14Transparency of government finances after Brexit
Background and Committee’s conclusions
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Committee’s assessment |
Politically important |
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Cleared from scrutiny; further information requested; drawn to the attention of the Public Accounts Committee, the Public Administration and Constitutional Affairs Committee and the Treasury Committee |
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Document details |
Report from the Commission to the European Parliament and the Council on the implicit liabilities with potential impact on public budgets. |
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Legal base |
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Department |
HM Treasury |
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Document Number |
(40387), 6461/19, COM(19) 81 |
14.1All EU Member States are party to the Stability and Growth Pact (SGP), which aims to ensure they have sound public finances. In particular, under Article 126 of the Treaty on the Functioning of the European Union all Member States, except the UK,111 are under a legal obligation to “avoid excessive government deficits” (defined as 3 per cent of Gross Domestic Product).
14.2The detailed European rules on the implementation of the Pact create both a ‘preventive’ and ‘corrective’ arm.112 The former is a process for the annual coordination of each EU country’s economic policies, with the aim of ensuring that Member States’ budgetary policies do not lead to unsustainable public finances.113 The ‘corrective’ arm, known formally as the Excessive Deficit Procedure or EDP, can be triggered when an EU country nevertheless breaches the limits on debt and deficit. In such a case, the other Member States in the Council have the power to impose financial penalties and other sanctions on the country concerned if no action is taken to bring the deficit under control.114 While such sanctions cannot be applied to the UK because it has an opt-out from the Economic and Monetary Union,115 the British economy is still monitored by the Commission for compliance with the SGP (and between 2008 and 2017, the UK was formally considered to have an excessive deficit).116
14.3Compliance of each EU country with the Stability and Growth Pact is monitored by the European Commission, which presents the results of its annual assessment early each year.117 To enable it to perform this analysis, each Member State submits the necessary data on its domestic economic activity—including government expenditure and debt—as described in its National Accounts. These accounts are compiled according to the European System of National and Regional Accounts (ESA), which in turn is based on a model statistical framework produced by the International Monetary Fund and the United Nations.118 The EU’s Member States, the UK included, are required to use the ESA standards to comply with their Stability and Growth Pact obligations, as they have been set out in a legally-binding Regulation.119
14.4Given the importance of reliable macroeconomic data to verify compliance with the Stability and Growth Pact, Eurostat—the EU’s statistics body, part of the European Commission—assesses the quality of the data reported by all Member States under the ESA rules. When doing so, it pays particular attention to the “delimitation of the government sector [and] the classification of government transactions and liabilities”, to ensure the public debt and deficit are accurately reported.120 The detailed rules for the implementation of the Excessive Deficit Procedure also require Eurostat and individual EU countries to “ensure a permanent dialogue with […] statistical authorities”, including “regular dialogue visits, as well as possible methodological visits”.121 Afterwards, Eurostat typically issues a number of detailed recommendations for further areas of review, or makes suggested changes to statistical practices by the national authorities. The relevant UK body is the Office for National Statistics (ONS), which is overseen by the UK Statistics Authority.122
Reform of the EU’s rules on financial transparency in Government
14.5Following the Sovereign debt crisis in 2010, and in particular the revelations about the enormous underestimation of Greece’s public debt by misapplication of the ESA rules,123 the EU adopted new legislation—known as the ‘six-pack’—to reinforce how individual countries should ensure they ensure they comply with the Stability and Growth Pact, and allowing such compliance to be verified independently by Eurostat based on accurate macroeconomic data.
14.6In particular, under a 2011 Directive on national budgets, all EU governments have to “ensure that fiscal planning is based on realistic macroeconomic and budgetary forecasts”, and national budgets have to be based on “the most likely macro-fiscal scenario”.124 This data also has to be made publicly available. The central role of national statistical authorities in providing economic data under the ESA standards, ultimately overseen by Eurostat, was maintained. In addition, the new legislation required each EU country to publish relevant information on contingent liabilities that could have “potentially large impacts on public budgets”, including government guarantees, non-performing loans, and financial liabilities stemming from the operation of “public corporations” (such as non-departmental public bodies in the UK).125
14.7The Eurozone’s Sovereign debt crisis also exposed weaknesses in the reliability of national accounts, since they had clearly not shown the full extent of financial risks to which national governments were exposed (which, in the EU context, affected the accuracy of data on Member States’ public deficits under the Stability and Growth Pact).126 After the UN produced an updated model version for National Accounts in 2009, the EU therefore also modernised the European System of Accounts by means of a new Regulation in 2013.127
14.8One of the main changes compared to the previous ESA standards, issued in 1995,128 related to identifying Member States’ implicit liabilities which may not be immediately apparent as having an impact on public finances or included on governments’ books. For example, the new standards make it clearer how potential financial commitments related to Public-Private Partnerships (PPPs) or loans made by public authorities should be accounted for on a government’s balance sheet.129
14.9In addition, ESA 2010 contained new guidance to establish whether or not a government is exposed to financial risks related to entities which they do not directly control (in which case they may still have to classified as ‘central government’ bodies, because they their assets and debts impact on public finances).130 This has been supplemented by specific Eurostat guidance, called the “Manual on Government Deficit and Debt“ (MGDD). The combination of the two means that non-profit bodies may have to be included in the statistics on the public deficit, if they are found to be both “controlled by government”—including through financial risk exposure, which is seen as an indicator of control—and whether they pass the “non-market test” (meaning a body is not financed primarily by its own sales on a commercial basis). In practice, these changes meant that EU governments had to start including more arm’s-length bodies in their statistics on government debt, which case they can affect the European Commission’s assessments under the Stability and Growth Pact.131
The implications of ESA 2010 for the UK
14.10One of the immediate, and most high-profile, consequences of the new EU statistical rules in the UK was the 2014 reclassification of Network Rail for the purposes of calculating the Government’s debt and deficit.
14.11Since its creation in 2002, Network Rail—which owns and operates the majority of Britain’s rail infrastructure—had been categorised as a “private non-financial corporation” by the Office for National Statistics, and was therefore not included on the Government’s books. This reflected the fact that there was no government “control or influence over the directors through the appointment process” and no “special factors that enabled any part of [the Government] to determine general corporate policy”, which were the relevant considerations under the 1995 ESA rules.132 However, following a regular visit by Eurostat officials to the UK in January 2013, the ONS committed to “analyse the classification of Network Rail under ESA 2010” and the new guidance on effective government control of private sector entities.133
14.12Following its review, the ONS concluded that the Government did have a degree of financial exposure that effectively amounted to control, because the Treasury had explicitly guaranteed Network Rail’s debt,134 and the Department for Transport also had a statutory duty to step in to keep the railways operating if the company were to collapse. It also found Network Rail was effectively a “non-market body” under the new EU rules, because its annual sales—the track access charges it levies on train companies—consistently accounted for less than half of its production costs, once total borrowing costs were taken into account.135 As a result of this review, in December 2013 the Government announced that the new EU rules would require the ONS to reclassify Network Rail from a notionally private sector entity to part of central government, making it formally accountable to the Department for Transport (and by extension, to Parliament).136
14.13The result of this decision was that Network Rail’s approximate £30 billion of debt, hitherto classified as private, was moved onto the Government’s balance sheets as of September 2014.137 In addition, rather than borrowing money on the open market, the body agreed a loan facility with the Treasury (but also receives grant funding from the Department for Transport). The Office for Budget Responsibility estimated at the time that this change was likely to increase the UK’s public sector net debt by about 2 per cent of GDP. In its 2018 Annual Report, Network Rail announced its net debt now stands at £51.2 billion, and its financial position—as, ultimately, a taxpayer-funded body—continues to be controversial. The Treasury recently used the £1.46 billion sale of part of Network Rail’s real estate portfolio to reduce a shortfall on the company’s books, reducing the deficit by £500 million.138
Commission report on implicit government liabilities in the EU
14.14In March 2019, the European Commission published a report on the extent to which the national data compiled on the basis of ESA 2010 “represents the entirety of all Member States’ implicit liabilities, including contingent liabilities, outside government”.139 In it, the Commission concluded that the new data collection represented “a step forward in terms of transparency as it gives a more comprehensive picture of the EU Member States’ financial positions”, and that the availability of comparable and harmonised data on government contingent liabilities “is an important achievement, making the EU a frontrunner in this area in the international context”.140
14.15With respect to the UK, the Commission notes that the Government’s liabilities related to Public-Private Partnerships—often known as Public Finance Initiatives in Britain—stood at 1.5 per cent of GDP in 2016, the fourth-highest out of all 28 EU Member States.141 It also remarks on the absence of data on British local authorities’ financial exposure to PPPs and non-performing loans,142 but adds in both cases that “the amounts are not expected to be significant”.
14.16The Financial Secretary to the Treasury (Rt Hon. Mel Stride MP) submitted an Explanatory Memorandum on the Commission report on 9 May 2019. In it, the Minister summarised the substance of the document but did not indicate the Government’s policy on how the Office for National Statistics intends to compile the UK’s National Accounts after EU law ceases to apply.143 At that point, the UK would be free, in principle, to deviate from the ESA 2010 standards with respect to both implicit government liabilities and the wider guidance, such as those that led to the reclassification of Network Rail as a public body. Following Brexit, Eurostat will also no longer perform any supervisory role in relation to ONS or the UK’s public finance statistics unless there was a specific UK-EU agreement to that effect. The Cabinet Office has laid a Statutory Instrument—the UK Statistics (Amendment etc.) (EU Exit) Regulations 2019—to prepare the UK’s statistical system for a potential ‘no deal’ Brexit. These regulations would repeal many individual pieces of EU statistical legislation at the point where European law ceases to apply in the UK. However, this Instrument does not refer to the 2013 ESA Regulation or the supplementary Eurostat guidance on Government Debt and Deficit.
Our conclusions
14.17Brexit means that, eventually, the EU’s Stability and Growth Pact—and the statistical rules underpinning its application—will cease to apply to the UK. The exact point at which this will happen is still unclear, because the Withdrawal Agreement on the UK’s departure, if ratified, would create a transitional period during which EU law would continue to apply as if the UK were still a Member State.
14.18When EU law does cease to have direct effect in the UK, the Office for National Statistics could have more flexibility to re-assess the Government’s implicit liabilities and overall financial position. In particular, since the ESA 2010 rules and associated Eurostat guidance on Government debt and deficit would no longer apply directly as a matter of EU law, there is a theoretical possibility that the ONS might take a different approach to the classification of certain arm’s-length bodies, like Network Rail, for the purposes of calculating the UK’s public debt and deficit.
14.19We note in this respect that Regulation 549/2013, which anchor the ESA 2010 standards in UK law for as long as EU law applies directly, would by default be fully retained as on the Statute Book under the European Union (Withdrawal) Act 2018.144 However, it does not yet appear to have been subject to an amending or repealing Statutory Instrument under that Act, even though the Regulation would need to be modified to apply correctly in a purely domestic context, for example because it currently provides for mandatory transmission of data to the European Commission.
14.20In any event, the Eurostat guidance on Government debt and deficit—which appears to have been key to the ONS’ decision to bring Network Rail’s debt on the Government’s books in 2014—is not itself legally binding, since it serves as an implementation manual for EU Member States. It would not be ‘retained’ as UK law under the 2018 Withdrawal Act. Its ultimate potency lies in the fact that Member States could risk infringement proceedings before the European Court of Justice if they do not apply the ESA 2010 Regulation in conformity with Eurostat’s interpretation of its provisions. That risk would no longer apply to the UK after the European Commission and the Court cease to have jurisdiction here. Therefore, even if the ESA Regulation itself was retained in full in domestic law, it could still be possible for the ONS to reach a new classification decision with respect to arm’s-length bodies, like Network Rail, and categorise them as private sector entities.
14.21Given the size of Network Rail’s debt and continuing controversy about its financial performance—impacting directly and substantially on the UK government debt and deficit while it remains classified as part of the Department for Transport for statistical purposes—it is worth obtaining a clear statement from the Government about the implications of Brexit in this area.
14.22Unfortunately, the Minister’s Explanatory Memorandum on the European Commission’s latest report on transparency of government liabilities contained no assessment of the implications of Brexit on the transparency of the UK’s public finances, once the constraints imposed by EU law—and oversight by Eurostat—no longer apply. As such, it is unclear whether the Government and the UK Statistics Authority intend to maintain the effects of the ESA 2010 rules, and the manner in which they have been interpreted for the calculation of the UK’s public finances in light of Eurostat’s guidance, beyond Brexit.
14.23In light of these considerations, we ask the Minister to:
- clarify if it is policy to preserve the substance of the ESA 2010 legislation (Regulation 549/2013) on the UK Statute Book after EU law ceases to apply, and whether a Statutory Instrument to prepare the Regulation for a post-Brexit context is forthcoming;
- confirm whether it is the intention to maintain the current interpretation of the ESA 2010 rules on the Government’s financial exposure the liabilities of arm’s-length bodies like Network Rail, as and when EU law ceases to apply in the UK; and
- confirm if this current interpretation, since it is based on non-binding Eurostat guidance, could be revised by the ONS in the future after EU law—and the enforcement powers of the Commission and Court of Justice—cease to apply.
14.24We look forward to receiving the Minister’s reply by 21 June 2019.
14.25Looking further ahead, we note that the ESA 2010 rules apply in Norway and Iceland under the terms of the EEA Agreement, as they form part of the legislative framework of the Single Market.145 Switzerland also provides macroeconomic data on Eurostat on its public finances, and is required to apply the ESA standards domestically under the EU-Swiss Agreement on Statistics.146 It is unclear if the Government would similarly be willing to commit to their continued application in the UK after Brexit (and any subsequent transition period) as part of the wider economic partnership with the European Union, in return for a preferential trading agreement, should the EU make a request to that effect. This is a matter Parliament will wish to keep under review as and when negotiations on the future UK-EU economic partnership begin, given the potential implications for the way in which Government debt and deficit are reported.
14.26We draw these developments to the attention of the Public Accounts Committee, the Treasury Committee and, given its role in scrutiny of the UK Statistics Authority, the Public Administration and Constitutional Affairs Committee. We are content to now clear the Commission report on implicit government liabilities from scrutiny.
Full details of the documents
Report from the Commission to the European Parliament and the Council on the implicit liabilities with potential impact on public budgets: (40387), 6461/19, COM(19) 81.
Previous Committee Reports
None on this document. The European Scrutiny Committee last considered the Regulation establishing the 2010 European System for National and Regulation Accounts in January 2013. See (32414), 5053/11 + ADDs 1–26 COM(10) 774: Thirtieth Report HC 86–xxx (2012–13), chapter 14 (30 January 2013).
111 Protocol 15 to the EU Treaties exempts the UK from further integration into the Economic & Monetary Union, including many of the provisions related to the Stability and Growth Pact. See paragraph 14.2 for more information.
112 See in particular Directive 2011/85/EU, Regulation 1177/2011 and Regulation 1175/2011.
113 The ‘preventive’ arm is based on Medium-Term Budgetary Objectives for each EU Member State, which—if not complied with—can lead to a “Significant Deviation Procedure” (the final step before the opening of an Excessive Deficit Procedure, which can lead to sanctions).
114 See Article 126(11) TFEU. In addition to financial penalties, the other Member States could—by qualified majority—ask the European Investment Bank to “reconsider” its lending policy towards an EU country with a persistent excessive deficit; require the Member State in question to make a “non-interest-bearing deposit” with the EU; or “publish additional information […] before issuing bonds and securities”. As of May 2019, the only Member State subject to an Excessive Deficit Procedure is Spain. The only EU countries never to have been subject to an EDP are Estonia and Sweden.
115 Under article 2(4) of Protocol (no 15) to the EU Treaties, Article 126(11) TFEU—which sets out the penalties that can be applied to a Member State for failing to address an excessive deficit—“shall not apply to the United Kingdom”. Instead, under the Protocol the Government must “endeavour to avoid an excessive government deficit”. Consequently, the UK does not vote on the imposition of EDP sanctions on other Member States.
116 In November 2017, the European Commission published its latest economic forecasts. These showed that the UK’s budget deficit had dropped below the reference value of 3 per cent of GDP in 2016–17 and was expected to stay below that value beyond 2020. Although the Commission also found that government debt had reached 86.8 per cent of GDP, it expects it to decline in the coming years. As such, it recommended to the Council that it should close the Excessive Deficit Procedure. The Excessive Deficit Procedure against the UK was ended by the other Member States in December 2017. See our Report of 10 January 2018 for more information.
117 The Commission’s analysis for 2019 was published on 27 February 2019.
118 Under these rules, ‘units’ such as Government departments, charities and businesses, are classified together with other similar units into a number of ‘institutional sectors’, and their activities described collectively. Additionally, all transactions between the sectors of the economy are categorised, includes assigning of entities to either public or private sector (which determines whether their balance sheets affect the public debt and deficit).
119 There is no requirement for Member States to use the ESA system for domestic purposes other than where mandated by EU law.
120 The quality of each Member State’s economic data is measured against “compliance with accounting rules, completeness, reliability, timeliness, and consistency”.
121 Council Regulation 479/2009, article 11. This requirement for statistical dialogue in the context of the Excessive Deficit Procedure was first implemented under Council Regulation 2103/2005.
122 The UK Statistics Authority is accountable to Parliament, and in particular to the Public Administration & Constitutional Affairs Committee.
123 Eurostat, “Report on Greek government deficit and debt statistics“ (11 January 2010). This noted: “The Greek government deficit for 2008 was revised from 5.0% of GDP (…) to 7.7% of GDP. At the same time, the Greek authorities also revised the planned deficit ratio for 2009 from 3.7% of GDP (…) to 12.5% of GDP, reflecting a number of factors (the impact of the economic crisis, budgetary slippages in an electoral year and accounting decisions).” Eurostat had already uncovered similar problems at the Greek statistical authority in 2004.
124 Directive 2011/85/EU on requirements for budgetary frameworks. Certain provisions of this Directive do not apply to the UK because the public debt and deficit objectives of the Stability and Growth Pact are not binding on it. As explained in the recitals to the Directive, “the obligation to have in place numerical fiscal rules that effectively promote compliance with the specific reference values for the excessive deficit, and the related obligation for the multiannual objectives in medium-term budgetary frameworks to be consistent with such rules, should therefore not apply to the United Kingdom”.
125 The UK does not legislate on the detailed outputs from its statistical system, which is independent from government, so there the Government never specifically transposed Directive 2011/85/EU into domestic law. The Treasury exchanged a number of letters with the European Commission on this issue, which culminated in the Commission accepting the Government’s position in April 2017. The core argument the UK put forward was that the UK Government already complied with, or exceeded, the substantive requirements the draft Directive set out without any new or additional legislation. Many of the statistical requirements of the Directive 2011/85/ EU were already in place in the UK’s existing statistical reporting, and Eurostat has confirmed that they are satisfied that the ONS had met the requirement under Directive 2011/85/EU with respect to the publication of information on contingent liabilities.
126 For example, the International Monetary Fund in 2009 identified various ‘data gaps’ that had contributed to a lack of awareness of the risks building up in the financial system. It concluded that there was a need for improved monitoring of the “vulnerability of domestic economies to shocks” by promoting “timely and cross-country standardized and comparable government finance statistics”. The IMF also identified a need to improve the communication of official statistics, as “in some instances users were not fully aware of the available data series to address critical policy issues”.
127 Regulation 549/2013 on the European system of national and regional accounts in the European Union.
128 See Regulation 2223/96 on the European system of national and regional accounts in the Community for the previous system.
129 In 2016, Eurostat produced further guidance on the statistical treatment of PPPs under ESA 2010.
130 Under the 1995 rules, such an assessment was made on the basis of any power for the government to “control or influence over the directors through the appointment process” or the existence of “any special factors that enabled any part of public sector […] to determine general corporate policy”. The Office for National Statistics has explained that ESA 2010 requires the classification of public bodies with respect to their to reflect the “degree of [government] financing” and “degree of government risk exposure” in relation to such bodies.
131 According to the ONS, in general terms the main changes relate to determining government control over non-profit institutions (NPIs), and the determination of whether a body is either a ‘market’ or a ‘non-market’ producer. This second aspect determines whether the body is included within General Government statistics or within statistics for the Public Corporations (PC) sector; while PCs are included in statistics for the public sector as a whole, they are not included in statistics for the General Government sector and so are not included in the main statistics produced for Excessive Deficit Procedure purposes.
132 Although this private sector classification of Network Rail under ESA 1995 was accepted by Eurostat, the National Audit Office did not agree, believing that the Government effectively bore the risks that would normally be borne by equity capital.
133 Eurostat, “Final findings—EDP dialogue visit to the United Kingdom 24–25 January 2013“ (accessed 13 May 2019).
134 The ONS also noted that there was no significant exposure to Network Rail by any other stakeholders, since the company has no shareholders.
135 The ONS explained: “The ESA 2010 market test uses the same general methodology but is different to the ESA95 market test as it adds ‘net interest charges’ into the calculation of production costs. For institutional units with high debt levels, like Network Rail, which incur substantial interest costs (around £1.5bn annually for Network Rail between 2009–10 and 2012–13), this new guidance has a critical impact on the outcome of the market test”.
136 Classification decisions for National Accounts purposes are taken by the National Accounts Classification Committee (NACC) within ONS.
137 At the time of the entry into force of ESA 2010, the ONS also looked at other regulated industries in order to check whether the new rules would apply to other UK bodies, such as water or utility companies. It concluded that “no other bodies in these areas need reclassification under ESA 2010”, mostly because they were already classified as public sector bodies, or because they were limited by shares. See also the Public Accounts Committee 2015 Report on Network Rail.
138 National Audit Office, “Network Rail’s sale of railway arches“ (2 May 2019).
139 The Commission was required to produce this report under Article 11 of Regulation (EU) No 549/2013, the ESA 2010 rules, by 2018 (meaning it was somewhat delayed). A previous report issued by the Commission on this issue was published in 2015 and presented existing information, at that stage, on public-private partnerships (PPPs) and other implicit liabilities, including contingent liabilities, outside general government.
140 However, the Commission also noted that the reported statistics were “not yet fully exhaustive and with meta-data that could be improved”.
141 The proportional exposure to PPPs was higher only in Portugal (3.2% of GDP), Slovakia (3.1%) and Hungary (1.7%). The EU-28 average government exposure to PPPs is 0.44% of GDP.
142 Non-performing loans granted by local authorities to external entities are a contingent liability since public finances would be affected if such loans are not paid off.
143 The exact point at which EU law, including ESA 2010, will cease to apply directly in the UK is unclear. By default, the UK is currently due to leave the EU on 31 October 2019. However, if the draft Withdrawal Agreement is ratified, there would be a post-Brexit transitional period lasting until at least 31 December 2020 during which EU law would continue to apply in the UK as if it were still a Member State.
145 Decision of the EEA Joint Committee 58/2014 of 8 April 2014.
146 Agreement between the European Community and the Swiss Confederation on cooperation in the field of statistics.
Published: 11 June 2019