Corporate Governance

• EU: no better
• Pension crisis comes to boil
• UK tax agencies in turmoil

EU: no better

The European Commission�s financial systems remain fundamentally weak, according to a new report from the UK�s National Audit Office. The NAO says the Commission �has not yet set out a comprehensive accounting framework� and �does not have a single integrated computerised accounting system�.

While the EC is moving towards accrual accounts - they are due to be fully implemented in January 2005 - information on accruals items cannot be automatically obtained from its computer system and must be calculated manually by reference to a variety of local management records. Sir John Bourn, the UK�s comptroller and auditor-general, commented that he believed that introducing accrual accounting by the proposed date was �a very tight timetable�.

The NAO was reviewing the European Court of Auditors� report of the Commission accounts for the 2001 year - which were qualified for the eighth successive year. The Court of Auditors drew attention to the persistent and ongoing weaknesses in the Commission�s accounting systems and, in particular, the lack of reliable information on assets held. The Court was unable to provide assurance on the legality and regularity of expenditure under the Common Agricultural Policy and the structural funds.

The Court noted the fact that the Commission had made some progress in implementing its strategy of financial management reforms. In particular, the Court welcomed the introduction of individual declarations by the Commission�s directors-general on the reliability of the financial controls in their areas which the Court considered offered �an unprecedented degree of openness as regards accountability�. But the Court also observed weaknesses, including a lack of consistency in the declarations of the directors-general. The Commission has since issued guidance to clarify how declarations should be drawn up.

Sir John stressed that the absorption of 10 new candidate countries in 2004 was likely to cause significant additional problems, with only provisional agreements in place on financial controls in these countries. Most of the accession states need to accelerate their pace of reform or implement new financial controls by the joining date.

�My report on the financial management of the European Union draws attention once again to continuing problems in the management of funds,� said Sir John. �It is a matter of concern that, for the eighth year in succession, the Court of Auditors has qualified its opinion on the reliability of the accounts. I also endorse the Court�s view that the Commission should take urgent, in-depth action to deal with the persistent weaknesses in its accounting system.�

Concern over accounting practices has been increased by publication of a leaked memo from the European Commission�s head of internal audit, Jules Muis, which allegedly says that the Commission has knowingly overstated the quality of its accounts. The criticisms echo those made earlier by dismissed Commission chief accountant, Marta Andreason, who claimed that its financial system was out-of-control and no better able to track or detect fraud than could Enron or WorldCom.

Problems further intensified with questions raised in the European Parliament, asking how much senior commissioners knew of accounting problems at Eurostat, the Commission�s statistical body. President Romano Prodi and commissioners in charge of administrative reform - Neil Kinnock, budget, Michaele Schreyer, and monetary affairs, Pedro Solbes - were all asked when they were informed of serious problems and what action they took.

Meanwhile, Italy has proposed a vast increase in European expenditure on outdated public sector infrastructure as a means of combating the downturn in the eurozone economy. The 490bn euros �European Action Plan for Growth� would focus on transport networks and other public works projects to assist both individual member states and connections between EU countries. Italy is already on the verge of winning funding from the EU for one of its key transport infrastructure projects, a 6bn euros road and rail bridge between Sicily and the Italian mainland. Schemes which could benefit include major new road developments in EU accession nations and new Alpine tunnels.

The Italian plan, launched by beleaguered prime minister Silvio Berlusconi - fighting domestic battles with his judiciary - and finance minister Giulio Tremonti, could be approved by the end of this year. It appears to have already gained the support of the German Government and the European Commission and will be driven forward under the Italian presidency of the Commission, which begins this month. Agreement, it would seem, does not depend on obtaining fundamental changes to the deficit rules established under the European growth and stability pact. The pact is already being defied by the eurozone�s largest economies, Germany, France and Italy.

Italy�s Government believes that the funding could be provided in an �off-balance sheet� manner, by copying the UK�s Private Finance Initiative schemes and public/private partnerships. The European Investment Bank already holds large balances and would lend about 50bn euros in the period 2003 to 2010. These funds could be used to add leverage to private finance. EIB loans do not normally appear in member states� debt calculations.

The European Investment Bank is the European Union�s financing institution, whose aim is to support the integration of the union, along with balanced development and economic and social cohesion. About 85% of its loans are to EU member states, with the rest to other countries - such as those in North Africa and the former Soviet bloc - whose development is beneficial to the EU. It raises much of its capital on the international markets.

A spokesman for the EIB explained that whether loans appear on member states� balance sheets depends on who the principal borrower is. Where the state itself borrows, a loan will appear as national debt. But in many cases the project promoters will be a special purpose vehicle, such as a public/private partnership, in which case the debt will be off-balance sheet for the relevant government.

Pension crisis comes to boil

The introduction of FRS 17 has been a factor in forcing the UK Government to take radical action to shore up pension schemes and prevent companies walking away from their pension promises, says the National Association of Pension Funds. The plan launched by Work and Pensions Secretary, Andrew Smith, came forward against an international background of strife as the scale of the potential cost of pensions liabilities became clearer.

Vicki Bolton, spokeswoman for the National Association of Pension Funds, said: �This is a long-term problem: increasing longevity is the key thing driving up pension costs. While FRS 17 draws attention [to the deficits], falling markets are really the factor that has focused attention on funded pensions.

�Certainly, FRS 17 doesn�t help. It just takes a very quick snapshot of what is happening in the scheme. It doesn�t give an accurate picture to investors.� But, she added, the decision of some companies to walk away from their promises to funded pension schemes was the single most important reason why Andrew Smith had had to take urgent action, preventing other companies from following suit.

The Association of British Insurers argues that, in particular, the use of the AA bond rate to calculate pension liabilities under FRS 17 has caused problems. In a new report, written for the ABI by Tony Jackson, policymakers were urged to adopt �a better method of discounting liabilities� in advance of the move to a new international pensions standard by 2005.

Jackson argued that the introduction of FRS 17 was �timed to make a bad situation look considerably worse�. But the ABI is not pushing for a return to non-reporting of pensions liabilities, or the use of a system that is not based on current market values. Tony Jackson suggested that other valuation systems might be based on a financial instrument linked to future wage inflation, or a fair value derived for the whole fund, based on what it might be worth to anyone acquiring the sponsoring company. The ABI said that the use of what it regards as the wrong method of valuing future liabilities may distort investment decisions to the detriment of pensioners by encouraging funds to minimise risks.

Measures announced by the Government to address the pensions crisis include the creation of a Pensions Protection Fund for final salary pensions, protecting pension rights to a maximum of 90% where a company goes bust. The fund is to be paid for by a compulsory insurance scheme, with contributions from all occupational schemes. Where a scheme is closed by a solvent company, it will be obliged to provide a full buy-out of members� benefits. There is also to be a new pensions regulator, who is expected to intervene where there is suspicion that occupational schemes are badly run, or high risk. Their primary duty will be to scheme members.

While all these measures are aimed at assisting future pensioners, they are partially offset by easing the burden of employers to cover above-expected inflation rises. Inflation protection is to be cut to 2.5% - in line with the Government�s target for the Bank of England - from 5%.

Andrew Smith said: �This balanced package strengthens protection for scheme members, whilst reducing the burden on companies who run schemes. The new Pension Protection Fund will ensure that, where company pensions have been promised, pensions will be delivered. I want to end the scandal of workers being denied the pensions they have built up over many years, or pensioners seeing their pension cut if their firm goes bust and their scheme winds up.�

According to Close Wealth Management, part of Close Brothers Group merchant bank, some 40,000 people have already had their pensions �slashed� after their employers ceased trading. Concern has been expressed by some lawyers that the new measures will still allow unscrupulous employers to move assets to associate businesses and put companies with high pensions� liabilities into voluntary administration.

Reactions to Smith�s measures were mixed. While insurers tended to be positive, pensions consultants said that the cost of the moves had been greatly underestimated by the Government. Mercer Human Resources Consulting calculates that the level of pension scheme underfunding in the UK currently stands at around £300bn, of which only about £150bn is disclosed in company accounts under FRS 17.

Tim Keogh, European partner at Mercer Human Resources Consulting, said: �The [Government�s] estimate that these changes only cost employers £50m to £100m is absurdly low - the true increase in potential liability is more like £100bn.� He added that he believed that the adoption of 90% benefit protection would also lead to a high cost, of £1bn on this measure alone compared with the DWP�s cost estimate of £340m to £375m.

Keogh continued: �The lower cap of 2.5% on inflation proofing is for future benefits only, so does nothing to reduce current accrued liabilities which create most of the problems. Employers will see only a limited benefit from this as long as inflation remains at or below this level. Employers may choose to anticipate savings in future high inflation conditions as a way of offsetting the Protection Fund levy. A typical scheme might anticipate savings of 5% to 10% of current contributions from this source, but this is only a fraction of the increase in cost experienced in recent years.�

Mike Hammer, senior consultant at the global benefits consultancy Towers Perrin, warned: �Together, these two proposals [the requirement to secure members� benefits fully and the creation of a Pensions Protection Fund] represent a significant additional burden on employers. The Government is making employers finance this security and in many places it will be an onerous burden. We believe this will give employers added incentive to switch employees to defined contribution pension plans.�

However, Close Wealth Management argued that the Government�s statement did nothing to clarify what would happen if deficits continued to accumulate and the level of insurance protection proved to be insufficient. A spokesman said: �Such questions are being asked about the Pension Benefit Guaranty Corporation, which is the equivalent insurance scheme in America, and which suffered a loss of £11.3bn for the financial year to September 2002.�

The Confederation of British Industry gave a cautious welcome to the proposals, provided they did not drive up employers� costs. Deputy director-general, John Cridland, conceded that confidence in pension schemes had suffered and that some scheme members �have lost out through no fault of their own�, following the closure of funded schemes. But he warned that �if we make pension schemes too costly, employers will not be able to provide them�.

Meanwhile, trade unions and consumers� groups were more hostile. Sheila McKechnie, director of the Consumers� Association, said: �If the Government thinks the action it has proposed solves the pension problem then it either doesn�t understand what the crisis is, or it lacks the political courage to deal with it. Many changes apply only to current employer schemes and the simple issue that we are not saving enough is being side-stepped. The Government has completely bottled out of facing up to the problems in the private pensions sector, which they are expecting current generations to rely on to fund their retirement. The industry cannot deliver a viable model for individual pensions. It is inefficient, expensive and contemptuous of its customers.�

A similar point has been made in a new report (Recent Trends in Pension Reform and Implementation in the EU Accession Countries) from the International Labour Organisation, funded by the French Government, which concluded that asking workers to save in personal schemes for their retirement would not have the desired effect of providing sufficiently for retirement, nor of relieving state pension expenditure.

Author Elaine Fultz, of the ILO, said that flexible pension schemes and job creation for older workers were a more important consideration in addressing the problems, along with increasing immigration to raise the number of people in work who could support state expenditure. �Two out of the five solutions are in the labour market rather than in the pension system: the labour market is the key to finding solutions to the ageing population,� she argued.

Pressures on pension funds have grown noticeably in recent months in many countries. Strikes have taken place in France and Austria, as governments attempted to cut back on benefits to future pensioners. Israel has just announced that its retirement age is to rise to 67. EU accession countries Bulgaria, Estonia, Hungary, Latvia and Poland are all privatising state pension schemes. And the European Council of Ministers has agreed a new Pensions Directive to improve transparency of schemes.

The Pensions Directive will form the basis for an internal market for occupation pensions, backed by guarantees of pensioners� rights. Schemes in the European Union cover about a quarter of its workers, with managed assets of about 2,500bn euros (£1,560bn).

Under the new Commission rules - which member states have until May 2005 to implement within national legislation - pension scheme members and beneficiaries must be properly informed of the terms of the scheme, the situation of the institution and their individual rights. Future and promised benefits must be calculated prudently and covered by sufficient assets. Schemes must also be capable of operation across the European Union: at present, a multi-national with a base in all 15 member states needs to use 15 different occupational pension providers. Under the new directive a multi-national will be able to operate an integrated scheme across the Union. Savings for a corporation could be as much as 40m euros a year, calculates the Commission.

UK tax agencies in turmoil

Richard Broadbent, chairman of Customs & Excise, has shocked ministers and observers by announcing that he is leaving his position at the end of July. His deputy, Mike Eland, is taking over on an interim basis. It is rumoured that Broadbent is to become a non-executive director of a company which is building-up its PFI contracting with the Government.

Broadbent had been a Treasury high flyer, who went on to work for investment bank Schroeders as group managing director for corporate finance before joining Customs in his current position.

The departure of Customs� chairman threatens to destabilise the leadership of the two UK tax collecting bodies simultaneously. Sir Nick Montague is under growing pressure as chairman of the Inland Revenue, facing sustained demands for him to be sacked.

The biggest political challenge for Sir Nick is his publicly acknowledged failure to keep ministers informed of the detail of the property outsourcing contract with Mapeley. They only learnt of this after it was revealed in the press that Mapeley was taking over the Revenue�s office portfolio via a Barbados based offshore subsidiary - just at the time that the Treasury was trying to clamp down on offshore tax avoidance.

Labour MP Austin Mitchell responded by demanding Sir Nick�s resignation. Shortly afterwards, the main civil service trade union, the Public and Commercial Services Union, nearly passed a resolution at its annual conference also calling on him to go. In the end delegates decided to approve a very slightly less embarrassing motion, demanding the end for �those deemed responsible� for an outbreak of administrative chaos at Sir Nick�s department.

The problem exercising the attention of PCSU was the botched introduction of the Child Tax Credit and the Working Family Tax Credit. The Revenue�s computer system - operated on an outsource contract by EDS - has been unable to cope, and millions of claimants have been waiting weeks for payment under the new system. Where previous tax credits have been tax reliefs, the new tax credits are released as payments from the Revenue.

Critics say that the Revenue has been unable to adjust to a new culture of making payments to benefit claimants, dealing with claims as a matter of urgency. Staff argue that the quantity of claims, enquiries and phone calls has been much higher than the Revenue anticipated, reflecting a failure of management. But problems may be far from over - civil servants privately suggest that the implementation of the new Pensions Tax Credit is proving just as troublesome.