Public Audit Committee

Meeting date: Wednesday, October 26, 2011

Official Report 411KB pdf

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Section 22 Report

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“The 2010/11 Audit of the Scottish Government Consolidated Accounts”

We move on to item 3. I invite Mr Black to contribute.

The report that you have arises from the audit of the Scottish Government consolidated accounts for 2010-11. It was published on 3 October. I give an unqualified opinion on the accounts, but the report brings to the attention of the committee and the Parliament some transactions that are reflected in the accounts that relate to the loss of European funding to Scotland.

I will start by mentioning the background to the issues that are highlighted in the report. There can be no doubt that Scotland benefits from a significant amount of European funding, which helps to support public spending on economic development, farming, the rural economy and fisheries. The amounts of money for those areas are included in the Scottish budget and the associated income and expenditure are reflected in the Scottish Government’s consolidated accounts.

Within the broad policy framework that is established by the European Union, the Scottish Government has some discretion over how the funding is applied, but it must comply with detailed rules about the checks that must be done on the eligibility of applications for assistance under European programmes and the payments that are made.

10:45

The European Commission conducts its own audits to determine whether the required checks are in place. If it finds that they are not in place, it can withhold funding, leaving the Scottish Government to meet the costs from its own resources. The Commission does that through applying what are known as financial corrections, which are, in effect, a form of repayment. The system is designed to protect the European budget against the risk that ineligible expenditure has been charged to it. It also provides a strong incentive to ensure that national Governments and their agents have in place the management and control systems that are required under European rules.

My report highlights that as a result of such financial corrections, £51 million of European funding for programmes running between 1994 and 2006 has been repaid. The report also states that further repayments are likely to be required in relation to other European funding programmes over the years since 2000. At the moment, those further repayments are also estimated to be around £51 million.

I consider that all those repayments represent a loss of European funding to Scotland. They arise because Scottish Government procedures have not been meeting the standards required to ensure that the use of funds complies fully with European legislation. Under the accounting rules, the Scottish Government consolidated accounts include provisions for those repayments based on the best estimates of the final amounts before they are finally settled. Once the amounts are settled, they are met from those provisions. The relevant transactions are reflected in the 2010-11 accounts.

There is a fairly long time period—it runs over many years—between the European Commission identifying issues and settlement finally being made. In part, that is due to the time that the European Commission takes to conduct its investigations, but it is also the result of the time required to discuss and negotiate the amount to be repaid. During that time, the Scottish Government is able to undertake additional checks and provide further eligibility information relating to the payments that it has made. If the Commission accepts that, it will limit the final amount that it seeks to recover.

The Scottish Government has undertaken a significant amount of work, which has had the effect of limiting the settlement for previous European structural fund programmes to the £51 million. Those amounts are now agreed and settled.

A similar approach is being taken to the European agricultural guarantee fund. Discussions with the European Commission about that are continuing and, until they are concluded, the amount that will be recovered by the Commission will not be finally confirmed. The timescale for that is uncertain, but I am hopeful that discussions are nearing completion.

The Scottish Government has made some important changes to the way that it manages European payments since the time of the original audits. Those arrangements will be tested through an on-going programme of European Commission audits. I will continue to monitor progress through the annual audit.

I have highlighted in the report two other issues relating to more recent audit findings. Both relate to concerns about the checks that are being done by the Scottish Government on other aspects of European funding payments. In one case there has been an interruption in regional assistance payments, which in effect means that the flow of funds has stopped coming through for a period, but that issue is now resolved. In the second case, the issues are subject to a current European Commission audit and remain unresolved.

Looking to the future, I think that it is important that the Scottish Government continues to address concerns about the management and control of European funding programmes. The Government must ensure that it learns the lessons from its experience of previous programmes and applies them in the future.

I have with me my colleague Mark Taylor, who leads the team that audits the consolidated accounts. He will help me to answer any questions that you might have.

Clearly this is a matter of concern, not only because £51 million had to be repaid but because it is estimated that there will be a further likely repayment of £51 million. To put it in context, are you able to give us a total figure for how much was received in European funding for that period? What kind of percentage do those payments represent?

We have tried to do that and to give a feel for scale in the report. Total structural funding during the period was well over £1 billion and we have quoted figures in paragraph 13 to give a feel for scale. Because of the timeframe, it is difficult to match up two periods, but we have given a feel for scale that less than 5 per cent of the programme was repaid through these financial corrections. We have also tried to give a feel for the annual scale in relation to annual budgets in table 1 in the report. It is fair to say that the proportion is relatively small, but the absolute amounts are still significant.

I am aware, over the years, that many countries have had similar problems with repayments of European funding. How much of this was a failure by Scottish Administrations to apply the rules properly and how much was it a failure by the European Commission, first to clearly explain the rules and parameters within which the funds should operate, and also to monitor and audit what was happening? It seems strange that the problems have built up over many years and yet nothing seems to have been done. How much was this a failure by Scottish Administrations and how much was it a failure by the European Commission to explain properly?

It is difficult to apportion responsibility. European regulations set out clearly the criteria for the award of any assistance and there is no doubt that the controls that the European Commission expects to see in place are testing ones. At the same time, as the report indicates, there has been clear evidence that the controls being operated within Scotland do not measure up to that standard. You are right, convener, that Scotland is by no means alone in this; the Auditor General in England has reported on expenditure down there, and there have been issues in Northern Ireland, too. We are not unique in Scotland in having these problems, but nevertheless we think that the issues are significant enough to draw them to the attention of Parliament.

At what level did the problems arise? Was it at a Scottish level, through the Scottish Executive or Scottish Government, or was it in the programmes and the applications made by the local programmes?

The short answer to that is both. On the structural funds programmes, it was a case of oversight and direction from the Scottish Government; the way in which, at the time, bodies called programme management executives also applied those controls; and the interface between those two. Of course, the buck stops with the Scottish Government and that was clearly understood. The European Commission auditors, in reporting on that, made the point that it was an oversight issue for the Scottish Government. It is fair to say that, on structural funds, it was a mixture of both.

The payment agency for agricultural funds is the Scottish Government and there is no intermediary in the same way, so responsibility for that lies with the Scottish Government.

I realise that the rules are complicated, but, as Mr Black said, the European Commission lays down a very detailed set of rules and expectations. Are these problems that could and should have been avoided?

Essentially, I think that the control environment should have been stronger from the outset. We all have to recognise that hindsight is a wonderful thing and, with the benefit of hindsight, it is unfortunate that the controls were not as strong as they should have been in order to comply with European requirements. Having said that, I can say that the Scottish Government has been paying close attention to this over recent years and the audit team is confident that it has been strengthening the controls that have applied.

The control environment is an interesting angle from which to come at this issue. The date to which the problems relate predates devolution. Was the control environment that was inherited from Westminster at devolution deficient? Was no effort made at that time to consider whether the control environment needed to be made more robust or altered in any way? Was it simply inherited and continued with, despite the deficiencies that existed?

The largest financial correction relates to the European social fund for the period 2000 to 2006. It starts on the cusp of devolution and runs to 2006. As I mentioned in my on-going remarks, there were still outstanding issues relating to the next programme of work, running from 2007 to 2013; so, this has been an issue over a significant period. The audit that we are discussing is confined to the consolidated accounts for 2010-11. Over a number of years, however, the audit team has commented in the final audit report on the risks associated with the control environment. The risks have been known for some time and the controls have been subject to attention and improvement over a number of years.

I note, in table 2 in the report, that some of the figures date back to 1994, which was 17 years ago. I know that things sometimes move slowly in Europe, but that is a long time to catch up on some of the issues.

Systems of financial control and so on are surely not new. We are familiar with those audit principles when we engage with ERDF and EU structural funds management. Why were the issues not raised at the time, during the progress of some of the programmes, so that compliance could have been corrected and delivered as we were working through the programmes? Why have we waited five, six or seven years to be handed a bill requiring us to pay money back? Why can the corrections not be made while the programmes are in progress?

I am sure that Mark Taylor can help you with that. You must recognise that the European Commission applies its audit resources to the programmes after the event—it goes back to examine previous transactions. It must then make a judgment on whether there have been breaches of the rules and controls that are required. After that, there is an extensive period of checking within the Scottish Executive—latterly, the Scottish Government—and a period of negotiation with Europe on the matter. In the case of the £51 million that I highlighted, it has been possible to reduce the amount of the repayment to that level as a result of the negotiations. It is perhaps understandable that these things can take a number of years.

Mark Taylor may want to add some detail on that.

Yes, just to be clear on the timing of the audit process. The audits that the European Commission conducts are real-time audits that look at, and report on, the controls that are in place at the time. The delay happens as a result of that. All payment agencies and national Governments are able to demonstrate that any weaknesses in controls did not lead to ineligible expenditure, and that is what takes a lot of time. The audit takes place when the controls are in place and on the controls that are in place at that time. I will use an example to give members a sense of the timeframe. The audits relating to structural funds were carried out broadly between 2003 and 2005. It has taken until this year for the issues to be resolved, but the controls were assessed at that stage. The Scottish Government seeks to learn from that in order to improve and strengthen its control framework, which it has done in the case of structural funds.

On the agricultural funds, the issues at stake run right up until 2009 and early 2010, which is when the audits were done. Audits are carried out close to the controls, and it is the discussion and negotiation after that which take time. The system allows a national Government—in this case, the Scottish Government—to make every effort to show that it has looked at the cases, gathered evidence and tested it. Once it has presented that evidence, there is a negotiation of the ultimate figure.

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The sums that we are talking about are large. Will you give us a feel for the type of problem that is causing the issue? Is it overpayment on individual projects, or individual projects engaging in activities that were not relevant?

Part of the problem is the range of issues that are subject to such financial corrections. In relation to structural funds, there are potentially five separate cases and, in relation to agricultural funds, there are potentially six separate cases. I will give you some useful examples. The most accessible of them concern agricultural funds.

Part of the process for claiming the single farm payment—area-based aids, to use the technical term—is that the Scottish Government must have in place an inspection process to ensure that the land that is in receipt of those subsidies conforms to the rules and requirements. Inspectors are in place to check a sample. The European Commission’s auditors came along and reperformed the checks. They found some deficiencies in initial checks, which meant that ineligible features in land—for example, bracken or lochs, which are not eligible for subsidy—had not been identified in the initial inspections. Therefore, they raised concerns about the inspection process, which was subject to further investigation.

I will give another example from the same area. One of the tools that the Scottish Government uses is a database of fields in Scotland that are eligible for subsidies. Again, the Commission’s auditors identified concerns about the quality of information in that database, how eligibility was recorded in it, the extent to which features such as lochs and bracken were recorded in it and simple matters such as which maps had been used and the measurements on them.

Those are the most accessible examples. In relation to structural funds, the issue was, again, the checking of eligibility. A common example concerns additionality. Support is available only when additionality can be proven—in short, the project could not be funded any other way—and the European Commission auditors determined that that was not being checked properly.

Is that additionality in terms of the outcome or the funding that was made available to support the European project?

I will oversimplify, because the complexities in the regulations on additionality are significant. The basic principle is that, if somebody else could fund a project, it is not down to Europe to fund it. In short, Europe funds business propositions that would not receive normal business funding.

Over the years, I have been aware that there were tensions whenever colleges applied for European funding. The issue was whether the local authorities in the past or, subsequently, the colleges themselves, through the Scottish Government, should fund the projects concerned. Often, it was at the margins and quite complicated.

I have a couple of basic questions. Paragraph 13 of the Auditor General’s report mentions that the repaid income that is shown in table 2 arises

“from the findings of European Commission audits undertaken between 2003 and 2005,”

which is years after the event. Is there no time bar on how far back the EU can go to investigate and recover money? Any Government that goes that far back into the past must have great difficulty in retrieving the proper records. That is just a fact of life. It must sometimes be difficult to justify the expenditure or to find the pieces of paper that are needed to justify it. That may be part of the problem; I do not know.

My second point concerns items 1 and 4 in table 2. They occurred prior to the establishment of the Scottish Parliament, but the Scottish Parliament is reimbursing the money. Would it not be more appropriate for the money to come from the Westminster Government, given that the Scottish Parliament did not exist during the relevant period and the money came from a different budget?

On the latter point, when the Scottish Parliament came into existence, it took over responsibility for everything that is reflected in the consolidated accounts of what is now the Scottish Government. As a result, the financial benefits were being achieved before devolution but the consequences have flowed through to post-devolution. The system is the same; it is just that responsibility has been devolved from the UK Government to the Scottish Parliament.

Mark Taylor will pick up on the time bar issue.

Under the closure process for each of the programmes, the audit results are resolved. When that happens, the programme is closed and the Commission moves on to the next. That is a normal part of the European process. On the question whether there is a time bar, there is no hard-and-fast limit to the length of time that the process might take. However, when each programme is closed, the next is considered and investigated.

With regard to structural funds, the Scottish Government is working with Commission auditors on the closure of the structural funds programmes that ended in 2006. That process is nearing conclusion and this work has been done to allow that to happen.

Just for clarification, is it the case that there has to be an active audit for each programme in Scotland and that it is not simply a matter of saying that, if it is not challenged within five or 10 years, everything is okay and we can move on?

The audit arrangements are very well defined and involve a number of parties. However, the arrangements for structural and agricultural funds differ. In essence, the European Commission oversees the audit but, with regard to structural funds, the Scottish Government is required to engage its own independent audit and appoints its own internal audit service to do that work, whereas with agricultural funds Audit Scotland does that work as part of a consortium arrangement. The findings from the on-going audits feed up into what the European commissioners are doing and, as a result of those findings, they might decide to undertake additional work or investigate a completely different area.

The important point about the regime is that there is not a lot of discretion in its application. Again, its workings and the role of individual auditors are all defined in the European regulations. I point out, though, that we talk to one another about these things and have been in communication with Commission auditors on certain agricultural issues, most recently as a result of their recent visit.

The quite defined audit process that is in place allows issues to be identified as we go along and I think that it would be wrong to characterise the process as one in which we look back a long time and find problems that arose years ago. Such problems are identified; however, it is taking a long time to resolve the financial consequences.

Table 2 sets out some of the European Commission’s concerns, including

“Insufficient quality and quantity of verifications of expenditure ... Quality and volume of financial checks”

and

“lack of control”.

Some oversights seem quite serious, while others are less so. Are you confident that since 2006 the more serious failures have been addressed? Indeed, can you give an example of how those more serious failures have been tackled? Are there still gaps and, if so, is the Government working on them?

For a number of years, the Scottish Government has been working hard to fix the more significant problems; in fact, we have recognised some of those improvements in the report. I realise that they are no longer called structural funds, but one good example concerns the structural funds programme for 2007 to 2013. As part of a new management and control mechanism that has been agreed between the Scottish Government and the Commission for checking payments, 15 per cent of each case is checked individually for compliance. That system is up and running; indeed, the interruption that has been mentioned was caused because the checks were not in place earlier in the year. However, they have now been introduced.

We are very much aware of the improvements that have been made to the inspection process. As I said earlier, we know that a good training programme for inspectors has been introduced; claimants are being educated on eligibility; and work on developing information from the land parcel identification system is on-going.

We sought to recognise in the report that significant effort has been made to address the historical problems and to highlight that there are still on-going issues in particular areas. The interruption, which has been addressed, was a recent example of that. The question in that regard was whether the new checks were in place. There are also on-going pressures with agricultural payments. The important point, as the Auditor General said, is that the Scottish Government is able to learn from its experience over the past years when it designs the compliance schemes. There is an issue around projects being approved at one stage but expenditure being made on those projects for a number of years afterwards. Projects take a while to run and if the controls are not up to scratch at the start, it is difficult to dig oneself out of that two or three years down the line. The Scottish Government has put a lot of effort into addressing that to get ahead of the curve and be able to deal with the issues for future programmes. That is what a lot of the auditors’ discussion has been about.

In a sense, you are saying that there is an evolving process but that it does not really matter what controls the Government applies or when it applies them because difficulties will probably always arise because of the nature of the funds.

There will always be rigorous checks and tests on whether the expected controls are in place, but I do not agree that it is impossible for the organisation to ensure that those controls are in place. In particular, the Government has learned about the need to pay close attention to the requirements when designing the initial systems. Our audit was unable to look back and give detailed reasons why compliance failure had happened, but it is apparent that close enough attention was not paid to the rules when the initial systems were set up and the initial applications and schemes were examined. I know that the Government has learned that lesson for its approach in the future.

I want to follow up on Humza Yousaf’s final point about how we ensure that compliance failure does not happen again, because that is a key focus. The Auditor General’s summary refers to procedures being evolved to try to deal with the problem, which seems to suggest that there is still concern about whether procedures that are being put in place will, in fact, meet European Commission requirements. Is there no way of getting greater clarity about that to ensure that there will be no repetition of compliance failure in the future?

I referred earlier to the well-defined audit process that is in place. As auditors, we will consider the issues in agricultural funds soon and report back to the European Commission on them, so they are on our radar. We felt that it was important to bring attention to the current pressures, although we will do on-going work to see how the improvements are put in place. We remain to be convinced in some areas, which may be because we have yet to look carefully enough or because controls have yet to be identified. The on-going audit process will test and review that.

It sounds as though there is still a risk that more sums might have to be repaid in the future.

The Scottish Government recognises that risk in its accounts; provision is made for additional sums and in its contingent liability disclosures in the accounts. Indeed, the permanent secretary, in his statement of internal control, recognises that there is an on-going risk as the issues continue to be addressed.

I have a final question for clarity about the agricultural funds. I presume that those are moneys that have been paid out over a period of time to individual farmers. Is there any question that they will be asked to repay moneys, or is it a Government debt that it will have to pay to Europe?

It is the latter of those two: it is a Government debt. There are policy questions for the Government about how it would deal with some of those issues going forward, but in terms of the financial corrections, the transaction is between the Scottish Government and the European Commission.

It is perhaps worth saying that there is absolutely no question of there being a risk of the final recipient being asked to repay money—it is between the Government and Europe.

That leads me on to my point, which Murdo Fraser touched on. The Government receives the funds from Europe and they are, by and large, disbursed to agencies, organisations and individuals. Controls can be strengthened at the centre, but there are key issues to consider otherwise—for example, in point 5 of table 2 in the report:

“Ineligibility of costs incurred by intermediate bodies”.

The disbursal of the funds relies on controls being in place not just centrally, but where the funds are disbursed to. What guarantees are there that that aspect is being looked at? For example, when the Government hands out money to an intermediate body, what guarantee is there that it has the appropriate controls in place to ensure that it has no ineligible costs?

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I mentioned earlier that one of the findings was about the Scottish Government’s oversight of such bodies. There are strong responsibilities on the Scottish Government to oversee that process rather than to say, “Well, we’ve handed out the money and it’s up to you guys to manage it properly.” There has been a strong education programme with intermediate bodies around the rules that they need to apply and the work that the Government needs to do in overseeing the application of those rules. The Scottish Government is much stronger on that sort of thing at the moment, but that will be tested through the on-going programme of audits.

Thank you for your contribution to the discussion.