Scottish Water
The final item today concerns updates from the reporters and me on our investigation into Scottish Water. Following our investigation on 10 February, letters were sent to Allan Wilson and Scottish Water. They were circulated to members but have also been included in the papers before us today. Members will recall that we also wanted to write to the water industry commissioner. We have had a response from the water industry commissioner to my earlier letter of 13 January, which has been placed before the committee as it might have a bearing on the text of any letter that we want to send to him. The letter he sent us is fairly substantial, at least in terms of the number of pages. Given that many questions have been raised about end-year flexibility in the course of our investigation—particularly following the evidence that was given by Executive officials on 3 February—I asked our budget adviser to produce a paper to help our discussion. Members also have a copy of a letter that was sent to us by Andrew Scott of the water services unit.
As I said at our last meeting, the reporters and I agreed that it would not be possible to produce a further draft report for this meeting as we are still waiting for information, particularly on EYF. We have now been sent information from the Scottish Executive and we have got an awful lot of paper to get through and a lot of work to do in drawing the information together.
Since Arthur Midwinter has joined us, it might be useful to focus initially on his paper on EYF and allow members to seek clarification of his work.
We have received a great deal of substantial and, at times, technical and complex evidence. The Executive waited until yesterday to send us yet more substantial information, despite the fact that the request for that information was made by Mr and Mrs Cuthbert last year.
I have read the responses but, given that we received only recently the information from the Executive, the water industry commissioner and Scottish Water—and also in light of the fact that the Executive's response does not appear to answer all the questions that were raised—I do not think that we can make much progress today. We will need an opportunity to study the papers and to give them the time and consideration that they deserve. We cannot do justice to them in the short time remaining to us today. It would be better if we could have a considered discussion of the papers at a later date, once we have studied them.
The intention today was simply to provide an update to members and to report back the information that we have gathered. Clearly, we must work on the papers but I do not think that we are going to do that in the committee. The reporters and I must try to assimilate the information and come back to the committee with a revised draft report for the committee to consider.
Our budget adviser is here today to talk about the information that he has provided for us. If I am required to write to the WIC again because of any dissatisfaction on specific points, I could do so before the end of the week and ask for an early answer. However, we should now move towards concluding our exercise. We have done an awful lot of work on the water inquiry and there is an expectation that we will produce a report as quickly as possible. We should do so in time for the quality and standards III consultation exercise and the review of the charging framework.
I want to put on record my thanks for the work that the budget adviser has done in providing the reporters with background information, especially on EYF. Our inquiry has highlighted areas that will be in the final report.
I want to ask a question about borrowing and renewals and replacement, based on paragraph 3 in the adviser's paper, on the framework of financial control. The adviser asks us to get more information on the proposals for renewals and replacement, but has he seen the response that we have had from the WIC? If so, is he satisfied with it? I have had a quick look and it makes sense to me.
Professor Arthur Midwinter (Adviser):
I have not seen the document from the WIC—apart from a brief glance after which I said to Susan Duffy, the clerk, that I did not think that it fell within my remit as most of the arguments are to do with the revenue cap. That does not come under public expenditure and is therefore not within my expertise on the Scottish budget. I would be happy to have a look if the committee wishes. Our initial reaction was that there may be one paragraph about the golden rule that may be important.
Before committee members go off to clear their thoughts on the evidence that they have gathered—including evidence from the Executive—I would like to raise one or two concerns. Some of the evidence overstates the role of the WIC and I have concerns about some of the interpretations that members have heard. The role of the WIC is mentioned in paragraph 3. Dr Scott implied that the WIC set the lower borrowing requirement. The phrase "the WIC set" appeared several times in evidence. The WIC does not set anything; the WIC recommends and advises. The minister can reject that advice. It is important that members are clear about that. A number of documents refer to the WIC setting things.
The WIC responds to requests from the minister. The minister sets, with Parliament's approval, the public expenditure limits. The minister determines the size of the capital programme—the £2.7 billion or £2.8 billion. Obviously, all sorts of discussions will go on between the players, but the judgment is the minister's. In this case, the WIC was advised of the size of the capital programme before the strategic review. He knew that it was going to be £2.8 billion or £2.7 billion, which was the minister's decided figure after consultation. I now understand that the minister also decided what the split would be between new investment and renewals—the one third/two thirds split. From some of the discussions, I thought that that split was being presented as a technical judgment.
Obviously, there are elements of technical advice relating to that split but, if I may, I will quote from a paragraph in Allan Wilson's letter, which says:
"The division between replacement and new assets has to be assessed at a project level".
That is fine, but there are problems because not all projects are new or replacement—the definition acknowledges that some projects will both replace an item and enhance its performance. The committee should be clear that the split is a matter of judgment; it is not a precise measurement. The decision to make a one third/two thirds split is eventually taken by a minister. I understand that the WIC was also advised of that before the strategic review started.
I am loth to interrupt, but I wonder whether you have seen the letter from Allan Wilson. The e-mail copy does not have a date.
That is the one that I am referring to. The little paragraph about the division between—
The paragraph that is entitled "Replacement vs. new assets"?
Yes. Allan Wilson makes it clear that
"the current capital investment is broadly divided into one-third enhancement and two-thirds renewal".
All I want to say is that the committee should be clear that, as with all such matters, a political judgment was made—the minister determined that. All such matters, including depreciation assessments, in the end require a judgment, whether or not it is accurate; they are not a precise measurement.
Later on in the same sentence, it is stated that the judgment in question
"is based on the best information available from Scottish Water's knowledge of their assets."
Scottish Water gives the advice, but the minister takes the decision. It is important that the committee appreciates that he also sets the borrowing consents, because the language has inferred that the WIC sets them. The WIC advises. I have not examined the WIC's report, but we know from the debate that is recorded in today's newspapers that the WIC was not unduly happy about the extra £100 million that was allocated. That was a political decision. The initial decision was to allocate £500 million—£300 million plus the £200 million margin that was taken in 2001. I think that Andrew Scott mentioned that in evidence, in reply to a question from Jim Mather. He said that a further £100 million was recently added to the £300 million plus £200 million. That goes against the advice that the WIC has given in the strategic review. That is why his paper is quoted in the press today.
Much of the confusion arises on the difference between the public spending limits and the borrowing consents. There is an assumption that different people were taking the decision, but those decisions are all taken by ministers.
In 2001, the commissioning letter sought the WIC's advice on the revenue caps, on the scope for efficiency gains and on a prudent level of borrowing within the expenditure limits. The WIC was given a fairly clear brief on what to provide; he was also told to ensure that his advice would allow Scottish Water to improve its standards and quality. I hope that everyone is clear about the role. I just wanted to make clear where the buck stops.
There is a related point, on the evidence that the committee received on the commissioning letter. If I understand the criticism, it suggested two things—that there was a single control and that the department did not follow Treasury advice by setting an absolute limit. I want to put it on the record that I disagree with both those interpretations. The phrase "£299m plus profit" was interpreted as a single control figure. The decision to use profits in that way is a local decision for the Executive; it is not part of the framework of control. The Executive could have decided to use the money to pay off debts, for example. In addition, that part is not public expenditure, so I do not see how it can be a single control figure. We do not control profits—the control on profits is a minimum requirement to make 6 per cent. In 2002-03, the figure was more than 7 per cent, so more was available, but that did not affect the limit. We have a capital budget for new expenditure that has two funding streams—borrowing and the income from profits.
Secondly, there is the claim—it is recorded in Ross Burnside's note—that
"the Commissioning letter from Ross Finnie to the WIC wrongly states that the borrowing limit is an absolute limit at a time when HM Treasury guidance states that borrowing limits should not be treated in that way."
That statement is accurate as it refers to most departmental expenditure, but it is not accurate in the case of public corporations.
When Gordon Brown set up the new system, he was desperately keen to ensure that capital expenditure was protected. He made it clear that there had to be a single control figure for capital budgets. The spending review document of 2000 states:
"separating spending into a capital budget and a resource budget … with limited flexibility … ensures that essential capital investment is not squeezed out".
Clearly, there are two different controls. On page 146 of the statistical annex, which deals with resource accounting and budgeting, the non-self-financing public corporations' capital expenditure scores in departmental budgets—in departmental expenditure limits—rather than in accounting adjustments in annually managed expenditure, as the committee was told in evidence. That is precisely the approach that the Executive took in this case.
These are important issues and I want to ensure that members understand them fully.
Those comments are helpful. As I indicated earlier, the reporters—perhaps with the help of Arthur Midwinter and the clerks—need to produce a revised draft of the report that they have written that takes into account the information that we have received. Ideally, a revised draft report would be available for consideration at our committee meeting on 9 March. That means that we would need to complete drafting by the preceding Friday—5 March. The issues with which we are dealing are so complex and there are so many different avenues that we could go down that we may not be able to deliver to that timetable. However, I am keen that we should try to do so. I am prepared to commit my time and effort to achieving that. I know that the reporters would like to get this matter sorted out. Is the committee happy to receive a revised draft report in the way that I have suggested? We could have the discussion to which Fergus Ewing referred in that context.
I cannot speak on behalf of the committee, but a considerable number of issues have been raised by the WIC's letter and by his report, which is considerable. The report begs a number of questions that I would like to have clarified. I would also like further clarification of the response that we have received from the Scottish Executive, which is a bit thin, as it focuses only on 2001-02 and totally ignores the period from 2003-04 to 2005-06.
I take the point that Arthur Midwinter made about the percentage, the breakdown and the ministerial decision regarding new assets and renewal. However, I would like further clarification of when the one third/two thirds division was established formally as the formula. It is quite different from the approach that was taken in the strategic review and from what happened in 2001-02 and 2002-03, although clearly convergence was taking place. There are a number of questions that need to be examined and a hell of a lot—excuse my French—to assimilate in a very short period, including some of the new information that Arthur Midwinter has provided verbally.
In the latter years, the problem is certainly not a RAB problem. By that time, we had returned to a system of cash control. However, the division has not been one thirds/two thirds because of slippage in capital spending. More than 80 per cent of spending was on replacement.
Eighty-six per cent.
The cost of the programme is now set at £600 million and £1.2 billion. The strategic decision to set funding for new assets at £600 million was taken recently. However, I understand that the initial decision was taken in 2001.
It is important for us to see the audit trail and the timing and evolution of decisions, so that we can get a firm handle on the matter. Has Scottish Water been managed to optimise the competitiveness of the Scottish economy? That is the nub of the issue. Could things have been done better and more effectively? Are we loading on to industry costs that could well have been alleviated and spread over a longer period of time?
The nub of the issue, as I see it, is how we take the arrangements forward from here. That is probably the most immediate concern, but I recognise that there are some audit issues, which the Auditor General for Scotland and the Audit Committee may want to pursue in due course.
If members are agreeable to the approach that I have outlined—and getting it finished will put a lot of work on the reporters, on me and on the clerks—all the issues that Jim Mather has raised can be taken account of. We shall simply give it our best shot and try to produce something that we can kick around on 9 March.
I have battled for some weeks now to get my head around the submission by the Cuthberts on whether or not two hundred and something million pounds was denied to Scottish Water and whose fault it was. I have asked frequently and have heard different views from different people about whether it is just an accounting trick or whether the figures are really relevant. Will the draft report that we are talking about address that once and for all and will we come out with our view as to what that was all about?
We shall try to come out with our view on all those issues. If the issue is the £299 million, Arthur Midwinter may be able to give us an indication of where that figure comes from and whether it is valid.
The £299 million is the Executive's figure—the RAB control figure—but confusion arises for everyone because, although there was a RAB system in operation, the cash control was always the crucial thing on the borrowing limit. In the final stages of the budget, the figures get converted to cash, so it is actually the lower borrowing consent that is the crucial thing. That is not the same as the £300 million, which includes an allowance for RAB. The argument, as I understand it, is that the difference between the Executive's figures and what were described as the WIC's figures was around £400 million over the four years. My view is that that is simply the difference between the two sets of decisions that were taken and that it is not an accounting error at all.
It is a bit difficult. I understand why people want to get to the bottom of it, but it is wholly impractical for the committee to try to reopen that decision, which was suggested. The decisions were taken in 2001 under an accounting regime that was dropped the following year. That accounting regime does not exist any more, and that is what the argument is about. Since then, there have been huge EYF transfers of more than £200 million, so the money that was called the buffer is not there any more. The budget has now been reduced to £680 million—it is no longer the £900 million that it was—and the Treasury has confirmed its view that there was no double counting. Therefore, although I understand the intellectual interest in the issue, I do not believe that, from a practical point of view, the committee should spend a lot of time on the matter when it is not going to get any practical result from such an exercise.
What is of concern to me is the rationale for the 100 per cent EYF being given to Scottish Water, given the past problems of underspend on the programme as a whole. In light of the strategy that has been decided, convener, you may be happy with the suggestion that we should pursue that issue. We already know that, in the first year, the expenditure was £51 million, so there has already been £100 million slippage. Now, £80 million has been kept back as the buffer, which is quite small compared with the previous figure. What happens if there is slippage over the four years? Scottish Water has four-year EYF. What will happen if, at the end of the four years, there is £150 million slippage? I would be quite happy to try to resolve that at official level and just to feed a note in, if members are happy with that. You may feel that you need a formal response but, given the timetable, I would probably get the answer quicker sitting round a table with the officials.
It would certainly be helpful to get whatever information we can.
To pick up on Ted Brocklebank's point, I do not think that the committee will be able to answer every question that we could possibly ask. That is just not feasible, but our investigation has already triggered off some significant changes. The fact that there is now going to be a review of the framework of charges is a product of the work that we have already done. What we need to do is to use our report to highlight those issues where we feel there is some concern or controversy, to identify what we have found so far and to try to point to questions that still need to be resolved. I do not think that we can package it up completely with a bow, but we can give it our best shot and try to get the understanding that we need. We will, I think, deliver greater transparency and also ask for there to be greater transparency in future. That is certainly the substance of the discussions that have taken place among the reporters.
In order to make tidy that great plethora of data, to pull things together and to get some momentum so that Jeremy Purvis and I can even aspire to giving a clean pass back to the committee and beyond, would it not make sense for us to try to allocate a substantial chunk of time—perhaps on Friday 5 March—to breaking the back of the issue, rather than trying to do it in hurried, ad hoc meetings?
The three of us can have a meeting this afternoon and work out our timescale for producing the report. That is really a matter for us. Our commitment to the committee is to try to deliver something to the clerks by 5 March so that it can then come before the committee. Are members content with that approach?
Members indicated agreement.
I remind members that we are meeting on Thursday from 12.45 until 2.15 to discuss the latest monthly report on the Holyrood project. The monthly report will be available to members at the close of this meeting and will be released to the press thereafter.
Meeting closed at 12:47.