THE COURT’S OBSERVATIONS

INTRODUCTION

6.1. This chapter presents our findings for ‘Economic, social and territorial cohesion’ (MFF heading 1b). In part 1, the chapter presents the results of testing of: — the European Regional Development Fund (ERDF) and the Cohesion Fund (CF), which are the main instruments of the regional and urban policy area; including the contribution from this policy to the cross border cooperation of the European Neighbourhood Instrument (ENI); — the European Social Fund (ESF) and the Fund for European Aid to the Most Deprived (FEAD), which are the main instruments of the employment and social affairs policy area. Part 2 of this chapter presents performance related issues in regards to the examined projects of ‘Economic, social and territorial cohesion’. Key information on the composition of MFF heading 1b is provided in Graph 6.1 .

Graph 6.1 — MFF heading 1b — ‘Economic, social and territorial cohesion’ (billion euro) Total payments for the year 54,4 – advances (64) (65) 3,8 + clearings of advances (64) 2,2 + disbursements to final recipients from financial instruments under shared management 1,7 + advances used by final beneficiaries of state aid projects 1,2 Audited population, total 55,7

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6.2. During 2014, the vast majority of payments were interim payments to operational programmes (OPs) of the 2007-2013 programming period, whose eligibility period ends 31 December 2015. The advance payments to the 2014-2020 programming period amounted around 2 billion euro (1).

Specific characteristics of the MFF heading

Policy objectives

6.3. The MFF heading 1b — ‘Economic, social and territorial cohesion’ aims to reduce development disparities between different regions, restructuring declining industrial areas and diversifying rural areas and to encourage cross-border, transnational and interregional cooperation (2).

Policy instruments

6.4. ‘Economic, social and territorial cohesion’ comprises two parts: — the regional and urban policy area, which is mostly implemented through the ERDF, CF and the contribution to the ENI. It accounts for 80 % of spending covered by this chapter; — the employment and social affairs policy area, which is overwhelmingly implemented through the ESF. It accounts for 20 % of spending covered by this chapter.

Regional and urban policy area

6.5. The ERDF finances infrastructure projects, the creation or preservation of jobs, regional economic development initiatives and activities supporting small and medium enterprises in the 28 Member States.

6.6. The CF finances investments in infrastructure in the fields of environment and transport in Member States whose gross national income per capita is below 90 % of the EU average (i.e. in 16 out of the 28 Member States) (3).

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6.7. Other spending includes the contribution from the regional and urban policy area to the cross-border cooperation of the ENI that aims to bring EU and its neighbouring countries closer (4).

Employment and social affairs policy area

6.8. The ESF invests in human capital and supports actions in the 28 Member States that aim to improve the adaptability of workers and enterprises to the changes in working patterns, increase access to employment, reinforce the social inclusion of disadvantaged persons and strengthen the capacity and efficiency of administrations and public services.

6.9. Other spending takes the form of subsidies and grants to organisations implementing and coordinating social actions through the FEAD, which provide material assistance (5) to the most deprived to help people out of poverty.

Management and control of spending in cohesion policy funds (ERDF, CF and ESF)

6.10. The ERDF, the CF and the ESF are governed by common rules, subject to exceptions in the specific regulations of each fund, and are implemented through multiannual programmes, with management shared between the Commission and the Member States.

6.11. For each programming period, on the basis of Member States’ proposals, the Commission approves OPs and indicative financial plans (6). Projects selected by the Member State authorities are financed through the OPs and are carried out by private individuals, associations, private or public undertakings or local, regional and national public bodies. The rules according to which costs can be reimbursed from the EU budget are set out in the regulations and/or in national eligibility rules. 6.11. The establishment of eligibility rules at national level (Article 56 of Regulation (EC) No 1083/2006) was one of the main elements of simplification introduced in the 2007-2013 programme period. It aimed at providing Member States with more flexibility in adapting eligibility rules to the specific needs of regions or programmes and to harmonise them with rules in force for other national public schemes.

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6.12. For each project, beneficiaries declare the costs incurred to their national authorities. These individual declarations are aggregated into periodic expenditure declarations per OP certified by the Member State authorities and submitted to the Commission (7). The overall amount of EU co-financing is then reimbursed from the EU budget to the Member State.

Member States and regional level

6.13. Member States bear primary responsibility for preventing or detecting and correcting irregular expenditure, and report to the Commission. Responsibility for day-to-day administration lies with designated managing authorities and intermediate bodies (8). They must ensure through management verifications (desk reviews and on-the-spot inspections) that all projects are eligible for EU funding and that the costs declared comply with all conditions specified in the regulations and/or the national rules. Certifying authorities must ensure that adequate checks have been made and undertake additional verifications prior to declaring expenditure for reimbursement from the Commission.

6.14. In addition, for each OP (or a group of OPs), audit authorities in the Member States carry out system audits and, on a sample basis, ex post audits of operations (9). They report on these audits to the Commission through annual control reports, which include an annual audit opinion on the functioning of the systems and the audit authorities’ error rate estimate (see paragraphs 6.53 to 6.57) (10).

THE COURT’S OBSERVATIONS THE COMMISSION’S REPLIES

Commission level

6.15. The Commission (Directorate-General for Regional and Urban Policy and Directorate-General for Employment, Social Affairs and Inclusion) has to obtain assurance that the Member States have set up management and control systems which meet the requirements of the regulations, and that the systems function effectively (11).

6.16. If the Commission finds that a Member State has failed to correct irregular expenditure which had been certified and declared, or that there are serious failings in the management and control systems, the Commission may interrupt or suspend payments (12). If the Member State does not withdraw the irregular expenditure (which may be substituted by eligible expenditure for other projects of the same OP until the end of the programming period) and/or does not remedy any detected system failures, the Commission may apply financial corrections (13) (14).

Risks to regularity

6.17. In implementing the OPs, Member State authorities face competing priorities. Spending has to be subject to appropriate checks intended to ensure regularity and sound financial management. At the same time, there is an interest in absorbing the funds allocated by the EU. This may in practice militate against the consistent application of effective controls so that infringements of rules are not detected and corrected and ineligible expenditure is ultimately reimbursed from the EU budget. This may also result in the funding of projects which are too costly, not efficiently implemented or unlikely to achieve the intended results (15) (see also paragraph 6.80). This tension increases when the end of the eligibility period approaches, since Member States risk losing the non-spent share of the funds initially allocated to them. 6.17. Appropriate checks have to ensure regularity of all expenditure declared throughout the implementation period and up to closure. As the end of the eligibility period is 31 December 2015, the Commission expects that the risk referred to by the Court will be more acute for expenditure declared in 2015 and subsequent years. Closure documents from Member States are required by 31 March 2017 and will provide additional assurance. The Commission proactively adopted closure guidelines on 20 March 2013 (Decision C(2013) 1573) that were completed and updated on 30 April 2015. The Commission services have organised several closure seminars for Member States and have updated their risk assessments and consequently the Audit Strategy 2007-2013 to address any potential risk in view of the last part of the implementation period. In November 2014 the Commission also put in place a Task Force for Better Implementation in order to improve the implementation of ERDF/CF in eight Member States, while ensuring full respect of legality and regularity of expenditure (see also Commission reply to paragraph 2.18).

6.18. For several years we have detected a high incidence of irregularities in the area of cohesion. Since 2009, when most of the expenditure related to the 2007-2013 programming period, the estimated level of error has ranged between 4,5 % and 7,7 % (16). This rate is significantly lower than in previous years, when expenditure was linked to the 2000-2006 programming period. 6.18. The Commission considers that the decrease in the error-rate level in relation to the previous programming period reflects the improvement of the management and control systems for the 2007-2013 programming period.

6.19. For ERDF and CF expenditure the main risks relate to non-compliance with EU and/or national public procurement rules when awarding contracts and to the funding of projects which are not eligible or which do not comply with EU state aid rules (17). A further risk is that beneficiaries declare costs which are ineligible according to the regulations and/or national eligibility rules. 6.19. The Commission shares this assessment, as detailed in its Staff Working Documents (Analysis of errors in the Cohesion Policy for the years 2006-2009 (SEC(2011) 1179 of 5 October 2011)). The Commission has continued to take specific actions to mitigate these risks: e.g. additional guidance and training provided to managing authorities on the identified risks; timely implementation of financial corrections, interruption and suspension procedures; audits targeted to most risky areas. Such preventive and corrective actions were brought together with new initiatives under a comprehensive action plan set up in 2013 between DG Regional and Urban Policy and DG for Internal Market, Industry, Entrepreneurship and SMEs to improve the implementation of public procurement rules (see Commission reply under paragraphs 6.30 to 6.33). Another action plan with DG Competition to support programme authorities in implementing State aid rules, reviewed and simplified in 2014, is ongoing.

6.20. For ESF expenditure, the major risk relates to the intangible nature of the investments in human capital, and the involvement of multiple, often small-scale, partners in the implementation of projects. These factors can lead to non-compliance with EU and/or national eligibility rules resulting in ineligible costs being accepted by the systems in place. 6.20. The Commission has taken specific actions in order to mitigate the risks identified, which include in particular preventive and corrective measures such as guidance, training, simplification, a strict policy on interruptions and suspensions of payments and the timely implementation of financial corrections, when necessary. The Commission is also addressing this risk by actively promoting the use of simplified cost options by the Member States and by insisting on the importance of first-level checks by the Member States. Furthermore, the Commission updates its audit plan on an annual basis in order to address the most significant risks identified.

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Audit scope and approach

6.21. Annex 1.1, part 2 , of chapter 1 describes our overall audit approach and methodology. For the audit of ‘Economic, social and territorial cohesion’ the following specific points should be noted for Part 1, assessment on regularity:

(a) the audit involved an examination of a sample of 161 transactions for regional and urban policy area (18) and another sample of 170 transactions for employment and social affairs policy area (19) as defined in Annex 1.1 , paragraph 7. Each sample is designed to be representative of the entire range of transactions within each of the two policy areas. In 2014, both samples taken together consisted of transactions from 21 Member States (20);

(b) the audit involved an examination of financial instruments under shared management mainly in terms of their disbursement rates (i.e. the proportion of funds used at the level of final recipients). This was done through a review of the Commission’s progress reporting for 2013 and of seven ERDF and ESF financial instruments;

(c) the assessment of systems examined:

(i) the Commission’s supervisory activities of national and regional audit authorities in 18 Member States (21);

(ii) the annual activity reports (AARs) of the Directorate-General for Regional and Urban Policy and of the Directorate-General for Employment, Social Affairs and Inclusion.

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6.22. The audit also assessed, as a pilot exercise, whether and to what extent the completed examined ERDF, CF and ESF projects have achieved their output and result objectives as set out in the grant agreements. We also verified if these objectives were in line with the OP objectives. This was done for the 186 of the 331 examined projects which were completed at the time of the audit. The results of this exercise are presented in Part 2, which is dedicated to performance related issues.

PART 1: OUR ASSESSMENT ON REGULARITY

REGULARITY OF TRANSACTIONS

6.23. Annex 6.1 contains a summary of the results of transaction testing for ‘Economic, social and territorial cohesion’ as a whole as well as for each of the two policy areas involved (regional and urban policy and employment and social affairs).

6.24. Of the 331 transactions that we examined, 135 (41 %) were affected by error. On the basis of the 53 errors which we have quantified, the estimated level of error for ‘Economic, social and territorial cohesion’ as a whole is 5,7 % (22). The results for the two areas covered by this chapter were the following: 6.24. The Commission notes that the level of error reported by the Court is an annual estimate which takes into account corrections of project expenditure or reimbursements affected by errors detected and recorded before the Court’s audit. The Commission underlines that it is bound by the Financial Regulation, which stipulates, in Article 32(2)(e), that its internal control system should ensure, among other things, ‘adequate management of the risks relating to the legality and regularity of the underlying transactions, taking into account the multiannual character of programmes as well as the nature of the payments concerned’. The Commission will continue to exercise its supervisory role, in particular by implementing financial corrections and recoveries at the level that corresponds to the level of irregularities and deficiencies identified. The Commission further notes that given the multiannual character of the management and control systems under Cohesion policy, errors made in 2014 may also be corrected in subsequent years, as illustrated in section 4.2.2 of the respective 2014 AARs of DG Regional and Urban policy and DG Employment, Social Affairs and Inclusion. For the 2014-2020 period the Commission’s corrective capacity is further strengthened by providing for net financial corrections by the Commission and therefore reducing the possibility for Member States to re-use funds, for serious deficiencies detected by the Commission. This will be an important incentive for Member States to detect, report and correct serious irregularities before certifying annual accounts to the Commission.

— for the regional and urban policy area, of the 161 transactions that we examined, 75 (47 %) were affected by error. On the basis of the 25 errors which we have quantified, the estimated level of error is 6,1 % (23); The Commission notes that the most likely error rate calculated for 2014 is lower than in 2013 and in line with the error rates presented by the Court in the four last years, and with the error-rate range in DG Regional and Urban Policy’s 2014 AAR, subject to the differences set out in paragraph 6.70. This confirms that the error rate for the 2007-2013 programming period remains stable and significantly below the rates for the 2000-2006 period, as indicated in paragraph 6.18. This development derives from the reinforced control provisions of the 2007-2013 period and the Commission’s strict policy to interrupt/suspend payments as soon as deficiencies are identified, as reported in the 2014 AAR of DG Regional and Urban Policy (see pp. 53-54). The Commission will continue to focus its actions on the most risky programmes/Member States, to implement corrective measures when needed through a strict policy of interruptions and suspensions of payments up to closure, and to apply strict procedures at closure to exclude any remaining material risk of irregular expenditure. The Commission also notes that the error frequency decreased compared to 2013.

— for the employment and social affairs policy area, of the 170 transactions that we examined, 60 (35 %) were affected by error. On the basis of the 28 errors which we have quantified, the estimated level of error is 3,7 % (24). The Commission notes that the most likely error rate calculated for 2014 is in line with the error rates presented by the Court for the last four years and with the error-rate range in DG Employment, Social Affairs and Inclusion’s 2014 AAR, subject to the differences set out in paragraph 6.70. This confirms that the error rate for the 2007-2013 programming period remains stable and significantly below the rates for the 2000-2006 period, as indicated in paragraph 6.18. This improvement derives from the reinforced control provisions of the 2007-2013 period and the Commission’s strict policy to interrupt/suspend payments and implement any necessary financial corrections as soon as deficiencies are identified, as reported in the 2014 AAR of DG Employment, Social Affairs and Inclusion (see pages 59-62). The Commission will continue to focus its actions on the riskiest programmes/Member States and implement corrective measures when needed through a strict policy of interruptions and suspensions of payments and financial corrections up to closure, and to apply strict procedures at closure to exclude any remaining material risk of irregular expenditure.

6.25. Chapter 1 contains an assessment of the accuracy and reliability of the figures for financial corrections presented in Note 6 to the EU consolidated accounts (see paragraphs 1.43 to 1.44). Chapter 1 of the 2012 annual report explained also how financial corrections are taken into account when calculating the estimated level of error (25). 6.25. The Commission refers to its replies under paragraphs 1.43 to 1.44.

6.26. Graph 6.2 presents the extent to which the different types of errors contributed to our estimated level of error for 2014 for regional and urban policy, for employment and social affairs and for ‘Economic, social and territorial cohesion’ as a whole.

Graph 6.2 — Contribution by type of error to the estimated level of error for ‘Economic, social and territorial cohesion’ as a whole Source: European Court of Auditors.

THE COURT’S OBSERVATIONS

6.27. The main sources of error for ‘Economic, social and territorial cohesion’ as a whole continues to be infringements of public procurement rules, followed by the inclusion of ineligible expenditure in the beneficiaries’ cost declarations, infringements of state aid rules and, finally, the selection of wholly ineligible projects.

6.28. For employment and social affairs policy area the proportion of transactions with public procurement procedures is much lower than for regional and urban policy area. The main source of error for this policy area is ineligible costs.

6.29. Over the last three years, we did not detect any quantifiable error related to the use of simplified cost options (SCOs) (26). In 2014, we sampled 42 transactions, relating to 16 of the 24 payments to ESF OPs, which included SCOs in their cost declarations. We detected only two non-quantifiable errors related to the specific use of SCOs. This demonstrates that projects using SCOs are less prone to error than the ones using actual costs. This aspect is especially relevant for the 2014-2020 programming period (27).

THE COURT’S OBSERVATIONS THE COMMISSION’S REPLIES

Breaches of public procurement rules

6.30. Public procurement rules are a key instrument for spending public money economically and effectively and for establishing an internal market within the EU. As in previous years, public procurement procedures were particularly prone to error (28). This is the main source of errors for regional and urban policy area and for ‘Economic, social and territorial cohesion’ as a whole. 6.30. Common Commission reply to paragraphs 6.30 to 6.32. Public procurement rules are applicable for all public spending in the Member States and are not specific to Cohesion policy. Non-compliance with EU or national public procurement rules are a major source of errors in this policy area, in particular for regional and urban policy, mainly due to the types of projects co-financed. The Commission has therefore taken various preventive and corrective actions since the last programming periods in order to address weaknesses identified in that area. The Commission Action Plan on public procurement set up in 2013 between DG Regional and Urban Policy, DG Employment, Social Affairs and Inclusion and DG Internal Market, Industry, entrepreneurship and SMEs aims at further improving the implementation of public procurement rules in the Member States through additional preventive measures. New actions are underway and include notably: guidance and training; identification and sharing of good practices between Member States; the establishment of a comprehensive manual for practitioners; the setting-up of a new peer-to-peer exchange platform; as well as country-specific action plans. The legal framework for European Structural and Investment Funds 2014-2020 has also introduced ex ante conditionalities for the effective and efficient use of Union funds, which cover inter alia Member States’ public procurement systems. In that context, 12 country actions plans have been adopted and will have to be assessed by 2016. Suspensions of the interim payments may be decided in case of failure to fulfil an applicable ex ante conditionality by the end of 2016 (Article 19 of Regulation (EU) No 1303/2013). The 2014 Directives on public procurement introduce simplifications and are to be transposed into national laws by April 2016, and will thereafter start producing their effect on the ground. The Commission notes that in its special report on public procurement errors in the area of Cohesion the Court calls on the Member States to improve their administrative capacity in this area. The Commission expects that Member States will now seize all offered opportunities to improve the capacity of their programmes and contracting authorities to comply with public procurement rules.

6.31. Chapter 1 contains a section explaining the update to our approach to the quantification of serious infringements of public procurement rules. This resulted in a clarification of the way in which we assess the impact of these infringements (see paragraph 1.13). We have also published a special report on the actions taken by Member States and the Commission to address the problem of public procurement errors in the area of cohesion (29). 6.31. The Commission will follow up all errors reported by the Court in accordance with Commission Decision C(2013) 9527 final on ‘the setting out and approval of the guidelines for determining financial corrections to be made by the Commission to expenditure financed by the Union under shared management, for non-compliance with the rules on public procurement’.

6.32. In 2014, we examined 175 public procurement procedures related to contracts for works and services underlying the expenditure for the transactions tested for ‘Economic, social and territorial cohesion’. The estimated contract value for these public procurements amounted to approximately 3,3 billion euro (30). The vast majority of these contracts are for projects co-financed by ERDF and CF Ops (31).

6.33. We identified instances of non-compliance with EU and/or national public procurement rules for 39 of the 175 procedures examined. 13 of these were serious failures to comply with these rules and thus classified as quantifiable errors (see Box 6.1). These errors account for 25 % of all quantifiable errors and make up approximately 2,7 percentage points of the estimated level of error. 6.33. The Commission will follow up the cases identified by the Court and propose actions as it deems necessary.

Box 6.1 — Examples of serious failures to comply with public procurement rules

(a) Unjustified direct award: In a CF project in Malta related to the reconstruction and upgrade of a motorway section of a TEN-T road network (of the length of 7 km), the contracting authority negotiated directly a contract above EU-thresholds with one company without a prior call for competition. Thus, the declared expenditure for this contract is ineligible. Similar cases were found in other ERDF projects in Sweden and the United Kingdom and ESF projects in Germany and Italy.

(b) Unjustified direct award of additional works/services (absence of unforeseen circumstances): For an ERDF project in Germany related to the renovation and rehabilitation of a university building, expenditure related to a contract amendment was declared for co-financing. In particular, the architect increased the fees arguing the high complexity of the construction, the risk of delays and cost overruns. However, the reasons put forward to explain the increase in compensation are not based on unforeseeable circumstances. Therefore, the increase of fees of this contract amendment is considered to be ineligible. Similar cases were found in other ERDF projects in Belgium and Italy.

(c) Unlawful exclusion of bidders: In a CF project in Hungary related to the reconstruction of a railway line, the contracting authority was not consistent in assessing the compliance with the selection criteria. As a result, all bidders but one were excluded. If the reasons for exclusion had been applied in a coherent way, the outcome of the tender would have been different. This represents a breach of the principles of transparency and equal and non-discriminatory treatment and, thus, the declared expenditure for this contract is ineligible. Similar cases of unlawful award criteria were found in another CF project in Hungary and an ERDF project in Sweden.

(d) Conflict of interest and discriminatory selection criteria: In the case of an ESF project in Finland concerning actions to promote the business growth, multiple irregularities were found in the public procurement procedure. Conflict of interest was identified as the CEO of the sole bidding company was employed by the contracting authority at the time when the tender procedure was carried out. Also, the tender specifications included discriminatory selection criteria disallowing the equal access of tenderers in the procedure. As a result, all expenditure related to the public procurement is irregular and ineligible for co-financing.

6.34. Other errors relating to tendering and contracting procedures occurred in a further 26 of the 175 public procurements examined. These errors include cases of non-compliance with information and publication requirements, incorrect application of the selection criteria and shortcomings in the tender specifications. These errors do not contribute to the error rate we estimated (32). 6.34. The Commission will follow up the cases identified by the Court and propose actions as it deems necessary.

6.35. For eight transactions in six Member States (33), the national authorities had identified serious cases of non-compliance with public procurement rules and imposed specific financial corrections at project level (34). These corrective measures have been taken into account in the calculation of our estimated level of error, since the corrective measures were taken before the notification of our audit. 6.35. The Commission notes that adequate corrective action is indeed taken by some programme authorities in the quoted Member States, though not in all cases identified by the Court. The objective of the Commission’s action plan referred to in the reply to paragraphs 6.30 to 6.32 is to increase the occurrence of such proactive corrective actions at Member State level.

Ineligible expenditure

6.36. When declaring costs to the Commission, national authorities are certifying that these costs have been incurred in compliance with a number of specific provisions laid down in EU regulations, national legislation or eligibility rules, specific OP rules, calls for interest, decisions approving projects for co-financing or grant agreements (see paragraph 6.13).

6.37. Ineligible expenditure is the main source of error for employment and social affairs policy area and the second most important for regional and urban policy area. We found that ineligible costs had been declared in 10 % of the transactions examined (see Box 6.2). These cases account for 60 % of all quantifiable errors and make up approximately 1,5 percentage points of the estimated level of error. 6.37. The Commission will follow up the cases identified by the Court and propose actions as it deems necessary. The Commission notes that in some cases national or regional rules applied to Cohesion Policy expenditure are more demanding than those foreseen in the national legislation for similar nationally funded expenditure. These additional requirements can be seen as an instance of unnecessary administrative burden and complexity to Cohesion Policy expenditure imposed by the Member States on themselves as described in the reports on gold plating and simplification issued by DG Employment, Social Affairs and Inclusion in 2013.

Box 6.2 — Examples of ineligible costs declared

(a) Expenditure declared outside the eligibility period: In an ERDF project in Czech Republic related to the extension and reconstruction of a tramway track some of the invoices declared for co-financing were incurred and paid before the project’s eligibility start date. This expenditure is ineligible for EU co-financing. A similar case was found in another ERDF project in Germany.

THE COURT’S OBSERVATIONS

(b) Overcharged salaries: In an ESF project in Portugal related to a three-year training programme for young people that earn a degree on secondary education and a professional qualification, the beneficiary used for the calculation of teachers’ eligible salaries a different method than the one foreseen in the grant agreement. In addition, the teachers did not work as many hours as declared. This resulted in higher personnel costs declared for co-financing. The difference between the expenditure declared and the expenditure resulting from the approved formula is ineligible for EU co-financing. Similar cases were found in another ERDF project in Poland and ESF projects in Germany and Finland.

(c) Costs not related to the project: In an ESF project in the Netherlands the beneficiary undertook training and employability courses in the aviation sector and engaged a consultant to assist with the ESF administration of the projects. Contrary to the eligibility rules, part of the project costs for the consultancy services for another project was charged to the examined project. Similar cases were found in other ESF projects in Poland and Portugal.

(d) Non-compliance with national eligibility rules: A training centre in Poland organised training courses and provided advisory services to improve competitiveness and adaptation skills of 50 micro, small and medium enterprises as regards environmentally friendly solutions. Four coaches were hired to provide these services, none of whom had relevant education nor professional experience in the subject matter. Thus the costs in relation to all four coaches are ineligible. The beneficiary conducted 84 projects funded by EU funds between 2008 and 2015 for a total amount of 17 million euro.

(e) Revenue not deducted: An ESF project in Austria concerned the integration in the labour market of unemployed persons with difficulties to find employment through temporary posts in non-profit organizations. The income generated from the project, such as revenue from sales in shops, was not deducted from the ESF funded items. This is a breach of national eligibility rules and the revenue should have been deducted from the declared costs.

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Infringements of state aid rules

6.38. State aid is deemed incompatible in principle with the internal market since it may distort trade between Member States (35). The Commission directly enforces the EU state aid rules. Member States must notify all cases of state aid to the Commission (either through a scheme or case-by-case for a project), unless the project is below a ‘de minimis’ ceiling or is covered by the General Block Exemption Regulation (GBER) (36). For all cases notified, the Directorate-General for Competition forms a view on whether the aid is compatible with the internal market or not. This comprises an assessment of whether the same project would also have been undertaken without such aid. 6.38. Common Commission reply to paragraphs 6.38 to 6.40. In case of a State aid notification, the Commission assesses whether the support constitutes State aid and, if so, whether it is compatible with the internal market. A decision on State aid entails a Commission decision. Not all decisions on State aid require an assessment on whether ‘the same project would have been undertaken without such aid’. Also, the requirements for the so-called ‘incentive effect’ differ depending on the applicable State aid rules. The 2014 GBER introduced the following changes regarding the provisions on the incentive effect: — with respect to aid to small and medium enterprises, in addition to the fact that an application for aid must always be submitted before the start of works or activity (as was already the case under the 2008 GBER), such application has to comply with minimum requirements about the type of information to be submitted, — with respect to aid to large companies, the requirement for a counter-factual scenario to demonstrate the economic incentive effect is no longer necessary if the measure is scheme based. It remains however mandatory for ad-hoc aid.

6.39. We identified this year 14 ERDF/CF projects in 8 Member States that infringed the EU state aid rules (37). Where necessary, we requested and obtained a preliminary assessment by the Directorate-General for Competition. This assessment and the case law of the European Court of Justice were taken into account when classifying errors. 6.39. The Commission will follow up the cases identified by the Court and propose actions as it deems necessary.

6.40. For three of these projects, we consider that the project should have obtained no or less public funding from the EU and/or the Member State according to the state aid rules. The main reasons for non-compliance with state aid rules refer to the absence of economic incentive effect and the lack of notification to the European Commission of projects affected by state aid rules. These quantified errors make up approximately 1,5 percentage points of the estimated level of error for regional and urban policy area (see Box 6.3). In two other cases, we applied retrospectively the 2014 GBER and, therefore, did not quantify these errors (38). The 9 other cases of non-compliance with state aid rules do not impact upon our estimated level of error.

Box 6.3 — Example of a project infringing state aid rules The aid is not compatible with the internal market: An ERDF project in Romania related to the purchase of a truck to carry gravel and sand from quarries. In accordance with state aid rules, the call for proposals was open only to small-medium enterprises (SMEs) and cooperative enterprises. We found, however, that the beneficiary was not an SME, but rather part of a large group. As a result, the beneficiary is not eligible for co-financing and, thus, the aid granted is not compatible with the internal market.

Ineligible projects

6.41. We identified five ESF projects for which the eligibility conditions set out in the regulations and/or the national eligibility rules were not met and the errors were quantified. These projects account for 9 % of all quantifiable errors making up approximately 1,2 percentage points of the estimated level of error for employment and social affairs (see Box 6.4). 6.41. The Commission will follow up the cases identified by the Court and propose actions as it deems necessary.

Box 6.4 — Example of an ineligible project Co-financed project not in line with the objectives specified in the OP: An ESF project in Greece aiming to boost local employment through public benefit programs was initially approved under the OP Human Resources Development. In 2013, the Commission amended the OP Administrative Reform for inclusion of further projects underlining that the national authorities should ensure that these projects were eligible under this OP. After the project’s implementation, the national authorities moved the project from the OP Human Resources Development to the amended OP Administrative Reform under the target related to e-Government, although the examined project did not fulfil any objectives laid down in that OP. As a result, the statement of expenditure included costs for operations which are ineligible. Box 6.4 — Example of an ineligible project The Commission understands the issue raised and notes that the public works scheme, which was agreed in the Memorandum of understanding signed between, at the time, Troika and the Greek Government, was conceived as a temporary emergency measure to enable the long-term unemployed and the young not in employment, education training, to obtain basic work experience in activities benefitting the local community. The support of the ESF has been key for the delivery of such a programme, strongly advocated under the exceptional circumstances faced by Greece at the time and still now. Therefore, the Commission decided in December 2013 to amend the relevant ESF programme as the main available source of funding in order to accommodate the public works scheme, which was implemented by the Greek authorities with the involvement of local public authorities and NGOs.

Beneficiaries not reimbursed in time and unjustified payment of advances to a Member State

6.42. Beneficiaries declare paid expenditure to the national authorities which reimburse these as soon as possible and submit periodic aggregated expenditure declarations to the Commission for reimbursement. However, we have found that in some cases Member States have built up treasury reserves not in line with the rules. The regulation (39) stipulates that payments by national authorities to beneficiaries shall be made ‘as quickly as possible and in full’. In three Member States we identified 12 cases where the beneficiaries were only paid several months after the related statement of expenditure was settled by the Commission or were not reimbursed at the time of the audit, seven to nine months after the Commission’s settlement (see Box 6.5(a)). 6.42. The Commission underlines that, under the programming period 2014-2020, the Common Provision Regulation (CPR) has reinforced the rules both for the use of pre-financing (Article 82(1) CPR) and for payment to beneficiaries (Article 132(1) CPR).

6.43. In addition, the regulation also sets out that advance payments are payable if the underlying projects constitute state aid which is an exception to the rule of only claiming incurred and paid expenditure (40). Nevertheless, we found that a Member State (Greece) declared advances for projects wrongly classified as state aid. This remained undetected and the Commission accepted and paid the amount claimed without verifying whether the conditions for making such payments were fulfilled (see Box 6.5(b)). 6.43. The Commission notes that verifying whether the conditions to claim advance payments in the context of State aid are met is the responsibility of the competent national authorities. It will continue to work with the Greek authorities to strengthen controls in that area. The Commission will follow up closely in order to ensure that all advances unduly claimed by the Member State are recovered as foreseen by the Regulation.

Box 6.5 — Example of Member States not reimbursing beneficiaries in time and unjustified payment of advances to Member States Box 6.5 — Example of Member States not reimbursing beneficiaries in time and unjustified payment of advances to Member States

(a) Beneficiary reimbursed five months after the Commission payment: For an ESF project in Italy aiming at drawing up a report to map training needs in various Italian regions the beneficiary submitted the cost claim to the managing authority in March 2014. The costs included in the claim were certified by the national authorities and submitted to the Commission. Although the Commission settled the costs declared already in June 2014, the beneficiary received the interim payment only five months later, in November 2014. Similar cases were found in further four ESF projects in Italy, one project in France, and six projects in The Netherlands.

(b) Unjustified payment of advances to a Member State: In an ESF project in Greece for non-economic research carried out by a university, the Member State claimed an advance payment even though the related project did not constitute State aid. The Commission accepted and paid the unjustified amount claimed. Similar cases were found in other ESF projects in Greece. (b) See the reply of the Commission in paragraph 6.43.

Insufficient reliability of checks at Member State level

6.44. In 21 cases of quantifiable errors made by beneficiaries, national authorities had sufficient information (41) to prevent or detect and correct the errors before declaring the expenditure to the Commission. If all this information had been used to correct errors, the estimated level of error for this chapter would have been 1,6 percentage points lower. In addition, we found that for 13 cases, the error that we detected was made by national authorities. These errors contributed 1,7 percentage points to the estimated level of error. 6.44. Common Commission reply to paragraphs 6.44 and 6.45. The Commission is strictly following up these cases and agrees that sound and timely management verifications must be in place in order to prevent irregularities occurring in the first place or being included in payment claims. Since 2010, the Commission has been carrying out targeted audits on management verifications of high-risk programmes where it has identified that deficiencies could remain undetected or not detected in a timely manner by the programme audit authority. For DG Regional and Urban Policy and DG Employment, Social Affairs and Inclusion, results of these audits conducted up to 2014 are presented in their respective 2014 AARs (see pages 50 and 56, respectively). The Commission refers to the reinforced procedures in the regulatory framework for the 2014-2020 programming period, where management verifications and controls (including on-the-spot checks) will have to be carried out on time for the certification to the Commission of programme accounts and submission of management declarations by the managing authorities on an annual basis. Audit authorities will have to estimate reliable residual levels of error in the accounts as a result of all verifications, controls and corrections made since the end of the accounting year. The Commission considers that these reinforced control procedures should result in lasting reductions of the error rate. Furthermore, the Commission has developed new guidance in order to further strengthen the reliability of management verifications in the 2014-2020 programming period. This guidance, which draws on the lessons learned from the previous programming period, has been presented to Member States and will be published in July 2015.

6.45. Checks at Member State level were not fully reliable in both policy areas. The estimated level of error could have been reduced by 3,3 percentage points for the regional and urban policy area and 3,2 percentage points for the employment and social affairs policy area.

THE COURT’S OBSERVATIONS

EXAMINATION OF FINANCIAL INSTRUMENTS UNDER SHARED MANAGEMENT

6.46. Financial instruments under shared management provide assistance to enterprises or urban projects by way of equity investments, loans or guarantees (42). They can be used in mainly three areas: for the support of small-medium enterprises (SMEs) (43), for urban development (44) and for the promotion of energy efficiency.

6.47. By the end of 2013, 941 financial instruments had been set up under 176 ERDF and ESF OPs in all but three Member States (Croatia, Ireland and Luxembourg). Taken together, they have an endowment of around 14 278 million euro (45).

6.48. In general, funds implementing financial instruments receive a contribution from the OP when their legal structure is set up, and subsequently use this money to support projects. Such financial support can be provided only to projects which fall within the scope of the OP. These financial instruments are designed to have a revolving character or, for certain types of guarantee funds, to achieve a high leverage effect. Any resources returned from investments or loans made, including profits, are to be used again for the purpose of the activities implemented by the financial instrument.

THE COURT’S OBSERVATIONS THE COMMISSION’S REPLIES

Slow implementation of financial instruments

6.49. According to the Commission, the average disbursement rate for 941 ERDF and ESF financial instruments under shared management was 47 % at the end of 2013. This represents a 10 percentage points increase in comparison to 2012 and a 13 percentage points increase in comparison to 2011 (46). 6.49. Common Commission reply to paragraphs 6.49 and 6.50. The disbursement rate at the end of 2013 varies between Member States and financial instruments (FIs), established between 2008 and 2013.While some FIs are underperforming, 459 representing 15 % of total amounts paid into FIs have already achieved 100 % absorption and are now re-investing revolving funds. The Commission will report on 1 October 2015 on the situation at the end of 2014 and expects further progress in implementation. The Commission, together with the Member States, has undertaken a number of measures to ensure that the remaining investments made by FIs will reach final recipients in a timely manner, mainly by: — improving the close monitoring by concerned managing authorities of the performance of the FIs and encouraging active fund management by reallocation of amounts from low-performing funds to well-performing funds, — encouraging managing authorities, together with the financial institutions implementing FIs, to make changes to the instruments and financial products offered in order to adapt them to changing market conditions, — for FIs supporting long-term investments in urban development or energy efficiency where payments are made gradually with the progress of the projects, advising managing authorities to request a reporting of the investment pipeline and feedback to the Commission so as to allow a closer follow up of the progress of these instruments. The Commission notes that a detailed analysis by Member States requires an assessment of the various constraints affecting the implementation of each FI and should in particular also take into account that the ERDF FIs in Bulgaria, Greece, Spain, Romania and Slovakia are severely hit by the economic and financial crisis.

6.50. According to the structural funds regulations, only the payments or guarantees provided to final recipients and the management costs and fees of the fund managers are considered eligible at closure when unused endowments of financial instruments are to be returned to the EU budget (47).The overall disbursement rate as reported by the Commission is still too low to expect that all funds available will be used at least once. Particular problems were noted for financial instruments in five Member States (Bulgaria, Greece, Spain, Romania, and Slovakia) where the disbursement rates are significantly below the EU average for 2013.

Incomplete and/or inaccurate reporting on financial instruments by Member States

6.51. Information on implementation of financial instruments under shared management is based on data received directly from the Member States. Since 2011, substantial efforts were made by the Commission to improve the quality of these data. Nevertheless, the Commission acknowledges in its report on the implementation progress of financial instruments that the data presented in this report are in some cases incomplete or inaccurate. This was also the case for five of the seven financial instruments examined by us in 2014. 6.51. In May 2015, the Commission presented to the Member States an updated guidance note on reporting on financial instruments clarifying the reporting requirements. Furthermore, the Commission has improved its reporting tools.

Extension of the 2007-2013 eligibility period through a Commission decision only

6.52. Article 56(1) of Regulation (EC) No 1083/2006 establishes 31 December 2015 as the deadline for the eligibility period of payments. In April 2015 the Commission decided to extend the eligibility period until 31 March 2017 through a Commission decision (48) instead of asking the Council and Parliament to amend the Regulation. We consider that this way of extending the eligibility period does not respect the hierarchy of norms, by which a legal provision can only be modified by legislation of equal or superior legal value. 6.52. The Commission is convinced that it has acted, as requested under the impetus of the European Council of December 2014, within the margin offered by the existing regulatory framework. The modification decision on the closure guidelines of the Commission does not affect Article 56(1), according to which the contribution from the funds into FEIs must have been paid at latest at 31 December 2015. This remains the rule. The modification clarifies that Article 78(6) of Regulation (EC) No 1083/2006 provides specific modalities for the declaration of expenditure of financial engineering instruments at closure. Paragraph 6 indicates that, by way of derogation from paragraph 1, as regards financial instruments as defined in Article 44, the statement of expenditure shall include the total amount of expenditure paid in establishing or contributing to such funds or holding funds. The Article also specifies what the eligible expenditure will be at closure: ‘At partial or final closure of the OP eligible expenditure shall be the total of the support provided by the funds to the final recipients together with eligible management costs and fees’. As 31 March 2017 is the final date for submission to the Commission of the closure documents, the modification of the closure guidelines clarifies that closure as referred to in Article 78(6) of the General Regulation is the date of submission of the closure documents, i.e. 31 March 2017.

EXAMINATION OF SELECTED SYSTEMS AND ANNUAL ACTIVITY REPORTS

Assessment of the Commission’s supervision of audit authorities

Commission uses the work of audit authorities in Member States to estimate the level of error

6.53. Audit authorities provide assurance to the Commission as to the effective functioning of the management systems and internal controls for an OP and the legality and regularity of the expenditure certified. This information is provided by audit authorities in their annual control reports, audit opinions and system audit reports (see paragraph 6.14) (49). Since 2009, the Commission has carried out enquiries of the main audit authorities, including on-the-spot reviews of their work, to assess the level of reliance they can place on them. 6.53. The Commission is closely cooperating and coordinating with audit authorities, and started reviewing their methodologies and audit results as early as 2009. This contributed to capacity building by providing advice, guidance and recommendations to audit authorities through the Commission’s re-performance of audit work carried out by audit authorities. The Commission underlines that its assessment of the reliability of the work of audit authorities is to be seen in that context. As a result of its audit programme that entailed 265 audit missions carried out on the spot cumulatively since 2009, DG Regional and Urban policy concluded by end 2014 that the work of 42 reviewed audit authorities in charge of auditing around 91 % of ERDF/CF allocations for the 2007-2013 period can in general be relied upon. For the remaining five reviewed audit authorities, improvements were required. Concerning DG Employment, Social Affairs and Inclusion, at the end of 2014, 87 audit authorities out of 92 have been assessed (94,6 %). They cover 113 out of 118 OPs, representing 99,1 % of the financial programming of the 2007-2013 programming period. In their 2014 AARs, DG Regional and Urban Policy and DG Employment, Social Affairs and Inclusion provided a detailed assessment of the accuracy and reliability of the audit information and results reported by audit authorities in their 2014 annual control reports in relation to 2013 expenditure (see pages 40 to 45 of DG Regional and Urban Policy’s 2014 AAR and pages 51 to 54 of DG Employment, Social Affairs and Inclusion’s 2014 AAR).

6.54. The Directorates-General for Regional and Urban Policy and for Employment, Social Affairs and Inclusion make use of this information when preparing their annual activity reports (AARs) and throughout the year to decide on possible interruptions and/or suspensions of payments to OPs. 6.54. In 2014, DG Regional and Urban policy indicated in its AAR that around two thirds of the interruptions and pre-suspensions of payments were based on audit results reported to the Commission by audit authorities during the year or at year end (see page 54 of DG Regional and Urban Policy’s 2014 AAR). In the course of 2014, interruptions and pre-suspension procedures concerned 121 ERDF/CF programmes and almost EUR 7,9 billion of payment claims submitted by the Member States but not paid unless the Commission has obtained additional evidence that all necessary corrections had been made by the Member State concerned. For ESF, as reported on page 60 of DG Employment, Social Affairs and Inclusion’s AAR in 2014, the Commission sent 11 warning letters and 18 pre-suspension letters; it decided 31 interruptions of payments and suspended 11 operational programmes. In total, EUR 1,3 billion of payment claims were interrupted.

6.55. In order to assess whether they can rely on this information, the directorates-general check the error rates reported by the audit authorities for each OP (or group of OPs) (50): 6.55. The Commission underlines that this assessment of the reliability of error rates each year is based on a thorough desk analysis of all available information completed when necessary by risk-based on-the-spot fact-finding missions, also taking account of the overall assessment of the reliability of the work of audit authorities as a result of the comprehensive audit enquiry referred to in the reply to paragraph 6.53. When necessary the Commission requests and obtains from the audit authorities any additional information required.

— if the Commission considers the error rate to be reliable (and representative for the expenditure certified), it accepts the rate reported by the audit authority. Also the Commission may recalculate the rate for its own assessment based on additional information obtained from the audit authority;

— in the case of unreliable error rates, the Commission applies a flat error rate (between 2 % and 25 %) in line with the results of its assessment of the functioning of management and internal control systems.

6.56. The Commission also calculates a ‘residual error rate’ for each OP, which takes into account all financial corrections since the start of the programming period. This includes corrections already implemented at EU and/or national level (51).

6.57. Based on these two indicators and additional information at its disposal, the Commission forms its assessment of the management and control system for the OP. That assessment also takes account of the system audits submitted by audit authorities throughout the year and additional information available to the Commission. This assessment is then reported in the annual activity report of the directorate-general (52). 6.57. The Commission assesses the effective functioning of the management and control system for each programme and for each authority (managing, certifying and audit authorities), based on all available EU and national system audit results on 15 key regulatory requirements according to a methodology shared with audit authorities. Error rates reported by Member States and residual error rates calculated by the Commission are important elements of this assessment, but not the only ones. Operational line managers and authorising officers by sub-delegation also assess the level of assurance. For the purpose of the assurance disclosed in the AARs, the opinion for each operational programme is, therefore, the result of an overall assessment based on all information available to the Commission. This provides a comprehensive and detailed assessment of the effectiveness of management and control systems per Member State and, for operational programmes included in the 2014 reservations, information on the main issues identified and the actions taken.

Commission’s assessment of annual control reports can only partly address the risk of under-reporting of errors and over-reporting of financial corrections by national authorities

6.58. The robustness of the Commission’s assessment of ERDF, CF and ESF OPs depends on the accuracy and reliability of information reported by Member State authorities. Our audits in previous years have identified two main risks in this regard: 6.58. Common Commission reply to paragraphs 6.58 to 6.60. As explained in their respective AARs, both directorates-general have taken measures to improve the reliability of audit information and financial corrections reported by Member States. To mitigate the risk, the Commission is implementing two audit enquiries: — the assessment of the reliability of audit information, reported by audit authorities, including the error rate, is made following an in-depth audit programme to verify whether audit findings are confirmed, including through on-the-spot re-performance by Commission auditors. The desk review is complemented by fact-finding missions and covers a wide range of verifications linked e.g. to the accuracy of the calculations, parameters used, treatment of errors detected or reconciliation of the audited population (see also the Commission’s reply in paragraph 6.53), — specific risk-based on-the-spot audits (so far covering 68 OPs over the last three years) in order to ensure that the corrections reported are effectively implemented and, in case of doubts or insufficient evidence, deduction of the amounts concerned from the cumulative financial corrections taken into account for the purposes of the calculation of the residual error rate. As a result of their audits and desk consistency checks on the reliability of the article 20 statements submitted by 31 March 2014 for all programmes, the Commission services decided to exclude some of the reported financial corrections for the calculation of the cumulative residual risk (77 % of the financial corrections reported were used for ERDF and CF calculations and 91 % in case of ESF). The legal framework for 2014-2020 programming period has also evolved. Audit authorities will give their audit opinion based on residual error rates after corrections have been implemented, and therefore the accuracy of financial corrections will be systematically checked as part of the audit on accounts.

— audit authorities may understate the errors and/or may not extrapolate them properly. As a consequence, the reported error rates may not always be fully reliable;

— information on financial corrections reported by Member States may not always be reliable or accurate and, as a result, the Commission’s calculation method may result in an understated cumulative residual risk.

THE COURT’S OBSERVATIONS

6.59. The Commission’s verifications of the annual control reports consist mainly of desk reviews and can therefore only partly address these risks. In particular, we consider that the Commission’s scope for validating (and, where necessary, adjusting) the reported error rates is limited since audit authorities are not systematically requested to provide the Commission with more specific information on their audits of operations (scope, coverage/sub-sampling, details on error classification) for its verification of the annual control reports.

6.60. During 2014, both directorate generals performed on-the-spot checks on financial corrections implemented by 12 Member States. For 7 of the 12 Member States visited, deficiencies requiring adjustments to the financial corrections reported were identified. These findings confirm our own assessment and highlight, in the context of the new 2014-2020 programming period, the importance of ensuring that reliable reporting systems are put in place (53).

Commission considers that expenditure declared for 57 % of all OPs was free of a material level of error

6.61. For 2014, the Commission considers that it had assurance that 250 of the 440 ERDF/CF and ESF OPs (57 %) were free from a material level of error: audit authorities had reported error rates below the Commission’s materiality threshold of 2 %, and these rates had been validated by the Commission. These OPs represent around 55 % of the 2014 payments.

6.62. In 2014, as in previous years, we examined whether the Commission was effective in verifying the accuracy and reliability of the error rates reported by audit authorities. This was done for a sample of 139 OPs in 20 Member States (105 of the 322 ERDF/CF OPs and 34 of the 118 ESF OPs) on the basis of the Commission’s working files. Our sample included OPs for which the Commission had accepted the rates reported by audit authorities, but also OPs for which rates had been recalculated or where flat rates had been imposed.

THE COURT’S OBSERVATIONS THE COMMISSION’S REPLIES

6.63. Table 6.1 contains a summary of the results of the systems we examined. 6.63. The Commission notes the improvement in the assessment of Commission’s verification of error rates reported by audit authorities, and in particular the fact that none of the issues found by the Court would have required additional reservations or different quantifications, given that these issues are mainly of a technical nature.

Table 6.1 — Assessment of Commission's verification of error rates reported by audit authorities 2014 2013 ERDF/CF OPs examined ESF OPs examined TOTAL ERDF/CF OPs examined ESF OPs examined TOTAL We found: — no or limited issues with the Commission's checks (66) 84 (80 %) 30 (88 %) 114 (82 %) 108 (77 %) 47 (87 %) 155 (80 %) — significant issues with the Commission's checks, but without any impact on the number of reservations reported in the AARs (or their quantification) 21 (20 %) 4 (12 %) 25 (18 %) 17 (12 %) 6 (11 %) 23 (12 %) — significant issues with the Commission's checks, requiring additional reservations or different quantifications 0 (0 %) 0 (0 %) 0 (0 %) 15 (11 %) 1 (2 %) 16 (8 %) TOTAL number of OPs examined 105 (100 %) 34 (100 %) 139 (100 %) 140 (100 %) 54 (100 %) 194 (100 %)

Commission’s validation (or recalculation) of the error rates is coherent with the evidence provided by audit authorities

6.64. In relation to 25 OPs, we identified weaknesses that had not been detected (or properly addressed by the Commission) (see Box 6.6). However, we consider that none of these cases should have led the Commission to make additional reservations (or reservations with a higher financial impact) in the 2014 annual activity reports.

Box 6.6 — Examples of weaknesses in the Commission’s validation of error rates reported by audit authorities Box 6.6 — Examples of weaknesses in the Commission’s validation of error rates reported by audit authorities

(a) Population checked by the audit authority not in line with the expenditure declared: For 8 of the 139 OPs sampled it was not possible to reconcile the population checked by the audit authority with the expenditure declared. The Commission’s desk reviews did not identify this issue for 3 OPs.

THE COURT’S OBSERVATIONS THE COMMISSION’S REPLIES

(b) Incorrect sampling methodology applied by the audit authority: For 11 of the 139 OPs, the audit authority applied an incorrect sampling methodology: either it differed from the one described in the audit strategy approved by the Commission or had parameters which were not in line with the applicable Commission guidance on sampling. In those cases, the sample size was lower than it would normally have been required. In all cases the Commission’s desk checks identified the issue and concluded correctly that it did not affect the audit opinion. (b) The sampling methodology may evolve in accordance with the characteristics of the population to be audited. This evolution and the changes to the approved audit strategy are discussed in the annual coordination meeting between the Commission and the concerned audit authority.

(c) Incorrect extrapolation of errors found in sub-samples: For 59 of 139 OPs examined, the audit authority conducted the audits on the basis of the sample of invoices (sub-sample). If this approach is applied, the financial impact of the errors found in the sub-sample has to be extrapolated on the audited projects or claims before they are included in the calculation of the error estimate for the entire population. For five OPs, the errors found in the sub-samples checked were not correctly extrapolated. This led to an understatement of the total projected error rate, but did not affect the audit opinion. (c) The Commission recommends audit authorities to systematically disclose in the annual control reports the cases when the total population was not effectively audited and the ‘subsampling’ system used.

Deficiencies in audit authorities checks on state aid

6.65. In 2014, we also examined whether national audit authorities carried out appropriate checks of state aid rules. For 42 of the 139 OPs sampled the state aid checks done by the audit authorities were inadequate (for example providers of services of general economic interest were not covered or notified aid schemes and the aid intensity were not verified). An appropriate coverage of state aid is required by the Commission guidelines, but these deficiencies were not always identified by the 2014 desk reviews. 6.65. During the annual control report (ACR) review, the Commission examines whether the audit authority’s opinion is solidly grounded on the basis of the results of system and operations audits. The examination of the work of the audit authorities with regards to State aid is included, amongst other issues, in the Commission’s review on audit authorities which include an examination of the methodology for system audits and audits of operations (including check-lists) as well as re-performing audits already done by audit authorities (see reply to paragraph 6.53). In some cases the Commission had already recommended to the audit authorities concerned, through its own audit reporting, to reinforce their check-lists to better cover the verification of State aid issues. The Commission will continue to ensure that audit authorities use appropriate checklists.

Commission guidance requires audit authorities to include contributions to financial instruments to the audited population rather than checking the actual disbursements

6.66. Financial contributions from the OPs to funds implementing financial instruments for the whole period are generally made through a single payment as soon as the legal structure of the holding funds has been set up. Alternative financing arrangements can be specified in the funding agreements. In accordance with the regulation, these payments are certified to the Commission as expenditure incurred (54). Ex post verification of such payment by audit authorities generally relate to the financial year in which the payment has been made. These checks generally have a limited scope because within the first year few operations are selected for support and limited amounts are disbursed to final recipients and projects. 6.66. Common Commission reply to paragraphs 6.66 and 6.67. In line with Article 78(6) of Regulation (EC) No 1083/2006, the funds’ contribution into financial instruments is included in the payment claims to the Commission. These payments constitute part of the population to be audited by audit authorities through sample checks in line with the updated Commission guidance. As set out in the joint audit strategy for Structural Funds and as specified in the Commission’s audit framework for ESI Funds, audit authorities and the Commission may carry out thematic audits on financial instruments which cover both the constitution of the fund and the actual implementation of projects through the audit of a sample of projects carried out by final recipients. Audit authorities verify the performance of first-level checks by management authorities and will have to obtain sufficient assurance on the funds by closure. As regards the fund managed by the European Investment Bank, the Commission regrets the limitations to the access rights. A memorandum of understanding between the Commission and the European Investment Bank is under signature so that in the future, managing and audit authorities have the possibility to use the services of a contractor selected by the Commission for the verification and the audit work of the European Investment Bank.

6.67. Unless specific verifications are envisaged, the actual implementation of financial instrument operations is therefore unlikely to be checked by audit authorities until the closure of the 2007-2013 programming period. Where the financial instruments are managed by the European Investment Bank (EIB), the audit authority cannot check the contributions to the fund due to limitations imposed to the access rights by the EIB.

Very low error rates reported by the audit authorities for OPs for which we have found significant errors

6.68. For 110 of the 440 ERDF/CF and ESF OPs, the Commission has validated error rates equal or below 0,5 %. In 13 of these OPs, we performed at least one examination during the last two financial exercises. For five OPs we found significant errors in the projects examined (see paragraphs 6.61 and 6.62).

Review of the Commission’s annual activity reports

6.69. We assessed the 2014 annual activity reports (AARs) and accompanying declarations of the Directorates-General for Regional and Urban Policy, and Employment Social Affairs and Inclusion (55). In particular:

— we checked the consistency and accuracy of the Commission’s calculation of the amounts at risk;

— we assessed the reservations made for 2014.

Commission’s calculation of the amounts at risk for ERDF/CF and ESF OPs

6.70. Overall, the Commission’s calculation of the amounts at risk in the 2014 annual activity reports is consistent and accurate with the available information reported and/or provided by the audit authorities. We recall however that the annual error rates reported by the Commission in the annual activity reports are not directly comparable to those estimated by us (56). 6.70. The Commission agrees that the Court’s error rate and that of the Commission are not directly comparable. However, the objective of this process is essentially the same, i.e. assessment of the risk to the EU budget in a particular year. The Commission takes into account all the differences quoted by the Court in its special report 16/2013 in its assessment (see Commission reply to paragraph 11 of this report). Except for these differences, the Commission considers that for the 2014 annual report, as was the case for the last four years in a row for DG Employment, Social Affairs and Inclusion and three years in a row for DG Regional and Urban Policy before this annual report, the result of the Commission’s assessment is in line with the error rates calculated by the Court (see pages 90 and 92 of the respective AARs).

— the Directorate-General for Regional and Urban Policy estimated that between 2,6 % and 5,3 % of the interim and final payments for ERDF/CF OPs of the 2007-2013 programming period authorised during the year were at risk of error. The Commission made 52 % of payments to OPs it assessed as affected by material levels of error above 2 %; DG Regional and Urban Policy made 52 % of payments to OPs it assessed as affected by a material level of error above 2 %, but for the vast majority of these programmes sufficient corrections were made in order to bring the cumulative residual risk below materiality. Payments made to programmes with an error rate above 5 % concerned only 4 % of the payments (see the respective 2014 AAR, page 44). Reservations were made for all but three concerned programmes as disclosed in the AAR.

— the Directorate-General for Employment, Social Affairs and Inclusion estimated that between 2,8 % and 4,0 % of the interim and final payments for ESF OPs of the 2007-2013 programming period authorised during the year were at risk of error. The Commission made 45 % of payments to OPs it assessed as affected by material levels of error above 2 %. DG Employment, Social Affairs and Inclusion made 45 % of payments to OPs it assessed as affected by a material level of error, but for the vast majority of these programmes sufficient corrections were made in order to bring the cumulative residual risk below materiality. Payments made to programmes with an error rate above 5 % concerned 25 % of the payments (see the respective 2014 AAR, page 53). Reservations were made for all concerned programmes.

Commission’s reservations for ERDF/CF and ESF OPs

6.71. In cohesion policy, the Commission issues reservations on OPs (or groups of OPs) when:

— significant weaknesses in the OPs management and control systems have been identified, or

— the OPs validated error rate exceeds 5 %.

For OPs with a validated error rate between 2 % and 5 %, the Commission also considers whether the OPs ‘cumulative residual risk’ exceeds 2 %.

6.72. The number of OPs subject to reservation increased from 73 to 77 for ERDF/CF OPs in 2014 and remained unchanged to 36 OPs for ESF. Meanwhile, the estimated financial impact of these reservations decreased from 423 million euro in 2013 to 224 million euro in 2014 for ERDF/CF (57) and increased from 123,2 million euro in 2013 to 169,4 million euro in 2014 for ESF. Our analysis found that the reservations made by the Commission in the 2014 annual activity reports were in line with the Commission’s instructions and the information made available to the two directorates-general. 6.72. This demonstrates the maturity of the methodology used for reservations in the respective AARs and the strict implementation of this methodology by DG Regional and Urban Policy and DG Employment, Social Affairs, and Inclusion. Both directorates-general follow a strict approach with regard to the interruption and suspension of payments. They also apply a preventive approach as regards payments, i.e. no payments are made to operational programmes for which an audit mission is planned until the audit mission is completed. Payments are resumed afterwards unless significant deficiencies were identified.

6.73. The Commission estimates the ‘cumulative residual risk’ to be 1,1 % of the payments during for all ERDF/CF OPs and 1,2 % for all ESF OPs. These figures are based on the reported error rates by audit authorities and take also into account the financial corrections reported by Member States to the Commission.

6.74. The robustness of the calculated cumulative residual risk depends on the accuracy and reliability of the information reported by the Member States and on the capacity of the Commission to address these problems. We recall that the work of audit authorities presents some weaknesses (58) that the Commission cannot correct under the current scope of verifications. Moreover, the amount of financial corrections reported by the Member States to the Commission is not fully reliable (see paragraphs 6.58 to 6.60). Given the above, we consider that there remains a risk that the cumulative residual risk as calculated by the Commission is understated for some OPs. 6.74. For ‘Economic, social and territorial cohesion’, the use of a ‘cumulative residual risk’ is only an additional criterion to possibly make additional reservations in the AAR, following the system assessment and consideration of the validated error rate (see the common Annex 4 ‘Materiality criteria’ of the AARs of DG Regional and Urban Policy and DG Employment, Social Affairs and Inclusion). The Commission is aware of the risks related to error rates and to amounts of financial corrections reported by the Member States and has taken appropriate mitigating actions (see Commission reply to paragraphs 6.53 to 6.60 above). The Commission thus considers that there is no significant risk that the cumulative residual risk it calculated is understated.

Commission’s recalculation of our 2013 error rate estimate

6.75. The Directorate-General for Regional and Urban Policy also included in its 2014 annual activity report a recalculation of the estimated level of error published in our 2013 annual report (59). As a matter of principle, we consider that it is not appropriate for the Commission (being our auditee) to present a view on our audit findings in its annual activity report misrepresenting our audit findings (60). 6.75. The recalculation provided by DG Regional and Urban Policy in its 2014 AAR intended to illustrate the impact of the different methodological approaches used by the Commission and the Court when quantifying errors, in particular for public procurement errors and flat rate corrections already applied at the level of programmes. This was not an assessment of the validity of the Court’s findings.

CONCLUSION AND RECOMMENDATIONS

The conclusion for 2014

6.76. Overall audit evidence indicates that spending on ‘Economic, social and territorial cohesion’ and in both policy areas covered by this specific assessment (see paragraph 6.24) is affected by a material level of error. 6.76. Common Commission reply to paragraphs 6.76 and 6.77. The Commission notes that the most likely error rate calculated for 2014 is in line with the range presented by the Court in the last four years (see paragraph 6.18 above). It is also consistent with the error rates reported in the respective AARs, subject to the differences set out in paragraph 6.70. The error rate for the 2007-2013 programming period remains stable and significantly below the rates for the 2000-2006 period. This development derives from the reinforced control provisions of the 2007-2013 period and the Commission’s strict policy to interrupt/suspend payments as soon as deficiencies are identified, as reported in the 2014 AARs. However, the error rate remains too high and the Commission will continue to focus its audits and actions on the most risky programmes/Member States and implement corrective measures when needed through a strict policy of interruptions and suspensions of payments up to closure, and to apply strict procedures at closure to exclude any remaining material risk of irregular expenditure. The Commission further notes that given the multiannual character of the management and control systems under Cohesion policy, errors made in 2014 may also be corrected in subsequent years as illustrated in section 4.2.2 of the respective 2014 AARs of DG Regional and Urban policy and DG Employment, Social Affairs and Inclusion. For the 2014-2020 period, reinforced requirements on legality and regularity include the introduction of annual accounts, reinforced management verifications and accountability as well as audit opinions based on residual levels of errors each year. The Commission’s corrective capacity is further strengthened by the possibility to apply net financial corrections for serious deficiencies under certain conditions, thereby reducing the possibility for Member States to re-use funds. This will be an important incentive for Member States to detect, report and correct serious deficiencies before certifying annual accounts to the Commission. All these elements should contribute to a lasting reduction in the error rate. See also Commission reply to paragraph 6.24.

6.77. For this MFF heading area, testing of transactions indicates that the estimated level of error present in the population for the ‘Economic, social and territorial cohesion’ as a whole is 5,7 % (for regional and urban policy area 6,1 % and for employment and social affairs policy area 3,7 %) (see Annex 6.1 ).

Recommendations

6.78. Annex 6.2 shows the result of our review of progress in addressing recommendations made in previous annual reports. In the 2011 and 2012 annual reports, we presented 11 recommendations. Of these recommendations, the Commission fully implemented four recommendations, while six were implemented in most respects, and one was implemented in some respects.

6.79. Following this review and the findings and conclusions for 2014, we recommend that in the area of ‘Economic, social and territorial cohesion’:

— Recommendation 1: the Commission should carry out a focused analysis of the national eligibility rules for the 2007-2013 and 2014-2020 programming periods in view of identifying good practices. Based on such analysis, it should provide guidance to Member States on how to simplify and avoid unnecessarily complex and/or burdensome rules that do not add value with respect to the results to be achieved by the policy (‘gold-plating’); The Commission accepts this recommendation. However, the Commission recalls that under shared management, the establishment of national eligibility rules is the responsibility of the Member States who should in the first instance review and simplify their national eligibility rules and disseminate good practices, based on cumulative national and EU audit results from the 2007-2013 programming period and experience collected by managing authorities and intermediate bodies. The Commission also notes that it is providing observations on selection criteria to be decided by monitoring committees and has issued extensive and timely guidance to Member States during the start-up of the 2014-2020 programming period. It will continue to guide the Member States in order to simplify and avoid unnecessarily complex and burdensome rules whenever specific instances of gold plating are identified. In this framework, the Commission and the Member States meet on a regular basis to discuss and clarify these issues. The Commission is also heavily investing on the use of simplified cost options during the 2014-2020 programming period (see reply of the Commission under Recommendation 3). The Commission will also continue cooperating with national audit authorities to encourage them to identify and report, in system audits and other audits, eligibility rules which are unnecessarily complex and that can be simplified without putting at stake the legality and regularity of expenditure.

— Recommendation 2: managing authorities and intermediate bodies in Member States should intensify their efforts to address the weaknesses in ‘first level checks’ by taking into account all available information. In addition, the Commission should request audit authorities through their system audits to re-perform some of these checks and share the good practices and lessons learnt; The Commission notes that the first part of this recommendation is addressed to Member States. It agrees on the importance of the ‘first level’ checks conducted by the Member States and shares the view that these should be further strengthened. Therefore, it has given guidelines to Member States on the way managing authorities should define and implement their management verifications, including in relation to public procurement and State aid issues. This comprehensive guidance note on management verifications for the 2014-2020 programming period, drawing on the lessons learned in the 2007-2013 programming period and the Court’s findings, has been drafted and discussed with Member States in the second half of 2014 and will be published in July 2015. Audit authorities have the responsibility to perform audits of the management and control systems. They provide the Commission with system audit reports and annual control reports on the functioning of these systems and in particular the quality and effectiveness of the first level checks performed by management authorities. In that context, the Commission accepts the second part of the recommendation to request that audit authorities, through their system audits and control testing, should re-perform some of these checks and share the good practices and lessons learnt. In that respect, the Commission launched a new tool in 2015 for peer-to-peer exchanges among managing, certifying and audit authorities in Member States (‘Taiex Regio Peer 2 Peer’). This tool aims at helping Member States to improve their administrative capacity in managing the European Regional Development Fund and the Cohesion Fund, including in the area of management verifications. In line with its audit strategy as updated in 2015, the Commission will also continue to focus its audits on management verifications following a risk-based approach for 2007-2013 programmes, up to closure.

— Recommendation 3: Member States should make better use of the possibilities set out in the Common Provisions Regulation and ESF Regulation for the 2014-2020 programming period concerning simplified cost options for projects exceeding 50 000 euro public support; The Commission takes note of this recommendation which is addressed to the Member States. The Commission has actively worked since the introduction of the simplified cost options in the regulations to progressively extend their use by Member States and considers that these efforts have already led to positive results, in particular for the ESF. The Commission continues to actively promote the use of simplified cost options by Member States in the 2014-2020 programming period, where they have been significantly strengthened both in the Common Provisions Regulation and in the specific ESF Regulation, based on the lessons learned and the good practices identified in the previous programming period, in order to reduce the administrative burden on the beneficiaries, increase the focus on results and further reduce the risk of error. As regards ERDF and CF, the Commission encourages Member States to further explore the opportunities offered by the 2014-2020 legal framework regarding simplified cost options in order to widen the use of such options, in particular for thematic objectives 1 and 3. Furthermore, as part of its efforts to promote the use of simplified cost options by Member States, the Commission has recently issued extensive practical guidance concerning the options set out in the Common Provisions Regulation and in the specific ESF Regulation, and conducted a second round of simplification seminars in a significant number of priority Member States where the simplification opportunities have not been sufficiently leveraged in the previous programming period. Furthermore, the Commission launched surveys in June 2015 in order to assess the planned take up of the simplification opportunities, including simplified cost options by Member States in the current programming period.

— Recommendation 4: Member States should ensure the full and timely payment of funding under the 2007-2013 programming period by reimbursing the beneficiaries within a reasonable time after they have submitted for reimbursement a payment claim. In alignment with the rules applicable to the 2014-2020 programming period, we consider that all such payments should be made within 90 days after the submission of a correct payment claim by the beneficiary; The Commission takes note of this recommendation which is addressed to Member States. The Commission agrees that Member States should comply with Article 80 of Regulation (EC) No 1083/2006. This Article does not provide specific benchmarks. In the context of the programming period 2014-2020, Article 132 of the Common Provisions Regulation (EU) No 1303/2013 on ESI Funds has established specific rules for the reimbursement of funding to beneficiaries by national authorities. Subject to the availability of funding, the Managing Authority shall ensure that a beneficiary receives the total amount of eligible public expenditure due in full and no later than 90 days from the date of submission of the payment claim by the beneficiary.

— Recommendation 5: the Commission should submit a legislative proposal to amend, through a legislative act of equal legal value, Regulation (EC) No 1083/2006 with respect to the extension of the eligibility period for financial instruments under shared management to the Council and the Parliament; The Commission does not accept this recommendation. The Commission considers that the modifications introduced in its closure guidelines were within the scope of Article 78(6) of Regulation (EC) No 1083/2006, as amended, and therefore did not require an amendment of the legislative act.

— Recommendation 6: the Commission should extend to all Member States its assessment of the reliability of the financial corrections reported by the certifying authorities and its impact on the Commission’s calculation of the ‘residual error rate’; The Commission accepts this recommendation that it is already implementing in line with previous recommendations of the external and internal auditors in that regard. The Commission has widened the scope of its assessment and now performs consistency checks and desk reviews on the financial correction statements for all Member States and operational programmes whose results are reflected in the calculation of the cumulative residual risk. In addition, it carries out a risk assessment annually to decide which audit missions are to be carried out in which Member States to obtain reasonable assurance, in this case, of the financial corrections reporting. In the frame of this risk assessment the Commission also takes account of the need to conduct on-the-spot audits in all Member States with a material impact on the calculation of the cumulative residual risk, by the end of the programming period.

— Recommendation 7: the Commission should further strengthen the control system for audit authorities by:

— requesting audit authorities to provide specific information on audits of operations (in particular the coverage) to verify the accuracy and reliability of the information provided in the annual control reports; — The Commission accepts the recommendation which it is already implementing by requesting and obtaining additional specific information from audit authorities each time it deems it necessary, in particular in case of doubts, and by carrying out desk or on-the-spot review of annual control reports. As an example, DG Regional and Urban Policy has foreseen in its updated strategy for 2007-2013 to launch reinforced ‘pre-annual control report’ missions to prepare for the review of annual control reports to be provided in December 2015 for the last time and of closure declarations and opinions planned for March 2017. Furthermore, both DG Regional and Urban Policy and DG Employment, Social Affairs and Inclusion intend to continue covering a significant number of annual control reports through on-the-spot missions, on a risk basis.

— ensuring that all audit authorities appropriately cover in their audit of operations checks of compliance with state aid and public procurement rules; — The Commission accepts this recommendation and is already implementing it in the context of its audit enquiries concerning the review of the work of audit authorities. It will circulate the Court’s findings to ensure, where necessary, that reinforced checklists are used for the remainder of the 2007-2013 programming period and for the next one.

— requesting audit authorities to certify the accuracy of the data on financial corrections reported by certifying authorities for each OP whenever such action is deemed necessary. — The Commission accepts this recommendation which was already accepted in 2014. For the 2014-2020 programming period, the audit authorities are requested each year to issue an audit opinion based on a residual rate of error in the certified accounts. For the revision of the calculation of this rate, audit authorities have to check the accuracy of the financial corrections reported by the certifying authorities during the period for each operational programme and as reported in the certified accounts.

PART 2: PERFORMANCE RELATED ISSUES

ASSESSMENT OF PROJECTS’ PERFORMANCE

6.80. Implementing the EU budget under the principle of sound financial management requires that spending should not only focus on complying with the rules but also on the achievement of intended objectives (61). 186 of the 331 ERDF/CF and ESF projects examined were completed at the time of the audit (see paragraph 6.22). In addition to checking the regularity of these 186 transactions, we assessed as a pilot exercise and based on information provided by the beneficiaries whether and to what extent:

— the objectives specified for projects funded under ERDF/CF and ESF in the project application, grant agreement, contract and/or decision for co-financing were in line with those set out in the OPs;

— projects had achieved those objectives. Our analysis focused on project outputs and, where possible, we also assessed the extent to which results were achieved (62).

Moreover, we also assessed whether projects were implemented in line with the principles of sound financial management.

Three quarters of the projects examined achieved either fully or partially their objectives

6.81. Based on the project outputs observed (and, where possible, the assessment of the intended results), we conclude that 89 of the 186 projects (48 %) reached (or exceeded) all targets that had been specified to measure the project performance. For 56 projects (30 %) we found that one or several indicators specified for the project did not attain the intended target value. For 17 cases (9 %) the deadline to attain the targets was reached for some, but not all targets by the time of the audit. 6.81. The Commission notes that 143 projects out of the 186 examined have reached (either fully or partially) or exceeded their targets. Member States monitor implementation throughout the life of the projects. It is, however, only at the stage of the closure of the programmes in 2017 that the performance of projects financed by Operational Programmes will be finally evaluated and reported to the Commission. The Commission notes that under the Regulations for the 2007-2013 programming period the requirements to measure the performance of EU-funded projects have been strengthened. Performance evaluation of programmes has been further reinforced for the 2014-2020 period: as foreseen in the regulatory framework (Article 22(6) and (7) of Regulation (EU) No 1303/2013), the Commission will be able to sanction Member States in case of serious underachievement, as a result of the performance review (Article 22(6) of Regulation (EU) No 1303/2013) and at closure (Article 22(7)).

6.82. For three cases (2 %), none of the objectives of the project (as set out in the OP and/or the grant agreement) were attained. These projects do not add value because the investments are either not used, or cannot be used (see Box 6.7). This will represent a waste in spending of the EU funds unless the problems are addressed by the closure of the OPs. 6.82. The Commission will monitor with the concerned programmes authorities that these investments become functional by closure, which is a condition for the eligibility of the corresponding expenditure at that time.

Box 6.7 — Example of projects without added value Project delivered but remains unused: A CF project in Greece consisted of the construction of a sewage plant and of a sewerage network for two municipalities. The infrastructure works were completed in 2013. However, the project cannot be used until connections from private households and industry to the sewerage network are also constructed. From the initial announcement of the project (in 2006) the municipality had enough time to design and implement such connections to the sewerage network. However, at the end of 2014, our audit found that such connections were still not in place. The project of the private connections has been procured during 2015.

6.83. For 13 projects (7 %) the achievement of objectives could not be assessed since no relevant data was provided.

6.84. We also found that eight projects (4 %) had objectives that were not in line with those specified for the OP and the priority axis under which the project was funded (see Box 6.8). The achievement of the performance for these projects was concluded as ‘cannot be determined’.

Box 6.8 — Example of indicators not in line with OP Indicator for the project not specified: In Italy, an ERDF project consisted of an equipment purchase for a hospital. No relevant performance indicator was defined for the project. Moreover, no specific indicator was found for the measure under which the project was approved. Instead, the managing authority monitors some indicators defined at national level (such as the surface covered by a project in square meters, the total man/working days achieved and the number of projects physically completed), which do, however, not all