As you will remember, two years ago, Sub-Committee A conducted an inquiry into the European Court of Auditors (ECA), and we produced a report. The European Court of Auditors: The Case for Reform (Session 2000-01, 12th Report, HL 36). I am writing to you now to reiterate certain conclusions from our report on the ECA and to ask you to update the Committee on how the situation has developed since your initial response to the report.

  Our report highlighted a number of problems relating to the structure and functions of the ECA. In particular, the report warned that any enlargement of the European Union would accentuate these problems. The Committee concluded that urgent action was needed to ensure that the Court was properly structured and equipped to face this considerable challenge. The Committee is deeply concerned that, with the enlargement of the EU now imminent, it is still the case that very little has been done to reform the ECA.  

THE STRUCTURE OF THE COURT

  Amongst the number of suggestions for action which we put forward in our report, none seems to us more crucial to meeting the challenge of enlargement than the proposal to endow the Court with a highly-qualified chief executive, supported by a strong auditing staff, and reporting to a part-time, non-executive board of representatives from each of the Member States:

"The ECA's present structure of 15 members of equal status, one from each Member State, who act as a college, is in need of change and, come enlargement, will have to change. A Court with over 20 full-time executive members would be unwieldy, sluggish and ineffective. The proposal for a system of "chambers", a concept now incorporated in the Nice Treaty, appears to be merely a mechanism to absorb members without improving efficiency and is not radical enough to solve this problem. We accept the need for national representation to ensure the confidence of Member States in the ECA. However, this would best be served by the impartial .appointment of a highly-qualified chief executive, supported by a large team of audit staff, reporting to a part-time, non-executive board of representatives from each of the Member States. Such radical surgery would maintain the representation of the Member States and would considerably increase confidence in the ECA by strengthening the independent and professional nature of the audit function. Such an internal arrangement would in no way affect the ECA's external reporting requirements."

  During our inquiry, the Committee was encouraged that the ECA was beginning to pay more attention to the follow-up of previous observations. We recognise from its Annual Report relating to the 2001 budgetary year that the Court has now observed that it is frequently drawing attention to recurrent problems. However, the Court's desire not to get into political battles with other Community institutions and/or Member States will continue to inhibit more explicit criticism of those who take no action after errors have been identified. Counter pressures on Court members, to the extent that they exist, will be easier to resist if and when a radical reform endows the Court with an entirely professional and truly independent executive. This is just one of the many benefits that such a reform would deliver.

  On Tuesday 25 March 2003, when giving evidence to the Committee, Peter Hain, the UK Government Representative on the Convention on the Future of Europe, recognised that the ECA "could prove very difficult to manage with 25 full-time members." He said that this problem was something that the Government were "prepared to look at with an open mind." This is encouraging, but the Committee considers that the Government must be more pro-active in promoting reform of the ECA.

  In your response to the report, you said that the UK would have preferred a reduction in the number of Members of the Court to the system of "chambers" and would have considered "a system of rotation" but that these proposals did not receive general support in the IGC. Given the recent Council Decision on the voting modalities of the ECB, which introduces a system of rotation to the Bank Governing Council, are the Government or other Member States reconsidering the possibility of introducing a system of rotation to the ECA?

  Your response welcomed the Committee's proposal for an independent Chief Executive reporting to a part-time non-executive board of Member States' representatives. What have the Government done since to promote or explore further this proposal?

  Your response also mentioned the EIB as an example of an institution that combined representation of all Member States with a focused management structure. Are the Government advancing this model as a possibility for the ECA?

  Our report concluded that the time had come for an external management audit of the ECA to help determine how appropriate its structures are as it enters its second quarter-century. In our view, such an external management audit should be subject to a call for tender, and the resulting audit report should be addressed jointly to the Court of Auditors and to the two arms of the budgetary authority, namely the Council of Ministers and the European Parliament.

  You agreed that an external management audit could provide a useful contribution to the debate in advance of the IGC. What steps have the Government taken to instigate such an audit? How likely is it now that such an audit can happen before the IGC?

THE ECA SHOULD APPOINT MORE PROFESSIONALLY QUALIFIED AUDIT STAFF, IRRESPECTIVE OF WHETHER THEY ARE GRADUATES

  We concluded that the ECA's recruitment policy needed to be adapted so that the specific skills which applicants possess were taken into account. We argued that the recruitment of staff of the highest calibre would help the ECA to function as efficiently as possible.

  The Government agreed that it was important that ECA staff have the right experience and qualifications, to be able to carry out audits on Community revenue and expenditure. What changes have occurred to the recruitment policy of the ECA since July 2001? Are any other changes planned in this area?

  You mentioned that the UK was the only Member State to possess Chartered Bodies that could award professional qualifications and that the normal career path for an auditor or an accountant would be different in other Member States. What has been done to ensure the mutual recognition of qualifications and experience gained in the work place in order to ensure the mobility of accountants and auditors?

THE LENGTH OF THE DISCHARGE PROCEDURE IS EXCESSIVE AND NEEDS TO BE REDUCED

  We recognised that a dialogue between auditor and the body responsible was important, and that an element of negotiation, provided it was focused on getting the facts both correct and in perspective, was normal in global audit practice. However, we were concerned that too protracted a process alienated the European Parliament and risked inviting a public perception, exaggerated though it might be, of inter-institutional conflict resolved by fudging the audit.

  The Government acknowledged the problem identified by the Committee. What steps have been taken (or are planned) to reduce, the length of the discharge procedure?

  Your response mentioned that the Commission had proposed that it could ask for the official response from each Member State at an earlier stage, so that they could be taken into account during the discharge procedure. You mentioned that the Government supported, this proposal. What has happened to it?

FOCUS ON THE ANNUAL REPORT OF THE ECA AND FOLLOW UP WORK

  The Committee was deeply unhappy with the seeming indifference displayed at the Council's highest level to the auditing functions and findings of the ECA. Given the poor public perception of the management of the Union's funds, the Council should be more concerned with the criticisms made by the ECA. While the internal audit reforms in the Commission may bring substantial improvements, more rigorous follow-up to the Court's observations both in relation to the other institutions and to the Member States, remains a pressing priority. We urged the Council at ministerial level to focus on the Annual Report of the ECA as part of the process leading to their recommendation in the discharge procedure: does this now happen? What else has the Council done to address the criticisms made by the ECA? What changes, if any, has the Council introduced to improve follow up work on the ECA's observations?

EFFECTIVE COLLABORATION BETWEEN THE ECA AND THE SAIS IS CRUCIAL

  At the heart of the matter is the need for minimum standards of financial control in the Member States. It seemed to be broadly accepted that differences between systems of control were justified as long as each system was effective. We preferred, however, the delegated financial control system as used in the United Kingdom and welcomed the Commission's move to embrace it. Are there any further developments in this area?

  With respect to the different approaches to audit, we recognised that the ECA had to cope with cultural diversity and that that diversity would increase with Union enlargement. While we felt that it should not be beyond its abilities to assemble multicultural audit teams to handle it, we appreciated the Court's wish to see the Supreme Audit Institutions (SAIs) sharing as far as possible a common audit methodology. We agreed also that the institutions and the Court should, as far as possible, have similar competences and that in each country statutory rights of access granted to the SAIs should be as extensive as those enjoyed by the ECA. We therefore welcomed the actions being taken in various Member States (United Kingdom and Sweden excepted) to bring access for SAIs in line with that for the ECA. How far have such actions been taken? What effect have they had? What is the current situation in the UK and Sweden? To what extent can the EU be said to have a common audit methodology and how much will this change with enlargement?

  We shared the Court's satisfaction that the SAIs were, despite their heavy preoccupation with the auditing of national funds, paying increasing attention to the way the Community budget was being implemented by national administrations. To what extent is this still the case? What more could be done to encourage this process in the Member States?

COMMON DEFINITIONS OF FRAUD AND IRREGULARITY

  We found it strange that there was no agreement amongst the Member States and the institutions of the Community on definitions of fraud and irregularity. Is this still the case? Your response mentioned the work being carried out by the Advisory Committee for the Co-ordination of Fraud Prevention (COCOLAF) to reach agreement on the definitions. How far did this work get?

OFFICIAL FIGURES OF RATES OF ERROR, IRREGULARITY AND FRAUD

  We shared the European Parliament's frustration at having no official figures upon which to assess the extent of the problem of rates of error, irregularity and fraud. We suggested that if the Court had figures, it should publish them with full justification for claiming their accuracy. The Government agreed with our conclusion. Are such figures now published; and if not, why not? Does the ECA now give more details of specific problems in the different sectors—thus providing a qualitative as well as a quantitative assessment? Has the ECA introduced any features to the Statement of Assurance to allow the Council to measure progress and to make year-on-year comparisons?

THE CONVENTION ON THE FUTURE OF EUROPE

  Is the Convention expected to recommend any reforms of the Court? What representations have the Government or others made to the Convention on this issue?

THE INTER-GOVERNMENTAL CONFERENCE

  What plans do the Government have to discuss revisions to the structure of the Court at the forthcoming Inter-Governmental Conference? This Conference will present the Member States with a unique opportunity to equip the Court to meet the challenge of enlargement; it is an opportunity which we urge the Government to exploit.

10 April 2003

  We are grateful for your letter of 10 April to the Financial Secretary, seeking an update on progress with regard to certain conclusions of your report "The European Court of Auditors: The Case for Reform" (Session 2000-01, 12th report, HL 36). I am replying in her absence and hope you will be pleased to know that there have been developments on almost all the issues you raised.

STRUCTURE OF THE COURT: CONVENTION ON THE FUTURE OF EUROPE AND THE INTER-GOVERNMENTAL CONFERENCE

  The Government has examined further your recommendation on the future structure of the ECA following enlargement, and agrees that the present structure results in an organisation which will face increasing operational and management constraints following enlargement to 25 Members. We believe this should be addressed through a smaller Board of Auditors General, comprising nine Members drawn from the Member States, and which would report, as you suggest, to a part-time Governing Committee on which all Member States would be represented (and which might be drawn from the Heads, Deputy Heads or former senior members of Member States' National Audit Authorities). Although Members of the Board of Auditors General would be completely independent in the operation of their duties, for this proposal to be acceptable to all Member States the selection of Members of the Board of Auditors General would operate on a system of strict rotation. The Government has submitted a paper proposing this new structure to the Convention on the Future of Europe and a copy of this is attached. We will press for this proposal to go forward to the next Inter-Governmental Conference. And these changes to the structure of the Court would also have knock-on benefits applicable to other recommendations you made—in that it should free up resources for other activities and help better to direct the resources that are available.

  There have been no further developments to date on commissioning an external management audit of the ECA. We still believe that such an audit could provide a useful, although not essential, contribution to the debate on the structure of the ECA. But it is important to note that the ECA's annual audit by KPMG is not solely restricted to financial matters—as this quote from the latest audit report demonstrates:

"We therefore examined very closely the control environment, risk evaluation, control activities, information and communications systems and management procedures of the European Court of Auditors. The initial descriptive phase was followed by systems evaluation based on sample checks of supporting documents and interviews with staff. The nature and extent of our tests were determined by our appraisal of the control environment. In our opinion the current internal control rules ensure that the operational objectives are achieved satisfactorily, the financial statements are reliably drawn up and the legal framework is complied with."[14]

RECRUITMENT OF PROFESSIONALLY QUALIFIED AUDIT STAFF

  Competitions held by the ECA since you published your report have stressed that a relevant accountancy qualification is an acceptable alternative to a University degree. However, in the UK, most professional accountants do tend to be University graduates anyway. At the ECA, the great majority of staff recruited during recent years had had accounting or financial experience. It is true that there are currently few UK accountants employed by the ECA—this is thought to be due to lack of interest in the posts rather than lack of opportunity. In addition, extra resources freed up thanks to a better management structure would of course allow more auditors to be recruited.

LENGTH OF DISCHARGE PROCEDURE

  As you recognised, it is important that audit findings are agreed between auditor and auditee and it is inevitable that this "contradictory procedure" takes a lengthy period between the end of a financial year and the publication of the ECA report in the late autumn of the following year—and thus serves to delay the actual discharge procedure. The new Financial Regulation (Article 142) sets down clear dates by which the Court must submit its report to the Commission, and by when the Commission should respond. And a further, new, requirement, states that on publication of the report, the Commission must immediately inform the Member States of relevant findings. Member States then have 60 days to make their response, which must be summarised by the Commission and transmitted to the Court of Auditors, the Council and the European Parliament, by 15 February of the following year—so that the Council and European Parliament may take account of them during the consideration of the discharge recommendation. The new Financial Regulation came into force on 1 January 2003, and as part of the process towards discharge of the 2001 budget, earlier this year, the Commission respected the new deadlines in providing a summary of Member States' responses to the 2001 ECA report.

FOCUS ON THE ANNUAL REPORT OF THE ECA AND FOLLOW-UP WORK

  As our response to your report stated, we believe that there is already significant ministerial involvement in the consideration of the ECA Annual Report. But the report focuses on a considerable number of details, some of which are highly technical, and we acknowledge that these must be considered and responded to by the experts responsible at official level. And I am pleased to report that the new Financial Regulation (a Council Regulation) now provides a legal base (in Article 146) to require Member States to inform the Commission of measures taken to remedy shortcomings identified by the ECA, so that the Commission may take these into consideration in its follow-up report. Thus the Council has succeeded in strengthening the follow-up process.

EFFECTIVE COLLABORATION BETWEEN THE ECA AND SAIS

  You asked about developments in delegated financial control at the European Commission. The new Financial Regulation imposes clear standards of accountability at all levels, by making authorising officials responsible for their financial decisions. The publication of the first Annual Activity Reports by all Directorate-Generals—which include a declaration of assurance signed by each Director-General—provides an explicit demonstration of the Director-General's personal responsibility and accountability for the management of the resources at their disposal.

  On the question of a common audit methodology, it is reasonable to expect that both Member States and the European Court of Auditors will endeavour to comply with international auditing standards. And on the question of comparable access rights by Member States' Supreme Audit Institutions, I am sure you are aware that the Government's response[15] to Lord Sharman's report "Holding to Account"[16] undertook to provide statutory access for the Comptroller and Auditor General which will include access to bodies and undertakings in receipt of grants, and access to documents held by bodies in relation to contracts they have with organisations where the C&AG is the statutory auditor, and this will extend to access to associated documents held by sub-contractors. This is very similar to the Court of Auditors' right of access to "any body which manages revenue or expenditure on behalf of the Community and in the Member States, including on the premises of any natural or legal person in receipt of payments from the budget"[17] This new statutory access will be provided by using the order making provision in the Government Resources and Accounts Act, and this provision enters into force on 23 May 2003, following Parliamentary approval of an order.

  Sweden has also made some changes in the rights of access of its National Audit Office and from 1 July 2003 it will be able to audit final beneficiaries. However, it will not be unable to audit funds transferred directly to local authorities, limited companies or private persons, and so will continue to have less favourable access than the ECA.

COMMON DEFINITIONS OF FRAUD AND IRREGULARITY

  Since your report was published, a significant step has occurred in the definition of fraud by the coming into force on 17 October 2002 of the Convention on the Protection of the European Communities' Financial Interests (known as the "Fraud Convention") following ratification by all Member States. This means that a common definition of fraud, as stated in the Convention, is now agreed by all Member States. However, there are some practical difficulties in the interpretation and classification of fraud against the Community budget in a consistent way by all Member States (particularly with regard to the legislative requirements to report irregularities to OLAF) and it was to try to reach a better consensus on this that the Advisory Committee for the Co-ordination of Fraud Prevention (COCOLAF) discussed the question of common definitions of fraud and irregularity in considerable detail. Some Member States have legal difficulties with the application of the term "fraud", which they can only apply when a successful conviction has been made. COCOLAF agreed that in future we should use the category "suspected fraud" to apply to cases where "deliberate intent" to commit an irregularity can be demonstrated. With the help of Member States, OLAF is compiling a database of categories of "suspected fraud" cases in the main budget sectors.

OFFICIAL FIGURES OF RATES OF ERROR, IRREGULARITY AND FRAUD

  As you know, the ECA has not published a global error rate since 1996. This is mainly because it was subject to misinterpretation by the press, and could not be used to compare progress from year-to-year since it was extrapolated from a small number of sample transactions audited from different budget sectors. But the ECA recognises that there is a need to compare financial management from year to year—and is currently working on a series of new indicators which will provide a basis for future comparison.

  While the Government agreed with your conclusions that accurate figures for fraud and irregularity should be published, it is not the ECA's job to publish such an analysis. The ECA audits only a small sample of transactions and it would not be appropriate to extrapolate these audit findings. However, the European Commission publishes an annual report "Protection of the financial interests of the Communities and fight against fraud" (known as the "Fight against Fraud" report), which is prepared by OLAF and contains figures and analyses of the actual irregularities detected by Member States and reported to OLAF. OLAF's new Directorate of Intelligence, Operational Strategy and Information Technology now has the staff and the tools to analyse these reports and, for the first time, the 2001 "Fight against Fraud" report carried a brief analysis of classifications of irregularity and fraud. Given that 70-80 per cent of the budget is spent within Member States, OLAF is reliant on others for much of its data, but with our help operating common and agreed definitions, OLAF will be able in future to refine this analysis further.

30 May 2003

15   Audit and Accountability in Central Government, Cmnd 5456, March 2002. Back

16   Holding to Account: The Review of Audit and Accountability for Central Government, February 2001. Back

17   Treaty establishing the European Community (2002), Article 248(3). Back