Motion to Consider
My Lords, in moving that the draft regulations laid before the House on 29 October 2014 be considered, before I begin I should make the Committee aware of the report by the Joint Committee on Statutory Instruments. I will return to this later in my speech.
Before addressing the draft regulations, I would like to set out the context for this fundamental reform to Ministry of Defence procurement. Open competition remains the best way of ensuring value for money for the taxpayer but there are inevitably occasions where there is only a single provider of a capability we require. Equally, there are situations where we need to maintain critical national industrial capabilities or, indeed, control over intellectual property. This may be achievable only by placing contracts with UK companies without a competitive process. Clearly, in the absence of the disciplines of the marketplace, we need rules governing single source procurement to protect the taxpayers and to ensure our Armed Forces get the most out of every pound spent on defence.
The current framework—the so-called Yellow Book—has remained unchanged for 45 years. It fails to address inherent failures in single source procurement and the lack of competition undermines market pressure to reduce costs and improve efficiency. The lack of an alternative supplier means that we cannot walk away without also walking away from the capability we need. Our suppliers know this, which undermines our ability to drive a hard bargain. Put bluntly, this does not serve the best interests of the taxpayer, nor does it encourage industry to maintain a competitive edge in export markets.
In the Defence Reform Act 2014, the MoD set out the new statutory replacement for the Yellow Book, which we are calling the Orange Book. At the core of this lies the principle that industry should get a fair price in exchange for providing the MoD with much greater transparency on its costs and with the protections we need to ensure value for money. This new framework requires single source suppliers to operate on a truly open book basis. Before we sign a contract, suppliers will be required to provide us with extensive information outlining their pricing assumptions. Suppliers will be required to maintain extensive records on cost and performance and to share these records and explain them to us. Even before the DRA received Royal Assent, the MoD had been consulting with industry and Parliament on the draft regulations. While the Act establishes the principles behind the new framework, the regulations give the detail. This gives us the flexibility to adapt the new framework if required.
I should stress that in developing the regulations we have been consulting closely with the defence industry. We have listened carefully to the views of industry and—where appropriate—we have made changes to the regulations. It is simply not in our interests to have a system that is unworkable for industry.
By developing the draft regulations early, we were also able to take Parliament’s view on board. Here I thank noble Lords for the excellence of their scrutiny, and in particular I thank the noble Lord, Lord Tunnicliffe, for his interest and expert engagement on these issues. I have had many detailed conversations with him on these very complex questions and have always found his insights extremely useful. Following a meeting with him last week, I wrote to inform him how the regulations had changed since they were issued in January 2014. It might be useful if I read out this letter.
The letter states:
“At the meeting which I had with you on 3rd December, you raised a number of technical issues on the Single Source Contract Regulations which MOD officials responded to during the meeting. In addition, you asked for a note outlining the key changes made to the draft regulations since they were provided to Parliament prior to the House of Lords scrutiny of the Defence Reform Act in January of this year. I agreed that I would send you a note outlining these changes prior to the debate in Grand Committee.
As you are aware, the regulations were laid in draft before Parliament on 29 October 2014 following extensive consultations with stakeholders and legal scrutiny and assurance. The vast majority of the changes from the version provided in January were made for legal drafting reasons rather than policy changes. These changes reflect the high level of internal legal assurance, input from legal advisors representing the defence industry following consultation, and scrutiny by the Counsel for Joint Committee of Statutory Instruments (JCSI). It would be onerous to list all of these changes: most were made to make the regulations clearer and more effective, to avoid repetition and to fill in the detail, in particular, with regard to reporting requirements. Individual regulations and parts have also been re-ordered.
The main changes of note primarily for legal drafting are as follows.
a. To provide a better definition of the contract end date (Reg 4).
b. To make better provision for calculating the value of a contract (Reg 5).
c. To provide for qualifying defence contracts and qualifying subcontracts made under framework contracts (Reg 9 and Reg 60).
d. To remove duplication in regard to information required from contract reports (Reg 22-Reg 30).
e. To re-work the provisions, e.g. with reference to the obligation to provide supplier-level reports under Reg 34-Reg 39 (Reg 31 and Reg 32).
f. removal of duplication in regard to information required from supplier reports (Reg 33-Reg 45).
In addition, a number of changes have been made for policy reasons. The main changes made are as follows.
(a) The Coming into Force (CIF) date (Reg 1) has changed from ‘1 October 2014’ to ‘on the day after the day on which they are made’. In practical terms this means, subject to Parliamentary approval, a few days after debates in both Houses have concluded. This change was made because, given the detailed and technical nature of the regulations and restraints on Parliamentary time, the Oct 2014 date could not be met.
(b) The definition of ‘defence purposes’ (Reg 3) has been changed from the previous draft which referred to contracts where ‘Secretary of State for Defence is party to the contract’ to the current wording for contracts that are for ‘the purposes of defence (whether or not of the United Kingdom), or related purposes’. This has been done because a strict legal interpretation of the Act requires us to define defence purposes, and the original definition was a description of circumstances rather than a definition. Legal advice is that the new definition achieves the same policy effect.
(c) The introduction of a two-tier approach to value thresholds for qualifying defence contracts (Reg 6). Between CIF and the end of March 2015, the value threshold for a qualifying defence contract is £500m. After this date, this drops to £5m. This ensures the most material contracts are caught as soon as possible, while limiting the number of early adopters to a practical level, which will assist the Single Source Regulations Office (SSRO) to prepare for increasing volumes of qualifying contracts from April 2015.
(d) The introduction of two new regulated pricing methods (Reg 10). The ‘estimate-based fee pricing method’ allows for a form of cost-plus contract where the profit is agreed in advance rather than being proportional to costs. This removes a financial incentive on suppliers to increase their costs so as to receive a greater profit. The ‘volume-driven pricing method’ allows for availability contracts where the price is agreed as a price per unit output (e.g. £x per flying hour).
(e) The initial profit rates (Reg 11). The SSRO will recommend its first set of profit rates by 31 Jan 2015, and the Secretary of State will publish the final rates in the London Gazette by 15 Mar 2015. Between the CIF and the end of March 2015, there is no profit rate published in the London Gazette. During this period, transitional rates will be used which are those recommended by the Review Board for Government Contracts (the arms-length body who currently recommend profit rates for single source contracts, and who are being replaced in due course by the SSRO).
(f) The introduction of a minimum threshold for subcontracts to be considered when making an adjustment under step 3 of the calculation of the Contract Profit Rate (see section 15 of the Act) (Reg 12). The step 3 adjustment ensures that suppliers do not get multiple layers of profit by virtue of subcontracting to other suppliers within the same corporate group. Although simple in theory, in practice calculating this adjustment is complex and resource intensive, so we have introduced a value threshold of £100,000. Subcontracts below this value are not to be considered when making a step 3 adjustment.
(g) Greater contract-level reporting requirements for the ‘Interim contract report’ (ICR) (Reg 27). To avoid duplication, the information asked for in the ‘Quarterly Contract Report’ (QCR, see Reg 26) was removed from the ICR. The QCR is, however, only required for contracts above £50m, meaning contracts between £5m and £50m did not provide all information we wanted. Additional information requirements have been thus been added to the ICR for contracts between £5m and £50m.
(h) The introduction of a two-tier approach to the value thresholds for supplier-level reporting (Reg 31). As soon as a supplier signs a QDC in excess of this threshold, the supplier reporting requirement outlined in Part 6 applies to all the business units involved in single source procurement within that supplier’s corporate group. The value has been set to an initially lower level of £20 million until 1 April 2017, when it rises to £50 million. This is to expedite the introduction of the new supplier-level reporting and overhead recovery requirements.
(i) Increased supplier-level reporting information requirements (Regs 40-44). The ‘long-term overhead report’ (Reg 48 in the previous draft version provided to the House of Lords) has been replaced by the ‘Strategic industry capacity report’. Additional information requirements have been identified which support the MoD in getting value for money from single source procurement.
(j) Maximum penalties (Reg 50). The Act requires the regulations to set out maximum civil penalty amounts for reporting failures (see section 33(1)). These have now been included.
(k) Qualifying Subcontracts (Reg 58). To be a qualifying subcontract, the majority of the work done under a single source subcontract has to relate to qualifying defence contracts or subcontracts (current or prospective). This is to exclude subcontracts that are predominantly to support competitive contracts, for which there should be sufficient market pressure to encourage the supplier to get value for money from their subcontracts”.
Although the form and wording of the regulations have evolved since January, there have been limited substantial changes to the underlying policy. The regulations describe how the new framework will operate. It would be onerous to go into this in detail but I will draw the Committee’s attention to a few key elements.
First, I note that one of the main functions of the regulations is to set out the scope, frequency and nature of the information required from our suppliers. The Committee will understand why this needs to be spelt out in detail to remove any ambiguity.
Secondly, I will highlight our intention to bring the new framework into force with effect as soon as it has been cleared by Parliament. However, this will be implemented in two phases. Between the coming into force date and the end of March 2015, the value threshold for a qualifying defence contract will be £500 million and above. After this date, this threshold will drop to £5 million and above. This phased approach maximises the benefits from the new system while limiting the number of early adopters to a practical level. This will assist the SSRO to prepare for increasing volumes of qualifying contracts from April 2015 and will allow it the opportunity to issue guidance on the new framework.
As from April 2015 onwards, we estimate that between 100 and 200 single source contracts a year will be subject to the Orange Book. The MoD has been working hard to engage with the early adopter projects, which are likely to be the first to sign qualifying defence contracts over the coming months. We recognise that this reform represents a step change in how single source procurement is carried out.
We are also developing written guidance and training courses for MoD staff who are directly involved with the new framework, and we are engaging with industry through a variety of different channels to make it aware of how the changes will affect it and to encourage it to respond accordingly and in a timely manner.
Considerable progress has been made in establishing the independent regulator—the SSRO. The chair was appointed in May 2014 and non-executive directors in October. The SSRO has been consulting with stakeholders, especially in industry, on how the new framework will work. While the requirements imposed by the statutory legislation are clearly defined, we have assured stakeholders that we will adopt a pragmatic attitude with regard to implementation.
On the report issued by the Joint Committee on Statutory Instruments, I will first thank the committee for its careful scrutiny of the draft regulations. Given the complexity and scope of the regulations, it would be surprising if this distinguished committee did not find some points of difference. However, I am encouraged that the issues raised by the committee are modest in scope, which is a reflection of the extensive process of drafting review which the regulations have gone through. The department’s reply is on the JCSI website. I will address the committee’s points, but I stress that none of them impacts on the effectiveness of the regulations or creates ambiguity for the users of the regulations.
The JCSI has identified that Regulation 5(3)(i) is defectively drafted. That regulation refers to the date a particular assessment is made under Regulation 12(1). In fact, 12(1) sets out the circumstances in which an assessment must be made under 12(2) and 12(3), so the actual assessment is made in 12(2) and 12(3) rather than 12(1). Thus the reference to “12(1)” should more correctly read “12(2) or (3)”.
That is a very minor, technical point. We are of the view that there is no danger of users being misled or confused by our intended approach, and no ambiguity is created. We therefore agree that this point is cleared up as soon as convenient when the regulations are next amended. However, I stress that until this amendment is made, there will be no impairment to the effectiveness of the regulations.
The committee has also identified that the “firm pricing method” in Regulation 10(4) and the “target pricing method” in 10(11) are identical in that they both provide for the allowable costs to be estimated at the time of contract let. That was covered in the MoD memorandum. The committee is correct that the two pricing methods do not differ in terms of when the price is estimated, but they differ substantially once the price has been agreed.
For firm price contracts, the price remains constant, whereas in target price contracts an adjustment is made to the price at the end of the contract. Actual costs are compared with estimated costs, and the price is adjusted to share any gains or losses between the parties. These target price contracts are commonplace, typically accounting for 40% of the value of MoD single source procurement.
In preparing the DRA, we wanted to ensure that this commercial model was still available. This is expressly allowed for under Section 16 of the Act. As with all commercial models, it is necessary to specify in the regulations how the price of these target price contracts should be determined. We could have said that they are initially priced using the same approach as firm price contracts, or we could have done as we did: namely, specifying a target pricing method. From a practical perspective, there is little to choose between these two options. However, our approach has benefits, which I will explain.
Different pricing methods may be used for different components of a contract, as in Regulation 10(3). It is not uncommon for a contract to have one component priced using the firm price method and another priced using the target price method. Although the initial price of both components is determined in the same way, the subsequent reporting is different and the final price will differ, depending on which method is used. Including target pricing as a distinct pricing method allows the two components to be separately identified later in the draft regulations, such as in Regulation 22(2)(k), which requires that the total price be broken down by the different regulated pricing methods used for that contract. As this is a practice with which users are already familiar, it is our view that significant confusion would result were they not separately defined pricing methods. We therefore propose no change to the regulation, on the grounds that it is helpful to the users of the framework and does not in any way reduce the effectiveness of the regulations.
The committee also draws attention to Regulation 11 and the interim rates. Again, the MoD responded to this point in its memorandum; we noted that these are transitional provisions, the vires for which are in Section 42(1) of the Act. Regulation 11 determines the profit rate used on single source contracts, which is described in Section 17 and further expanded on by Regulation 11. Three of the six steps require the use of standard profit rates, which must be published by the Secretary of State by 15 March each year. In normal circumstances this will be an annual process, but for the first year after coming into force it would have required the Secretary of State to have published the rates before the Act received Royal Assent. The Act required transitional rates to apply between its coming into force and 1 April 2015. If there is any doubt as to the vires required to make these transitional arrangements, it is covered by the “supplementary” or “incidental” aspect of Section 42(1). Rather than setting out these transitional rates in Regulation 11, they could have been put in the relevant commencement order, the vires for which would be Section 50(10). However, we chose to put them in the regulations as that is easier for users.
The transitional rates used are the most recent recommendations made by the Review Board for Government Contracts, an existing arm’s-length body whose duty it is to recommend profit rates for use on single source contracts, albeit under the old non-statutory Yellow Book regime. The review board’s functions will be taken over by the new SSRO. I note that the committee stated that,
“there must at … least be doubts”,
about the MoD’s approach, which suggests that different but valid views are possible. The committee appeared to prefer that these interim rates should be established through a commencement order. We do not agree; it is better for users to have all these elements contained in a single place: namely, the regulations. We therefore propose to make no change to the regulations.
The last of the committee’s four points relates to the use of the words “within the relevant year”. The committee points out that in a strictly legal sense we do not need to repeat that phrase, which is defined in Regulation 13(1), in its paragraphs (2), (4) and (5). While technically correct, these words are harmless and do not impair the meaning of the regulations. However, the MOD agrees to make a suitable correction when the regulations are amended.
In summary, with regard to the points raised by the JCSI, the MoD has obtained legal advice and is confident that the regulations are entirely fit for purpose as drafted. We have considered the JCSI report very carefully and are proposing to make two amendments at an appropriate time. We are confident that the regulations as drafted are fully effective in achieving our objectives.
In conclusion, the changes we are introducing to single source procurement are long overdue and represent a significant enhancement to how we procure for this key part of our defence capability. This is a fundamental reform developed over a considerable period of time and following extensive preparation. We expect that the benefits will fully emerge only over the longer term but are entirely confident that these benefits will be both substantial and wide-ranging. I commend the regulations to the Committee.
My Lords, I thank the Minister, the noble Baroness, Lady Jolly, for that introduction. I would just like to say a word about the role of the Official Opposition in this process. The Act and the regulations are enormously complex and, in taking the Bill through, we took a decision to have most of our conversations with the Government not on the Floor of the House, and to make sure that the clarifications and so on that emerged were read into Hansard during the subsequent debates. That worked very well.
The problem with taking that forward, of course, is that the regulations, I think, are actually longer than the section of the Act that they refer to. Therefore there were as many concerns of detail in the regulations as there were in the Act, and I thank the Minister and her officials for finding time to talk to us about the regulations and for her letter. It was important to read it into the record because Hansard, in a sense, lives for ever—one has only to walk down our corridors to realise that—whereas, splendid as the letter is, I will probably lose it and probably nobody else will actually see it. Having it in the record is therefore worth while. Therefore I thank the Minister for that repetition, long as it necessarily was.
On the general thrust of the Act and the regulations, I commend the Government for bringing them forward. I believe that it has taken them something like five years to work on this issue. I see nothing political about it, and the Ministry of Defence is now equipped with a piece of legislation that gives it some sort of equality of arms when working with large manufacturers —to which, for reasons of sovereignty, we have effectively ceded monopoly power. So far, I am happy with where we are. I accept that the divisions the noble Baroness set out in the letter were technical policy matters. We have checked through the letter and are happy with it.
Unfortunately, in a sense, the Joint Committee on Statutory Instruments came through with its report a little late. I am not criticising that committee. The accident of timing, together with the demands of my wife, meant that my attention rested on the report only on Monday morning. I thank the Minister for taking it on board and responding to it.
I hope that I will be forgiven for my rather halting presentation. There are four relevant issues, the first of which relates to Regulation 5(3)(a)(i) and the Joint Committee’s concern about the reference to Regulation 12(1). As I understand it, the Government entirely take this point and will correct it in a subsequent regulation. The Committee will today not be well served by me going on about it any further.
The next point that the Joint Committee raised was essentially a drafting point. I think in a sense the committee was complaining that there was repetition. The problem with repetition if you are a lawyer is that you create synonyms, and synonyms are bad news because it is a feast for lawyers to work out which interpretation to take and gain the edge. The problem arises because of the shape of Regulation 10. In some ways, if the different methods of contract had been set out plainly with reference to pricing, it would be clearer. Despite the explanation given by the Minister, I still think that this particular regulation is—how shall I put it?—a little messy and inelegant. However, I accept that it probably has no substantial impact.
The area that is somewhat worrying is the assertion by the committee that Regulation 42(1)—concerned with interim figures—was in fact not powerful enough. In private discussions I have asked whether 42(1) was in effect a Henry VIII clause, and people say it is not because it does not change primary legislation. It is something less powerful and the committee is essentially saying that it addresses the whole essence of Section 17 of the Act, which gives no opportunity for the interim regulations.
I do not want to press the matter further simply because the number of contracts to which this refers is going to be limited. However, if you have one set of lawyers—and let us face it, that is what the JCSI is saying—asserting that they do not believe Regulation 41 gives you the power to do this, and the ministry has another set of lawyers who say that we do have the power to do it, it will be a lawyers’ fest if that turns into a row. I always like to help the Government not to encourage lawyers’ fests, because the last group of people in this world I want to see get richer are lawyers. It seems the Government are not willing to take the committee’s point on this beyond doubt. I think the Minister mentioned that it could have been handled in Section 50(10); perhaps it should have been. Equally, I recognise that the whole relevance of this regulation, inasmuch as 42(1) is called into question, dies in the spring of next year. In that sense, let us hope that we do not have a row with a big bully supplier before then.
I think that the final concern of the JCSI was a somewhat fine point, which is really code for, “I had to read it a lot of times to start to understand it”. Since the Minister is saying that that fine point is taken and will be addressed in subsequent revisions, I will say that I am content not to pursue the matter further at this point.
I would like just a little bit of a moan about the two documents. It may be a moan that is impossible to satisfy. Such intercomplexity—if there is such a concept—may be absolutely inevitable for a document such as this. For my own entertainment I tried to trace down the cross-referencing and it bored me to tears—so I do not see why the Committee should not have a minute or two of it.
Section 16(1) in the Act demands Regulation 10. Then there are Sections 18(2)(a) and 18(2)(b). Every time the Opposition say, “We don’t like ‘may’, we like ‘must’”, we are told that the drafting convention is that “may” means “must”. However, for the first time in history, “may” apparently really means “may”, and the may in there says, “We are not going to bother with a regulation to cover 18(2)(a) and (b)”. That is a joy, but I would be gratified if the Minister would confirm that that is the decision.
To find the regulation referred to in Section 18(2)(c), you have to go to Regulation 13; for Section 18(3), Regulation 18; for Section 21(1), Regulation 17; and to find the regulations relating to Sections 21(4), 21(5) and 21(6), you go back to Regulation 16. I do not believe that there is a bear of little brain out there who actually understands that lot. In a sense, I think the Ministry takes that point, because it is committed to providing training, guidance material and even—perhaps the Minister can clear up this point—training for industry to help it understand this.
The only problem with that is that there will then be a difference between the guidance and the Act and the regulations. We have to go back to what the Act and these regulations are for. On my reading, they are to stop big industry bullying government and to create a legal framework that says to big industry, “This is the only way we can do business”. The problem with that is that big industry has deep pockets, often created by us, the taxpayers. With those deep pockets, if there is a dispute, industry would, again, have an army of lawyers, and one area that may emerge is the complexity of the relationship between the Act and regulations, and then the guidance.
In some ways, I wish that these regulations had come along a little bit later. They could have done a little more tidying up and included some cross-referencing, and could have perhaps taken longer to consider the JCSI’s comments, which could then have been taken account of in resubmitted regulations. In general, I am happy and can assure the Minister that what she has said today will be studied by my much more expert friends in the Commons before they have their own discussion tomorrow. We will therefore perhaps get another view of how acceptable these regulations are. However, in the review that I have done so far, I am concerned about undue complexity but am content that the key issues that the JCSI has brought up are going to be subsequently corrected.
However, I would like to ask the Minister about the whole issue of transparency, which is in a sense subsequent to the regulations. We have shone a light on this mysterious area by virtue of having a Bill. I suspect that none of us other than those working in the Ministry of Defence has thought about this problem at the very top of our minds before, but that has caused us to research this and to suddenly realise that you do not know when these things are happening. If you google them, you would get more out of the rather boastful BAE Systems press releases assuring its shareholders that it has done a good deal as opposed to it coming out from government.
I may not have been listening or not reading every Written Statement, but I ask the Minister in what way Parliament will know how the Act is working. How will it know which of the various pricing mechanisms that we have very carefully gone over are being used? There is a final price adjustment, which is an important part of that. I have looked into the Act and the schedules and note that the SSRO has to give an annual report. However, the requirements of that annual report are very thin. Basically, it has to account for its budget and so on. Do the Government have any ideas on keeping Parliament informed about how the Act and regulations will be used?
It is worth stressing for the record that we are talking about something in the order of £7 billion-worth of expenditure per annum—a very considerable sum of money. Everyone who has been involved in defence procurement has been deeply uncomfortable for years, and probably decades, about whether the taxpayer was getting value for money with these contracts because of the sheer difficulty of seeing into them and the limited powers we had from the Yellow Book. I applaud the emergence of the Orange Book and I look forward to getting a copy, if only for the colour.
I thank the noble Lord for his interesting and valuable comments and I shall address the points he raised as far as I can. We shall be in touch with him on any unaddressed points.
On his comment about the regulations being difficult for a lay audience to understand, and that the way they are laid out bears no relationship to the Act and that the cross-referencing of the two proved quite a challenge, we have done everything we can to make them as clear and comprehensible as possible. However, inevitably, they are highly technical and dry. They relate to a complex and specialist subject and it is necessary that they are accurate and precise. Everything in the regulations addresses specific issues in providing for the new framework for single source procurement.
When we had our meeting last week we discussed the intention that industry would probably not use the regulations but that the SSRO would produce specialist toolkits to guide industry through the morass of legislation and regulation. So, although those of us who enjoy reading these sorts of things might have had a problem, the department is doing all it can to smooth them out.
On the issue of training for industry, extensive briefing material has been provided. We have discussed this extensively in consultation with industry. We are providing workshops, briefing early adopters—including industry—and much of our guidance is on the internet, visible to industry and transparent.
“Mays” and “musts” is a good House of Lords regulation issue. I can confirm that the “may” in Section 18(2)(a) and (b) has not been used in the regulations. “May” does not mean “must”. I hope that the noble Lord is happy about that.
I thank the noble Lord for his comments and I hope that I have answered the main points raised during the debate. I further hope that Members of the Committee appreciate the Government’s commitment to improving this key component of our approach to procurement. This is a fundamental reform to a system which is well overdue for change. We continue to work with the SSRO and industry to ensure that implementation of the new approach is pursued as effectively and smoothly as possible.
Before I finish, I will not only repeat my thanks to the noble Lord, Lord Tunnicliffe, but thank the officials who not only had to teach me the intricacies of single source procurement—
My Lords, it is important that we should understand how any taxpayers’ money is being spent. How will Parliament know? The SSRO will publish an annual adherence report that will be laid before Parliament—helpfully, the officials, who I am praising to the hilt, have told me this—in the usual way. It may be that the noble Lord and I will have to google for press releases.