Standing Committee on Economics, Finance and Public
Administration
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:
- maximise the transparency of the operations and financial status of
all statutory authorities; and
- provide the Executive Government with adequate information to protect
its interests and maintain adequate control, albeit at arms length,
over the activities of these bodies which the Parliament has established
as financially and legally autonomous entities.
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:
- identifying the role of the Auditor-General as auditor of each Commonwealth
authority;
- articulating the obligations of the directors of each authority to
prepare an annual report (comprising a report of operations, financial
statements and an auditor's report) and present it to the responsible
Minister;
- establishing the Minister for Finance and Administration's authority
to request that a body provide the responsible Minister with an interim
report of operations or financial statements (covering a specific period
within a financial year) in accordance with the Finance Minister's Orders;
and
- prescribing that the directors of an authority must provide their
Minister with the details of any proposals to change the strategic direction
of the authority (eg, by commencing or ceasing a significant business
activity).
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:
- directors are responsible for managing risks and for reporting in
corporate plans and progress reports on risk management strategies and
practices implemented to protect the interests of the Commonwealth as
shareholder (GBEs usually borrow from financial markets, not from the
Budget);
- directors' annual report on operations and financial statements to
the shareholder Ministers should detail the means by which areas of
significant business risks are identified and managed;
- the Government may choose to set limits on particular GBE activities
which generate risks (for example, liabilities, financial exposures,
use of derivative instruments etc); and
- generally, the Commonwealth's policy is that no (new) non-statutory
guarantees of GBEs' liabilities are to be issued.
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:
- advise officials to seek formal authorisations before accepting contingent
liabilities; and
- explain the rationale for this advice in the context of the common
law principle known as the CarItona principle - which provides that
an official may be presumed at law to have acted on behalf of the Commonwealth,
even if he or she has not been specifically authorised to do so. In
such circumstances, the Commonwealth could still be liable for losses
associated with the (albeit unauthorised) acceptance of a risk by the
official in question.
13. The Guidelines also aim to provide advice aimed at reducing the incidence
of unauthorised acceptance of risks by:
- drawing the distinction between authorisations to accept contingent
liabilities and authorisations to spend public money; and
- recommending that managers should report to Ministers each year on
the purposes for which particular categories of authorisations have
been exercised.
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:
- the Financial Management and Accountability (FMA) Act 1997
(which came into operation on 1 January 1998) confers responsibility
on each agency head to manage the affairs of the agency in a manner
that promotes the efficient, effective and ethical use of Commonwealth
resources; and
- a model set of generic Chief Executive Instructions (CEIs) being promulgated
by DoFA to provide information on topics of Commonwealth financial policy
and 'best practice' which agencies are expected to emulate in their
respective individual sets of CEIs -which will replace previous Secretaries'
Instructions tailored to their specific circumstances. The model set
include a chapter on managing risk and internal accountability covering
topics such as the Commonwealth's policy on issuing indemnities.
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:
- a comprehensive risk/benefit analysis should be undertaken before
accepting any indemnities or guarantees;
- measuring the financial implications of such instruments is an inherent
element of the risk assessment process; and
- events or periods of time to which the instruments apply should be
specified or, if the nature of a particular instrument makes this impracticable,
the terms of the instrument should be reviewed periodically.
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:
- undertake a thorough risk assessment and determine which risks properly
belong to the contractor and which to the Commonwealth; and
- seek indemnities from the contractor for any losses for which he or
she is responsible or to which he or she contributes.
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:
- fiscal risks; and
- contingent liabilities
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:
- entry into; or
- subsequent management of contingent liabilities.
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:
- not reflect an appropriate balance of the risks involved;
- lead to unnecessary duplication of a role which is properly the responsibility
of program managers; and
- reverse the general thrust of public sector reforms in recent years
by
- a) withdrawing powers provided to program managers and
- b) sending the wrong message about the accountability of program
managers for their actions.
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:
- issuing guidelines reinforcing the need for this data to be accurate;
and
- conducting a reconciliation of the data supplied by portfolios for
inclusion in the 'Statement of Risks' with that disclosed in the 'Schedule
of Contingencies' attached to the audited agency financial statements.
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:
- initial risk assessments and updates, to identify and quantify
the various risks facing each agency and entity, so that the Government
knows what its exposures are and so that managers know where to direct
risk management activities. The cost of the initial risk assessment
will be borne by the managed fund;
- education programs to provide managers with tools to increase
awareness of risks arising from activities and strategies to avoid or
reduce them;
- comprehensive recording and reporting of losses to provide
management with information on areas of their organisation which generate
the greatest risk exposure and where management practice can be improved;
and
- the setting of deductibles and claims sensitive premiums
which reflect the agency's risk experience.
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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