Risk Factors Aumentar Diminuir

a. Risks Related to the Company and its businesses

i) The Company does business under the federal concession regime.

As it is an operation under concession, the Licensing Power may change the energy production, allocation and commercialization rules. Those changes may bring a significant impact to CESP, damaging its results and cash flow.

ii) The Company’s plant concessions have an established maturity term.

The Company holds concessions for exploration of electric energy generation services impacted by the amendment of the Provisional Presidential Decree no. 579, of September 11, 2012 (thereafter converted into Law no. 12.783, of 01/14/2013).By means of this Provisional Presidential Decree, the Federal Government, in the capacity of Licensing Power, offered CESP with the advancement of the renewal of the concessions of Ilha Solteira and Jupiá plants, expiring in 2015, to January 2013, provided that the conditions for commercialization of energy from those plants are accepted. Additionally, the same treatment was extended to Três Irmãos Plant, which maturity date of the first concession period has taken place in November 2011.

CESP’s shareholders, gathered in a meeting held on December 03, 2012, decided not to renew the concessions as offered by the Provisional Presidential Decree. Upon making this decision, CESP will continue to operate Ilha Solteira and Jupiá Plants until the end of the concession term, which will take place in July 2015. On April 17, 2013, the Ministry of Mines and Energy – MME assigned, by means of the Ordinance No. 125, the Company as the responsible for providing the energy generation services of Três Irmãos Hydroelectric Power Plant until the assumption of winning bidder of public auction held on October 10, 2014, when TIJOÁ Participações took control over concession of HPP Três Irmãos.

On July 7, 2015, the concessions of the two largest hydroelectric plants of CESP, Ilha Solteira and Jupiá expired, which together represented 75% of the installed capacity. In an unprecedented manner for the renewal process, the Federal Government instituted the payment of the concession for the renewal of the concessions of the plants defined in ANEEL Bid Notice No. 12/2015, including the two of CESP.

Notwithstanding the efforts of the administrators and the controlling shareholder, the Company was not allowed to participate in the Auction held on November 25, 2015.

In the period between the end of the concessions and the assumption of the new concessionaire, CESP operated the two plants in the quota system until the end of the assisted operation period ended on June 30, 2016. It was a marginally profitable operation and it complied with our social responsibility for the continuity of the electric power generation service.

The Company understands that the assumption of a new entrant characterizes labor succession and entered the court to obtain this recognition. Likewise, it understands that the litigation concerning the lawsuits related to those plants accompany the concessions, since they are inherent to them.

Regarding the Jaguari Hydroelectric Power Plant, which will expire in 2021, CESP, in accordance with Law No. 12,783, of January 11, 2013, and in a timely manner, requested the renewal of this concession and awaits the pronouncement of Aneel. For the Paraibuna Hydroelectric Plant, the same procedure was adopted.

At the end of 2016, CESP maintains concessions for a generating park made up of three hydroelectric plants, totaling 1,654.6 MW of installed capacity. The Porto Primavera Hydro Generator (concession maturity originally in May / 2028, but extended to July 11 of the same year due to the hydrological risk renegotiation agreement), Paraibuna (March / 2021) and Jaguari (May / 2020) will continue to be operated By CESP.

The Ministry of Mines and Energy published Ordinance No. 258, dated December 21, 2016, reducing the physical guarantee of Porto Primavera HPP from 1,017 to 992.6 average MW. With this, the current amount of energy that CESP can market (physical guarantee) is now 1,056.6 average MW.

The plants have the following characteristics and concession terms:

Basin Hydro Generation Unit Installed Power MW Physical Garantee MW Start Concession Term
Paraná Porto Primavera 1,54 992.6** 01/23/1999 07/11/2028*
Paraíba Jaguari 27,6 14 05/05/1972 05/20/2020
Paraíba Paraibuna 87 50 04/20/1978 03/09/2021*
Total 1.654,6 1.056,6  

*Concession extended for 53 days according to agreement to renegotiate the hydrological risk established by Law 13.203 / 2015
**According to Ordinance MME nº 258, of December 21, 2016

Porto Primavera (maturity date of the concession in May 2028), Paraibuna (March 2021) and Jaguari (May 2020) Plants were not comprised by the Provisional will continue on being normally operated by CESP.

iii) The Company, in the capacity of electric energy generation public utility concessionaire, is subject to ANEEL’s regulation and inspection.

ANEEL may impose penalties to the Company in case it fails to meet its obligations as a result of the concession or it breaches the legislation or sector standards. Depending on the seriousness of the default, the applicable penalties may range from warning to termination of the concession due to caducity. The imposition of fines or penalties to the Company or the termination of any of its concessions may affect its revenue, as well as its cash flow generation.

iv) The Company is included in the State De-statization Program of the State of São Paulo.

The Company is included in the State De-statization Program of the State of São Paulo, instituted by State Law no. 9.361, of July 5, 1996. At this time, there is no official initiative in progress, by the Government of the State of São Paulo or any Company’s controlling shareholder to promote the disposition of representative shares of the Company’s controlling interest.

In case the Company changes its controlling interest, the new controlling shareholder shall be obliged to pay 100% of the unit value paid for the shares purchased in order to acquire the Company’s controlling interest to the PNB shareholders exercising such a right t.PNA and ON shareholders shall have their treatment established in the legislation in force.

Additionally, the Company’s controlling interest alteration is an Event of Assessment provided in the item (d) of the Article 51, of the FIDC IV CESP Fund Regulation, which provides the opportunity for the General Shareholders’ Meeting to be convened.

v) Adverse judgments against the Company in judicial proceedings may have a significant negative effect on the Company.

The Company is involved in several judicial proceedings involving significant monetary claims, including, but not limited to, civil, environmental, tax, fiscal proceedings, public-interest civil actions, citizen suits, employment claims and condemnation proceedings. An adverse decision to the Company involving substantial monies in one or more of such proceedings may have a negative impact on its results and financial condition, as well as its future cash flow generation. Additional information on the progression of the judicial proceedings, in which the Company is a party, as well as its probable conclusions and respective provisions, may be observed in items 4.3 to 4.5.

vi) Insurance

The Company has insurance agreements with coverage as determined by experts, taking into consideration the risk nature and degree, in order to cover occasional losses on its assets and/or liabilities, however, the insurance agreements may not be sufficient to fully cover the damages and liabilities which may be incurred in the regular course of its businesses, operating business and financial situation.

vii) CESP Foundation

The Company sponsors retirement and pension benefit plans for its employees and former employees, and their respective beneficiaries, in order to supplement the benefits provided by the official social security system. CESP Foundation is the entity in charge of the management of the benefit plans sponsored by the Company.

The Company, by means of negotiations with the category representative unions, reformulated the plan in 1997, having as its main characteristics the mixed model, comprised of 70% of the actual shadow wage as defined benefit and up to 30% of the actual shadow wage as optional defined contribution. This reformulation was intended to set out the actuarial technical deficit and decrease the risk of future deficits.

In addition to the plan benefits, the Company provides its employees with other benefits, such as medical and dental assistance. The plan costing to the defined benefit is jointly borne by the Company and the employees. The costing of the installed established as the defined contribution is jointly borne by the Company and the employees, based on the percentage freely chosen by the participant up to the limit of 2.5%, higher levels are only contributed by the participant. The costing fees are reassessed on a periodical basis by any independent actuary.

BSPS (Balanced Proportional Supplementary Benefit) is insured to the employees participating in the supplementation plan and adhering to the new implemented model, as from January 1, 1998, who were dissociated. This benefit insures the proportional value of the supplementation relating to the service period prior to the supplementation plan reformulation date. The benefit shall be paid as from the date in which the participant completes the minimum waiting periods provided in the new plan regulation.

Thus, any occasional actuarial deficit may have a negative impact on its results and financial condition, as well as its future cash flow generation.

b. Related to its controlling shareholder, either direct or indirect, or controlling group

The Company is controlled by the State of São Paulo, which has powers to determine the operating and strategic policies, control the election of most of the Board of Directors’ members and appoint the Company’s Board of Officers. On December 31, 2013, the State was the holder of 94.08% of the common shares issued by the Company.

The condition of a company controlled by the State of São Paulo may imply conflicts of interest between the Company’s institutional role, policies and guidelines of controller, and may eventually differ from investor interest.

Changes in the Government of the State of São Paulo or its governmental policy may entail changes in the Company’s Board of Officers, as well as its business strategies, and they may cause an impact on its results and financial condition, as well as its future cash flow generation.

c. Related to its shareholders

i) Volatility and lack of liquidity of the capital market may adversely affect the share sales.

The volatility and/or lack of liquidity of the Brazilian capital market, which is less liquid, more volatile and concentrated than the major international markets, have potential to jeopardize the sales capability of the investors at the intended price and time.

ii) The Company’s shareholders may not receive dividends or interests over their own capital.

Depending on the future results, the Company’s shareholders may not receive dividends or interests over their own capital, in case it does not assess its profits. If the dividend or interest earning over own capital is incompatible with the Company’s financial situation, the dividends or interests over own capital may not be paid either.

iii) In the future, the Company may increase its capital, by issuing securities, and it may result into the dilution of the investors’ interest in Company’s shares at that time.

As occurred in July 2006, where the Company raised funds in the amount of R$ 3.2 billion by issuing new shares, the issuance of new shares, as well as public or private placement of securities convertible into shares, either providing or not the preemptive right to its current shareholders, resulting into the dilution of the investors’ interest in the Company’s capital share.

d. Related to its controlled and affiliated companies

The Company had no Controlled or Affiliated Company by the date of publication of the Reference Form.

e. Related to its suppliers

The Company depends on third parties to supply machinery and equipment used at its facilities, as well as specific maintenance services, being subject to price variation, as well as delivery availability for such machinery, equipment and services. Due to the technical specifications of the equipment used at its facilities, the Company has few suppliers. In case any supplier discontinues the production or disrupts the sales of any of the equipment acquired by the Company, perhaps it is not possible to acquire such equipment from other suppliers, which may damage its operating activities.

f. Related to its customers

The Company has several types of customers as a counterpart in several types of energy supply agreements and, occasionally, any customer may not be able to meet its obligations with the Company.
The risk arises out of the possibility of the Company to incur losses resulting from the difficulty to receive amounts invoiced to its customers. The receivables may be classified into three groups, which have the following characteristics: (i) for receivables arising out of the sales of distribution concessionaires – concentrated number of customers, existence of agreement guarantees, they are energy distribution public utility concessionaires, subject to the intervention of the concession and since there is no track record for significant losses when realizing their receivables; (ii) for receivables arising out of the sales to end customers or commercializers – concentrated number and size of the company of their customers, prior credit analysis and existence of agreement guarantees of, at least, two months of billing; (iii) for receivables of operations settled at the Electric Energy Commercialization Chamber – CCEE, for the same type of customers as the aforementioned items.

In case there is any difficulty to receive the invoiced amounts, there may be a negative impact on the Company’s results, its financial condition, as well as future cash flow generation.

g. Related to the economic sectors in which the Company acts

i) Influência do Governo

The Company acts in the Brazilian market, being subject, therefore, to the effects of the economic policy of the Federal Government.
Brazilian Government’s measures to control the inflation and implement economic and monetary policies have been involving, in past few years, interest rate alterations, currency depreciation, exchange control, rate control, electricity consumption control, fiscal and tax policy alteration, among other. Such measures may impact the Company’s businesses, as well as its financial condition, its operating results and, accordingly, its revenue and future cash flow generation.

ii) The Company’s generation of electricity depends on favorable hydrological conditions.

The Company’s main hydroelectric power plant, Engº Sérgio Motta (Porto Primavera), which accounts for 94% of the physical guarantee for sale, is concentrated in the area of influence of the Paraná river basin, in the western region of the State of São Paulo, and operates one year reservoir.

Risks of water scarcity due to rainfall conditions are cyclical, but with more frequent occurrences in recent years. Localized unfavorable hydrological situations are covered by the Energy Reallocation Mechanism (MRE), a hydrological risk sharing instrument that the Brazilian Electricity Sector has and allows the National Electric System Operator (ONS) to seek the optimization of hydroelectric resources through dispatch by power plant , so that temporary shortfalls of each generating agent of the system are covered by generation of other generators, with additional cost to an Energy Optimization Tariff – TEO:

Homologation Resolution Beginning of Validity R$/ MW
Homologatória n° 1.840, de 12/09/2014 01/01/2015 11.25
Homologatória n° 2.002, de 12/15/2015 01/01/2016 12.32
Homologatória n° 2.190, de 12/13/2016 01/01/2017 11.58

The scarcity of water throughout the Brazilian hydroelectric system has limited the country’s hydroelectric power generation capacity. This may have a negative impact on the Company’s results and its financial condition, as well as on its future cash flow generation.

In order to reduce the financial impacts of the hydrological risk on hydraulic generation in the SIN, the Federal Government published Provisional Measure No. 688/2015, later converted into Law 13203/2015, which deals with a renegotiation agreement of this risk, with participation only of the generators in the MRE – Energy Reallocation Mechanism (voluntary) and distributors (compulsory), involving portions of the physical agent energy guarantee, related to the amounts of the Contracts for the Regulated Contracting Environment (ACR) and the Free Contracting Environment – ACL.

The renegotiation has retroactive effects to 01/01/2015 and, on the other hand, contemplates a risk premium charged by the generators and, as an effectiveness clause, that each agent abdicates individually from the lawsuits related to the hydrological risk.

After extensive studies and analysis, CESP filed an application with ANEEL for the adhesion to the renegotiation of the hydrological risk in the ACR, in which average 350 MW contracted in 2016 and 230 average MW contracted from 2017 to 2028 are cleared of the liens and, of the bonuses, caused by this risk. Regarding the Free Contracting Environment, the decision was for non-adherence, caused by the non-attractiveness confirmed, inclusively, by the other agents.

Additionally, in the occurrence of unfavorable hydrological conditions there may be an impact on the current levels of the reservoirs. Thus, there is the possibility of implementing measures necessary to maintain the country’s electricity supply, such as: rationing or rationalization of electric energy consumption. Such measures may have a negative impact on the Company’s results and financial condition, as well as on its future cash flow generation.

iii) The Company may have to acquire short-term energy to fulfill sales contracts.

The reduction of 24.4 average MW of the physical guarantee of the Porto Primavera HPP, established through Ordinance MME no. 258, of December 21, 2016, whose fulfillment occurred from its publication, may entail the necessity of adjusting its balance Of energy.

Likewise, from 2018 onwards, with the publication by MME – Ministry of Mines and Energy of the revision of the physical guarantee of the Company’s plants, there may be a need to acquire short-term energy to fulfill its contractual obligations to supply Energy and to balance the differences between physical ballast (physical guarantee) and contracted energy, which are accounted for and settled in CCEE – Electric Energy Trading Chamber.

Should the Company acquire short-term energy, it will be subject to price changes in this market, which is more volatile than in regulated or free contracting environments. Therefore, should the Company have to contract short-term energy, it may have a negative impact on its results and financial condition, as well as on its future cash flow generation.

h. Related to regulation of the economic sectors in which the Company acts

i) The Company acts in the Brazilian electric sector, restructured by the Federal Government. Changes may take place in the electric sector with impact to the companies subject to their rules, such as the Company.

Podem ocorrer mudanças no modelo do setor elétrico com impacto para as empresas sujeitas às suas regras, como a Companhia.

On March 15, 2004, the Law of the New Electric Sector Model was enacted, promoting deep changes in the current electric sector structure, among which:

  • the alteration of the rules on electric energy purchase and sales among energy generating companies and electric energy public utility concessionaires, permissionaires and authorized service providers;
  • new rules for generation enterprise bidding;
  • creation of the Electric Energy Commercialization Chamber – CCEE;
  • creation of new sector agencies; and
  • alteration of the competences of the Ministry of Mines and Energy and ANEEL.

The Law of the New Electric Sector Model has its constitutionality defended before the Federal Supreme Court by means of ADINs (Direct Actions of Unconstitutionality).There is no decision on such matter yet. By the date of this Reference Form, it is not possible to predict the occasional adverse effects of the ADINs’ judgment, as well as the impact it might cause to the Company’s revenue and its future cash flow generation.

On September 11, 2012, the Provisional Presidential Decree 579 (converted into the Law no. 12.783, January 14, 2013) was edited, amending in a significant manner the concession renewal of the plants operated by CESP. The most immediate impact was regarding Três Irmãos Plant, which was returned to the Licensing Power in April 2013.

On April 17, 2013, the Ministry of Mines and Energy – MME published the Ordinance No. 125, making official the permanence of the Company as the responsible for providing the energy generation services of Três Irmãos Hydroelectric Power Plant until the bid-winning concessionaire takes it.

On March 28, 2014, the auction for definition of a new operator of Três Irmãos hydroelectric power plant has taken place. The contest object was only the power station; Pereira Barreto Channel and sluices remained out of the contest. Consórcio Novo Oriente, composed of an investment fund, and Furnas won the tender, with discount of R$ 0,87 in relation to the ceiling price established by National Agency of Electric Energy – ANEEL (R$ 31.623.036,87). However, on the same date, the Brazilian Federal Court of Accounts (Tribunal de Contas da União) –TCU – by means of Injunctive Relief, has suspended the auction result and has determined that ANEEL is not to contract the concession with contest winners while it analyses the impacts and implications of the operational division.

In April 9, 2014, in an assembly meeting, the Federal Court of Accounts – TCU kept the decision that suspended the signature of the contract regarding the auction of UHE Três Irmãos, until the entity judges the process.

In August 20, 2014, TCU authorized the signature of the concession contract as the government presented a proposal stating that the National Department of Transports Infrastructure – DNIT would take responsibility for operating the floodgate and waterway, according to contract to be signed.

In September 10, with interference of the Fundo de Investimentos em Participações Constantinopla and Furnas Centrais Elétricas S/A, TIJOÁ Participações e Investimentos S/A signed with the Ministry of Mines and Energy – MME, the concession contract for generation of electric energy at the Três Irmãos Hydroelectric Power Plant, with 30 days of assisted operation, starting October 10, 2014, for 30 years.

On July 7, 2015, the concessions of the two largest hydroelectric plants of CESP, Ilha Solteira and Jupiá occurred, which together represented 75% of the installed capacity. In an unprecedented manner for the renewal process, the Federal Government instituted the payment of the concession for the renewal of the concessions of the plants defined in ANEEL Bid Notice No. 12/2015, including the two of CESP.

Notwithstanding the efforts of the administrators and the controlling shareholder, the Company’s participation in the Auction held on November 25, 2015 was not made viable. The decision demonstrates discipline in the use of CESP’s capital.

In the period between the end of the concessions and the assumption of the new concessionaire, CESP has been operating both plants in the quota system and remain in this condition until the end of the period of operation assisted to end on June 30, 2016. It is marginally profitable operation and which complies with our social responsibility for the continuity of the electric power generation service.

The Company understands that the assumption of a new entrant characterizes labor succession and entered the court to obtain this recognition. Likewise, it understands that the litigation concerning the lawsuits related to those plants accompany the concessions, since they are inherent to them.

ii) Renewal of Concessions

Another regulatory risk involves changes in the criteria for renewing hydroelectric power plant concessions, which occurred twice in the last three years, with the publication of Law No. 12,783 / 2013 (MP 579/2012), which established the system of guarantee physical quotas at a tariff determined by ANEEL, and Law 13203/2015 (MP 688/2015), which established the payment of a bonus for the concession of the project to be tendered. Such changes in the regulatory framework imply substantial changes in the planning of companies in the sector, including CESP.

iii) The Company may have its physical guarantee (electric power ballast) reduced by up to 5% due to sect oral rules.

The Physical Guarantee corresponds to the maximum limit used in the contracting of electric energy by each plant. The ordinary revision of these amounts must occur every five years, as provided for in Decree No. 2.655, of 1998. This Decree determines that the physical guarantee reductions caused by the revisions must be a maximum of 5% of the current value, limited to 10% in the entire concession of the HPP.

The publication of revised physical energy guarantees for hydroelectric plants is scheduled to occur in the first half of 2017, effective as of January 1, 2018. In this way, the Company’s energy balance may be negative as from 2018, subject to The Company also to pay penalties for lack of energy ballast at CCEE-Electric Energy Trading Chamber, in case no action is taken in this situation.

iv) Participation in the apportionment of the cost of additional thermal dispatch due to energy security.

The National Council for Energy Policy (CNPE), through Resolution no. 3 of March 6, 2013, defined that part of the cost of additional dispatch of thermal plants for reasons of energy security, decided by the Committee of Monitoring of the Electric Sector (CMSE) , Should be apportioned among all market agents, through a CCEE accounting and settlement process. The charge will be made through Charge of Services of the System due to energy security, according to the provisions in art. 59 of Decree nº 5.163, of July 30, 2004.

However, associations representing companies in the electricity sector filed injunctions that suspended the Resolution articles related to the topic. CESP is part of one of these associations. If the injunctions are reversed, the Company and all other agents that obtained them will be impacted by the amounts accumulated during the judicial suspension. In any event, the participation in this apportionment may have a negative impact on the Company’s results, as well as on its future cash flow generation.

i. Related to foreign countries where the issuer operates

At the date of publication of this Reference Form, the company registered only in Brazil, and therefore does not have any relevant risks related to foreign countries.

j. To socio-environmental issues

i) The Company’s facilities and operations are subject to environmental regulations at the federal, state and municipal levels, which may become more rigorous in the future, which may lead to increased liability and increased capital expenditures.

The Company’s activities and facilities are subject to various federal, state and local laws and regulations, as well as various operating requirements related to environmental protection. More stringent additional laws or regulations may be approved and enforcement, as well as the interpretation of existing legislation, may become more severe. In addition, the facilities and the Company’s operations are subject to environmental regulations at the federal, state and municipal levels, which may become stricter in the future and may result in increased responsibility and increased capital spending.

2) Market risks

The Company’s business comprises particularly the energy generation to be sold to large customers (free market) and electric energy distribution public utility concessionaires (regulated market).The main risk factors of the market affecting its businesses are as follows:

a. Interest and Inflation Rate Risk

This risk arises out of the possibility of the Company to incur losses in virtue of interest and inflation rate fluctuations, increasing the financial expenses relating to loans and financings raised. The Company has no derivative agreements made to hedge against this risk; however, it continually monitors the interest rate of the market in order to assess the need for replacement of the debt modality. On December 31, 2013, the Company had R$ 2,483,716 thousand at variable interest rates and/or indexed to inflation rates, and R$ 63,521 thousand at fixed rates: Em 31 de dezembro de 2016, a Companhia possuía R$ 636.484, captados a taxas variáveis de juros e/ou indexados à taxas de inflação, e R$ 15.061 captados a taxas fixas:

In thousands of reais

Liabilities Linked to Fees Accounting Balance
12.31.2016 12.31.2015
National Currency 98,212 329,536
CDI 83,151 309,322
TAXA FIXA 15,061 20,214
Foreign Currency 553,333 862,495
UMBNDES 552,196 860,878
LIBOR 1,137 1,617
Total 651,545 1,192,031

Sensitivity analysis of interest and inflation rate risk

CESP considers that the risk to be under liabilities in agreements which, in addition to the fixed rate and spread, have costs with variable indexers (updated with post-fixed interest rates or inflation rates), is the increase of those indexes and consequent increase of financial expenses related to the liabilities, raised in national and foreign currency.

The Company grouped the liabilities per contracted indexer and prepared the sensitivity analysis, in compliance with CVM Instruction no. 475/08 and, as suggested by CPC 40 and IFRS 7, by using in these liabilities the scenario disclosed in Focus (Bacen) report of 10/11/2013 06/01/2017.In the liabilities in foreign currency, the conversion into Brazilian Reais was considered with the same closing parity as this statement, in order to reflect only the alterations of interest rate scenarios:

Rate % a.a.

Indexes Prediction Appreciation of the
25% 50%
CDI 11.53 14.41 17.30
UMBNDES 4.32 5.40 6.48
LIBOR 1.31 1.64 1.97

The result of this analysis reflects the nominal sum of the increment in Brazilian Reais of the cash outflow, based on the total debt service short-term payable (January to December/2017), including the interest appropriation up to the date of each maturity date and by deducting the amount recorded on the current assessment date of those financial statements, as per the table as follows:

In thousands of reais

Financial Liabilities Risk Probable Scenario Possible Scenario Remote Scenario
Linked to rates:        
National Currency CDI Variation (212) 154 514
Foreign Currency UMBNDES Variation - 5,769 11,682
LIBOR Variation - 9 18
Total   (212) 5,932 12,214

The Company, as a result of the variation in projected ratios, would have a decrease in cash outflow of R $ 212 in the probable scenario, an increase of R $ 5,932 in the possible scenario and R $ 12,214 in the remote scenario, compared to the flow recorded in the short Period.
Based on the financial position and notional value of the outstanding financial instruments as of 12/31/2016, the Company adopted scenarios of variations, estimating that the effects on 12/31/2017 would be close to those indicated in the scenarios projected in the table below :

The Company, as a result of the projected index variation, would have an increment of R $ 443 thousand in the cash outflow in the probable scenario, R $ 11,655 thousand in the possible scenario and R $ 23,010 thousand in comparison to the flow recorded in Short term. Based on the equity position and notional value of the open financial instruments on 12/31/2013, the Company, by adopting variation scenarios, estimated that the effects on 12/31/2014 would be close to those indicated in the project scenario columns in The table as follows:

Impact on the Debit Balance Projection for 12/31/2017
Financial Liabilities Risk Balance on 31/12/2016 Probable Scenario Possible Scenario Remote Scenario
National Currency          
CDI CDI Variation 83,151 - - -
FIXED RATE No Risk 15,061 9,907 9,907 9,907
Foreign Currency          
UMBNDES UMBNDES Variation 552,196 386,635 390,808 394,981
LIBOR LIBOR Variation 1,137 1,376 1,381 1,385
Total 651,545 397,918 402,096 406,273

b. Exchange Rate Risk

The Company’s indebtedness and operating result are significantly affected by the market risk factor of the exchange rate (US Dollar).

On December 31, 2013, the total balance of loan and financing account, including charges incurred up to this date, amounted to R$ 762,923 thousand (R$ 1,269,614 thousand, on 12/31/2012) referring to foreign currency fundraising, exclusively US Dollars: Risco de Taxa de Câmbio.

The Company’s indebtedness and results of operations are significantly affected by the exchange rate (US dollar) market risk factor. As of December 31, 2016, the total balance of the loans and financing account, including charges incurred to date, amounted to R $ 553,333 (R $ 862,495 at December 31, 2016) related to funding in foreign currency, exclusively US dollars .

In thousands of reais

Liabilities Accounting Balance
12/31/2016 12/31/2015
US Dollars Loan and Financing 553,333 862,495
Total 553,333 862,495

Sensitivity analysis of Exchange Rate Risk

CESP considers that the risk of being under the liabilities in foreign currency is the increment of the US Dollar quote (PTAX) by the maturity date of each installment of the loan and financing agreements raised in foreign currency, impacting the financial expenses of the year. In compliance with the provision in CVM Instruction No. 475/08 and as suggested by CPC 40 and IFRS 7, for determination of the adverse variation effects in the exchange rates, the Company adopted the scenarios of minimum negative variations defined by the said instruction and equivalent to 25% and 50% on the respective exchange rates used when determining the probable, possible and remote scenarios:

Currencies Prediction Rate Appreciation at
25% 50%
US Dollar: US$/R$ 3.39 4.24 5.08

The result of this analysis reflects the nominal sum of the increment in Brazilian Reais of the cash outflow, based on the total debt service short-term payable (January to December/2014), including the interest appropriation up to the date of each maturity date and by deducting the amount recorded in short term from the current financial statement, as per the table as follows:

In thousands of reais

Financial Liabilities Risk Probable Scenario Possible Scenario Remote Scenario
Loans and Financings at US$ US$ Appreciation 8,616 64,398 120,180

The Company would have, as a result of the projected exchange variation, an increase in cash outflow in the period from January to December / 2017 of R $ 8,616 in the probable scenario, of R $ 64,398 in the possible scenario and R $ 120,180 in the remote scenario.

Based on the financial position and notional value of the outstanding financial instruments as of 12/31/2016, the Company, adopting scenarios of variations, estimated that the effects on 12/31/2017 would be close to those indicated in the scenarios projected in the table below. follow:

The Company would have, as a result of the projected exchange variation, an increment in the cash outflow from January to December/2014 of R$ 4,470 thousand in the probable scenario, R$ 51,195 thousand in the possible scenario and R$ 97,920 thousand in the remote scenario. Based on the equity position and notional value of the open financial instruments on 12/31/2013, the Company, by adopting variation scenarios, estimated that the effects on 12/31/2014 would be close to those indicated in the project scenario columns in the table as follows:

Impact on Debtor Balance Projection for 12/31/2017
Financial Liabilities Balance at 12/31/2016 Probable Scenario Possible Scenario Remote Scenario
US Dollar – US$ 555,333 575,557 719,447 863,336
Total 555,333 575,557 719,447 863,336

c. Price Risk

In accordance with the legislation in force, the electric energy distribution concessionaires should execute electric energy purchase agreements only in the Regulation Contracting Environment, through public auctions of energy, and free consumers, commercializers and generators should execute agreements with the Company only at the Free Contracting Environment, through freely negotiated bilateral agreements. Thus, it is not possible to predict the price by which the Company may contract its energy or it is not possible to contract its entire physical guarantee in long term, after the end of the effective Energy Sales Agreements.

The prices of commercial electricity also come from the energy auctions of Existing Units (2008/2009), whose prices at the time were between R $ 83.50 and R $ 93.43 per MWh, which can be updated annually, and of energy auctions of New Units (2005/2006), with prices between R $ 116.00 and R $ 124.97 per MWh, which can be updated annually. As the contracts resulting from the 4th Existing Energy Auction (average 120 MW) had their maturities at the end of 2016, the risk would be not to obtain prices that are adequate to the Company’s objectives, in the next auctions that may occur. On the other hand, there were reductions in energy ballast for sale from 2013, with the transfer of the Três Irmãos HPP to the new controller; In 2015, due to the end of the concessions of the Ilha Solteira and Jupiá hydroelectric plants, and; In 2016, due to the publication of the Ordinance by the Ministry of Mines and Energy, reducing the physical guarantee of the Porto Primavera HPP by 2.5%.

For this reason, all of the Company’s energy ballast for sale is compromised, even with the expiration of the aforementioned contracts, a factor that contributes to the Company’s decrease in revenues.

As a result, the Company has practically all of its physical guarantee contracted in both environments until the year 2021. These contracts have been in force since 2004, with the objective of ensuring a balanced billing for the Company.

ANEEL homologates annually the minimum and maximum prices of PLD – Settlement Price of Differences, valid for the year.

It is observed that due to the water crisis, the PLD has shown great volatility

R$/MWh

Homologatory Decision Beginning of Minimum Maximum
Homologatória n° 1.832, de 11/25/2014 01/01/2015 30.26 388.48
Homologatória n° 2.002, de 12/15/2015 01/01/2016 30.25 422.56
Homologatória n° 2.190, de 12/13/2016 01/01/2017 33.68 533.82

d. Early Debt Settlement Risk

There are no covenants on existing loans and financing agreements.

3) Risk management policy

a. If the issuer has a formalized policy of risk management, highlighting, if so, the body that approved it and the date of its approval, and, if not, the reasons why the issuer did not adopt a policy.

CESP’s Risk Management Policy was submitted to the Board of Directors for approval at the 622nd Ordinary Meeting of June 7, 2011, as proposed by Executive Board Resolution 2511/05 / 1495th and Report to the Board of Directors P/008/2011, both of 27.05.2011 and was adopted unanimously.

b. Objectives and strategies of the risk management policy

CESP’s risk management policy establishes the process, methods and criteria for the identification, evaluation, monitoring and reporting of risks and respective control or mitigation actions to be observed by agents responsible for the risk management activity within the scope of the Company .

The Company’s Strategic Risks Matrix was reviewed with the support of the Decentralized Directors and Risk Managers, and was submitted to the Risk Committee’s assessment and subsequently to the Board of Directors’ appreciation at the 692nd Ordinary Meeting on May 10.

i. Risks for which protection is sought

HYDROLOGICAL RISK

The Porto Primavera hydroelectric plant is concentrated in the area of influence of the Paraná river basin, west of the State of São Paulo, operating by one year reservoir capacity. The geographical location is considered favorable because the Paraná River is formed by the confluence of two large rivers, Paranaíba, which descends from the central-western region of the country, and the Grande River, on the border with the State of Minas Gerais.

The Jaguari and Paraibuna plants are located in the Paraíba do Sul river basin, which has strategic importance regarding the generation of electric power, water supply and regularization of flows along its route (multiple use).

The Company’s power plant, in the area of influence of the Paraná river basin, is located downstream of other hydroelectric plants, so that they benefit from being almost at the end of the waterfall, with only the Itaipu plant at its disposal. Downstream.

The region is tropical, with high historical rates of rainfall. Risks of water scarcity due to rainfall conditions are cyclical, if any. In critical situations, the Granting Authority must act aiming at the economic-financial balance of the agents.

LEGAL RISK

The Company evaluates the loss prognosis related to the lawsuits in which it is involved. This evaluation is supported by the judgment of the Administration together with its legal advisors, considering the jurisprudence, decisions in initial and superior instances, the history of possible agreements and decisions, the experience of the Administration and legal advisors, as well as other applicable aspects. The risks, in their different legal aspects, were evaluated and classified based on the opinion of the Company’s management and of its internal and external legal counsel, according to the probability of an economic-financial risk for the Company and provisioned for those that presented an expectation of probable loss.

ENVIRONMENTAL RISK

Social and environmental liabilities are recorded as the Company assumes formal obligations with regulators or has knowledge of potential risks related to social and environmental issues, whose cash disbursements are considered probable and the estimated amounts.

ii. Instruments used for protection

HYDROLOGICAL RISK

Risks of water scarcity due to rainfall conditions are cyclical, if any. In critical situations, the Granting Authority must act aiming at the economic-financial balance of the agents. Unfavorable hydrological situations, usually regional and of short duration, are covered by the Mechanism of Reallocation of Energy – MRE, a financial instrument of hydrological risk sharing of which the Brazilian electric sector disposes.

Due to the worsening hydrological situation that affected most of the generation agents, ANEEL held a public hearing in 2015, which resulted in a proposal to renegotiate hydrological risk in regulated and free marketing environments. In January 2016, CESP adhered to the agreement to renegotiate this risk, established by Law 13203, of 12/8/2015, regulated by Normative Resolution No. 684 of December 11, 2015, transferring to the consumer the effects arising from Hydrological risk in the amount of 350 average MW of its physical guarantee, contracted in the regulated environment for the year 2016, upon payment of a risk premium. The renegotiation contemplates all energy contracted in the regulated environment during the concession period.

Likewise, in 2016, unfavorable hydrological conditions caused the MRE hydroelectric plants to be dispatched in order to generate below their physical guarantees for much of the year, resulting in the application of the so-called GSF – Generation Scaling Factor. As a result, the MRE generators faced the shortfall between generation and physical guarantee, which is valued at PLD – Settlement Price of Differences.

LEGAL RISK

CESP maintains a Legal Department to represent and defend the Company’s interests in civil, labor and tax lawsuits. It also contracts, eventually, specialized offices to deal with the causes of higher values.

ENVIRONMENTAL RISK

During the implementation phase of the project, the provisioned amounts are recorded as a contra entry to property, plant and equipment in progress. After the commercial start-up of the enterprise, all costs or expenses incurred with social and environmental programs related to operating and maintenance licenses of the enterprise are recorded directly in the income for the year.

In December 2015, the implementation of the Environmental Management System – EMS at the UHE Eng. Sergio Motta was completed. The EMS is a set of procedures with emphasis on sustainability and focus on the adoption of practices that seek to reduce to the maximum the environmental impact of the Company’s activities. The SGA (Environmental Management System) of the Eng. Sergio Motta plant is being refitted, and those of the Paraibuna and Jaguari mills are being implemented.

iii. Organizational Structure of Risk Management Control

The Company implemented a corporate risk management framework based on the COSO II principles – the International Risk Management Standard (ERM).

CESP’s Risk Management Policy establishes guidelines for the identification, evaluation, monitoring and reporting of risks and respective control or mitigation actions to be observed by the agents responsible for the risk management activity within the scope of the Company.

They are part of the organizational structure of risk management control:

  • Risk Committee – Comprised by the President and Directors, Managers of the Executive Coordination of the Presidency and the Internal Audit Department. It is the responsibility of the Risk Committee to define the guidelines and strategies for risk management and evaluation of controls, to follow up the action plans presented by the Company’s managers, as well as to direct the activities carried out by the Risk Management Coordination.
  • Risk Management Coordination – CGR – It is the responsibility to follow the actions of the Decentralized Risk Managers in the identification, evaluation and monitoring of risks and periodic communication to the Risk Committee. It should also guide the Company’s managers regarding the methodology of self-evaluation of control, in order to guarantee the efficiency of the controls that mitigate the risks mapped, and to advise the Presidency, the Risk Committee and other stakeholders in matters related to risk and control management.
  • Decentralized Risk Managers – GRDs – These are the representatives appointed by the Board of Directors, who are appointed to assist the Managers of the various areas of the Company in the identification, evaluation, control and monitoring of the risks inherent to the objectives in their areas of responsibility. It is also incumbent upon the GRDs to periodically position the Risk Management Coordination and its Directorate of Subordination on the risks and controls inherent to the responsibility of their performance.

c. Adequacy of the operational structure and internal controls to verify the effectiveness of the adopted policy

CESP complies with the best practices of the Internal Control System, such as: Control Environments and Activities, Risk Assessment, Information, Communication and Monitoring.

CESP’s Internal Control System is composed of the set of policies, standards and procedures and activities established by the Company, with the purpose of reducing the possibility of financial losses, impairing the institutional image, improving the quality of accounting, financial and management information, As well as to safeguard compliance with existing legislation and regulations, in order to ensure that the objectives are achieved.

Included in the Company’s Internal Control System are Corporate Policies, Standards and Procedures, Manual of Delegation of Authority – MDA, Code of Ethics and Business Conduct, Computerized Systems, Internal Audit body, as well as Risk Management, Among other control practices and processes.

Based on Law 13,303, dated June 30, 2016, CESP’s Board of Directors was presented on October 18, 2016, the set of items already served by CESP in accordance with Law 13,303 / 2016, as the Disclosure Policy , The Dividend Distribution Policy, the Annual Sustainability Reports Ethics and Business Conduct, the risk management model, as well as the existence of a permanent Fiscal Council. Other items requiring action should be implemented in 2017.

In compliance with article 23, paragraph 1, item II of Law 13,303 / 2016, the Board of Directors approved on 08.11.2016, the Company’s Long-Term Strategy.

Meeting held on January 24, 2017, a schedule of activities was presented to the Board of Directors to comply with the obligations of State Decree No. 62,349 / 2016, which regulated Federal Law No. 13,303 / 2016.
In line with good corporate governance practices, In 2015, CESP revised the Company’s Code of Ethics and Business Conduct and, among other updates, incorporated the provisions of Federal Law 12.846, dated August 1, 2013 (Anti-Corruption Law) and State Decree No. 60.106, of 01/29/2014, which deals with the administrative and civil liability of legal persons for the practice of acts against the public, national and international administration.

In 2016 CESP promoted the On-Line Training of its Code of Ethics and Business Conduct with the purpose of recycling knowledge and strengthening the awareness of its professionals regarding the principles and values that govern relations in the Company.

The Code is available on the intranet (Netcesp) and on the CESP website (http://www.cesp.com.br). When accessing it, a link is already available to, if it is the case, the registration of the representation is made. There is also the e-mail codigo.eticaeconduta@cesp.com.br, so that the interested parties can make representations.

CESP, integrating itself to the Ombudsman System of the State Government of São Paulo, makes available on its website a channel of relationship with the purpose of receiving, clarifying and responding to any and all expressions of citizen interest in the Company. It acts as final instance in its defense, including provoking internal transformation actions aimed at improving the quality of the services provided by the Company.

In 2016, the CESP Ombudsman’s Office registered 62 demonstrations. Amongst the main themes were the guidelines and clarifications of doubts related to human resources, assets and environment, as well as complaints regarding electricity distribution companies, an activity that has not been part of CESP’s business since 1998. Registered also denunciations of citizens alerting the Company, through the Ombudsman’s Office, regarding invasions or interventions in border areas of reservoirs.

In accordance with the provisions of the Government of the State of São Paulo (State Decree nº 58.052, dated 05/16/2012, which regulated Federal Law 12,527 of November 18, 2011), CESP joined the Citizen Information Service (SIC), through which the Company provides access to information requested by citizens and entities, reinforcing good practices Governance and transparency. Access to the system is done through the website www.sic.sp.gov.br.

In 2016, the Company recorded 33 applications, received and served through the SIC System, which presents various forms of citizen access to information, including The attendance form, with attendance in an exclusive room for this service.

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