The purpose of the Bertelsmann risk management system (RMS) is the early identification and evaluation of as well as response to internal and external risks. The internal control system (ICS), an integral component of the RMS, controls and monitors the risks that have been identified. The aim of the RMS is to identify, at an early stage, material risks to the Group so that countermeasures can be taken and controls implemented. Risks are possible future developments or events that could result in a negative deviation from outlook or objective for Bertelsmann. In addition, risks can negatively affect the achievement of the Group’s strategic, operational, reporting-related and compliance-related objectives.

The risk management process is based on the international accepted frameworks of the Committee of Sponsoring Organizations of the Treadway Commission (COSO Enterprise Risk Management – Integrated Framework and Internal Control – Integrated Framework, respectively) and is organized in sub-processes of identification, assessment, management, control and monitoring. A major element of risk identification is the risk inventory that lists significant risks year by year, from the profit center level upward, and then aggregates them step by step at the division and Group levels. This ensures that risks are registered where their impact would be felt. There is also a Group-wide reassessment of critical risks every six months and quarterly reporting even if no risk event occurs. Ad hoc reporting requirements ensure that significant changes in the risk situation during the course of the year are brought to the attention of the Executive Board. The risks are compared against risk response and control measures to determine the so-called net risk. Both one-year and three-year risk assessment horizons are applied to enable the timely implementation of risk management measures. The basis for determining the main Group risks is the three-year period, similar to the medium-term corporate planning. The risk, measured against possible financial loss, is the product of the estimated negative impact on the free cash flowA company’s cash inflows and outflows during a specific period. should the risk occur and the estimated probability of occurrence. Risk monitoring is conducted by Group management on an ongoing basis. The RMS, along with its component ICS, is constantly undergoing further development and is integrated into ongoing reporting to the Bertelsmann Executive Board and Supervisory Board. Corporate risk management committees and divisional risk meetings are convened at regular intervals to ensure compliance with statutory and internal requirements.

Under section 91 (2) of Germany’s Stock Corporation Act (AktG), the auditors inspect the risk early warning system for its capacity to identify developments early on that could threaten the existence of Bertelsmann SE & Co. KGaAA partnership limited by shares (KGaA) with a European stock corporation (Societas Europaea, or SE) as the personally liable partner. The personally liable partner is responsible for the management and representation of the KGaA., then report their findings to the Supervisory Board. Corporate Audit conducts ongoing reviews of the adequacy and functional capability of the RMS in the divisions of Penguin Random House, Arvato and Be Printers as well as the Corporate Investments and Corporate Center segments. The risk management systems of RTL Group and Gruner + Jahr are evaluated by the respective internal auditing departments of those divisions and by external auditors. Any issues that are identified are promptly remedied through appropriate measures. The Bertelsmann Executive Board defined the scope and focus of the RMS based on the specific circumstances of the company. However, even an appropriately designed and functional RMS cannot guarantee with absolute certainty that risks will be identified and controlled.

The objectives of the accounting-related RMS and the ICS are to ensure that external and internal accounting is proper and reliable in accordance with applicable laws and that information is made available without delay. Reporting should also present a true and fair view of Bertelsmann’s net assets, financial position and results of operation. The following statements pertain to the consolidated financial statements (including the “Notes” and “Management Report” sections), interim reporting and internal management reporting.

The ICS for the accounting process consists of the following areas. The Group’s internal rules for accounting and the preparation of financial statements (e.g., IFRSInternational Financial Reporting Standards. Accounting standards intended to ensure internationally comparable accounting and reporting. manual, guidelines, circulars) are made available without delay to all employees involved in the accounting process. The consolidated financial statements are prepared in a reporting system that is uniform throughout the Group. Extensive automatic system controls ensure the consistency of the data in the financial statements. The system is subject to ongoing development through a documented change process. Systematized processes for coordinating intercompany transactions serve to prepare the corresponding consolidation steps. Circumstances that could lead to significant misinformation in the consolidated financial statements are monitored centrally by employees of Bertelsmann SE & Co. KGaAA partnership limited by shares (KGaA) with a European stock corporation (Societas Europaea, or SE) as the personally liable partner. The personally liable partner is responsible for the management and representation of the KGaA. and by RTL Group (for the preconsolidated subgroup), then verified by external experts as required. Central contacts from Bertelsmann SE & Co. KGaA and the divisions are also in continuous contact with the local subsidiaries to ensure IFRS-compliant accounting as well as compliance with reporting deadlines and obligations. These preventive measures are supplemented by specific controls in the form of analyses by the Corporate Financial Reporting department of Bertelsmann SE & Co. KGaA and RTL Group (for the preconsolidated subgroup). The purpose of such analyses is to identify any remaining inconsistencies. The Group- and division-level controlling departments are also integrated into the internal management reporting. Internal and external reporting are reconciled during the quarterly segment reconciliation process. The further aim in introducing a globally binding control framework for the decentralized accounting processes is to achieve a standardized ICS format at the level of the local accounting departments of all fully consolidated Group companies. The findings of the external auditors and Corporate Audit are promptly discussed with the affected companies, and solutions are developed. An annual self-assessment is conducted to establish a reporting of the quality of the ICS in the key Group companies. The findings are discussed in Audit and Finance Committee meetings at the divisional level.

Corporate Audit and the internal auditing departments of RTL Group and Gruner + Jahr evaluate the accounting-related processes as part of their auditing work. As part of the auditing process, the Group auditor also reports to the Bertelsmann SE & Co. KGaA Supervisory Board Audit and Finance Committee about any significant vulnerabilities of the accounting-related ICS that were identified during the audit and the findings regarding the risk early warning system.

Bertelsmann is exposed to a variety of risks. The major risks to Bertelsmann identified in the risk reporting are listed in order of priority in the table below. In line with the level of possible financial loss, the risks are classified as endangering, considerable, significant, moderate or low for the purposes of risk tolerability. The risk inventory carried out did not identify any risks that would be classified as considerable or endangering.

Given the diversity of the core business fields in which Bertelsmann is active and the corresponding diversity of risks to which the various divisions are exposed, the key strategic and operational risks to the Group identified below are broken down by business segment. Integration risks from acquisitions carried out and information technology risks were identified as the primary risks and are therefore described separately. This is followed by an outline of legal and regulatory risks and financial market risks. These risks are largely managed at the corporate level.

The development of the global economy in 2013 reflected the moderate growth level of the previous year. In 2014, the subdued global growth dynamic of recent years is expected to accelerate slightly. Although uncertainty over economic developments has eased somewhat, Bertelsmann’s business development is still dogged by certain risks. Assuming the continuing normalization of the overall economic situation, Bertelsmann expects stable development of Group revenues for 2014. In addition to the risk from economic development, other significant Group risks include customer risks, the risks from changes in the market environment, supplier relationship risks and pricing and margin risks. How these risks develop depends, among other things, to a large extent on changes in customer behavior due to factors such as the digitization of media, the development and implementation of products and services by current and future competitors, bad debt losses as well as default and interference along the production chains in individual sectors such as IT. Employee-related risks, the integration risks associated with the Penguin Random House merger and the audience and market share are moderate risks for Bertelsmann.

The most important risks for RTL Group are a decrease in audience and advertising market shares as well as risks arising from changes in market environment and economic downturns. A decrease in audience shares could lead to decreasing revenues. RTL Group actively monitors international market changes and program trends. This is increasingly the case in the digital world, where audiences generally have more choice and market entry barriers are reduced. Higher competition in program acquisition, ongoing audience fragmentation and expansion of platform operators may also impact RTL Group’s ability to generate revenues. Furthermore, economic development directly impacts the advertising market and therefore RTL Group revenue. With a focus on developing non-advertising revenue streams this risk is countered. Apart from potential cost increases triggered by content suppliers, the business can be impacted by the risk of losing key suppliers of content and customers. To address these risks, long-term contracts with major content providers are closed, and active customer relationship managementCustomer Relationship Management (CRM) is a strategic approach which establishes, maintains and reinforces companies’ customer relationships using state-of-the-art information and communication technologies. is established. RTL Group’s strategy is also to further diversify its business by establishing complementary families of channels and utilizing the opportunities presented by digitization.

The principle risk for Penguin Random House arises from the merger of the two companies. As with any merger of this size, the process of integrating the two companies, and in particular the process of integrating the companies’ IT systems, creates significant risks. Management has established work streams to carry out the integration plan and is closely monitoring its progress. Otherwise, the creation of the larger company has increased the scale of, but has not significantly altered the nature of, the risks that Random House faced prior to the merger. The increase in the digital portion of the business presents opportunities, but also creates challenges related to pricing and customer margin. The overall market trend, especially toward declining physical sales in book stores, could threaten the long-trend viability of certain customers and will likely result in continued margin pressure. Also, higher paper prices and general economic uncertainty continue to pose risks. The risk minimization strategy includes credit insurance to limit bad debt risks, long-term contracts with suppliers and a flexible cost structure in response to economic downturns. The continuing decline in store space of physical book retailers will be partially mitigated by e-book and online sales of physical books and further measures to improve the competitive situation.

The risks from a changing market environment constitute the greatest risk position for Gruner + Jahr. There is also the particular risk that higher agency discounts in the German advertising markets and the growing significance of digital advertising will lead to falling margins. The aim is to reduce risks through active customer management, including new forms of offers. The risk of a deterioration of the overall market environment and resulting falls in advertising and circulation revenues remains. Countermeasures include cost savings and reviewing individual titles. On the supplier side, there is still a risk of increasing commissions being charged by individual distributors. Furthermore, there is the risk of losing key customers, for example as advertising customers could switch to other media, coupled with the risk associated with upcoming tenders in the client business. These are to be addressed through targeted measures for key account customers as well as marketing measures. Advertising restrictions discussed at the EU level (e.g., car advertising) could lead to declining advertising revenues.

Arvato sees itself particularly exposed to risks from customer relationships, risks from a changing market environment as well as risks from supplier relationships. The reorganization in the form of a matrix and a clear division into Solution Groups while simultaneously taking into account the regional dimension will make it possible to target customers more effectively and help to reduce these risks. The potential loss of key customers is being counteracted through active key account management, long-term contracts with flexible cost structures and through integrated service elements. Offering key customers a successful bundle of services reduces the risk of losing an entire service relationship. The markets in which Arvato operates and that are characterized by overcapacity (primarily replication) show sustained price pressure. In other areas, competitors are following Arvato’s strategy by expanding their value chains, which is increasing the level of competition. New competitors entering the market could intensify the competitive pressure and lead to lower margins. By constantly developing the range of services, the aim is to improve the competitive position and increase customer loyalty through integrated solutions together with a trend toward higher value added. A worsening of the economic environment could result in declining revenues and thus lower margins, which would necessitate cost-cutting measures and capacity downsizing. The broad diversification across customers, sectors and regions helps to reduce this risk. On the procurement side is the risk that the procured intermediate products could be of inferior quality, leading to corresponding subsequent costs. Increased procurement prices that cannot be passed on to customers constitute further risks. Countermeasures include agreeing long-term contracts and monitoring the supplier market. The ongoing trend toward digitization entails further risks for individual customer segments of Arvato, particularly in the manufacturing and distribution of physical media products. These risks are being addressed, for example, by developing business priorities, which comprise digital services. Furthermore, business segments that offer no strategic or economic prospects are being deliberately scaled back. The handling of IT risks with sector-specific requirements (data protection and data security requirements) is an additional risk for Arvato as an international service provider. This risk is being reduced by introducing an Information Security Management System based on the ISO 27001 standard, which is used to systematically identify and resolve information security risks.

Customer risks, in particular the greater dependence on a few major customers in structural terms, are the most significant risks for Be Printers. There are also risks from the market environment, which is characterized by shrinking markets and overcapacity. Risks can arise from a continuing market concentration leading to tougher price competition and lower margins. Deterioration in the economic environment may lead to declining circulations with a negative impact on earnings. The same applies to the increasing spread of digital end devices, which is resulting in a decline in printed media. There are further risks on the supplier side associated with rising raw material prices – particularly for paper – that cannot be passed on to customers. The risk minimization strategy is based, among other things, on flexible contractual arrangements, particularly for key accounts. Other key elements of this strategy include the agreement of price-adjustment clauses, optimizing cost structures and making them more flexible as well as ongoing market monitoring.

Corporate Investments essentially comprises the fund investments and BMG as well as the Group’s remaining Club and Direct Marketing activities. From a Group perspective, the identified risks are of minor importance.

Finally, it should be noted that because of demographic change a greater emphasis in the risk reporting is placed on employee-related risks such as a shift in the age distribution of the workforce, challenges in recruiting qualified personnel and the departure of top executives. This risk applies to all divisions. Countermeasures include further training measures and health programs, increased recruiting measures as well as interdivisional talent development.

As well as organic growth, the Group’s development strategy includes targeted acquisitions of promising businesses. These types of acquisitions, such as in 2013 the merger of Penguin Random House, the takeover of the remaining shares in BMG and the acquisition of Gothia, present opportunities as well as risks. Integration into the Group requires one-time costs that are usually offset by increased benefits in the long term thanks to synergy effects. In this context, there are risks in that the integration costs may be higher than expected or the predicted level of synergies may not materialize. The integration processes are therefore being permanently monitored by management.

For a global media company like Bertelsmann, the reliability and security of information technology is crucial. This means that the Group is now facing a wide range of IT risks. Challenges are constantly increasing as the business environment becomes more and more complex due to the increasing networking and IT penetration of business processes, many internal processes that are not yet standardized and potential external risks. In the future, this issue will be actively addressed by the introduction of the Group-wide Information Security Management System. The implementation of the management system includes regular and structured monitoring of compliance with the regulations as well as systematic recording of information security risks and deriving appropriate measures.

Bertelsmann, with its worldwide operations, is always exposed to a variety of legal and regulatory risks ranging from litigation to varying interpretations of tax assessment criteria. These risks are being continuously monitored by the relevant departments within the Group.

In November 2008, RTL II filed legal actions against IP Deutschland, a wholly owned subsidiary of RTL Group, and Seven One Media (“SOM”) as a result of the proceedings in 2007 of the German Federal Cartel Office against the discount scheme agreements (“share deals”) offered by IP Deutschland and SOM. RTL II’s claim is currently limited to access to information on the basis of which the claimants want to prove that they suffered damages from these discount schemes. The court of first instance in Düsseldorf decided to order an expert report.

At the end of January 2013, Kabel Deutschland (KDG) appealed a decision of the German Federal Cartel Office to settle a case in accordance with section 32b of the German Act Against Restraints of Competition following commitments of the channels of Mediengruppe RTL Deutschland to broadcast digital channels in standard quality unencrypted and to refrain from certain restrictions on the usage of digital signals in standard quality. The preliminary oral proceeding is scheduled for September 2014.

Foreign investments in media companies in the People’s Republic of China are subject to restrictions. In order to comply with local legal provisions, some of the Bertelsmann participations in China are held by trustees. Bertelsmann has agreements with these trustees with respect to the securing of Bertelsmann’s rights. This type of structure is common for investments in China and has been tolerated by the Chinese authorities for many years. However, a basic risk exists that it will not be possible to safeguard such structures through Chinese courts if the People’s Republic should change its policies toward foreign investment and, for example, no longer recognize offshore investments in general or in the media area in particular. In addition, it cannot be ruled out that Chinese authorities or courts in the future will interpret existing provisions differently from the previous practice. In the event that legal violations can be proven, in an extreme case, Bertelsmann could be exposed to considerable fines and the revocation of business licenses leading to immediate closure of participations in China. This would affect Arvato and Gruner + Jahr companies as well as Bertelsmann Asia Investments (BAI). In the past, however, such extreme measures by the Chinese authorities have only been reported in exceptional cases.

Aside from the matters outlined above, no further significant legal and regulatory risks to Bertelsmann are apparent at this time.

As an international corporation, Bertelsmann is exposed to various forms of financial market risk, especially interest rate and currency risks. These risks are largely controlled centrally on the basis of guidelines established by the Executive Board. Derivative financial instruments are used solely for hedging purposes. Bertelsmann uses currency derivatives mainly to hedge recorded and future transactions involving foreign currency risk. Some firm commitments denominated in foreign currency are partially hedged when they are made, with the hedged amount increasing over time. A number of subsidiaries are based outside the euro zone. The resulting translation risk is managed based on economic debt in relation to operating EBITDAEarnings before interest, taxes, depreciation, amortization and special items. (leverage factorThe leverage factor is the ratio of economic debt to operating EBITDA. In calculating the leverage factor, modifications are made to the balance sheet figures to better reflect the Group’s actual financial strength from an economic viewpoint.). Bertelsmann’s long-term focus is on the maximum leverage factor permitted for the Group. Foreign currency translation risks arising from net investments in foreign entities are not hedged. Interest rate derivatives are used centrally for the balanced management of interest rate risk. The cash flowA company’s cash inflows and outflows during a specific period. risk from interest rate changes is centrally monitored and controlled as part of interest rate management. The aim is to achieve a balanced ratio of different fixed interest rates by selecting appropriate maturity periods for the originated financial assets and liabilities affecting liquidity, and through the ongoing use of interest rate derivatives. The liquidity risk is regularly monitored on the basis of the planning calculation. The existing syndicated loanLoan facility involving a consortium of banks., as well as appropriate liquidity provisions, form a sufficient risk buffer for unplanned payments. Counterparty risks exist in the Group in invested cash and cash equivalents and in the default of a counterparty in derivatives transactions. Financial transactions and financial instruments are restricted to a rigidly defined group of banks with an excellent credit ratingExpression of creditworthiness of a creditor or financial instrument by an agency specialized in evaluating credit risk.. Existing risks from investing cash and cash equivalents are continuously monitored. Financial investments are generally made on a short-term basis so that the investment volume can be reduced if the credit rating changes (see also further explanatory remarks on “Financial Risk Management” in section 25 of the notes).

The overall risk position has increased year on year primarily due to the increase in business volume through the Penguin Random House merger. The risks arising from the process of integrating the two companies are shown as an individual risk. Risks from technological challenges that were included in the top ten Group risks last year remain but they have become less significant. The continuing digital transformation of businesses is already largely anticipating the technological changes so that the risks in this connection are being increasingly reflected in other operating risks such as pricing and margin risks. As a result of the diversification of Group businesses, there are no concentration risks stemming from dependency on individual business partners or products in either procurement or sales. The Group’s financial position is solid, with liquidity needs currently covered by existing liquidity and available credit facilities.

No risks endangering Bertelsmann’s continued existence were identified in financial year 2013, nor are any substantial risks discernible from the current perspective that could threaten the continued existence of the Group.

An efficient opportunity management system enables Bertelsmann to secure its corporate success in the long term and to exploit potential in an optimum way. Opportunities are possible future developments or events that could result in a positive deviation from outlook or objective for Bertelsmann. The opportunity management system, like the RMS, is an integral component of the business processes and company decisions. During the planning process, the significant opportunities are determined each year, from the profit center level upward, and then aggregated step by step at the division and Group levels. By systematically recording them on several reporting levels, opportunities that arise can be identified and exploited at an early stage. This also creates an interdivisional overview of Bertelsmann’s current opportunities. A review of major changes in opportunities is conducted at divisional level every six months. In addition, the largely decentralized opportunity management system is coordinated by central departments in the Group. The department of Business Development and New Businesses continuously pursues strategic opportunity potential and seeks to derive synergies through targeted cooperation in the individual divisions. The interdivisional experience transfer is reinforced by regular meetings of the Group Management Committee.

While the opportunities associated with positive development may be accompanied by corresponding risks, certain risks are entered into in order to exploit potential opportunities. This close link to the key Group risks offers strategic, operational, legal, regulatory and financial opportunities for Bertelsmann.

Strategic opportunities can be derived primarily from the Group’s four strategic priorities. Strengthening core businesses, driving forward the digital transformation, developing growth platforms and expanding in growth regions constitute the most important long-term growth opportunities for Bertelsmann (see section “Strategy”). In particular, there are general opportunities for exploiting synergies as a result of the portfolio expansions. Furthermore, there is potential in the existing divisions for efficiency improvements and the possibility of more favorable economic development as well as individual operational opportunities. For RTL Group, the TV advertising markets in some core markets could develop better than expected. The many different possible applications for the increasingly digital means of distribution will allow RTL Group to target their end customers and advertising customers more effectively. At Penguin Random House, successful debut publications, strong market growth and higher e-book revenues provide further opportunities. Gruner + Jahr has opportunities in international markets through new and digital businesses. In the magazine business, growth may be achieved particularly in Spain, China and India through higher advertising revenues. At Arvato, the ongoing trend toward outsourcing and the successful development of new businesses are creating opportunities. Arvato could benefit in particular from higher growth of SCMSupply Chain Management (SCM) is a strategic approach which uses integrated logistics chains to establish, implement and optimize the organization of all logistics processes from companies to end customers. activities in the e-commerce, high-tech and health-care segments and additional new business from the CRMCustomer Relationship Management (CRM) is a strategic approach which establishes, maintains and reinforces companies’ customer relationships using state-of-the-art information and communication technologies. Solution Group. There are also opportunities for growth in the Solution Groups: IT Solutions, Financial Solutions, Digital Marketing and Print Solutions. The Be Printers print businesses, particularly in Southern Europe, may decline less steeply through additional volume and new customers. This would provide opportunities from the targeted servicing of market segments that are still growing. At Corporate Investments, there is potential for growth thanks to lower restructuring costs in the Club and Direct Marketing businesses. In addition, potential artist signings or music catalog takeovers could offer growth opportunities for BMG. The current innovation efforts detailed in the “Innovations” section offer further potential opportunities for the individual divisions.

Other opportunities could arise from changes to the legal and regulatory environment.

The financial opportunities are largely based on a favorable development of interest and exchange rates from Bertelsmann’s point of view.