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To the public hearing – Committee on budgetary control “EU’s financial management: Fact, fiction and future”

Mr Vítor Caldeira, Member of the European Court of Auditors
Presentation of the establishement of a Community Internal Control Framework

To the public hearing – Committee on budgetary control “EU’s financial management: Fact, fiction and future”

Brussels, 4 October 2005

I would like to thank you M. FAZAKAS and the honourable members of this Committee for the kind invitation to participate in today’s seminar.

I will share with you some topics relating to the establishment of a Community Internal Control Framework following the European Court of Auditors (ECA) opinion. An improved internal control framework is a key factor for an efficient financial management and control of the EU funds.

However, while recognising this fundamental issue, the debate seems to frequently divert to an idea where one assumes that “if we have an integrated internal control and audit framework, then we will automatically achieve a positive DAS”, thereby simply reducing the EU’s financial management to a DAS problem. This confuses the issue of the responsibility for the quality of the EU’s financial management with the role of its independent external auditor to provide objective opinions.

I hope that today we can avoid these misunderstandings. The statement of assurance can only reflect the Court’s audit findings on the reality of financial management in the large scale and complex environment of the EU. The Court audits reality not fiction.

The Court’s DAS audit is governed by the provisions of Article 248 (1) of the Treaty. It has to be objective, professional and useful, together with other Court output, to the discharge authority and other users.

As other speakers have reminded us today, these are the tasks of a public audit institute in a democratic polity.

Because the Court has to be objective our message is not always nice to hear and not always welcome. We report on EU expenditure as we find it. A lot of that expenditure is high risk – payments dependent on information for beneficiaries. There are often very complex eligibility rules – more rules, so more rules to break. And then there are all the well known problems of shared management and delegated responsibility.

It is therefore perhaps not surprising that the Court has been unable to give assurance about the legality and regularity of a large part of the EU spending.

A common understanding on the implementation of the Treaty’s provisions concerning the DAS could contribute to a better identification of the objectives of the exercise.

On the basis of the legal requirements of the DAS defined by the Treaty, the “subject matter” is the “legality and regularity of underlying transactions”. A way to obtain a part of the reasonable assurance required for the issuance of the audit opinion in respect of the legality and regularity of the underlying transactions is to determine whether the supervisory and control systems operate effectively, thereby preventing or detecting and correcting material misstatements. In this sense, the effectiveness of the supervisory and control systems to manage the risk, as regards legality and irregularity of underling transactions may also be considered as a “subject matter”.

I am personally convinced that this approach allows for greater added value for the DAS users for two major reasons. First, by an improved understanding of the risks affecting the management of EU’s funds. Second, by providing better information on the origin, nature and financial impact of problems not detected/corrected by systems and controls, thus allowing introducing the necessary improvements.

Some issues need to be highlighted in respect of the DAS approach’s compliance with international auditing standards and possible best practices developed by other public audit bodies. The approach is based, in particular, on INTOSAI (International Organisation of Supreme Audit Institutions) Auditing Standards and the International Standards on Auditing issued by IFAC (International Federation of Accountants). The special features of the Community environment (direct and indirect centralised management, shared management, decentralised management, joint management) and the complexity of the individual component systems make the Court’s situation unique, not only in comparison with private audit firms but also with national and international audit institutions.

Given the exceptional character of the obligation, the application of international auditing standards must take into account the special and specific features of the environment in which the Court’s DAS-audits are carried out. However, adapting does not mean departing from the spirit of the standards. Rather, it implies applying recognised methods and practices with appropriate variations, i.e. fine-tuning these recognised methods and practices to the specific requirements of the environment in which the Court operates.

In this context, it must be emphasised that the standards essentially cover the audit of financial statements of private companies or public entities. Only in exceptional cases are guidelines provided with a view to reaching an audit opinion concerning the legality and regularity of underlying transactions. Therefore, most of the international standards can only be applied by analogy.

Establishing an integrated internal control framework

Since 2000 the European Commission has developed a series of fundamental reforms aimed at improving the quality of financial management. This reform process has lead to major changes in the European Commission environment, namely the decentralisation of responsibilities for the use of funds to those managing them (i.e., authorising officers) and the replacement of the Financial Controller’s role by an internal audit function.

Despite the significant progress made, the quality of the systems of administration and control over Community income and expenditure remains variable as is illustrated by the most recent findings presented in the ECA’s annual report concerning the financial year 2003.

Furthermore, both the European Parliament and the Council have expressed concerns about a lack of coordination of the various controls and checks at the different administrative levels. In this context, the Court’s opinion on the “single audit” model is of major importance. In fact, the Court’s Opinion has responded to the European Parliament’s discharge decision of April 2002 on the 2000 financial year in which both the Court and the Commission were requested to examine the feasibility of introducing a single audit model, with each level of control building on the preceding one, thereby improving the quality of audit activities without compromising the independence of the audit bodies concerned.

In the EU environment, it is recognised that the resources applied to the internal control and audit of public finances should be organised more coherently and cost effectively. The “single audit” concept must be addressed in terms of an internal control concept, allowing for a more efficient and effective internal control framework in the European Union architecture. This is reflected in the Court’s opinion on the “single audit” model which includes a proposal for a Community Internal Control Framework over all levels of the management of EU finances.

The aim was to provide a useful, thought-provoking and perhaps inspirational document, which also recognises the realities we all face in the growth and development of the Union.

The Court took the opportunity to be ambitious in its Opinion by considering the whole process of internal control of the EU budget. It proposes the creation of a Community Internal Control Framework to be used as a basis for developing new systems, as well as updating and improving existing ones, based on a common logical and coherent strategy.

According to the Court’s opinion, the establishment of this internal control framework should be based on five key attributes.

The first is that this framework should set out the basis for a comprehensive and coherent internal control system within the European Union, which provides reasonable assurance that income and expenditure is raised and spent in accordance with the legal provisions, and managed so as to obtain value for money.

Secondly, it must be effective and efficient. For this to materialise, it is necessary that the legislation underlying policy and processes should be sufficiently clear and unambiguous, to secure the proper use of funds, but not unnecessarily complex. Controls should be undertaken in an open and transparent way, allowing the results to be used and relied upon by all parts of the system.

In order to optimise the use of resources, the third attribute implies an effective and transparent chain of control procedures operating to common standards, with each level having specifically defined objectives, which take into account the work of the others.

The fourth attribute requires the definition of minimum requirements for control systems at all levels within the process, taking into account the specific characteristics of the different budgetary areas. Furthermore, control procedures should be implemented based on an acceptable common standard, and the work performed together with the corresponding results, should be documented in a common format and recorded in a way that allows others in the control chain have access for purposes of obtaining the assurance required by each level of control.

There should also be an agreement on the type and extent of controls by ensuring an appropriate balance between the costs of controlling a particular budgetary area and the benefits derived. The current control arrangements call for greater transparency: for the majority of the budget covering shared management most of the associated costs are incurred by Member States. As a consequence, there is a lack of information on the total cost of controlling the EU budget.

The last attribute of the EU internal control framework should be a clear understanding of the roles and responsibilities of all the relevant parts and actors that are directly or indirectly linked to it, i.e. European Institutions and Member States authorities. The Commission should provide assurance that management and control systems are operating effectively (supervisory controls). It should also be required to define the common characteristics of the systems for the different budgetary areas.

The external audit function

The external auditors – ECA and NAIs – are not, by definition, a direct element of the EU internal control framework. They have, however, a professional interest in the effective functioning of this internal control framework. Its tasks would include the audit of the application of controls, providing an independent overview of financial management including the operation of internal control systems.

I would like to focus for a minute on the role of the European Court of Auditors. The Court is the external auditor of the European Union and therefore not part of the internal control system. To be so would compromise the Court’s ability to provide an independent overview of the effectiveness of the system. The Opinion makes this clear.

However, in order to be able to audit efficiently the Court should rely, where possible, on the work of others. This means that work should be undertaken to an adequate standard and the results readily available. Clearly defined standards and objectives for internal control systems would also provide an effective basis against which the Court could assess their design and operation when auditing them, thereby increasing the effectiveness of its work. The Opinion addresses both of these concerns.

Roles and responsibilities of the key players

Before moving on I would like to briefly summarise the roles and responsibilities of the different actors implicit in the proposed framework:

The Court, as the external auditor, would audit the efficient and effective operation of the whole system of internal controls;
The European Parliament and Council, in their role of budgetary and discharge authority would continue to provide a political overview on the management of the EU finances;
The Commission, as the institution with the responsibility for the execution of the budget, would assure the management, coordination and implementation of internal controls;
A logical chain structure would operate within Member States with clear and distinct roles for local or regional, and central authorities.
The Court – as an independent Institution and the external auditor of the EU – plays an important role to help achieve greater effectiveness of the management and control systems, at both European and national levels. This implies not only increasing the cooperation between the Court and the National Audit Institutions, but also reinforcing the internal control systems through recommendations based on its audits.

Outlook

The Court’s Opinion on the single audit and internal control framework has had a significant impact on political debate.

Possibly the most important consequence of these discussions, has been the Commission’s Communication of 15 June 2005 on a “roadmap to an integrated internal control framework” with a view to initiating a process leading to a common understanding by the end of 2005, to be formalised in an inter-institutional agreement between the Parliament, the Council and itself, on how the current internal control framework can be improved in order to provide the Court with the reasonable assurance it seeks.

This is an excellent initiative. Any debate focused on how to improve the management and control of EU funds is to be welcomed.

The establishment and implementation of a coherent and comprehensive system of internal controls requires the active participation of all parties involved in the financial control of the EU budget. Both improved legislation and work practices are also needed as a level of openness and transparency over the management and control of the EU budget. This will demand considerable commitment from both the Institutions and the Member States of the European Union.

Considerable change is needed, and not all of it will be easy. It is therefore of imperative that both the Commission and Member States work together to identify the weaknesses in the design and operation of current systems and introduce appropriate remedial action aiming at achieving a better financial management of EU funds.

The analysis of the existing gaps with a view to establishing an action plan to improve the situation is an important step forward. However, the key success factor is realistic deliverables. In this sense, we should concentrate on the substance and on the results to achieve, rather then in the form of the output. Otherwise we risk failing the objective of the exercise and lose this unique opportunity.

As the Court’s Opinion concludes “by working together to ensure an efficient and effective control of the EU budget, the institutions and Member States of the European Union would demonstrate their commitment to a common purpose for the benefit of the citizens”.

For its part, the Court will continue to report on what it founds. We shall endeavour to be objective, professional and to add greater value for the users of our reports and opinions through better information on risks, systems and controls, thus contributing to the improvement of the financial management of the European Union.

Pierre Perrin-Monlouis
Pierre Perrin-Monlouis
Fondateur de Rente et Patrimoine (cabinet de gestion de patrimoine), Pierre Perrin-Monlouis est un analyste et trader pour compte propre. Il vous fait profiter de son expérience en trading grâce à ses analyses financières et décrypte pour vous les actualités des marchés. Son approche globale des marchés combine à la fois l'analyse technique et l'analyse fondamentale sur l'ensemble des marchés : crypto, forex, actions et matières premières.
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