Committee (4th Day)
Relevant documents: 17th and 21st Reports from the Delegated Powers Committee.
My Lords, it is now 3.30 pm. As required, I must advise the Grand Committee that if there is a Division in the Chamber while we are sitting, which I consider unlikely, the Committee will adjourn as soon as the Division Bells ring and resume after 10 minutes.
Clause 13: Single Source Regulations Office (or “SSRO”)
Debate on whether Clause 13 should stand part of the Bill.
I hope noble Lords will forgive me if I give a Second Reading introduction to this part of the Bill to make clear the Opposition’s general position. First, I declare an interest, although not a pecuniary one or any interest that I would be required to declare, to show the position I am coming from in terms of experience. I was a non-executive director of the Defence Logistics Organisation, the Defence Procurement Executive and a founder director of DE&S, so I tend to see these matters from the rather more sympathetic viewpoint of those poor professionals who are caught in the middle of the many debates about the efficiency of this process.
I shall speak briefly on Part 2 in general. The view of the Opposition is that this is an admirable attempt at an intractable problem. I commend the creation of Part 2 and congratulate the noble Lord, Lord Currie of Marylebone, on his excellent report and the MoD staff who have turned that report into legislation and regulations. I particularly thank the noble Baroness, Lady Jolly, Philip Dunne, the Permanent Under-Secretary of State for Defence, and their adviser, Jason Petch, for their time in taking me through the Bill line by line. The Opposition’s duty in this sort of legislation, which is largely apolitical—quite honestly, I am scratching around for any political points this afternoon—is to scrutinise the legislation line by line. I assure the Committee that we have done this but mostly off the Floor of the House. Therefore, we have before us a relatively modest number of groups and we hope to finish the Committee stage this afternoon.
My general thrust this afternoon will be to look at the independence and quality of the SSRO, the whole issue of transparency in its operation and its accountability to Parliament. I will also pick up on one or two concerns that have been put to us by industry. Where industry wants assurances, we should like to be able to read them into the record to meet its concerns. It is important to note that, although this debate takes place in the Moses Room with a modest number of us present, words spoken by the Minister will be extremely important to industry.
I should also make a point about procedure. Rather lazily, we have not crafted wickedly clever amendments with which to do our probing but are using the device of a clause stand part debate. I hope to brief the Minister in more detail than I have been able to about the questions that will arise from that. I have given her some briefing but I entirely understand that on some of the questions, which came up just as I made the final run-through, line by line, she may have to write to me. In this important area, it really is better to have accurate and considered responses, rather than hastily cobbled together ones, not that I suggest that the Ministry of Defence would have hastily cobbled together answers anyway. That is quite a useful procedure but if we are not satisfied with the responses and feel that they need to be read into the record, we will use Report to achieve that objective.
I turn now to the Clause 13 stand part debate and Amendments 18G and 18H. I wish to probe the key concept of the SSRO: its independence—not in its role, with which I am comfortable, but in its working. I start with the appointment of the chairman, the rules about which are in paragraph 1(1)(a) of Schedule 4, which states simply that the chair of the SSRO shall be,
“appointed by the Secretary of State”,
and gives no further guidance as to how that chair may be appointed. I first ask the Minister to expand on how the chair will be appointed. I caution her about too much reliance on reference to the Commissioner for Public Appointments, because the commissioner very recently put out a useful press release about appointments in which he clearly stated:
“Ministerial appointments to public bodies regulated by the commissioner must be made in line with the commissioners code of practice which sets out that appointments must follow an open, fair and merit-based process, overseen by a panel. In the case of chair appointments, the panel must be chaired by an independent public appointments assessor appointed by the commissioner”.
That is so far, so good. It goes on:
“The panel’s job is to judge the suitability of candidates and to provide a list of candidates who are ‘above the line’ i.e. they have the ability to do the job. It is then for the relevant Minister to choose which of these candidates to appoint”.
I read that to stress the point that the appointment of the chair is in the discretion of the Secretary of State. It is, in that sense, a political appointment. It is entirely within his discretion.
The complementary area that I shall now explore is the relationship that the chair and the board have with the Secretary of State. I go back to paragraph 2(2) of Schedule 4, which states:
“A person may not be appointed as an executive member without the consent of the Secretary of State”.
The first point is that the executive members will need the consent of the Secretary of State. It is clear from paragraph 1 of Schedule 4 that the Secretary of State appoints not only the chair but the non-executive chair of the SSRO. Moving on, paragraph 3(2) states:
“Appointment as a member of the SSRO is for a term of … not less than three years, and … not more than six”.
Sub-paragraph (6) of the same paragraph states:
“A person who ceases to be a non-executive member is eligible for reappointment”.
Returning to the commissioner’s press release, it states clearly:
“The Public Appointments Commissioner plays no part in a decision not to re-appoint someone at the end of their term of office. That is a matter for Government”.
That makes it very clear that reappointment is a matter for the Government. Looking further at the schedule, paragraph 6 sets out:
“The SSRO may, with the approval of the Secretary of State … pay remuneration and allowances to the non-executive members, and … pay or provide for the payment of pensions, allowances and gratuities to or in respect of a person who is or has been a non-executive member of the SSRO”.
Finally, in pursuance of that point, I move to paragraph 16, on “Finance”, which says:
“The Secretary of State may make to the SSRO such payments out of money provided by Parliament as the Secretary of State considers appropriate”.
Taking all these together, let us suppose, to make it simple, that I was to be appointed—it does not pay enough but we can put that to one side. Let us look at this relationship. The Secretary of State appoints me, reappoints me, determines my remuneration, controls my budget, appoints my non-executives and then approves the appointment of my executives. It is for the Minister to convince me that this is an independent organisation. I have been there; I have been the chairman of a nationalised industry and the chief executive. I have lived under these rules and I have to tell noble Lords that independence was not one of the things I felt. I felt from time to time that I had conversations with the Secretary of State where there was a degree of influence.
I repeat my request to the noble Baroness and invite her to convince the Committee that the SSRO is truly independent. What mechanisms will be put in place to assure us, the world, industry and so on that this independence is real? Can she give us some practical indication: for instance, will the Secretary of State or MoD staff be allowed to communicate with the chairman or SSRO staff?
SSRO staff are covered in paragraph 7 of the same schedule, which says, quite bluntly:
“The SSRO may appoint employees”,
“may pay its employees remuneration and allowances. Employees of the SSRO are to be appointed on such other terms and conditions as the SSRO may determine … The SSRO may pay or provide for the payment of pensions, allowances and gratuities to or in respect of any person who is or has been an employee of the SSRO”.
Finally, paragraph 17(3) says, very clearly:
“Service as a member or employee of the SSRO is not service in the civil service of the State”.
I ask the noble Baroness whether, as it appears from the schedule, the appointment is at the sole discretion of the SSRO. Will there be no interference from the state in any way, from the MoD or the Cabinet Office? Will pay be unfettered and will the SSRO be able to pay what is necessary to achieve the quality of employee necessary? In other words, will it have the sort of freedom—as far as one can see from simply reading this, the complete freedom—to appoint people on terms and conditions that are competitive with industry and, indeed, as good as, if not better than, those that will be allowed to DE&S-plus?
I move on to a straightforward question about procedure. Paragraph 10 of Schedule 4 states:
“The SSRO may determine its own procedure”.
I do not know why draftsmen do that, because it then goes on to say,
“but this is subject to sub-paragraphs (2) to (6)”,
which pretty well say that everything of importance has to be done by a committee. That is what I think it says. Can the Minister confirm that those provisions in sub-paragraph (3) cannot in fact be made by the board of the SSRO itself but will be made through a procedure of the committee as defined in, I think, sub-paragraph (2) and with the particular caveats that are in the subsequent sub-paragraphs?
Finally, I wish to raise an issue that I know we all worry about in public office: revolving door syndrome. I invite the noble Baroness to comment on the extent to which there will be limitations on where the members of the board, the executives of the SSRO, come from or go to. In particular, I am concerned about the extent to which they may be leading lights in the industry and carry their industry heart with them into the SSRO or, conversely, come out of the SSRO into plum jobs in industry. Will there be some limitations?
We have a couple of amendments in this group, which are just to enliven the debate. In the first, I wish to bring some independence to these appointments and suggest that they should be ratified by the House of Commons Defence Select Committee. In the second amendment, I suggest that the committee to which I referred earlier should have a majority of members who are not employees of the SSRO. I beg to move.
My Lords, I thank the noble Lord, Lord Tunnicliffe, for raising a number of questions to which I am sure my noble friend will seek to reply. They were interesting issues. I also liked the noble Lord’s comment that it was an admirable attempt at an intractable problem. Indeed, such an attempt is being made, which is really the point. Let us hope it is an issue that is cross-party and of no party, which could be seen as a good thing.
The other interesting point made by the noble Lord was that the words spoken by the Minister will be followed by the industry. That is the point about this debate: the words that are spoken and reported in Hansard are what the industry can see and take confidence from, as well as the amendments before us. I was also grateful that the amendments are not an attempt to wreck the Bill. The noble Lord’s final comment—that they would enliven the debate—was a pleasant way of looking at this matter.
Clause 13 in Part 2 is an important technical advance that attempts to bring sanity to single-source contracts. Clearly, the clause is necessary, and the Motion to remove the clause is purely a technical effort to debate it. The issue in Amendment 18G relates to how one ratifies appointments, which it suggests should be done by a Select Committee. I ask the Minister whether, if any ratification by a Select Committee takes place, it should have to interview the applicants. That would surely be beyond what was necessary and would end up involving a comprehensive interview process, which would be too much. The point made by the noble Lord was about how much influence and power would go to the Secretary of State, rather than to some other body of people. Although the Secretary of State must be allowed to have influence, he should not be the person taking the real decision as to who is supported.
When the Minister replies, I hope that she will also deal with a question not raised by the noble Lord, Lord Tunnicliffe. Should the Single Source Regulations Office be the sponsoring department? Should the sponsoring department be the MoD? What about the Department for Business, Innovation and Skills? I have raised this matter with the Minister on other occasions, not only in this context. Here we have a department, the Department for Business, Innovation and Skills, whose raison d’être is to sell and encourage business and industry, but the brief of the Ministry of Defence is also to engage in contracts, selling and so on. Indeed, that ministry sells overseas and I often wonder why we do not look holistically at how we deal with selling this country’s products. I wonder why, in the context of this amendment, the sponsor of the SSRO should be only the Secretary of State for Defence. Why should it not also or instead be the Secretary of State for Business, Innovation and Skills?
The noble Lord, Lord Tunnicliffe, has raised in a variety of ways the issue of the independence of the SSRO from government. I raised one further point on that at Second Reading. I got a reply, but I was not absolutely confident that it provided the right answer. The point I made was that the SSRO has an interest in value for money, but so has the Treasury throughout government. I asked to what extent the SSRO stands free of, or is supervised by, the Treasury. For the record, it would be helpful to have that point covered once again. If I remember correctly, I got a very full answer from the Minister, the noble Lord, Lord Astor of Hever, but I was not absolutely happy that it gave a feeling of the pure independence of the SSRO from the Treasury.
My Lords, I thank noble Lords for their comments at the beginning of this fourth day in Committee. In particular, I thank the noble Lord, Lord Tunnicliffe, and commend him for his preparation for the scrutiny in this Committee stage. I apologise in advance to noble Lords because some of my earlier speaking notes are quite lengthy, but they get shorter. The purpose of the length is that we need much of this on record.
Clause 13 is at the heart of the reforms to single-source procurement. It establishes the Single Source Regulations Office, a small, arm’s-length body responsible for keeping the new framework under review, monitoring adherence and providing expert determination between the MoD and single-source suppliers. It is therefore essential to the success of these reforms. Clause 13 also establishes in law the overriding aim of the SSRO to assure that good value for money is obtained in government expenditure on qualifying single-source defence contracts and that defence suppliers are paid a fair and reasonable price under those contracts.
The creation of an independent body is absolutely central to the success and longevity of the framework. I cannot say this too strongly. The purpose of this body is to be independent and transparent, thus giving confidence to both parties who need to play in this area. It was a key recommendation of the independent review conducted by the noble Lord, Lord Currie. The SSRO will replace the existing Review Board for Government Contracts, which, as the noble Lord, Lord Currie, identified, has, through no fault of its own, failed to evolve to reflect changing circumstances, largely because either party can block any change that it regards as contrary to its own interests.
Clause 13 brings into effect Schedule 4, which establishes the governance structure of the SSRO. In this we have closely followed guidance published by the Cabinet Office on executive non-departmental public bodies and have considered existing governance arrangements for similar bodies, such as Monitor. So we have not started with a blank piece of paper and, as the Committee will see, with the following key characteristics of the SSRO, the structure we have created is in common with other similar public bodies. It has a separate chair and chief executive and a board which has a majority of non-executive directors, which is aligned with best practice in the Financial Reporting Council’s UK Corporate Governance Code and Cabinet Office guidelines. Non-executive members of the SSRO should be appointed for a period of between three and six years to assure a staggered process of appointments to the key positions. There will be a process that allows the Secretary of State to remove or suspend a member from office on the grounds of failure to carry out his or her duties, incapacity, such as ill health, or misconduct, which rightly follows Cabinet Office guidance on the creation of public bodies. The SSRO will have the ability to appoint its own employees, which is consistent with Public Bodies: A Guide for Departments, produced by the Cabinet Office; and, in accordance with the Cabinet Office’s guidance on good corporate governance in executive NDPBs, the SSRO’s committee structure will be the body that makes key binding determinations, including where there is an appeal from one of the parties to a qualifying defence contract. We have listened to industry requests in this area, and have agreed that committees can contain members who are not employees or members of the SSRO.
The SSRO will also have separate responsibilities to the Secretary of State, the Auditor-General and Parliament. These, which are set out in Schedule 4, include the provision of annual accounts which are consistent with international finance reporting standards, which will be audited by the National Audit Office. These accounts will be prepared between three to six months of the end of the financial year. An annual report on its activities must be provided by the SSRO to the Secretary of State, who in turn will lay the report before Parliament.
As the sponsoring department of the SSRO, the Secretary of State will make payments to the SSRO to finance its operations. This is in common with Cabinet Office guidance on the funding of ENDPBs. There will be a framework agreement established between the MoD and the SSRO that sets its budget, in accordance with HMT’s guidelines in Managing Public Money and performance targets. The SSRO will be jointly funded by the MoD and industry, but we have agreed with industry that the MoD will pick up its costs over the first three years, as it is established and until we determine its precise annual running costs. The SSRO will be allowed to borrow money only on a temporary basis up to an overdraft limit set by the Secretary of State. There may be occasions where the SSRO has a higher number of adjudications or determinations that it is administering, where it may require additional resources to meet its objectives in a timely fashion.
We have given the SSRO the ability to pay pensions to its non-executive members. This is not because we intend to pay a pension to every non-executive member the SSRO appoints; rather, we have done this to give the Secretary of State the flexibility to recruit non-executive members from both the private and public sectors who may have existing pension arrangements. Other elements of Schedule 4 ensure that the SSRO will be a body that is subject to the Freedom of Information Act 2000, allow the parliamentary commissioner to investigate the SSRO, and ensure that its staff are not civil servants.
This clause is therefore crucial to the overall establishment of the SSRO and the functioning of the new framework. The SSRO will, over time, become an independent expert in defence single-source pricing, ensuring that we do not need to wait another 45 years for this framework to be reviewed again. It is therefore crucial that this clause is retained in the Bill.
Amendments 18G and 18H revolve around a concern, primarily expressed by industry, but also by the noble Lord, about the independence and impartiality of the SSRO. I assure noble Lords that we are committed to ensuring that the SSRO will be both independent and impartial. The credibility of the new single-source framework rests upon this. For example, the SSRO can act as an independent adjudicator in the event of disputes between parties and it is the appeal body to which industry can refer if we apply a civil penalty to it. Perhaps even more significantly, it annually recommends the profit rate and recommends changes to the framework as part of the quinquennial review process. It is the guardian of the new framework and its impartiality is at the core of the dual aims under Clause 13 of ensuring a fair and reasonable price for contractors and value for money for the Government.
If the SSRO was perceived as being partial, this would create great difficulties. If the perception was that it was too biased towards the Government, shareholders could decide that the defence sector was no longer worth investing in and our suppliers could be driven to leave it. If the perception was the other way—as too biased towards our suppliers—we would seek to change the framework entirely or we would exempt our contracts from it and thus lose the protections we are establishing in this Bill. Neither of these outcomes serves either the MoD or our single-source suppliers. It is the need for independence and impartiality that has led to our desire to set up the SSRO in the first place. The current framework requires consensus to change. This has meant that for 45 years, any change that one side has felt puts them at a disadvantage has been blocked. This is the principal reason why the old system has remained frozen in time for so long. Consensus will not serve us. The alternative, a statutory framework determined entirely by the MoD, would always be resisted by industry. There would be a risk that over time the framework would become steadily more one-sided and that industry would be driven out of the sector, so this option is also not desirable. What we need is an independent body, namely the Single Source Regulations Office.
Industry representatives have looked at some of the provisions of the Bill, which have given them some concerns that the SSRO will not be independent. Specifically, they have pointed to the fact that the chair and other non-executive members are appointed by the Secretary of State. They consider that this gives the Secretary of State considerable leverage over the SSRO. There are reasons for this process, and they do not stem from a desire to exert influence over the SSRO. We looked at the different models for arm’s-length bodies. We wanted to give the SSRO as much freedom as possible, including the ability to recruit its own staff. We did not want the SSRO to be a servant or an agent of the Crown and thus subservient to Ministers. These requirements have led to it being designated a non-departmental public body.
There has been considerable attention on NDPBs over the past few years, and one of the aims of this Government has been to reduce their number. In this case, the SSRO will be replacing an existing NDPB, the Review Board for Government Contracts, which through no fault of its own has not had the power to amend the current framework. However, noble Lords will be aware that there is substantial guidance around non-departmental public bodies. For example, they must be sponsored by a department which, given the functions of the SSRO, in this case is the MoD, and the Secretary of State of that department must appoint the chair and non-executives of the body. I think that that answers the question put by my noble friend Lord Palmer. The independence of the chair and the other non-executive members is essential, so forgive me if I now describe the recruitment process in some detail.
To ensure that this appointment will result in a suitable independent and unbiased person, we are running the recruitment process in full accordance with the guidelines of the Office of the Commissioner for Public Appointments. All the posts will be publicly advertised, with public selection criteria. The recruitment process for the chair is already well under way, with interviews for the post held within the last two weeks. The recruitment panel for the chair is headed by a public appointments assessor chosen for us by the Office of the Commissioner for Public Appointments. The panel has reviewed and cleared the advertisements, the selection criteria and the recruitment strategy. Also on the recruitment panel is a second independent person suggested by the Office of the Commissioner for Public Appointments and approved by the public appointments assessor. There are also two others on the panel, one MoD official and another person who has been suggested by industry, namely Paul Everitt, the chief executive officer of ADS, which is one of the industry trade bodies for the defence sector. Only one of the four members of the interview panel is from the Government.
The interview panel’s selection of suitable candidates will now be reviewed by the Secretary of State, who may not add candidates to or remove them from the shortlist, or appoint a candidate not assessed as appointable.
The same recruitment panel, with the addition of the chair, once appointed, will be used to select the other non-executive directors. There are additional requirements on suitable candidates. They must not have recently come from the MoD or a defence supplier. They must represent a balance of private and public sector experience, and they must have a variety of relevant experience—for example, legal, regulatory and private sector acquisition. Once appointed, the non-executives will appoint their chief executive officer and chief operating officer. Together, the board will then appoint what staff it needs.
This is a rigorous appointment process, and I am confident that the result will be an independent SSRO board. I do not think adding the need for the appointment of the chair and other non-executive members to be ratified by the House of Commons Defence Select Committee is a necessary additional step. The process of pre-appointment approval by Select Committee was introduced in 2007, and there has been discussion between the Government and the House of Commons Liaison Committee over which posts should be subject to such approval. Ultimately, it should be a matter for agreement between the Secretary of State and the chair of the Select Committee, and no such direction has been made for this post.
The SSRO is, for the most part, free to determine its own procedures, including making committees, which is the subject of the next amendment. The exceptions to this are where its procedures are laid out in the Bill or in the SSRO framework document with the MoD. This will, for example, require it to run a full public consultation in support of the quinquennial review.
All of this points to the considerable efforts we have made to ensure that the SSRO will be independent. The fact that the Secretary of State appoints the chair is not what will determine the independence and impartiality of the SSRO. It is its statutory aims, namely to balance the interests of value for money and a fair and reasonable price. It is the recruitment process of the chair and board, which I have just explained in some detail. It is the nature of its functions, which are set out in the Bill, and it is its freedom to determine its own processes and recruit its own staff. Finally, it is the checks and balances that the SSRO, like all public bodies, is subject to—for example, the Competition and Markets Authority and the National Audit Office. It is the fact that the SSRO’s chief executive officer will be an accounting officer, and that its chair can be brought before a parliamentary committee at any time.
Amendment 18H, the second in this group, also revolves around the independence and impartiality of the SSRO. Paragraph 10 of Schedule 4 to the Bill requires the SSRO to appoint a committee for the purpose of making any opinion or determination in response to a referral, and that such a committee must consist of three people, at least one of whom must not be a member or employee of the SSRO. Determinations are to be made on a majority basis, and this amendment would require that a majority of the committee must not be members or employees of the SSRO. In effect, this amendment would increase the number of committee members who must be external to the SSRO from at least one to at least two out of three.
I note that the current drafting does not prevent a majority, or indeed all, of the members of the committee being external to the SSRO should that be appropriate, for example to assist with capacity or specific additional expertise. Since no amendment is necessary to allow a majority of the committee to be appointed externally to the SSRO, I assume that the intent of this amendment stems from an underlying concern that the SSRO itself will not be an impartial body. I will return to this.
Matters that may be referred to the SSRO are almost all of a technical nature. The SSRO, as guardian of the framework, will hold an expert understanding of the issues that are brought to it, and an appreciation of the broader context of the framework within which the referral sits. It will be bound by its statutory aim of ensuring a fair and reasonable price and value for money. For these reasons, we consider the SSRO to be best placed to make these technical determinations. Indeed, it is one of the primary functions the SSRO is being created to fulfil.
Industry has, throughout our engagement with it over the past two years, continued to express its concern over independence and impartiality. I have addressed much of our response to this concern in my comments on the previous amendment, and while we understand the concern, we do not share it. The existing requirement that at least one member of the committee be external to the SSRO was specifically introduced in response to industry’s concern over the impartiality of the determination committees. For the many reasons already discussed, we believe that the SSRO will be independent and impartial. In the unlikely event that a committee displays partiality, the independent member of the committee may raise a red card. In the extreme, they could remove themselves from the committee, making it no longer quorate. We consider that this is sufficient to address that concern. Beyond addressing the perceived impartiality of the SSRO, we consider that requiring a majority of the committee to be external to the SSRO will be to the detriment of the efficiency and effectiveness of the SSRO’s function to provide expert determinations, without any change to the committee’s impartiality.
Requiring another member to be external to the SSRO will increase the cost of the committee as such external members would be expected to be more expensive than members or staff of the SSRO. It may reduce the experience and understanding of the technical framework under Part 2 that will be available in the committee’s deliberations. It is likely to impact on the effective governance of these committees as the pool of suitably experienced and qualified experts with an understanding of this technical framework is expected to be relatively small, so there may be delays in establishing committees and in their deliberations owing to the external commitments of members. Finally, all members of the committee, whether internal or external, will still be appointed by the SSRO chair. Unless we make the assumption that members and employees of the SSRO, who are subject to its dual statutory aims, are somehow less impartial than external appointees, there is no benefit to increasing the number of external appointments.
For all these reasons, we do not consider that this amendment is necessary and believe that it will reduce the effective operation of the SSRO’s function to provide independent and impartial determinations.
I shall move on to points made by noble Lords. The noble and gallant Lord, Lord Craig, asked about the independence of the SSRO from the Treasury. I will write to him to give him more detail on that.
The noble Lord, Lord Tunnicliffe, asked several questions. This may well repeat some of what I have already said, so please bear with me. Three of four on the appointment panel are non-MoD.The chair can be required to appear before parliamentary committees. We are well aware that the independence of the SSRO is still a subject of concern. I assure the Committee that the Government are committed to ensuring that it is impartial. If a new system is perceived as too biased towards the Government, suppliers could decide that they no longer wished to invest in the sector or in the industry altogether. If the perception was the other way around—that the system was too biased towards industry—we would seek to change the framework entirely.
On what the board does versus what must the committee do, the matters listed in paragraph 10(3) of Schedule 4 are inexplicable on their own, but I am sure the noble Lord has cross-referenced them to understand what they do. They are what must be done by the committee, but they apply only to referrals, determinations and opinions. They ensure the use of an independent person for the key decisions.
In response to the question put by my noble friend Lord Palmer, about whether the SSRO’s sponsoring body should be BIS, there is a requirement across government that all non-departmental public bodies should be associated with a specific department and that the Secretary of State for that department must approve the relevant board appointments. The functions being assumed by the SSRO are of most pressing interest to the MoD rather than any department. They are specialised in nature and require technical understanding of the specific nature of single-source procurement as undertaken by the MoD. No other government department has used the Yellow Book arrangements for many years, and therefore at the current time it would be impracticable to consider any department other than the MoD as the sponsor of the SSRO. With that, I urge the noble Lord not to oppose the clause standing part of the Bill.
Clause 13 agreed.
Schedule 4: Single Source Regulations Office
Amendments 18G and 18H not moved.
Schedule 4 agreed.
Clause 14: Regulations relating to qualifying defence contracts
18J: Clause 14, page 10, line 22, at end insert “provided the stipulation in subsection (7A) below is satisfied”
My Lords, I am sorry that I did not make a closing speech because the idea of HMT having performance targets and a bonus culture does not fill me with enthusiasm. I may write to the Minister on that.
In moving Amendment 18J I shall speak also to Amendment 18K and to oppose that Clause 25 should stand part of the Bill. The issue here is essentially one of transparency. The offending subsection in Clause 14 is subsection (7), which states:
“The Secretary of State may direct that a particular contract to which subsection (3) applies is not a qualifying defence contract even though the contract otherwise meets the requirements of subsection (2)”.
One loves legislation that contains such clauses because they mean something like, “Never mind the whole of this document because the Secretary of State can decide it does not apply”, which roughly speaking is what this says. Amendments 18J and 18K recognise that there will be circumstances in which, frankly, this whole part of the Bill is excluded by the Secretary of State. It invites the Secretary of State to bring full details to Parliament and explain why the decision has been made. I should like the Minister to set out the circumstances in which subsection (7) would be used. I have asked the question privately and was given a general answer saying, “It is about the peculiarities of government-to-government contracts”. It seems to me that my amendments are entirely reasonable in those circumstances. It is entirely reasonable where there is some other assurance process, such as, “The Americans are going to do it for us” or that there is a treaty with the French which lays out the provisions to do this. That would be when this clause is used.
The Grand Committee is a small group today and we are discussing a very dry subject, but it is one that concerns the moving about of hundreds of millions and, indeed, billions of pounds. If a chunk of money of that order is moving about, Parliament should know under what circumstances it is being moved about, why the SSRO is not involved, and what assurances the public purse can be given by the Government as to what is being done. I expect that in her response the noble Baroness will talk about government-to-government contracts and I look forward to her touching on the detail of that.
The other area that came to light only when I delved into this with more care is the fascinating area of critical industrial capability. I am not sure whether that is the favourite way of referring to the concept these days, but I am sure that my meaning will emerge. Critical industrial capability is a concept whereby the taxpayer shovels out an awful lot of money to various contractors, a substantial part of which goes to BAE Systems, in order to keep workers on the books who are not doing work so that they are available to do work later. I am not even saying that that is wrong. I can see precisely why it makes sense. A more holistic view of the problem might be to schedule one’s procurement in a smoother way so that they are working continuously, but, conceptually, I can see why the former concept is necessary. However, it is important to realise just how substantial this is. We had a recent Statement on aircraft carriers. I read what the Minister said but the BAE Systems press release is in some ways even more interesting in that it is quite revealing. It states:
“BAE Systems has reached agreement in principle with HM Government on measures to enable the implementation of a restructuring of its UK naval ships business”.
The perception of BAE Systems is that this is about the naval ships business. The press release goes on to say:
“In 2009, BAE Systems entered into a Terms of Business Agreement (ToBA) with the Ministry of Defence that provided an overarching framework for significant naval shipbuilding efficiency improvements in exchange for commitments to fund rationalisation and sustainment of capability in the sector. The agreements announced today, together with an anticipated contract for the design and manufacture of the Type 26 Global Combat Ships programme, will progressively replace that ToBA”.
This is about maintaining capability. A couple of paragraphs later, it states:
“Under the new Target Cost contract the industrial participants’ fee will move to a 50:50 risk share arrangement”—
it is talking about carriers—
“providing greater cost performance incentives. The maximum risk to the industrial participants will continue to be limited to the loss of their profit opportunity”.
This clearly—at least in my view—is not compatible with Part 2 of the Bill. Apparently, Part 2 allows risk-sharing only under Clause 16, as far as I can see, and that in no part talks about limiting the loss to the profit component. It implies that the loss would go down the middle and deeper into it.
The press release refers also to the three offshore patrol vessels. Noble Lords may recall that the Secretary of State’s speech made it clear that these were pretty cheap because, frankly, they were being paid for by the industrial capability budget. The press release goes on:
“Following detailed discussions about how best to sustain the long-term capability to deliver complex warships, BAE Systems has agreed with the UK Ministry of Defence that Glasgow would be the most effective location for the manufacture of the future Type 26 ships”.
We should remember that the press release is written for shareholders, not the public, so it re-emphasises:
“The cost of the restructuring will be borne by the Ministry of Defence”.
It seems to me that these sorts of contracts do not come within the proposed framework that Part 2 talks about. In order for such a contract to be completed or negotiated in the future, Clause 14(7) would have to be invoked. Essentially, I am asking whether I am right in those presumptions. I am very happy to be written to because I accept that I have raised rather a new point. If that subsection is to be invoked, and if this capability and that sort of contract is to be involved, costing hundreds of millions of pounds, and probably the odd billion, it seems to me that the public and government should know about it in a rather more open way. Our amendments would require this to happen: the public should know and Parliament should know.
On Clause 25, essentially I am asking the Minister whether I am right that this is the only reference in the Bill to the issue that I have been talking about. Clause 25 seems to stand out as not being cross-referenced anywhere else in the Bill. It suddenly pops up on the subject of overheads and forward planning. I assume that this relates to the reporting structures. I should have said at the beginning that the reporting structures in the Bill are in many ways the essence of it, and the fact that I have no amendments on them is an acknowledgement that I commend the reporting structures and what they do. However, regarding Clause 25, I ask whether this relates to this concept of critical industrial capability and, if it does, in what circumstances Clause 25(8) would apply. Those of us who are required to study legislation always look for this paragraph:
“The Secretary of State may direct that a particular contract is not to be taken into account in determining whether the ongoing contract condition is met in relation to a financial year”.
In other words, if it gets very difficult, the Secretary of State can determine that it shall not be taken account of.
I hope that the Minister will be able to help with these questions and I am content that she may need to write to me. I beg to move.
My Lords, I will consider Amendments 18J and 18K together and then move to the clause stand part debate.
These amendments relate to the Secretary of State’s power to exempt contracts from the new framework, provided for by Clause 14(7). Amendment 18J has no impact in its own right other than to add scope for a limitation to the Secretary of State’s exemption power. That limitation is provided by Amendment 18K. Subsection (7) gives the Secretary of State the power to exempt individual contracts that would otherwise be subject to the new regime. While it is not possible to foresee all future circumstances, this power is considered necessary for a number of reasons.
Before considering the limitation introduced by Amendment 18K, it might be helpful to noble Lords if I outline and give examples of the key circumstances in which we expect this power to be used. The first circumstance is where there is no market failure. The framework addresses the situation where a contract price is not subject to the competitive pressures of the market. If those pressures are evident in the contract price, the framework is not required. An example is the purchase of additional items that are readily available in the civil market, such as computers. To ensure compatibility with our existing infrastructure, we might want to use a particular manufacturer, so the procurement would be a single-source procurement. However, the item might have a price that has been established in a competitive market. In such cases, there would be no requirement for standardised reporting and open book rights to ensure value for money, because it would be self-evident from the marketplace. Applying the framework in such a case would not represent value for money, as the additional costs of making the contract a regulated contract would not be outweighed by the benefits of transparency.
The second circumstance is national security. The Bill provides for some categories of contract to be excluded from the framework automatically, and Clause 14(2)(c) provides for these categories to be specified in the single-source contract regulations. The draft regulations identify a few such categories, one of which is when a contract is for the purposes of intelligence activities. We intend that these exclusions will apply only if the whole contract is covered by one or other of the excluded categories. So in the case where a significant part, but not all, of the contract is for intelligence activities, the contract would not be excluded from the framework automatically. Since transparency is a significant part of the framework, this is unlikely to be appropriate, so the whole contract may require exemption by the Secretary of State.
The third circumstance concerns our relations with other nations. Transparency is one of the key elements of the new framework, and some of the standard reports would give us sight of a supplier’s plans for the key industrial sites sustained by MoD’s single-source procurement. We require that information so that we can monitor planned investment or disinvestment activity and compare it with our forecast capability requirements. However, that could result in a supplier having to reveal the forecast throughput assumptions of facilities that are predominantly used by a foreign Government, which could expose that country’s defence planning assumptions to our gaze. Needless to say, that is likely to be treated with considerable reluctance by the foreign Government.
In such a circumstance, we might expect a contractor to use the provision of Clause 27, identifying a “relevant restriction” over such information. However, this possibility applies only after the contract has been entered into, so the contractor and foreign Government may not be willing to rely on this provision. We would therefore first consider using the lesser exemption provided by Clause 25(8), which provides specific exemption from such reports while leaving in place the pricing and contract-specific reporting provisions. Despite all this, a complete exemption using the power under Clause 14(7) may still be required should the other measures not be sufficient to satisfy the concerns of a foreign Government.
Without the power to exempt individual contracts, the MoD could find itself in the uncomfortable position of having to choose between not being able to procure certain equipment or applying the framework in circumstances that do not provide value for money, risk the security of sensitive contracts or risk trying to force a supplier to provide information against the wishes of another Government. These situations are expected to be rare, but this is an essential power for the effective operation of the framework.
To summarise, we expect the Secretary of State to use his exemption power only in exceptional cases. The new framework will help us to get value for money, so we have no desire to limit its application, except where there is no market failure to correct, or it would be impractical.
To return to the amendments, we do not see a need for additional and specific parliamentary scrutiny over the use of this power. It will be subject to normal processes, as with other powers granted to a Secretary of State, and his decision to apply the exemption will ultimately be subject to judicial review. Where we are using the exemption for national security reasons, or where we judge that it would be potentially damaging to foreign relations if we did not exempt a contract, there may also be reasons why we do not wish to have a public and high-profile debate on the matter. I hope this explains our position, and I therefore urge the noble Lord to withdraw the amendment.
Clause 25 is about reports. The new supplier reports defined in it are a fundamental component of the new framework, and a very significant amount of the benefits case for these changes rests on the use that will be made of the reported information and the analysis that will be derived from it. This clause is therefore vital to the overall function of the new framework.
The new reports will provide the MoD with much greater transparency over the assumptions suppliers have made in proposing the cost-recovery rates that form such a vital component of the price in large single-source contracts. This transparency will allow us to understand much better the effectiveness of those agreed rates as a mechanism used to recover suppliers’ allowable overhead costs, estimated in total to be £2 billion pounds each year. Analysis of new standard-format cost data will enhance our ability to benchmark the business units we do business with, and better challenge costs we are asked to pay for in an objective and analytical way, backed by evidence. The requirement for all companies to provide information in a standardised way will enhance the MoD’s ability to compare and contrast costs and recovery rates though time, between business units and suppliers, and also against externally published data for both the defence sector and the wider industrial landscape.
Finally, the new reporting requirements will promote and inform very senior dialogue between industry and government around better alignment of long-term supply and demand, attempting to ensure that the MoD contributes only towards the maintenance of industry capacity it reasonably expects to need in the future. Most of the information in these reports will be available to commercial teams responsible for contractual negotiations and also to MoD project, finance, planning and cost-assurance teams.
Overall, when fully implemented and matured, the new reports will make a substantial contribution to making the MoD a more intelligent and informed customer. Over time, the information provided by the new supplier reporting requirements will make a very real end-to-end contribution to the process of agreeing, using and validating cost recovery rates and, in turn, where appropriate and justified, this will lead to lower contract prices. This clause, which enables the creation of these critical reports, will significantly improve the understanding and transparency of the costs the MoD has to pay and help us to become an even more intelligent customer.
To address some of the noble Lord’s points on the exclusion of government-to-government contracts, these contracts are already excluded by the single-source contract regulations under Clause 14(2)(c). The exemption power of the Secretary of State will not be used for these contracts. I have a lengthy response on transparency over strategic capability, and it is probably better if I set it down in a letter to the noble Lord; it runs to one and a bit pages. If the noble Lord is happy with that, I would be grateful if he would withdraw his amendment.
The framework provides for a range of reports to be specified in the single-source contract regulations upon both specific contract costs and upon supplier costs that relate to wider capabilities and capacity. It is estimated that around a third of the costs of single-source contracts relates to so-called overheads. These account for some £2 billion a year of expenditure under single-source contracts. These costs do not relate to any one individual contract but, it is said, represent the costs of providing particular industrial capabilities and capacity. Not all of the costs of this capacity will be reflected in the costs recovered through single-source contracts. Some may be recovered through MoD contracts won competitively, or through non-MoD customers. However, in some sectors where single-source activity is particularly concentrated, these costs may represent the majority, if not all, of the costs of capacity.
The new framework has six reports relating specifically to these costs. These include reports on the estimated costs that are used to price contracts, the assumptions that underpin those estimates and the actual costs that are subsequently incurred. The requirement for suppliers to keep relevant records in relation to costs and the MoD right to examine those records also apply equally to these overhead costs, as they do to any other allowable costs. In addition to these transparency rights, the pricing principles set out in relation to allowable costs also apply to these overhead costs. Such costs must be appropriate in nature and reasonable in value.
The transparency provided by these reports, the access to records supporting them and the requirement to follow the pricing principles will further enhance the ability of the MoD to act as an intelligent customer when considering the cost of the capacity it requires. The single-source contract regulations will also provide for a further report that specifically considers the industrial capacity provided by our key suppliers. This report will supply senior individuals in the department with consistent information across suppliers when considering capacity requirements, contributing to the alignment between requirement and the industrial capacity we have to pay for. I hope that the noble Lord will now consider withdrawing his amendment.
My Lords, I thank the noble Baroness for that response. We have used different terms but I think she has gone half way to meeting my concerns over what I have called the critical industrial capability. I did not of course put down a clause stand part debate in order to not have a clause, but to understand it better.
However, one area still concerns me. The sort of deals that I described from the BAE Systems press release are very large, and I have great difficulty in seeing how you would fit them, in future, into Part 2, which is full of pricing mechanisms, profit share and so on. It is quite detailed and there is a framework. I am happy for the Minister to write to me rather than give me an answer now, but one of the questions is whether she envisages that such deals will be fitted into Part 2 or whether it will be necessary to use Clause 14(7) or some other exception—as the Minister has pointed out, there are other exceptions in that clause. Does the Minister envisage there needing to be an exception for those sort of deals or is it envisaged that future deals of this nature will be somehow compatible with Part 2 in ways that, at the moment, I am incapable of understanding? I would be very grateful for a response to that detailed question, although I would not encourage her to give me one now. With that, I am content to withdraw Amendment 18J.
Amendment 18J withdrawn.
Amendment 18K not moved.
Clause 14 agreed.
Clauses 15 to 17 agreed.
Clause 18: Contract profit rate: supplementary
18L: Clause 18, page 13, leave out line 19 and insert—
“(3) Single source contract regulations may provide that, if the achievement of a fair and reasonable contract profit rate for a qualifying defence contract at the time of pricing was frustrated because the information supplied or made accessible by one party to the other at the time of pricing, and on which that contract profit rate was based in whole or in part, was materially inaccurate or incomplete, the SSRO—”
My Lords, in moving Amendment 18L, I will also speak to Amendments 18M and 18N. I find myself in the unusual position of a public sector socialist politician putting forward some amendments nakedly proposed by industry. However, it seemed that the questions being posed deserved a response and a discussion. I hope the Committee will forgive me proposing these amendments as a bunch of probing amendments for the Minister to respond to.
The industry argues that Clause 18(3) creates uncertainty as to the contract price. It enables the contract price to be challenged at any time after it has been agreed if the party considers that adjustments under steps 2, 3 or 6 of Clause 17(2) were not appropriate. When approving or signing a contract, a board of directors will require certainty of income against which it can assess its cost estimates and associated risks. It contends that the sense of uncertainty over price may have unintended consequences for shareholder value, group decisions on where to invest, and the perception in the wider marketplace that the UK remains a good place to invest in and do business. It believes that the parties should have a limited time period in which to challenge the adjustments made in steps 2, 3 or 6 to reduce uncertainty, and that a period of six months from the date of price agreement is more reasonable.
The industry also argues that the grounds for a challenge need to be included in the Bill. There needs to be a material basis for the challenge such as that the adjustment has caused harm or disadvantage to one party. An error or an omission that has caused harm or disadvantage, and if corrected would give rise to a material adjustment, would be a more reasonable basis. Without materiality or a de minimis threshold, challenges could be made for trivial amounts. I beg to move.
My Lords, we are considering in this group of amendments three related changes to the power under Clause 18 for a referral to be made to the SSRO for a determination to adjust the price of a contract. On a minor drafting point, the proposed amendments address only the SSRO’s adjustment of the profit element of the price and, indeed, to only three of the six steps that set contract profit rate. However, I shall assume in my response that the intent of the amendments is also to limit the ability of the SSRO to adjust the cost element of the price as outlined in Clause 20 rather than the profit element alone.
The contention behind these amendments is, I believe, that this price determination introduces an unacceptable degree of uncertainty to the price of a contract, and so they seek to restrict the scope of the determination in three ways: by restricting the grounds on which a referral may be made, as set out in Amendment 18L; by restricting the period in which a referral may be made, as set out in Amendment 18M; and finally by restricting the determination that the SSRO may make. We do not consider that any of these restrictions are necessary or desirable, and placing such restrictions on the determination will significantly weaken compliance with the pricing rules of the new framework. I think it will be helpful if I outline the purpose and scope of the SSRO’s price determinations before we consider the individual amendments.
The new single-source framework is essentially a deal between suppliers and the Government. Suppliers get a fair and reasonable price and we get the protections we need to ensure value for money. This is a good deal for both parties. We have a duty to ensure taxpayer value for money and an efficient and thriving defence sector that gets a fair price, which is good for defence as a whole. It means that our Armed Forces get the equipment and support they need and the wider economy benefits from an efficient defence sector that can drive innovation and exports. Determining a fair price is thus a key component of Part 2, and Clauses 15 to 21 set out how this is to be done. They set out, for example, that the price must be determined on the basis of allowable costs—costs that are reasonable, appropriate and relate to the contract. They also set out that on top of these costs, the supplier is entitled to a fair and reasonable profit rate. Following these pricing rules will result in a price that is fair and reasonable. The rules on profit ensure that suppliers are adequately compensated for their expertise, and the rules on costs ensure that taxpayers do not pay more than they should. There would be no point in having these rules if they were not enforceable. Indeed, it would undermine the deal that is central to the framework.
This is the situation we have at the moment. Even though the current Review Board for Government Contracts annually recommends a profit rate, there is no obligation to use it, and it is being used less and less on our larger contracts. It may be asked why we need price enforcement provisions at all. Why would anyone sign a contract with a price that is not fair and reasonable? The answer stems from the market failures inherent in single-source procurement. This form of procurement is used when there is no alternative supplier. It means that we cannot walk away from the supplier without also walking away from the essential military capability that that supplier provides. This is not a strong negotiating position, as our suppliers are only too aware. In addition, we are sometimes under time pressures, so that any delay to signing the contract puts lives at risk. This compounds the problem, and partly explains why we may not always get the best deal.
Another reason why we might sign a contract with a price that is not fair and reasonable stems from the fact that in single-source procurement there is only one supplier pricing the work. The knowledge that there is no one who can put forward a cheaper, more competitive price puts a supplier in a highly unusual and privileged position. Instead of a healthy market incentive to price keenly, our single-source suppliers are under a direct financial incentive to do just the opposite, and the current framework encourages this. This is not to say that our suppliers always, or even routinely, do this. However, it cannot be denied that an environment where suppliers are rewarded for inflating their price is hardly conducive to getting value for money.
The MoD, of course, has a duty to challenge a supplier’s price estimates. As a brief aside, I will note that this price challenge has not been a level playing field historically. Suppliers’ commercial staff, for whom financial incentives are paramount, typically outnumber our commercial staff, and they employ specialist consultants to help them—which, under the current system, they can often charge back to us. Returning to the market failures of single-source procurement, a substantial difficulty in challenging suppliers’ costs is that they always know more about them than we do. Clearly we need to see their cost assumptions before we agree a price. This is what we should get under the current system, although it is not legally binding. Under the current system we can also challenge their price up to two years after the contract has ended, if we can prove that they did not show their assumptions to us.
This brings me to Amendment 18L. This seeks to introduce a single and specific ground for a price referral to the SSRO—namely, that the SSRO can amend the price only if the initial pricing assumptions were not shown to the MoD. However, seeing suppliers’ price assumptions is not sufficient. Suppliers are in a strong position and can present a convincing case—for example, by showing that their costs forecasts are aligned to historic expectations even if these represent poor value. It requires specialist knowledge and experience to challenge this. It is not enough for a supplier to show us their assumptions, and to put all of the duty on to the MoD to check that each and every one is reasonable, as with the current approach. This encourages a supplier to add extras to their price and hope that the MoD does not find them all. This is an appalling pricing incentive, far removed from a healthy market, and we must address it if we want to get value for money. Again, I do not say that this always happens but I am sure that it is not conducive to getting value for money.
We want suppliers to be encouraged to use good quality pricing assumptions in the first place; assumptions that are fit for purpose. If the cost is worth hundreds of millions of pounds, then they should do a certain amount of due diligence to support this estimate. If they do not, they should be at risk of a future price change when it transpires that outturn costs bear little resemblance to the original estimates. Equally, and just as importantly, I accept that the MoD has a duty to check these estimates. If we fail in our duty, any SSRO-determined price change will take this into account.
The SSRO price referrals, in the way that they are currently drafted, will replace the current misaligned pricing incentives with incentives that act as a proxy for the missing competitive pressures. We have chosen to give the SSRO, in its role as an independent expert of single-source procurement, the function of acting as an independent adjudicator in the event that these pricing rules are not followed. One alternative might have been the courts. However, the technical and specialist nature of single-source procurement means that this route might be more complicated and time consuming for both parties, and probably much more expensive.
So the SSRO, under Clauses 18 and 20, can make a determination that the price of the single-source contract must be adjusted. It will make this assessment if it considers, for example, that a contractor’s assumptions were misleading or not fit for purpose at the time of pricing; in other words, that they were not fair and reasonable.
The SSRO will not penalise either party for getting an assumption wrong—no one can be expected to know the future—but if it considers that a party provided misleading assumptions or withheld crucial information known to that party at the time, such as, for a supplier, known efficiency measures, then the SSRO can adjust the price. If the SSRO considers that the MoD should have asked more questions, it will also take this into account in its determination. Industry has raised concerns that this adds uncertainty into single-source procurement. My challenge back is that it is an uncertainty that can easily be mitigated. If you follow the pricing rules and keep an audit trail of your assumptions, then any uncertainty will be minimal.
Amendment 18L would reduce the grounds for referral to the SSRO. A referral could be made only if inaccurate or incomplete information had been provided by either party to the contract. If information was provided but was misleading or not fit for purpose, this amendment would prevent the SSRO reviewing and, potentially, adjusting the price of a contract. Similarly, if the adjustments had been determined without regard to the statutory guidance or there was an error of calculation, there would also be no ability to refer the matter. This amendment puts all the duty back on to the MoD to ensure that all the details of a price are fair and reasonable; all the supplier has to do is show its assumptions to us. It takes away from the supplier the duty to do its own due diligence and ensure its estimates are reasonable. This amendment is not an equitable arrangement, particularly given that suppliers have greater knowledge about their costs, and it frustrates our intent to put a proxy for market pressures back on to our single-source suppliers. I therefore urge the noble Lord to withdraw Amendment 18L.
Having provided a great deal of background for the first amendment, I will be brief with the next two amendments in this group. Amendment 18M seeks to restrict the ability of either party to a contract to make a referral to the SSRO for a determination. This amendment would limit the period in which such a referral could be made to the first six months after the price of a contract has been determined. As I discussed earlier, there are a number of reasons why an SSRO price determination might be appropriate: whether information was withheld from one party at the time of pricing, whether due regard was given to statutory guidance, whether the detailed calculations were performed correctly, or any other reason why the pricing assumptions may not have been fit for purpose. In all these scenarios, information will continue to emerge throughout the course of the contract. For example, the supply chain employed may be significantly different from that assumed at the time of pricing, and this may be a prompt to investigate whether information was appropriately shared or whether the pricing assumptions were fit for purpose. If a contract is for the design, manufacture and initial in-service support of equipment, this kind of information may not become apparent until several years into the contract. To restrict the period for this determination to six months is to restrict the ability to consider information that later comes to light, conduct investigations and assess whether an adjustment might be appropriate. We consider this an artificial and unnecessary restriction upon the SSRO’s aim of ensuring that the contract price is fair and reasonable and that good value for money is obtained. As before, any uncertainty can easily be mitigated by a contractor following the pricing rules and keeping an audit trail of its assumptions.
We however recognise that it is appropriate clearly to specify the periods in which opinions and determinations, including this determination under Clause 18, may be made. It was for this reason that we introduced in the House of Commons what is now Clause 41. This provides that the single-source contract regulations may specify time periods for all referrals to the SSRO, and the draft regulations do just that. The draft regulations are the subject of the ongoing consultation with industry, so we do not consider it necessary to single this one referral out to specify a period in the Bill rather than in the regulations.
Amendment 18N is the final amendment in this group. Unlike the previous two amendments, which would restrict the basis upon which a referral to the SSRO may be made, this amendment seeks to limit the determination that the SSRO is able to make by introducing the requirement for a price adjustment to be material. In most circumstances, the requirement for materiality is implicit in the overall process for this referral and determination. In order to arrive at a price adjustment, parties must first have recognised an issue, failed to reach agreement through discussion and negotiation, referred the matter to the SSRO, and the SSRO must consider that an adjustment is appropriate. The SSRO is not under a duty to make an adjustment in response to a referral. It may do so if it considers that the existing price is not appropriate. We would not expect to arrive at a referral to the SSRO over an immaterial matter, and would not generally expect the SSRO to determine a price adjustment if it were immaterial.
However, while in most cases any adjustment would be naturally expected to be material, there is also the important matter of compliance with the regime. Part 2 introduces a civil penalty compliance process, which deals with contraventions relating to the duties of a contractor once they have entered into a qualifying defence contract—duties such as keeping records and providing reports. That process does not directly address the pricing of a contract. That is dealt with by the determinations under Clauses 18 and 20 that allow for the SSRO to determine a price adjustment.
These determinations play an essential role in ensuring that a contract is priced in accordance with the principles set out in the Bill and regulations, and with regard to statutory guidance. Without these determinations, there would be rules relating to the pricing of these contracts, but no compliance process.
To limit this determination to material price adjustments would limit the power of the SSRO to make determinations based upon principle, irrespective of value, and in doing so to award appropriate costs. The determination may deal with important matters of principle but, based upon the balance of circumstances, the SSRO may consider that a nominal adjustment is appropriate, setting out its reasons for doing so. To prevent the SSRO from making such determinations would be an unfortunate restriction upon its freedom to make determinations in such cases. I therefore urge the noble Lord to withdraw Amendment 18L, and not to move Amendments 18M and 18N.
Amendment 18L withdrawn.
Amendments 18M and 18N not moved.
Clause 18 agreed.
Clause 19: Rates etc relevant to determining contract profit rate
18P: Clause 19, page 13, leave out line 32 and insert—
“(1) The Secretary of State shall by regulations, for each financial year, provide a determination of—”
My Lords, in moving Amendment 18P I will speak to the rest of the amendments in this group. The points I want to make are simple, but I look forward to the reply I shall receive to these simple ideas.
The group essentially refers to Clauses 19 and 20. Clause 19 addresses the issue of the contract profit rate and, essentially, the amendments would require that the rates must be set by regulation each year. Amendments 23A and 23E turn this into an affirmative-procedure process.
More interesting is Clause 20, “Allowable costs”. As the report of the noble Lord, Lord Currie, points out, we have over the years had a lot of debate, effort and negotiation into the contract profit rate which, typically, is 10%—pedantically, it is 9%—of the total price; and too little, one might argue with the benefit of hindsight, into the issue of allowable costs, which represent 90% to 91% of the total price. Therefore, Clause 20 properly addresses this issue.
Subsection (1) states:
“The SSRO must issue guidance about determining whether costs are allowable costs under qualifying defence contracts”.
Subsection (2) attempts to define allowable costs. It is important to emphasise that these are the big bucks. This is where the big money is in the contract. This is 90% or more of the total price. The guidance we get from the primary legislation is that they must be appropriate, attributable to the contract and reasonable in the circumstances. Much as I praise this part of the Bill—and I do as it is a really good attempt to address this extremely difficult issue—I cannot but be amused by these three descriptors of one of the most important elements. I remember that when I was privileged to be in the noble Baroness’s position, whenever an official used the word “appropriate” in my response, it meant we did not have an argument, so I dismiss subsection (2)(a) as pretty well irrelevant. I do not have a lot of time for paragraph (b) either, because if it is not “attributable to the contract”, who would in all conscience try to argue that it should be there? We are left with “reasonable”. Much as I applaud the concept of being reasonable, it is not a very full description. Therefore, inevitably, and quite properly—I am not unhappy about this—it will have to be left to the SSRO to develop guidance about it. However, surely this is so important that it should not be merely guidance but should be in regulations. Regulations of this importance should be exposed to public gaze and debate and should be accountable to Parliament through the affirmative procedure. I beg to move.
My Lords, I, too, am worried about these words. I shall not repeat what the noble Lord, Lord Tunnicliffe, has said. It is really a question about what are allowable costs. As anybody in business knows, allowable costs can be described in so many ways. For instance, Starbucks does not pay any tax in this country because it charges its royalties from overseas against its costs in this country. Would that on a contract for a submarine be allowable costs? If the contractor is producing, let us say, one submarine, can it therefore charge all of its chairman’s, managing director’s and executive board’s salaries against the cost of that one submarine? If it is also producing a group of battleships or carriers, those executive costs, for example, would be spread over all the costs of all those items of equipment.
In her previous reply, the Minister spoke about an audit trail. The noble Lord, Lord Tunnicliffe, used the word “reasonable” and all the other adjectives. A contractor who wished to drive a coach and horses through this could do so by manipulating what could be administrative costs. It is very easy to say that if the mythical submarine requires a widget, that widget is applicable to that submarine. You can see that, but when you are dealing with, let us say, the premises for the submarine, if it is one submarine, is the contractor allowed to charge the whole of the premises costs against the cost of that submarine? If it was also building an aircraft carrier, it could charge some of that premises costs against it. I invite the Minister to come back, perhaps on Report, with some better reassurance about how allowable costs will be allocated and particularly about how to spread large costs if only one item of equipment is produced by that contractor.
My Lords, I, too, was surprised to read these words. I had looked in the draft regulations to see whether there is anything within them which would help us. There is not. There is a reference to allowable costs in paragraphs 13 to 15, but that merely refers us back to Clause 20. It does not develop the concept of allowable costs, as I believe the noble Lord, Lord Tunnicliffe, rightly suggested it should. I wonder whether the Minister will be able to tell me that this could be looked at in the final version of the draft regulations.
My Lords, Amendment 18P would have the effect of directing the Secretary of State for Defence to provide Parliament annually with a determination of the contract profit rate and, specifically, the process that is to be used to determine the profit rate. Before considering the amendment, it will be worth while outlining the existing process that the Bill provides for.
Under Clause 17, the contract profit rate is to be determined through six steps. Three of those steps will be determined with reference to rates that are to be calculated annually: step 1, the baseline profit rate; step 4, the SSRO funding adjustment; and step 6, the adjustment for capital employed by the contractor. Two of these steps are not new; steps 1 and 6 have their equivalents under the existing regime. The rates to be used in determining these three steps must themselves be determined annually as they will reflect the most recent accounts of companies and the SSRO in relation to the SSRO funding adjustment.
The process for determining these rates is provided for by Clause 19 and has several stages. First, the Secretary of State will issue statutory guidance containing the principles that should be used in determining the rates. Secondly, the SSRO must recommend rates, having regard to the Secretary of State’s guidance, by 31 January each year. Thirdly, upon receiving the SSRO’s recommendations, the Secretary of State must then determine and publish in the London Gazette no later than 15 March each year the rates to be used. In publishing the rates to be used, the Secretary of State must also publish the reasons for any differences from the SSRO’s recommendations.
I appreciate that at first sight this may appear to be an unnecessarily complicated process, but it has been carefully considered to fulfil a number of requirements: first, for the Secretary of State to be able to set out clear guidance on the principles that should be used in determining the rates; secondly, and crucially, for the SSRO as the independent and impartial body to be free to recommend rates in accordance with its statutory aim to set a framework that delivers a fair and reasonable price. While the SSRO must have regard to the principles established by the Secretary of State, it should also be free to consider any other matters that it considers relevant to the setting of the rates. It must be able to recommend the rates that it considers will provide a fair and reasonable return to contractors and value for money to the Government, even if that means not following the principles set out by the Secretary of State.
The amendment would require that the powers conferred by Clause 19 should be contained in regulations made by statutory instrument and therefore be subject to the same level of parliamentary scrutiny as the other regulations. While I appreciate that Parliament should exercise an appropriate level of oversight in these matters, I do not think that this proposal is proper in this instance. First, I note that this would form a potentially unhelpful precedent across government, since, as far as I am aware, none of the other regulatory bodies—such as for the railways or water—are subject to this degree of parliamentary scrutiny, even though they deal with issues of great national significance. Secondly, the Secretary of State for Defence is already subject to parliamentary oversight for his powers over the defence budget and is therefore accountable to Parliament for how he discharges these powers. The amendment would add an unhelpful degree of additional and overlapping scrutiny for this specific area of his responsibility.
In addition, this is clearly a very technical and complex issue and there is a risk that making this area subject to parliamentary debate would lead to the politicisation of profit rates which ought to be set through impartial and expert judgment. There would be scope for Parliament to be subjected to lobbying by the various interest groups, a factor that could result in pressure to set the rates either too high or too low.
Finally, I should point out that the Bill already makes provision for the SSRO to make an annual recommendation to the Secretary of State for the profit rate. The SSRO, as the independent body, is the appropriate body to provide the necessary expert oversight of the Secretary of State’s determination of the profit rates. The Secretary of State will have to publish in the London Gazette the rates to be used and must publish the reasons for any difference from the SSRO recommendations. This therefore provides an appropriate level of oversight and transparency.
Amendment 18Q is similar to Amendment 18P in that it seeks to set out matters in regulations rather than in statutory guidance, in this case relating to allowable costs. Clause 20 deals with allowable costs under the new framework. Those costs will account typically for some £5.5 billion per annum of government expenditure, or 90% of the total cost of single-source procurement, so the rules around determining the allowable costs are important.
There are three principles contained in the Bill for determining whether a cost is an allowable cost, and each of these must be met in order for a cost to be allowable. First, a cost must be appropriate. This relates to the type of cost, such as whether it is for labour or materials, insurance or pensions costs, or rationalisation and redundancy costs. Some types of cost are always appropriate, such as direct labour, and some never. For example, suppliers should never be able to pass on the costs of their charitable donations to the taxpayer. Secondly, a cost must be reasonable. This relates to the quantum of the cost, and a cost may be reasonable if it does not exceed that which would be incurred by a prudent person in the conduct of competitive business. Finally, a cost must be attributable to the contract. This may sound obvious, but without this principle a cost incurred by a supplier could be both appropriate and reasonable, yet be either wholly or partially related to work other than that under the qualifying contract. The amendment seeks to ensure that the single-source contract regulations will provide the detailed guidance to support these three principles, rather than the SSRO issuing statutory guidance as currently provided for.
As noble Lords are aware, the single-source contract regulations made by the Secretary of State will contain the further detail essential to the operation of the new framework. The Bill also provides for a range of statutory guidance, some to be issued by the Secretary of State, but most to be issued by the SSRO. Like the regulations, the statutory guidance has legal power. However, unlike the regulations, parties subject to Part 2 can deviate from statutory guidance if they have reasonable grounds to do so. Parties must have regard to the statutory guidance. For matters where it is difficult to set out rules that will cater for every possible set of circumstances, statutory guidance provides a means of setting rules that provide for the majority of cases but allow the flexibility to deal with unforeseen circumstances or grey areas. As we developed the framework, we considered whether guidance would be better put into the legally binding single-source contract regulations or whether to use statutory guidance with the greater flexibility that that provides. If statutory guidance is to be used, there is then a secondary question of who should issue that guidance—the Secretary of State or the Single Source Regulations Office.
For allowable costs, we judge that the best approach is to use statutory guidance, and that it should be issued by the SSRO. Using statutory guidance rather than regulations is a matter of practicality, and requiring the SSRO rather than the Secretary of State to issue that guidance is a matter of principle. If we were to specify binding rules for determining allowable costs in regulations, those regulations would need to be very detailed and extensive, catering for every possible scenario that may occur. Such regulations would probably run into many hundreds of pages, perhaps thousands, and it would require an army of people to monitor, police and review them. Noble Lords might be interested to know that this is currently the situation in the United States, where the Defense Federal Acquisition Regulations are more than 3,000 pages long and more than 1,000 accountants are employed to ensure that they are complied with. This may be a suitable approach given the scale of US defence spending, but we do not consider this approach necessary for the scale of our defence budget.
The alternative is to use statutory guidance. As it is possible for a person subject to the statutory guidance to deviate from it if they have sound reason to do so, the guidance can focus upon principles and the rules appropriate for the vast majority of cases. Where there are specific circumstances which reasonably justify an alternative approach, that approach may be taken while still being compliant with the law, although the person must be prepared to justify the approach they have taken. Given the broad nature of activity that will be covered under qualifying contracts—everything from research and development to test facilities, the design and manufacture of complex equipment and the provision of support services—the range of potential costs and accounting issues are innumerable.
I therefore consider statutory guidance to be a far more appropriate mechanism than regulations for dealing with this important, yet complex, area. It can be responsive, for example, to changes in international accounting standards, and flexible to deal with specific accounting complexities. It would not be appropriate to commit the department to using extensive and valuable resources to maintain a complex set of regulations. I hope noble Lords will accept that is a sensible approach.
In terms of who should issue this guidance, as the independent arm’s-length body charged with the dual aim of ensuring value for money and a fair and reasonable price, the Single Source Regulations Office is ideally placed. Were this amendment to be accepted, it would place an inappropriate power with the MoD, since the determination of allowable costs would then rest with one of the parties to the contract.
In summary, I believe that our approach, which is to set out in the Bill the three clear principles for determining whether a cost is an allowable cost, supported by statutory guidance issued by the Single Source Regulations Office, is the best approach to ensure a fair and flexible system that works in the interest of all parties.
I now turn to those amendments that relate to the parliamentary process for the regulations that would be introduced by Amendments 18P and 18Q. The Bill as currently drafted provides for the regulations that would be introduced by Amendments 18P and 18Q to be made by statutory instrument in the single-source contract regulations, or SSCRs, which are introduced under Clause 14(1).
On 20 December 2013, the Delegated Powers and Regulatory Reform Committee published its report on the Bill, which included recommendations on the parliamentary process to be applied to the regulations under Part 2. These included that the SSCRs should be subject to a first-time affirmative procedure and that the regulations to be made under Clause 14, which determine the scope of qualifying defence contracts to which Part 2 and the regulations will apply, should always be made by the affirmative procedure. We have accepted these recommendations, and the government amendments to be discussed later make the necessary changes to the Bill.
A further recommendation noted that Clauses 14(1) and 28(1) could potentially be interpreted as providing for the SSCRs to make general provision, which the committee considered would be too wide and imprecise a power to delegate. We agree that such a power would indeed be inappropriate, but it is the department’s view, based on legal advice, that these subsections are introductory in nature, and must be read in the context of the whole of Part 2, which contains a series of detailed and specific powers, and the usual power to make supplementary or incidental provision which is included in Clause 42(2). It should not be necessary to rely on these general clauses to make provision that is not otherwise permitted by the other powers in Part 2. I hope it is clear from the draft regulations placed in the Lords Library that we have not done so.
The final recommendation was that the determination of rates relevant to the contract profit rate under Clause 19 should be made in the regulations. This recommendation is the subject of Amendment 18P, which we have already discussed. I shall return to this recommendation shortly as it is also relevant to Amendment 23E.
Amendment 23A provides for the specification of which regulations should be subject to the affirmative process. This has a similar effect to government Amendment 23, which also provides a mechanism for specifying regulations to be made subject to the affirmative process. We therefore agree with the intent of the amendment, but it is not required if government Amendment 23 is accepted. Amendments 23D and 23E provide for regulations under Clause 19, covering rates relevant to determining the contract profit rate, and Clause 20, covering allowable costs to be subject to the affirmative procedure. The current Bill does not provide for regulations under either of these clauses, so the amendments rely upon earlier Amendment 18P for rates relevant to the contract profit rate and Amendment 18Q for allowable costs. The Delegated Powers and Regulatory Reform Committee did not recommend that guidance on allowable costs should be in regulations. It recommended in paragraph 12 of its report that the rates relevant to the contract profit rate should be in regulations, as we have already discussed under Amendment 18P. However, the committee did not recommend that the regulations should be subject to the affirmative procedure. As discussed earlier under Amendments 18P and 18Q, we do not believe that either of these matters should be in regulations, so clearly we do not agree that they need to be subject to the affirmative procedure. However, I will briefly consider each amendment in turn.
Amendment 23D relates to allowable costs. The guidance on allowable costs may need to change on a regular basis, for example, in response to changes in international financial reporting standards. If it was set out in regulations this guidance would be long and technical, and any changes are likely to reflect relatively minor changes in accounting practices. We do not consider that such matters justify the affirmative procedure. Amendment 23E relates to rates relevant to the contract profit rate. Even if in regulations, the Delegated Powers and Regulatory Reform Committee did not recommend that these should be subject to the affirmative procedure. The annual setting of the profit rate has similarities with the determinations made by price regulators, such as those in water, energy and rail. In all these cases, the regulators have considerably more power than the Secretary of State or the Single Source Regulations Office in that they set the overall revenue of the regulated industry, not just the profit rate, which typically accounts for only 10% of the price. However their determinations are not subject to direct parliamentary approval.
Parliament has oversight of the regulators through Select Committees and the Comptroller and Auditor-General, which is also the case for the SSRO. Parliament has already delegated to the Secretary of State overall responsibility for providing strategic direction on acquisition and allocating resources appropriately. The setting of rates relevant to the contract profit rate to apply to single-source contracts falls within this remit. Placing the provisions of Clause 19 in regulations following the negative procedure would already provide a far greater degree of parliamentary approval than that applied to other similar regulatory powers. To apply the affirmative procedure to these matters would, in the department’s view, be further out of proportion to the nature of the power. We do not consider that these regulations should be subject to the affirmative procedure. I hope this explains our position, and I therefore urge the noble Lord to withdraw his amendment.
I have a couple of further points to make. My noble friend Lord Roper asked whether allowable costs could be addressed in future drafts of the regulations. There is no provision in the Bill for this as it is going to be dealt with in statutory guidance, as set out in Clause 21. It would require an amendment. My noble friend Lord Palmer asked how overhead costs such as directors’ salaries, facilities and so on are spread or allocated to contracts. These are addressed through a process known as cost recovery rates. These are allowable costs which are subject to a requirement to follow the three tests under Clause 20 and are the subject of the reports provided for in Clause 25. These give all the powers and transparency necessary to ensure that overhead costs are fair and reasonable, and that we do not pay more than we should for them.
My Lords, I thank all noble Lords who have taken part in this debate. I congratulate the Minister on her spirited defence. Unfortunately, it failed. Our concern about the processes is real, and our overwhelming concern is the billions of pounds that are tied up in allowable costs. As we will go on to discuss, the various forms of contract are an important chunk of the real profits of the company. At the end of the day, this is a negotiating game. It is a matter of how much you can legitimately build into your allowable costs, with a profit rate on top of that. Allowable costs are at the centre of what defence contracts cost and what the taxpayer must pay. I do not feel that the Minister, despite her spirited defence, has addressed our concerns—not only my concerns, but those of other Members of the Committee—on allowable costs. I fear that we will be tempted to return to this on Report. As I believe this to be an apolitical issue, I encourage the Minister to ponder today’s debate and to see what she can add to it. We would all enjoy receiving a letter from her that would provide nuance to the Government’s position and I encourage her to do that. It is a matter of real concern to the Committee. In the mean time, I beg leave to withdraw the amendment.
Amendment 18P withdrawn.
Clause 19 agreed.
Clause 20: Allowable costs
Amendment 18Q not moved.
Clause 20 agreed.
Clause 21: Final price adjustment
Debate on whether Clause 21 should stand part of the Bill.
My Lords, I will speak to Clause 21 and to Amendment 23C. I must emphasise that our opposition to Clause 21 standing part of the Bill is not directed at the essence of the clause; it is to explore the clause. However, I fear that we must explore it fairly widely.
The concept in this clause, of a final price adjustment, comes out of the report by the noble Lord, Lord Currie. It addresses the key issue of profit that arises from the outturn. In my view, it is conceptually very sound. It is utterly meaningless without the regulations so I thank the officials and the Minister for sharing the regulations with me. After considerable effort, I think that I understood the early part of the regulations, particularly in relation to Clause 21(2), and they seem very sensible. They have a clawback of excessive profit of up to 75% and they support the supplier in a position of excessive loss at 50%, on the simplistic assumption that the profit rate is 10% of the allowable costs. There is quite a broad band, between 96% and 110%, where all variation falls to the supplier’s bottom line, which is a very strong incentive for the supplier to become more efficient and make more profit. I am not against suppliers increasing profit if that is achieved through efficiency. I am entirely in favour of it in this new open book, multi-reporting regime whereby the MoD can share in that experience through the reporting regime, understand it and help future suppliers understand how they can deliver at lower costs and more efficiently. It is a good regime.
Essentially, Amendment 23C simply argues that the regulations referred to in Clause 21(2) should be approved by Parliament using the affirmative procedure. Having recovered from the effort of understanding subsection (2), I gave up the ghost intellectually at that point and stopped reading the Bill. However, since then, I have started to read it again and I find Clause 21 a little difficult to understand, so I have a series of genuine questions for the Minister.
Clause 21(3) states:
“Provision made under subsection (2) must include provision for the amount of any adjustment to be determined … by agreement between the Secretary of State, or an authorised person, and the primary contractor”.
Does that mean that the regulations set out in subsection (2) may or may not be obeyed? In other words, can the Secretary of State agree to disregard the regulations under subsection (2), in which case it seems that the process of developing and publishing the regulations was valueless; or does it simply mean that the parties agree that the figures are right and so on? Is it a clause which simply invites the parties to agree, and if they do not agree the matter can be referred to the SSRO?
Given the precision of the regulations as I read them—I recognise that many thousands of man hours have gone into crafting them—I had some difficulty in understanding Clause 21(4), which states:
“Provision under this section may be expressed so as to apply … to particular kinds of qualifying defence contracts”.
What would be the differences and how would they apply? I genuinely have trouble envisaging what the different sorts of contracts may be like.
I assume that Clause 21(4)(b) is a simple de minimis provision—namely, that there should be a value below which you do not quibble because it is simply not worth doing so. I was fairly comfortable that it was a de minimis provision until I read Clause 21(5)(a) and (b), at which point I gave up the ghost because I could not understand what subsections (5)(a) and (5)(b) meant if subsection (4)(b) is a simple de minimis provision because subsections (5)(a) and (5)(b) seem to be super de minimis provisions. My general view of Clause 21 is that it is great in so far as I understand it, but I have to confess that I do not fully understand it and I seek enlightenment.
My Lords, this is a crucial element of the Bill because it protects the taxpayer against contractors earning excessive profits while also protecting industry from excessive losses.
The basis of the Bill is that contractors should get a fair return on single-source work, and even better returns if they can drive cost efficiencies which deliver long-term benefits to the MoD. However, they should not be entitled to super-profits just because, despite best intentions and efforts, both parties happened to get the pricing wrong. Likewise, in the same circumstances, suppliers should not be expected to suffer losses. This clause offers protection to both parties. The clause enables a final price adjustment on completion of a contract if the actual costs of the contract turn out to be markedly different from those agreed at the time of pricing. The mechanism will be applied to all qualifying defence contracts priced at the outset on the basis of a firm or fixed price.
At Second Reading in the House of Commons, statements were made to the effect that provisions such as this are undesirable because an agreed contract price should be an agreed contract price and that clauses like this remove pricing certainty and dampen supplier incentivisation. There is some truth in the observation, but I believe the clause strikes a good and proper balance between incentivising suppliers and protecting the public purse in the way that the noble Lord, Lord Currie, recommended it should. It should also be noted that on a number of occasions in the past when suppliers incurred very substantial losses, such as on the Nimrod programme, they have come back to us for more money. Since we need the capability they provide, it is not in our interest to let a supplier go bankrupt by holding it rigidly to its contract price.
I must also tell the Committee that this clause does not introduce a new idea into single-source contracting. Provisions for a final price adjustment have been in place since 1968 under the existing Yellow Book arrangements, and a mechanism very like Clause 21 has been in place since 2004. It is in many of our single-source contracts and has already been successfully used to recover excess profits from our suppliers on some contracts. However, because the existing mechanism is contractual and needs to be negotiated, sometimes suppliers refuse to agree to its terms. This happened on a recent large maritime maintenance contract where commercial officers had to give it up in exchange for another provision we desired. That is why we want to legislate to provide this protection. If Clause 21 falls, a significant protection for both parties falls with it.
Clause 21 also states that any adjustments to the final price will be determined by the Secretary of State and the contractor. However, if an agreement cannot be reached on whether an adjustment is required or on the amount of that adjustment, the clause enables either of the parties to refer the matter to the SSRO for a binding determination. The clause will be used for particular types of contracts—firm and fixed-price contracts, which account for 60% of our single-source contracts—and the SSCRs will set out the minimum value for applying these provisions.
Finally, the clause gives the Secretary of State a power, on a case-by-case basis, to exempt a QDC from any final price adjustment as long as the value of that QDC is within the range to be specified in the SSCRs, which is expected to be between £5 million and £50 million. When deciding whether to make such an exemption, the Secretary of State must have regard to any matters which will be specified in the regulations. The clause is an important element in protecting both parties in defence contracts: the Government against suppliers’ excessive profits and industry from substantial losses, which ultimately would not be in the MoD’s interest. It is therefore crucial that it remains in the Bill.
Amendment 23C is part of a group of amendments which relate to the regulations that are to be made by statutory instrument under Part 2 and the parliamentary procedure by which those regulations will be made. We have previously discussed this in relation to Clauses 19 and 20 and Amendments 23A, 23C and 23D. Amendment 23C would provide for regulations under Clause 21 to be subject to the affirmative procedure. These regulations are for the final price adjustment and are currently subject to the negative procedure. The final price adjustment is expected to apply to around half of qualifying defence contracts—those which are firm or fixed price—and will have effect only when the costs incurred under these contracts are significantly different from those estimated at the time of pricing. The mechanism provided for by the draft regulations under Clause 21 is a relaxation of an existing mechanism that has been in place since 2004 and follows one of the recommendations by the noble Lord, Lord Currie. The Delegated Powers and Regulatory Reform Committee did not recommend that regulations under Clause 21 need be subject to the affirmative procedure and we, too, do not consider that these regulations warrant it. I urge the noble Lord not to move Amendment 23C.
Clause 21(4)(a) applies only to a particular kind of contract. The final price adjustment applies to all firm and fixed-price contracts, but with “pain and gain share” contracts, where the MoD and industry agree sharing provisions such as 50:50, it would not be appropriate to have two sharing mechanisms running simultaneously. Clause 21(4)(a) allows us to exclude “pain and gain share” contracts from the final price adjustment. The noble Lord queried the effect of Clause 21(4)(b). It is only to provide for a de minimis level. I am advised that the effect of Clause 21(5)(a) and 21(5)(b) is complex, and I will write on that.
Clause 21 agreed.
Clauses 22 to 25 agreed.
Clause 26: Duty to report relevant events, circumstances and information
18R: Clause 26, page 18, line 40, leave out from beginning to “on” and insert “A primary contractor and the Secretary of State must notify the other”
My Lords, Amendments 18R, 18S and 18T are prompted by industry, which seeks to argue that there should be a mutuality in obligation and a test of materiality. The industry argues that there should be a mutual obligation on the primary contractor and the Secretary of State to notify the other of events, circumstances and information that are likely to have an effect on, or relevance to, a contract. The MoD will have information that is likely to have an effect in relation to a qualifying defence contract, whether that affects its price or performance. The MoD should have a duty to disclose relevant information to the contractor, which must be reflected in the Bill. I understand that this duty was confirmed by the Government in Committee in the House of Commons but I would value further affirmation.
As a result of the broad scope of events and circumstances that are likely to have an effect on, or relevance to, a contract covered by Clause 26(1), it is realistic that the contractor or the Secretary of State should be required to notify only when they believe there is a likely effect or relevance. Without this restriction, the obligation to notify is extremely broad. Further, it is argued that it is not necessary to refer to the effect on costs per se; the important aspect is whether there is an effect on price, such that Clause 26(3)(a) is unnecessary. I beg to move.
My Lords, one of the flaws in the current Yellow Book framework is that it provides little transparency once on contract. A key objective of the new framework is that the MoD should be able to monitor the health of single-source contracts on an ongoing basis, receiving timely information so that it can take fast and effective action. This is very important. There have been too many examples in the past when the MoD has discovered cost or time overruns on single-source contracts far too late for remedial action to be taken. Receiving information throughout the course of a contract will give the MoD the opportunity to work with contractors to take early action to avoid or minimise the impact of issues as they arise. This clause is one of several that provide this transparency.
A supplier will always know more than the MoD about the issues affecting its their delivery of a particular contract. Some of our suppliers share information on an open basis, alerting us as issues arise so that decisions can be taken on a joint understanding of the best information available at the time, but not all of our suppliers do this.
The standardised reports that will be required under Clause 24 will provide periodic snapshots of contract performance. However, for contracts below £50 million in value, a report may be received annually or still less frequently, and even for our largest contracts a standardised report is only required quarterly. These periods are appropriate for standardised reporting, but three months can be a long time in managing a contract, especially complex contracts worth many millions, or billions, of pounds.
Clause 26 therefore supplements the regular contract reporting, placing a duty on contractors to let the MoD know, in a timely fashion, of matters material to the contract. Putting the onus on the contractor in this way means that the new framework can be “lighter touch” than it would otherwise be if the only means by which alarm bells could be sounded on a project was through periodic reporting and the MoD’s monitoring powers.
Amendment 18R would make the Secretary of State subject to the same duty, providing notifications to the contractor. Clause 26 will place a duty upon a contractor to notify the Secretary of State when the contractor becomes aware of the occurrence, or likely occurrence, of “events”, “circumstances”, or “information” that are likely to have a material effect on a qualifying defence contract. Applying this same duty would require the Secretary of State to notify the contractor of events, circumstances or information that are likely to have a material effect on the contractor’s costs—the subject of Amendment 18T—the contract price, or the contractor’s performance.
Let me first be clear that this does not concern changes to our contractual requirements. If the requirements of the MoD change, and this affects an existing contract, then we require a contract amendment to reflect those new requirements. This should be quite separate to the delivery of requirements already contracted for; if we wish to amend the contracted requirement, we will tell the contractor and begin the commercial process of amending the contract, and this is not a matter that requires legislation. The contractor is not forced to make the amendment, and they will charge us for any additional costs that might arise, or amend performance requirements if this is relevant. Until we seek a contract amendment, a contractor should be concerned with managing the existing contract.
For contracts which we are not in the process of amending, this duty would require the Secretary of State to assess the impact of events, circumstances and information across the department upon each contractor’s contracts. This is quite different from the duty placed upon a contractor when they are managing a contract in the normal course of business. It would require the Secretary of State to assess what might, or might not, affect a contractor’s cost or performance, to look beyond the contract and assess whether a contractor’s activities are likely to be affected. This duty would be impossible for any Government to discharge.
We agree that when a contract is being priced, the duty to share information should be reciprocal. Both parties should share their assumptions to ensure that the price agreed for the contract is both fair and reasonable and value for money. However, once a contract has been entered into, it is the contractor who must manage the delivery of the contract, and who is responsible for the performance of its business and costs. It is not the responsibility of the Government to second guess what is likely to have an impact upon how a contractor achieves their contracted requirements. We do not accept that Clause 26 represents an equal duty when placed upon the Secretary of State compared to a contractor. It would be inappropriate to place this duty on the Government and impossible for a Government to fulfil.
Amendment 18S is the second in this group, and it seeks to qualify the duty to notify by adding the requirement that, for each of the three elements under subsection (1), the contractor believes in the existence of the effect or relevance. Each element requiring notification under subsection (1) is expressed as,
“likely to have a material effect”,
“likely to be materially relevant”.
This means that a contractor need only notify the Secretary of State if two tests are met: first, that an effect or relevance is likely; and, secondly, that an effect or relevance is material. If a contractor considers that an effect or relevance is not likely or not material, then no notification is required.
The effect of this amendment would be to add a third test: that an effect must be likely, material, and believed to exist. We do not think that an effect could be considered both likely and material and yet at the same time not be believed to exist. To put it another way, if it were not believed to exist, how could it also be considered likely to have a material effect? Without embarking on a debate on the nature of belief, it is not clear what this third test adds.
Where there is a disagreement between a contractor and the Secretary of State over whether a contractor should have provided a notification under this duty, the Secretary of State may issue a compliance or penalty notice. Ultimately, it will be for the SSRO to determine whether a notification should have been provided and, in doing so, it will consider the two conditions of “likely” and “material”. We consider that the two conditions already required for there to be a duty to notify are sufficient and that the third test of belief proposed by this amendment is unnecessary.
Moving on to Amendment 18T, Clause 26 provides for three matters that are the subject of the duty to notify; these are listed in subsection (3). They are the costs under the contract, the total price payable under the contract, and the contractor’s performance of material obligations under the contract. This amendment seeks to remove the first of these matters—the costs of the contractor under the contract. The effect of this amendment requires some explanation as there is some overlap between the first two matters—the cost and the price payable under the contract. For cost-plus and target-cost contracts, the costs incurred under the contract will directly affect the price payable under the contract, so there is a limited difference between the two matters for these contracts, which represent just under half of the single-source landscape. The rest are firm or fixed-price contracts under which the contractor’s costs may vary while the price payable may not. So it is firm and fixed-price contracts that would primarily be affected by this amendment.
The reason that we wish to be notified in relation to both costs and price under the contract is the same as the overall requirement for Clause 26—to ensure that the MoD receives timely warning of matters affecting contracts. If the costs of a firm or fixed-price contract are likely to materially change, this is still important management information for the MoD. It may indicate a significant risk to the project or signal future performance issues. Just because it may not affect the price payable does not mean that this is not important information. For example, a contractor could manage a contract for a year in between standardised reports being provided to the MoD. In that year, a significant risk could be recognised and material costs could be incurred in trying to manage the risk in the expectation that performance under the contract will not be affected. However, despite the additional costs incurred, it finally becomes apparent that performance is likely to be affected after all, at which point a notification would be required.
It is a characteristic of single-source procurement that there is only one supplier that can provide the capability we require. If the contract fails we lose the capability we need. This has led suppliers in the past to seek price increases even though we have agreed a fixed price. Where the cost increases are very large, this puts the MoD in a difficult position. Seeking to keep to the fixed price can lead a supplier into great financial difficulty, putting not only that contract but others with that supplier at risk. If the supplier fails, then we lose the capability we need. This is a real risk that has arisen in the past, and thus we need the same transparency over the costs of fixed-price contracts as we do for other contract types. We do not see a benefit to applying a different notification requirement to firm and fixed-price contracts, so that for these contracts notification is only required once performance is likely to be affected, while for other contracts notification would be required at the point that costs, and therefore price, are likely to be affected. This is not the early warning that this provision is intended to provide.
For all these reasons, I urge the noble Lord to withdraw the amendment.
Amendment 18R withdrawn.
Amendments 18S and 18T not moved.
Clause 26 agreed.
Clauses 27 to 32 agreed.
Clause 33: Amount of penalty
19: Clause 33, page 24, leave out line 21 and insert “single source contract regulations”
This group of amendments relates to the regulations that are to be made by statutory instrument under Part 2 and the consultation and parliamentary procedures by which those regulations may be made. There are seven amendments in this group, and I will deal with the government amendments first.
The Bill currently provides for two separate sets of regulations to be made by statutory instrument. The first is the single-source contract regulations—SSCRs—which are introduced under Clause 14(1). The SSCRs would contain all the regulations with the exception of those made under the second set of regulations, the penalty regulations, which are introduced under Clause 33. The penalty regulations would provide maximum penalty amounts under the civil penalty compliance regime provided for in Part 2. Drafts of both these statutory instruments were placed in the House of Lords Library on 22 January 2014.
The Bill provides for different parliamentary processes for these two sets of regulations, with the SSCRs to be made by the negative procedure under Clause 42(4) and the penalty regulations to be made by the affirmative procedure under Clause 33(7). I have previously discussed the recommendations of the Delegated Powers and Regulatory Reform Committee’s report on the Bill. The recommendations that the SSCRs should be subject to a first-time affirmative procedure and that the regulations made under Clause 14 should always be made by the affirmative procedure have been accepted, and the government amendments in this group make the necessary changes to the Bill.
In order to make the recommended changes to the parliamentary process, it was considered that simplifications could be made in order to allow all the regulations under Part 2 to be made in one statutory instrument rather than the two currently provided for, being the SSCRs and the penalty regulations. Amendment 19 therefore provides for provision about maximum penalties to be made under the SSCRs rather than in separate regulations. Amendments 20 to 22 make some simplifying amendments to accommodate the fact that there is now just one set of regulations, not two, and Amendment 23 provides for the new parliamentary process by which the unified SSCRs may be made. I will now address each of these amendments in turn.
Amendment 19 is a simplifying amendment. It removes the current provision for the maximum penalty amounts to be made via a separate statutory instrument—the penalty regulations—and instead provides for this to be done in the SSCRs as with all other provisions for regulations under Part 2. There is no change to the scope of provision that will be made under Part 2 as a result of this amendment, but using a single statutory instrument for all regulations under Part 2 allows for simpler provision for the parliamentary process to be used for that one statutory instrument.
Amendment 20 follows on from Amendment 19. Clause 33(6) currently provides for the penalty regulations, as a separate statutory instrument from the SSCRs, to vary the maximum penalty amounts for two purposes: first, for “different purposes” and, secondly, specifically by reference to the value of contracts. As a result of Amendment 19, the maximum penalty values will now be included in the SSCRs, while Clause 42(2) already provides for the SSCRs to make different provision for different purposes, which is a standard provision for regulations. Therefore the part of the current subsection (6) providing for different provision for different purposes is no longer required. This amendment replaces the current subsection (6) to provide only that different provision for the maximum penalty amounts may be made by reference to the value of contracts.
Amendment 21 deletes Clause 33(7), which dealt with the parliamentary process for the penalty regulations. It is no longer required because the provisions for maximum penalty amounts will now be in the SSCRs rather than in a separate statutory instrument. So this will now be covered by the parliamentary process for the SSCRs under Amendment 23.
Amendment 22 simplifies Clause 39, which provides for the review of Part 2 and the regulations made under it by the SSRO and the Secretary of State. As there will now be only one statutory instrument, the SSCRs, Clause 39(1) can be simplified to refer only to the review of the SSCRs, rather than the more general “regulations under this Part”.
The first four amendments of the group that I have now outlined make simplifying provisions in order to make all regulations under Part 2 via one statutory instrument, the SSCRs. Amendment 23 addresses two of the recommendations of the Delegated Powers and Regulatory Reform Committee relating to the parliamentary process under which the SSCRs should be made.
To begin with, it removes the current Clause 42(4), which provides that the SSCRs should be subject to the negative procedure, and replaces it by a provision reflecting those recommendations on the parliamentary process for the SSCRs: first, that they should be affirmative the first time that they are made; secondly, that any changes to the regulations related to Clause 14 should always be affirmative, as this governs which contracts will be subject to Part 2 and thus sets the scope of Part 2; and thirdly, that the affirmative procedure will also apply for any changes to regulations made under Clause 33, which relates to maximum penalty amounts and was previously to be contained in the penalty regulations. These were always to be subject to the affirmative procedure, so there is no change to the procedure as a result of this amendment. Finally, the SSCRs will follow the negative procedure for all cases other than those just outlined.
My Lords, I welcome the Government’s amendments to these various clauses. They are a very full response to the report of our Delegated Powers and Regulatory Reform Committee of last December, which was responded to by the noble Lord, Lord Astor, in his letter to the committee published earlier this year. It seems that in these amendments the Government have taken fully the points that were made by the report. We are very well served by that committee, which ensures that there is the technical scrutiny to ensure that parliamentary control is maintained when there are questions of delegated powers. I feel that the Government have responded fully to the proposals of the committee. I am not sure whether it has yet had a chance to respond to the letter of the noble Lord, Lord Astor, or if there are any further points that we may need to come back to on Report, but I understand that it is generally satisfied with these amendments.
My Lords, at this point I have no objection to the government amendments, but that may be partly because I do not understand them. I shall find them easier to read when the Bill is reprinted for the Report stage but, as I say, I have no comment or objection at the moment.
I may be about to contradict myself when speaking to Amendments 22A and 23B. Amendment 22A is prompted by the industry, which has argued that the regulations arising as a result of the review should be made and updated in an open and transparent manner. It argues that an industry-wide consultation should be undertaken, the Secretary of State should have regard to that consultation and the regulations should be laid before Parliament. Amendment 23B argues essentially that the penalties regulations should be passed by the affirmative procedure on every occasion. These are penalties which could have dramatic effects.
I think that this is the last time I will speak, so I should like to congratulate the Minister on her marathon performance. I recall from when I occupied her place that it can seem a bit futile, but I know that what she has read into the record will be held to be of great value by both parliamentarians and those outside. I thank her and her officials for their efforts, and I look forward to reading with great care the products of our discussions. I also look forward to her letters.
I thank the noble Lord for his comments and I am sure that I will get my pen out and start writing as soon as I have consulted with the gentlemen sitting behind me. On a slightly more serious note, I am sure that we will have meetings with the Bill team and people from the MoD.
I turn now to the amendments. Amendment 22A would place a statutory duty on the SSRO when performing its review of the single-source framework to consult with industry and to publish the results of the consultation exercise. As noble Lords will be aware, many aspects of the single-source framework under Part 2 will lie in regulations rather than in primary legislation, and many of the clauses in this part give the Secretary of State the power to make those regulations. This is to allow the regulations to be periodically updated to take into account changes in procurement approaches, the defence sector and what is being procured, without the need for primary legislation. I reassure noble Lords that we are aware that the new single-source framework represents an important change to single-source procurement. We have been consulting closely with the industry throughout the development of Part 2, including the Bill and the detail of the regulations.
In October 2011, the noble Lord, Lord Currie, published his report and we subsequently ran a full public consultation which completed in January 2012. In April of that year we started a defence suppliers’ forum subgroup with our top 10 single-source suppliers. These included BAE Systems, Finmeccanica, Rolls-Royce, Babcock, Thales, MBDA, QinetiQ and others. Over the past two years we have met with them more than a dozen times to share our proposed approach and understand their concerns. Beneath this forum we also established a number of technical working groups on specific matters such as confidentiality, the SSRO and risk, and most recently on the regulations themselves. In January alone this year we spent four full days discussing the draft regulations line by line with industry, and we expect further such discussions before the summer. This is a substantial level of consultation, more than is typical for new government policy, and it has resulted in our making some important changes to our framework, such as introducing the new criminal offence to protect industry information.
It is certainly not in our interests to create an unworkable framework. For one thing, we pay for any additional overheads our suppliers will incur, which will be incorporated into their single-source prices, provided that they are reasonable. We also need the capability they provide and have no desire to make it hard to do business with the MoD. Indeed, it is out of a desire to ensure that the framework is as practical as possible that we have consulted with industry to the extent that we have. Industry cannot claim that it has not been consulted prior to the first regulations being made.
Returning to the amendment, we also want the new framework to be kept up to date. We do not want to end up again in the situation in which we find ourselves now: namely, with a framework that is 45 years old, clearly out of date and not fit for purpose. That is why we have introduced a statutory duty for the SSRO to keep the framework under review at all times, not just at the end of the five-year review period. This is set out in Clause 39.
In making recommendations, the SSRO will follow a rigorous process. First, it will draw upon its experience of monitoring and analysing single-source procurement. It will talk to suppliers, the MoD and other interested parties, such as trade bodies. It will draw up its recommendations and publish these. It will then conduct a full public consultation, following the relevant Cabinet Office guidelines and only then, once the results of all of this feedback are taken into account, will it formulate their recommendations.
This process will be set out in the framework document between the MoD and the SSRO. All executive non-departmental public bodies have a framework document which sets out detailed aspects of the relationship between the body and the sponsoring department, such as payment provisions. This framework agreement will be in the public domain and, as part of our ongoing engagement with industry on the SSRO, we will be sharing the draft framework agreement with industry prior to its publication.
I hope that the Committee agrees with me that the SSRO will be following an open and comprehensive consultation process in recommending changes to the regulations. I am aware that this is not written out in the Bill. However, this is a detailed procedural matter, so it is not necessary so to do. However, I assure the Committee that there is no intent to lay down regulations without consulting industry beforehand. I am confident that the SSRO will take its role very seriously, and consult with all appropriate parties. We did not feel it was necessary to put a statutory duty on them to consult with industry, any more than we did to require them to consult with the MoD. I hope I have reassured noble Lords that industry will always be appropriately consulted.
Amendment 23B would provide for regulations under Clause 33 to be subject to the affirmative procedure. Regulations under Clause 33 have always been subject to the affirmative procedure; they are under the current Bill drafting, and they remain so under government Amendment 23. We therefore agree with the intent of this clause, but it is not now required if government Amendment 23 is accepted. I hope this explains our position on this group of amendments, and I urge the noble Lord not to move Amendments 22A and 23B.
Amendment 19 agreed.
Amendments 20 and 21
20: Clause 33, page 24, line 34, leave out subsection (6) and insert—
“( ) The provision that may be made under subsection (1) by virtue of section 42(2) includes power to specify penalties of different amounts according to the value of the contract to which the contravention relates.”
21: Clause 33, page 24, line 37, leave out subsection (7)
Amendments 20 and 21 agreed.
Clause 33, as amended, agreed.
Clauses 34 to 38 agreed.
Schedule 5 agreed.
Clause 39: Review of Part and regulations under it
22: Clause 39, page 26, line 38, leave out “regulations under this Part” and insert “single source contract regulations”
Amendment 22 agreed.
Amendment 22A not moved.
Clause 39, as amended, agreed.
Clauses 40 and 41 agreed.
Clause 42: Single source contract regulations: general
23: Clause 42, page 27, line 33, leave out subsection (4) and insert—
“(4) A statutory instrument containing—
(a) the first single source contract regulations,(b) provision made by virtue of section 14(2), (6) or (8) (contracts to which single source contract regulations apply), whether alone or with other provision, or(c) provision made by virtue of section 33 (amount of penalty), whether alone or with other provision,may not be made unless a draft of the instrument has been laid before, and approved by a resolution of, each House of Parliament.(5) Any other statutory instrument containing single source contract regulations is subject to annulment in pursuance of a resolution of either House of Parliament.”
Amendment 23 agreed.
Amendments 23A to 23E not moved.
Clause 42, as amended, agreed.
Clause 43 agreed.
Clause 48 agreed.
Clause 49: Commencement
24: Clause 49, page 31, line 35, at end insert—
“( ) No statutory instrument containing an order under subsection (1) in respect of Part 1 (with or without provision under subsection (4)) is to be made unless a draft of the instrument has been laid before, and approved by a resolution of, each House of Parliament.”
Amendment 24 agreed.
Amendment 25 not moved.
Clause 49, as amended, agreed.
Clause 50 agreed.
Bill reported with amendments.
Committee adjourned at 6.21 pm.