Written evidence submitted by Prospect
INTRODUCTION
1. Prospect is the professional union for the
majority of staff employed in the Audit Commission (the Commission).
Currently we represent 1,300 staff, though employment has already
declined quite sharply since the announcement of abolition in
August 2010. It is worth emphasising that there was no consultation
with the Commission or Prospect prior to this announcement, and
it is not clear if Ministers were provided with all the relevant
facts before decisions were made. Clearly the announcement and
ensuing redundancies and uncertainties have since had a dramatic
impact on our members.
2. This submission draws on members' experience
and expertise and publicly available documents, including those
on the CLG website. The Commission has also made public papers
in particular "Issues for Consideration" in September
2010. Use has been made of other websites such as Monitor, the
regulator of Foundation Trusts (FT's), and the NAO. The submission
explores how value for money and localism are at the heart of
the Commission and are best served by the organisation remaining
within the public sector. We consider the next best option to
be the creation of a mutual company comprising former staff from
the Commission.
EXECUTIVE SUMMARY
— The
Government's decision will result in the abolition of a cost effective
and uniquely based approach to localised audit as practised by
the Commission. We believe this puts at risk an approach that
has helped transform local government.
— The
proposed abolition targets savings of £50 million. Despite
a considerable passage of time since the announcement, there are
still no detailed breakdowns of the projected cost savings in
the public domain, thus preventing any real discussion or challenge
to the Government's claims. Following earlier announcements and
its own ongoing efficiencies, we estimate that the Commission
is on target to save £75 million while maintaining its core
current functions.
— The
proposed abolition provided little or no details on potential
liabilities, which we estimate as over £100 million for pensions
and up to a further £70 million of redundancies above the
current cost of £50 million.
— We
believe that the changes to the current independent appointment
of auditors will compromise the current high standards of scrutiny
and subsequent performance in local government.
— We
recommend that the Commission should continue as a public sector
audit body. This is not an argument against well-founded change,
with which Prospect would wish to engage constructively. The next
best option would be the creation of a mutual, which would provide
local government bodies with a genuine choice in a market that
is likely to be dominated by only a few auditors.
BACKGROUND
3. For 28 years the Commission has operated as
an independent watchdog, driving economy, efficiency and effectiveness
in local public services to deliver better outcomes for everyone,
across local government, health, housing, community safety and
fire and rescue services. It is a widely held view that the Commission
has had a positive impact. Even in the context of advice on abolition
CLG officials have acknowledged that "the Commission made
its mark—quality of local government has been transformed."
That said, on 13 August the Minster of State for CLG, announced
"My aim is to replace the current centralised audit systems,
managed by the Commission, with new decentralised audit, to 'provide
genuine support for local democratic accountability, and save
tax payers some £50 million per year'." Yet, from answers
to written Parliamentary Questions and from a face-to-face meeting
with the Parliamentary Under Secretary subsequent to the abolition
announcement, we have yet to obtain any evidence that this decision
was based on costings. This suggests that this is a political
rather than a cost saving measure.
VALUE FOR
MONEY
Cost cutting savings
4. One of the main arguments put forward for
the abolition of the Commission was that "the current arrangements
are needlessly costly". Savings of £50 million were
estimated from the abolition of "superfluous activities in
the central Commission" and as a result of competition for
audits. The failure of the Government to provide detailed information
in respect of cost savings makes informed debate hugely problematic.
However, as shown in this paper, savings over and above the specified
£50 million could be made without recourse to a risky abolition
process
SAVINGS THROUGH
CUTTING CORPORATE
AND CENTRAL
DIRECTORATES
5. The underlying papers on the CLG website do
not provide a breakdown of the £50 million savings figure,
but do refer to the cost of the corporate and central directorates
as £52.1 million. Correspondence dated 18 June from Paul
Rowsell, Deputy Director for Local Democracy at CLG, notes "significant
savings can be expected from the abolition of the Commission's
corporate core and centralised functions". We are not convinced
by this—although some work will be discontinued work, as
discussed below, there are a number of functions and costs that
will continue. Further, CLG papers acknowledge that "costs
are already being cut through the internal efficiency programme".
We estimate that in salaries alone the Commission is looking to
save £25 million from central and support costs.
SAVINGS THROUGH
COMPETITION
6. Papers supporting the Minister's interview
with the Daily Telegraph on 13 August state, "Private firms
are prepared to work at fees lower than those charged by the Commission
to the audited bodies." However, an examination of the official
papers does not provide any supporting evidence or source for
this statement. A paper entitled "Armchair Auditor Draft
Narrative" on the CLG website, says "Genuine competition
in the public audit market should see fee rates tumble by around
a third…. estimated at saving at least £65 million annually."
However, the source of this estimate is not given.
7. Official papers do identify issues around
the level of existing fees. For example, correspondence dated
29 June looks to the attraction of "a competitive environment
that will drive down the inflated audit fees that the councils
have suffered in recent years." Officials quote an increase
in fees to local government from £80 million in 1997 to £150
million in 2010. Yet no contextual or comparative information
is provided. In fact since 2002-03 the turnover of the Commission
has remained level despite a period of increased audit requirements
in part due to the high profile failure of private sector companies
such as ENRON. This is indicative of efficiencies being achieved
by the Commission.
8. More broadly, following growth of the Commission
from 1997 expenditure has levelled in recent years and is now
below expenditure growth in related areas of local government.
In addition, the cost of auditing FTSE 100 companies has risen
by 121%, from £238 million to £527 million.
9. The performance of the audit market for FT's
is also instructive. The first FT's were established in 2004 under
a new regulatory regime including competition amongst auditors,
overseen by Monitor. The average fee of the first 32 FT's has
fallen from £81k in 2005-06 to £75k in 2009-10, but
a further analysis of the figures indicates:
— Other
audit costs have risen from £9k to £32k so that the
full cost charged by auditors has increased from £90k to
£106k.
— The
Commission auditors may have contributed significantly to holding
fees down, as in 2009-10 the Commission average fee at the earliest
Trusts was £61k, compared to £78k from private firms.
10. The experience of the FT's indicates that
the hoped for "one third" cut in fees is not likely
to materialise. Moreover, papers on the Commission website state
that "Baker Tilly and Mazars … were unsuccessful in
the latest procurement exercise on grounds of price." This
would indicate that for some private sector firms the audit fees
are already considered low.
11. The Commission also suggests, "Our experience
has been that prices fall as the guaranteed volume of work increases:
in other words, there is a volume discount. Under the proposed
decentralised system, this benefit will be lost, as audit suppliers
could not be assured of sufficient work overall to be in a position
to bid as competitively as they do in the present system. This
is likely to impact on prices."
EXISTING AND
PLANNED AUDIT
COMMISSION EFFICIENCIES
12. Prior to the announcements of its abolition,
the Commission was looking to making significant savings. Our
own estimate indicates that cost savings of over £75 million
are likely in relation to the end of the work on Comprehensive
Area Assessments (CAA), Inspections, a reorganisation of central
services and some reduction in work by auditors. This comprises
savings to clients of £40 million, to central government
of £25 million and internal savings of £10 million.
In its final year of operation the Commission, while maintaining
its audit function as well as its regulatory role, is likely to
be about half the size it was in 2007-08.
PRIVATISATION
13. On 18 June Paul Rowsell referred to "the
potential for receipts from the privatisation/break up of the
Commission's audit practice." Officials stated in an e-mail
of 28 July, "we are recommending a relatively low key announcement
…to enable wider engagement and stimulate market interest."
A range of options is under consideration including: a trade sale;
management buy-out; or mutualisation or some other form of employee
ownership.
14. However, it is not clear what is being valued
and then sold. There are no obvious tangible assets. A value could
be placed on the intangible customer relationship but the future
cash flows are not certain as, in contrast to the current structure,
there are no guaranteed future income streams. A value could be
placed on the expertise of staff, but this would need to reflect
potential liabilities such as redundancy terms.
15. We believe there is a risk that existing
major players in the audit market will monopolise the current
Commission audits to the exclusion of new players in the public
audit market. These would be the same private sector companies
whose ethics were recently attacked by the Financial Reporting
Council's Professional Oversight Board. It was their incomplete
attention to detail, or some would say negligence, that allowed
the Banks to precipitate the recent financial crisis and companies
like Enron to conduct their business in a far from appropriate
manner. Prospect does not believe that this level of deregulation,
particularly in respect of the public finances, is appropriate.
Evidence from previous privatisation of core business functions
such as IT and R&D is that once the State has lost the ability
to be an intelligent customer, then the private sector does not
deliver good quality, affordable services. Notable examples include
MOD's air refueling fleet and Nimrod programme and HMRC's computer
system.
COST OF
ABOLITION OF
THE AUDIT
COMMISSION
16. An examination of the official papers on
the CLG website covering the abolition of the Commission reveals
little information on the costs involved. The two main areas of
cost relate to redundancies and retirement pensions, although
there will be costs of the new regulatory regime and penalties
for early termination of property leases.
REDUNDANCY
17. The abolition of the Commission will entail
significant redundancy costs. One of the very few references to
this in CLG papers refers to the Commission "funding redundancies
from its own reserve." These were £29.1 million at 31
March 2010. The Commission's 2009-10 Annual Report includes redundancies
averaging £70,000 for the staff affected. Using this figure,
the cost of redundancies for the 1990 staff employed at 31 March
2010 can be calculated as follows:
— Pre-abolition
announcement on end of the CAA work. Estimated 300 staff or £21
million.
— Reduction
of central staff estimated at 300 or £21 million.
— Scaling
down of auditors and support staff estimated at 300 or £21
million.
— Potential
reduction of the remaining audit business would result in further
redundancy costs of at least £60 million.
18. This amounts to a total liability of over
£120 million, significantly higher than the Commission's
reserves of £29.1 million. Clearly redundancy costs would
be reduced as a result of staff turnover or transfers, if feasible,
to private audit firms. However, given the redundancy liabilities
of transferring staff, firms may require financial guarantees,
underwritten by the taxpayer and forming an ongoing liability
for the Government.
PENSIONS
19. Official papers reveal what appears to be
an initial consideration of pension fund liability. After reflecting
on the figures, an e-mail concludes "What all this shows
is that this is an area of considerable risk." The key figures
for 31 March 2010 were:
— Existing
net pension liability of £106 million.
— Solvency
basis method of valuing the pension liabilities (essentially the
cost of buying out the benefits) with a suitable insurer at £357
million.
20. In the light of this "considerable risk"
Prospect is very concerned that nearly five months after the abolition
announcement the Government has made no concrete proposals in
respect of pensions. It is difficult to envisage how the cost
of, at least £106 million—and in Prospect's view likely
to be much more—will not end up being passed on to the taxpayer
as an ongoing liability.
COST OF
ALTERNATIVE REGULATORY
BODIES
21. Discussions have identified the need for the
continuation of many of the Commission's current functions following
abolition, such as the regulatory role. In September 2010 the
Commission also stressed the need to "invest significant
resources in providing technical guidance and advice, and support
to its appointed auditors". The Commission identified the
total cost of the regulating regime as £3.1 million. Adding
the cost of technical support, total regulatory and support costs
is estimated at £8 million, or £9k for each principal
audit.
22. The cost of regulation can be much higher
as illustrated by the £15.9 million cost of Monitor, equivalent
to £123k for each of the 129 FT's and equivalent to almost
twice the cost of the basic audit fee. In the next few years the
cost effective Commission regulatory regime will be replaced by:
— NAO
overseeing local government.
— Monitor
overseeing NHS Foundation Trusts.
— NHS
Commissioning Board for other NHS bodies.
— Fire
and emergency not known.
— Police
not known.
— Housing
not known.
23. It is also worth emphasising that the regulatory
regime operated by the Commission has, by widespread consent,
contributed to the improvement in local government performance.
Change will put this at risk. Research quoted in the Government
Memorandum of Evidence to the Inquiry by The House of Lords Economic
Affairs Committee in September 2010, found a number of failings
in the private sector. The report concludes that for many listed
companies there is "much room for improvement in their narrative
reporting as required by the Companies Act."
RESEARCH AND
OTHER FUNCTIONS
24. The abolition announcement included the statement
that "The Commission's research activities will stop, ending
duplication with others and strengthening the NAO's role in this
area …. responsibility for overseeing the current anti-fraud
data matching functions will be transferred to the NAO, or to
other bodies currently operating data matching systems."
Therefore the cost of these functions will continue, albeit at
a reduced level. Yet, an important element of the Commission's
research and anti-fraud work is the link it has with local audit
teams. It is not clear how the London based NAO will continue
to reflect this local perspective.
LOCALISM
25. It is worth emphasising that the Government
has trumpeted the principle of "total place"—governance
without borders. Initiatives like the creation of a single Chief
Executive for the Herefordshire local authority and Primary Care
Trust have been welcomed. Yet the removal of a single agency that
is already auditing across departmental borders is counter to
this direction of travel.
PERCEIVED AUDIT
COMMISSION FOCUS
26. The abolition of the Commission has been
justified on the basis of a need to foster localism. The Government's
press notice of 14 August stated, "Local people will now
be the audience for assurances that their council is spending
money wisely, that they are well governed, their council is financially
robust, achieving value for money and providing accurate information
and data." The "Project Armchair draft narrative",
reflects a view that "performance managers in the audited
bodies dance to the tune of the auditors and inspectors not citizens
and communities. The Commission today fosters compliance not improvement—its
part of the problem, not the solution."
ACTUAL AUDIT
COMMISSION FOCUS
27. These views are not justified by evidence.
In fact, the Commission auditors follow an approach that is grounded
in localism. Auditors account for their work plans and output
to locally elected councillors; or in the NHS to non-executive
directors, usually through regular presentations to the local
Audit Committee. At most principal bodies there will be separate
presentations of the:
— The
proposed audit plan for the year;
— The
results of the work on the financial statements; and
— The
results of all aspects of the work in the Annual Audit Letter.
28. The public have rights with regard to audit
processes and local auditors respond to these as part of their
work, including meeting the public as required. Private firms
under also follow this approach under the current regulatory arrangements.
However, unlike private firms and the NAO, many Commission staff
work at permanent sites in local government offices. This provides
auditors with a local focus and easy access to councillors, council
officials and members of the public. In London, for example, Commission
auditors are based in the council offices at 19 out of the 20
Boroughs they audit.
29. It has been proposed that work should be
refocused to ensure the "council is financially robust, achieving
value for money and providing accurate information and data".
However, this is currently a basic function of the local auditors.
The results of this work are specifically reported each year in
the auditors Annual Audit Letters. The critical focus on the high
profile inspection and CAA work undertaken by the Commission has
obscured the underlying approach to the local audit work that
has been in place for over 150 years.
CHOICE OF
AUDITORS AND
COST
30. Under the current system the Commission appoints
auditors from its own audit practice and private firms, following
consultation with local bodies. The papers published on the CLG
website indicate the end of this approach in order to create "genuine
local choice to be exercised by councils and other bodies about
their auditors," (Paul Rowsell 18 June). In reality however,
choice will be fettered as there is only a limited range of auditors
that can undertake the work.
31. A number of concerns have been expressed
over the lack of choice of auditors and the dominance of the market
generally by a few private firms. This is reflected in the submission
and discussions relating to the House of Lords Economic Affairs
Committee inquiry "Auditors: Market concentration and their
role," which highlights that four firms undertake the audits
of 99% of FTSE 100 companies and 95% of FTSE 350 companies. The
development of FT's also confirms that choice is limited. In 2009-10,
excluding the Commissions auditors, just two firms, PWC and KPMG,
undertook almost 75% of the remaining audits.
32. Choice also comes at a cost. The Commission
in its paper "Issues for Consideration" says, "In
a free market, we believe there is a risk that some local authorities
may find it hard to attract an auditor with the necessary skills
and experience, at a reasonable price…. the current benefits
of pooling auditors' costs will be lost and councils in remote
geographical locations will have to meet the economic cost of
the audit."
33. It also has associated risks. Commission
papers reveal a range of problems encountered during an earlier
procurement exercise: "In 2000-01 we offered nearly 1,400
parishes the opportunity to appoint their own auditors. Only 300
expressed an interest in doing so and only just over 80 proceeded
to the final stage of carrying out their own tendering exercise.
Many of those not proceeding said that the costs of tendering
were prohibitive. Our review showed that all bar a handful of
the 24 firms of auditors selected by parish councils failed to
recognise conflicts of interest and to understand local government
law and the special accountabilities associated with public funds.
The quality of audits was generally poor."
34. The CLG papers do not provide any cost estimate
of local procurement for audit fees, but across the thousands
of bodies for which the Commission currently appoints auditors,
this is likely to run into millions of pounds.
35. It is also worth emphasising that the Government
does not seem entirely convinced of its own arguments: despite
the emphasis on localism, a CLG paper on 5 August stated "If
necessary, the Government may retain a power to set fee levels."
Such central government interference clearly runs contrary to
the move to localism and also questions the independence of any
new regulatory regime before it is established.
OTHER ISSUES
36. The abolition of the Commission does raise
some other issues, as outlined below:
INDEPENDENT APPOINTMENTS
AND NON-AUDIT
WORK
37. It is commonly held that the most effective
way of ensuring the independence of auditors is for them to be
appointed wholly independently of the audited body. The current
system, in which the Commission appoints auditors on behalf of
the local and national taxpayer, ensures that those responsible
and accountable for the stewardship and use of public money are
not involved in appointing those responsible for scrutinising
how it is spent. This duty to appoint external auditors will be
transferred to local public bodies themselves with freedom to
appoint auditors.
38. Papers on the CLG website refer to the "perceived
accountability gap" arising from abolition of the Commission,
but provide no comprehensive assurance that this will be satisfactorily
resolved. The apparently limited CLG concern is not consistent
with debates at the political and professional level. At the root
of a number of concerns around independence has been the view
that auditors compromise in order to maintain or win lucrative
non-audit related work. This is currently under investigation
by the House of Lords Economic Affairs Committee and also the
EU. In the USA, the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley")
barred public accounting firms from performing non-audit services
for audit clients.
39. Concerns surrounding the independence of
consultancy work added to pressures in FT's where, from 2008-09,
the cost of consultancy work has to be disclosed. The figures
disclosed in 2009-10 for the 129 FT's were as follows:
— Statutory
audit fee —£8.7 million.
— Other
audit costs—£6.2 million.
— Consultancy
costs—£141.6 million.
40. Non-audit firms undertake much of the consultancy
work but private sector auditors' interest in audit work is stimulated
by access to the lucrative consultancy market. At £1.1 million
for each FT taxpayers are paying considerably more for advice
than statutory audit work. The Commission bars its own auditors
undertaking consultancy work; an approach that should apply in
the future to all firms at bodies they also audit.
AUDIT COMMISSION
ALLOCATION OF
AUDIT WORK
41. The independence of the Commission has been
questioned in CLG papers, which argue "that the Commission
ensures independence of external challenge—yet it appoints
mainly its own auditors (70% of the time—only 30% is from
private practice)." The main reason for this is that traditionally
the in-house auditors have been more cost-effective. In addition,
this facilitates economies of scale, which private firms also
benefit from in relation to their business as whole. It should
be noted that other public sector accounting bodies in the UK
such as the NAO, Audit Scotland and Welsh Audit Office follow
a similar division of around a 70% share for in-house auditing
and a 30% share for private firms.
January 2011
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