Oral evidence: Financial management of the European Union budget in 2014, HC 730
Oral evidence, 25 February 2016.
Witnesses
Phil Wynn Owen, UK Member, European Court of Auditors and Dr Manfred Kraff, Deputy Director-General of DG for Budget and Accounting Officer of the European Commission, gave evidence.
Chair
Good morning and welcome to our hearing on budget management in the European Union. I think you were sitting in before, so I do not need to repeat my preamble, but I warmly welcome you, because we have the power to summon certain people, but I don’t think you fall into that category. We welcome Phil Wynn Owen, who—I think—formerly worked at the Treasury and other Departments. Is my memory of your CV right?
Phil Wynn Owen
That is correct. I have worked at the Treasury, the Cabinet Office, the DWP and DECC in the UK.
Chair
So welcome back to London and to Britain. Mr Wynn Owen is the British member of the Court of Auditors in Europe. We give a warm welcome to Dr Manfred Kraff, who is the Deputy Director-General of the European Commission. You work with Kristalina Georgieva, who we had the pleasure of meeting. Richard Bacon and I were on that delegation about a year ago, and we were very impressed with some of her plans. We are here today to challenge and question you about budget management at Commission level, what you think is happening in member states and what the plans are with the mid-term review and the seven-year financial framework. I will ask Anne-Marie Trevelyan to kick off, and then I will go to Caroline Flint.
Mrs Trevelyan
As the UK’s voice in the Court of Auditors, Mr Wynn Owen, do you feel that we have a strong voice and that you are able to be a very clear UK voice, or do you feel that you are separate from the UK and part of an audit framework that looks down across the whole of the EU process? Are there colleagues of yours who you feel bring more to the party in skills? You have an enormous background in public service and the civil service compared with some of your colleagues.
Phil Wynn Owen
First, I thank the Committee for holding this hearing and for inviting me, as I offer to come every year to talk about our annual report. It is very good that you are holding a hearing on it. Thank you for the question, which gives me an opportunity to explain my role, which I should make clear at the outset. I am the UK member of the European Court of Auditors, which is an independent body with responsibility for auditing the EU budget. The Court on which I sit is a collegiate body with collective decision making by its 28 members—one from each member state. Each of us resigned all previous appointments when we joined. I resigned from the UK civil service when I joined the ECA. I am not of the UK Government, like an ambassador would be; I am an independent party now sitting on a collegiate body. Each of us on the Court took an oath to carry out our duties in a fully independent manner—that is absolutely crucial, as you know from working with the NAO in the context of audit—and in the general interests of the European Union. That is the context in which I appear here. The Court is a collegiate body. I have made many good friends and colleagues. There is a lot of professionalism, both from audit backgrounds and financial backgrounds like my own. The UK has a history of sending people with a substantial degree of Treasury and financial experience: I was in and around the Treasury for more than 20 years.
Chair
I do not want to interrupt you, Mr Wynn Owen, but you have given us a flavour and we have a clear idea of what your role is.
Mrs Trevelyan
The key message from the report, as I have gone through it, is that everything is still very complex and the level of error is really very high, particularly on the UK side, as you heard earlier when we were discussing that with some of our civil servants. After 21 years of continued failure to control areas below that materiality threshold of 2%, it strikes me as a system that is not really doing what it is setting out to do. First, what do you feel are the reasons for that continuing failure? Are some countries worse than others? Is the system really not working and clearly not making progress to improve?
Phil Wynn Owen
The treaty charges us with two fundamental roles. The first is to look at the financial accounts, and I am grateful to Caroline Flint, who pointed out that we gave a clean opinion on the reliability of the 2014 accounts of the EU. We have done that since 2007. We said that they present a true and fair view. It is important to get that on the record, because honestly as a Brit I do not think that that is often understood here. We are also charged to look at the legality and regularity of the underlying transactions. On the revenue side, we said it was legal and regular, but on the payments side, you are correct that we gave an adverse opinion on the legality and regularity. The estimated level of error was 4.4%, which is well above the 2% materiality threshold. What are the drivers? Let me go straight to the point, because we did more to analyse the drivers in this year’s report, because we think it is important—to, for instance, the previous witnesses times 28 member states and the Commission—to really understand the problems and to try to address them. There is a short version of this annual report, and there is a tome in which there is a lot of good stuff if you have the time to glance through it, with some charts that are easily intelligible. We identify in the report the three biggest types of error across the European Union: first, ineligible costs included in reimbursement claims—that was around 1.8% of the 4.4% error; secondly, public procurement errors; and thirdly, incorrect declarations of area by farmers. If my addition is correct, and, as an auditor, I hope it is, those three—1.8%, 1.2% and 0.9%—add up to 3.9% of the 4.4%. In other words, those three are the three big drivers of error. I could go on. We give more drivers in the report, and the fourth and fifth are important too, but that tells a lot of the story.
Mrs Trevelyan
Looking at those by country, are there clear system failures in certain countries, or is every country bad at those things across the board at that sort of level? If it’s the latter, that would imply to me a systemic failure in what is coming out of the EU.
Phil Wynn Owen
We audit the EU budget and not individual member states. Each member state has its own audit institution—you have an excellent one in the NAO, so we wouldn’t presume to do their job. Also, statistically our sample would have to be much bigger if we were going to draw error rates out for each member state. We simply cannot do that. We audit around 1,200 transactions on a random sample basis across the EU to get a statistically relevant sample at EU level. We do what we can, though. Particularly in recent years we have sought to do what we can to cast some light on what is going on. For the previous annual report, in autumn 2013 we published a little document called “Agriculture and cohesion: overview of EU spending”, which included some tables in which the UK featured, like all other member states. We broke down the total number of errors over a five-year period, which gave a bit more insight than just one year, and we split it between agriculture and cohesion so that people could see at a glance some of the areas, at least on the basis of our samples, where there had been problems in their member state. For some member states we couldn’t draw much of a conclusion at all, because a very small member state might not have any transactions looked at in any particular year, but the conclusion we drew was that all member states for which a conclusion could be drawn—obviously the UK is big enough for that in our samples—are affected by a material level of errors with a degree of fluctuation around the average. The Court finds errors of the type I mentioned—those three big drivers—throughout the EU member states. We also do sampling of control systems—if you like, the management systems in member states. We have predominantly concluded that they are partially effective, but there is some way to go. In our 2012 annual report, we identified the agricultural systems—the paying agencies—in England and Northern Ireland as not effective, and we drew that to the attention of this Committee and the relevant managing authorities and Departments in the UK at the time. As was previously discussed, we have all known for some time that there were serious problems in how the UK managing authorities—particularly in England and Northern Ireland in that case—were conducting their business.
Mrs Trevelyan
Dr Kraff, the auditors have produced this report. I am an auditor by background, so drilling down until you get to the root of the cause is important to me, but clearly both country and system failures are going on. As the accounting officer for the Commission responsible for moving this forwards, how do you see your role? What can the Commission do to really drive down the error rate?
Dr Kraff
First, let me thank you for inviting me to this hearing. We know, of course, that EU financial management is an issue which is discussed, and it attracts a lot of political interest, especially in your country. I am happy to answer your questions. First of all, we agree with all the findings of the European Court of Auditors. We stated this very clearly in the annual report; we share the diagnosis of the Court of Auditors. In the annual activity reports of the Directors-General for the different policy areas—regional policies, social fund, agriculture—you find a lot of information on what is going wrong and what is going well in the different member states. You can find statistics on the error rates and on the residual level of error. The residual level of error is the level of error after all the corrections have been implemented. In the discussion with the previous witnesses, you focused a lot on the protection of the EU budget. We impose financial corrections whenever we find evidence that there is expenditure incurred in breach of law. We agree entirely with the court’s error rate of 4.4%, but one should take into consideration that it would have been even higher without our corrective capacity. The Court of Auditors told us correctly that without the corrective mechanisms applied by the Commission and the member states, the error rate would have been 5.5%. The corrections that we impose create the 1.1% reduction in the error rate before payments were made. So the court provides you with a correct snapshot of what is happening in the EU, but that is not the end of the story. Then come the financial corrections imposed after payments were made. You discussed especially the clearance of accounts procedure in agriculture; we have a similar procedure in the area of cohesion. When you analyse carefully how much money is involved, you can see that it is roughly 2% of the EU budget, depending on how you calculate it. So taking that into consideration, we think that the risk to the budget is adequately managed. Of course, you cannot deduct this amount from the Court’s error rate. Why? Because those financial corrections refer to previous years. The errors in the year that we are discussing now, 2014, will be addressed by upcoming financial discussions. You had a discussion with a DEFRA colleague on the risk that exists.
Mrs Trevelyan
So as the accounting officer for the Commission, you obviously want to manage the 28 member states’ money which is put into the kitty for you to redistribute as well as possible. What are you trying to do to make sure that that corrected 4.4% decreases? That is a lot of wasted money, a lot of effort and a lot of member states failing to achieve what is referred to as EU added value—we give you a chunk of cash, and you give it back to us with a set of rules on how to spend it. If we are not doing it right, no one is getting any added value at all. It would be easier if I just wrote a cheque to my farmer. What are you doing as the Commission to improve that added value and reduce the error rate?
Dr Kraff
I agree entirely with your analysis. We have to bring down the error rate; there is no doubt about that. We should not focus on ex post financial corrections. It is important that we get it right from the beginning. Therefore, Commissioners Hogan and Creţu started immediately after they came into office a simplification initiative to make it easier for those who get EU money to get things right, and for the administrations to ensure that expenditure is legal and regular. Furthermore, the Court of Auditors asked us, as well as the Council and the European Parliament, to carry out a profound analysis of why error rates are persistently high in certain areas. We will present a document in connection with a midterm review, which will take especially into consideration the excellent analysis by the European Court of Auditors that tells us that if you organise your schemes around entitlements, the risk is much lower than if you ask for invoices showing the eligibility of expenditure that has to be co-financed. So we will take this into consideration. A second element that is extremely important is that it is as well to analyse with member states why things go wrong. In other words, how can we improve the management and control systems in member states? There, it is important to know that in many areas under shared management, member states had sufficient information to prevent or correct errors before payments were made. For example, in the first pillar of agriculture, if all this information had been used correctly, it would be below 2%. The same is the case with the social fund. In ERDF, the regional development fund, we are slightly above the materiality threshold and a little bit higher in rural development. So this is another area which we will take into consideration to try to bring the error rate down. Please let me add a further element. You mentioned Kristalina Georgieva, Vice- President of the Commission. The Director-General of DG Budget is Nadia Calviño. With them, I took the decision to create a taskforce to discuss together with member states why in certain areas action plans to improve the situation had a positive impact, but in others that does not yet work. We sent a letter signed by Nadia Calviño to all member states inviting them to take part in a working group to make progress in this area.
Mrs Trevelyan
That is very encouraging. With the change that Mr Joicey mentioned in the disallowance system so that the risk of disallowance has gone up, which is like me telling my kids to be good because they will then get a sweet, it is a good idea in theory, but if the systems in some countries really are not strong enough, you will just be billing people for a great deal more disallowance. Will the Commission be doing things to support those countries that hopefully, as you say, are coming together, but are in need of more help to make progress quickly to avoid that? The system is self-defeating. I get hitting them on the head to try to make them improve, but if there are countries that have not been improving, it will simply be an aggressive fining system rather than a constructive process to help them improve so that by the time we get to 2020 we can look back over this MFF and see that there has been a coherent improvement and therefore a reduction in wasted money.
Dr Kraff
Of course, we do not have an objective to impose financial corrections. We use financial corrections to protect the EU budget. Our objective is to bring the error rate down. We do everything to make sure that in the end we will be close to the materiality threshold or even below. Simplification is the principal instrument that we have at our disposal. At the previous hearing, you asked whether the rules are more complicated. The diagnosis at the level of the Commission is that we made progress in some areas, but a lot still has to be done. For example, in January Commissioner Hogan went to the European Parliament Agriculture Committee and identified precise actions that he will implement to deliver this issue. The same is happening in regional development and the social fund. You may ask me what can be done concretely and implemented in the very short term: for example, simplified cost options. The Court of Auditors tells us that, especially with the social fund, whenever you, together with member states, apply simplified cost options, the level of error is virtually zero. Now you will probably ask me why do member states not take this opportunity to move in this direction. Some of them are afraid that they do not correctly interpret the rules or that they see a risk that they probably go too far. So we are proactive and provide guidance, organise training and take further initiatives to make progress in this area.
Chair
If I could just chip in on your earlier point, Dr Kraff, you said that you were going to have this group that will work with member states. We might call it a bit of a Star Chamber, but I don’t know whether that is over-egging it. Will you be working with our Department for Environment, Food and Rural Affairs? There are clearly really big issues, but I am unclear whether it is the Commission’s role to go in and micro-manage what is happening in member states. I don’t think that that is quite your intention. Could you perhaps expand on that a little more?
Dr Kraff
To explain a little bit, how we work means that, for example, DEFRA would co-operate with the DG AGRI. I told you that the Director-Generals of the European Commission have to present annual activity reports. In those reports, you have declarations. In the declarations, the Director-Generals have to sign off whether, for example, the expenditure has been legal and regular. If there are problems, they have to identify them by reservation. Whenever there is a reservation, the Commission’s Director-Generals make contact with the member states and with the regions concerned in order to establish action plans. So there is co-operation on that bilateral basis. The same is happening with the social fund, the fisheries fund, and the regional fund.
Chair
That’s great. I want to interrupt you there, because, as you heard very clearly, the problem—we have a bit of an obsession on this Committee about how badly this has been going—is that it is not going very well in the UK. What difference is the Commission’s support or intervention making?
Dr Kraff
I think you mentioned the key thing already: learning from others. In DG BUDG, because we have a horizontal co-ordination role like the Treasury, our idea was to have cross-cutting analysis not only vertically, meaning in the different policy areas, but between the policy areas to see what lessons can be learned in order to improve things. I am very confident that we will be successful in this area. Why? Because there are very concrete examples of where member states that faced large financial corrections approved action plans and then brought down the error rate and did not suffer any more from the negative decisions of the European Commission.
Chair
Can you give an example of a country that has done that well?
Dr Kraff
I think you can find elements everywhere, even in the United Kingdom. In the United Kingdom, you had reservations that were lifted after action plans were implemented. Certain questions were resolved together with the Administrations, so the risk of a financial correction turned out to be zero in the end. Why? Because certain issues were solved in a proactive way. In addition, it is excellent that the National Audit Office is leading the consortium of certifying bodies in agriculture. Why? Because the European Commission, with the help of the legislator, requires the certifying bodies to publish error rates. As we know, error rates are an indicator of whether things go right or wrong. We will have the possibility of taking action together with these audit authorities and certifying bodies, and we are working in the direction of implementing single audit. Why do I mention single audit? Because the president of the council body dealing with the discharge procedure, Mr Dijsselbloem, was proud to say in the Committee on Budgetary Control of the European Parliament on Tuesday that single audit has been identified for the first time as an important subject in the discharge recommendation of the European Council. Therefore, there is political pressure on us, together with member states, to ensure that we, as a Commission, can rely on the work of the audit authorities and certifying bodies in member states. We will have a common diagnosis, which will then allow us to improve financial management in different areas.
Mrs Trevelyan
Paragraph 1.1.2 of the NAO Report talks about EU added value, which is an interesting statement. Could you expand a little on how you see that in tangible terms? How do you monitor it? Mr Wynn Owen, in terms of the auditor, is that something that can be quantified and should be looked at in a financial way?
Phil Wynn Owen
Thank you for the question. In presenting our annual report, our Court’s president, Vítor Caldeira, called for a wholly new approach to EU budgeting. What does that mean? First, a focus on performance and results. That includes identifying EU added value and how to use the money to best effect, so you fulfil the policy objectives and secure value for money for the taxpayer. We very much want to see that, and it is something we have been making the case for in our annual reports and special reports year on year. Secondly, it means seeking greater flexibility in the use of existing funds. We all know there are constraints on the EU budget, but we believe the money could be used flexibly and better, and we want that continuous improvement. Thirdly, we highlighted in our annual report that it means tackling problems with unused funds, which you might want to come to.
Mrs Trevelyan
I think my colleagues are going to discuss that. So how are you going to monitor and quantify whether that is actually working, from an audit perspective?
Dr Kraff
I referred to your Committee’s visit to Brussels, where Kristalina Georgieva explained the budget focused on results initiative, in which we are focusing on the following questions. In which areas do we spend? An analysis is being done of European public goods with higher added value of funds. Then we analyse how we spend. That means more leverage from EU funds and more simplification efforts. Also, how are we assessed? There it is extremely important to have the performance framework, which is now incorporated into the legal requirements for the multi-annual financial framework 2014 to 2020. We have indicators which define exactly what we have to achieve by spending European money. We have milestones indicating when certain objectives have to be met, and so on. We are now implementing this. For example, if you have a look at our programme statements, these are documents accompanying the draft budgets, so the European Parliament and the Council get this information in order to be able to take it into consideration when they take political decisions. Then we will have to improve our reporting. In the annual activity reports, we have a specific chapter which analyses what has been achieved with EU money—input, output, results—and an overall or horizontal report which evaluates the results of European policies. This report, by the way, is used together with the annual activity report in the discharge procedure by the European Parliament and the Council, and the objective of the discharge rapporteur for the budget 2014, Mrs Dlabajová, said very clearly that she wants a two-pillar approach. As well as compliance—bringing down the error rate is very important—she wants to focus on performance and added value in what has been achieved.
Q94Mrs Trevelyan
So 40% of the EU budget is spent on agriculture in its broadest forms.
Dr Kraff
Yes.
Q95Mrs Trevelyan
So what will be the EU’s added value? To me, that is not only financial. Will it improve how we use our land across the European land mass that we are looking after? Will it improve productivity in food production? Will it increase or reduce tariffs? What is the EU’s added value into that 40% of the budget that is spent on agriculture? What will it look like in real terms?
Dr Kraff
That is an excellent question. The objectives of the agriculture policy are defined in the treaty. You mentioned some of them. Then we have other objectives: for example, the greening of agriculture. All these aspects will have to be taken into consideration. Detailed reports will provide information on whether the results have been achieved. Of course, it must be taken into consideration that the first pillar of agriculture is 100% financed by the EU budget. It is not together with the member states. The second pillar is different. There is rural development. The EU budget finances a share, and the national budgets finance a share, so it is important that we get an overall picture to see what has been achieved with the EU budget. If you allow me to give an overall assessment to evaluate the performance in the area of the EU budget, one has to take into consideration the fact that our budget represents roughly 1% of GNI and 2% of public expenditure, so it would not be fair to say that we are responsible for 100% of the failure or the success. That means that, in the area of evaluation, we have to take into consideration not only the EU budget, but the national budgets. The social partners are a very important exogenous factor. It is a challenging task, but it is very high on our agenda, and we consider it an absolute priority to deliver on it.
Chair
We remember that from our visit last year. I will go to Caroline Flint and then back to Anne-Marie.
Caroline Flint
Welcome to our Committee. Mr Wynn Owen, how does the 20% directly administered by the European Commission compare to the 80% administered by member states, in terms of error rates?
Phil Wynn Owen
This year, we found very similar error rates across the two, which scotched the perception that the fault is largely in the member states. We find faults across the two. We found a more interesting distinction in areas such as whether reimbursement is being done on actuals or on flat rates. For instance, we suggested that reimbursement on actuals was leading to a lot of errors. We included analysis of where the differences lay, and I mentioned three of the big drivers of the errors in our reports. There are two types of managed expenditure: directly, which is managed by the Commission, such as in some of the competitions for research; and so-called indirectly, where they do it through a third party, such as the EBRD or whatever. I am doing an audit of nuclear decommissioning, where the EBRD is the indirect manager. We found similar error rates across the piece.
Caroline Flint
Do you have any thoughts about whether the error rates for the Commission—given that you said that it is not all necessarily directly, and that there is sometimes a third party—should be less than what you might expect, all things being equal, for member states, because it is once more removed?
Phil Wynn Owen
In theory, the fewer players you have, as long as you have the core functions of audit and administration, the fewer opportunities there are for error. One important lesson I am learning from this hearing is that there is scope for ever more education and discussion between all the parties who bear a responsibility—the member states; the Commission; the auditors themselves, who must explain what they are doing; and parliamentarians, who must ask the challenging questions. It is great that you are holding this hearing. I should mention in that context that I have undertaken an initiative with the help of your own National Audit Office in the past two years. I write to Committee Chairs to present our annual report and offer to come and give evidence. I also had meetings hosted by the National Audit Office in about late November. I brought a team over from the ECA to present and explain our annual report to officials not only from across Whitehall but from across the whole of the UK. Particularly this year, we had break-out groups on agricultural errors and cohesion errors, and we tried to get a bit of a learning experience going—albeit from a very small sample—on what we have seen going wrong and what the difficulties are. That is fruitful, and I think we should do more of it.
Caroline Flint
Mr Wynn Owen, you have considerable experience here in the UK. I think you were in the Treasury from 1981 to 2004, and you have been a DG in DWP and DECC up to 2013. I hope you would acknowledge that you have a fairly good insight into how UK Departments manage EU funding. Can you offer something from that experience about what could be done differently?
Phil Wynn Owen
If you mean I have probably been involved in a lot of mistakes in Government—
Caroline Flint
Poacher turned gamekeeper—
Phil Wynn Owen
—I hope I have learnt from them. I have, of course, been in front of some of you before as an accounting officer on challenging issues. Thank you for the question, and if I may take it as an opportunity for a few personal reflections, for me one of my biggest learning experiences was being director of the regulatory impact unit in the early 2000s. I think the principles of better regulation are very important. I was actually one of the initiators and sat on the so-called Mandelkern group in early 2000s that published an independent report from member states that forced/encouraged the Commission to adopt impact assessment and better regulation in Europe. This is a journey towards better regulation. It is not a destination you get to, but the means of operating according to the simple principles of wanting balanced systems of governance with checks and balances that mean you target the right things and your outcomes are realistic. You do not target everything. It is very easy, for instance, in building a performance regime to build a Heath Robinson or Byzantine structure with far too much being measured and with its own bureaucracy, so we are working with the Commission, as they begin to embrace performance management, to make sure that what they do is proportionate—that is another key word—so you make sure that you pursue performance but that you get the systems right. You also get the incentives right. We touched earlier on sticks and carrots, and you need both. We as the Court of Auditors encourage our auditee—particularly if the Commission—to use the instruments it has got. I have published an in-depth deep dive into the second biggest error I mentioned: public procurement. This came out in the autumn, and this is on public procurement errors in cohesion. In one of the most contentious recommendations, I said to the Commission that if certain member states have not fulfilled the so-called ex ante conditionalities—that is a slightly elaborate European term for criteria—to get the money, you have got the power at the end of this year to suspend payments and you should use it. That is a stick. There is also a carrot. There is something called a performance reserve in the new MFF period such that several percent will be held back for 2019 and if member states are not able to demonstrate within reporting on their performance that they have achieved the targets set, they will not be able to draw down the last several percent of their allocation. There is a lot of debate about whether that performance reserve was well designed—personally I think it could have been better designed, but that was the work of the legislators—but that is potentially a carrot to encourage better behaviour by member states to draw down the final capital available.
Caroline Flint
Dr Kraff, I was looking at your CV as well. You have massive experience in terms of work at the ECA—I think you joined them in 1983 and you were there until 2008—so you clearly have many years of experience in the auditing process and now, while I would not say you are on the other side, you have to receive these reports from Phil and others and try to make sure that the Commission and the EU, as much as possible, spends the money wisely. What do you have to add on the question I asked about the 20% and the 80% and the fact that, as Mr Wynn Owen said, the error rate is comparable between the two? Do you feel frustrated that, when it comes to directly administered funds, the Commission could be leading the way for member states on this?
Dr Kraff
Yes. Thank you for reading my CV. Maybe that explains why we agree with virtually everything that the Court of Auditors says. We—not only me, but also my colleagues out there—take all of their recommendations in order to improve the situation.
Caroline Flint
You know where all the bodies are buried, don’t you?
Dr Kraff
No, no. Phil mentioned suspensions and we do not shy away from using suspensions. For example, in the communication on the protection of the EU budget, you can see that €7 billion of suspensions was imposed in 2014 in order to put pressure on the administrations that manage the funds. As regards the performance reserve, I would not be as pessimistic as Phil. I still think that it is an incentive for management to make sure that they really deliver on the objectives. As regards my frustration, yes, I was very frustrated to get a message from the Court of Auditors that we are not in reality better than the member states, because as Phil has stated very clearly, it is not linked so much to the management mode, it is linked to the type of expenditure that we have to manage. Of course, we analysed very carefully why it went wrong in the 20% that are managed directly or indirectly by us. The Court of Auditors told us—and we agree—that roughly half of the error rate could have been identified by our certified auditors or our own auditors. Again, that is the same phenomenon that we find in the member states, but I see a light at the end of the tunnel. Some of the errors cannot occur any more under the new legal framework. Why? Because there we have simplified. For example, there was a huge—I think it was 100%--error, so completely ineligible, linked to in-house consultants, based on whether they are or are not eligible. All that has been simplified so it is not possible any more to commit this error. I hope that at least will not pop up in the new sample of the European Court of Auditors in the coming years.
Caroline Flint
Can I move on to a slightly different area? We have spent a lot of time talking about errors, which is quite right, but I was interested to read in the NAO Report of the unspent commitments. My understanding is that at the end of 2013, there were €222 billion-worth of unspent commitments. I understand those are projects of all sorts such as infrastructure for which it has legally been said, “Yes, we accept the bid” but they have to find match funding in order to get the EU part of the funding to come through. That is correct as well. If we look at figure 12 on page 27, a lot of these commitments are not being realised. That says to me that there is a huge amount of the EU budget lying in wait for something to happen. That was the figure for the end of 2013. I understand that it has gone down for 2014 and is likely to go up in 2015. Why is that? Is there something the Commission, with special reports from the ECA as well, should be looking at to see whether or not these commitments should be allowed to continue? I know you can de-commit. Does it hamper, for example, the flexibility of the European Union to tackle other necessary areas that might require budgets? For example, on page 9, figure 1 has a breakdown of how the 2014-20 multiannual financial framework has been divided up. Security represents 2% as a proportion of the total commitment appropriations. Given the circumstances we are facing at the moment, with a massive challenge across the European Union of migration, people seeking refuge and everything else that is going on, I would like to know that, instead of holding money in a vacuum against something that may or may not happen, there was flexibility to reassess those commitments and take action to reassign some money to more immediate concerns for the EU.
Dr Kraff
You tackle the very interesting and challenging question. The figure on page 27 in the NAO Report is very interesting. There you see the member states that have problems regarding the absorption. Why do they have those problems? Sometimes it is administrative capacity, sometimes the lack of co-financing, sometimes it is legal procedures that block, for example, the implementation of programmes and so on. The Commission took action by creating a taskforce for better implementation. So the figures that you see went down but there are still enormous challenges, one can say. Now you correctly said that the outstanding commitments went down but they will go up again. To put it in a picture, I would say it is like a swimming pool. You have legal pledges regarding future activities, which fill the pool, and whenever you incur expenditure by implementing projects, the swimming pool is emptied. We now have new legal pledges for the period from 2014 to 2020, which is why the water is rising again. On whether that hampers sound financial management and whether it might it be wiser to use the unused commitments, which will not lead to payments, and finance something else, yes, that would of course make sense, but we have to be absolutely certain that the money will not be used. As you know, the legislator has extended the n+2 rule to the n+3 rule, meaning that it now takes three years before unused legal commitments can be cancelled when previously it was two years after they were agreed. In other words, we have to wait a longer time in order to have a legal basis to de-commit. However, whenever we have the possibility to move money from one area to another, we do that, which explains why we were able to make more money available for the fight against the problems of the migration crisis, for example.
Caroline Flint
I understand the logic of that. Looking at figure 12, these countries are at the top because they are obviously newer entrants to the EU. My region of South Yorkshire benefited a lot from objective 1 money some years ago when I was first elected. It is understandable and good that such countries are coming forward with many projects to level up their economies, because that will help with some of the migration pressure. I understand the de-committing and what you said about the year extension and decisions being put off is interesting, but I wonder whether there could be some more front-ended work to look at the capacity of these countries to realise big projects. I am not saying that this is just a Romanian or Bulgarian problem—we have looked at major projects and delivery in the UK on this Committee—but does the front-ended side of things need more attention? You don’t want to set these countries up to fail.
Dr Kraff
As I mentioned, we have created a taskforce to deal with exactly that in order to have discussions with those that have to implement the commitments or programmes and to find possibilities in order to ensure that they are able to use the money that has already been earmarked for the projects going on. If it is not possible to ensure that the money will be used, it should be de-committed and used for other expenditure in other policy areas.
Mrs Trevelyan
So are you saying that not only will the taskforce look at existing unspent commitments and work out what to do with them, but there will be a new framework? Would it need to be legislative so that there can be an assessment before any money is committed? Would that require legislative change? The taskforce or A. N. Other body could look at it and say, “Romania wants a new road. That’s a £50 billion investment. They have to match fund it. They cannot match fund it for the next five years, so we are not going to commit that money.” Can we not get to that point so that there is money—we have 15% of the budget sitting in an unused pot, which is not value for money for all those member states who have put it into the kitty to help, as Ms Flint says, increase economic benefit across the whole EU.
Dr Kraff
The starting point, as you know, is the national envelopes. These are political decisions taken by Heads of State and Heads of Government, earmarking and accepting the amounts available for different member states. Then, in the process of adopting the operational programmes, the commitments are made and then comes the process of implementing the projects and using the money. But it must also take into consideration that unlike in other policy areas, in the area of cohesion, these national envelopes are objectives. They should be reached. This was a decision at the highest political level of the EU, so it is then very difficult to change to a different regime. We have been proactive. We tried to help. We want to make sure that the money is really used as an instrument of last resort. Then we de-commit and use it for other purposes.
Mrs Trevelyan
How much has been de-committed?
Dr Kraff
I cannot tell you off by heart, but I will provide you with the answer in writing.
Phil Wynn Owen
We are making it clear in our annual report that we would like to see better long-term forecasting by the Commission, drawing on data from member states. We would like to see the opportunity taken in the mid-term review, for which they are due to produce their ideas by the end of this year. If budget based on results is to mean something, it must mean a focus on performance and greater flexibility. There are problems with unused funds, especially around commitments. We have just announced in our work programme for 2016 a study of the absorption problems in cohesion. A nice thing about special reports is that we do not just focus on errors; we can also promote best practice where we see it, so hopefully there can be some shared learning there. I should mention that there is also another issue about unused funds, which is both a problem and a potential opportunity for Manfred and his team as they seek greater flexibility. There are funds building up in financial instruments—those are the involvement of private sector funds used by the Commission—and in so-called financial engineering instruments, or FEIs, which are largely administered by member states. We gave a figure at the end of 2014 of €1.3 billion sitting in financial instruments. We were not sure of the figure for financial engineering instruments, but we think there may be significant funds building up in those too. Those are pots of money that, notwithstanding all the problems of flexibility and who the decision makers are that Manfred identified, could be used flexibly to tackle some of the very real challenges that the Union faces at the current time.
Chair
Dr Kraff, you mentioned in response to both my colleagues that you want to ensure that the money allocated goes to meet EU priorities about levelling up—we do not need to rehearse what those are—and that you work hard to help them make sure it is spent. Can you perhaps take an example in Romania or Bulgaria? What practical support are you giving to make sure that this large amount of money that is sitting there waiting to be spent is spent? Do you get stuck in? Do you get them to work with other member states that have the capacity to deliver?
Dr Kraff
The taskforce went on the spot to discuss with those responsible in order to see, first of all, what the problems are and to find solutions. This was then implemented. The feedback that we got is that the situation is much better than it was. For example, you can see here the situation in 2014. As regards financial engineering instruments, which Phil mentioned, yes, there is indeed a problem. There was a figure of €14 billion in money sitting in financial engineering instruments. The Court of Auditors told me to focus—I will do so—on the three biggest countries, which make up a huge percentage of the whole amount, in order to see whether the money will be used and what amount is available. That was for the past. For the new financial framework, the legislator limited the possibility of advance payments, so much smaller amounts are now put aside and made available for the financial instruments. It is now clearly forbidden for member states to have excessive balances. They have to identify those, inform us and take the necessary action. Also, the reporting requirements are much better than in the past. In the past, for the Commission, it was sometimes difficult to get the information, because member states were not obliged to provide precise information on the amounts concerned.
Caroline Flint
Finally, I want to ask something about fraud, which is obviously different from what we have been talking about today, and we have a European Anti-Fraud Office, known as OLAF. I noticed that page 16 of the NAO Report says: “Between January 2007 and December 2014, OLAF made 16 recommendations to UK competent authorities to recover EU monies. Eleven of these recommendations were dismissed. The remaining 5 recommendations led to an indictment (representing an indictment rate of 31%, compared with the EU member state average of 53%).” Do you want to comment on that or say something more generally about how fraud is dealt with?
Phil Wynn Owen
If I go first, Manfred may have something to add. Combating fraud is not an easy business. You will know that in the UK that has had a somewhat chequered history: the history of the Serious Fraud Office and so on. It is not our core function; you are right that it is OLAF’s, which is a part of the Commission, but an independent part of it. We have been doing more in the ECA, because error is not fraud. As you know, there is a multiplicity of types of error, but where our auditors come across suspected fraud, they have a duty discreetly to gather what information they can and then we report it to OLAF to investigate. That work has had a slightly rising profile. In the 2013 annual report period, we reported 14 cases and 22 in 2014. We have been doing more training for our auditors in fraud awareness, which may account for some of that increase. We also published an opinion on the Commission’s first report on anti-corruption measures in April 2014. There was a special paper from us. We applauded the fact that there was such a report from the Commission, although we said it needed more data and more analysis, which is perhaps a familiar refrain of this morning’s session. We did a special report on this public procurement in cohesion, where there are elements of fraud suspected in some cases, as you can imagine on very large construction projects. We pointed to the potential for new technology to really make a difference in this respect. I should applaud the Commission; it has a tool called ARACHNE, which is a computerised database that can identify irregular patterns in public procurement, to which they have been encouraging as many of the member states as possible to sign up.
Caroline Flint
Has the UK signed up to use that tool for identifying irregular payments?
Dr Kraff
I think they did, but I am not—
Phil Wynn Owen
When we published our report several months ago, the Commission had not yet visited and had the discussion fully with the UK, so it was an open question several months ago. We don’t always track all follow-up activity to our reports because we move on to others. One source of concern was that the Germans had decided not to use ARACHNE, but a lot of other member states had signed up and I believe the number is growing. Of course, this is a classic single market initiative whereby the more who play, the better a result you get, because you can do cross-comparisons, for instance, of cross-shareholdings between companies.
Chair
We can check with the British Government.
Dr Kraff
I will provide you with a written answer on where we are with the United Kingdom. I only want to add one element to what Phil said. If you read the report of OLAF on the protection of the financial interest of the EU, you can see that the fraud as regards the EU budget represents 0.2% of the overall financial volume. So what you can read in the press is not at all reflected on the basis of the official statistics that are available.
Mr Bacon
I have a question for Mr Wynn Owen about special reports; in appendix six of our Report, there is a list of them. Last year the Court of Auditors did 22 reports; in 2014 it was 24. What is the cost to the European Court of Auditors of producing special reports?
Phil Wynn Owen
I haven’t got the exact breakdown, but the cost of the ECA in 2015 was about €130 million, which is less than one tenth of 1% of the EU budget.
Mr Bacon
Remind me, what is that in sterling?
Phil Wynn Owen
It depends which exchange rate you take.
Mr Bacon
I only want a rough idea.
Phil Wynn Owen
As of close two days ago, it was about 78p to the pound, but I may be a p or two out, and it is probably changing as I speak. Take roughly three quarters of that, so around about—
Mr Bacon
£90 million to £100 million.
Phil Wynn Owen
We have just under 900 staff, excluding our 28 members.
Mr Bacon
So in terms of size, you are quite comparable to the National Audit Office, which has just over 800 staff and a budget of about £70 million—obviously a bit larger.
Phil Wynn Owen
Yes.
Mr Bacon
Of that budget, how much is spent on special reports?
Phil Wynn Owen
Depending on how you count it, something like a half to two thirds of our budget is responsible for the work that goes into our annual report and our statement of compliance exercise, which would imply—allowing for overhead costs—that a large part of the other half is going towards special reporting.
Mr Bacon
Really? So most of €65 million is going into these special reports? I find that extraordinary.
Phil Wynn Owen
No, I said our annual report—the thing that produces the error rate.
Mr Bacon
Yes, yes. You keep on answering a question that I have not asked. I am asking about the special reports.
Chair
I think Mr Wynn Owen was just doing the maths out loud.
Mr Bacon
Yes, I understood that. By a process of elimination, the remaining half—subject to overheads—was the rest.
Phil Wynn Owen
I haven’t got the exact figure for you. My estimate would be that somewhere between a quarter and a half of our total costs go on special reporting. We are seeking to increase that proportion, which stakeholders have welcomed. We recently published our special report, Work Programme 2016, which shows that we are likely to publish somewhere between 20 to 40 special reports this year. The number is uncertain because we obviously have very high quality standards ourselves.
Mr Bacon
So does the National Audit Office. I am just slightly surprised that it is as high as that. A quarter would suggest €31.5 million. A half would suggest €65 million. So it is somewhere between €30 million and €60 million to produce 22 reports. That suggests that they are about €3 million each. That does not sound right, to be honest. I mean, the National Audit Office Reports cost £200,000 to £300,000 each, which is about €0.5 million, so for each special report of the list of 22 reports—the landscape of these is on page 59—to cost €3 million or even €1.5 million sounds extraordinarily top heavy.
Phil Wynn Owen
There are two things. One is that we have been seeking to learn from the excellence of the National Audit Office in the way they support this Committee in producing special Reports. There is a lot we have learnt from them and there is a lot more that we could learn from them. Secondly, without being an apologist, I point out that we are dealing with slightly different landscapes. We are dealing with a very large land mass of 500 million people in 28 different countries and Administrations. We do some sampling audit visits to individual member states—perhaps four or five in each case. On public procurement, we actually had an audit team that came to the UK to look at good practice and development needs here. It also went to Italy, Spain and the Czech Republic. That and costs such as translation, which I do not think that the National Audit Office bears massively—other than my own dear native Welsh—is a major factor in our cost base, so there are differences between our cost bases.
Mr Bacon
Various things push up the cost.
Phil Wynn Owen
I have no doubt that we could become more efficient in the production of our special reports. We actually had a peer review by German, French and Swedish national audit offices in early 2014, from which we have learnt a lot. It said that we could do our special reports quicker and more efficiently on some of the more salient topics of the Union. We have been doing everything we can to drive that forward. The point behind your question—that we ought to be looking at the unit cost of each and every special report—is a good one and one that I am happy to take away.
Mr Bacon
Actually, that was only my preliminary question. I sit on the Public Accounts Commission and we provide the budget for the NAO. My question—I think you have sort of answered this—was that 22 sounds not really enough for the scale and range of activity of the EU. If you were right-sized for the number of special reports you ought to do for the range of activity, what would the sweet spot be? What would the optimum number each year be on an ongoing basis?
Phil Wynn Owen
We have further to go but we are getting better all the time. I am happy to send the Committee Chair and members a copy of our Work Programme 2016—
Chair
Please do.
Phil Wynn Owen
—which has 40 potential reports for this year. I am not saying that we will produce them all this year, but we will certainly start or complete them this year. We are now focusing on all the really big challenges of the Union. You will see a stream of interesting reports coming out of the European Court of Auditors. I recently completed one on the problems in the internal energy market and energy security.
Mr Bacon
I wasn’t actually after the detail. If you were right-sized, how many reports do you think, in a normal year and in a steady state, ought you to be producing?
Phil Wynn Owen
I don’t think that we are necessarily wrong-sized. Look at our 2016 Work Programme, which I think has a comprehensive programme of special reports. Clearly, special reports are always on a sample of the major problems that the body you are auditing faces, but if you look at the 2016 Work Programme, which I will send to you, you will see that we are hitting many of the big European issues of the day.
Chair
So 40 is not bad.
Phil Wynn Owen
I think if we hit that, that will be a good result. Obviously, you are then dependent on the quality of each and every report.
Chair
I thank you both for your time and for coming from Brussels to speak to us. It is a very important issue anyway, but it is particularly important in the UK right now as we have a big decision to make as a nation in the next few months. Our transcript will be available on the website in a couple of days, but we will of course send you a copy. If you have any corrections, please let us know. We will also send you a copy of our final report. I cannot tell you exactly when it will be out, but it may well be after the Easter recess. We look forward to hearing your comments on it. Thank you very much. Oral evidence: Financial management of the European Union budget in 2014, HC 730 37