Relations of Corporate Governance

REPORT ON CORPORATE GOVERNANCE AND APPLICATION OF THE CORPORATE CODE OF CONDUCT ADOPTED IN 2006

The changes made in the Italian “TUF”, or Consolidated Text on Financial Intermediation (henceforth the “TUF”), made corporate governance regulations even more relevant and visible than they already were. Please remember that article 124 ii of the TUF required listed companies to provide information as to the extent of their adherence to the codes of conduct recommended by the companies managing regulated markets, and by trade associations, in accordance with the terms and means set by CONSOB. The consecutive article 124 iii provided that CONSOB set the rules by which this information is published.

In a review of their Regulations for Issuers adopted through decision no. 11971/99, CONSOB recently indicated the terms and means by which this information is reported, as well as the related types of publication, specifying that such a Report must:

• be prepared according to guidelines set by the issuer of the Code of Conduct;
• give data regarding the adherence to each requirement of the Code;
• give grounds for the failure to comply with any requirements;
• highlight any conduct which may not conform to these requirements;
• be published in a dedicated section of the Company’s web site;
• be deposited at the Company’s registered office no later than 15 days prior to the date of the meeting set to approve the financial statements.

Moreover, CONSOB also stated that the Report must be included in full in the Report of the Board of Directors or in an attachment thereof, and that notice must be given that it has been deposited with CONSOB, Borsa Italian S.p.A. and the market.

We also remind you that in 2006 the Code of Conduct as set by Borsa Italiana S.p.A.’s Corporate Governance Committee (henceforth “the Code of Conduct” or simply “the Code”) has been reviewed, and that the Company’s Board of Directors at their meeting on 10 November 2006, giving notice to the market through a press release issued simultaneously with the Quarterly Report at 30 September 2006, declared that they would adopt the 2006 edition of the Code, and would gradually proceed to introduce its principles in the Company structures, giving notice of the activities made towards the completion of this objective in the Report on Corporate Governance prepared for the 2006 financial statements.

This Report on Corporate Governance, which accompanies the Report of the Board of Directors for the financial statements closed at 31 December 2006, was prepared according to indications set in the 2006 edition of the Code of Conduct, and aims at describing the extent to which the company’s structure complies with the provisions of the Code, identifying any situation in which it may differ and explaining the reason for this.

Please remember that the Company has been providing corporate governance information as from the financial statements closed on 30 June 2000, continuously improving the quality and quantity of this information. These Reports are available on the website www.kme.com within the financial statements of the individual financial years. As from the year closed 31 December 2006, the corporate governance reports are available in a dedicated section of the site.

Indications furnished by Assonime in their memo no. 5 dated 12 February 2007 were considered in the preparation of this report, as were the guidelines issued by Borsa Italiana S.p.A. and in the “Guide to the preparation of the Report on Corporate Governance” issued by Assonime jointly with Emittenti Titoli S.p.A. (2004 edition).

As an additional introductory comment, we remind you that the so-called “Savings Law”, which came into effect in January 2006 and was reviewed in December of the same year, has led to numerous changes in the provisions of the Civil Code for corporate matters regarding the TUF, changes that in many cases involve the issuance of specific regulations by CONSOB and that will require the company’s bylaws to be revised by 30 June 2007. As a consequence, shareholders will also be convened in an extraordinary meeting to make the necessary changes to the bylaws. Please note that the current version of the bylaws is available on the KME Group website at www.kme.com.

Obviously, the issuance of new provisions on such strict terms and the brief period allowed for them to be applied to the Company (the most recent changes in fact were put into effect on 25 January 2007, and the CONSOB regulations have not yet been finalised) have caused this annual report to be more weighty in terms of content and preparation, and therefore also in terms of perusal, which is especially complex also considering the fact that the company bylaws will soon be changed.

For simplicity’s sake, we would like to inform you in advance, with convenient references, of the matters that will have to be addressed for the change of the bylaws.

Therefore, we would like to invite our shareholders to peruse this Report alongside the one that will be issued regarding the updating of the bylaws, in order to have a complete and full view of the situation regarding:

• the Company’s organisational structure and gradual development;
• the changes that will be subject to shareholder approval at the extraordinary meeting.

This report, which may also be found on the website www.kme.com, is divided into two parts:

a) the first part is dedicated to the system of corporate governance adopted by the company;

b) the second part has as its objective a comparison between the system adopted and the provisions of the Code of Conduct.

The actions taken and those planned for the implementation of the above Code into Company structures are highlighted in both sections.

GENERAL PART
The Company has a traditional corporate governance structure, with a General Meeting of Shareholders, a Board of Directors and a Board of Statutory Auditors.

Share Capital
At the approval date for this Report (i.e. in reference to the last exercising of the company warrants on 28 February 2007), Company share capital was Euro 319,685,924.75 and composed of 750,724,051 shares, of which 693,507,719 are ordinary shares and 57,216,332 are savings shares, all without nominal value according to approvals made at the Extraordinary General Meeting on 19 May 2006.

At the date of approval of this Report, there were 74,087,600 warrants outstanding, issued through the same Extraordinary General Meeting approval, the possible exercising of which (at a unit price of Euro 0.35) by the final date at 11 December 2009 could cause the issue of a maximum of 74,087,600 ordinary shares without nominal value and with a corresponding share capital increase of a maximum of Euro 25,930,660. The possible exercising of these warrants would cause a change in share capital, and consequently of the Company bylaws on a monthly basis. Updates regarding this matter are reported to the market through a notice (for more information on the “NIS” market information system please see the following paragraph entitled “Shareholder and Market Communications”), and thereafter displayed on the www.kme.com website.

G.I.M. - Generale Industrie Metallurgiche S.p.A. is the controlling shareholder, with 53.83% of the ordinary shares. We remind you that at the date of this Report a merger of the above-mentioned Company with Intek S.p.A. is currently being finalised.

The Company’s ordinary shareholders number approximately 13,000, a figure based on the results from the share capital increase that was concluded in August 2006. Besides the controlling shareholder, no other shareholder declared possessing more than 2% of ordinary shares.

For the sake of completeness, we remind you that the agreement between G.I.M. - Generale Industrie Metallurgiche S.p.A. shareholders and Pirelli & C. S.p.A. was resolved amicably on 19 December 2006.

The General Meeting of Shareholders
The General Meeting of Shareholders is made up of ordinary shareholders and has the responsibilities and competence provided for by the Civil Code and the TUF.

Company bylaws permit the Board of Directors to approve resolutions regarding the location of the company’s registered office and secondary office, the issue of convertible bonds, the merger of subsidiaries and amendments to the bylaws for withdrawal and for modification as the result of new legislation.

Provisions regarding the correct constitution of the meeting and regarding voting procedures are those applicable pursuant to articles 2368 and following of the Civil Code and article 126 of the TUF.

For the provisions that regulate shareholder meeting participation, please see the extra sections of our Report regarding the proposed changes of articles 10 (convening of shareholder meetings) and 11 (participation and representation at shareholder meetings), specifically the changes relating to the recent provisions governing minority shareholders for the nomination of Directors and Auditors. We will also propose that the convocation of shareholders’ meetings be announced in a daily newspaper as an alternative to the Official Journal.

One aspect that differs from the Code is that the Company has not adopted its own “Regulations for Shareholders’ Meetings”, as the respective provisions are already contained in Chapter III of the bylaws. To protect the rights of shareholders regarding this matter, we remind you that article 12 of the bylaws expressly requires the Chairman of the Meeting to guarantee the correct proceedings of the meetings, overseeing and regulating debate and intervening on the length of individual contributions if necessary.

Savings shareholders may not participate in the ordinary shareholders’ meetings, and the rights of the former are displayed in articles 5, 8 and 28 of the bylaws. Their representative, who may participate and intervene in ordinary shareholder meetings and whose rights are displayed in article 26 of the bylaws, is Mr Romano Bellezza, nominated for the 2006/2008 period at the special savings shareholders’ meeting that was held on 5 May 2006.

The Board of Directors
The Board of Directors has the widest powers for the organisation, administration and ordinary and extraordinary management of the company (article 14 of the bylaws). The Board determines the strategic line to be followed by the company and takes such action necessary to achieve this, guarantees the continuity of administration and delegates executive directors (articles 15 and 16 of the bylaws).

The present Board of Directors was appointed by shareholders’ general meeting on 19 April 2006 for a term covering the years 2006, 2007 and 2008, expiring at the general meeting of shareholders which will be held to approve the financial statements for the year ending 31 December 2008.

The Board may consist of a varying number of Directors, from a minimum of nine to a maximum of twelve. The general shareholders’ meeting held on 19 May 2006 set the number of directors at nine, compared to the ten directors previously. The names of the members of the Board, together with an indication of their respective functions, including those on committees, are as always stated at the beginning of the booklet issued on the occasion of shareholders’ meetings and on the publication of the annual financial statements and half-year and quarterly reports.

Specifically regarding the new provisions regarding representation of minority shareholders on the Board of Directors, we note that no Director was appointed through the presentation of a voting list by a minority shareholder, and article 17 of the bylaws needs to be updated at an extraordinary meeting of shareholders.

The Board of Directors meets at least four times a year (article 18 of the company’s bylaws). Meetings may also be held by teleconference or by videoconference (article 19 of the company’s bylaws) and are called at reasonable notice with notification of the agenda of the matters to be discussed (article 18 of the company’s bylaws). Minutes of the meetings are distributed, keeping in mind the need to ensure the confidential nature of some individual matters.

Resolutions of the Board are passed with the attendance of the majority of directors holding office and by an absolute majority of those attending. In the case of a split decision, the Chairman has the casting vote (article 19 of the company’s bylaws).

The Board of Directors may establish committees, determining the powers, responsibilities and competence of these (article 14 of the company’s bylaws), and has provided for the establishment of the following committees:

• the Committee for Internal Control;
• the Compensation Committee.

Their members and duties are detailed further on in this report.

The Board of Directors did not establish an Executive Committee — as it had nominated a Managing Director — nor a Nominations Committee, since the Company has a controlling shareholder.

The Board of Directors met nine times during the year compared to ten times in the previous year.

The individual attendance records of each meeting are shown in a table at the end of this Report. However, we inform you that participation at the meetings by Directors and Auditors averaged 86% and 77%, respectively.

The Board of Statutory Auditors
The Board of Statutory Auditors governs the observance of laws and bylaws, ensures that the principles of proper company administration are adhered to, especially regarding the organisational, administrative and accounting structures of the Company, and oversees its physical workings.

The present Board of Statutory Auditors was appointed by G.I.M. - Generale Industrie Metallurgiche S.p.A., at the general meeting of shareholders held on 19 May 2006, for the years 2006, 2007 and 2008, and therefore will dissolve at the general meeting held to approve the financial statements at 31 December 2008.

The Board consists of three standing members and two alternate members, and, as is the case for the Directors, their names are stated in the periodic accounting documents made available by the company. The following paragraphs give brief curriculum vitae for each member.

Marcello Fazzini (Chairman)
Mr Marcello Fazzini, born in 1932, graduated from the University of Florence in Social Sciences and Economics, and is registered with the National Accountants and Accounting Auditors Boards. He works in Florence. He has held and holds management positions in the administration and control of many important companies, and was the managing director of Banca Toscana S.p.A. from 1986 to 1996. He is involved at a high level in significant Florentine cultural institutions such as the Gabinetto Scientifico Letterario G.P. Vieusseux (as Chairman), and is a co-founder/member of the
International University of Art.

Alessandro Trotter (Standing Auditor)
Mr Alessandro Trotter, born in 1940, graduated in Business and Economics, and is registered with the National Accountants and Accounting Auditors Boards. He works in Milan. He holds positions on the Boards of Auditors of many important companies.

Pasquale Pace (Standing Auditor)
Mr Pasquale Pace, born in 1938, graduated in Business and Economics, and is registered with the National Accountants and Accounting Auditors Boards. He works in Bari. He is a member of other Boards of Auditors, and, besides having held judicial offices, is an expert court assessor regarding legal administration and penal matters.

Marco Lombardi (Alternate Auditor)
Mr Marco Lombardi, born in 1959, graduated in Political Science, and is registered with the National Accountants and Accounting Auditors Boards. He works in Florence. He holds positions on other Boards of Auditors and legal boards. He has written various works on tax law.

Angelo Garcea (Alternate Auditor)
Mr Angelo Garcea, born in 1969, graduated in Business and Economics, and is registered with the National Accountants and Accounting Auditors Boards. He works in Florence. He is the author of many works on tax law.

No auditor was appointed through any lists presented by a minority shareholder; according to article 22 of the bylaws, minority shareholders are those owning 3% or less of ordinary shares. Regarding an update of the bylaws, we would like to inform you in advance that this level will probably be changed in light of new provisions on the subject.

Article 22 of the bylaws is entirely dedicated to the Board of Statutory Auditors and, in addition to providing the requisites that must be held by members of the Board and the procedure by which they are appointed, requires that each candidate deposit his curriculum vitae at least two days prior to the shareholders’ meeting at which the appointment will be made, instead of the fifteen days prior to the meeting as indicated by the Code of Conduct and the Regulations for Issuers. Moreover, this article provides that Auditors hold no more than five similar roles in other companies listed in Italy, which was already the case before the introduction of a similar provision in article 148 ii of the TUF, and much more specific governance is currently being drawn up by CONSOB.
As indicated above, please see the comments and proposals in the Report of the Board of Directors regarding the changes to article 22 of the bylaws.

The members of the Board declared on appointment that they possess the characteristics of professionalism and honour required by prevailing legislation and the company’s current bylaws and stated that there are no impediments to their holding office. Following their appointment, the Board periodically checks that each of its members possesses the requirements of independence based on the criteria included in the combined provisions in articles 10.C.2. and 3.C.1. of the Civil Code.

In this regard, the Board verified that Mr Alessandro Trotter was appointed Standing Auditor of the Company for the first time at the general meeting of shareholders held on 14 November 1997 for the years closed on 30 June 1998, 1999 and 2000, and therefore has held this role without interruption for over nine calendar years over 10 financial years, including the one closed at 31 December 2006.

The Board, in accordance with the optional faculty provided by the Code in evaluating the independence of its members, believe that the Standing Auditor Alessandro Trotter may be held “independent” according to a substantial evaluation of the report that considered both the personality of the subject and the economic and professional “significance” of the role he performs in service of the Company. Please note that Mr Trotter’s position will expire upon the approval of the financial statements that will close on 31 December 2008.

Similarly, please note that the Board’s inquiry also involved the role of the Chairman of the Board, Mr Marcello Fazzini, which displayed largely the same situation in reference to the current financial year, his ninth consecutive year as auditor. He was first appointed at the general meeting of shareholders held on 28 October 1999 for the financial year closed on 30 June 2000, but had previously been an Alternate Auditor, becoming a Standing Auditor on 8 June 1999, starting his role with the financial year closed on 30 June 1999.

Beyond the formal reference to the calendar year instead of the financial year as per article 3.C.1. letter e), the Board believes, for the same reasons indicated above, that Mr Marcello Fazzini also possesses the necessary requirements of independence.

As a result, the Board gave notice that they had adhered to the provisions of article 149, paragraph I, letter c-ii of the TUF, which requires them to oversee the regulations of the physical implementation of the Code of Conduct.

The administration and control positions held by the Auditors in other companies are shown below, and were made available at the general meeting of shareholders in which they were appointed. All Auditors that held such positions during 2006 are included in this list.

The Board of Statutory Auditors performs its activities on a regular basis, attends meetings of the Board of Directors and committees established by that Board and maintains continuous contact with the company’s offices, which it addresses directly and in full autonomy. Relations with the Independent Auditors are distinguished by collaboration and by the exchange of data and information.

The fees received by members of the Board are shown in the table below, in accordance with CONSOB provisions:

(1) Emolumenti per cariche ricoperte in società controllate

METTERE TABELLA DELLA VERSIONE ITALIANA

The Board met six times during the year; there were seven meetings in the previous year. There was 100% attendance by members at these meetings.

Offices held by the Statutory Auditors
The following table sets out for each Statutory Auditor the positions held at 31 December 2006 as either Director or Statutory Auditor in stock corporations, in partnerships and in limited liability companies.

Marcello Fazzini

• HDI Assicurazioni S.p.A. Chairman of the Board of Statutory Auditors
• HDI Finanziaria S.p.A. Chairman of the Board of Statutory Auditors
• FINOA S.p.A. Chairman of the Board of Statutory Auditors
• Europa Metalli S.p.A. Chairman of the Board of Statutory Auditors
• Lanificio Roberto Draghi S.p.A. Chairman of the Board of Statutory Auditors
• F.lli Reali S.p.A. Chairman of the Board of Statutory Auditors
• InChiaro Assicurazione S.p.A. Standing Statutory Auditor

Massimo Mandolesi (until 19.05.06)

• PREVIRA INVEST SIM S.p.A. Managing Director
• Cassa Nazionale di Previdenza e Assistenza Ragionieri Member of the Board of Directors
• CESPA Costruzioni Edili S.p.A. Chairman of the Board of Statutory Auditors
• Bluestone S.p.A. Chairman of the Board of Statutory Auditors
• H1 Holding S.p.A. Chairman of the Board of Statutory Auditors
• Acentro Turismo S.p.A. Standing Statutory Auditor
• Albergo Centrale Srl Standing Statutory Auditor
• Albrofin S.p.A. Standing Statutory Auditor
• Bellavista Imm.re 1ª Srl Standing Statutory Auditor
• Car Life Italia S.p.A. Standing Statutory Auditor
• Le Palme Srl Standing Statutory Auditor
• S.G.I.R. Srl Standing Statutory Auditor

Pasquale Pace

• ASECO Srl (Gruppo Gesteco) Chairman of the Board of Statutory Auditors
• Edil Vacanze S.p.A. Chairman of the Board of Statutory Auditors
• CE.DI APULIA Srl in liquidazione Chairman of the Board of Statutory Auditors
• New Team Srl Chairman of the Board of Statutory Auditors
• Fidanzia Sistemi Srl Standing Statutory Auditor
• Marzocca Srl Standing Statutory Auditor
• Supercar S.p.A. Standing Statutory Auditor

Alessandro Trotter

• Autostrade Lombarde S.p.A. Member of the Board of Directors
• BREBEMI S.p.A. Member of the Board of Directors
• Immobiliare Lombarda Member of the Board of Directors
• ADRIAOIL S.p.A. Chairman of the Board of Statutory Auditors
• Autostrade per l’Italia S.p.A. Chairman of the Board of Statutory Auditors
• Euricom S.p.A. Chairman of the Board of Statutory Auditors
• Faro S.p.A. Chairman of the Board of Statutory Auditors
• Fillatice S.p.A. Chairman of the Board of Statutory Auditors
• Petraco S.p.A. Chairman of the Board of Statutory Auditors
• Pietro Fiorentini S.p.A. Chairman of the Board of Statutory Auditors
• Radiall Elettronica Srl Chairman of the Board of Statutory Auditors
• Rebosio S.p.A. Chairman of the Board of Statutory Auditors
• Rotolito Lombarda S.p.A. Chairman of the Board of Statutory Auditors
• SITECH in liquidazione Chairman of the Board of Statutory Auditors
• TLX S.p.A.Chairman of the Board of Statutory Auditors
• UNICREDIT Banca S.p.A. Chairman of the Board of Statutory Auditors
• Autostrade S.p.A. Standing Statutory Auditor
• Autostrade Sud America Srl Standing Statutory Auditor
• FIDIA S.p.A. Standing Statutory Auditor
• Mediobanca S.p.A. SStanding Statutory Auditor
• Schemaventotto Standing Statutory Auditor
• Siena Mortgages 00-1 S.p.A. Standing Statutory Auditor
• Sistemi Tecnologici Holding S.p.A. Standing Statutory Auditor
• T.A.F. Abrasivi S.p.A. Standing Statutory Auditor
• UBM S.p.A. Standing Statutory Auditor
• Ulisse S.p.A. Standing Statutory Auditor
• UNICREDIT Clarima Banca S.p.A. Standing Statutory Auditor

Angelo Garcea

• Travertino Toscano S.p.A. Chairman of the Board of Statutory Auditors
• Polimoda Srl Chairman of the Board of Statutory Auditors
• Cesvit S.p.A. (in liquidazione)Standing Statutory Auditor
• Immobiliare S. Gemignanello S.p.A. Standing Statutory Auditor
• Cooperativa Borgo Pinti 80 Scarl Standing Statutory Auditor

Marco Lombardi

• RECS Srl Sole Director
• Brandini S.p.A. Chairman of the Board of Statutory Auditors
• Car Sharing Firenze Srl Chairman of the Board of Statutory Auditors
• C.P.F. Costruzioni S.p.A. Chairman of the Board of Statutory Auditors
• D&D La Certosa Firenze S.p.A. Chairman of the Board of Statutory Auditors
• Daliana Andrea & C. S.p.A. Chairman of the Board of Statutory Auditors
• Fattoria dei Barbi Srl Chairman of the Board of Statutory Auditors
• L.A. Fashion S.p.A.Chairman of the Board of Statutory Auditors
• Jaguar Firenze S.p.A. Chairman of the Board of Statutory Auditors
• Villa Donoratico Srl Chairman of the Board of Statutory Auditors
• Firenze Industria Finance S.p.A.Standing Statutory Auditor
• Europa Metalli S.p.A. Standing Statutory Auditor
• Grifoni & Masini S.p.A.Standing Statutory Auditor
• SAIF Servizi Ass.ni Industriali Firenze Srl Standing Statutory Auditor

 The Independent Auditing Company
Deloitte & Touche S.p.A. is the company appointed pursuant to articles 155 and following of the TUF to perform an audit of the annual and consolidated financial statements, as well as to perform a review of the half year report, including that prepared on a consolidated basis. The auditors’ activities cover 100% of the subsidiaries included in the scope of consolidation.

The current engagement, which is for the second of the two renewal terms permitted, was approved by shareholders in the general meeting on 27 April 2005 and ends with the financial statements for the year ending 31 December 2007.

In charge of the project on behalf of the Independent Auditing Company is Mr Paolo Guglielmetti, who has held this office since 2005 with reference to certification made on 6 April 2005 for the 2004 financial year, thus respecting article 160, Paragraph I iv of the TUF, which states that this position may be held for a maximum of six financial years.

The auditors’ present annual fee amounts to Euro 65,000, inflation-linked on an annual basis to the ISTAT retail price index.

The Independent Auditing Company carried out the following additional engagements during the year:

• the compilation of a report on the assumptions made and underlying factors upon which the Group’s accounting figures are based, including in the Prospectus prepared for the options deal relating to the capital increase approved on 19 May 2006;

• the compilation of a report on the market value of the issue price of the shares relating to the capital increase, not including the options rights pursuant to article 2441, Paragraph IV, ii of the Civil Code;
• a review of the Company’s income tax declaration and the simplified 770 tax form.

Please note that regulations regarding audit review have recently been modified, and note the “grounds for proposals” made by the Board of Statutory Auditors relating to the second point of the agenda of the ordinary general meeting of shareholders, and relating to the cancellation and transferral of the independent auditing appointment to KPMG S.p.A..