Public Audit Committee, 04 Nov 2009

Meeting date: Wednesday, November 4, 2009

Official Report 160KB pdf

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Section 22 Report

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“The 2008/09 audit of Registers of Scotland”

Agenda item 3 is on the section 22 report "The 2008/09 audit of Registers of Scotland". I invite Mr Black to give us a briefing.

The report is intended to inform the committee about developments affecting the finances of Registers of Scotland. Because of the effects of the economic downturn, ROS made an operating deficit of about £11 million in 2008-09 and further, larger deficits are anticipated in the future. ROS is responsible for compiling and maintaining 16 public registers relating to property and other legal documents. It gets its income from customers by charging for registrations and for providing information from the registers. Those customers include the general public and professional users, particularly solicitors.

ROS has operated at a trading profit since 1996 and, until 2008-09, it generated a significant financial surplus every year. The £11 million operating deficit in 2008-09 compares with a previously budgeted surplus of £4 million. The change reflects the unforeseen slowdown in the property market in 2008, which had the effect of greatly reducing ROS's fee-earning activity. The unforeseen deficit also resulted in ROS not meeting the financial target that the Scottish ministers set for 2008-09. However, because of its trading fund status, ROS has made no call on the Scottish budget. It has met the deficit from its reserves, which remain substantial. At the end of 2008-09, the balance on ROS's accumulated income and expenditure reserve was almost £123 million.

Looking forward, ROS's future finances will change significantly, in that it anticipates large deficits each year for the next five years. The projected losses are detailed in exhibit 2, which is on page 2 of my report. It is important to note that the projected losses are not solely the result of the recent downturn; they also reflect a decision in 2007 to reduce fees, as well as ROS's broader aim of maintaining stable prices for customers in the medium and longer run, while reducing the annual surpluses. Even so, the projected losses in the next five years are now about £25 million higher than was anticipated before the full impact of the downturn had been experienced.

The auditor of ROS considers that the future projections are subject to some uncertainty but that, nevertheless, ROS's overall financial planning and management of its reserves policy are effective. ROS has indicated to us that it will continue to keep its fees under regular review and that it will act should the position change because the recession has a deeper impact than is currently anticipated.

In summary, ROS incurred a large operating deficit in 2008-09 and forecasts more deficits in future. Those deficits are larger than previously forecasted because of the economic downturn, but ROS has substantial accumulated reserves to meet them and at the same time is continuing to develop and improve its services in line with its corporate plan.

It goes without saying that ROS must manage its income and expenditure plans to take account of future market movements and that it must make sure that those plans remain realistic. I have asked the auditor to continue to monitor performance on that, and if I think it is necessary, I will make a further report to Parliament in due course.

I am very happy to answer any questions that the committee has, with support from my team.

You mentioned the historical situation with ROS having large reserves, and clearly it will draw on those reserves for the difficult period in which it is operating just now. Is it common for public organisations to be able to build up reserves in that way and then draw on them?

It would be unusual for a trading organisation such as ROS to build up such substantial reserves over a number of years. Although we have not reported it in the past, Audit Scotland has been aware of the build-up of more than £100 million in reserves over a number of years.

However, as we all know, there has been a period of substantial economic growth and prosperity over the past 10 years, with probably unprecedented levels of activity in the property markets. As a result, one would expect the reserves to increase. It would be entirely appropriate and good business practice for a body such as ROS to make provision in the good years and build up reserves to cope with the more difficult years in order to avoid any risk of calling on public funds. The level of those reserves on a year-to-year basis is a matter of judgment about the business of ROS. We are not prepared to comment on that; such questions should be addressed to ROS. However, it seems that the current situation is transitory and, as we outline in the report, the reserves are likely to decline substantially over the next few years.

So there is nothing in the accounting rules to prevent a public body such as ROS from building up reserves of the level that it has at the moment.

There is nothing to prevent that. If necessary, ministers have the opportunity to question a body such as ROS about the build-up of reserves and to take policy decisions in principle about the level of fees set and so on in consultation with the body concerned.

When you carry out audits in the wide range of organisations that you cover, do you look at the level of reserves?

It is monitored through the audit process, yes.

Do we have any way of knowing what the cumulative reserves are for publicly funded bodies in Scotland?

I would find it difficult to answer that question off the top of my head and, if I may say so, I would find it rather difficult to draw any conclusions from such a figure because the business environments of individual bodies are quite different.

I understand that, but a substantial amount of money could be sitting in the reserves of publicly funded bodies, and we do not know how much.

In theory, that is the case. Can Dick Gill help us with that, on the basis of our audit involvement?

It is important to remember that Registers of Scotland is a trading fund—I think that it is the only trading fund in Scotland—so it has a particular commercial position. By definition, it is an unusual body because of its status as a trading fund.

I emphasise that ROS has been looking carefully at its reserves policy over the past two or three years with questions and scrutiny from the auditor, so it is acutely aware of the issue. Ministers must set financial targets for ROS and I would expect them to take into account the level of reserves when setting fees, although that is, of course, a policy matter.

Thank you. I will also ask about operating expenses. You have referred to the downturn in activity and the impact that that has on ROS. The operating expenses outturn for 2008-09 is £66.2 million. Given the difficult period in which ROS is currently operating—I refer to the downturn in activity—what is the explanation for the jump in operating costs for 2009-10 to £74.2 million, which continue to rise the following year and do not come back down to anywhere near current levels until 2013-14? Is there any correlation between operating costs and business activity?

It is ROS's responsibility to account for and justify its spending. There will, of course, be a correlation between activity and operating expenditure. We report in the section 22 report that ROS's turnover in 2008-09 was significantly lower than forecast—a surplus of £4 million was forecast, but ROS ended up with an operating loss of £10 million. The picture on operating costs is similar, in that the budgeted operating costs for 2009 were, I think, £73 million but the outturn was £66 million. Therefore, there is some evidence that ROS's costs have reflected the reduction in activity, but the audit did not investigate that in depth, I am afraid.

The 2008-09 operating expenses were £41 million on staff, £12 million on equipment and service costs and £13 million on depreciation. We know from the work done on the audit that ROS continues to invest significantly in its information technology capability to improve the service that it offers.

From my knowledge of Registers of Scotland—I used to be in legal practice—I imagine that the substantial proportion of its costs are staff costs, because it employs large numbers of people whose job is to check transactions. Given that there has been a substantial fall-off in the number of transactions, we would expect that there would be much less work for those people to do. ROS cannot simply sack them all, because it would lose the skills base that would be required if there was an uplift in the market. However, I would expect that people would leave and vacancies would not be filled, so it concerns me that the operating costs will go up over the next two years at least, which suggests that ROS is not making any attempt to reflect the lower level of transactions by having fewer staff. Do you have any figures for how the projected operating costs break down between staff costs, depreciation and IT?

Will you give me a few moments to check that? In its published corporate plan, ROS sets out five-year projections, which are in exhibit 2 of the report. I am turning to my copy to find out how much information is included in those projections.

I do not think that the corporate plan reveals that level of detail, although it sets out plainly ROS's plans to improve its services. It is investing significantly in new technology. I do not know how that affects the underlying plans in the five-year projections, but I expect that it will have an effect on the organisation's operating costs. I also believe that ROS anticipates a recovery, which must be factored into its projections.

Perhaps we can follow that up with ROS directly.

I was surprised to discover that there is a trading fund in Scotland with a £123 million surplus. I was also staggered to read in paragraph 13 on page 2 of the report that ROS's

"total anticipated operating deficit over the five years to 2013-14 is £86 million."

The organisation is planning to operate with a deficit of £86 million over that period. It would be worth pausing and finding out more information about that before we leap to conclusions. It would be valuable for the committee to learn more about the trading fund and the criteria and objectives under which it operates. In order to do that, it may be necessary to speak to Registers of Scotland first and then the responsible minister. I do not know who the responsible minister is, although I assume that it is John Swinney—it would be interesting to find that out.

It might come as quite a surprise to the responsible minister to learn that there is a fund with a £123 million surplus sitting in it. Although ministers set clear objectives for Registers of Scotland, I would have thought that, in the light of the information in the report—the £123 million surplus and the plan to lose £86 million over the next five years, with higher operating costs and a significantly lower turnover than those in previous years—it would be at least worth revisiting those objectives and discussing them. A significant sum of taxpayers' money is involved.

The report is short, interesting and informative, and it could be quite valuable and important in the context of the current constraints on public spending in Scotland.

I agree with much of what Nicol Stephen has said. It would be worth considering matters further. Even if we assume that the losses to 2013-14 will be £86 million, that still leaves £38 million in the reserve fund. I would be interested to know whether anything could legally prevent the Scottish Government from making a call on reserve funds held by Registers of Scotland or other public bodies. It is clear that we are in a time of a lot of scrutiny of budgets, with tight public finances. It would be interesting to know whether there is any facility to call on such reserve funds and whether they could be used to fund other projects and help to boost the economy.

I am not sure whether we can fully answer the question about ministerial powers over ROS.

The reserves policy is important for ROS. Among other things, it provides a property transactions indemnity. Cost consequences might arise if a title is not found to be sound. For that reason alone, it is important that ROS maintains some level of reserves. The actual level of reserves that there should be to satisfy that indemnity and meet the business's other requirements is quite a complex and technical issue, which the committee would have to speak directly to ROS about. Caution needs to be adopted.

The issue is worth clarifying.

If Mr Black's exhibit 2 was extended to cover an earlier period, we would see a very healthy picture of a profitable organisation; if it was extended to cover later years, we would see a broke organisation, with all its reserves used up. That is why members express concerns about quite severe fluctuations having been permitted in the organisation for a period of time.

It would be of interest to members to delve into the issue more deeply at some point to try to understand a bit better what is going on.

Thanks for that. This is another item to which we will return later.