incentive paid increasing by around 11% compared to last year. In this context, the Committee is satisfied that the total single figure outcomes are appropriate and not excessive. Salary The salaries shown in the table reflect a 2016/17 salary, effective from 1 April 2016 to 31 March 2017, of £844,104 for the Chief Executive and £652,424 for the Finance Director. This represented an increase of 2.4% from the previous year, which was in line with the average performance-based salary increase for the wider SSE employee population. Benefits Benefits are provided at an appropriate level taking into account market practice at similar sized companies and the level of benefits provided for other employees in the Company. Core benefits include car allowance, private medical insurance and health screening. The Executive Directors participate in the Company’s all-employee share schemes on the same terms as other employees. Pension The Executive Directors are members of either the Southern Electric Pension Scheme or the Scottish Hydro-Electric Pension Scheme and their plan membership predates their Board appointments. These are both funded final salary pension schemes and the terms of these schemes apply equally to all members. The Directors’ service contracts provide for a possible maximum pension of two thirds final salary from the age of 60. In relation to Executive Directors who are subject to the scheme-specific salary cap (which mirrors the provisions of the previous HMRC cap arrangements) the Company provides top-up (unfunded) arrangements which are designed to provide an equivalent pension on retirement from the age of 60 to that which they would have earned had they not been subject to the salary cap. From 1 April 2017 pensionable earnings will be capped at RPI +1%. These are legacy arrangements and would not be used for any new external appointments. The Executive Directors, in common with all other employees who joined at the same time, have the following pension provisions relating to leaving the Company: for retirement through ill-health an unreduced pension based on service to expected retirement is paid; in the event of any reorganisation or redundancy an unreduced accrued pension is paid to a member who is aged 50 or above, with at least five years’ service or, for a member who has not yet reached that age, it will be payable with effect from 50; and from the age of 55, a scheme member is entitled to leave the Company and receive a pension, reduced for early payment, unless the Company gives consent and funds this pension on an unreduced basis. 86 SSE plc Annual Report 2017 Directors’ Report – Corporate governance Dependent on the circumstances surrounding the departure of the Executive Director and financial health of the Company at the time, the Committee’s policy is to give consideration to a cash commutation of the unfunded unapproved retirement benefit (UURB) pension at the time of leaving. Any cash commutation will limit SSE’s liability, taking into account valuations provided by independent actuarial advisors, and will be calculated on what was judged to be a cost neutral basis to SSE. Alistair Phillips-Davies Gregor Alexander Accrued pension as at 31 March 2017 £000s Accrued pension as at 31 March 2016 £000s 381 356 354 335 2016/17 AIP The AIP award is determined by performance against three financial metrics (Adjusted PBT, DPS Growth and Cash-flow) and three areas of non-financial performance (Customer, Teamworking and Personal). The table below provides more information on the measures and the performance that was ultimately delivered. Financial (50%) Adjusted PBT DPS Growth Cashflow (Retained cashflow/net debt) Total Weighting Threshold Target Maximum Actual outcome % Out-turn £1,449m £1,526m £1,604 rpi + 2% £1,546m rpi 62% 50% rpi 30% 10% 10% rpi 13% 13.5% 14% 15.7% 100% Total 19% 5% 10% 34% Adjusted to 30% The financial performance targets were set at the start of the financial year taking into account internal financial plans, external consensus where it exists and the expected impact of identified opportunities and threats to the business in the context of wider economic conditions. The performance target range is set on a realistic basis but requiring true outperformance for Executive Directors to achieve the maximum. The Remuneration Committee has a history of setting challenging targets, evidenced by the average AIP payout over the previous five years of 41% (with a maximum achieved of 64%). While the committee measured overall financial performance at 34% it decided to exercise its discretion to make a downward adjustment to 30% taking into account factors influencing some of the exceptional charges during 2016/17. Non-financial (50%) When setting non-financial targets, the Committee ensures they are specific, measurable, attainable, realistic and timely (“SMART” objectives). By their nature, some objectives require a more subjective assessment than others and this is completed by the Committee following the input from the wider Board and other Board Committees as appropriate. The Committee is committed to providing as much retrospective detail of the measures as possible, setting out clearly the decision making process and the levels of attainment achieved, but mindful that we cannot disclose any information which could be considered commercially sensitive. Customer (15%) Performance is assessed using a selection of internal and external surveys including the Citizen’s Advice Bureau’s Energy Supplier Complaints league table, the Institute of Customer Service, the National Customer Satisfaction Index UK, Ofgem Customer Satisfaction measure and other trusted third party customer satisfaction surveys. For Network customer performance the Committee considers the wide range of Ofgem metrics that are used to determine incentives and penalties for that part of the business. The Committee takes a broad view of performance against each measure before approving the overall performance outcome. Retail customer service performance – A strong year for customer service in Retail. SSE was the leading large energy supplier as measured in the quarterly Citizens Advice Energy Supplier Performance Report throughout 2016/17. A new company record score was achieved twice during the year. SSE continues to have the lowest Ombudsman complaints in the industry with fewer than five complaints accepted per 100,000 customers in every quarter of 2016/17 (compared with an average of between 19 and 23 for the industry as a whole). Networks customer service performance – Customer interruption performance in Distribution, measured through an Ofgem scheme, delivered incentive earnings of almost £13.9m and performance against Ofgem’s customer service satisfaction measure saw the incentive award increasing significantly to almost £2.8m, reflecting measures to improve customer contact and engagement. Customer complaints performance has also improved, with 78% of all complaints resolved during 2016/17 within 24 hours an increase from 65%. Total 88% 80% 84% 13% 87 3.2. Directors’ Report1.Remuneration continued Teamworking (20%) This section is based upon an assessment of the SSESET of values. The Committee assesses each one individually before reaching an overall conclusion on the performance outturn. Safety – Performance was overshadowed by the tragic death of a contractor colleague on an SSE construction site. The number of SSE employees injured in the 12 month period reduced from 57 to 47 and there was a slight improvement in the 12 month rolling combined Total Recordable Injury Rate (0.22) and a slight decrease in Accident Frequency Rate to (0.11). There was a concerted focus in the year on further developing SSE’s safety culture, managing process safety risks , ensuring appropriate authorisation processes and improving employee wellbeing. Taking everything into account, however, overall performance was adjusted down. Service – Strong performance with Retail retaining a leading position in the Citizens’ Advice Energy Supplier Performance Report; and with Networks securing incentive earnings relating to customer interruption performance, customer contact and engagement (Distribution) and strong performance in a survey of stakeholder satisfaction (Transmission). See also page 87. Efficiency – excellent progress in bearing down on controllable costs, including sustainable savings of £50m realised against an original target of £30m and detailed plans in place to deliver further controllable savings in 2017/18. In 2016, SSE announced the disposal of a partial stake of SGN, with the price secured confirming SSE’s ability to deliver value for shareholders. Strong performance in refinancing with debt replaced at lower like for like costs. Sustainability – Strong progress was made in this area. Achieved an ‘A-‘ rating in the annual CDP (formerly Carbon Disclosure Project) assessment. Enhanced tax disclosure was delivered through the Talking tax 2016 report and retention of Fair Tax Mark accreditation. Achieved British Standard for inclusive service provision for its Networks business and committed to securing the Standard for its Retail business. A new partnership was developed with the Institute of Business Ethics in support of implementing a revised and robust code of ethical business practice. Excellence – Significant progress made with a number of key capital projects progressing well, including the completion of the Beauly-Denny transmission line. Strong progress was also made in delivering renewable energy projects in Scotland and Ireland. Excellence in large capital project delivery was also recognised with SSE winning the Excellence in Sustainability in Irish Construction Awards 2016. Early disclosure on gender pay contributed to SSE securing the Building Public Trust in Corporate Reporting Award for people reporting in the FTSE 100. Teamworking – Good progress with the review of the Executive-level governance framework to ensure decisions are made at the right level, and good progress with the review of organisational design to improve the effectiveness of organisational structures in SSE’s businesses. Detailed structural changes made with people and business impact well managed. Continued focus in support of the inclusion and diversity agenda with each business developing specific action plans. 65% 85% 90% 85% 85% 79% Total 82% 16% Personal (15%) Personal performance measures are intended to focus executive directors on the key operational and strategic objectives which support the longer-term performance of the business. Some objectives are consistent across all members of the senior management team, but others are personal to the individual reflecting the key responsibilities of their role. Some goals have quantifiable targets, but others require a more subjective assessment. The Committee considers performance against each measure before determining an aggregate outcome for this element of the AIP. Alistair Phillips-Davies – Delivered a very strong business performance against a challenging backdrop. A clear focus on simplifying the SSE group and delivering strong controllable cost savings through increased efficiency and review of organisational design. Led an effective strategy and future growth review for the Board. A strong focus on stakeholder engagement, with the approach of having the customer at the forefront of SSE’s thinking. Continues to focus on moving SSE forward as a responsibly- minded organisation that delivers value for shareholders. All objectives met or exceeded. Gregor Alexander – Delivered very strong business results, supporting a strong financial performance with effective management of debt costs and cashflow. Effective delivery of the SGN sell down and strong performance in system delivery and across the wider corporate service arena. Effective interaction with a wide range of stakeholders with strong and effective relationships maintained. All objectives met or exceeded. 86% 86% Total Overall total (including downward adjustment) Both Alistair Phillips-Davies and Gregor Alexander 88 SSE plc Annual Report 2017 86% 13% 72% Directors’ Report – Corporate governanceAlistair Phillips-Davies Gregor Alexander Maximum potential (% of salary) 150% 130% AIP earned £910,366 £609,821 AIP cash AIP deferred 1 £609,945 £408,580 £300,421 £201,241 Note: 1 33% of AIP is deferred into shares for three years which are then retained until a year after stepping down from the Board. Both the cash and deferred element remain subject to clawback provisions. The Remuneration Committee believes that the range of measures used in the AIP ensures that performance is assessed using a balanced approach, without undue focus on a single metric which could be achieved at the expense of wider initiatives. Given the performance noted above and wider operational achievements noted in the Strategic Report on page 16 the Committee is comfortable that the AIP outcomes represent a fair reward for performance delivered. PSP awards vesting in the year (2014-2017) PSP awards granted during the 2014/15 financial year, have three-year performance periods which ended on 31 March 2017. Performance was assessed against the targets as set out in the table below: Performance condition Measure Weight Threshold Maximum Outcome Relative TSR Financial/Share-Based v FTSE 100 v MSCI EPS DPS 20% 20% 20% 20% Median Median Rpi Rpi Rpi + 10% Rpi + 4% Upper Quartile 47th out of 94 Upper Quartile 10th out of 23 Customer Total Consumer Futures ranking 20% Rank 2 Rank 1 10% of trade receivables. The biggest customer balance, due from a wholesale customer (also a wholesale supplier), is 9% (2016 – 8%) of the total trade receivables. The ageing of trade receivables at the reporting date was: Not past due Past due but not individually impaired: 0-30 days 31-90 days Over 90 days Less: allowance for impairment Net Trade receivables 2017 £m 2016 £m 2,374.6 1,690.2 133.8 49.4 160.8 2,718.6 (120.0) 2,598.6 156.3 59.2 208.6 2,114.3 (147.5) 1,966.8 The Group has past due debt which has not had an impairment allowance set aside to cover potential credit losses. The Group has certain procedures to pursue customers in significant arrears and believes its impairment policy in relation to such balances is appropriate. Those debts which are neither past due nor impaired are considered to be good and are expected to be recoverable. The Group has other receivables which are financial assets totalling £16.6m (2016 – £23.7m). The movement in the allowance for impairment of trade receivables was: Balance at 1 April Increase in allowance for impairment Impairment losses recognised Balance at 31 March 2017 £m 147.5 21.7 (49.2) 120.0 2016 £m 154.3 54.3 (61.1) 147.5 At the end of each reporting period a review of the provision for bad and doubtful debts is performed. It is an assessment of the potential amount of trade receivables which will not be paid by customers after the balance sheet date. This amount is calculated by reference to the age, status and risk of each class of receivable. 178 SSE plc Annual Report 2017 Financial StatementsA6. Financial risk management continued A6.3 Liquidity risk and going concern Liquidity risk, the risk that the Group will have insufficient funds to meet its liabilities, is managed by the Group’s Treasury function. The Group can be exposed to significant movements in its liquidity position due to changes in commodity prices, working capital requirements, the impact of the seasonal nature of the business and phasing of its capital investment and recycling programmes. Treasury is responsible for managing the banking and liquidity requirements of the Group, risk management relating to interest rate and foreign exchange exposures, and for managing the credit risk relating to the banking counterparties with which it transacts. Short-term liquidity is reviewed daily by Treasury, while the longer term liquidity position is reviewed on a regular basis by the Board. The department’s operations are governed by policies determined by the Board and any breaches of these policies are reported to the Risk and Trading Committee and Audit Committee. In relation to the Group’s liquidity risk, the Group’s policy is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, under both normal and stressed conditions, without incurring unacceptable losses or risking damage to the Group’s reputation. During the year, the Group’s approach to managing liquidity was to seek to ensure that the Group had available committed borrowings and facilities equal to at least 105% of forecast borrowings over a rolling 6 month period. The Group uses cash flow forecasts to monitor its ongoing borrowing requirements. Typically, the Group will fund any short-term borrowing positions by issuing commercial paper or borrowing from uncommitted bank lines and will invest in money market funds when it has a cash surplus. Details of the group’s borrowings are disclosed at Note 21. In addition to the borrowing facilities listed at Note 21.2, the Group has £150m of uncommitted bank lines and a £15m overdraft facility. The refinancing requirement in the 17/18 financial year is the intended redemption of £1.03bn of NC5 hybrids issued in 2012, the Group has already successfully issued a dual tranche hybrid debt in March 2017 in order to cover this refinancing. This dual tranche issue comprises £300m with a coupon of 3.625% and $900m with a coupon of 4.75%. The $900m tranche has been swapped back to both Euros and Sterling, bringing the all-in rate down to 2.72% and resulting in an all-in funding cost for both tranches to SSE of 3.02% per annum which compares favourably to the all-in funding cost of 4.02% achieved on SSE’s most recent hybrid equity securities issued in 2015. The Group has also signed a new £200m facility (£100m for SSE plc and £100m for Scottish Hydro Electric Transmission plc) with the European Investment Bank which will be drawn during 2017 at which point it will become a 10 year term loan. As a consequence, it is the view of the Directors that the Group’s 105% funding policy will be met out its forecast borrowing requirement to September 2017. Given the committed bank facilities of £1.5bn maintained by the Group and the current capital market conditions, the Directors have concluded that the Group has sufficient headroom to continue as a going concern. In coming to this conclusion, the Directors have also taken into account the successful issuance of £4.5bn of medium to long-term debt and hybrid equity since February 2012, and the Group’s credit rating. The statement of going concern is included in the Directors’ Corporate Governance report on page 72. Treasury also manage the Group’s interaction with its relationship banks (defined as those banks that support the Group’s financing activities through their ongoing participation in the committed lending facilities that are maintained by the Group). These are each allocated financial limits, subject to the maintenance of a minimum credit rating of investment grade or better allocated by a recognised major ratings group. In respect of short-term cash management, counterparties are subject to review and approval according to defined criteria. As at 31 March 2017, the value of outstanding cash collateral in respect of mark-to-market related margin calls on exchange traded positions was £105.2m (2016 – £78.3m). The contractual cash flows shown in the following tables are the contractual undiscounted cash flows under the relevant financial instruments. Where the contractual cash flows are variable based on a price, foreign exchange rate or index in the future, the contractual cash flows in the following tables have been determined with reference to the relevant price, foreign exchange rate, interest rate or index as at the balance sheet date. In determining the interest element of contractual cash flows in cases where the Group has a choice as to the length of interest calculation periods and the interest rate that applies varies with the period selected, the contractual cash flows have been calculated assuming the Group selects the shortest available interest calculation periods. Where the holder of an instrument has a choice of when to redeem, the amounts in the following tables are on the assumption the holder redeems at the earliest opportunity. The numbers in the following tables have been included in the Group’s cash flow forecasts for the purposes of considering Liquidity Risk as noted above. 179 3. Financial Statements2.1.Accompanying information continued A6. Financial risk management continued A6.3 Liquidity risk and going concern continued The following are the undiscounted contractual maturities of financial liabilities, including interest and excluding the impact of netting agreements: 2017 2016 Carrying value £m Contractual cash flows £m 0-12 months £m 1-2 years £m 2-5 years £m > 5 years £m Carrying value £m Contractual cash flows £m 0-12 months £m 1-2 years £m 2-5 years £m > 5 years £m – 556.2 1,783.7 – (576.9) (2,332.0) – (111.7) (72.5) 5,208.2 – 257.4 (7,674.8) – – (220.9) – – – (4.8) (186.5) (726.5) – – – (460.4) (322.3) 198.8 – – 1,256.0 991.8 (1,750.7) (1,821.1) (4,906.3) 4,138.9 200.7 81.8 – – – – (198.8) (1,292.1) (1,352.0) (6,521.2) (487.4) – (198.8) (710.2) (38.2) (183.6) (22.8) – – (113.2) (50.7) – (317.6) (392.2) – (151.1) (870.9) (183.6) (22.4) – (1,000.8) (67.0) – (5,175.2) (375.2) – 7,805.5 (10,583.7) (405.1) (917.8) (2,603.8) (6,657.0) 6,868.0 (9,851.5) (1,153.6) (369.9) (1,777.6) (6,550.4) 276.9 (439.1) (55.5) (53.3) (153.0) (177.3) 300.8 (494.9) (53.9) (55.2) (160.0) (225.8) 8,082.4 (11,022.8) (460.6) (971.1) (2,756.8) (6,834.3) 7,168.8 (10,346.4) (1,207.5) (425.1) (1,937.6) (6,776.2) 1,443.1 250.3 820.6 (509.9) (60.4) – 2,218.3 5,667.0 4,645.5 951.4 70.1 – 40.9 (40.9) (17.4) (11.0) (9.2) (3.3) 58.4 (58.4) (19.7) (19.7) (16.6) (2.4) 362.6 (362.6) (22.2) (21.1) (58.6) (260.7) 357.1 (357.1) (20.1) (19.9) (54.7) (262.4) 9.8 (538.6) (538.6) – – – – – – – – – 7.4 (180.3) (89.9) (90.1) (0.3) 0.1 (0.1) (0.1) – – – – 1,856.4 (691.8) 242.4 (542.0) (128.2) (264.0) 2,641.3 5,071.1 4,515.7 821.7 (1.5) (264.8) Liquidity risk Financial liabilities Loans and borrowings Commercial paper and cash advances Loans – floating Loans – fixed Unsecured bonds – fixed Non-recourse funding Fair value adjustment Finance lease obligations Derivative financial liabilities Operating derivatives designated at fair value Interest rate swaps used for hedging Interest rate swaps designated at fair value Forward exchange contracts held for hedging Forward exchange contracts designated at fair value Other financial liabilities Trade payables 2,606.7 (2,606.7) (2,606.7) 2,606.7 (2,606.7) (2,606.7) – – – – – 1,868.3 (1,868.3) (1,868.3) – 1,868.3 (1,868.3) (1,868.3) – – – – – – Total 12,545.5 (14,321.3) (2,824.9) (1,513.1) (2,885.0) (7,098.3) 11,678.4 (7,143.6) 1,439.9 396.6 (1,939.1) (7,041.0) Derivative financial assets Financing derivatives Operating derivatives designated at fair value (518.0) 86.2 (63.0) (46.8) 134.5 61.5 (298.7) (512.7) (519.6) (69.2) 37.6 38.5 (1,279.8) (1,487.5) (1,027.9) (410.3) (49.3) – (1,854.0) (5,146.1) (4,082.9) (950.6) (112.6) – (1,797.8) (1,401.3) (1,090.9) (457.1) 85.2 61.5 (2,152.7) (5,658.8) (4,602.5) (1,019.8) (75.0) 38.5 Net total (i) 10,747.7 (15,722.6) (3,915.8) (1,970.2) (2,799.8) (7,036.8) 9,525.7 (12,802.4) (3,162.6) (623.2) (2,014.1) (7,002.5) (i) The Group believes the liquidity risk associated with out-of-the-money operating derivative contracts needs to be considered in conjunction with the profile of payments or receipts arising from derivative financial assets. It should be noted that cash flows associated with future energy sales and commodity contracts which are not IAS 39 financial instruments are not included in this analysis, which is prepared in accordance with IFRS 7. 180 SSE plc Annual Report 2017 Financial StatementsA6. Financial risk management continued A6.4 Commodity risk The Group’s Energy Portfolio Management (‘EPM’) business manages the Group’s exposure to energy commodity price movements and requirement for the delivery of its physical commodity needs as part of its normal course of business. The risk management activity carried out by EPM arises from the Group’s requirement to source gas, electricity or other commodities such as renewable obligation certificates for Energy Supply, and to procure fuel and other commodities and provide a route-to-market for Electricity Generation. The Group’s strategy is to manage all exposures to commodity risk through volumetric limits and to measure the exposure by use of Value at Risk (VaR) models. The exposure is subject to financial limits established by the Board and managed by reference to guidance agreed by the Risk Committees of Retail and Wholesale. Exposures are reported to the Committees on a monthly basis and to the Board when certain trigger levels are exceeded. Within this approach, only certain of the Group’s energy commodity contracts are deemed to constitute financial instruments under IAS 39. As a result, while the Group manages the commodity price risk associated with both financial and non-financial commodity contracts, it is only the fair value of IAS 39 financial instruments which represents the exposure of the Group’s commodity price risk under IFRS 7. This is a consequence of the Group’s accounting policy which stipulates that commodity contracts which are designated as financial instruments under IAS 39 should be accounted for on a fair value basis with changes in fair value reflected in profit or equity. Conversely, commodity contracts that are not designated as financial instruments under IAS 39 will be accounted for as ‘own use’ contracts. As fair value changes in own use contracts are not reflected through profit or equity, these do not represent the IFRS 7 commodity price risk. Therefore, as the overall Group VaRs associated with commodity risk will be monitored for internal risk management purposes and is outside the scope of IAS 39. In EPM, the economic volatility that the Group is exposed to related to this risk is managed through a selection of longer and shorter term contracts for commodities such as gas, electricity, coal and carbon allowances, the arm’s length arrangements with the Group’s gas production business and through flexibility from the Group’s fleet of generation assets including assets such as pumped storage generating plant, flexible hydro generating plant, standby oil plant and contracts with the gas storage business. Short-term exposures will arise from the requirement to match volumes of procured gas and electricity with demand for gas and electricity by Energy Supply customers. In addition, exposures can arise from matching fuel and other commodity procurement with demand for these commodities arising from the Group’s Generation assets. Both can vary from expectations and result in a requirement to close the contracted positions at unfavourable prices. Longer-term exposures are managed by EPM through longer term contracts (including forwards, futures contracts and other financial instruments). These, in turn, are used to reduce short-term market exposures. As noted, certain commodity contracts are entered into primarily for own use purposes to supply to customers or to provide fuel to power stations. However, as noted, a number of these contracts do not qualify for own use treatment under IAS 39 and are subject to fair value measurement through the income statement. In addition to this, the Group enters into certain contracts to manage commodity price and volume risk. These are also subject to fair value measurement through the income statement. Finally, other physical contracts can be treated as the hedging instrument in documented cash flow hedging relationships where the hedged item is the forecast future purchase requirement to meet production or customer demand. The accounting policies associated with such items are explained in the Accompanying information Section A1. The consequential commodity risk which derives from these activities is quantified by the use of a Value at Risk (VaR) model which considers exposures in all commodities and provides an estimate of the potential change to the Group’s forecast profits over a given period and to a given confidence level. The calculated financial risk is controlled through the imposition of a number of risk limits approved by the Board and monitored and managed by the Risk Committees of Retail and Wholesale. The Group’s exposure to Commodity risk is subsequently reported to and monitored by the relevant Risk Committees and to the Executive Committee by exception. The Group’s exposure to commodity price risk according to IFRS 7 is measured by reference to the Group’s IAS 39 commodity contracts. IFRS 7 requires disclosure of a sensitivity analysis for market risks that is intended to illustrate the sensitivity of the Group’s financial position and performance to changes in market variables impacting upon the fair value or cash flows associated with the Group’s financial instruments. Therefore, the sensitivity analysis provided discloses the effect on profit or loss and equity at the balance sheet date assuming that a reasonably possible change in the relevant commodity price had occurred, and been applied to the risk exposures in existence at that date. The reasonably possible changes in commodity prices used in the sensitivity analysis were determined based on calculated or implied volatilities where available, or historical data. The sensitivity analysis has been calculated on the basis that the proportion of commodity contracts that are IAS 39 financial instruments remains consistent with those at that point. Excluded from this analysis are all commodity contracts that are not financial instruments under IAS 39. 181 3. Financial Statements2.1.Accompanying information continued A6. Financial risk management continued A6.4 Commodity risk continued Commodity prices UK gas (p/therm) UK power (£/MWh) UK coal (US$/tonne) UK emissions (€/tonne) UK oil (US$/bbl) 2017 2016 Reasonably possible increase/ decrease in variable Base price (i) Reasonably possible increase/ decrease in variable Base price (i) 43 40 65 5 54 +/-11 +/-10 +/-10 +/-2 +/-9 33 33 42 5 49 +/-4 +/-5 +/-4 +/-1 +/-7 (i) The base price represents the average forward market price over the duration of the active market curve used to calculate the sensitivity analysis. The impacts of reasonably possible changes in commodity prices on profit after taxation based on the rationale described are as follows: Incremental profit/(loss) Commodity prices combined – increase Commodity prices combined – decrease 2017 Impact on profit and equity (£m) 2016 Impact on profit and equity (£m) (239.0) 239.0 77.6 (77.6) The sensitivity analysis provided is hypothetical and is based on the Group’s commodity contracts under IAS 39. This is analysis only and should be used with caution as the impacts disclosed are not necessarily indicative of the actual impacts that would be experienced. It should also be noted that these sensitivities impacts provided are indicative only and are based on calculations which do not consider all interrelationships, consequences and effects of such a change in those prices. A6.5 Currency risk The Group publishes its consolidated financial statements in Sterling but also conducts business in foreign currencies. As a result, it is subject to foreign currency exchange risk arising from exchange rate movements which will be reflected in the Group’s transaction costs or in the underlying foreign currency assets of its foreign operations. The Group’s policy is to use forward contracts, swaps and options to manage its exposures to foreign exchange risk. All such exposures are transactional in nature, and relate primarily to procurement contracts, commodity purchasing and related freight requirements, commodity hedging, long-term plant servicing and maintenance agreements, and the purchase and sale of carbon emission certificates. The policy is to seek to hedge 100% of its currency requirements arising under all committed contracts excepting commodity hedge transactions, the requirements for which are significantly less predictable. The policy for these latter transactions is to assess the Group’s requirements on a rolling basis and to enter into cover contracts as appropriate. The Group has foreign subsidiary operations with significant Euro-denominated net assets. The Group’s policy is to hedge its net investment in its foreign operations by ensuring the net assets whose functional currency cash flows are denominated in Euros are matched by borrowings in Euros. For the acquired net assets whose functional cash flows are in Sterling, the Group will ensure Sterling denominated borrowings are in place to minimise currency risk. Significant exposures are reported to, and discussed by, the Risk and Trading Committee on an ongoing basis and additionally form part of the bi-annual Treasury report to the Audit Committee. At the balance sheet date, the total nominal value of outstanding forward foreign exchange contracts that the Group has committed to is: Forward foreign exchange contracts 2017 £m 2016 £m 2,580.2 2,783.8 182 SSE plc Annual Report 2017 Financial StatementsA6. Financial risk management continued A6.5 Currency risk continued The Group’s exposure to foreign currency risk was as follows: 2017 2016 DKK (million) SEK (million) ¥m €m $m NOK (million) CHF (million) DKK (million) SEK (million) ¥m €m $m NOK (million) CHF (million) Loans and 15,000.0 – – 2,375.3 1,994.0 borrowings Purchase and commodity contract commitments 390.1 Gross exposure 15,000.0 390.1 – – – 360.2 (843.2) 540.2 360.2 2,915.5 1,150.8 – – – Forward exchange/ swap contracts Net exposure (in currency) Net exposure (in £m) 15,000.0 390.1 360.2 1,700.3 1,144.0 – – – – – 1,215.2 – 1,036.5 6.8 5.4 – – – – – – – – 15,000.0 – – 2,063.3 850.0 – – – 41.8 41.8 15,000.0 982.1 982.1 1,105.9 1,105.9 453.9 2,517.2 377.5 1,227.5 23.9 23.9 34.6 34.6 – 41.8 15,000.0 982.1 1,105.9 2,029.1 1,239.0 23.9 34.6 – – – – – – – – 488.1 (11.5) 386.0 (8.0) – – – – This represents the net exposure to foreign currencies, reported in pounds Sterling, and arising from all Group activities. All sensitivity analysis has been prepared on the basis of the relative proportions of instruments in foreign currencies being consistent as at the balance sheet date. This includes only monetary assets and liabilities denominated in a currency other than Sterling and excludes the translation of the net assets of foreign operations but not the corresponding impact of the net investment hedge. The sensitivity analysis is indicative only and it should be noted that the Group’s exposure to such market rate changes is continually changing. The calculations are based on linear extrapolations of rate changes which may not reflect the actual result which would impact upon the Group. A 10% change in foreign currency exchange rates would have had the following impact on profit after taxation, based on the assumptions presented above: US Dollars Euro DKK ¥ SEK NOK CHF Equity Income statement At 31 March 2017 £m At 31 March 2016 £m At 31 March 2017 £m At 31 March 2016 £m – 87.1 – – – – – 87.1 – 43.2 – – – – – 43.2 (0.5) 6.2 – – – – – 5.7 0.7 (8.1) – – – – – (7.4) The impact of a decrease in rates would be an identical reduction in the annual charge. A6.6 Interest rate risk Interest rate risk derives from the Group’s exposure to changes in the value of an asset or liability or future cash flows through changes in interest rates. The Group’s policy is to manage this risk by stipulating that a minimum of 50% of Group borrowings be subject to fixed rates of interest, either directly through the debt instruments themselves or through the use of derivative financial instruments. The floating rate borrowings are provided by banks including the European Investment Bank (EIB). Such instruments include interest rate swaps and options, forward rate agreements and, in the case of debt raised in currencies other than Sterling, cross currency swaps. These practices serve to reduce the volatility of the Group’s financial performance. Although interest rate derivatives are primarily used to hedge risk relating to current borrowings, under certain circumstances they may also be used to hedge future borrowings. Any such pre-hedging is unwound at the time of pricing the underlying debt, either through cash settlement on a net present value basis or by transacting offsetting trades. The floating rate borrowings mainly comprise cash advances from the European Investment Bank (EIB). 183 3. Financial Statements2.1.Accompanying information continued A6. Financial risk management continued A6.6 Interest rate risk continued The impact of a change in interest rates is dependent on the specific details of the financial asset or liability in question. Changes in fixed rate financial assets and liabilities, which account for the majority of cash, loans and borrowings, are not measured at fair value through the income statement. In addition to this, changes to fixed-to-floating hedging instruments which are recorded under cash flow hedge accounting also do not impact the income statement. Changes in variable rate instruments and hedging instruments and hedged items recorded under fair value hedge accounting are recorded through the income statement. The exposure measured is therefore based on variable rate debt and instruments. The net exposure to interest rates at the balance sheet date can be summarised thus: Interest bearing/earning assets and liabilities: – fixed – floating Represented by: Cash and cash equivalents Derivative financial assets/(liabilities) Loans and borrowings Finance lease obligations 2017 Carrying amount £m (7,529.7) 942.6 (6,587.1) 1,427.0 68.3 (7,805.5) (276.9) (6,587.1) 2016 Carrying amount £m (5,613.9) (1,372.1) (6,986.0) 360.2 (177.4) (6,868.0) (300.8) (6,986.0) Following from this, the table below represents the expected impact of a change of 100 basis points in short-term interest rates at the reporting date in relation to equity and income statement. The analysis assumes that all other variables, in particular foreign currency rates, remain constant. An increase in exchange rates would be a change to either the income statement or equity. The assessment is based on a revision of the fair value assumptions included in the calculated exposures in the previous table. All sensitivity analysis has been prepared on the basis of the proportion of fixed to floating instruments being consistent as at the balance sheet date and is stated after the effect of taxation. The sensitivity analysis is indicative only and it should be noted that the Group’s exposure to such market rate changes is continually changing. The calculations are based on linear extrapolations of rate changes which may not reflect the actual result which would impact upon the Group. Income statement 2017 £m 4.9 4.9 2016 £m 14.3 14.3 The impact of a decrease in rates would be an identical reduction in the annual charge. There is no impact on equity as the analysis relates to the Group’s net exposure at the balance sheet date. Contracts qualifying for hedge accounting are, by definition, part of the Group’s covered position. 184 SSE plc Annual Report 2017 Financial StatementsA7. Fair value of financial instruments A7.1 Fair value of financial instruments within the group The fair values of the primary financial assets and liabilities of the Group together with their carrying values are as follows: 2017 2016 Amortised cost or other (i) £m Classified as trading (ii) £m Total carrying value £m Amortised cost or other (i) £m Classified as trading (ii) £m Total carrying value £m Fair value £m Fair value £m Financial assets Current Trade receivables Other receivables Cash collateral and other short-term loans Cash and cash equivalents Derivative financial assets 2,598.6 16.6 105.2 1,427.0 – – – – – 1,269.5 2,598.6 16.6 105.2 1,427.0 1,269.5 2,598.6 16.6 105.2 1,427.0 1,269.5 1,966.8 23.7 121.8 360.2 – – – – – 1,615.0 1,966.8 23.7 121.8 360.2 1,615.0 1,966.8 23.7 121.8 360.2 1,615.0 4,147.4 1,269.5 5,416.9 5,416.9 2,472.5 1,615.0 4,087.5 4,087.5 Non-current Unquoted equity investments Loans to associates and jointly controlled entities Derivative financial assets Financial liabilities Current Trade payables Bank loans, commercial paper and overdrafts Finance lease liabilities Derivative financial liabilities Non-current Loans and borrowings (iii) Finance lease liabilities Derivative financial liabilities 9.6 – 9.6 9.6 9.9 – 9.9 9.9 788.4 – 798.0 – 528.3 528.3 788.4 528.3 788.4 528.3 1,326.3 1,326.3 591.6 – 601.5 – 537.7 537.7 591.6 537.7 591.6 537.7 1,139.2 1,139.2 4,945.4 1,797.8 6,743.2 6,743.2 3,074.0 2,152.7 5,226.7 5,226.7 (2,606.7) – (2,606.7) (2,606.7) (1,868.3) – (1,868.3) (1,868.3) (118.8) (23.6) – – – (1,153.2) (118.8) (23.6) (1,153.2) (122.3) (23.6) (1,153.2) (898.8) (24.5) – – – (1,783.8) (898.8) (24.5) (1,783.8) (900.6) (24.5) (1,783.8) (2,749.1) (1,153.2) (3,902.3) (3,905.8) (2,791.6) (1,783.8) (4,575.4) (4,577.2) (7,429.3) (253.3) – (257.4) – (703.2) (7,686.7) (253.3) (703.2) (8,876.5) (253.3) (703.2) (5,887.4) (276.3) – (81.8) – (857.5) (5,969.2) (276.3) (857.5) (6,889.9) (276.3) (857.5) (7,682.6) (960.6) (8,643.2) (9,833.0) (6,163.7) (939.3) (7,103.0) (8,023.7) (10,431.7) (2,113.8) (12,545.5) (13,738.8) (8,955.3) (2,723.1) (11,678.4) (12,600.9) Net financial liabilities (5,486.3) (316.0) (5,802.3) (6,995.6) (5,881.3) (570.4) (6,451.7) (7,374.2) (i) Recorded at amortised cost or loans and receivables. (ii) (iii) Includes non-recourse borrowings. IAS 39 financial instruments. A7.1.1 Basis of determining fair value Certain assets and liabilities designated and carried at amortised cost are loans and receivables. For certain current assets and liabilities their carrying value is equivalent to fair value due to short-term maturity. Assets and liabilities designated at fair value and the fair value of other financial assets and liabilities have been determined by reference to closing rate market values. This basis has been used in valuing interest rate instruments, foreign currency hedge contracts and foreign currency denominated long-term fixed rate debt. Commodity contracts fair values are based on published price quotations. The fair values are stated at a specific date and may be different from the amounts which will actually be paid or received on settlement of the instruments. The fair value of items such as property, plant and equipment, internally generated brands or the Group’s customer base are not included as these are not financial instruments. 185 3. Financial Statements2.1.Accompanying information continued A7. Fair value of financial instruments continued A7.2 Fair value hierarchy The following table provides an analysis of financial instruments that are measured subsequent to initial recognition at fair value, grouped into Levels 1 to 3 based on the degree to which the fair value is observable. – Level 1 fair value measurements are those derived from unadjusted quoted market prices for identical assets or liabilities. – Level 2 fair value measurements are those derived from inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices). – Level 3 fair value measurements are those derived from valuation techniques that include inputs for the asset or liability that are not based on observable market data. Financial assets Energy derivatives Interest rate derivatives Foreign exchange derivatives Equity investments Financial liabilities Energy derivatives Interest rate derivatives Foreign exchange derivatives Loans and borrowings Level 1 £m 335.9 – – – 335.9 (341.9) – – – (341.9) Level 2 £m 943.9 471.8 46.2 12.5 1,474.4 (1,101.2) (403.5) (9.8) 257.4 (1,257.1) Level 3 £m Total £m – – – – – – – – – – 1,279.8 471.8 46.2 12.5 1,810.3 (1,443.1) (403.5) (9.8) 257.4 (1,599.0) There were no significant transfers out of level 1 into level 2 and out of level 2 into level 1 during the year ended 31 March 2017. A8. Hedge accounting A8.1 Cash flow hedges The Group designates contracts which qualify as hedges for accounting purposes either as cash flow hedges or fair value hedges. Cash flow hedges are contracts entered into to hedge a forecast transaction or cash flow risk generally arising from a change in interest rates or foreign currency exchange rates and which meet the effectiveness criteria prescribed by IAS 39. The Group’s accounting policy on cash flow hedges is explained in the Accompanying Information Section A1. The following table indicates the contractual maturities of the expected transactions and the qualifying cash flow hedges associated: Cash flow hedges Interest rate swaps: Assets Liabilities Forward exchange contracts: Assets Liabilities 2017 Carrying amount 2017 Expected cash flows 2017 0-12 months 2017 1-2 years 2017 2-5 years 2017 > 5 years 2016 Carrying amount 2016 Expected cash flows 2016 0-12 months 2016 1-2 years 2016 2-5 years 2016 > 5 years 1.8 (4.0) (2.2) 1.8 (4.0) (2.2) 0.2 (0.4) (0.2) 0.2 (0.4) (0.2) 0.5 (1.2) (0.7) 0.9 (2.0) (1.1) 0.4 (0.1) 0.3 0.4 (0.1) 0.3 – – – 0.1 – 0.1 0.1 – 0.1 42.2 (9.8) (474.0) (538.6) (321.2) (538.6) (122.1) – (30.7) – 32.4 (1,012.6) (859.8) (122.1) (30.7) – – – 36.5 (7.4) (631.9) (180.3) (460.5) (89.9) (130.3) (90.1) 29.1 (812.2) (550.4) (220.4) (41.2) (0.3) (41.5) 0.2 (0.1) 0.1 – – – A8.2 Net investment hedge The Group’s net investment hedge consists of debt issued in the same currency (€) as the net investment in foreign subsidiaries with € denominated functional currencies being the Airtricity Supply business and the thermal plants and wind farms in Ireland. The hedge compares the element of the net assets whose functional cash flows are denominated in € to the matching portion of the € borrowings held by the Group. This therefore provides protection against movements in foreign exchange rates. Gains and losses in the hedge are recognised in equity and will be transferred to the income statement on disposal of the foreign operation (2017 – £22.5m loss, 2016 – £33.4m loss). Gains and losses on the ineffective portion of the hedge are recognised immediately in the income statement (2017 – £nil, 2016 – £nil). 186 SSE plc Annual Report 2017 Financial StatementsCompany balance sheet as at 31 March 2017 Assets Equity investments in joint ventures and associates Loans to joint ventures and associates Other investments Investments in subsidiaries Trade and other receivables Deferred tax assets Derivative financial assets Retirement benefit assets Non-current assets Trade and other receivables Cash and cash equivalents Derivative financial assets Current assets Total assets Liabilities Loans and other borrowings Trade and other payables Current tax liabilities Derivative financial liabilities Current liabilities Loans and other borrowings Deferred tax liabilities Derivative financial liabilities Non-current liabilities Total liabilities Net assets Equity: Share capital Share premium Capital redemption reserve Hedge reserve Retained earnings Equity attributable to ordinary shareholders of the parent Hybrid equity Total equity Note 2017 £m 2016 £m 3 3 3 4 5 7 11 10 5 8 11 8 6 7 11 8 7 11 9 9 126.5 439.0 2.9 2,817.9 9,124.8 – 287.7 525.4 13,324.2 4,364.8 1,250.7 194.8 5,810.3 190.0 538.9 6.8 2,728.8 4,958.9 56.4 175.6 10.0 8,665.4 4,828.9 155.9 81.3 5,066.1 19,134.5 13,731.5 118.8 7,271.4 17.6 48.3 7,456.1 6,107.7 132.2 347.5 6,587.4 14,043.5 5,091.0 507.8 885.7 26.5 15.6 1,445.7 2,881.3 2,209.7 5,091.0 898.8 3,385.8 21.9 39.1 4,345.6 4,494.4 – 360.4 4,854.8 9,200.4 4,531.1 503.8 880.4 22.0 14.2 901.0 2,321.4 2,209.7 4,531.1 These financial statements were approved by the Board of Directors on 16 May 2017 and signed on their behalf by Gregor Alexander Finance Director Richard Gillingwater Chairman SSE plc Registered No: SC117119 187 3. Financial Statements2.1. Company statement of changes in equity for the year ended 31 March 2017 Share capital £m Share premium account £m Capital redemption reserve £m Hedge reserve £m Retained earnings £m Total attributable to ordinary shareholders £m Hybrid capital £m Total £m At 1 April 2016 503.8 880.4 22.0 14.2 901.0 2,321.4 2,209.7 4,531.1 Total comprehensive income for the year Dividends to shareholders Scrip dividend related share issue Distributions to hybrid equity holders Issue of shares Share repurchase Credit in respect of employee share awards Investment in own shares – – 7.9 – 0.6 (4.5) – – – – (7.9) – 13.2 – – – – – – – – 4.5 – – 1.4 – – – – – – – 1,344.4 (906.6) 237.9 – – (131.5) 13.1 (12.6) 1,345.8 (906.6) 237.9 – 13.8 (131.5) 13.1 (12.6) 119.3 – – (119.3) – – – – 1,465.1 (906.6) 237.9 (119.3) 13.8 (131.5) 13.1 (12.6) At 31 March 2017 507.8 885.7 26.5 15.6 1,445.7 2,881.3 2,209.7 5,091.0 At 1 April 2015 Total comprehensive income for the year Dividends to shareholders Scrip dividend related share issue Distributions to hybrid equity holders Issue of shares Redemption of hybrid equity Credit in respect of employee share awards Investment in own shares At 31 March 2016 Share capital £m 496.5 – – 5.9 – 1.4 – – – 503.8 Share premium account £m Capital redemption reserve £m 862.7 – – (5.9) – 23.6 – – – 880.4 22.0 – – – – – – – – 22.0 Total attributable to ordinary shareholders £m 1,693.0 1,317.7 (884.0) 175.8 – 25.0 (8.5) 13.5 (11.1) Retained earnings £m 324.6 1,290.7 (884.0) 175.8 – – (8.5) 13.5 (11.1) Hybrid capital £m 3,371.1 124.6 – – (124.6) – (1,161.4) – – Total £m 5,064.1 1,442.3 (884.0) 175.8 (124.6) 25.0 (1,169.9) 13.5 (11.1) 901.0 2,321.4 2,209.7 4,531.1 Hedge reserve £m (12.8) 27.0 – – – – – – – 14.2 188 SSE plc Annual Report 2017 Financial StatementsNotes to the Company financial statements 1. Principal accounting policies SSE plc (the Company) is a company domiciled in Scotland. The address of the registered office is given on the back cover. The Company financial statements present information about the Company as a separate entity and not about the Group. Basis of preparation The financial statements have been prepared in accordance with FRS 101 (Reduced Disclosures) (‘FRS 101’) and its interpretations as issued by the International Accounting Standards Board (‘IASB’) and adopted by the European Union (‘adopted IFRS’). This represents a change in accounting standards adopted as the Company previously adopted IFRS, as a result of the change no transitional adjustments were identified. Under section 408 of the Companies Act 2006 the Company is exempt from the requirement to present its own income statement and related notes. It has also taken advantage of the following disclosure exemptions available under FRS 101: – A Cash flow statement and related notes; – Related party disclosures; – Disclosures in respect of capital management; and – The effects of new but not yet effective IFRSs. As the consolidated financial statements of SSE plc include the equivalent disclosure, the Company has also taken advantage of the exemptions, under FRS 101, available in respect of the following disclosure: – Certain disclosures required by IFRS 13 Fair value measurement and the disclosures required by IFRS 7 Financial instrument disclosures. – Share-based payments required by paragraphs 45(b) and 46 to 52 of IFRS 2 Share-based Payment. Going concern The Directors consider that the Company has adequate resources to continue in operational existence for the foreseeable future. The financial statements are therefore prepared on a going concern basis. Basis of measurement The financial statements of the Company are prepared on the historical cost basis except for derivative financial instruments, available-for- sale financial assets and assets of the Company pension scheme which are stated at their fair value, and liabilities of the Company pension scheme which are measured using the projected unit credit method. The directors believe the financial statements present a true and fair view. The financial statements of the Company are presented in pounds sterling. Critical accounting judgements and estimation uncertainty In the process of applying the Company’s accounting policies, management necessarily makes judgements and estimates that have a significant effect on the amounts recognised in the financial statements. Changes in the assumptions underlying the estimates could result in a significant impact to the financial statements. The Group’s key accounting judgement and estimation areas are noted in Note 4.1 of the consolidated financial statements, with the most significant financial judgement areas as specifically discussed by the Audit Committee being highlighted separately. Significant accounting policies The significant accounting policies applied in the preparation of these individual financial statements are set out below. These policies have been applied consistently to all the years presented, unless otherwise stated. Investments In the Company, investments in subsidiaries are carried at cost less any impairment charges. Interests in joint arrangements and associates Associates are those investments over which the Company has significant influence but neither control nor joint control. The Company’s interests in its joint operations are accounted for by recognising its share of the assets, liabilities, revenue and expenses of the operation. In these arrangements, the Company’s share of the revenue will be eliminated as it relates to its purchased share of the output from the arrangement. The Company’s joint ventures and associates are accounted for using the equity method of accounting where the joint venture and associate investments are carried at historical cost plus the Company’s share of post-acquisition results, less any impairment in value. The Company recognises its share of the results of these equity-accounted operations after tax and interest in the income statement. Applicable Group accounting policies The following significant accounting policies are consistent with those applied for the Group consolidated financial statements: – Equity and equity-related compensation benefits (Supplementary information A1.2, page 165). – Defined benefit pension scheme (Supplementary information A1.2, page 165). – Taxation (Supplementary information A1.2, page 160). – Financial instruments (Supplementary information A1 and A6, pages 165 and 177). 189 3. Financial Statements2.1.Notes to the Company financial statements continued 2. Supplementary financial information 2.1 Result for the year The profit for the year attributable to ordinary shareholders dealt with in the financial statements of the Company was £1,144.3m (2016 – £1,182.2m). 2.2 Auditor remuneration The amounts paid to the Company’s Auditor in respect of the audit of these financial statements was £0.3m (2016 – £0.3m). Amounts paid to the Company’s Auditor in respect of services to the Company other than the audit of the Company’s financial statements have not been disclosed as the information is required instead to be disclosed on a consolidated basis. 2.3 Employee numbers The average number of people employed by the Company (including Executive Directors) during the year was 2 (2016 – 2). The costs associated with the employees of the Company, who are the Executive Directors of the Group, are borne by Group companies. No amounts are charged to the Company. 2.4 Directors’ remuneration and interests Information concerning Directors’ remuneration, shareholdings, options, long-term incentive schemes and pensions is shown in the Remuneration Report on pages 80 to 97. No Director had, during or at the end of the year, any material interest in any other contract of significance in relation to the Group’s business. 3. Investments 3.1 Associates and joint ventures Share of net assets/cost At 31 March 2015 Increase in shareholder loans Repayment of shareholder loans Transfer of loan to subsidiary At 31 March 2016 Increase in shareholder loans Repayment of shareholder loans Disposal Transfer of loans to subsidiary At 31 March 2017 At 31 March 2015 Revaluation through other comprehensive income/(loss) At 31 March 2016 Disposals in the year At 31 March 2017 Equity Other JCEs and associates £m – – – – – – – – – – SGN £m 190.0 – – – 190.0 – – (63.5) – 126.5 Equity total £m 190.0 – – – 190.0 – – (63.5) – 126.5 Loans Other JCEs and associates £m 277.5 30.6 (13.4) (22.7) 272.0 155.1 (14.3) (1.2) (150.4) 261.2 SGN £m 266.9 – – – 266.9 – – (89.1) – 177.8 Loans total £m 544.4 30.6 (13.4) (22.7) 538.9 155.1 (14.3) (90.3) (150.4) Total £m 734.4 30.6 (13.4) (22.7) 728.9 155.1 (14.3) (153.8) (150.4) 439.0 565.5 Faroe Petroleum £m 15.2 (8.4) 6.8 (3.9) 2.9 On 26 October 2016, the Group completed the disposal of a 16.7% equity stake in Scotia Gas Networks (SGN) to wholly owned subsidiaries of the Abu Dhabi Investment Authority (ADIA). After transaction costs and adjustments, cash consideration received was £615.1m and an exceptional gain on sale of £462.9m was recognised on disposal. Following the divestment, the Group will retain a 33.3% equity stake in SGN. These assets were not held for sale at 31 March 2016. 190 SSE plc Annual Report 2017 Financial Statements4. Subsidiary undertakings Details of the Company’s subsidiary undertakings are disclosed in the Accompanying Information Section (A3) on page 170. Investment in subsidiaries At 31 March 2016 Increase in existing investments (i) At 31 March 2017 Total £m 2,728.8 89.1 2,817.9 (i) The increase in existing investments held by the Company relates to the capitalisation of loan stocks held by the Company in Scottish and Southern Energy Power Distribution Limited and the equity shares in the Company awarded to the employees of the subsidiaries of the Group under the Group’s share schemes, which are recognised as an increase in the cost of investment in those subsidiaries as directed by IFRIC 11 (2017 – £16.2m; 2016 – £16.5m (both before tax)). 5. Trade and other receivables All current and non-current trade and other receivable balances in the current and prior financial year represent amounts owed by subsidiary undertakings. 6. Trade and other payables All current and non-current trade and other payable balances in the current and prior financial year represent amounts due to subsidiary undertakings. 7. Taxation Current tax liabilities Corporation tax 2017 £m 17.6 2016 £m 21.9 Deferred taxation The following are the deferred tax liabilities and assets recognised by the Company and movements thereon during the current and prior reporting periods: At 31 March 2015 Charge/(credit) to Income Statement Charge/(credit) to equity At 31 March 2016 Charge/(credit) to income statement Charge/(credit) to equity At 31 March 2017 Fair value gains/(losses) on derivatives £m Retirement benefit obligations £m (47.2) 5.1 5.0 (37.1) 10.0 (2.1) (29.2) (26.1) (0.4) 28.3 1.8 3.4 178.7 183.9 Other £m (14.6) (6.5) – (21.1) (4.4) 3.0 (22.5) Total £m (87.9) (1.8) 33.3 (56.4) 9.0 179.6 132.2 191 3. Financial Statements2.1.Notes to the Company financial statements continued 7. Taxation continued Deferred taxation continued Certain deferred tax assets and liabilities have been offset, including the asset balances analysed in the tables above. The following is an analysis of the deferred tax balances (after offset) for financial reporting purposes: Deferred tax liabilities Deferred tax assets Net deferred tax liabilities/(assets) 2017 £m 132.2 – 132.2 2016 £m – (56.4) (56.4) The deferred tax liabilities/assets disclosed include the deferred tax relating to the Company’s pension scheme liabilities. 8. Loans and borrowings Current Other short-term loans Non-current Loans Total loans and borrowings Cash and cash equivalents Unadjusted net debt Add/(less): Hybrid equity (Note 9) Adjusted net debt and hybrids 2017 £m 118.8 118.8 6,107.7 6,107.7 6,226.5 (1,250.7) 4,975.8 2,209.7 7,185.5 2016 £m 898.8 898.8 4,494.4 4,494.4 5,393.2 (155.9) 5,237.3 2,209.7 7,447.0 Cash and cash equivalents (which are presented as a single class of assets in the face of the balance sheet) comprise cash at bank and short-term highly liquid investments with a maturity of six months or less. 8.1 Borrowing facilities The Company has an established €1.5bn Euro commercial paper programme (paper can be issued in a range of currencies and swapped into sterling) and as at 31 March 2017 no commercial paper was outstanding (2016 – £198.8m). During the year the Company extended its existing £1.5bn of revolving credit and bilateral facilities by invoking the one year extension options with the facilities now maturing in August 2021 (£1.3bn) and November 2021 (£0.2bn). These facilities continue to provide back up to the commercial paper programme and, as at 31 March 2017 they were undrawn. The Company has a further £200m facility available with the European Investment Bank which will be fully drawn during 2017 when it will become a 10 year term loan. 192 SSE plc Annual Report 2017 Financial Statements8. Loans and borrowings continued 8.1 Borrowing facilities continued Analysis of borrowings Current Commercial paper and cash advances Bank loans – non-amortising (i) US Private Placement 16 April 2017 Total current Non-current Bank loans – non-amortising (i) 5.00% Eurobond repayable 1 October 2018 US Private Placement 16 April 2017 US Private Placement 16 April 2019 2.00% 600m Eurobond repayable 17 June 2020 4.25% Eurobond repayable 14 September 2021 2.375% €500m Eurobond repayable 10 February 2022 2017 Weighted average interest rate (iii) 2017 Face value 2017 Fair value 2016 Weighted average interest rate (iii) 2017 Carrying amount 2016 Face value £m 2016 Fair value £m – 1.8% 3.2% – 2.1% 5.0% – 3.7% – 106.0 12.8 118.8 526.6 500.0 – 67.0 – 106.1 16.2 122.3 558.2 530.0 – 86.4 – 106.0 12.8 118.8 526.6 499.2 – 66.9 0.9% 1.0% – – 2.1% 5.0% 3.2% 3.7% 198.8 700.0 – 898.8 632.6 500.0 12.8 67.0 199.0 701.6 – 900.6 683.4 542.2 14.2 75.7 2016 Carrying amount £m 198.8 700.0 – 898.8 632.6 498.6 12.7 66.9 2.0% 511.8 540.1 509.4 2.0% 474.4 498.8 471.3 4.3% 300.0 339.2 298.2 2.4% 415.0 453.8 414.5 – – – – – – – – Between two and five years – 2,320.4 2,507.7 2,314.8 1,686.8 1,814.3 1,682.1 US Private Placement 16 April 2022 US Private Placement 28 April 2023 US Private Placement 6 September 2023 US Private Placement 16 April 2024 US Private Placement 8 June 2026 US Private Placement 6 September 2026 US Private Placement 6 September 2027 8.375% Eurobond repayable on 20 November 2028 6.25% Eurobond repayable on 27 August 2038 4.25% Eurobond repayable 14 September 2021 2.375% €500m Eurobond repayable 10 February 2022 (iv) 5.875% Eurobond repayable 22 September 2022 1.75% €700m Eurobond repayable 8 September 2023 (v) 4.75% $900 NC5.5 hybrid maturing 16 September 2077 (vi) 3.625% NC5.5 hybrid maturing 16 September 2077 Over five years Fair value adjustment (ii) Total non-current Total 4.3% 2.8% 2.9% 4.4% 3.1% 3.2% 3.2% 162.7 35.0 120.0 204.1 64.0 247.1 35.0 213.8 36.6 124.8 268.0 68.0 270.7 37.4 162.4 34.3 117.1 203.7 62.5 241.2 34.2 4.3% – – 4.4% – – – 162.7 – – 204.1 – – – 187.8 – – 235.8 – – – 162.3 – – 203.6 – – – 8.4% 500.0 800.9 495.1 8.4% 500.0 752.2 494.7 6.3% 350.0 536.5 346.6 6.3% 350.0 465.1 346.4 – – – – – – – – 4.3% 300.0 331.7 297.9 2.4% 415.0 446.9 414.4 5.9% 300.0 368.9 298.5 5.9% 300.0 361.3 298.2 1.8% 514.6 544.7 513.2 1.8% 514.6 533.0 513.0 4.8% 730.9 734.0 727.9 3.6% 300.0 300.0 298.8 – – – – – – – – 3,563.4 4,304.3 3,535.5 2,746.4 3,313.8 2,730.5 – – 257.4 – – 81.8 5,883.8 6,812.0 6,107.7 4,433.2 5,128.1 4,494.4 6,002.6 6,934.3 6,226.5 5,332.1 6,028.7 5,393.2 (i) Balances include term loans and EIB debt and is a mixture of fixed and floating rate debt. (ii) The fair value adjustment relates to the change in the carrying amount of the borrowings as a result of fair value hedges that are in place. The movement in the fair value adjustment is recognised in the income statement with a corresponding movement on the hedging instrument also being recognised in the income statement. (iii) The weighted average interest rates (including the effect of interest rate swaps) for the year ended 31 March 2017 was 3.66% (2016 – 3.73%). (iv) The 2.375% €500m Eurobond maturing 10 February 2022 has been swapped to Sterling giving an effective interest rate of 3.53%. (v) The 1.75% €700m Eurobond maturing 8 September 2023 has been swapped to Sterling giving an effective interest rate of 3.16%. (vi) The 4.75% $900m NC5.5 hybrid maturing 16 September 2077 has been swapped to Euros ($605m) and Sterling ($295m) giving an effective interest rate of 2.25% and 3.29% respectively. 193 3. Financial Statements2.1.Notes to the Company financial statements continued 8. Loans and borrowings continued 8.1 Borrowing facilities continued Hybrid debt During the year SSE successfully issued £1.0bn of new debt accounted hybrids with the intent of using the proceeds to replace SSE’s hybrid issued in 2012 (at an all-in rate of 5.6%), which has an issuer first call date on 1 October 2017. This dual tranche issue comprises £300m with a coupon of 3.625% and $900m with a coupon of 4.75%. The $900m tranche has been swapped back to both Euros and Sterling, bringing the all-in rate down to 2.72% and resulting in an all-in funding cost for both tranches to SSE of 3.02% per annum which compares favourably to the all-in funding cost of 4.02% achieved on SSE’s most recent hybrid equity securities issued in 2015. Due to the hybrids having a fixed redemption date, they have been accounted for as a debt item and included within “Loans” in Loans and Borrowings above, this is in contrast to the previous hybrid issues which have no fixed redemption date and are accounted as Equity, see Note 9. 9. Equity Share capital Allotted, called up and fully paid: At 1 April 2016 Issue of shares (i) Share repurchases (ii) At 31 March 2017 Number (millions) 1,007.6 16.9 (8.9) 1,015.6 £m 503.8 8.5 (4.5) 507.8 The Company has one class of ordinary share which carries no right to fixed income. The holders of ordinary shares are entitled to receive dividends as declared and are entitled to one vote per share at meetings of the Company. (i) Shareholders were able to elect to receive ordinary shares in place of the final dividend of 62.5p per ordinary share (in relation to year ended 31 March 2016) and the interim dividend of 27.4p (in relation to the current year) under the terms of the Company’s scrip dividend scheme. This resulted in the issue of 9,395,092 and 6,324,986 new fully paid ordinary shares respectively (2016 – 10,600,639 and 1,172,973). In addition, the Company issued 1.2m (2016 – 2.8m) shares during the year under the savings-related share option schemes for a consideration of £13.8m (2016 – £25.0m). (ii) During the current financial year the Company began a programme of share repurchases. During the year to 31 March 2017 8.9m shares were repurchased for total consideration of £131.5m. The programme was enacted in December 2016 and the group plan to continue this activity until December 2017. The nominal value of share capital repurchased and cancelled is transferred out of share capital and into the capital redemption reserve. During the year, on behalf of the Company, the employee share trust purchased 0.8m shares for a total consideration of £12.6m (2016 – 0.8m shares, consideration of £11.1m). At 31 March 2017, the trust held 2.9m shares (2016 – 3.0m) which had a market value of £42.5m (2016 – £45.5m). Capital redemption reserve The capital redemption reserve comprises the value of shares redeemed or purchased by the Company from distributable profits. Hedge reserve The hedge reserve comprises the effective portion of the cumulative net change in the fair value of cash flow hedge derivative instruments related to hedged transactions that have not yet occurred. Hybrid equity USD 700m 5.625% perpetual subordinated capital securities EUR 750m 5.625% perpetual subordinated capital securities GBP 750m 3.875% perpetual subordinated capital securities EUR 600m 2.375% perpetual subordinated capital securities 2017 £m 427.2 598.2 748.3 436.0 2016 £m 427.2 598.2 748.3 436.0 2,209.7 2,209.7 194 SSE plc Annual Report 2017 Financial Statements10. Retirement benefit obligations Defined benefit scheme The Company has a funded final salary pension scheme which provides defined benefits based on final pensionable pay. The scheme is subject to an independent valuation at least every three years. The future benefit obligations are valued by actuarial methods on the basis of an appropriate assessment of the relevant parameters. The scheme operated by the Company the Scottish Hydro Electric scheme. Pension summary: Scottish Hydro Electric IFRIC 14 movement Net actuarial gain and movement in IFRIC 14 liability Scheme type Defined benefit Net actuarial gain/(loss) recognised in respect of the pension asset in the statement of comprehensive income Net pension asset 2017 £m 235.4 262.7 498.1 2016 £m 191.3 (49.5) 141.8 2017 £m 525.4 – 525.4 2016 £m 272.7 (262.7) 10.0 IFRIC 14 During the financial year the Scottish Hydro Electric pension scheme amend the rules of its scheme in order to be clear of the rights to a surplus upon final winding up of the scheme. This current year amendment presented a change in circumstance that has meant the Company now believes that is nor longer required to apply IFRIC 14 to the Scottish Hydro Electric pension scheme surplus or liability in the current year or in the future, this has the effect of no longer restricting the pension scheme assets from the current financial year onwards. The net pension asset of the Scottish Hydro Electric Scheme at 31 March 2017 was equal to £525.4m (2016 – net asset of £10.0m presented after an IFRIC 14 minimum funding requirement of £262.7m). The individual pension scheme details based on the latest formal actuarial valuations are as follows: Latest formal actuarial valuation Valuation carried out by Value of assets based on valuation Value of liabilities based on valuation Valuation method adopted Average salary increase Average pension increase Value of fund assets/accrued benefits Scottish Hydro Electric 31 March 2015 Hymans Robertson £1,916.0m £1,964.7m Projected Unit Inflation curve plus 1.0% pa RPI 97.5% 10.1 Pension scheme assumptions The scheme has been updated to 31 March 2017 by qualified independent actuaries. The valuations have been prepared for the purposes of meeting the requirements of IAS 19. The major assumptions used by the actuaries in the scheme were: Rate of increase in pensionable salaries Rate of increase in pension payments Discount rate Inflation rate At 31 March 2017 At 31 March 2016 4.3% 3.3% 2.7% 3.3% 4.1% 3.1% 3.6% 3.1% The assumptions relating to longevity underlying the pension liabilities at 31 March 2017 are based on standard actuarial mortality tables, and include an allowance for future improvements in longevity. The assumptions, equivalent to future longevity for members in normal health at age 65, are as follows: Currently aged 65 Currently aged 45 At 31 March 2017 Male At 31 March 2017 Female At 31 March 2016 Male At 31 March 2016 Female 23 25 24 28 26 29 26 29 195 3. Financial Statements2.1.Notes to the Company financial statements continued 10. Retirement benefit obligations continued 10.1 Pension scheme assumptions continued The impact on the scheme’s liabilities of changing certain of the major assumptions is as follows: Pensionable salaries Pension payments Discount rate Longevity At 31 March 2017 At 31 March 2016 Increase/ decrease in assumption 0.1% 0.1% 0.1% 1 year Effect on scheme liabilities +/- 0.2% +/- 1.2% +/- 2.2% +/- 4.5% Increase/ decrease in assumption 0.1% 0.1% 0.1% 1 year Effect on scheme liabilities +/- 0.2% +/- 1.6% +/- 2.0% +/- 2.9% These assumptions are considered to have the most significant impact on the scheme valuations. 10.2 Valuation of pension scheme Equities Government bonds Corporate bonds Insurance contracts Other investments Quoted £m 513.8 752.0 645.0 – 118.5 Total fair value of plan assets Present value of defined benefit obligation 2,029.3 Pension asset (pre-IFRIC 14) IFRIC 14 liability (i) Surplus in the scheme Deferred tax thereon Net pension asset Unquoted £m – – – 221.3 – 221.3 Value at 31 March 2017 £m 513.8 752.0 645.0 221.3 118.5 2,250.6 (1,725.2) 525.4 – 525.4 (183.9) 341.5 Long-term rate of return expected at 31 March 2017 % 5.5 – 2.7 2.7 3.4 Quoted £m 509.2 784.1 488.9 – 98.7 1,880.9 Unquoted £m – – – – – – Value at 31 March 2016 £m 5.6 1.2 3.0 – 3.8 Value at 31 March 2016 £m 509.2 784.1 488.9 – 98.7 1,880.9 (1,608.2) 272.7 (262.7) 10.0 (1.8) 8.2 (i) The IFRIC 14 liability represents the deficit repair obligations, application of this standard was changed within the current year. 196 SSE plc Annual Report 2017 Financial Statements10. Retirement benefit obligations continued 10.3 Movements in the defined benefit asset obligations and assets during the year at 1 April Included in income statement Current service cost Past service cost Interest income/(cost) Included in other comprehensive income Actuarial (loss)/gain arising from: Demographic assumptions Financial assumptions Experience assumptions Return on plan assets excluding interest income Other Contributions paid by the employer Benefits paid 2017 Assets £m Obligations (i) £m 1,880.9 (1,608.2) – – 65.9 65.9 – – – 396.6 396.6 36.2 (129.0) (92.8) (25.4) (3.4) (56.0) (84.8) 174.7 (341.5) 5.6 – (161.2) – 129.0 129.0 Total £m 272.7 (25.4) (3.4) 9.9 (18.9) 174.7 (341.5) 5.6 396.6 235.4 36.2 – 36.2 2016 Assets £m Obligations (i) £m 1,913.6 (1,838.2) – – 61.8 61.8 – – – (67.9) (67.9) 33.7 (60.3) (26.6) (30.7) – (58.8) (89.5) 56.3 129.0 73.9 – 259.2 – 60.3 60.3 Balance at 31 March 2,250.6 (1,725.2) 525.4 1,880.9 (1,608.2) (i) The retirement benefit obligations are stated before IFRIC 14 liabilities, application of this standard was amended within the current year. 10.4 Pension scheme contributions and costs Charges/(credits) recognised: Current service cost (charged to operating profit) Charged/(credited) to finance costs: Interest from pension scheme assets Interest on pension scheme liabilities IFRIC 14 impact on net interest The return on pension scheme assets is as follows: Return/(loss) on pension scheme assets 2017 £m 28.8 28.8 (65.9) 56.0 – (9.9) 2017 £m 462.5 Total £m 75.4 (30.7) – 3.0 (27.7) 56.3 129.0 73.9 (67.9) 191.3 33.7 – 33.7 272.7 2016 £m 29.9 29.9 (61.8) 58.8 6.7 3.7 2016 £m (6.1) Employer financed retirement benefit (EFRB) pension costs The increase in the year in relation EFRB was £5.4m (2016 – £0.7m decrease). This is included in other provisions. Further discussion of the pension scheme assets, liabilities, polices, risk and strategy can be found on page 141 of the Group consolidated financial statements. 197 3. Financial Statements2.1.          Notes to the Company financial statements continued 11. Financial instruments For financial reporting purposes, the Company has classified derivative financial instruments as financing derivatives. Financing derivatives include all fair value and cash flow interest rate hedges, non-hedge accounted (mark-to-market) interest rate derivatives, cash flow foreign exchange hedges and non-hedge accounted foreign exchange contracts. Non-hedge accounted contracts are treated as held for trading. The derivative financial assets and (liabilities) are represented as follows: Derivative financial assets Non-current Current Derivative liabilities Non-current Current Total derivative liabilities Net asset/(liability) 2017 £m 287.7 194.8 482.5 (347.5) (48.3) (395.8) 86.7 2016 £m 537.7 1,615.0 2,152.7 (857.5) (1,783.8) (2,641.3) (488.6) Information on the Group’s financial risk management and the fair value of financial instruments is available at A6 and A7. 12. Commitments and contingencies Guarantees, indemnities and other contingent liabilities SSE plc has provided guarantees on behalf of subsidiary, joint venture and associated undertakings as follows: 2017 2016 Bank borrowing Performance of contracts Purchase of gas SSE on behalf of subsidiary £m SSE on behalf of joint operations and ventures £m SSE on behalf of partnerships £m 654.4 1,526.6 10.0 – 258.0 – – 0.7 – Subsidiaries have provided guarantees on behalf of the Company as follows: Bank borrowing Total £m 654.4 1,785.3 10.0 2017 £m 1,773.9 Total £m 352.2 1,357.6 10.0 2016 £m 1,971.1 In the year to 31 March 2017, the Group had drawn down £50m from it’s European Investment Bank facility. SSE Plc had entered into a guarantee with the European Investment Bank in relation to this facility to guarantee the obligations of Scottish Hydro Electric Transmission Plc. In relation to bank borrowings the guarantee amounts outlined include accrued interest. Unlimited guarantees have been provided on behalf of subsidiary undertakings in relation to eight contracts in respect of performance of work and any liabilities arising. SSE Services Plc, a wholly owned subsidiary of the Company, has provided a guarantee to Group Trustee Independent Trustees in respect of Southern Electric Group of the Electricity Supply Pension Scheme in respect of funding required by the Scheme. SSE Contracting Limited, a wholly owned subsidiary, has provided a guarantee to Tay Street Lighting (Leeds) Ltd, Tay Valley Lighting (Newcastle & North Tayside) Ltd and Tay Valley Lighting (Stroke on Trent) Ltd in respect of provision and maintenance of public street lighting and illuminated traffic signage. SSE E&P (UK) Limited, a wholly owned subsidiary of the Company, has provided a guarantee to Hess Limited in respect of decommissioning liabilities. SSE E&P (UK) Limited has also provided a guarantee to Britoil Limited and Arco British Limited in respect of the acquisition of the Sean Field. SSE E&P (UK) Limited has also provided a guarantee to Perenco UK Limited in respect of a Sale and Purchase Agreement for the Minerva, Apollo and Mercury Fields. Scottish Hydro Electric Transmission Plc, a wholly owned subsidiary of the Company, has provided a guarantee to ABB Limited in connection with the use of HVDC Replica Control Panels for Caithness-Moray Project. Where the Company enters into financial guarantee contracts to guarantee indebtedness of the other companies within its group, the Company considers these to be insurance arrangements, and accounts for them as such. In this respect, the Company treats the guarantee contract as a contingent liability until such time as it becomes probable that the Company will be required to make payment under the guarantee. 198 SSE plc Annual Report 2017 Financial StatementsIndependent Auditor’s Report to the members of SSE plc only Opinions and conclusions arising from our audit 1. Our opinion on the financial statements is unmodified We have audited the financial statements of SSE plc for the year ended 31 March 2017 set out on pages 106 to 198. In our opinion: – the financial statements give a true and fair view of the state of the group’s and of the parent company’s affairs as at 31 March 2017 and of the group’s profit for the year then ended; – the group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union; – the parent company financial statements have been properly prepared in accordance with UK Accounting Standards, including FRS 101 Reduced Disclosure Framework; and – the financial statements have been prepared in accordance with the requirements of the Companies Act 2006; and, as regards the group financial statements, Article 4 of the IAS Regulation. Overview Materiality: Group financial statements as a whole Coverage Risks of material misstatement £75m (2016 – £75m) 5% (2016 – 5%) of profit before tax before exceptional items and before certain remeasurements 99% (2016 – 99%) of group profit before tax vs 2016 Recurring risks Carrying value of certain non current assets Accounting for estimated revenue Recoverability of GB retail receivables Group pension obligation 2. Our assessment of risks of material misstatement In arriving at our audit opinion above on the financial statements, the risks of material misstatement that had the greatest effect on our audit, in decreasing order of audit significance, were as follows (unchanged from 2016): The risk Our response Carrying value of certain non-current assets and inventories (£13.4bn; 2016 – £13.6bn) Refer to page 72 (Audit Committee Report), pages 114, 161 and 162 (accounting policy) and page 139 (financial disclosures). Forecast-based valuation Certain non-current assets (tangible and intangible) significant and at risk of impairment due to a number of global and national factors including low commodity prices, the type of plant owned, poor operating returns for thermal plant, the unpredictability of reserves in relation to exploration and production assets. The estimated recoverable amount is subjective due to the inherent uncertainty involved in forecasting and discounting future cash flows. Subjective estimate There are significant trade receivables with customers in GB with the risk of customer default remaining high, due to continued economic uncertainty and the fact that for domestic customers, gas and electricity bills can be a large part of income, resulting in significant judgement being applied in the Group’s assessment of the recoverability of these receivables. Provision for GB retail receivables (£0.1bn; 2016 – £0.1bn) Refer to page 72 (Audit Committee Report), pages 115 and 166 (accounting policy) and page 145 (financial disclosures). Our procedures included: – Assessing methodology: Assessing the principles and integrity of the cash flow model and agreeing certain of the inputs to source documents; – Our sector experience: Evaluating assumptions used, in particular those relating to future commodity prices using our industry knowledge; – Benchmarking assumptions: Comparing the group’s assumptions to externally derived data in relation to key inputs such as future commodity prices, discount rates or to historical data (as a guide to expected future outcomes); – Comparing valuations: Comparing the sum of the discounted cash flows to the group’s market capitalisation to assess the reasonableness of those cash flows; and – Assessing transparency: Assessing whether the group’s disclosures about the sensitivity of the outcome of the impairment assessment to changes in key assumptions reflected the risks inherent in the valuation of non-current assets and inventory. Our procedures included: – Test of detail: Assessing and challenging the Directors’ assumptions behind the provision against experience of cash collection during the year and subsequent to the year end in relation to significant elements of the receivables balance. Ensuring the provision has been accurately and consistently calculated; – Our sector experience: Assessing the Directors’ assumptions behind the provision against trade receivables against our own knowledge of bad debts experience by the group; and – Assessing transparency: Assessing the adequacy of the group’s disclosures about the degree of estimation involved in arriving at the provision. 199 3. Financial Statements2.1.Independent Auditor’s Report continued The risk Our response Accounting for estimated revenue (£0.8bn; 2016 – £0.9bn) Refer to page 72 (Audit Committee Report), pages 114 and 159 (accounting policy) and page 145 (financial disclosures). Subjective estimate Certain of the Group’s energy sales revenues, where no bill has been issued at the year end date, are based on estimates of the values of electricity and gas supplied to customers between the date of the last meter reading and the year end (‘estimated revenues’). The method of estimating such revenues is complex and judgemental and requires estimates and assumptions to: 1. estimate the volumes of energy consumed by customers. The group’s estimated accrual for revenue at the year end is based on the closing unbilled volume reflected within the financial statements in the prior year, with principal adjustments made for gas or electricity distributed to customers (as identified from the industry wide settlements system), and gas or electricity billed to customers (as identified from the group’s billing system); and 2. assess the value to be ascribed to that volume given the range of tariffs. The group applies a price per unit (which is dependent on a number of factors including location of customers and type of billing arrangement) to the estimate of volume of energy to be accrued at year end to arrive at the total estimated value of energy sales between the date of the last meter reading and the year end. Subjective valuation Small changes in the assumptions and estimates used to value the group’s pension obligation (before deducting scheme assets) would have a significant effect on the group’s net pension surplus/deficit. Group pension obligation (£0.1bn surplus; 2016 – £0.4bn deficit) Refer to page 72 (Audit Committee Report), page 114 and 165 (accounting policy) and page 152 (financial disclosures). Our procedures included: – Benchmarking assumptions: we challenged the group’s assumptions relating to volume and price used in determining the level of estimated revenue, as follows: Underlying assumption on volume We compared volume data to the external settlements systems and internal billing systems, having performed testing of the controls over new customer authorisations, pricing calculations, billing exceptions, interfaces with the general ledger and price updates. To further corroborate the volumes used, we compared the estimated volume determined by the Group with benchmarks that the Group has developed over a number of years using internal and external information and analysed and sought and assessed explanations for variances from that. Underlying assumptions on price We challenged the assumptions of price per unit by comparing the price applied with current actual billing internal trends and data. Further, we assessed the overall consistency period on period of the assumptions and of the inputs to the calculation of estimated value of revenue; – Analytical procedures: We set expectations as to the likely level of total revenue and compared this with the Group’s estimate, obtaining explanations for significant differences. We assess processes and controls giving rise to the Group’s revenue as part of these procedures; and – Assessing transparency: Assessing the adequacy of the group’s disclosures about the degree of estimation involved in arriving at the estimated revenue. Our procedures included: – Benchmarking assumptions: We assessed the independence and competence of the Group’s external actuaries challenging, with the support of our own actuarial specialists, the key assumptions applied, being the discount rate, mortality and inflation rate against externally derived data, In order to assess the reasonableness of these assumptions, we performed a benchmarking exercise against other companies’ assumptions; and – Assessing transparency: Considering the adequacy of the group’s disclosures in respect of the sensitivity of the deficit to these assumptions. 3. Our application of materiality and an overview of the scope of our audit Materiality for the Group financial statements as a whole was set at £75 million (2016 – £75 million), determined with reference to a benchmark of group profit before taxation, excluding exceptional items and certain remeasurements (mainly fair value movements on derivatives) as disclosed on the face of the income statement, of which it represents 5% (2016 – 5%). We reported to the Audit Committee any corrected or uncorrected identified misstatements exceeding £3 million (2016 – £3 million) in addition to other identified misstatements that warranted reporting on qualitative grounds. Of the group’s 232 (2016 – 224) reporting components, audits for group reporting purposes were performed at 115 (2016 – 127) components in the UK and Ireland. These represent all components that we considered to be individually financially significant. These audits accounted for the following percentages of the group’s results: 97% (2016 – 98%) of Group revenue, 99% (2016 – 98%) of Group profit before tax; and 98% (2016 – 98%) of Group net assets. Specified risk-focused audit procedures were performed in relation to 12 (2016 – 7) components which accounted for 2% (2016 – 1%) of revenue and nil% (2016 – 1%) of group profit before tax and 1% (2016 – 1%) of group net assets. The latter were 200 SSE plc Annual Report 2017 Financial Statementsnot individually financially significant enough to require an audit for group reporting purposes but did present individual risks that needed to be addressed. For the remaining components, we performed analysis at an aggregated group level to re-examine our assessment that there were no significant risks of material misstatement within these. The Group team instructed component auditors as to the significant areas to be covered, including the relevant risks detailed above and the information to be reported back. The Group team approved the component materialities, which ranged from £8 million to £30 million, having regard to the mix of size and risk profile of the Group across the components. The work on 10 (2016 – 10) of the components was performed by component auditors (including the auditor of SGN, the group’s most significant joint venture) and the rest by the Group team. The Group team issued reporting instructions to the component auditors as to the significant areas to be covered during their audit. The group team performed procedures on the items excluded from normalised group profit before tax. Telephone calls were held with the component auditors (including with the partner of the component auditor in respect of the audit of SGN) as part of the assessment of the audit risk and strategy. As part of the close out process further calls were held with component auditors and on these calls the findings reported to the Group team were discussed in more detail, and any further work required by the Group team was then performed by the component auditors. Profit before tax and before exceptional items and certain remeasurements £1,510m (2016 – £1,451m) Materiality £75m (2016 – £75m) £75m Whole financial statements materiality(2016 – £75m) Profit before tax and before exceptional items and certain remeasurements Group materiality £30m Range of materiality at 115 components (£8m – £30m) (2016 – £10m to £25m) £3m Misstatements reported to the audit committee (2016 – £3m) Group revenue – 99% (2016 – 99%) Group profit before tax – 99% (2016 – 99%) 2% 1% 1% 98% 97% 98% 99% Group net assets – 98% (2016 – 98%) Group profit before exceptional items and taxation – 99% (2016 – 99%) 1% 1% 1% 1% 98% 98% 98% 98% Full scope for group audit purposes 2017 Specified risk-focused audit procedures 2017 Full scope for group audit purposes 2016 Specified risk-focused audit procedures 2016 Residual components 201 3. Financial Statements2.1. Independent Auditor’s Report continued 4. Our opinion on other matters prescribed by the Companies Act 2006 is unmodified In our opinion: – the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006; and – the information given in the Strategic Report and the Directors’ Report for the financial year is consistent with the financial statements. Based solely on the work required to be undertaken in the course of the audit of the financial statements and from reading the Strategic Report and the Directors’ Report: – we have not identified material misstatements in those reports; and – in our opinion, those reports have been prepared in accordance with the Companies Act 2006. 5. We have nothing to report on the disclosures of principal risks Based on the knowledge we acquired during our audit, we have nothing material to add or draw attention to in relation to: – the directors’ statement on longer-term viability on pages 24 to 27, concerning the principal risks, their management, and, based on that, the directors’ assessment and expectations of the group’s continuing in operation over the 3 years to 2020; or – the disclosures in Note 1 of the financial statements concerning the use of the going concern basis of accounting. 6. We have nothing to report in respect of the matters on which we are required to report by exception Under ISAs (UK and Ireland) we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading. In particular, we are required to report to you if: – we have identified material inconsistencies between the knowledge we acquired during our audit and the directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the group’s position and performance, business model and strategy; or – the Report of the Audit Committee does not appropriately address matters communicated by us to the audit committee. Under the Companies Act 2006 we are required to report to you if, in our opinion: – adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or – the parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or – certain disclosures of directors’ remuneration specified by law are not made; or – we have not received all the information and explanations we require for our audit. Under the Listing Rules we are required to review: – the Directors’ Statement, set out on pages 72 and 27 respectively, in relation to going concern and longer-term viability; and – the part of the Corporate Governance Statement on pages 54 to 97 relating to the company’s compliance with the eleven provisions of the 2014 UK Corporate Governance Code specified for our review. We have nothing to report in respect of the above responsibilities. Scope and responsibilities As explained more fully in the Directors’ Responsibilities Statement set out on page 100, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate. This report is made solely to the Company’s members as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at www.kpmg.com/uk/auditscopeukco2014a, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions. William Meredith (Senior Statutory Auditor) for and on behalf of KPMG LLP, Statutory Auditor Chartered Accountants 319 St Vincent Street Glasgow, G2 5AS 16 May 2017 202 SSE plc Annual Report 2017 Financial StatementsNotes 203 3. Financial Statements2.1.Notes 204 SSE plc Annual Report 2017 Financial StatementsManage your shares online/ eCommunications Programme To manage your holding online, simply register through the Signal Portal, the online platform provided by Capita Registrars www.sse-shares.com/welcome which allows shareholders to: – view their shareholding; – have dividends paid into their bank account; – update personal details; – sign up for electronic shareholder communication; – buy and sell shares online using Capita’s share dealing service; and – vote in advance of company general meetings. If you have not used this service before, you will require your Investor Code (IVC) to register. You will find this on your share certificate or on recent items of communication. SSE encourages its shareholders to elect for electronic communications. By joining our eCommunications Programme, shareholders can help us to reduce our impact on the environment and save paper by choosing to receive shareholder documents electronically. Shareholders are notified by email that documents such as the Annual Report or Notice of Annual General Meeting are available on our website. Amalgamation of multiple share accounts Many shareholders receive several copies of the annual report and dividend documentation who could merge their shareholdings. If you receive more than one copy of these documents you could help SSE reduce its impact on the environment and save paper by merging your accounts into one. Please contact Capita Asset Services to amalgamate your accounts. Keep us informed Keep us informed of changes to your email address by visiting www.sse.com/investors/ecommsprogramme and follow the instructions under ‘how to register or update your email address’. Shareholder information Shareholder enquiries The Company’s register of members is maintained by our appointed Registrar, Capita Asset Services. Shareholders with queries relating to their shareholdings should contact Capita directly: Capita Asset Services Shareholder Solutions The Registry 34 Beckenham Road Beckenham Kent BR3 4TU Telephone: 0345 143 4005 Email: sse@capitaregistrars.com Financial calendar Publication of Annual Report AGM (Perth) and Trading Statement Ex-dividend date for final dividend Record Date for final dividend Final date for Scrip elections Payment date Notification of Close Period by 16 June 2017 20 July 2017 27 July 2017 28 July 2017 25 August 2017 22 September 2017 30 September 2017 Results for six months to 30 September 08 November 2017 Website SSE’s website, sse.com, contains a wide range of information including a dedicated investors section where you can find further information about shareholder services including: – share price information; – dividend history and trading graphs – the Scrip Dividend Scheme; – telephone and internet share dealing; and – downloadable shareholder forms. Digital news SSE use a dedicated news and views website (available at www.sse.com/newsandviews) and Twitter (www.twitter.com/sse) to keep shareholders, investors, journalists, employees and other interested parties up-to-date with news from the Company. Dividends The Company typically pays dividends twice yearly. Interim dividends, are paid in March, and final dividends are paid in September once approved by shareholders at the AGM. SSE encourages its shareholders to have dividends paid directly into their bank/building society account, to ensure secure payment of funds on payment date whilst reducing the environmental impact through reduced print and paper use. Shareholders who elect to receive their dividend payment in this way will only receive an annual dividend confirmation at the end of each financial year. Any shareholder who requires a separate dividend confirmation for each dividend payment should contact Capita Asset Services. For further information about SSE, please contact: SSE plc Corporate Affairs Inveralmond House 200 Dunkeld Road Perth PH1 3AQ UK Tel: +44 (0)1738 456000 Email: info@sse.com Registered in Scotland No. 117119 sse.com Follow the latest news from SSE on Twitter at: www.twitter.com/sse @SSE STOCK CODE 008229 S S E p l c A n n u a l R e p o r t 2 0 1 7 

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