THE COURT'S OBSERVATIONS THE COMMISSION'S REPLIES

Information in support of the Statement of Assurance

Reliability of the accounts

21. The sum of 27,5 million euro for recovery orders issued and not yet collected at the end of 2003 does not represent the total value of receivables. 21.

(a) Claims arising from projects (advances to be recovered, ineligible expenditure, etc.) are not all registered by the Commission's central services or by the Delegations. Often, the latter simply enter as revenue (negative payments) sums which third party debtors have, in fact, repaid. Moreover, as there are no procedures for monitoring claims outside the accounts, the Commission cannot quantify the amount of actual debts to be established against projects at the end of 2003 (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43). (a) Advances to be recovered are monitored, and this matter is the subject of a chapter in the management report. Careful analysis and monitoring of advances in 2003 enabled EUR 56.2 million to be recovered. From 1 January 2005, accruals-based accounting will make it possible to establish provisions for potential recovery orders.

(b) Among the 400 million euro of advances outstanding for more than 18 months that it has registered, the Commission has not indicated the total value of unjustified amounts which are to be recovered or cleared. The Court cannot establish what fraction of the advances is, therefore, to be recovered and included in the debt. (b) The Commission would underline the efforts made in 2003. A considerable amount of work was directed towards identifying recoveries of advances and there is very close monitoring of the action to be taken as regards the recoveries.

22. Funds transferred to the EIB in 2003 (209 million euro) and to other international institutions in previous years, which have not yet been fully utilised by those bodies, do not appear in the assets on the balance sheet. 22. The Commission considers that these movements reflect payments to external agents acting on behalf of the Commission. As such, the Commission considers them to be genuine payments and not mere internal treasury movements between accounts controlled by the EDF Accounting Officer. The Commission would also point out that details of the amounts outstanding on these transactions at 31 December 2003 are shown in Table 4.2.3 in the Financial Implementation Report. From 2005 onwards, following the introduction of accruals-based accounting, such transactions (pre-financing paid to intermediaries) will be shown as an asset in the balance sheet, in accordance with the provisions of Article 135(3) of the 9th EDF Financial Regulation.

23. Following the Court's earlier observations the Commission, in 2003, carried out an inventory of the use of the Stabex funds transferred to the local accounts of beneficiary countries. Local disbursements from these accounts are still subject to Delegation approval (see paragraphs 63-68). As at the end of 2003, the information obtained by the Commission from the ACP States concerned was still incomplete. The Court considers that even if the results are incomplete, the Commission should include the results of this inventory in its report on financial management and give the details in the annex to the reports on financial implementation. 23. The Commission has collected data for 80 % of the countries concerned, covering 97 % of the total amount of Stabex funds in the 7th and 8th EDFs. The Commission intends to include the relevant information related to the Stabex local account in an inventory. The local accounts, although the Commission must co-sign in order to use them, are not the Commission's property. This detailed inventory is therefore to be included in the ‘Report on Financial Management’. Following the recommendation of the Court, a note on this issue is included in the balance sheet for the financial year 2003.

Legality and regularity of the underlying transactions

24. The observations expressed in paragraph III of the Statement of Assurance are based on an analysis of the EDF supervisory systems and controls, examination of a sample of underlying transactions, analysis of the annual activity report, and the declaration by the Director-General of EuropeAid. The main conclusions are given below.

Analysis of supervisory systems and controls

Improvement in supervisory systems and controls at Commission level

Implementation of internal control standards

25. During 2003, EuropeAid, which is responsible for implementing the EDF, has continued to introduce the various internal control standards adopted by the Commission in 2001. The internal control standards are being implemented simultaneously by the Delegations and by headquarters, in parallel with the devolution process, which will not be complete until the end of 2004. At the level of the central services, the Court is able to draw the following conclusions, which are principally based on the results of the analysis of internal control standards carried out by the various Commission departments.

26. Each directorate-general was to introduce appropriate supervisory measures, and in particular, where necessary, an ex-post review of a sample of transactions. An ex-post financial management control unit was set up in 2003 at EuropeAid level. Its principal tasks are to detect recurrent errors in the financial management and internal control systems and to propose measures to correct the weaknesses found. Accordingly, some 1 800 risk transactions underwent a thorough ex-post review. The review concerned recovery orders, outstanding amounts to be recovered, uncleared advances, guarantees and sureties. The significant conclusions reached by the ex-post review unit included observations on the checks on outstanding advances and recoveries. More than 400 million euro of advances outstanding for more than 18 months was registered in connection with EDF projects. Furthermore, the various departments responsible have been requested to deal with 27,5 million euro that are still to be recovered. 26. Advance payments are a normal and regular means of ensuring the effective implementation of many aid projects and are monitored.

27. The supervisory measures are supplemented by an ex-ante control unit, set up as an interim precautionary measure. The unit is not in itself required by the internal control standards. It began work in June 2003 in the authorising directorate of the EDF and has examined 540 out of a total of 5 261 transactions (both commitments and payments). No significant errors have been detected under the ex-ante procedure.

28. In addition to these two units, there are other activities related to the supervision of transactions, such as the production of checklists for commitments and payments, inter-unit meetings and audit visits to Delegations. Generally speaking, supervision is more extensive than it was, but it has still not been harmonised. To make it more efficient, coordination is needed, in order to determine which type of check covers which aspect of the legality and regularity of the underlying transactions. 28. EuropeAid continues to work towards strengthening and rationalising the measures already put in place. To that end, harmonisation (financial guide, centralised ex-post checks, checklists, etc.) was carried out in 2004.

29. In accordance with the internal control standards, EuropeAid has also developed an internal audit capability. As a result and as regards the EDF, in 2003 the workloads of the Delegations (one audit visit to Mali) and of headquarters were evaluated in the context of devolution, as also, for the authorising directorate, the progress made in implementing the internal control standards. In addition, some essential work was done, thus making it possible to identify the main risks and weaknesses of EuropeAid's supervisory systems and controls. In its Annual Report for 2002 the Court emphasised some of those risks and weaknesses, in particular those relating to checks on the reality of services, work and supplies paid for by the EDF. 29. The Commission is aware that the management of EDF credits involves some risks. Setting up improved control and monitoring systems as well as regular audits helps to minimise those risks. In the context of the annual declaration by the Director-General, none of the weaknesses identified was regarded as material. As the Commission stated in its reply to point 30 of the Court's annual report for 2002, it considers that the set of control systems set up for the EDFs ensures the legality and regularity of the underlying operations. This system allows any weaknesses at local authority level to be remedied.

30. As regards ad hoc information concerning management, the external aid management reports (EAMRs) devised at the end of 2002 (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43) were introduced in 2003. They are a periodic information resource which enables the devolved Delegations to send to headquarters the most important information on implementation, payments and external audits relating to the largest projects. A standardised format has been sent out and is used by these Delegations. However, as at March 2004 the Commission had still not received the full complement of EAMRs, although these had been due by 31 January 2004. As well as providing the central services with occasional information on management, the EAMRs are one of the basic elements for the preparation of the Director-General's annual report and declaration. 30. External Assistance Management Reports are one of the information tools used in the management of external aid that devolved delegations send to the EuropeAid Directors responsible (authorising officers by subdelegation) and to the Directorates-General for External Relations and for Development. They constitute one of the information sources used by the Directors to draw up their activity reports for the Director-General. The EAMRs are not, however, used to prepare the annual report and declaration of the Director-General. The instructions given to the delegations state very clearly that producing an EAMR does not relieve a head of delegation from the responsibility for informing the Director concerned in good time of any problems or specific matters for which the Director is responsible as the authorising officer for the appropriations managed by the Delegation.

31. As regards the reporting of irregularities, which is one of the internal control standards, information concerning three cases of alleged fraud linked to the EDF (Sierra Leone, Papua New Guinea and the Dominican Republic) was sent to OLAF in 2003. The Delegations, which are closer to the beneficiaries, are more exposed than the central services to cases of irregularity (and better informed about them). The Commission must therefore continue to improve staff awareness about these matters. Implementation of action plans 31. In accordance with the internal control standards, delegations are informed of the procedure to be followed when detecting irregularities or suspected fraud, including the contacts to be made with OLAF. All new members of staff, and those about to be seconded to a delegation, attend compulsory courses to make them aware of the fight against irregularities. This course is also open to all other officials.

32. In addition to the implementation of the internal control standards, the Court also examined the action plans for strengthening the supervisory systems and controls. The action plans were introduced following the 2002 annual activity report by the Director-General of EuropeAid or were decided upon in view of the requirements observed in 2003.

33. As regards external audits, headquarters units provide ad hoc support for the Delegations and operational directorates. They have drafted standard terms of reference so as to harmonise the audits carried out by outside firms in respect of the vast majority of the projects financed. The 2003 audit programme for headquarters thus made provision for around 30 audits concerning the EDFs (these were entrusted to external auditors), a relatively large figure when compared with previous years. A new IT tool (CRIS Audit) was introduced at the end of 2003, but was still only partially operational; it enables the Commission to monitor the planning and implementation of external audits. However, as the tool is not linked to the financial information system, the coverage of the audits cannot be evaluated. Ultimately, CRIS Audit will be extended to the audit activities of all the Delegations. 33. Apart from the headquarters audit plan, altogether the plans of the delegations for 2003 covered 192 audits at 1 July 2004. Furthermore, the CRIS audit system was set up in 2004 for the EDFs. There is, however, already a system for reporting audits which includes the information on the audit (terms of reference, order form, mission, draft report, etc.) and the main findings of the auditors.

34. In spite of all these resources it is still difficult to establish the level of additional assurance which external audits provide as regards the legality and regularity of the transactions underlying the EDF. The fact is that the follow-up of audit findings is still not very effective owing to the wide range of uses to which the findings are put by the various parties involved. Following the progress made in standardising the terms of reference, an effort is now required to ensure that audit findings are more adequately followed up. 34. The level of programming and follow-up of audits corresponds to that of the management of the project that is to be audited, which gives a better yield in terms of exploitation of results. The Commission agrees that progress is needed in following up the conclusions of audits which is why it introduced a follow-up reporting system in 2004.

35. Measure 2, which appears in the synthesis of the annual activity reports and declarations of the Directors-General for 2001, provided for an analysis of the risks associated with external aid. A working document describing these risks was drafted by the Commission in 2003 (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43). The analysis and measures it recommends take account of the various ways in which external aid is implemented, i.e. on a centralised, devolved or joint basis. This valid approach to risk analysis and management must now be applied to each aid instrument and type of project in order to help strengthen the supervisory systems and controls. 35. The Commission will take account of the Court's comments.

36. The unit responsible for the ex-post control of financial management implemented a specific action plan in 2003 to reduce the outstanding recoveries of 27,5 million euro accumulated in respect of projects and owed to the EDF by third parties. This measure enabled responsibility for initiating recoveries in this area to be divided between the authorising officer and the accounting officer of the EDF. It highlights the lack of coordination between the authorising officer and the accounting officer of the EDF, as well as the Commission's difficulties in applying the provisions governing debts and recoveries. Furthermore, no operational procedure was adopted for clearing the new recovery orders which will arise in respect of projects for the financial year 2003 and subsequent years. 36. In 2003, following the adoption of the specific plan, the services of the authorising officer and the EDF accountant set up a system for following up recovery orders which enabled considerable progress to be made despite the particular difficulties affecting recovery under the EDF, due in particular to the legal requirements and to the functioning of the OLAS computer system. With better coordination and cooperation between the two services, progress was also made with creating new operating procedures for OLAS to facilitate the follow-up and settlement of recovery orders. The setting-up in 2004 of an ex-post transaction control system within EuropeAid will allow the problems of recovery orders to be dealt with in a broader, integrated context of controls that supplement the regular recovery activities carried out by authorising officers by subdelegation. The devolution process, which brings management closer to the work in the field, should also make the management of recovery orders more efficient.

Supervisory systems and controls in the ACP States generally well-designed

37. The supervisory systems and controls of the EDF are based on a partnership between the ACP States and the European Commission. In the case of contracts and payments the main partners are the national authorising officer (the Minister for Finance or the Minister for Foreign Affairs) and the Head of Delegation, who rely on the checks carried out by other parties, including the technical ministries of the ACP States, programme management units, inspection visits funded by projects, and technical assistants and outside experts such as private-sector engineering consultants and auditors.

38. The Court carried out audits on the spot in six ACP States (Kenya, Mali, Mauritania, Senegal, Papua New Guinea and the Solomon Islands) so as to examine the EDF's supervisory systems and controls. As regards Stabex, the Court also examined on the spot a sample of final payments from the local account which received the funds to the beneficiaries of the Stabex programmes.

39. The supervisory systems and controls for contracts and payments in the ACP States visited were mostly well-designed. Very few examples of applicable legislation not being observed were noted.

40. As regards the performance of the supervisory systems and controls for payments, the national authorising officers responsible under the Cotonou Agreement for authorising and clearing EDF expenditure did not always verify that key controls in respect of invoices had been correctly carried out by themselves or by other parties. Consequently, some key controls were not carried out, e.g. to ensure that the work, supplies or services provided complied with the relevant contracts and that the financial clauses of the contracts were observed (as regards price adjustments, the adequacy of guarantees, the application of correct exchange rates, the payment of part of a contract in euro rather than in local currency, etc.). The Heads of Delegation, who are responsible for approving payment authorisations, are therefore urged to rectify the shortcomings of the national authorising officers. In some cases, however, they did not check the reliability of these key controls, inter alia as regards the beneficiaries' utilisation of Stabex funds. 40. In most ACP countries, the EDF finances the implementation of support programmes for national authorising officers in order significantly to increase their monitoring control capacity. As part of the devolution process, the delegations have been strengthened to allow them to shoulder their full responsibilities.

41. One positive step is that the devolved Delegations now use checklists when authorising their payments. Checks are occasionally listed as carried out and without anomaly where this is not the case (e.g. a contractor who does not have a valid bank guarantee). 41. The use of checklists was set up and formalised in 2002. The Commission is working on controlling the quality of use of the checklists, whilst inspection visits and training for officials have been organised.

42. The follow-up to the conclusions and recommendations of external audits of projects is varied and limited due to chronic delays in audit reports and the administrative purpose often attributed to them by the Delegations: all too often, audit reports simply serve as supporting documents for the closure of a project or for further payments into an imprest account, but do not lead to the necessary adjustments being made. 42. The Commission would point out that: (1) A large number of financial audits relating to programme estimates are in fact carried out at the end of an action as they are a prerequisite for the final payment. (2) The financial audits of grant contracts are ordered by the beneficiary of the contract in accordance with the detailed rules set out in the contracts (see also reply to point 34).

43. As regards Stabex, the Commission has put itself in a situation where it is not possible for it to check the total use of the funds as it has tolerated the national authorising officers' failure to account for their use, contrary to the requirement of Article 212 of the revised Lomé Convention. Similarly, audit visits by the Court confirmed that local bank accounts into which Stabex funds were paid had been used without the authorisation of the Head of Delegation (Kenya and Mauritania) or that the Head of Delegation had authorised movements of funds even though he was not on the (out of date) list of authorised signatories used by the bank (Senegal). 43. Article 212 provides for a report by the national authorising officer on the use of funds by beneficiary countries. The flow of data received by the Commission was not uniform. For that reason, and on the basis of the Court's recommendations, a comprehensive inventory was launched in 2003 in order to carry out a complete survey of these funds.

Conclusion regarding supervisory systems and controls

44. The supervisory systems and controls for the EDF cover a wide range of mechanisms and objectives. Renovation of these systems and controls began during the financial year 2003. It will be necessary to wait until they have been consolidated, in order to assess their actual contribution to the legality and regularity of the underlying transactions. At the current stage, nevertheless, more coordination is required so as to ensure that controls are not duplicated and that significant risk areas are covered, particularly those that take the form of anomalies noted by the Court. This will involve applying the controls and conclusions of the Commission's various inspectors fully at Delegation level. Flows of Stabex funds must also be subject to the appropriate level of internal control. 44. Following these inventories, the Commission is drafting more specific and more detailed guidelines for the utilisation of the Stabex funds in order to ensure better monitoring of the use by beneficiary countries of the funds still available.

Audit of transactions

45. A sample of 49 payments was examined on the basis of the documentation available at the Commission in Brussels and, where appropriate, at the Delegations in the ACP States. In addition, 37 other payments, including the corresponding global and individual commitments, were examined on the spot in the six ACP States selected so as to establish how the supervisory systems and controls performed, especially as regards the reality of the work, supplies or services covered by the documentation.

46. As far as direct budget support is concerned (see paragraph 19), the legal framework of the EDFs offers considerable scope for interpretation and exemptions. Furthermore, the checks in respect of the legality and regularity of the underlying transactions merely verify that the relevant conditions have been appropriately assessed. The initial assessments that are performed when the financial commitments are adopted are not sufficiently formalised in terms of each of the criteria listed in Article 61(2) of the Cotonou Agreement. Formalisation of this kind is essential, especially as regards the transparency, reliability and effectiveness of the management of public finances, otherwise it will subsequently not be possible to judge whether that management has improved, a prerequisite for further aid. The criteria for releasing further funds largely consist of macroeconomic indicators, which provide only part of the information about the management of public finances. 46. As regards the adoption of financial commitments, the Commission proposals for financing submitted to the Member States systematically include an assessment of the macroeconomic situation and public finances which, based on the most recent data, analyses the themes and the issue concerned by the criteria in Article 61, paragraph 2. It is designed in principle to provide the information listed in paragraph 3.4 of the Guide for budget support issued in March 2002. It is also useful to restate the major principles governing the release of tranches of budget support: — for fixed tranches, a macroeconomic balance must prevail, verified by the existence of a programme with the Bretton Woods Institutions; — for performance or variable tranches, the indicators are different: indicators linked to results (reflecting the implementation of poverty reduction strategies), general budget performance indicators (implementation rates, payment periods, etc.); process indicators linked to sectoral reforms or the management of public finances. The Commission shares the Court's view of the importance of in-depth, rigorous monitoring of public finances in the countries benefiting from budget support. The public finance analysis framework, comprising 28 indicators and developed with other donors under the Public Expenditure and Financial Accountability project, was tested in a number of ACP countries in 2004 with a view to becoming operational in 2005. Lastly, since 2003, the headquarters of EuropeAid has developed a template for monitoring the management of public finances which allows the Delegations to present quarterly reports on this subject.

Financial commitments

47. According to Article 17(2) of Annex IV to the Cotonou Agreement, the financing agreement between the Commission and the ACP State or States must be drawn up within 60 days of the decision by the Community's decision-making body. As far as the Court is concerned, the only evidence that a financing agreement has been drawn up is that it has been signed by both parties. Out of a sample of more than a hundred new commitments in 2003, i.e. nearly all of the financial commitments charged to the financial year, 82 % were covered by a financing agreement signed within 60 days of the decision. Of the remaining 18 %, 3 % (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43) were signed more than 120 days after the initial decision. This situation is an improvement over previous years. Nevertheless, the Commission must indicate how it intends to ensure that future agreements are drawn up within the 60-day time limit. 47. Drawing up a financing agreement in 60 days does not mean that the agreement has been signed. However, the Commission acknowledges that by virtue of this rule diligence is required in implementing a financing decision. This in fact occurs in a large majority of cases, as the percentages quoted by the Court indicate. Some 99 % of financing agreements are signed by the Commission within 60 days. The rare exceptions are cases (involving in particular direct budget support) where it emerges after the decision is taken that the conditions for concluding the agreement are no longer fulfilled, so that to maintain sound financial management it is necessary to wait until they have been re-established before continuing with signing.

Individual legal commitments

48. The few isolated and unimportant errors regarding individual legal commitments were as follows: 48.

(a) guarantees in support of contracts are characterised by repeated irregularities: some are not provided and others are incomplete or are provided after the deadline has expired; (a) The Commission has taken steps to improve the monitoring of bank guarantees; a specific module relating to bank guarantees in OLAS has been developed and instructions sent to the delegations. The Commission would point out that the Court has not identified any negative financial impact due to that finding.

(b) there are still cases where significant further changes to contracts have resulted in the actual final amount exceeding the statutory limits on changes;

(c) some Delegations follow the practice of signing contracts without dating them or without requiring the contractors and the national authorising officer to date the contracts that they approve. This anomaly makes it difficult for the Delegations to ensure that the regulations are applied when the latter depend directly on the date on which the contracts have been signed (e.g. to verify that the national authorising officer did not approve the contract until the contractor had provided a performance guarantee). (c) The Commission notes that the signature of a delegation endorses a contract. The date of the endorsement therefore does not have the same contractual value as that of the signature of the contractors.

Payments

49. The few isolated and unimportant errors regarding individual legal commitments concerned: (a) payments not in line with contractual stipulations (in terms of price, methods of payment, and the type and quantity of articles); (b) reimbursement of expenditure which was ineligible because there was no provision for it in the contract; (c) reimbursement of expenditure for which the supporting documents explicitly required by the contract were not provided by the applicant; (d) payments for work, articles or services the reality of which was not confirmed by reasonable prior assurance.

50. Other, more frequent, errors were noted regarding the implementation of procedures; however, their potential impact on the actual substance of the payments is difficult to assess (e.g. the scope for interest on arrears where suppliers' payments are late). 50. The Commission considers that considerable progress has been made in the last few years in reducing payment delays. It believes that the efforts should be continued and the Court's recommendations adopted.

51. The production of reports after contractually stipulated deadlines is a frequent procedural irregularity. Where these reports concern the implementation of the projects, the delay is often indicative of a weakness in the financial management of the projects. In the case of audit contracts, the late production of audit reports significantly reduces the possibility of the authorising officer's taking effective corrective action and follow-up. In general, further payments should be conditional upon these reports. 51. As regards the submission of contract reports, it is for the contractors to supply them. The Commission makes every effort to receive them in time. The question of audit reports has already been dealt with in paragraph 42.

52. Some further anomalies affecting the handling of certain payments or revenue complete the list of areas of EDF internal control to be strengthened as a matter of priority: 52.

(a) payments from local Stabex bank accounts, which do not appear in the Commission's accounts, must nevertheless be jointly authorised by the local Delegation and the national authorising officer. However, some of these payments were not signed by the Delegation;

(b) the bank interest generated by some projects' cash accounts is not entered in the accounts, even though it is supposed to be allocated to the resources of the corresponding projects. This anomaly could be remedied by means of appropriate bank reconciliation checks. (b) In the case of a programme estimate, it is for the project accountant to enter bank interest in the accounts. External audits allow the Commission to check that accounts are being kept properly in this respect.

Annual activity report and declaration by the Director-General of EuropeAid

53. The annual activity report and the declaration cover activities financed from the general budget as well as those of the EDF, even though each of these areas is subject to a different financial regulation. The report cites the EDF on some points but says nothing about others, which makes it difficult to decide how far the point or reservation concerned may or may not affect the EDF (e.g. the 250 million euro in contracts affected by the reservation about NGO associations). To make future reports easier to read, the Court would like to see the information and observations about the EDF presented more clearly in the annual report and in the declaration itself. 53. The reserve does not affect the EDF inasmuch as all the actions covered by the food aid instrument are financed from resources coming from the Community budget. The annual activity report covers all the activities managed by the authorising officer by delegation and is not intended to provide a breakdown of those data by source of programme financing. The data and the assessment of the control system, as well as the declaration, concern the functioning of the system overall without distinguishing between the budget and the EDF. The report focuses rather on the concept of Activity (ABB) which goes beyond the strict Budget/EDF demarcation. Thus the Activity ‘Relations with the ACP States and the OCT’ covers operations financed by funds from the Budget and the EDF. It should also be noted that a breakdown of data by ABB Activity is provided in a specific section of the Report. The Commission will take account of the wishes of the Court, within the limits of the aims and the format of Annual Activity Reports.

54. The debts still to be established and the correct use of the Stabex funds correspond to an amount which is, in all likelihood, material as regards the quality of the financial information. The Director-General should therefore have made a reservation to this effect (see paragraph 21). 54. Once transferred to the beneficiary countries, Stabex funds belong to them and have officially left EDF accounts. The subsequent use made of the funds by the beneficiary country therefore has no formal impact on EDF accounts.

55. Owing to the incomplete nature of the results of the Stabex inventory (see paragraph 23), the Director-General did not at that time have all the information he needed to conclude in his declaration on the use of resources for the specified purposes in accordance with the principle of sound financial management, and on the legality and regularity of the underlying transactions. 55. Stabex was an instrument for the rapid disbursement of funds and was designed to offset reductions in the export revenues from key agricultural products in the ACP countries. It disappeared with the entry into force of the Cotonou Agreements in April 2003. Thus the last transfers to be carried out concern funds which it had been decided in preceding years to transfer to the beneficiary countries that satisfied the eligibility criteria. No Stabex transfers took place in 2003. The annual declaration by the Director-General concerns 2003. The EDF accounts did not contain any information on the use made of Stabex funds by beneficiary States as, once the funds are transferred to the beneficiaries under the ‘Transfer Agreements’, they belong to those countries and have officially left the EDF accounts. Beneficiary States are required (see reply to paragraph 43) to report to the Commission on the use of these funds; it is then possible for the Commission, after informing the EC-ACP Council of Ministers, to defer the application of decisions on further transfers if the information supplied by the beneficiary State is not deemed satisfactory. On the basis of the information received from the beneficiaries in the past, the Commission has never actually done this. However, as there is no harmonised reporting system to ensure the uniformity of information received by the delegations, the Commission launched an inventory of the funds in 2003 in order to monitor the funds outside the accountings and consolidate all the information available.

Changes in the performance of the supervisory systems and controls

56. All the above observations are to be included in a table of indicators, so that changes in the performance of supervisory systems and controls can be evaluated (see Table 4 ).

Table 4 — EDF DAS 2003: Possible indicators resulting from audit work 1. KEY OBSERVATIONS — CHANGES IN THE SITUATION 2001 2002 2003 Observations Commission's reply Observations Action to be taken Observations Action to be taken 1.1 Management of Stabex treasury Insufficient control Future correspondence with the bank regarding the purchase and sale of securities will not be deleted Trading has sharply declined, but accounts do not clearly show gains and losses from trading or the year-end market value of securities The accounts should clearly show the gains and losses from trading and the year-end market value of securities The accounts show the (sometimes substantial) gains and losses from trading and the year-end market value of securities The required action has been taken 1.2 Implementation of aid under structural adjustment programmes The legal framework does not permit strict checks on legality and regularity because conditionality is not always strictly enforced Derogations from conditions are provided for in the legal framework of the EDFs Due to lack of information on the quality of public finance management in the ACP States, the Court cannot give an opinion on the use of direct budget aid Improve the information on public finance management in the ACP States The Commission has provided more information on its monitoring of public finance management in the ACP States, in particular in its financial management report for the financial year 2003 Continue to improve communication on this key topic 1.3 Venture capital transactions managed by the EIB Interest rates higher than provided for in Lomé Convention Believes it acted correctly though will verify correct application of Lomé Convention in consultation with the EIB Interest rates higher than provided for in Lomé Convention Correct application of the Lomé Convention The financial regulation applicable to the ninth EDF transferred responsibility for managing the investment facility to the EIB The Court no longer needs to comment on this matter in the context of the DAS 1.4 Price revision mechanisms Contracts do not provide for price revisions The Commission will remind all Delegations of this point in order to prevent a recurrence of these problems Price revisions continue to be paid without a clear contractual basis Improve the wording and checking of contract clauses on price revision The application of price revision clauses continues to cause problems on occasion Continue monitoring this aspect of contract implementation 1.5 True level of primary commitments Overstated in the accounts because of failure to decommit The Commission will continue its efforts to improve monitoring procedures Not accurately reflected in accounts because of lack of prompt action to cancel commitments Measures to monitor commitments and check them promptly The Commission has carried out an in-depth review of the outstanding commitments that are causing problems Continue the systematic review of the outstanding commitments that are causing problems 1.6 Clearance of advances and miscellaneous sums to be recovered No observations N/A Advances and sums to be recovered do not appear in the accounts in a reliable way Omission to be remedied Very poor management of the clearance of advances going back more than 18 months (400 million euro) and the recovery of sums to be recovered (27,5 million euro) Improve the procedures for identifying, registering and monitoring advances requiring clearance and sums to be recovered 1.7 Reports on the use of Stabex funds and checks on final payments Stabex transfers are entered in the accounts as payments, although they have not yet reached the final beneficiaries Improve the quality of accounting information No information in the accounts on the use of Stabex funds Omission to be remedied, since the Commission shares responsibility for the use of these funds The Commission is unable to verify the use to which Stabex funds are put (Article 212 of Lomé IV), and there is inadequate authorisation of bank transfers Obtain all the reports on the use of Stabex funds from the national authorising officers, and strengthen internal checks on bank transfers 2. SUPERVISORY SYSTEMS AND CONTROLS 2001 2002 2003 REVIEW OF FINANCIAL AUDITS Frequency (a) Frequency (a) Frequency (a) 2.1 Terms of reference do not clearly define the nature of ineligible expenditure frequent frequent occasional 2.2 The audit report does not clearly quantify the expenditure audited or the amounts of eligible and ineligible expenditure. frequent frequent occasional 2.3 Insufficient action to recover ineligible expenditure identified by external auditors frequent frequent frequent INTERNAL CONTROL SYSTEMS IN BRUSSELS Rating of supervisory systems and controls (b) Rating of supervisory systems and controls (b) Rating of supervisory systems and controls (b) 2.4 True level of implementation of a selection of internal control standards relating to underlying transactions not available B B/A INTERNAL CONTROL SYSTEMS IN 6 ACP COUNTRIES (34) (35) 2.5 Overall assessment of calls for tender not available B B/A 2.6 Overall assessment of payments not available B B/A 2.7 Overall assessment of audits not available B B 2.8 Overall assessment of recoveries not available C C 2.9 Overall assessment of accounts not available B B/A 2.10 Overall assessment for all countries visited not available B B (a) Frequency (occurrence) rare occasional frequent (b) Rating of supervisory systems and controls A Works well, a few minor improvements required B. Works, but improvements necessary C. Does not work as intended

CHAPTER III — FOLLOW-UP TO PREVIOUS OBSERVATIONS

Including the EDF in the general budget

Summary of previous observations

57. On several occasions, the Court has made observations concerning the complications and difficulties of implementing successive EDFs and has considered, as a possible solution, that they be included in the budget (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43). The Commission undertook to submit a communication in 2003 on the advantages and drawbacks of including the EDF in the budget (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43). For the Commission, including it in the budget, which the European Parliament has also been recommending for a long time, would provide a solution to the recurrent transitional problems that are associated with the setting-up of new EDFs; it would also permit uninterrupted implementation of the agreements reached with ACP States. 57. The Commission does indeed consider that including EDFs in the budget would be a solution to the problems of transition between EDFs but points out that this is not the sole argument in its favour (standard procedures, budgetary transparency, dropping of the negotiation and ratification process, and all the time that takes). See the Commission reply to point 12.

Development of the situation

58. On 8 October 2003, the Commission adopted a communication to the Council and the Parliament entitled ‘Towards the full integration of cooperation with ACP States in the EU budget’, in which it develops its reasoning in favour of integration. All the parties concerned (and the ACP States in particular) are giving careful consideration to this question. The European Parliament has already spoken in favour of the rapid ‘budgetisation’ of the EDFs (see paragraph 42 of the 2002 discharge report). 58. The Commission has suggested that EDFs be included in the budget on several occasions. In view of the enlargement of the EU and the decisions to be taken on the financial perspective 2007-2013, it would be particularly desirable to incorporate EDFs in the budget from 2007/2008.

Participation in auditing the EDF by the ACP States' Supreme Audit Institutions

Summary of previous observations

59. In the context of earlier examinations of EDF management (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43), the Court, the Parliament and the Council stressed how important the establishment and support of strong, effective and independent Supreme Audit Institutions (SAIs) could be in improving the quality of public finance management in the ACP States, especially the audit of operations financed by the EDF. 59-60. Direct support for the Supreme Audit Institutions (SAIs) takes the form of projects not covered by the budget support financing agreements and also of one-off technical assistance operations financed from budget resources for institutional support (budget lines managed in accordance with EDF procedures) which, in each budget support financing agreement, supplement the funds allocated. The Commission has updated the information contained in Annex 6 and included the one-off operations referred to above. Direct support operations, irrespective of financing source, are ongoing in nine countries and being studied in seven others. — where direct support for an SAI is not provided by the Commission, it is often supplied by another donor following consultations in which the Commission is involved. — support for SAIs can also take an indirect form through the incorporation in the financing agreements on the budget support of conditions and/or process indicators to strengthen the status and resources of such institutions, — the Commission also intends, wherever possible, to involve SAIs in the public finance assessments. The Commission intends to present a proposal to systematise and better structure its support for SAIs. It would be delivered under the action plans stemming from the public finance reform programmes running in each ACP country and operated jointly with all the partners involved in the budget support, especially the Member States.

Development of the situation

60. While indicating that it shared this view and was working towards the same end, the Commission made it known that, since for it this was a new and politically sensitive field, it was adopting a gradualist approach (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43). In response to the Parliament's request for information on EDF financing for the SAIs (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43), the Commission set out, in Annex 5 to its financial management report for the financial year 2003, a list of 14 projects that included support for public audit bodies in particular. The Court has taken note of the clear value of these projects, which are essentially concerned with strengthening ministries of finance, and on occasion strengthening their internal control structure. However, only one or two aim chiefly at strengthening the SAIs.

Monitoring of Stabex funds

Summary of previous observations

61. The Court of Auditors has published observations regarding Stabex funds on several occasions (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43). In all these observations it emphasised that there was no appropriate monitoring of accounts to make it possible to determine when and how these funds had finally been used. 61. As soon as Stabex funds are first transferred to the recipient countries, they become the property of those countries and are no longer included in the EDF accounts, although the Delegations continue to monitor their use closely. In 2003 the Commission produced an inventory of the funds in order to monitor them by a non-accounting procedure. Stabex has not existed since the 9th EDF and, as the FLEX instrument provided for in the Cotonou Agreement is fully compatible with the standardised EDF system, the problems identified by the Court will not occur again in the future (see Commission reply to point 68).

62. The EuropeAid Cooperation Office recently reiterated that the ACP States could only use Stabex funds after specific conditions had been met and with the Commission's agreement, and that it would take steps to monitor and report on the situation (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43). 62. On the basis of the analysis of the inventories on the use of Stabex funds at 31 December 2003 sent by the Delegations, more detailed and precise standard procedures and formats will be introduced before the end of the 2004 accounting year and will be fully operational by 2005.

Development of the situation

63. In 2003, the Commission made an inventory of all the Stabex funds that had hitherto been transferred to the ACP States and that remained partially unused in bank accounts at the end of 2002. By means of this information, which was still incomplete when the final accounts for 2003 were presented, the Commission was able for the first time in years to provide an estimate of the amount that had not yet been utilised by the beneficiary countries — around 700 million euro. 63. On the basis of the information supplied (at 1 July 2004) by 80 % of the countries concerned which covers 97 % of total Stabex funds in the seventh and eighth EDFs, there was some EUR 700 million still to be committed by the beneficiary countries at 31 December 2003.

64. Although they have been transferred to the beneficiary countries and have formally left the EDF accounts, the Commission continues to share responsibility for these funds and retains control over their proper use through the requirement that its agents sign final payments. When preparing the Statement of Assurance, the Court examined this specific aspect of Commission management. Stabex funds are normally assigned to productive investment projects in the field affected by the decline in export earnings that underlies the transfer decision (1 2 3 6 7 8 9 10 11 12 13 14 15 21 22 23 24 25 26 27 28 29 30 31 32 33 36 37 38 39 40 41 42 43), yet they are sometimes used by common agreement to support operations with no obvious link to the field in question (for example, 50 million euro in targeted budget aid for Kenya, assigned to meet, amongst other things, teachers' salary payments, was funded from compensation for the fall in revenue from the country's coffee exports). 64. In general, the bulk of Stabex resources were allocated to the target rural populations. In the case of Kenya and the last transfer of EUR 50 million earmarked for targeted budget aid, the measures are specifically aimed at the geographic areas affected by the fall in revenue that is the reason for the Stabex funds in question.

65. Broadly speaking, there is very little rigour in the management of Stabex funds and the monitoring of the funds via the accounts, which goes a long way towards explaining why the Commission had such difficulty in regaining control of the accounting information on the funds. For example, the interest revenue generated by the funds is sometimes irregularly accounted for and utilised (cf. in particular in Papua-New Guinea and the Solomon Islands, where interest revenue was not included in the accounts and was used for expenditure that was wholly unexplained). 65. Following the inventories completed in 2003, the Comission is drafting new, more precise and detailed guidelines for the utilisation of Stabex funds in order to improve monitoring and the use of unused funds. As regards the Court's comment on Papua-New Guinea and the Solomon Islands, the Commission has initiated an audit.

66. Since the outset, in fact, the Commission has paid too little attention to the need for a minimum framework for monitoring the proper use of Stabex funds. The Commission's Delegations have had no reference framework and no guidelines for monitoring the funds. The only obligation placed upon the partners, which was that they report on the use of Stabex funds — a requirement not always heeded in practice — rapidly proved to be inadequate in this respect. 66. The comment of the Court of Auditors should be viewed in the context of the original purpose of Stabex and its totally decentralised management of funds as soon as they have been transferred to the countries. The initial aim of Stabex was to set up a rapid payment mechanism and a flexible system for directly compensating small producers for income lost in the preceding farm year. Although the reference framework was not always very exact in the case of Stabex funds owing to its very specific nature, it was always clear that the rules and procedures of the seventh and eighth EDFs also applied to Stabex. A number of Delegations and national Authorising Officers managed to use the instrument successfully.

67. It is crucial, now that the Commission is starting to regain control over these operations, which in some cases got under way more than a decade ago, that it adopt a general strategy with its partners to clear unused funds once and for all. Having agreed on an appropriate legal framework, it could envisage using funds in such a way as to supplement the budget support that it grants to beneficiary States in other ways. 67. The Commission will make every effort to ensure that all the funds are committed in respect of the beneficiary countries by the end of 2005; budget support will constitute a valuable means of achieving this wherever conditions allow.

68. The Commission will need in any case to ensure that similar operations provided for under the Cotonou agreements (FLEX) are correctly managed and monitored in such a way that it can prove within a reasonable period of time that the funds in question have been put to appropriate use. 68. The FLEX arrangements provide either for budget aid or, failing that, for additional resources for the programmable part (envelope A) of the 9th EDF. In both cases expenditure is included in the standardised accounting system of the 9th EDF and follows the relevant rules. The problems experienced with Stabex should not arise with FLEX.

CHAPTER IV — MAIN OBSERVATIONS SET OUT IN SPECIAL REPORTS PUBLISHED BY THE COURT SINCE THE LAST DISCHARGE PROCEDURE

Special Report No 15/2003 concerning the audit of microproject programmes financed by the EDF

69. Some 2 % of EDF aid takes the form of multiannual microproject programmes which finance small-scale infrastructure projects. The Court examined the management and control by the Commission's central services and, in six ACP States (Ghana, Madagascar, Malawi, Uganda, Zambia and Zimbabwe), by its Delegations. The Court also checked whether the aims of the programmes had been achieved.

70. The main observations concern the formulation of the programmes, their implementation and the concrete results achieved in the countries selected. The Court gave a positive opinion of the microproject programmes, noting nonetheless that: 70. The Commission welcomes the positive view taken by the Court of the multiannual microproject programmes.

(a) the Commission's central services have insufficient information about these programmes and did not provide the Delegations with appropriate guidelines. The legal status of the units that manage the programmes in the ACP States is not always clear. Implementation of the programmes by means of ‘programme estimates’ can be confused or slow. Although the procedures for management and control are, on the whole, satisfactory, deficiencies remain and the information systems are often poorly designed or applied; (a) Although in the past the central services have encountered difficulties in monitoring microprojects more closely, they are endeavouring to play an increasingly important role in terms of thematic support and dissemination of good practice and are currently drawing up a general guide for microprojects. Whilst the legal status of the management units is not always clear, their main relations with the national Authorising Officer are nonetheless laid down in protocols or contracts. Projects requiring lengthy preparations can be slow as regards implementation and disbursement of funds but have the advantage of fostering better understanding of projects by local authorities, which then have a better insight into the spirit of the projects. The 9th EDF now includes adequate provisions for improving the reliability and effectiveness of the management of the ‘programme estimates’. The EuropeAid Cooperation Office has now finished drawing up a register of ongoing microprojects and those completed since January 2003.

(b) although the difficulties of precisely measuring impact are under-estimated, the fact that microprojects are useful to the communities concerned is widely attested and verifiable. The conditions that impact on the sustainability of projects appear to have been satisfied, but they may be affected by the weaknesses of local authorities. (b) The Commission attaches considerable importance to strengthening institutional capacities at all levels with a view to promoting the sustainability of results. Local administrations and municipalities are encouraged as much as possible to support the process of ownership and the sustainability of results.

71. Following its audit, the Court recommends that the Commission: 71. In its replies, the Commission agrees with the greater part of the Court's observations and recommendations and explains how it intends to implement the Court's main recommendations. The EuropeAid Cooperation Office plans to:

(a) improve the organisation of its central services in order to exploit this form of cooperation more fully; (a) play a greater support role;

(b) provide the Delegations with precise and consistent guidelines that are appropriate for microprojects, exercise greater control over the management system and provide it with a better legal framework, so that programme implementation can be monitored more easily; (b) translate best practice into a detailed guide and ensure that programme management is more reliable and effective;

(c) ensure that implementation of the programmes allows the project cycle to be monitored and time limits respected in accordance with the priority expectations of the communities concerned; (c) as far as possible, involve local authorities and municipalities in projects in order to improve efficiency and ensure that results are sustainable. The provisions of the Cotonou Agreement enable the decentralised stakeholders to play a more important role in this area;