Public Audit and Post-legislative Scrutiny Committee

Meeting date: Thursday, September 19, 2019

Official Report 655KB pdf

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Section 22 Report

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“The 2018/19 audit of Highlands and Islands Enterprise: Cairngorm mountain and funicular railway”

Agenda item 3 is a section 22 report entitled “The 2018/19 audit of Highlands and Islands Enterprise: Cairngorm mountain and funicular railway”. I welcome to the meeting our witnesses from Audit Scotland: Caroline Gardner, Auditor General for Scotland; Gordon Smail, audit director; and Maggie Bruce, senior audit manager. I also welcome Edward Mountain MSP, who is attending for this item.

Auditor General, would you like to make an opening statement on the report?

Thank you, convener. I will make a brief opening statement.

The report provides a summary of the circumstances surrounding Highlands and Islands Enterprise’s establishment of a subsidiary company—Cairngorm Mountain (Scotland) Ltd, or CMSL—to take over the operation of the Cairn Gorm mountain ski resort. I intend to prepare a more detailed report on HIE’s management of the ski resort, including the funicular railway, in spring 2020.

The Cairngorms mountain range is an environmental and economic asset for Scotland, and it plays a key role in underpinning the local tourism industry and the economy. HIE, which is the long-term owner and custodian of Cairn Gorm mountain, began the construction of a funicular railway to serve the ski resort in 1999.

I apologise for the number of acronyms that crop up in the report and that will crop up as I talk. I am happy to clarify what I can.

Cairngorm Mountain Ltd—or CML—assumed operation of the funicular railway in 2001 under a lease agreement with HIE. However, CML experienced financial losses, and HIE took CML into public control back in 2008 to keep the resort open. It transferred ownership to Natural Assets Investments Ltd—or NAIL—in June 2014 following a competitive dialogue procurement process.

In September 2018, CML took the funicular railway out of service because of safety concerns. In October 2018, it requested a working capital loan of up to £1.8 million from HIE in order to ensure the continuation of winter sports activities while the funicular was closed. HIE’s board rejected the request because of concerns about CML’s ability to repay the loan and because NAIL did not offer any security for the possibility of CML defaulting. CML subsequently went into administration, and HIE established CMSL in December 2018 to take over the operation of the ski resort.

HIE’s 2018-19 financial statements make a number of references to CMSL, including an accounting provision of £9.6 million to reflect its obligation to repair the funicular.

HIE continues to develop proposals for the future operation of the funicular. That has involved in-house teams and consultancy support to consider options. The likely cost of bringing the funicular back to full working order and the development of a business strategy that will provide for the long-term sustainability of the resort are key issues. HIE intends to repair and reopen the funicular, but it is still not clear how much it will cost to do so, how that will be afforded, and what impact that will have on HIE’s financial position. That is likely to require some tough decisions to be made over the coming months.

As members know, those events and the future of the Cairngorm funicular railway have generated significant public and media interest. It is important that HIE can demonstrate that its decision to transfer CML to NAIL was robust, that it managed its relationship with CML well, and that its decision making in the run-up to the company’s administration was well founded. That will be the subject of my fuller performance report next year.

We will do our best to answer the committee’s questions.

Thank you very much, Auditor General. I ask Liam Kerr to open the committee’s questioning.

We have just had a session on transparency so, for the avoidance of doubt, I declare that I got married at the resort. However, I will be as objective as ever.

At the start of your remarks, you very clearly set out the company structure. What were the responsibilities of each of the companies?

I ask Gordon Smail, as the auditor of HIE who has looked very closely at that issue, to talk members through that.

As we have just heard, the structure is complicated. That has particularly been the case over recent months as events have unfolded. The key issue is that HIE owns the assets—the funicular, the buildings and the business on the mountain. The assets are therefore in public ownership.

Over time, different companies have been responsible for operating the business on the mountain. They have operated the day-to-day business and, until recently, paid HIE rental income for the use of the assets. The businesses have been operated in that style, so there is a clear separation. In a technical sense, there is an agency agreement whereby HIE has handed over the rights of the operation of its public assets to a company—CML until around autumn last year and CMSL since then—to operate the assets on the mountain.

10:45  

In October 2018, CML was still there and the funicular was closed. CML requested a working capital loan of up to £1.8 million to continue winter sports activities while the funicular was closed. That request was rejected by HIE. Did CML set out clearly what it needed £1.8 million for and how it would spend it?

We need to look at that in more detail. There is a separation—which we might discuss this morning—between what we set out in this report on HIE’s 2018-19 accounts and the work that we are planning to do to better understand the circumstances around what happened at that time.

Broadly, a business case was made and HIE had to consider it. As I said a minute ago, the key thing for HIE is to make sure that it protects the public assets that it is responsible for. It is responsible for making sure that such assets are safeguarded and used to best effect. Presented with the circumstances, HIE had to do something. We need to look more closely at and make some judgments about what happened when things started to unfold in autumn last year, particularly regarding the problems with the funicular.

You might give me a similar answer in response to this follow-up question. I think that at the same meeting where CML requested £1.8 million and HIE rejected that, there was talk of a £1 million investment in snow-making equipment—I presume to keep the resort working—that HIE approved. Did it give approval for CML to purchase the equipment or did HIE purchase the equipment?

As you anticipated, that is the type of thing that we want to look at in a bit more detail. Our understanding is that HIE was on track to look at options about what might be available to support skiing and winter sports in particular, given the experience over recent years in relation to the availability of snow.

Our understanding is that HIE was going down the path of investigating how to improve the business on the mountain through the purchase of snow-making and snow-spreading equipment. However, we have to unpick that a wee bit and understand the sequence of events better.

Yes, because if HIE has been getting involved in that sort of thing, it has stopped being simply a landowner and has been becoming an operator, like CML.

HIE owns the assets on the mountain and it is looking at what further assets may be available to support the business on the mountain. As I said, it is responsible for the operations on the mountain and for the public assets, and indeed it has a responsibility to support the economy, tourism and the like, so there are lots of elements to consider. We would want to look at those things in more detail as we get under the skin of the events that were happening around that time.

Auditor General, the feel of this report is slightly different from the ones that you normally produce. You give more of a position statement, rather than taking it to the next level. I presume that that is what you were referring to when you said that you were going to be revisiting the situation. What is the timescale for the follow-up report?

You are absolutely right. This is one of the section 22 reports that I have the power to produce on the back of a body’s annual audited accounts. There is a fixed timescale in legislation for doing that and a deadline by which such reports need to be laid. Given the public interest, I thought that it was appropriate to bring this report, which was produced on the back of the 2018-19 accounts, to the committee now.

As Gordon Smail said, we are doing the work that is needed to answer those wider questions, not just about the decision making last autumn but about the decision to enter into an agreement with Cairngorm Mountain Ltd back in 2014. We expect to be able to publish that report and bring it to this committee in spring 2020.

The questions that arise from your conclusions in paragraph 22 will, we hope, be answered in your follow-up report.

That is our intention. In the report, we have tried to highlight, in effect, the accounting treatment and the financial implications for 2018-19. We are doing a wider piece of work to answer those questions and to take account of the work that HIE is doing to develop options for the longer-term future of the resort. The next report will be published in spring 2020.

This is a random question. Paragraph 14, on page 6 of the report, says that HIE spent £0.25 million on “legal and accountancy advice”. Is that not a lot of money for advice?

It is a significant amount of money. We would expect HIE to take proper legal advice, particularly in such circumstances. I will ask Gordon Smail to give you a bit more colour on what we have seen on this occasion.

Is it value for money?

I do not think that we can answer that question yet, but we can give you a bit more information about what has been spent so far.

As the Auditor General said, and as the committee knows from what we have already explored, there was a complicated set of circumstances that involved the administration of one company handing over responsibility for the operations on the mountain to another company. As you would expect, lawyers and accountants were involved in helping to support the decision-making process. As the Auditor General said, that was appropriate. We will look at whether the amount represents value for money and at what has been expended.

I make the point that there were a complicated set of circumstances that we will need to untangle. HIE is looking at what options might be available after it looks at the circumstances that led to the administration of CML, as it was at the time, and at the subsequent starting up of CMSL.

On the need for that advice, the 2018-19 annual budget report recommends that

“HIE should considers whether its finance team has the capacity and expertise ... to account for the”

complexity of the transactions that

“it is involved with”,

and whether the tasks that are, I presume, being outsourced could be brought in-house.

I am not sure that that is quite right. I will ask Gordon Smail, the auditor, to unpick those issues a bit.

That is right, Mr Beattie. You are referring to our annual audit report, which accompanies the output from the year’s audit work. The audit team and I have been reporting on those issues for the past couple of years. As we have done with other organisations, we wanted to highlight the capacity and expertise issues in finance departments. We thought that in was particularly important to refer to those issues last year and, indeed, again this year. The point was heightened this year by what we have reflected on not only recently at Cairn Gorm but in relation to other challenges that HIE faces. As I said, we are highlighting the fact that many things that are going on in HIE’s business world require a good, strong finance department. We are ensuring that we reflect that and bring our judgment to bear.

We have had some positive responses from HIE, through its audit committee. It wishes to pursue those points to ensure that it is as best placed as it can be to deal with the challenges of Cairn Gorm and the many other financial challenges that we set out in the audit report.

My next logical question is about how HIE responded to the recommendations. Has it done anything about them?

Maggie Bruce and I were pleased with the response that we got from HIE’s audit committee, which is taking up the recommendations and has been active in getting assurances from officials that action is being taken. The audit committee has asked for officials to give a clear steer on what they will do in response to our audit recommendations. We are pleased that the work has been taken forward in that way.

Taking that to the next step, the session 3 Public Audit Committee’s report asked Highlands and Islands Enterprise to

“provide evidence to demonstrate that its current procedures and control systems produce dependable budget estimates”.

In the light of the significant findings in the 2018-19 audit report, are you satisfied that Highlands and Islands Enterprise has in place procedures and control systems to produce dependable budget estimates?

Our report on the audit refers to our overall conclusions on the internal controls, which we believe are adequate for the preparation of the accounts.

Are they adequate or good?

They are adequate—they provide a safeguard over public money and controlled processes for the production of the accounts.

That is accountant speak.

We reach conclusions on that side of things annually, as you would expect. As you will see, there is quite a lot of information in our annual audit report.

On the budget, the audit report has conclusions in the section on financial sustainability, which is one of the dimensions that we look at. In that section, we highlight some of the substantial risks and challenges that HIE faces in its finances. Just to be clear, it is not just us who are raising those issues. HIE recognises the issues. In our section 22 report, which we are talking about today, we highlight a few sections in the annual report part of HIE’s “Annual Report and Accounts 2018-2019” where the risk that HIE sees and some of the conditions that it has identified are needed to put its finances on a more sustainable footing are writ large. HIE faces significant financial challenges.

I think that more questions will arise when the follow-up report is published.

I have a couple of questions about the “Conclusions” paragraph in the section 22 report. You state:

“It is important that HIE can demonstrate that its decision to transfer ... was robust, that it managed its relationship with CML well and that its decision-making around events leading to the company’s administration was robust and well-founded.”

The events happened some time ago. Has nobody asked HIE to demonstrate that already? Will HIE do that in future or has it done so already?

That refers to the audit work that we will carry out between now and next spring. We have looked at some of those issues. Clearly, HIE will already have the information, records and documents, if it has them at all. However, to answer the questions properly, we need to go back and look at events in 2014 when CML was established to consider the due diligence that was done, the quality of the business case that was in place and the detail of the agreement between the two bodies. You will recognise that the audit of the financial statements is in itself a demanding period, so I made the judgment that we would produce a section 22 report now with what is known at this stage and then return next spring with a section 23 report that covers the wider picture.

My reading of the sentence that I quoted is that you have some doubt about whether HIE can demonstrate those things.

It is not our intention to suggest that. My intention is that we should step back and look at the whole picture in detail with the proper audit evidence that we require to reach conclusions. As I said, we need to recognise that HIE is in the process of developing options for the future of the funicular railway and how it will be managed. I am holding off in order to give you the big picture.

In the next sentence in the “Conclusions” paragraph, you state:

“While HIE’s intention is to repair and reopen the funicular, it is still not clear how much it will cost to do so, how it will be afforded, or what impact it will have on HIE’s financial sustainability.”

That is a serious comment, as it brings HIE’s sustainability into doubt. We have heard that the audit report cleared the accounts and did not mention that issue. However, in the section 22 report, you give a clear warning that something could threaten HIE.

I will ask Gordon Smail to comment in a moment, but I think that you are focusing on the specific going-concern judgment that the auditor is required to reach in relation to the annual reports and accounts. We are comfortable about that, given the status of HIE as a Government body that receives Government funding. However, given what is known about the cost of rectifying and making good the funicular railway and the impact on the financial position within its current budget, that is one of the things that we will look at in our further piece of work.

When you refer to an effect “on HIE’s financial sustainability”, to me that suggests that you are calling into question HIE’s ability to continue.

During last year, because of the events around the funicular, HIE needed additional funding from the Scottish Government over and above its normal grant to enable it to carry out its activities. HIE is looking at the options for bringing the funicular back into safe operation and is looking at business models that might avoid the repetition of the problems that we have seen over a long period, heading for two decades. It is the issue of how the repairs can be carried out and how a sustainable business model for the future can be put in place that leads me to ask that question. I am not prejudging the answer, but it is an important question.

There have been previous occasions on which you have brought serious matters to the committee’s attention—for example, in relation to NHS Tayside—yet the accounts have been cleared. Very serious issues have arisen that have not been mentioned in the auditor’s opinion.

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That is not quite the position. The financial statements have received a true and fair opinion. I will ask Gordon Smail to talk you through the thinking behind that. Because I think that there are significant issues here, I have taken the judgment to produce a report using my powers under section 22 of the Public Finance and Accountability (Scotland) Act 2000, which is what we are discussing this morning. I will use my section 23 powers to answer the wider questions around that that do not affect the audit opinion but are significant in terms of how public money is used in the body.

As regards the technical point about the going-concern requirement, it is for the management of the organisation to make that assessment, because it is the management who produce the accounts and they have to decide whether a going-concern basis is the proper basis on which to prepare the accounts. As auditor, I am required to do work to confirm that that is indeed a valid assertion. We do the work on that, as you would expect us to do, as part of the audit.

There are many public sector organisations that are under financial pressure and are experiencing challenges. The going-concern aspect is something that we look at, but it is unusual for it to become an issue in that technical sense because, in the case of HIE and public organisations generally, we can refer to the fact that the Parliament is committed to continuing to finance them through the Government. We must separate the technical nature of the clean conclusion that I came to in my auditor’s report in relation to the going-concern basis of the accounts from what we do in what we call our wider dimension public audit, which we do through our annual audit report. In that context, we believe that it is right for us to make judgments on financial sustainability.

In the case of HIE’s report, we have made it clear that HIE has to manage a range of challenges and risks. The report identifies two or three fairly substantial issues. It is in that context that we wanted to play in the issues surrounding Cairngorm, because the figures that we are talking about—which relate to what the funicular has cost so far and the prospect of repairing it in the future—are big numbers in HIE’s terms. HIE is a £100 million organisation and, as we say, the accounts this year contain provision of almost £10 million for repair of the funicular. It is right that we identify where there are risks to the organisation’s financial sustainability and make a judgment on the extent to which it is preparing for and dealing with those risks.

You just have to hunt for them, whereas the Auditor General brings us the report and makes that clear.

My question is on the same theme as Bill Bowman’s line of questioning. Does it come as a surprise that a funicular railway that is 20 years old needs to be maintained? Is there a design issue here? Is there an argument about maintenance and who is responsible for that? It seems to me that, after 20 years, such a facility will require maintenance and servicing, which will come at a cost. Why was provision for that not built in at the initial stages of the project? Was the possibility that the railway might need to be repaired at some stage in its life overlooked?

That is exactly the sort of question that we will be looking to answer in the section 23 report next spring. You are right that there should be provision for maintenance in the agreement between HIE and the company that operates the resort, and there should be mechanisms for making sure that those provisions are monitored and that that investment is made. We need to do the work to answer that to our satisfaction before we can report back to Parliament.

Is there a dispute about who owns the railway and who is responsible for fixing it?

The ownership of the funicular is quite clear—HIE owns it. Within that, there are questions that we need to look at to do with the relationship between HIE as the owner of the assets and the operator, which was previously CML and is now CMSL. As the Auditor General said, those are central points that we want to consider as part of the further work that we will do.

So there is no question of design failures or things like that; it is purely a maintenance issue that we are talking about, and what the cost will be.

We do not know that yet. That is part of the wider picture on which we are looking to provide answers.

I thank the convener for allowing me to ask a couple of questions. As members know, I wrote to the committee on the subject last year, and I am pleased that the Auditor General is looking at it.

I make the observation that HIE’s cost of £10 million for repairing the funicular, which seems to be 50 per cent of the cost of building it, is an amazing figure. I do not accept that figure; I think that the costs will be much higher.

I want to build on an earlier question. From my experience as a surveyor I know that obligations exist between a landlord’s agent—which in this case is HIE—and a tenant. Are you satisfied that £10 million-worth of repairs happened in the last year of Cairngorm Mountain Ltd’s period of operation of the funicular railway, or do you feel that the landlord’s agent failed to inspect the asset throughout those five years? I do not believe that repairs of that value happened in 2019.

I clarify that the £9.6 million to which we refer in our report is the provision in HIE’s accounts at this stage, which means that it reflects an uncertain amount. I ask Gordon Smail to talk members through what we know so far about that figure.

Much of the reasoning behind our bringing the section 22 report is to unpick and give some transparency on the complicated position that is set out in HIE’s accounts, as the committee would expect us to do. The provision is there and meets the requirements of the accounting rules on how much has been set aside. However, there are uncertainties on that, which is what I think Edward Mountain is alluding to.

On the more fundamental aspect of his question, I go back to a point that we have made a couple of times. We need to explore further the nature of the relationship between HIE and CML and what expectations were in their agreement in relation to on-going assessment of the funicular’s state of repair and what might require to be done to it. That is another central issue that we will want to look at.

Following on from that, will you also be looking at the payments that were made by CML to Natural Assets Investments Ltd for being a subtenant? It appears to me that money was being taken out of the asset but that no repairs were being carried out. I would like to have a handle on how much those payments were per annum.

As part of our work for the section 23 report we are looking at issues such as the whole relationship between HIE and NAIL, the owner of CML, and the extent to which that was based on due diligence in the first place and then properly monitored during the life of the agreement, until CML went into administration last autumn.

Convener, I would like to go a wee bit further on that. Because of commercial confidentiality, it is impossible to see the terms of the contract between HIE and Natural Assets Investments Ltd. I want to know whether there was an agreement on subtenancy and change of ownership, as there would be in all commercial contracts. Where ownership of the asset ended up in 2019 was not where it started in 2014. I have severe doubts that any due diligence was carried out. Will you be looking at that? I think that we all know that Natural Assets Investments Ltd was the only organisation that was really interested in taking on the project.

One of the benefits to the Parliament of having an Auditor General with the powers that I have is that I have access to contracts that are not otherwise publicly available. I have said that we will be looking at the due diligence that was done, the quality of the contract and the way in which it was managed during its life. We will note the specific issues that you have raised and will do our best to answer them as part of that work.

I have a final question. If, as I suspect, there is some dubiety about the way in which people have acted on behalf of the general public who own the asset—because although HIE holds the title, it is just an agent for the people of Scotland in this case—will those people be chased? Will you be advising that the matter is pursued back to those who have possibly taken money out of the asset and allowed it to crumble in front of their eyes?

My responsibilities are to report to the Parliament on what we find in those areas, but we will certainly be looking at issues of accountability and liability as far as we are able to do so.

Thank you—and thank you, convener, for allowing me to ask those questions.

The committee published a report on the asset in 2009, at which point £26.75 million of public money had been spent on it. Have you any indication of how much public money has been spent up to this point?

We have. For the reasons that I mentioned earlier, in the section 22 report we have tried to highlight some of the important figures in HIE’s accounts and to focus on its balance sheet as at 31 March, which is linked to our assessment of sustainability. Having carried out work to prepare for today’s meeting, we believe that, in 2018-19, the overall cost incurred by HIE was of the order of £3.7 million.

I will briefly break that figure down. It includes £1 million on the snow-making equipment that was mentioned earlier and £2.4 million on the set-up and operation of CMSL. A final point that members might find helpful is that, as we mention in the section 22 report, there has been an associated cost of the order of £0.3 million for HIE’s officers to deal with all the issues that have unfolded. We think that it has been quite good practice that HIE has been able to identify the cost that it has incurred through its people having been involved in that process. The cost has come about not through extra money having been spent but through the time and cost incurred through HIE officials having to deal with the Cairngorm issue instead of its other operations.

One assumes that the 2009 figure of £26-odd million was the global figure up to that point. Do we have one up to this point?

Not for the overall project. In the interests of helping the Parliament to understand the 2018-19 accounts when they are laid before it, we have looked specifically at the key elements that relate to the Cairngorm mountain project and HIE’s involvement in it.

There is one final thing from me. Obviously a lot of public money has gone into the project, so there will have been investment in the asset itself. However, there will have been a much wider benefit of having such an asset there. Has anyone quantified the extra value of the return on that investment?

It is very much part of the business case that we see that starting to emerge. You are right to say that the issue is not just about the cost of repairing the funicular and the like; there is a much broader one about the effect on the local economy, jobs and tourism. Lots of different factors are involved, but those are the issues that we would expect to see when we do our additional work. As auditors, our job is to look at the basis on which crucial decisions have been made. We look at what information was available, its strength and whether those decisions were reasonable based on the information that was available at that time. Those are all valid points that we would consider as part of the wider work on which we are now embarking.

As members have no further questions, I thank our witnesses very much for giving their evidence. I now close the public part of the meeting.

11:12 Meeting continued in private until 11:29.