HOUSE OF LORDS European Union Committee 50th Report of Session 2005–06 Financial Management and Fraud in the European Union: Perceptions, Facts and Proposals Volume II: Evidence Ordered to be printed 7 November 2006 and published 13 November 2006 Published by the Authority of the House of Lords London : The Stationery Office Limited £price HL Paper 270-II CONTENTS Page Oral Evidence Mr Ivan Lewis MP, Economic Secretary to HM Treasury, Mr Chris Austin, Head of EU Finance and Mr Chris Butler, Head of Assurance, HM Treasury Written evidence 1 Oral evidence, 2 May 2006 4 Supplementary written evidence 15 Letter from Ed Balls MP, Economic Secretary 17 Mr Hubert Weber, President, Mr Vitor Manuel da Silva Caldeira, Member, Mr David Bostock, Member and Mr Josef Bonnici, Member, European Court of Auditors Oral evidence, 16 May 2006 18 Commissioner Kallas, Commissioner for Administrative Affairs, Audit and Anti-Fraud, Mr Kristian Schmidt, Mr Brian Gray and Mr Reijo Kemppinen, European Commission Written evidence 34 Oral evidence, 6 June 2006 38 Supplementary written evidence 45 Sir John Bourn, Comptroller and Auditor General, Ms Caroline Mawhood and Mr Frank Grogan, National Audit Office Written evidence 45 Oral evidence, 6 June 2006 48 Supplementary written evidence 53 Mr Ashley Mote MEP, European Parliament and Mr Christopher Arkell Written evidence 56 Oral evidence, 13 June 2006 61 Mr Terry Wynn MEP, European Parliament Written evidence 70 Oral evidence, 27 June 2006 73 Mr Brian Gray, Accounting Officer, European Commission Written evidence 85 Oral evidence, 11 July 2006 89 Supplementary written evidence 98 Ms Marta Andreasen Written evidence 101 Oral evidence, 11 July 2006 106 Mr Jules Muis Written evidence 114 Oral evidence, 18 July 2006 122 Rt Hon the Lord Kinnock Oral evidence, 25 July 2006 132 Ambassador d’Ansembourg, Dutch Ambassador and Mr Peter Bartholomeus, Ministry of Finance, Netherlands Oral evidence, 17 October 2006 147 Mr Graham Meadows, Mr Nicholas Martyn and Mr Marco Panigalli, Directorate General for Regional Policy, European Commission Oral evidence, 17 October 2006 153 Mr Nicholas Ilett, Director, General Affairs and Deputy Head of the European Anti-Fraud Office, OLAF Written evidence 162 Oral evidence, 24 October 2006 166 Ms Rosalind Wright, Chairman, Supervisory Committee, OLAF Oral evidence, 24 October 2006 172 Written evidence Dutch Senate 176 Dennis Harrison 177 Danuta Hübner, Commissioner for Regional Policy, European Commission 178 John Purvis MEP, European Parliament 181 Lord Williamson of Horton 181 3458082001 Page Type [Ex 1] 08-11-06 22:08:12 Pag Table: LOENEW PPSysB Unit: PAG1 Minutes of Evidence TAKEN BEFORE THE SELECT COMMITTEE ON THE EUROPEAN UNION (SUB-COMMITTEE A) TUESDAY 2 MAY 2006 Present Alliance, L Jordan, L Blackwell, L Kerr of Kinlochard, L Cobbold, L Maclennan of Rogart, L Inglewood, L Radice, L (Chairman) Jones, L Steinberg, L Memorandum by HM Treasury The Government welcomes this inquiry. The Government has attached a high priority to securing improvements to the financial management and control of the EC Budget, in order to ensure it provides value for money for UK and other EU tax payers. There have been some important achievements in recent years, including during the UK Presidency in the second half of 2005. But it is clear that more eVort is required. The Government looks forward to the findings of this Inquiry, which will further inform ongoing policy eVorts. Questions What are the fundamental problems that have led to 11 successive years in which the accounts have not been given a positive statement of assurance? There are two fundamental issues: first, the audit methodology is very precise and so tends towards a negative assessment; and second, the quality of financial management is not consistently good enough. This is a shared responsibility between the Commission and Member States. There is always a small element of the budget that could be subject to financial mismanagement, and an even smaller element that may be subject to fraud. But it is fair to say that most of the budget is managed satisfactorily. However the nature of the ECA’s DAS audit, which relies primarily on old-fashioned transaction testing selected via a method of random sampling, is such that it tends to focus on errors and therefore tends not to take notice of the strength of the internal control system. It also tends not to distinguish between errors and minor irregularities, making it more likely that the audit will give a negative assurance. The ECA has recently expanded its approach to include an assessment of internal control systems and an examination of the declarations in the Commission Directorate-Generals’ Annual Activity Reports. Where appropriate, the ECA also reviews the findings of other external auditors. But it is still heavily reliant on transaction testing. The ECA sets a materiality threshold of between 0.5 per cent and 2 per cent of gross expenditure or revenue: this means that a very small level of discrepancy can lead to whole categories of expenditure failing to achieve a positive DAS. EC expenditure is complex and notoriously diYcult to manage. Any expenditure involving a subsidy or multiple sources of funding is open to abuse. And any spending that is controlled by complex legislation will be prone to confusion and error. A further factor is the complex nature of the chain of control, especially in those budget sectors where management of funds is shared between the Commission and the Member States. The Treaty establishing the European Community (Article 274) puts the Commission in charge of implementing the budget “on its own responsibility”. The same Article also states “Member States shall co-operate with the Commission to ensure that the appropriations are used in accordance with the principles of sound financial management”. But in practice many Member States regard financial management as solely for the Commission, even though some 80 per cent of the EC Budget is subject to shared management responsibility. This means the Commission is not always able to obtain adequate assurances from Member States about shared financial management in order to satisfy the ECA. 3458082001 Page Type [E] 08-11-06 22:08:12 Pag Table: LOENEW PPSysB Unit: PAG1 2 financial management and fraud in the european union: evidence 2 May 2006 Are the mechanisms which have been suggested by the Commission to improve management of the budget appropriate? Yes. The Government supported the “roadmap to an integrated internal control system”1 and, broadly, the measures that it proposed for the Commission, for Member States, and the ECA. But the key challenge will be to integrate control systems better, in order to fill the gaps in the chain of responsibility. The November 2005 ECOFIN conclusions laid out detailed measures to take this forward. Are these mechanisms likely to lead to a positive statement of assurance on a set of accounts by the end of the tenure of the Barroso Commission? The Commission’s strategic objective to strive for a positive DAS by 2009 is indeed an ambitious and challenging target and will require considerable eVort by itself alongside the co-operation of Member States. It is encouraging that the 2004 report gives assurance on a greater proportion of the budget than ever before, because of improvements on financial management and control in key areas of expenditure, but there is still a long way to go. The Commission’s Action Plan2 oVers the prospect of further progress towards the achievement of a positive DAS, perhaps most significantly through launching a dialogue between the Council and the European Parliament on the risks to be tolerated in the underlying transactions. The continuing eVorts to simplify complex legislation are also likely to have a beneficial eVect on the level of assurance achieved. But ultimately it is for the ECA to consider how any proposed changes impact on its approach and the level of assurance it can give. It is not possible to say categorically that a 100 per cent positive DAS will be achieved by 2009. However, there is a clear ambition by all EU institutions to work towards a positive DAS in 2009. Are there further steps which need to be taken? We intend to ensure that there is substantive discussion of Commission’s Action Plan–this is provisionally tabled for the May ECOFIN. However, we believe that many of the measures proposed would begin to make an impact as soon as they are implemented. In particular it is important to make progress against: — a principle of internal control in the general Financial Regulation; — agreeing on the requirement to provide an annual control statement (including an opinion on the legality and regularity of transactions) in the structural funds, to match the existing certificate for CAP funds; — an inter-institutional dialogue on the basic principles to be considered regarding the risks to be tolerated in the underlying transactions; and — facilitating the greater involvement of Supreme Audit Institutions in providing assurance. In brief, the Commission and all Member States need to improve their compliance with the legislation. Can lessons be learned from accounting procedures and practices in other countries? The Commission’s and ECA’s audit practices already comply with international standards to some extent. But they tend to rely more on transaction testing than the risk-based and/or value-for-money approach that most Member States use. Worldwide accounting and auditing practices tend to fall into two forms: — a legalistic/regularity approach where the audit is primarily concerned with the legality and regularity of transactions; and — a results or outcome focused approach where there is more interest in the eVectiveness with which objectives are achieved as well as accountability for how the money has been spent.