House of Lords - European Union

Select Committee on European Union Fiftieth Report

CHAPTER 2: The Statement of Assurance: its development and its weaknesses; proposals for reform

16. Proposals for reform of the Statement of Assurance and wider financial management have come from, amongst others, the European Court of Auditors, the European Commission, the European Parliament and the Council. We summarise each of these in the boxes below.

Proposals for reform

BOX 1

Proposals from the European Court of Auditors in 2004 [12]

The European Court of Auditors proposed a new internal control system based on:

An effective chain of controls operating to common standards and clearly defined objectives for each level;

Applying, documenting and reporting controls openly and transparently;

A clear and simple legislative framework;

A definition from the Commission of minimum requirements for all levels;

Setting the type and intensity of checks with reference to costs and benefits; and

The Commission having responsibility for promoting improvements in partnership with the Member States.

BOX 2

Proposals from the Commission in 2005 and 2006

The Commission brought forward a Roadmap[13] and Action Plan[14] to an Integrated Internal Control Framework these:

A. Put new responsibilities on the Member States including requirements for:

Annual ex ante Disclosure Statements and ex post Statements of Assurance signed off at the highest level;

Each operational agency to make similar statements and declarations, backed up by independent auditor opinions;

The appropriate Supreme Audit Institutions to exercise oversight and report on design and operational weaknesses; and
The appropriate Supreme Audit Institutions to audit the ex post Declarations of Assurance and report the results to national legislatures.

B. Require from the Commission that:

Each Director General's Annual Activity Report must give a clear and sound basis for financial assurance, including appropriate indicators;

The Accounting Officer signs off the Commission's accounts annually;

The role of resource directors in the Directorates General are clarified and strengthened;

The Commission's follow up reports are strengthened so the Court can better asses what actions have been taken;

The management role of the annual synthesis report of the Annual Activity Reports is reinforced;
The scope for further rule simplification is explored;

A common methodology for risk assessment and for ensuring control requirements are proportionate to risk is introduced;

Guidelines on carrying out checks and controls are provided;

Types of errors and error rates for inclusion in Annual Activity Reports are defined; and

Cost-benefit analysis on the use of checks ex ante and ex post is used.

C. Seek to improve co-operation between the Commission and the Member States through:

A framework of incentive and coercive measures for compliance/non-compliance; and

A single audit system.

BOX 3

Reaction and proposals from the European Council in 2005

At the November 2005 ECOFIN meeting, the Council[15]:

Supported the Court's Opinion 2/2004 on the internal control system and the related issues of the simplification of Community legislation;

Reserved its position on the Commission's Roadmap and Action Plan, asking the Commission and the Member States to provide an assessment of the present controls at sector and regional level;

Reaffirmed the principle of shared management between the Commission and the Member States;

Did not support the introduction of national Statements of Assurance;

Encouraged the Member States who wish to do so to proceed with Contract of Confidence arrangements with the Commission for Structural Funds programmes;

Supported operational level Declarations of Assurance from the Directorates General as an important element in the assurance process;

Supported the strict distinction between internal and external audit, arguing that external bodies are not part of the internal control framework;

Did not support steps to further the current framework of cooperation between the European Court of Auditors and national Supreme Audit Institutions; and

Encouraged the European Court of Auditors to broaden the evidence base of the Statement of Assurance, to engage in dialogue with the Member States, to address the issue of multi-annual programmes, and to reach an understanding with the European Parliament regarding tolerable rates of error.

BOX 4

Proposals from the European Parliament

A In the annual ex ante Disclosure Statements (as proposed by the Commission) the Member States should include:

A description of the managing authority's control systems;

An assessment of their effectiveness;

A joint remedial action plan agreed by the managing authority and the Commission (where required); and

Confirmation by an external auditor or the national Supreme Audit Institution of the accuracy of the descriptions.

B The national Statement of Assurance should be based on a national equivalent to the Annual Activity Reports produced by the Directors General and should be signed by a competent minister or official.

C All paying agencies should be audited annually by an external auditor; their performance should be measured against pre-agreed indicators; failing agencies should have payments to them suspended or financial penalties imposed on them.

D The Commission should provide a Statement of Assurance on its accounts signed by the Accounting Officer and the Secretary General.

E The Court should engage further with national Supreme Audit Institutions in pursuit of the single audit process; and should extend its qualitative work.

The Statement of Assurance

17. The Statement of Assurance is provided for under Article 248 of the EC Treaty which sets out the general powers of the European Court of Auditors. These are:

to examine the accounts of all revenue and expenditure of the Community with a view to its legality, regularity and sound financial management; and to publish special and annual reports, to make observations and publish opinions; and

Additionally, the Court "shall provide the European Parliament and the Council with a Statement of Assurance (DAS) as to the reliability of the accounts and the legality and regularity of the underlying transactions". This Statement may be supplemented by specific assessments for each major area of Community activity.

That the Court of Auditors has these various general powers has been a source of confusion. We recommend that in future the annual examination and audit of all revenue and expenditure of the Commission should be separated from the broader objectives of the Statement of Assurance.

18. The idea behind the Statement of Assurance was to give a true and fair view of the accounts as a whole. The requirement for the Court of Auditors to provide such a Statement was included at a late stage in the drafting of the Maastricht Treaty with strong backing from the UK and Dutch governments and the support of the European Parliament's Budgetary Control Committee (COCOBU). The Court was not provided with any extra resources to carry out the Statement of Assurance, although in fact its staff numbers grew faster than those in the Commission in the years following Maastricht[16]. We reprint the full text of the Court's most recent Statement of Assurance, on the 2005 accounts, at Appendix 4.

19. To date there has never been a positive Statement given to the payments side. However, revenue and commitments have been judged reliable and regular in every year since 1994. The lack of a positive Statement has created a large amount of adverse publicity for the EU and has prompted the Commission and the European Parliament in particular to bring forward proposals to remedy the situation. Both of these Institutions see the achievement of a positive Statement of Assurance for payments as an important objective[17], and indeed this is the leitmotif for the Commission's 2005 Roadmap for an integrated internal control framework[18]. In his oral evidence to us, Ivan Lewis MP, then Economic Secretary to HM Treasury, underlined the concerns that many felt about the lack of a positive Statement of Assurance. He told us that "In terms of the credibility and the reputation of the EU, it is a disaster really" (Q 44).

20. As noted above we share the concerns raised with us over the lack of a positive Statement of Assurance from the Court of Auditors since 1994 and consider that improving the financial management of European funds must be a priority. We are pleased to see that the Commission and the European Parliament are actively addressing issues regarding European financial management which are raised by the Court of Auditors in their annual audits.

DAS Methodology

21. The legislation introducing the Statement of Assurance was permissive: it did not prescribe how the Statement should be conducted nor what methodology should be used. Furthermore it did not require specific assessments for each major area of activity. It was the decision of the Court itself to provide a single Statement of Assurance on all the accounts, rather than to provide a number of separate opinions.

22. We explored the decision to give a single Statement at some length during our inquiry, particularly with a view to comparing the Court's Statement with the statements and audits of other audit institutions. Sir John Bourn, Comptroller and Auditor General at the UK's National Audit Office told us that, were he required to issue a single Statement of Assurance on the UK Government's accounts in the same way as the Court of Auditors does for Europe's accounts, he, like the Court, would be unable to do so (Q 192). This is because last year he issued a qualified opinion on 13 of the 500 accounts of the British Government which he audits (Q 190).

23. We consider that the Court's decision to give a single Statement of Assurance on the accounts as a whole means that a positive Statement is difficult to achieve. We consider that it would be preferable for the Court to issue statements on each of the spending areas; in much the same way that the National Audit Office in the UK issues separate audits for each Government department. This would give a more accurate picture of the state of financial management in the Union and would make comparisons with other public bodies easier.

TRANSACTION TESTING AND THE DEVELOPMENT OF THE COURT'S METHODOLOGY

24. To provide this single Statement the Court initially relied exclusively on sample transaction testing, whereby a selection of transactions is checked for irregularities. These samples are assumed to be representative of all the transactions which take place and hence the global error rate is extrapolated. In practical terms, transaction testing means that teams of auditors investigate a series of transactions with a view to identifying any errors. The investigation of a transaction is a full and thorough process. According to Mr David Bostock, the United Kingdom's Member of the Court of Auditors, it involves "going right to the recipient, going to the farmer, going to the farm in some cases, going to the Structural Fund recipient to see what has actually happened" (Q 89).

25. Over the years, the Court has added new elements to the methodology behind the Statement. According to our witnesses from the Court[19], they have moved towards a risk-based approach. This includes the following:

An assessment of supervisory systems and controls;
A review of the Annual Activity Reports[20] and Declarations from each of the Directors General in the Commission; and
An evaluation of the results of other auditors.

Before implementing these changes, the Court drew from the experience of a number of other Supreme Audit Institutions including the National Audit Office in the United Kingdom. The changes are, for Sir John Bourn Comptroller and Auditor General at the National Audit Office, an example of how "the procedures of the European Court of Auditors have come closer to those of the United Kingdom" (Q 190).

26. However, as a number of our witnesses pointed out[21] the Court's methodology still relies heavily on transaction testing. In this context, we note that in its statement of November 8 2005, the ECOFIN Council saw operational level declarations of assurance from the Directorates General as an important element in the assurance process. The ECOFIN Council has encouraged the Court to broaden the evidence base of the Statement of Assurance, engage in dialogue with Member States, address the issue of multi-annual programmes and reach an understanding with the European Parliament regarding tolerable rates of error[22].

27. This continued reliance on testing a sample of transactions has been the focus of much critical attention. In his evidence, Terry Wynn, former MEP, implied that the Court is setting itself a near impossible task. He draws a distinction between the two aspects of the Statement of Assurance—the accounts on the one hand which are basically sound, and some of the underlying transactions on the other. He argues that the statistical sampling method chosen by the Court (Monetary Unit Sampling), coupled with the relatively small sample of transactions (initially 300, now 500+), examined by the Court "made it practically impossible to get below the materiality threshold of 1% decided for a positive DAS in respect of transactions"[23].

28. We concur with the observation that the methodology employed by the Court still relies heavily on transaction testing. Due to the small number of transactions actually looked at each year we do not consider that this methodology can lead to an accurate picture of financial management. The Court should aim to improve the methodology behind the Statement's production so as to provide more accurate data. We consider that these weaknesses must be remedied as a matter of priority so an accurate picture of the error rate can be obtained.

29. We are therefore pleased to see that the Court has responded to calls from the ECOFIN Council and added additional auditing techniques over the years. In particular we are pleased to see that the Court now conducts an assessment of supervisory systems and controls; reviews the Annual Activity Reports and Declarations from each of the Directors General in the Commission; and evaluates the results of other auditors. We consider that these need to be further developed to give a more rounded picture of performance over the year. In particular, greater use by the Court of the Annual Activity Reports could add positive pressure for their development into proper accounting tools.

THE MEANING OF AN IRREGULARITY

30. In addition to the debate over the distinction between the accounts and the underlying transactions there is confusion over what should be recorded as an irregular transaction. Terry Wynn argued that the Court's definition of erroneous transactions does not differentiate between intentional irregularities (viz. fraud) and those where there has been a substantial or formal mistake[24] [25]. Vice President Kallas, the Commissioner responsible for audit and anti-fraud echoed this in his evidence. He pointed out that the distinction between fraud and irregularity "is quite clear. An irregularity is just a mistake" (Q 189): it is not deliberate and could be, for example, as minor as a slight delay in making a payment. Fraud, on the other hand, according to Mr Nicholas Ilett, Deputy Director of the European Anti-Fraud Office, is "criminal activity, defined in the 1997 Convention as intentionally obtaining European funds to which one is not entitled or misusing them for the wrong purpose or depriving the EU of revenue" (Q 561).

31. We encourage the Court to put in place measures clearly to distinguish between irregularity and fraud and to publish separate figures for the level of fraudulent transactions and administrative mistakes.

32. Commissioner Kallas and Terry Wynn further argue that the overall error rate is exaggerated by taking both these types of irregularities into account. If the substantial or formal mistakes were discounted Terry Wynn goes so far as to assert that a positive Statement of Assurance could be made for payments[26].

33. Whilst the distinction between fraud and other irregularities must be made clear, we consider that administrative mistakes could still indicate deficiencies in the control systems operated by the Member States or the Commission. Attention should therefore be drawn to both administrative mistakes and fraudulent activity. Sources of error, from whatever quarter and for whatever reason under current definitions should be taken into account when calculating material error rates.

Dividing the Statement of Assurance into categories

34. As noted above, it was the decision of the Court itself to provide a global Statement of Assurance. According to Terry Wynn, the European Parliament's Committee on Budgetary Control has long asked for a "breakdown of the Member States or of the different areas like agriculture [or] structural funds" (Q 269). In the most recent Statement of Assurance available during the bulk of the evidence taken for our inquiry (for financial year 2004), some of our witnesses drew attention to the beginnings of the sectoral approach by the Court. Commissioner Kallas notes that the 2004 Statement gave a positive statement for the legality and regularity of commitments, revenue and payments for "the pre-accession strategy, administration and for agricultural payments covered by the Integrated Administrative and Control System (IACS), where properly applied" (p 34).

35. We support the recent decision of the Court of Auditors to produce a Statement of Assurance giving details of each of the areas analysed. We recommend that this should be developed into a Statement which concentrates on an analysis of the audits conducted in each expenditure category and Member State rather than on the single Statement of Assurance on all the accounts.

36. We note with approval the achievements made by the Commission in developing a system for agricultural payments which led the Court to give a positive Statement of Assurance to this area for the first time in 2004.

National management of European funds

37. A number of witnesses pointed out that the majority of the errors identified by the Court occurred in the Member States. According to one of our witnesses, "80-plus percent" (Q 273) of the errors which the Court identifies are in the underlying payments transactions which are administered by the Member States. For some, the real responsibility for these errors should properly rest with Member State governments rather than with the Commission. Terry Wynn notes that the European Parliament has repeatedly asked the Court to draw up a black list of errant Member States, but that the Court has refused to do so[27].

38. We support calls for the European Court of Auditors to produce a list of those Member States demonstrating poor management of European funds. We consider that such a list would encourage all Member State governments to take this issue seriously. Such a list should only be produced on the basis of accurate data and so will require the development of a sound basis for payment transaction sampling.

12 Opinion 2004/2 OJ (2004/C 107/01). Back

13 COM(2005) 252. Back

14 COM(2006) 009. Back

15 ECOFIN conclusions, 8 November 2005, 13678/05 (Presse 277). Back

16 Figures in Levy, R, 2000, Implementing European Union Public Policy, Cheltenham, Edward Elgar, Tables 2.5 and 2.6 pp. 49 and 52. Back

17 See Boxes 2 and 4. Back

18 COM (2005) 252 final; COM (2006) 9 final; COM (2006) 49 final. Back

19 Q 81. Back

20 On the basis of its annual management plan, each Directorate General monitors the realisation of policy objectives and establishes the link with the corresponding resources used during one year's activities. The annual activity report is also each Director General's management report to the Commission, concerning the performance of their duties. The the most recent Annual Activity Reports can be found at http://ec.europa.eu/atwork/synthesis/aar/index_en.htm. Back

21 QQ 192, 399. Back

22 ECOFIN conclusions, 8 November 2005, 13678/05 (Presse 277). Back

23 http://www.terrywynn.com. Back