Documents considered by the Committee on 7 November - European Scrutiny Committee Contents


17 Financial management: internal audits and discharge

(a)

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14431/12

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COM(12) 563

(b)

34302

14652/12

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COM(12) 585


Commission Report: Annual report to the discharge authority on internal audits carried out in 2011 (Article 86(4) of the Financial Regulation)


Commission Report on the follow-up to the discharge for the 2010 financial year (Summary)

Legal base
Document originated(a) 28 September 2012; (b) 3 October 2012
Deposited in Parliament(a) 4 October 2012; (b) 9 October 2012
DepartmentHM Treasury
Basis of considerationEMs of 22 October 2012 and 24 October 2012
Previous Committee ReportNone
Discussion in CouncilNone planned
Committee's assessmentPolitically important
Committee's decisionCleared

Background

17.1 The annual audit by the European Court of Auditors (ECA) of the EU Budget is the basis which informs the decision and recommendation of the Discharge Authority (the Council and the European Parliament) on whether to discharge the Commission from its responsibility for that year's EU Budget. The ECA's report on the 2010 EU Budget was published in November 2011. The Council made its recommendation on discharge to the European Parliament in February 2012, which in turn granted discharge in June 2012, signalling the closure of the EU accounts for 2010.

17.2 The Council and the European Parliament deliver recommendations and observations to the Commission as part of this process. The Commission is obliged to report to the Council and the European Parliament on the action it has taken, intends to take or is unable to follow up in response to the two institutions, in accordance with Article 319(3) TFEU, Article 147 of the Financial Regulation and Article 119(5) of the European Development Funds Financial Regulation.

17.3 The Internal Audit Service (IAS) was set up in July 2001 as an independent service for the Commission. Directorates-General were also each given small internal audit units, known as Internal Audit Capabilities, which are supervised by the IAS. The Commission is required, under Article 86 of the Financial Regulation, to submit an annual report to the Discharge Authority about the work of the IAS.

The documents

17.4 The Commission Report, document (a), covers IAS audits carried out in 2011. The document summarises the audits carried out and the findings made. Details of the objectives and scope of each audit, and statistics showing the number of recommendations accepted by those audited, can be found in the accompanying Staff Working Document.

17.5 In 2011 the IAS issued 78 reports covering 23 audits, 50 follow-up audits, one consultancy review/management letter[47] and one report on the overall audit opinion. In all, 160 audit recommendations, none of which were critical, were made and all but two were accepted. Findings and Commission comments are summarised under the following headings.

GOVERNANCE

17.6 The IAS performed a number of audits of the governance arrangements within the Commission:

  • a number of audits of the governance structures to prevent or detect fraud were carried out;
  • recommendations were made for improving governance arrangements in two Directorates;
  • these included improvements in raising fraud risk awareness in vulnerable areas, clearly assigning anti-fraud roles and responsibilities, developing an anti-fraud strategy, strengthening anti-fraud controls at Member State level for shared management, improving the follow-up of and reporting on identified fraud cases, identifying "red-flags", making sure that anti-fraud checks are embedded in control systems and working towards better cooperation between Directorates, including on specific risks;
  • action plans to address the findings are scheduled for delivery during 2012;
  • one Directorate was found to have developed ground-breaking anti-fraud initiatives — these should be built upon to help develop a common fraud strategy for the area concerned as a whole;
  • in relation to Business Continuity Management (BCM) a follow up audit was carried out in the Secretariat and three Directorates;
  • a qualified audit opinion was expressed, giving reasonable assurance regarding the achievement of the business objectives, except for one issue relating to BCM supervision; and
  • the Commission is evaluating the most appropriate and effective measures to resolve this issue.

PERFORMANCE AUDITS

17.7 In its resolution on the discharge for 2009, the European Parliament invited "the Internal Audit Service to allocate part of its resources to an examination of whether the spending by the main DGs is efficient, economical and effective and thereby completing the current financial and compliance audits". Consequently, the IAS included a number of performance audits in its 2010-2012 strategic audit plan. In 2011 it delivered its first performance audits on the Entrepreneurship and Innovation Programme (EIP) in the Enterprise and Industry Directorate-General (ENTR) and on the operational activities of Humanitarian Aid funded operations (Directorate General-ECHO):

  • recommendations for improvement related to the EIP included development of meaningful and stable indicators for similar action under the EIP successor programme, improvement of performance measurement in evaluations and in guidance on performance aspects to the Executive Agency for Competitiveness and Innovation, to which it was considered that more projects could be outsourced;
  • the Commission's proposal for the Programme for Competitiveness of Enterprises and SMEs (COSME) under the next Multiannual Financial Framework (MFF) pays due heed to the results of this review;
  • recommendations for improvement in the operational activities of Directorate-General ECHO included addressing weaknesses in moving from relief aid to development assistance, mainstreaming of Disaster Risk Reduction and disaster preparedness methodologies in projects and improvements in co-ordination of activities with other Directorates;
  • the action plans in response to the findings are scheduled to deliver improvements by the end of 2012;
  • an audit was also carried out on the effectiveness and efficiency of the monitoring by Internal Market and Services (Directorate-General MARKT) of the application of public procurement rules in the Member States;
  • it concluded that the Directorate-General should take a more proactive, preventive approach, in partnership with the Member States;
  • in particular, the collection, analysis and reporting of information should be enhanced and enforcement action better prioritised and targeted; and
  • the Commission took the review recommendations into consideration in its proposals for revised public procurement legislation.

CONTROL STRATEGIES

17.8 Under this heading a number of reviews are reported:

  • in relation to research, reviews were carried out in two Directorates;
  • improvements have been made in the efficiency and co-ordination of research policy audits;
  • in relation to external aid a review was carried out of Development and Cooperation, EuropeAid (Directorate-General DEVCO) and improvements were recommended in the supervision and controls over both decentralised and centralised calls for proposals and, more specifically, strengthening of monitoring mechanisms and controls, in order to obtain assurance on the effectiveness and transparency of the grant award process and compliance with the established rules;
  • other improvement recommendations covered staff training, enhanced data inputting controls through improved training and a more rigorous data review process;
  • where improvement action has not yet been taken action plans are in development;
  • in relation to pre-accession programmes a review of the Instrument for Pre-Accession Assistance for Rural Development (IPARD), managed by Agriculture and Rural Development (Directorate-General AGRI), highlighted the delays in implementing the IPARD programmes, resulting in poor financial execution and a possible budget loss;
  • the review recommended that Directorate-General AGRI do more to establish the steps and timeline of the pre-accreditation process up to the conferral decision and give better guidance and communication to candidate countries and their pre-accreditation bodies;
  • actions have been agreed to improve guidance, revise the conferral process and provide regular evaluation of bottlenecks up to the end of 2012; and
  • in relation to the Trans-European Transport Network Executive Agency a review of the Agency's control strategy concluded with a satisfactory audit opinion, confirming that executive agencies can constitute a workable and effective management model for further development in the next MFF.

THE GLOBAL NAVIGATION SATELLITE SYSTEMS (GNSS) PROGRAMMES

17.9 Three reviews were carried out of two programmes under this heading ¯ European Geostationary Navigation Overlay Service (EGNOS) and Galileo:

  • a review of governance, risk management and project management concluded with an adverse audit opinion, recommending more stability in these space programmes and in their governance structure;
  • other recommendations were that leadership of the Commission Programme Manager be strengthened, the Commission and the European Space Agency (ESA) focus more on their respective roles, the role of the GNSS Agency be clarified and stabilised and the human resources strategy be improved in relation to temporary staff to ensure continuity of personnel;
  • a review of actions, grants and procurement management resulted in a qualified opinion;
  • this recommended that a new review of the ESA's internal control system be organised in line with the Financial Regulation requirements for indirect centralised management;
  • the conditions for allowing open competitive tenders should also be strengthened and the use of negotiated procedures should be limited to exceptional cases;
  • a further recommendation was tightening up ESA's reporting requirements to create a better link between payments and deliverables, with a view to better planning, supervision and monitoring of ESA;
  • action was agreed to re-perform (outsource) the assessment of ESA's systems and procedures;
  • a review of accounting for fixed assets, financial circuits and financial management concluded with an adverse audit opinion on the completeness and valuation of fixed assets;
  • the review recommended that Directorate-General ENTR strengthen its supervision of fixed assets management and develop an appropriate accounting strategy;
  • it should work with the Budget Directorate (Directorate-General BUDG) and the Accounting Officer to determine appropriate valuation and accounting methodologies for the different fixed asset streams;
  • in addition to this new assessment of the ESA's internal control system, Directorate-General ENTR's ex post audits should take all available information into account, notably the qualifications expressed by the ESA's Board of Auditors on the Agency's annual accounts;
  • the Commission immediately took action to address these issues;
  • a new Deputy Director-General was assigned to oversee the whole programme;
  • measures were adopted to improve the administrative processes;
  • external consultants have been recruited to assist in the valuation and accounting;
  • in October 2011, the first two operational satellites were successfully launched; and
  • the Commission adopted, in November 2011, a proposal for a new Regulation on the implementation and exploitation of European Satellite Navigation Systems.[48]

FINANCIAL MANAGEMENT PROCESSES

17.10 Under this heading:

  • reviews concentrated mainly on two processes at Commission level (management of guarantees and recoveries) and on the management of procurements in three operational services (infrastructure and logistics in Brussels, Directorate-General HR and the Joint Research Centre);
  • in addition, the series of GNSS programme audits also covered some financial activities, notably grants and procurement management, financial circuits and financial management;
  • the multiple Directorate review identified areas for improvement in the management of financial guarantees;
  • a follow-up review of recovery procedures showed adequate implementation of the recommendations, contributing to more stringent processes;
  • the follow-up reviews of procurement procedures showed that the systems and procedures in the reviewed services had been significantly improved; and
  • overall, the conclusions on financial management processes in the Commission are positive.

INFORMATION TECHNOLOGIES

17.11 Reviews focused on IT governance, IT project management and IT security. Particular attention was given to the management of sub-contracted activities, where outsourced services might exacerbate the inherent risks of failure to meet business needs, budget overrun and breaches in the security of the systems. The review findings demonstrated the need to strengthen governance and IT risk management in administrative departments and for IT projects. In particular, the role of senior management in overseeing IT investments should be enhanced. Other areas for improvement relate to IT security.

CONCLUSIONS

17.12 The IAS said that the response to the audit recommendations contributes to steady improvement of the Commission's internal control framework and that, on the basis of the work carried out in 2011, the following conclusions can be drawn:

Performance Audits

  • the first performance audits produced positive results, but highlighted the need for better links between the activities of Directorates, more relevant performance indicators for certain programmes and better performance measurement in evaluations;
  • for the next MFF the Commission has proposed radical simplifications and included in all sectoral programmes general and specific objectives and key performance indicators with a view to improved performance reporting;
  • a standard clause on evaluation requires a final evaluation report on whether each programme's objectives have been achieved;

Control Strategies

  • with a view to strengthening the controls on the way EU research policy is run, the review in two Commission research-related departments underlined the need for a common audit strategy in the research area, with no fewer than eight Commission departments;
  • the interconnected nature of research means that there are bound to be common beneficiaries, requiring a more co-ordinated audit approach;
  • in the external aid area the review recommended stronger supervision and controls in the European Development Fund grant management process, both at Commission headquarters and in the EU Delegations;
  • the action plans were designed to improve supervision of devolved expenditure, notably by improving the Delegations' reporting, rationalising the control programmes and monitoring control activities;
  • the measures were considered adequate but have yet to bear fruit;
  • separation of tasks between the Commission and the European External Action Service presents new risks, which are being addressed;
  • reviews of the control strategies of the Structural Funds Directorates-General in 2010 concluded that they are on the right track;
  • this work will be continued in 2012 in the cohesion area, by way of audits covering the closure of the previous programming period for the European Regional Development Fund, the Cohesion Fund and the European Social Fund and implementation of controls over the 2007-13 programming period, to seek reasonable assurance that Directorates-General are effectively addressing the issue of the persistently high rate of error;

Management of major industrial programmes

  • reviews of the GNSS Programmes concluded that the Commission should ensure it has the capacity to run such complex programmes, as they require large-project management skills which are not readily found internally;
  • they also require management responsibility to be assigned at an appropriately high level and a stable governance structure;
  • the Commission took immediate action to address these issues by adopting its proposal for a new Regulation on implementation and exploitation, which will provide a new framework for the financing and governance of the EGNOS and Galileo programmes for 2014-2020;

Financial management processes

  • the follow-up reviews on financial management processes have shown much improvement over recent years, so the conclusions in this area are positive;
  • work is still needed to ensure that the control framework remains robust despite pressure on resources;

IT governance

  • the Commission has taken a number of initiatives, such as establishing Activity Based Management and IT Steering Committees, the High Level Group on IT, the IS Project Management Board and the Special IT Working Group on office automation, all of which have improved IT governance;
  • in 2010 and 2011, the IT rationalisation process was initiated;
  • to this end, many Commission IT systems were reviewed and assessed in 2011, with a view to limiting the number of local IT systems and IT staff and to streamlining existing systems and this work is ongoing; and
  • it is essential that any rationalisation decisions be based on a thorough and objective analysis of the costs and benefits of each option under consideration.

17.13 The Report, document (b), is to the Discharge Authority in relation to the Commission's follow-up to the 2010 discharge. It summarises two accompanying Staff Working Documents which reply to the requests of, respectively, the European Parliament and the Council. Of the 428 requests identified by the Commission (an increase of 44% compared with 2009):

  • 337 were from the European Parliament's discharge resolution;
  • the Commission agreed to take action on 95 requests, but considers that actions have already been taken or are ongoing for 217, though in some cases the results will need to be assessed;
  • due to reasons related to the existing legal framework or its institutional prerogatives, the Commission did not accept 25 requests;
  • the remaining 91 were Council recommendations to the European Parliament, 24 of which the Commission agreed to take action on;
  • it considers that actions have already been taken or are ongoing for 66 requests, though in some cases the results of the actions will need to be assessed; and
  • one request was not accepted.

17.14 Principal follow-up action in the Commission's Report concerns:

Closer monitoring of the use of Financial Engineering Instruments (FEIs)

  • the Commission has committed to improving the monitoring of FEIs and plans to continue to do so for the next programming period with its proposal to further enhance monitoring mechanisms, including detailed reporting requirements for financial instruments under shared management;
  • in February it presented a detailed analysis of FEIs, together with an assessment of the experience, including lessons learned and inherent risks, by both the Commission and the Member States in implementing FEIs in cohesion policy;
  • in a report on FEIs within the European Regional Development Fund, the ECA formally recommended that the Commission introduce greater guidance on the use of FEIs to ensure sound financial management, specifically, by aligning best practice, setting indicative leverage ratios and indicators and defining minimum revolving periods for recycled funds;
  • the Commission has responded by introducing rules for leverage and recycling into the common provisions for programmes and the new Financial Regulation and undertakes to continue to seek consistency across the new regulatory landscape;
  • for the 2011 discharge procedure, the Commission plans to provide the Discharge Authority with a newly established annual report on FEIs, their subsequent evaluation and audit results;
  • the Commission has introduced two additional processes ¯ an analysis per Member State on the use of FEIs and a thematic audit on implementation of a sample of FEIs, enabling it to report in detail on FEIs in forthcoming Annual Activity Reports (AARs ¯ summary documents issued by each Directorate General on its progress against planned objectives);

Accountability chain

  • the Commission has introduced a specific section into AARs analysing annual summaries provided by Member States and anticipates that this accountability chain will be enhanced with the introduction of national management declarations under the new Financial Regulation;
  • it also updated the instructions for the preparation of AARs to further improve their quality, guidance provided and the estimation of the residual error rate and risks compared to the ECA's assessment;
  • it reaffirms its political accountability for the EU Budget, via the Annual Synthesis Report;
  • with regards to the European Parliament's call for Commissioners to append their signatures to AARs, the Commission makes the point that the reports are management tools for Directorates General to express their results and assurance and that the Code of Conduct and the standing instructions already require Commissioners to hold regular meetings with their Directors-General, including at least two per year to discuss all issues related to internal control, audit and fraud;
  • the Commission addresses the issue of differing error rates found by the IAS and the ECA by explaining their alternative approaches;
  • the former seeks assurance on the quality of control systems and the latter makes an assessment of the accuracy of the accounts and legality and regularity of the accounts' underlying transactions;
  • furthermore, the ECA's error rates refer to broad policy areas, whilst the IAS is concerned with individual programmes;

The increased use of pre-financing

  • the Commission agrees on the need for pre-financing to be regularly checked, but explains its increased use in recent years as a reflection of the spending cycle of multiannual programmes and the beginning of the 2007-13 programming period;
  • additional pre-financing in the context of the package to tackle the effects of the economic crisis in 2009-10 and the increased use of FEIs in Structural Funds, which are also presented as pre-financing in the annual accounts, also contributed to the increase;
  • in the new Financial Regulation, a provision has been made for regular clearance of pre-financing following the timing and economic substance of underlying projects;
  • the Commission observes a decrease in the amount of pre-financing in 2011, which is to be expected as the current MFF draws to an end;

Effective sanctioning mechanism in the area of cohesion policy

  • the Commission considers the preventive and corrective measures it currently has in place (interruptions, suspensions and financial corrections) to be sufficient in aiding its supervisory role;
  • it however agrees on the need for their further improvement and strengthening in some areas;
  • its proposals for the 2014-2020 programming period largely address long standing concerns of the European Parliament with the introduction of net financial corrections to Member States "where irregularities affecting annual accounts sent to the Commission are detected by the Commission or by the ECA" (under the common provisions on all structural instruments and streamlining procedures and conditions under which payments can be interrupted or suspended);
  • the Commission's proposals also put a focus on results and effectiveness through objectives based strategic programming, thematic concentration, a performance review framework, common indicators and focus on the quality of monitoring data, with the possible sanction of payment suspensions if that data is not reliable; and
  • it also intends to reinforce its supervisory role and the accountability of Member States by clarifying the use of different sanctioning mechanisms at its disposal.

17.15 The Commission also makes summary remarks on various policy groupings and horizontal issues, such as corporate governance of the Commission, responsibility of Member States (particularly to voluntarily provide national declarations of expenditure under the new Financial Regulation), clarification regarding Member States' liability for loans provided under the European Financial Stabilisation Mechanism and transparency (where the Commission maintains that, through for example publishing information relating to beneficiaries of EU funds under direct management, it is fulfilling its responsibilities under the current Financial Regulation). Specific issues it covers are:

  • the Commission reasserting its ownership of the Evaluation Report and commitment to producing it together with the other documents it produces on evaluation issues;
  • the Commission, in response to a call to identify weaknesses in Member States and regions beset by high rates of error in cohesion policy, presented a working document in November 2011 with that analysis and affirms its commitment to monitor these areas;
  • it says it only resumes interrupted payments when satisfied that systems are adequate;
  • the Food for Deprived People programme is to be continued in its current form until the 2013 annual plan and is proposed to be financed by the cohesion budget in accordance with the MFF proposal for 2014-2020;
  • regarding the EDFs, the Commission undertakes to ensure greater consistency and effectiveness between partner countries and co-ordination and complimentary action between geographical and thematic programmes and instruments;
  • it considers that budgetary support instruments have already been enhanced with rigorous and well-defined conditions (as recommended by the European Parliament); and
  • it undertakes to present a 'roadmap' on implementation of the Common Approach in relation to decentralised agencies and joint undertakings by the end of 2012.

The Government's view

17.16 In relation to the internal audit Report, document (a), the Financial Secretary to the Treasury (Greg Clark) says that:

  • as the UK is a net contributor to the EU Budget, the Government takes the management of EU funds extremely seriously;
  • it considers that this Report provides a useful summary of the work of the Commission's IAS and shows that it has an important role to play in improving the Commission's governance and internal control;
  • it is encouraging to note that almost all 2011 audit recommendations were accepted and progress had been made towards reducing the number of outstanding recommendations; and
  • there are no direct policy implications for the UK following this Report.

17.17 On the Report on the Commission response to the 2010 discharge, document (b), the Minister, noting that the Government welcomes it, says that:

  • it provides a helpful summary of the actions taken by the Commission in response to the recommendations of the Council and the European Parliament; and
  • the Government would expect these actions to lead to improvements in the management of the EU Budget over the longer term.

17.18 The Minister comments further that:

  • the Government reiterates its strong support for sound financial management and budget discipline in relation to EU Budget expenditure;
  • it is encouraged that the Commission accepted all Council recommendations with the exception of the single issue of greater decentralisation of Commission aid management, which the UK has pushed for a number of years;
  • it is, however, clearly unacceptable that for the 17th year in a row the ECA has been unable to sign off the EU Budget, due to an unacceptable number of errors in the transactions carried out that year;
  • that is why, in February, the Government took the unprecedented step, together with the Netherlands and Sweden, of voting against the sign-off of the EU's accounts for 2010 and issued a joint statement calling for immediate improvements;
  • this sent the strongest possible message that financial management in the EU must urgently improve; and
  • the Government has called on the Commission and Member States to pursue greater simplicity of rules, make payments and the use of EU money more transparent and imbed better management practices in programmes, such as SMART (specific, measurable, attainable, relevant and time-bound) objectives.

The Minister continues that the Government broadly welcomes the positive statements of intent set out by the Commission, but has a number of specific observations on the Commissions' response:

  • the Government agrees that FEIs have the potential to leverage the EU Budget significantly by attracting external investment to programmes;
  • however, these substantial long-term funds must be monitored effectively to ensure both financial propriety and ongoing value for money and must not put upward pressure or liability on to the EU Budget;
  • the Commission's plan to increase monitoring, to ensure consistency, and to introduce recommended rates and ratios of leverage is therefore to be welcomed, in so far that it does not imply disproportionate administrative burdens;
  • the Government welcomes any effort to improve the quality and consistency of AARs, and accepts that accountability should not be diluted within Directorates-General;
  • however, it is cautious regarding the Commission's hope that Member States will undertake to voluntarily disclose their national management declarations, as provided for in the new Financial Regulation;
  • without compulsory disclosure, the concern is that many Member States will not do so;
  • the Government cannot see any argument against enhancing transparency via compulsory disclosure;
  • the Government does not support the proposals for pre-financing, which, as well as increasing pressure on the EU Budget early in the MFF period, raises the potential to reduce transparency in the Budget;
  • the Government welcomes the Commission's plans for an increasing focus on results to be implemented through thematic objectives, the use of common output indicators and a performance framework;
  • however, the proposed performance reserve should be limited to a voluntary mechanism at Member State discretion;
  • the Government believes much can still be done to improve transparency across the EU;
  • it would like to see more robust provisions for Member States to disclose data on the use of EU citizens' money, ideally in a consistent, machine-readable format;
  • other examples are annual statements of expenditure (as the UK does together with the Netherlands, Sweden and Denmark), and the compulsory rather than voluntary disclosure of national management declarations;
  • the Government does not agree that the Food for Deprived People programme fits in with the objectives of the European Social Fund; and
  • this proposal covers the provision of goods found on the open market and therefore represents a 'social measure' which should not be funded from the EU Budget, but by individual Member States.

17.19 The Minister concludes that the Government will be looking to see the Commission follow through on these proposed improvements and will continue to engage with it and other Member States to push for further improvements to the implementation of the EU Budget.

Conclusion

17.20 Whilst clearing the Report on internal audits, document (a), we draw it to the attention of the House for the evidence it shows of some improvement in the Commission's internal management. As for the Report on the Commission response to the 2010 discharge, document (b), it illustrates continuing efforts to increase that improvement and, whilst clearing it, we draw it also to the attention of the House.



47   Management letters provide management with advice, usually derived from the findings of a series of audits or from a consultancy engagement, and do not lead to a formal follow up by auditors. Back

48   (33511) 17844/11 + ADDs 1-2: see HC 428-xlviii (2010-12), chapter 5 (25 January 2012); HC 86-ii (2012-13), chapter 1 (16 May 2012); HC 86-vii (2012-13), chapter 1 (4 July 2012); and Gen Co Debs, European Committee C, 11 July 2012, cols 3-14. Back


 
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Prepared 16 November 2012