Modern Dairy Risk Management and Internal Risk Control Policy

1. Risk Management Governance Structure and Responsibilities

The Board of Directors is responsible for comprehensively reviewing and ensuring the effectiveness of the company’s risk management and internal control mechanisms, leading evaluation work, and disclosing it in annual reports. The Audit Committee, on behalf of the Board, reviews the management’s construction, implementation, and supervision of risk management and internal control systems semi-annually; it also reviews the effectiveness of risk management and internal control systems annually.

Under the authorization of the company’s Board of Directors, the Board Audit Committee is responsible for comprehensively controlling, guiding, and making decisions on the company’s internal control and risk management affairs, covering strategic planning, policy review, risk prioritization, setting risk appetite and tolerance, ensuring business continuity, research and decision-making on major risks and deficiencies, and budget approval, and regularly reports on the status to the Board of Directors.

The company has one independent non-executive board member with expertise in risk management. In addition, the vice presidents and heads of each business unit and functional department sign annual “Bottom-Line Indicator Contracts,” which include reward and punishment measures.

The company adheres to the COSO “Enterprise Risk Management Framework,” improving a risk management and internal supervision system led by the Board of Directors. Based on business departments, the Compliance Management Department, Internal Audit Department, and Discipline Inspection Commission Office, a “three lines of defense” risk management model is established, respectively responsible for daily compliance management, risk coordination management, auditing, and violation investigation work, achieving collaborative risk co-management.

The Compliance Management Department, under the guidance of the company’s Board Audit Committee, is responsible for comprehensively formulating and executing risk identification and risk assessment standards, organizing various business and functional departments to systematically carry out risk identification and assessment work in strategic, market, financial, operational, quality, sustainable development, and legal fields. It focuses on implementing special controls for risks, collaborates with the committee to formulate response strategies, and promotes the implementation of emergency plans and risk response measures by responsible departments. Simultaneously, it optimizes the risk management framework, improves process construction, and establishes regular evaluation mechanisms, regularly evaluating and reporting risk status, effectively preventing the potential impact of major risks on the group’s strategic goals and sustainable development, and continuously strengthening all employees’ risk control awareness and cultural identity.

2. Risk Identification, Assessment, and Response

The company has established a systematic process for risk identification, assessment, response, and early warning. Under the guidance of the Audit Committee, the Compliance Management Department takes the lead in comprehensively formulating and executing internal control evaluation and risk assessment plans. We organize various business and functional departments to systematically carry out risk identification and assessment work in areas such as strategy, market, finance, operations, quality, sustainable development, legal compliance, and emerging technologies.

In the risk assessment process, we not only describe the risk itself but also focus on quantitatively assessing its potential impact (magnitude) and likelihood of occurrence, and conduct in-depth analysis by combining various factors such as business relevance and geographical location. For example, we use tools such as risk matrices, scenario analysis, and sensitivity analysis to evaluate the potential impact of risks on the company’s operations and financial performance in extreme situations, thereby more precisely defining the company’s specific risk exposure. We assess risk exposure once at the beginning of each year, identify major risks, and report on risk response status at the end of the year, ensuring that risk information is promptly communicated to management and the Board of Directors.

For identified major risks, we focus on implementing special controls, collaborating with the Audit Committee to formulate targeted response strategies, and promoting the implementation of emergency plans and improvement measures by responsible departments. At the same time, we continuously optimize the risk management framework, improve the construction of risk management processes, and establish regular evaluation and early warning mechanisms to effectively prevent the potential impact of major risks on the group’s strategic goals and sustainable development.

3. Continuous Optimization and Audit of Risk Management System

To ensure the effectiveness and adaptability of the risk management system, the company continuously strengthens all employees’ risk control awareness and cultural identity. We regularly review risk management processes and risk improvement measures, evaluate the adequacy and effectiveness of existing risk management measures, and identify existing and potential threats to adapt to the constantly changing risk landscape, ensuring the timeliness and relevance of risk appetite and mitigation measures.

The company has conducted a comprehensive internal audit of its risk management processes. The audit work is performed by the Compliance Management Department, following international standards such as ISO 31000:2018 “Risk management – Guidelines,” systematically evaluating the methods, tools, and processes for risk identification, assessment, control, monitoring, and reporting. The audit frequency is once a year, ensuring the continuous improvement and effectiveness of the risk management system. Audit results and improvement recommendations are submitted to the Board of Directors and the Audit Committee for review, and the implementation of improvement measures is supervised.

The company’s external auditors conduct an external audit of the company’s risk management processes once a year. The external audit report and its recommendations are also submitted to the Board of Directors and the Audit Committee and serve as an important basis for our continuous improvement of the risk management system.

4. Risk Culture Building

Modern Dairy is committed to integrating risk management into its corporate culture, making it a shared responsibility of all employees. We promote the formation of a strong risk culture through the following measures:

Board Risk Management Education: In addition to regular risk reports, we provide regular, in-depth specialized training on risk management for non-executive directors, including but not limited to integrity and anti-corruption training, continuous responsibility training for listed companies and directors, identification and disclosure of inside information, etc., to ensure that board members can effectively identify and respond to potential risks.
All-Staff Risk Management Training: We regularly organize group-wide risk management training covering all employees, with content covering basic principles of risk management, company risk management policies, and employees’ responsibilities in risk management. The forms include organizing risk liaisons to conduct training on how to identify and assess risks, and on-site training on the application of risk management tools and processes in various farms, guiding employees on how to apply risk management principles in their daily work for risk identification, assessment, and control, aiming to enhance all employees’ risk awareness and response capabilities.
Risk Considerations in Farm Operations and Technological Innovation: In innovative practices such as introducing new breeding technologies, optimizing feeding plans, upgrading farm facilities, applying digitalization and artificial intelligence, dairy cattle breeding, or exploring new raw milk categories, we have established a strict risk assessment mechanism. This includes comprehensive consideration of key factors such as potential technological risks, data security risks, operational efficiency risks, compliance risks, market acceptance risks, and the impact on raw milk quality and yield, ensuring that farm innovation and risk control proceed in sync.
Incentive Mechanism for Risk-Related Goals: We integrate risk management goals into the employee performance appraisal system and provide corresponding financial incentives. For example, for key risk areas such as health and safety and compliant operations, clear risk control goals are set and linked to employee bonuses, encouraging employees to actively identify and manage risks.

5. Major Risks Faced by the Group

5.1 Risk Name: Raw Milk Market Change Risk

Risk Exposure: High likelihood, but high potential impact.
Risk Description: As a company primarily selling raw milk to large dairy processing enterprises, the company continuously faces challenges from changes in the end-market consumption structure. The increasing health awareness of consumers, the rise of personalized consumption trends, and the constantly changing demand for high-quality, specific nutritional components, flavors, and segmented categories of dairy products are profoundly influencing the raw milk procurement structure and strategies of downstream dairy processing enterprises. This may lead to adjustments in the supply and demand pattern of the raw milk market, which in turn could have a significant impact on raw milk prices and the procurement volume of the company’s major customers.
Risk Mitigation Measures: Modern Dairy is committed to adapting to market changes by improving raw milk quality and diversity. We closely monitor the demand trends of the end market and downstream customers, continuously optimize dairy cattle feeding management and breeding technologies, and actively plan for high-value-added, differentiated raw milk categories, such as producing A2 beta-casein milk and organic raw milk, to ensure that the nutritional components and flavor characteristics of raw milk meet high-end market demands, thereby enhancing the market competitiveness of raw milk. At the same time, we actively maintain close communication with downstream dairy processing enterprises to understand their product innovation directions and customized raw milk requirements, in order to provide more adaptable and competitive raw milk products, ensuring the stability of raw milk sales and market position.

5.2 Risk Name: Supply Chain and Geopolitical Risk

Risk Exposure: High likelihood, but high potential impact.
Risk Description: The complexity of the global geopolitical situation, trade policy uncertainties, extreme weather events, and sudden public health incidents continue to lead to increased volatility in the import costs of bulk feed raw materials (such as soybean meal, alfalfa) and key equipment, and may even lead to supply chain disruptions, severely affecting production costs and operational stability.
Risk Mitigation Measures: Modern Dairy is committed to building a diversified and highly resilient supply chain system. We establish long-term strategic cooperative relationships with multiple domestic and international suppliers to diversify procurement risks; actively explore localized alternative solutions to reduce dependence on single sources; we use market analysis and forward-looking procurement strategies to effectively hedge against commodity price fluctuations by locking in forward prices and flexible procurement arrangements; and establish a sound inventory management and emergency preparedness mechanism to ensure production continuity and stability even under external shocks.

6. Future Emerging Risks Faced by the Group

6.1 Risk Name: Technological Innovation Risk

Risk Exposure: Medium likelihood, but medium potential impact.
Risk Description: The rapid development of cutting-edge technologies such as artificial intelligence, IoT, big data, gene editing, and synthetic biology in livestock farming, dairy processing, supply chain management, and consumer interaction may bring disruptive changes to traditional dairy farming models and management methods. Failure to adapt and utilize these technologies in a timely manner will lead to the risk of technological obsolescence and decreased market competitiveness.
Risk Mitigation Measures: Modern Dairy actively embraces digital transformation by investing in and building smart farm management systems, utilizing cloud-based cattle farming for real-time monitoring of dairy cattle health, milk yield, and environmental data; introducing big data analysis to optimize feed formulations and disease early warning; and exploring the application of artificial intelligence in farm operations and dairy product quality control. At the same time, we collaborate with scientific research institutions, pay close attention to the latest developments in biotechnology in breeding and epidemic prevention and control, and establish an internal innovation incubation mechanism to ensure that the company maintains a leading position in technological change, achieving intelligent, refined, and traceable farming.

6.2 Risk Name: Biosafety Risk

Risk Exposure: Low likelihood, but high potential impact.
Risk Description: With global climate change, increasing ecological complexity, and growing international trade and personnel movement, animal epidemics are exhibiting new emerging characteristics such as faster spread, stronger variability, and higher risk of cross-species infection. New pathogens (such as unknown viral strains) or mutations of existing pathogens pose unprecedented threats to dairy cattle health and farm biosafety. A large-scale epidemic outbreak could lead to mass culling of dairy cattle, sharp declines in raw milk production, production interruptions, and even market panic and consumer trust crises, significantly impacting the company’s operations, financial performance, and brand reputation.
Risk Mitigation Measures: Modern Dairy regards biosafety as the lifeline of farm operations and has built a forward-looking, high-standard biosafety prevention and control system to address emerging epidemic challenges. We strictly implement internationally leading biosafety management procedures, enforce strict personnel, vehicle, and material entry/exit management and disinfection systems to ensure effective isolation of internal and external farm environments. We introduce advanced rapid disease diagnosis technologies, maintain close cooperation with domestic and international scientific research institutions, closely monitor global animal epidemic dynamics and research progress on emerging pathogens, and enhance early warning and rapid response capabilities for epidemics. We formulate scientific immunization programs and promote precise health management models to improve the dairy cattle’s own immunity and reduce the risk of disease occurrence. We regularly conduct epidemic emergency drills and stockpile sufficient emergency supplies to ensure that emergency plans can be quickly activated in the event of a sudden epidemic, effectively controlling the spread of the epidemic, and minimizing the impact on production and operations. We actively participate in industry exchanges and cooperation, share best practices, and jointly improve the biosafety level of the entire dairy supply chain.

6.3 Risk Name: Tightening Regional Water Resource Constraints and Adjustments to Farm Footprint

Risk Exposure: Medium likelihood, but medium potential impact.
Risk Description: As policies concerning rigid constraints on water resources and controls over total groundwater abstraction and groundwater levels continue to be strengthened, regions facing water scarcity and groundwater over-extraction may further refine their water abstraction quotas, groundwater withdrawal reduction schedules, conditions for renewing water abstraction permits, and differentiated water resources tax policies. The relevant local implementation standards, timelines and levels of stringency remain subject to uncertainty. Although these developments may not have a significant impact on the Group in the short term, they have begun to affect decisions regarding water metering, water conservation upgrades and site selection for new projects. Some of the Group’s farms are located in water-stressed areas, including Hebei, Inner Mongolia, Ningxia, Shandong and Henan. If these regions further reduce groundwater abstraction, tighten water abstraction permits or increase water costs over the medium to long term, this may constrain capacity expansion at multiple existing farms and the development of new projects. It may also increase capital expenditure on alternative water sources, water-saving facility upgrades and wastewater recycling and reuse. If the scope of these impacts continues to expand, the Group may need to adjust its geographical farm footprint, production planning and water resource utilization model.
Risk Mitigation Measures: The Group continues to adopt water-saving technologies, processes and equipment and reduce water consumption through water recycling, wastewater treatment and reuse, and related technical upgrades. We improve water metering facilities, conduct inspections of water use, control actual water consumption within applicable limits and continuously enhance water use efficiency. The Group closely monitors water abstraction quotas, permit requirements and groundwater withdrawal reduction requirements in key regions and assesses the water resource carrying capacity and alternative water source availability of each farm in advance. When planning new or expanded farms, the Group incorporates regional water resource availability and long-term water supply capacity into site selection assessments and gives priority to regions with relatively stronger water resource carrying capacity, thereby reducing the impact of regional water constraints on its long-term production capacity planning.

6.4 Risk Name: Shifts in Forage Crop Suitability Zones Driven by Compound Natural Events and Emerging Pests and Diseases

Risk Exposure: Medium likelihood, but high potential impact.
Risk Description: In recent years, compound natural events, such as persistent drought combined with concentrated rainfall and abnormal cold and heat, together with changes in the geographical spread and occurrence patterns of pests and diseases, may have long-term effects on crop growth, harvesting windows and storage conditions in major forage-producing regions. Considerable uncertainty remains regarding where and how frequently these events may occur and how they may interact in the future. Their impacts may already be emerging in certain production regions, while long-term changes in areas suitable for forage cultivation and stable supply patterns remain difficult to predict accurately. If multiple major forage-producing regions are simultaneously affected by compound natural events or emerging pests and diseases, the production of major roughage crops, including silage corn and alfalfa, may experience sustained declines, disruptions to harvesting schedules or deterioration in nutritional quality. This may, in turn, affect feed formulation stability, dairy cattle dry matter intake, milk yield and raw milk quality across a significant proportion of the Group’s farms. If the long-term suitability of traditionally advantageous production regions changes, the Group may need to reconfigure its forage production base footprint, sourcing regions, supplier structure and ration formulation system.
Risk Mitigation Measures: The Group secures key local forage sources, including silage corn and alfalfa, through long-term land leases, contract farming and long-term supply agreements. We also promote the multi-regional distribution of forage production bases and suppliers to reduce reliance on any single production region. The Group continuously monitors weather conditions, pests and diseases, crop growth and harvesting conditions in major production regions to identify potential supply and quality changes at an early stage. At self-operated and partner cultivation bases, the Group enhances soil health and crop resilience through measures such as manure application, crop rotation and soil improvement, while strengthening forage harvesting, testing and storage management. Subject to meeting the nutritional requirements and milk production performance of dairy cattle, the Group continuously optimizes its roughage mix and alternative feed options, improves its ability to allocate forage from different sources, and strengthens the long-term resilience of its forage supply system.