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Risk Management

TSMC and its subsidiaries are committed to proactively and cost effectively integrating and managing strategic, operational, financial and hazardous risks together with potential consequences to operations and revenue. TSMC established its Enterprise Risk Management (ERM) program based on both its corporate vision and its long-term sustainability and responsibility to both industry and society. ERM seeks to provide for the appropriate management of risks by TSMC on behalf of all stakeholders.

To reduce TSMC’s supply chain risks, a cross-function taskforce comprised of members from fab operations, material management, risk management and quality system management worked with TSMC’s primary suppliers to develop business continuity plans, and effectively manage the risks faced by its suppliers. As a result of those efforts, there was no interruption in TSMC’s supply lines in 2012.

As TSMC continued to expand production capacity in 2012, risk treatment practices and green factory projects were initiated and implemented, beginning in the design phase for all new fabs.

Risk Management (RM) Organization Chart

Reports to Audit Committee;
Is composed of functional heads;
Reviews risk control progress; and
Identifies and approves the prioritized risk lists.

Is composed of representatives from each function;
Aligns functional ERM activities; and
Follows up the risk control action plan.

Coordinates the RM Working Committee activities;
Facilitates functional risk management activities; and
Consolidates ERM reports into the RM Steering Committee.

Strategic Risks

Industry Developments

The electronics industries and semiconductor market have historically been cyclical and subject to significant, and often rapid, increases and decreases in product demand. TSMC’s semiconductor foundry business is affected by market conditions in such highly cyclical electronics and semiconductor industries, within which most of its customers operate. Variations in order levels from customers result in volatility in the Company’s revenues and earnings.

From time to time, the electronics industries and semiconductor industries have experienced significant, and sometimes prolonged, periods of downturns and overcapacity. Because TSMC is, and will continue to be, dependent on the requirements of electronics and semiconductor companies for its services, periods of downturn and overcapacity in the general electronics and semiconductor industries could lead to reduced demand for overall semiconductor foundry services, including TSMC’s services. If it cannot take appropriate actions such as reducing TSMC’s costs to sufficiently offset declines in demand, the Company’s revenues, margins and earnings will suffer during periods of downturn and overcapacity. Furthermore, due to the increasingly complex technological nature of its products and services and the ever uncertain global economic environment, TSMC may need to provide higher accounting provisions on potential sales returns and allowances by its customers that may adversely affect the results of its operations.

Changes in Technology

The semiconductor industry and its technologies are constantly changing. TSMC competes by developing process technologies using increasingly advanced nodes and on manufacturing products with more functions. TSMC also competes by developing new derivative technologies. If it does not anticipate these changes in technologies and rapidly develop new and innovative technologies, or if the Company’s competitors unforeseeably gain sudden access to more advanced technologies, TSMC may not be able to provide foundry services on competitive terms. In addition, TSMC’s customers have significantly decreased the time in which their products or services are launched into the market. If it is unable to meet these shorter product time-to-market, TSMC risks losing these customers. These challenges also place greater demands on its research and development capabilities. If TSMC is unable to innovate new technologies that meet the demands of its customers, its revenues may decline significantly. Although it has concentrated on maintaining a competitive edge in research and development, if TSMC fails to achieve advances in technologies or processes, or to obtain access to advanced technologies or processes developed by others, it may become less competitive.

Decrease in Demand and Average Selling Price

A vast majority of the Company’s revenue is derived from customers who use TSMC’s services in communication devices, personal computers, consumer electronics products and industrial/standard product. Any significant decrease in the demand for one of these products may decrease the demand for such other products as well as overall global semiconductor foundry services, including TSMC’s services, and may adversely affect the Company’s revenues. Further, a significant portion of TSMC’s operating costs is fixed because the Company owns most of its manufacturing capacities. In general, these costs do not decline when customer demand or TSMC’s capacity utilization rates drop, and thus declines in customer demand, among other factors, may significantly decrease margins. Conversely, as product demand rises and factory utilization increases, the fixed costs are spread over increased output, which can improve TSMC’s margins. Additionally, the historical and current trend of declining average selling prices of end-use applications places downward pressure on the prices of the components that go into such applications. If the average selling prices of end-use applications continue to decrease, the pricing pressure on components produced by the Company may lead to a reduction of TSMC’s revenues, margin and earnings.

Competition

TSMC competes internationally and domestically with other foundry service providers, as well as with integrated device manufacturers that devote a significant portion of their manufacturing capacity to foundry operations. Some of these companies may have access to more advanced technologies and greater financial and other resources than TSMC, such as the possibility of receiving direct or indirect government bailout/economic stimulus funds or other incentives that are unavailable to us. The Company’s competition may, from time to time, also decide to undertake aggressive pricing initiatives in one or more technology nodes. Increases in these competitive activities may decrease TSMC’s customer base, or TSMC’s average selling prices, or both.

Over the past few years, TSMC has seen the rise of certain companies with the capability of providing foundry services. These companies are committed to attracting TSMC’s customers. If TSMC is unable to compete with these new competitors with better technologies and manufacturing capacity and capabilities, it risks losing customers to these new contenders.

The Company competes primarily on the basis of process technology, quality and service. The level of competition differs according to the process technology involved. For example, in more mature technologies, the number of competitors tends to be more numerous and specialized. Some companies compete with TSMC in selected geographic regions or application end markets. In recent years, substantial investments have been made by others to establish new pure-play foundry companies in mainland China and elsewhere, or to spin off integrated device manufacturers’ manufacturing operations and transform them into a pure-play foundry company.

Risks Associated with Changes in the Government Policies and Regulatory Environment

TSMC management closely monitors all domestic and foreign governmental policies and regulations that might impact TSMC’s business and financial operations. As of February 28, 2013, the following changes or developments in governmental policies and regulations may influence the Company’s business operations:

The Taiwan Financial Supervisory Commission (FSC) requires listed companies, starting from January 1, 2013, to prepare their consolidated financial statements in accordance with Taiwan’s “Guidelines Governing the Preparation of Financial Reports by Securities Issuers” and the following FSC endorsed standards and interpretations: “International Financial Reporting Standards,” “International Accounting Standards,” and relevant Interpretations (collectively, “IFRSs”). TSMC has already set up an IFRSs project team in 2009 and is currently implementing its IFRSs adoption plan. In addition, the progress of such adoption is regularly reported to the Board. The impact of IFRSs adoption may include certain changes in the accounting treatment for certain types of transactions and certain modifications to the presentation of financial statements. TSMC will keep monitoring IFRSs updates and the development of related laws and regulations in Taiwan and evaluate the respective impact to the Company. According to FSC’s requirements, TSMC has disclosed its IFRSs project plan, status and the effects arising from the significant differences between IFRSs and its current accounting policy in its 2012 annual and interim consolidated financial statements.

The Taiwan “National Health Insurance Act” was amended in January 2011, to create an obligation for employers and employees to pay an extra 2% “supplementary premium,” effective from January 1, 2013. TSMC will need to pay such extra 2% “supplementary premium” when TSMC distributes employees’ profit sharing and variable bonus. TSMC will continue participating in the seminars and briefings held by the National Health Insurance Bureau to understand the details related to the implementation and take the necessary managerial and financial precautionary steps with respect to such amendment.

According to the “Income Basic Tax Act“ (i.e., Alternative Minimum Tax, “AMT”) amended in August, 2012, effective on January 1, 2013, the corporate income tax rate of AMT will be increased from 10% to 12%. As a result of this change, and changes in the various tax credit incentives and exemptions available to the Company, TSMC anticipates its effective tax rate for 2013 will be 14.0%, an increase from 8.7% in 2012, which is anticipated to negatively affect its net income in 2013. TSMC has evaluated the impact of these amendments on its financial statements and will ensure compliance in accordance with the relevant laws.

The “Personal Information Protection Act,“ as amended and promulgated in May 2010, for the most part took effect on October 1, 2012. All nature persons, legal entities and other organizations that collect, process and use personal information are now subject to this new law which expands the scope of protected personal information to include both electronically and paper-stored data. Appropriate protective measures must be taken to prevent personal information security breaches. TSMC has had adequate mechanisms in place to properly process and retain personal information and will continue to protect and manage personal information in compliance with applicable laws and regulations.

In addition, the Taiwan legislative authority has been studying relevant laws relating to environmental protection and employee safety and health protection (e.g. “Greenhouse Gas Reduction Act,” “Energy Tax Act” and “Labor Safety and Health Act”). Though the “Greenhouse Gas Reduction Act” has not been passed, TSMC has been implementing various long-term energy saving and carbon reduction programs since 2000. As to the proposed “Energy Tax Act,“ there has been no concrete guidance or law issuing from the Taiwan government as of yet, so the impacts of such law are indeterminable at the moment. However, it is very likely that such law may increase the operating costs of the Company. The “Labor Safety and Health Act” will be amended (and renamed “Occupational Safety and Health Act”) to increase the duties of employers to protect the physical and mental health of their employees. TSMC has already developed relevant initiatives and implemented various policies and will continuously improve and maintain the safety and health of its workplace and employees.

Other than the above laws and regulations, it is not expected that other governmental policies or regulatory changes would materially impact TSMC’s operations and financial condition.

Operational Risks

Risks Associated with Capacity Expansion

TSMC performs regular long term market demand forecasts to estimate market and general economic conditions for its products and services. Based upon these estimates, TSMC manages its overall capacity in accordance with market demand. Because market conditions may vary significantly and unexpectedly, our market demand forecast may change significantly at any time. Further, since certain manufacturing lines or tools in some of TSMC’s manufacturing facilities may be suspended or shut down temporarily during periods of decreased demand, the Company may not be able to ramp up in a timely manner during periods of increased demand.

Base on demand forecast, TSMC has been adding capacity to its 12-inch wafer fabs in the Hsinchu Science Park, Southern Taiwan Science Park and Central Taiwan Science Park. Total monthly capacity of the Company’s 12-inch wafer fabs was increased from 290,100 wafers as of December 31, 2011 to 366,800 wafers as of December 31, 2012. Overall, TSMC increased its annual production capacity by approximately 1.87 million 8-inch equivalent wafers in 2012. The total average billing utilization rate for 2012 was 91%. Expansion and modification of the Company’s production facilities will, among other factors, increase TSMC’s costs. For example, the Company will need to purchase additional equipment, and hire and train additional personnel to operate the new equipment. If TSMC cannot generate higher revenue to offset these higher costs, TSMC’s financial performance may be adversely affected.

TSMC has established systems and processes to evaluate and forecast market demand and refers to these forecasts and evaluations when considering whether to expand or reduce capacity. As of the date of this Annual Report, the benefits brought about by such capacity expansion were in line with TSMC’s expectations.

Risks Associated with Sales Concentration

Over the years, TSMC’s customer profile and the nature of its customers’ business have changed dramatically. While it generates revenue from hundreds of customers worldwide, TSMC’s ten largest customers accounted for approximately 56% and 59% of net sales in 2011 and 2012, respectively, and the Company’s largest customer accounted for approximately 14% and 17% of net sales in 2011 and 2012, respectively. This customer concentration results in part from the changing dynamics of the electronics industry with the structural shift to mobile devices and applications and software that provide the content for such devices. There are only a limited number of customers who are successfully exploiting this new business model paradigm. Also, in order to respond to the new business model paradigm, TSMC has seen the nature of its customers’ business model changes. For example, there is a growing trend toward the rise of system houses that operate in a manner which make their products and services more marketable in a changing consumer market. The loss of, or significant curtailment of purchases by, one or more of the Company’s top customers, including curtailments due to increased competitive pressures, industrial consolidation, or change in their manufacturing sourcing policies or practices of these customers, or the timing of customer or distributor inventory adjustments, or change in its major customers’ business models may adversely affect TSMC’s results of operations and financial condition.

Risks Associated with Purchase Concentration

TSMC’s production operations require that it obtain adequate supplies of raw materials, such as silicon wafers, gases, chemicals and photoresist, on a timely basis. In the past, shortages in the supply of some materials, whether by specific vendors or by the semiconductor industry generally, have resulted in occasional industry-wide price adjustments and delivery delays. Also, since TSMC procures some of its raw materials from sole-source suppliers, there is a risk that its need for such raw materials may not be met when needed or that back-up supplies may not be readily obtainable. The Company’s revenue and earnings could decline if it is unable to obtain adequate supplies of the necessary raw materials in a timely manner or if there are significant increases in the costs of raw materials that it cannot pass on to its customers.

To reduce the supply chain risk and to manage the cost actively, TSMC is committing resources toward developing new supply sources. In addition, the Company encourages its suppliers to reduce their supply chain risk by decentralizing production plants, and to intensify their cost competitiveness by moving their production site to Taiwan from high-cost areas. The Company believes this benefits both suppliers and TSMC. Moreover, the Company continually refines its planning system and monitors its inventory and replenishment on a daily basis so as to sustain an optimal level with rational cost.

The Company’s operations and ongoing expansion plans depend on its ability to obtain an appropriate amount of equipment and related services from a limited number of suppliers in a market that is characterized from time to time by limited supply and long delivery cycles. During such times, supplier-specific or industry-wide lead times for delivery can be as long as six months or more. To better manage its supply chain, the Company has implemented various business models and risk management contingencies with suppliers to shorten the procurement lead time. TSMC also provides its projected demand for various items to many of its equipment suppliers to help them plan their production in advance. The Company has purchased used tools and continues to seek opportunities to acquire relevant used tools. Further, the growing complexities especially in next-generation lithographic technologies may delay the timely availability of the equipments and parts needed to exploit time sensitive business opportunities and also increase the market price for such equipment and parts. If TSMC is unable to obtain equipment in a timely manner to fulfill its customers’ orders, or at a reasonable cost, its financial condition and results of operations could be negatively impacted.

Risks Associated with Intellectual Property Rights

The Company’s ability to compete successfully and to achieve future growth will depend in part on the continued strength of its intellectual property portfolio. While TSMC actively enforces and protects its intellectual property rights, there can be no assurance that its efforts will be adequate to prevent the misappropriation or improper use of its proprietary technologies, trade secrets, software or know-how. Also, the Company cannot assure that, as its business or business models expand into new areas, or otherwise, it will be able to develop independently the technologies, trade secrets, patents, software or know-how necessary to conduct its business or that it can do so without unknowingly infringing the intellectual property rights of others. As a result, TSMC may have to rely increasingly on licensed technologies and patent licenses from others. To the extent that the Company relies on licenses from others, there can be no assurance that it will be able to obtain any or all of the necessary licenses in the future on terms it considers reasonable or at all. The lack of necessary licenses could expose TSMC to claims for damages and/or injunctions from third parties, as well as claims for indemnification by its customers in instances where it has contractually agreed to indemnify its customers against damages resulting from infringement claims.

TSMC has received, from time-to-time, communications from third parties asserting that its technologies, manufacturing processes, the design of the integrated circuits made by TSMC or the use by its customers of semiconductors made by TSMC may infringe upon their patents or other intellectual property rights. Because of the nature of the industry, the Company may continue to receive such communications in the future. In some instances, these disputes have resulted in litigation. Recently, there has been a notable increase in the number of claims or lawsuits initiated by certain litigious, non-practicing entities and these non-practicing entities are also becoming more aggressive in their monetary demands and requests for court-issued injunctions. Such lawsuits or claims may increase TSMC’s cost of doing business and may potentially be extremely disruptive if the plaintiffs succeed in blocking the trade of its products and services. If TSMC fail to obtain or maintain certain government, technologies or intellectual property licenses and, if litigation relating to alleged intellectual property matters occurs, it could prevent it from manufacturing or selling particular products or applying particular technologies, which could reduce its opportunities to generate revenues.

TSMC has taken other measures to minimize potential loss of shareholder value arising from intellectual property claims and litigation filed against the Company. These measures include: obtaining licenses from certain semiconductor and other technology companies; timely securing of intellectual property rights for defensive and/or offensive protection of TSMC technology and business; aggressively defending against frivolous litigation; and acquiring or licensing strategic intellectual property rights necessary to protect its technologies and business offerings.

Risks Associated with Litigation

As is the case with many companies in the semiconductor industry, TSMC has received from time-to-time communications from third parties asserting that its technologies, manufacturing processes, the design of the integrated circuits made by it or the use by its customers of semiconductors made by it may infringe upon patents or other intellectual property rights of others. In some instances, these disputes have resulted in litigation by or against the Company and certain settlement payments by it in some cases. Irrespective of the validity of these claims, TSMC could incur significant costs in the defense thereof or could suffer adverse effects on its operations.

In June 2010, Keranos, LLC. filed a lawsuit in the U.S. District Court for the Eastern District of Texas alleging that TSMC, TSMC North America, and several other leading technology companies infringe three expired U.S. patents. In response, TSMC, TSMC North America, and several co-defendants in the Texas case filed a lawsuit against Keranos in the U.S. District Court for the Northern District of California in November 2010, seeking a judgment declaring that they did not infringe the asserted patents, and that those patents are invalid. These two litigations have been consolidated into a single case in the U.S. District Court for the Eastern District of Texas. The outcome cannot be determined at this time.

In December 2010, Ziptronix, Inc. filed a complaint in the U.S. District Court for the Northern District of California accusing TSMC, TSMC North America and one other company of infringing several U.S. patents. The outcome cannot be determined at this time.

Other than the matters described above, TSMC was not involved in any other material litigation in 2012 and are not currently involved in any material litigation.

Risks Associated with Mergers and Acquisitions

As of the date of this Annual Report, there were no such risks for TSMC.

Risks Associated with Recruiting and Retaining Qualified Personnel

The Company depends on the continued services and contributions of its executive officers and skilled technical and other personnel. TSMC’s business could suffer if it lost, for whatever reasons, the services and contributions of some of these personnel and it cannot adequately replace them. The Company may be required to increase or reduce the number of employees in connection with any business expansion or contraction, in accordance with market demand for its products and services. Since there is intense competition for the recruitment of these personnel, the Company cannot ensure it will be able to fulfill its personnel requirements in a timely manner during an economic upturn.

Therefore, TSMC provides a varied and competitive compensation programs, and is generous in sharing the Company’s long-term business achievements with its employees. Furthermore, in order to attract and retain talent, the Compensation Committee of the Board of Directors decided to enhance the compensation system and provide a timely distribution of employees’ cash bonus from the Company’s profits. TSMC believes that by rewarding employees’ hard work in a timely fashion, it not only encourages employees to contribute consistently to ensure the success of TSMC, but also links their interests with those of TSMC’s shareholders.

Future R&D Plans and Expected R&D Spending

For additional details, please refer to “Future R&D Plans” of this Annual Report.

Changes in Corporate Image and Impact on Company’s Crisis Management

TSMC has established an excellent corporate image around the world based on its core values of “Integrity, Commitment, Innovation, and Customer Trust,” as well as its outstanding operations, rigorous corporate governance, and dedication to corporate social responsibility to pursue sustainable development, equality and justice, and a harmonious society to live and work.

TSMC’s corporate image was further strengthened in 2012 with a number of awards. The Company was once again recognized as Semiconductor Sector Leader by the Dow Jones Sustainability Index, and was selected as an index component for a 12th consecutive year. In addition, TSMC received the R.O.C. Environmental Protection Administration (EPA) National Enterprise Environmental Protection Award, the EPA Energy Conservation and Carbon Reduction Action Mark, and the Science Park Low-Carbon Enterprise Achievement Award. TSMC was also recognized as the Most Admired Company in Taiwan by CommonWealth Magazine , and won the CommonWealth Corporate Citizenship Award as well as the first prize in the Environmental Protection category for the GlobalViews Magazine Corporate Social Responsibility Award. The Company was named as “Best Managed Company in Asia - Technology Sector” by Euromoney, the Most Recognized Foundry in the EETimes China Fabless Awards, ranked first place in the China Credit Information Service poll of “Top 10 Happiest Companies” in Taiwan, first place in the Asia Corporate Governance Association and CLSA Asia-Pacific Markets survey of Corporate Governance in Asia, and received the “Best-Managed Company in Taiwan and Hong Kong,” “Best Corporate Governance, Taiwan,” and “Best Corporate Social Responsibility, Taiwan” Awards from FinanceAsia.

In addition, TSMC has departments such as Brand Management, Customer Service, Public Relations, Employee Relations, Investor Relations, Risk Management, Fab Industrial Safety and Environmental Protection, Internal Audit, and the TSMC Foundation to coordinate the Company’s resources and further enhance TSMC’s positive corporate image. To address potential events that may affect the Company’s public image, including natural disasters, fires, workplace accidents, power outages, water shortages and workplace injuries, these departments have established emergency response procedures, hold regular drills, and continue to improve emergency performance. In the event of emergencies, early warning procedures eliminate or reduce casualties and minimize impact on the surrounding environment, company property, and manufacturing operations. The Public Relations department is also involved in the first stage of emergency response to communicate with stakeholders and act as a single point of contact with outside parties to maintain the Company’s reputation.

Risks Associated with Change in Management

As of the date of this Annual Report, there were no such risks for TSMC.

Financial Risks

Internal Management of Economic Risks

TSMC’s exposure to interest rate risks derives primarily from short-term borrowing and long-term debt obligations incurred in the normal course of business. In order to limit its exposure to interest rate risks, TSMC finances its funding needs primarily through internal generation of cash and the issuance of long-term, fixed-rate debt. On the asset side, we place our cash on hand mainly in very short tenor time deposits. Furthermore, the primary objective of TSMC’s cash investments in fixed income securities is to preserve principal in highly liquid markets. In order to maintain the Company’s liquidity profile, the majority of fixed income securities are at the short end of the yield curve.

Over one-half of TSMC’s capital expenditures and manufacturing costs are denominated in currencies other than NT dollars, primarily in US dollars, Japanese yen and Euros. In 2012, more than 90% of the Company’s sales were denominated in US dollars and currencies other than NT dollars. Therefore, any significant fluctuation to its disadvantage in such exchange rates would have an adverse effect on TSMC’s financial condition. For example, during the period from September 1, 2010 to December 30, 2010, the US dollar depreciated 8.9% against the NT dollar, which had a negative impact on the Company’s results of operations. Specifically, based on TSMC’s 2012 results, every 1% depreciation of the US dollar against the NT dollar exchange rate may result in approximately 0.4 percentage point decrease in TSMC’s operating margin. TSMC utilizes short-term debt denominated in foreign currencies and derivative financial instruments, including currency forward contracts and cross currency swaps, to hedge our currency exposure.

Fluctuations in the exchange rate between the US dollar and the NT dollar may affect the US dollar value of the Company’s common shares and the market price of the Company’s American Depositary Shares (ADSs) and of any cash dividends paid in NT dollars on TSMC’s common shares represented by ADSs.

The world economy is becoming more vulnerable to sudden unexpected fluctuations in inflationary and deflationary market expectations and conditions. For example, certain structural changes that resulted from the global financial crisis in 2008-2009 and EU sovereign debt crises, such as highly accommodative monetary policies by major central banks worldwide, may cause variations in the expectation of inflation or deflation. Both high inflation and deflation adversely affect an economy, at both the macro and micro levels, by reducing economic efficiency, disrupting saving and investment decisions and reducing the efficiency of the market prices as a mechanism to allocate resources. Such fluctuations may negatively affect the costs of TSMC’s operations and the business operations of its customers who may be forced to plan their purchases of TSMC’s goods and services within an uncertain macro and micro economy. Therefore, the demand for TSMC’s products and services could unexpectedly fluctuate severely in accordance with market and consumer expectations of inflation or deflation.

Risks Associated with External Financing

Capital requirements are difficult to plan in the highly dynamic, cyclical and rapidly changing semiconductor industry. From time to time and increasingly so for the foreseeable next few years, TSMC will continue to need significant capital to fund its operations and manage its capacity in accordance with market demand. TSMC’s continued ability to obtain sufficient external financing is subject to a variety of uncertainties, including:


Sufficient external financing may not be available to the Company on a timely basis, on reasonable market terms, or at all. As a result, TSMC may be forced to curtail its expansion and modification plans or delay the deployment of new or expanded services until it obtains such financing.

Risks Associated with High-risk/High-leveraged Investment; Lending, Endorsements, and Guarantees for Other Parties; and Financial Derivative Transactions

TSMC did not make high-risk or high-leveraged financial investments during 2012 and up to the date of this report. The Board approved TSMC’s provision of a guarantee to TSMC Global, a wholly-owned subsidiary of TSMC, for its issuance of US dollar-denominated senior unsecured corporate bonds for an amount not to exceed US$1,500 million at its Meeting on February 5, 2013. As of February 28, 2013, TSMC had an intercompany loan of US$160.5 million arranged among the Company’s subsidiaries, which was in compliance with relevant rules and regulations.

The financial transactions of a “derivative” nature that TSMC entered into were strictly for hedging purposes and not for any trading or speculative purpose. For more information, please refer to Financial Report. The fair market value of our trading and available for sale financial securities are subject to prevailing market conditions and may fluctuate from TSMC’s carrying value from time to time, which may impact the returns of those securities.

To control various types of financial transactions, the Company has established internal policies and procedures based on sound financial and business practices, all in compliance with the relevant rules and regulations issued by the Taiwan Securities and Futures Bureau. TSMC policies and procedures include “Policies and Procedures for Financial Derivative Transactions,” “Procedures for Lending Funds to Other Parties,” “Procedures for Acquisition or Disposal of Assets,” and “Procedures for Endorsement and Guarantee”.

Risks Associated with Strategic Investments

From time to time, TSMC has made or will make a series of strategic investments that serve two major purposes. Firstly, some of TSMC’s major strategic investments were (or will be) made to help the Company open new sources of revenues and innovate alternative business models that target to generate additional shareholders’ value going forward in the future. For example, in order to help the Company grow into next generation business areas, TSMC has invested to develop potential businesses in solid state lighting, solar power and other renewable sources of energy. The Company believes these investments into these areas will generate new sources of revenues as the transition into consuming cleaner sources of power is generally expected gradually. For further information on these investments, please refer to “Subsidiary Information and Other Special Notes” of this Annual Report. Secondly, some of TSMC’s significant strategic investments were (or will be) made to help the Company grow its existing business by augmenting key technology development. For example, to accelerate the development of next-generation lithographic technology, in August 2012, TSMC joined the ASML Holding N.V. Customer Co-Investment Program (along with other major technology firms). The program’s scope includes development of extreme ultraviolet (EUV) lithography technology and 450-millimeter (450mm) lithography tools. Under the agreement with ASML, TSMC invested EUR838 million to acquire 5% of ASML’s equity and has committed EUR277 million to be spread over five years, to ASML’s research and development program. The Company is exposed to share price fluctuations arising from the investments in ASML, especially when its equity investment is subject to a lock-up period of 2.5 years. In the future, TSMC may make more strategic investments in various forms, whether through stock purchases, assets purchases, licensing of major intellectual property rights, joint investments or research and development projects, outright mergers and acquisitions, private equity transactions or receiving investments from a consortium of large institutional, public or private investors, etc. Any such investment will incur risks, which may result in losses if not carefully managed. Any such loss resulting from such investments may result in significant impairment charges, lower profit margin and ultimately lower distributable earnings.

Risks Associated with Impairment Charges

Under Generally Accepted Accounting Principles (GAAP) of both the Republic of China and the United States, TSMC is required to evaluate its investments, long-lived assets and intangible assets for impairment whenever triggering events or changes in circumstances indicate that the asset may be impaired. If certain criteria are met, TSMC is required to record an impairment charge. TSMC is also required under R.O.C. GAAP and U.S. GAAP to evaluate goodwill for impairment at least on an annual basis or more frequently whenever triggering events or changes in circumstances indicate that goodwill may be impaired and the carrying value may not be recoverable. For example, TSMC holds certain investments in publicly listed companies, some of which have incurred certain impairment charges disclosed in Financial Report.

The determination of an impairment charge at any given time is based significantly on the expected results of the Company’s operations over a number of years subsequent to that time. As a result, an impairment charge is more likely to occur during a period when the Company’s operating results are otherwise already depressed.

TSMC has established the process and system to closely monitor and assess the risk of any impairment charge. However, management currently is unable to estimate the extent or timing of any impairment charge for future years. Any impairment charge required may have a material adverse effect on the Company’s net income.

Hazardous Risks

TSMC maintains a comprehensive risk management system dedicated to the conservation of natural resources, the safety of people, and the protection of property. In order to effectively handle emergencies and natural disasters at each facility, management has developed comprehensive plans and procedures that focus on risk prevention, emergency response, crisis management, and business continuity. TSMC has adopted local and international standards for Environmental, Safety & Health (ESH) management. All TSMC manufacturing fabs have been ISO 14001 certified (Environmental Management System), OHSAS 18001 certified (Occupational Health and Safety Management System) and QC 080000 certified (Hazardous Substance Process Management System); all manufacturing fabs in Taiwan have also been TOSHMS (Taiwan Occupational Safety and Health Management System) certified. The new fabs will also acquire the above certificates within 18 months after mass production.

The Company pays special attention to preparedness for emergencies or disasters, such as typhoons, floods, droughts caused by climate change, earthquakes, environmental contamination, large-scale product returns, service disruption of IT systems, strikes, pandemics (such as H1N1 influenza), and sudden and unexpected disruptions to the supply of raw materials or water, electricity, and other public utilities. TSMC has established a company-wide task force dedicated to managing the risk of water shortage that might arise due to climate change. This task force keeps watch on the external supply and internal demand for water. Cross-company consolidations and external collaborations with public agencies are also ongoing in the industrial parks to ensure and sustain a stable water supply.

TSMC has further strengthened its business continuity plans, which include periodic risk assessment, risk mitigation , and implementation through the establishment of emergency task forces when necessary, combined with the preparation of a thorough analysis of the emergency, its impact, alternative actions, and solutions for each possible scenario together with appropriate precautionary and/or recovery measures. Each task force is given the responsibility of ensuring TSMC’s ability to conduct business while minimizing personal injury, business disruption, and financial impact under the circumstances. TSMC’s business continuity plan is periodically reviewed according to results of test scenarios or practical implementation for ensuring effective and successful business continuity. Customers are informed of TSMC’s strong business continuity capability in order to establish resilience and flexibility in both their supply chain and insurance placement. For the year 2012, and up to the date of this Annual Report, there have been no reportable material events that have necessitated the activation of such contingency plans. The Company has also conducted a continuous improvement project, including evaluating building anti-seismic capability, holding earthquake response drills and enhancing tool anchorage, and has improved TSMC business continuity procedures with reference to BS 25999 business continuity management.

TSMC and many of its suppliers use highly combustible and toxic materials in its manufacturing processes and are therefore subject to the risk of loss arising from explosion, fire, or environmental influences which cannot be completely eliminated. Although the Company maintains many overlapping risk prevention and protection systems, as well as comprehensive fire and casualty insurance, including insurance for loss of property and loss of profit resulting from business interruption, TSMC’s risk management and insurance coverage may not be sufficient to cover all of the Company’s potential losses. If any of TSMC’s fabs or vendor facilities were to be damaged, or cease operations as a result of an explosion, fire or environmental influences, it could reduce the Company’s manufacturing capacity and may cause it to lose important customers, thereby having a potentially adverse and material impact on TSMC’s financial performance. In addition to periodic fire protection system inspection and firefighting drills, the Company has also carried out a corporate-wide fire risk mitigation project focused on management and hardware improvements.

Changes may cause unpredictable interruption to production. In order to reduce such uncertainty, TSMC has adopted a number of standards to maintain operational continuity, ranging from design, procurement and construction of facilities, to operation and decommission.

Climate Change Risks

The manufacturing, assembling and testing of our products require the use of chemicals and materials that are subject to environmental, climate-related, and health and safety laws and regulations issued worldwide. Although TSMC may be eligible for various exemptions and/or extensions of time for compliance, our failure to comply with any of these applicable laws or regulations could result in:

Existing and future environmental and climate related laws and regulations as well as applicable international accords to which TSMC are subject, could also require it, among other things, to do the following: (a) purchase, use or install expensive pollution control, reduction or remediation equipment; (b) implement climate change mitigation programs and “abatement or reduction of greenhouse gas emissions” programs, or “carbon credit trading” programs; (c) modify our product designs and manufacturing processes, or incur other significant expenses associated with such laws and regulations such as obtaining substitute raw materials or chemicals that may cost more or be less available for our operations. It is still unclear whether such necessary actions would affect the reliability or efficiency of our products and services.

Any of the above contingencies resulting from the actual and potential impact of local or international laws and regulations as well as international accords on environmental or climate change, could harm the Company’s business and operational results by increasing expenses or requiring TSMC to alter its manufacturing, assembly and test processes.

Increasing climate change and environmental concerns could affect the results of TSMC’s operations if any of its customers request that TSMC exceed any standard(s) set for environmentally compliant products and services. For example, TSMC has been working on an on-going basis with our suppliers, customers, and several industry consortia to develop and provide products that are compliant with the EU “RoHS” (European Union Restriction of Hazardous Substances) Directive. Even though TSMC are entitled to rely on various exemptions under RoHS, some of our customers might request that we provide products that exceed the legal standard set by RoHS without using any of the exemptions still permitted under RoHS. If TSMC is unable to offer such products or offer products that are compliant, but are not as reliable due to the lack of reasonably available alternative technologies or materials, it may lose market share to our competitors.

Further, energy costs in general could increase significantly due to future climate change and other regulations. Therefore, TSMC’s energy costs may increase significantly if utility or power companies pass on their costs, either fully or partially, such as those associated with carbon taxes, emission caps and carbon credit trading programs.

To mitigate risks resulting from climate change, TSMC continues to carry out energy conservation measures, implementing voluntary PFC emission reduction projects and conducting GHG inventory and verification each year. TSMC has publicly disclosed climate change information every year since 2005 through participation in an annual survey conducted by the nonprofit Carbon Disclosure Project (CDP), which includes greenhouse gas emission and reduction information for all TSMC fabs.

Other Risks

Potential Impact and Risks Associated with Sales of Significant Numbers of Shares by TSMC’s Directors, and/ or Major Shareholders Who Own 10% or More of TSMC’s Total Outstanding Shares

The value of TSMC shareholders’ investment may be reduced by possible future sales of TSMC shares owned by the major shareholders.

One or more of our existing shareholders may, from time to time, dispose of significant numbers of our common shares or ADSs. For example, the National Development Fund, which owned 6.4% of TSMC’s outstanding shares as of February 28, 2013, sold our shares in the form of ADSs in several transactions during the period between 1997 and 2005.

Currently no shareholder owns 10% or more of TSMC’s total outstanding shares.

Other Material Risks

During 2012 and as of the date of this Annual Report, TSMC’s management is not aware of any other risk event that could impart a potentially material impact on the financial status of the Company.