House of Representatives Committees

Standing Committee on Economics, Finance and Public Administration

Review of ANAO Audit Report No.6 1996/97: Commonwealth guarantees, indemnities and letters of comfort

Government response

(Tabled on 26 May 1998)

This document has been scanned from the original government response. It may contain some errors.


GOVERNMENT RESPONSE TO THE HOUSE OF REPRESENTATIVES STANDING COMMITTEE ON FINANCIAL INSTITUTIONS AND PUBLIC ADMINISTRATION'S REPORT OF THE INQUIRY INTO ANAO AUDIT REPORT NO. 6 1996-97 ON COMMONWEALTH GUARANTEES, INDEMNITIES AND LETTERS OF COMFORT

This response addresses the 12 recommendations of the above report which was tabled in Parliament on 29 September 1997.

Recommendation 1 (paragraph 2.15)
That the power of Commonwealth statutory authorities to accept liabilities, including contingent liabilities, be regularly reviewed by portfolio departments, in consultation with the ANAO and Finance, to ensure that the Commonwealth's interests are protected.

2. The capacity of any Commonwealth entity to accept liabilities is generally dependent on the nature of the statutory powers that were conferred on the body when it was created, or when its governing legislation was amended. However, the Government agrees that authorities' use of such powers (in determining strategies to achieve their objectives and manage current and contingent liabilities) has a crucial impact on the Commonwealth's overarching interests. For this reason, such bodies are subject to stringent reporting and accountability requirements which apply universally to all wholly owned Commonwealth entities within the ambit of the Commonwealth Authorities and Companies (CAC) Act 1997 (which commenced operation on 1 January 1998); furthermore, additional requirements apply to those statutory authorities classified as Government Business Enterprises (GBEs). Overall, the requirements aim to:

3. The CAC Act provides the legislative basis underlying the reporting and accountability framework applying to all statutory authorities and Commonwealth controlled companies. With respect to authorities, the provisions of the Act include:

4. The CAC legislation does not explicitly address the issue of entering into liabilities. However, the Act requires members of the Boards (and other officers) of CAC authorities to act honestly and to exercise due care and diligence in the exercise of the powers entrusted to them by Parliament under the respective Acts establishing the authorities. The CAC Act also requires authorities to keep responsible Ministers informed of the operations of the authorities and their subsidiaries and to notify them of significant proposals affecting the businesses (eg, the acquisition or disposal of a company).

5. For those statutory authorities which are also GBEs, the June 1997 Governance Arrangements for Commonwealth Government Business Enterprises which outlines the respective responsibilities of the directors of GBEs and the 'shareholder' Ministers, includes the requirement for the directors of each wholly owned GBE to prepare and present an annual corporate plan (covering a period of at least three years) which, inter alia, must provide an "analysis of factors likely to affect achievement of targets or create significant financial risk for the GBE or for the Commonwealth." Directors are also required to provide six monthly progress reports (including financial statements) to shareholder Ministers on progress against, or any changes to, corporate plans.

6. Furthermore, the Governance Arrangements stipulate that:

7. As a result of a 1997-98 Australian National Audit Office (ANAO) report: Government Business Enterprise Monitoring Practices, the ANAO recommended that the 1997 Governance Arrangements be amended to require GBEs to specify their material risks and strategies for treating these risks in their corporate plans and progress reports. This recommendation has been agreed to by the Department of Finance and Administration (DoFA), which oversees the arrangements, on the proviso that adoption of the recommendation does not compromise the integrity of the principle that GBE directors are themselves responsible for managing risks.

8. The ANAO has almost completed a follow-up audit of its 1996-97 audit of guarantees, indemnities and letters of comfort which the Government understands aimed to focus on the size of the Commonwealth's exposure; the management and monitoring of the Commonwealth's exposure; the adequacy of reporting; and the management of risk across agencies.

Recommendation 2 (paragraph 2.19)
That agencies be required to follow the recommendations of the ANAO and Finance concerning the formal authorisation of officers to issue indemnities on behalf of a Minister. Each agency should also be required to provide a copy of its register of authorised officers to Finance on a regular basis.

9. The Government agrees that officials should follow the guidance articulated in the Guidelines for Issuing Indemnities, Guarantees and Letters of Comfort developed by the former Department of Finance (DoF), the Attorney-General's Department (A-G's) and the ANAO in May 1997 and issued via Finance Circular 1997/06: Potential Liabilities and Losses. As the Committee is aware, the circular has been disseminated widely within the Australian Public Service.

10. Implementation of the guidance is a matter for each agency head, to whom the Guidelines were circulated, together with a (commending) covering letter signed by the Secretaries of DoF and A-G's, as well as the Auditor-General. The letter requested agency heads to recommend the Guidelines to relevant officers in their respective agencies.

11. Whilst it is agreed that the ability of officers to commit the Commonwealth to significant contingent liabilities should be adequately regulated, controls over the acceptance of contingent liabilities are not entirely synonymous with controls over authorisation procedures. Therefore it is considered that there would be little added value in DoFA's scrutinising any agency's register of authorised officers: the comprehensiveness of such a register would not necessarily ensure that no unauthorised officer accepted a significant contingent liability.

12. Ultimately, the responsibility for raising awareness about the ramifications of accepting potential liabilities on behalf of the Commonwealth is a matter for management in each agency. To facilitate this process, the Guidelines:

13. The Guidelines also aim to provide advice aimed at reducing the incidence of unauthorised acceptance of risks by: Recommendation 3 (paragraph 3.12)
That agency heads be required to take account of their responsibility with regard to management of the Commonwealth's contingent liabilities. Subject to ultimate Ministerial responsibility and accountability to the Parliament, it is the responsibility of agency heads to ensure the agency complies with guidelines and other instructions concerning contingent liabilities.

14. The Government agrees with the recommendation and will promote its financial management framework which supports and strengthens accountability for compliance with guidelines and other instructions relating to contingent liabilities via:

15. In addition, since the ANAO's release of Audit Report No. 6, 1996-97: Commonwealth Guarantees, Indemnities and Letters of Comfort, DoFA has continued to follow-up agencies' implementation of the ANAO's recommendations. (A report on the status of the recommendations as at 31 August 1997 was transmitted to the Joint Committee of Public Accounts (JCPA) on 17 September 1997 in response to (JCPA) Report 350: Review of Auditor-General's Reports 1996-97, First Quarter.) The response noted that most agencies have taken substantive actions to implement those recommendations which are relevant to their operations.

Recommendation 4 (paragraph 3.22)
That agencies take account of the direction to include a limit where possible. Agencies should always attempt to measure the potential financial cost as part of risk assessment, either internally or with external assistance, and should keep a record of that assessment. Where a limit is not included, agencies should record the reason for that arrangement as part of the risk assessment.

16. The Government agrees with the recommendation and will continue to promote the importance of quantifying contingent liabilities wherever practicable. As the Committee is aware, the Guidelines on Issuing Indemnities, Guarantees and Letters of Comfort emphasise that:

17. In addition, the Guidelines advise that legal advice on instruments (including those contained in standard contracts) should be sought. This advice was provided to remind agencies that certain terms and conditions may involve covert risks which may otherwise be accepted unintentionally.

18. In urging agencies to remain vigilant in recording, monitoring and reviewing existing contingent liabilities, the Guidelines also aim to reiterate accountability requirements relating to the potential financial impact of instruments which for some reason are not quantified and/or not subject to a time limit at inception.

19. As a corollary, the conditions applying to the reporting regime relating to liabilities demands that agencies have the capacity to identify, within a particular timeframe, any likely (material) financial consequences of entering into a contingent liability.

20. As the Committee is aware, this regime requires agencies to report on their contingent liabilities for input to the annual consolidated Financial Statements of the Commonwealth Government of Australia. Furthermore, in producing their own annual financial statements, each agency is obliged to report all material contingencies in a separate schedule of contingencies affecting that agency. For these purposes, agencies must disclose contingent liabilities consistent with standards that enable assessment of the likelihood and financial effects of potential losses resulting from the instruments. Guidelines for the preparation of annual Financial Statements of Commonwealth Departments (issued most recently in June 1997) state that "estimates of the outcome and financial effects of contingencies should be based on consideration of information available up to the date on which the financial statements are certified and should include a review of events occurring after the end of the reporting period".

Recommendation 5 (paragraph 3.29)
That the Department of Finance in consultation with the ANAO issue a 'better administrative practice' document to provide agencies with more direct assistance on how to introduce and maintain a central register of contingent liabilities.

2 1. The Government will examine the need for such a document once the findings of the ANAO's follow-up audit indicate whether existing registers are adequate.

22. As mentioned above in response to Recommendation 3, DoFA's follow-up of agencies' implementation of the recommendations of ANAO Report No 6, 1996-97 indicated that, as at August 1997, many agencies had initiated new practices as a result of that audit. With respect to introducing and maintaining central registers of contingent liabilities, most agencies which issue indemnities, guarantees or letters of comfort advised that they already met the requirement or were taking steps to establish registers.

Recommendation 6 (paragraph 3.40)
That agencies consider introducing contract registers, in particular with a view to addressing concerns about the increased emphasis on outsourcing Commonwealth functions. In the absence of a register, agencies should ensure that contingent liabilities in contracts, if any, are recorded separately on a Register of Guarantees, Indemnities and Letters of Comfort.

23. The Government agrees that contract registers may prove valuable vehicles for recording contingent liabilities in certain agencies; however, the administrative effectiveness of maintaining such registers may depend on the number of contracts issued. For very large agencies, recording every contract on a register, irrespective of whether or not that contract contains any significant potential liability, may not prove to be a prudent use of resources. The Government would prefer that agencies use their discretion in the use of contract registers (as mentioned in the Guidelines for Issuing Indemnities, Guarantees and Letters of Comfort) so long as those agencies have adequate internal controls to ensure potential liabilities are registered and reviewed regularly.

24. As indicated in the Guidelines, in terms of protecting the Commonwealth's interests in regard to contingent liabilities arising from contracts involving outsourcing of activities, the imperatives for managers are that they:

Recommendation 7 (paragraph 3.41)
That Defence review its existing contracts and its contract management practices to ensure that its central record keeping and finance areas are fully informed of all contingent liabilities contained in contracts.

25. The Government agrees that there is a need for the Department of Defence's (DoD's) program mangers to keep central management areas informed about significant contingent liabilities. To this end, DoD has implemented a system whereby all deeds of indemnity are recorded in a central register. However, many indemnity clauses in the large number of contracts awarded by DoD annually (over 50,000) simply serve the purpose of articulating the Commonwealth's acceptance of potential liabilities for which it could be liable at common law, were the Commonwealth or its agents to contribute to losses suffered by the contractor.

26. As all major contracts are subject to centralised scrutiny processes, it is considered that nominating a threshold over which contingent liabilities in contracts are recorded will prove a workable compromise between reporting every liability and demonstrating DoD's commitment to accurate and comprehensive central recording of its contingent liabilities. A threshold amount of $5million is considered to represent an appropriate balance between risk management/reporting requirements and administrative efficiency (in 1996-97 DoD awarded 57 contracts with a value greater than this amount). This threshold will also achieve commonality with the threshold used by DoD to collect other current purchasing statistics.

Recommendation 8 (paragraph 3.60)
That agencies which report contingent liabilities to the public or to Ministers, review those values, in consultation with the ANAO where relevant, to ensure that they calculate the values accurately.

27. The value of contingent liabilities reported in agencies' annual reports are audited by the ANAO.

28. Furthermore, the data provided in respect of contingent liabilities reported in the consolidated Financial Statements of the Commonwealth Government of Australia for the year ended 30 June 1996 was examined by the ANAO and reported to the Minister for Finance. For the year 1996-97, the Statements, tabled in March 1998, were fully audited.

29. The Government's plans to implement a full accrual financial management framework by 1999-2000 are also expected to have a major impact on the comprehensiveness of agencies' focus on the resource implications of their strategic and operational plans, involving among other factors, specification of liabilities.

Recommendation 9 (paragraph 3.61)
That the Department of Finance, in consultation with the ANAO, takes all steps necessary to ensure that whole of government risk reporting in the Statement of Risks provides an accurate description of the Commonwealth's exposure.

30. The disclosure of comprehensive and accurate information in the Budget and related papers is one of the basic tenets covering the production of material for public dissemination by DoFA.

3 1. Both the Mid-Year Economic and Fiscal Outlook 1996-97 and Budget Paper No. 1, 1997-98 included a 'Statement of Risks' which listed the Commonwealth's:

with a possible impact greater than $20 million in any one year, or greater than $40 million over three years.

32. Under the provisions of the Constitution, all Ministers have the ability to enter into arrangements that may give rise to a contingent liability of the Commonwealth. Accordingly, except at the express desire of the relevant Minister or his or her portfolio, neither the Minister for Finance and Administration, nor DoFA has a direct role in:

33. Indeed, it is considered that imposing an additional level of control by DoFA on the action of other portfolios to manage contingent liabilities would: 34. In these circumstances, DoFA is reliant upon portfolios and agencies for the accuracy of the information they provide for inclusion in the 'Statement of Risks'. In addition, it should be noted that the ANAO does not review the annual budget process and therefore does not examine the 'Statement of Risks'.

35. Nevertheless, reflecting in part the concerns identified in Audit Report No. 6, 1996-97 about the accuracy of information on contingent liabilities disclosed in the 'Statement of Risks', DoFA has enhanced the quality assurance processes associated with its production. These changes in the quality assurance process include:

36. The latter changes should minimise the risk of specific contingent liabilities being overlooked and provide a benchmark for making an assessment of the magnitude of the extent of those liabilities.

Recommendation 10 (paragraph 3.88)
That Finance, in its review of the Commonwealth policy of self insurance, take account of the need for expertise in managing risk and the cost to departments of providing such expertise in-house or externally.

37. The review of the Commonwealth's non-insurance policy was completed in August 1997. Consistent with the findings of the ANAO and the Committee, the review revealed that the risk management practices of agencies and entities varied widely in quality. The review found that in addition to the need for expertise in risk management, managers also needed sufficient incentives to effectively manage their risks. After evaluating a number of options, self-insurance via a single Commonwealth managed fund was considered to offer the most comprehensive and cost-effective approach to the management of risk exposures. The Government is pursuing this course of action and, subject to meeting certain conditions, intends to implement a managed fund from 1 July 1998 or as soon as possible in 1998-99.

38. Proposed key features of the managed fund will include:

39. On the whole, the managed fund will provide managers with incentives to effectively manage their risks and assist them to develop expertise in the identification, measurement and management of risks facing their organisation. The fund should also accumulate risk management expertise and be able to access such expertise to assist agencies and entities where required.

Recommendation 11 (paragraph 3.97)
That the review of the governing legislation for EFIC under the Commonwealth's Legislation Review Schedule include consideration of the appropriate prudential regulation arrangements for EFIC where commercial risks are covered.

40. The Government agrees with the recommendation. While it is considered that current prudential regulation arrangements are appropriate, the legislation review process should cover all significant aspects of EFIC's operations, including this issue.

Recommendation 12 (paragraph 3.108)
That the ANAO review the management of the Commonwealth's contingent liabilities, and agency compliance with the guidelines on issuing indemnities, guarantees and letters of comfort, in two years time.

41. As mentioned with respect to Recommendations 1 and 5, the ANAO has almost completed a follow-up audit of its 1996-97 audit of guarantees, indemnities and letters of comfort. The Government understands that this review has included examining the extent to which agencies have complied with the recommendations of Audit Report No. 6, 1996-97: Commonwealth Guarantees, Indemnities and Letters of Comfort, relevant Parliamentary committee reports on the subject and the 1997 to Guidelines for Issuing Indemnities. Guarantees. and Letters of Comfort referred to above.

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