Special Report No 5/2003 concerning PHARE and ISPA funding of environmental projects in the candidate countries together with the Commission's replies
Date: 2003-04-10
Institutions: European Court of Auditors
Subjects: accession to the European Union, environmental protection, financing, pre-accession aid, project evaluation, report

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I

(Information)

COURT OF AUDITORS

SPECIAL REPORT No 5/2003

concerning PHARE and ISPA funding of environmental projects in the candidate countries
together with the Commission’s replies

(pursuant to Article 248(4), second subparagraph, of the EC Treaty)

(2003/C 167/01)

CONTENTS

Paragraphs

Page

SUMMARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

The environment sector and the enlargement of the European Union . . . . . . . . . . . . . . . . . .

The Court’s audit

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

I-V

1-6

1-3

4-6

INSTITUTION-BUILDING PROJECTS IN THE ENVIRONMENT SECTOR . . . . . . . . . . . . . . . . .

7-17

Limited scale of PHARE funding committed to institution-building in the environment
sector . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Limited impact of PHARE twinning and technical assistance projects . . . . . . . . . . . . . . . . . .

The need for institution-building in the context of ISPA . . . . . . . . . . . . . . . . . . . . . . . . . . . .

THE FINANCING OF ENVIRONMENTAL INFRASTRUCTURE PROJECTS . . . . . . . . . . . . . . . . .

Shortcomings in environmental strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Co-financing of PHARE and ISPA grants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Delays in establishing financing strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Reducing grant levels for income generating projects . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Effective cooperation with international finance institutions . . . . . . . . . . . . . . . . . . . . . . .

THE MANAGEMENT OF ENVIRONMENTAL INFRASTRUCTURE PROJECTS . . . . . . . . . . . . . .

Difficulties in preparing projects for ISPA funding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Weaknesses in tendering and supervision . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

CONCLUSIONS AND RECOMMENDATIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

There continues to be a significant need for institution-building . . . . . . . . . . . . . . . . . . . . . .

Scarce grant financing can be targeted more effectively . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Absorption capacity should be increased by strengthening project preparation and tender-
ing capabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

7-10

11-14

15-17

18-29

18-20

21-29

21

22-25

26-29

30-39

30-34

35-39

40-45

40-41

42-43

44-45

The Commission’s replies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

2

3

3

4

5

5

6

7

7

7

8

8

8

9

9

9

11

12

12

12

13

14

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SUMMARY

I.
The audit covered PHARE and ISPA funding of environment projects financed during the period 1995
to 2000 in the 10 candidate countries of central and eastern Europe. The objective of the audit was to assess
the effectiveness of PHARE and ISPA aid to the environment sector in the candidate countries, notably in rela-
tion to helping to prepare these countries for accession.

Institution-building projects in the environment sector

The audit found that the Commission’s assistance to support institution-building in the environment
II.
sector in the candidate countries has been only partially successful. As the Commission itself recognised in its
2001 and 2002 Enlargement Strategy Papers, there is still a need for candidate countries to further strengthen
their administrative capacities in the environment sector (see paragraph 8). This situation partly reflects both
the limited scale of funding which the Commission committed to institution-building (see paragraph 9), despite
the particular challenges faced by institutions in this sector (see paragraph 7), and the only modest impact of
the twinning and technical assistance projects that have been funded (see paragraphs 11 to 14). The Commis-
sion’s institution-building strategy has placed too much reliance on the twinning instrument which cannot be
expected to overcome many of the underlying structural problems faced by candidate countries’ administra-
tions. These problems may hinder their capacity to comply with the environmental acquis (see paragraphs 11
to 14). The weaknesses in administrative capacity persist in relation to ISPA, not only at national level but also
at final beneficiary level, where attention should be paid to establishing sufficient capacity to ensure the sus-
tainability of infrastructure projects (see paragraphs 15 to 17).

The financing of environmental infrastructure projects

III.
Candidate countries should have developed environmental and financing strategies at an earlier stage
to identify priority projects and how to finance them most efficiently (see paragraphs 18 to 21). ISPA has
sought to reduce the level of grants below the 75 % ceiling (see paragraph 23) and has cooperated effectively
with the EIB, EBRD and other international financing institutions to achieve this (see paragraph 26 to 28).
Nevertheless, the Court considers that there remains further scope for reducing grant levels (see paragraphs 24
and 25).

The management of environment infrastructure projects

IV.
Institutional weaknesses were also reflected in problems with project cycle management which the
Commission has not always effectively addressed. Thus candidate countries encountered difficulties in prepar-
ing projects to an adequate standard, and the consultants financed by the Commission to rectify these prob-
lems sometimes did not perform satisfactorily (see paragraph 31). The Commission for its part did not employ
sufficient resources at the project appraisal stage (see paragraph 32). For certain infrastructure projects, notably
waste water treatment plants, there was a risk that they would be too large (see paragraph 34). Candidate
countries were experiencing significant difficulties tendering ISPA contracts, partly because of the complexity
of the Commission procedures, and required more support in this area. ISPA project budgets did not systemati-
cally include the necessary funds to recruit engineers with sufficient experience to supervise contracts effec-
tively (see paragraphs 35 and 36). While most infrastructure projects, once up and running, were satisfactorily
implemented, a few important exceptions were found (see paragraph 39).

V.

The Court’s recommendations are focused on:

— the continuing need for significant institution-building (see paragraphs 40 and 41),

— the need to target scarce grant financing more effectively and increase funding from other sources (see

paragraphs 42 and 43),

— the need to improve absorption capacity by strengthening project preparation and tendering capabilities

(see paragraphs 44 and 45).

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INTRODUCTION

The environment sector and the enlargement of the European
Union

1.
The environment sector, which is covered by Chapter 22
of the accession negotiations, represents one of the most chal-
lenging areas to be tackled in preparing for the enlargement of the
European Union for the following reasons:

(a)

it requires the transposition of a large body of environmen-
tal acquis consisting of approximately 140 directives relat-
ing, inter alia, to air quality, water quality, waste manage-
ment, nature protection and industrial pollution control, as
well as sector-wide legislation, such as environmental impact
assessments and access to environmental information;

(b)

a huge investment in infrastructure is needed for the imple-
mentation of certain key directives. For example, recent esti-
mates place the total costs of compliance between 79 and
110 billion euro, making the environment sector the single
most investment-intensive sector (1);

(c)

it requires the development of monitoring structures, includ-
ing the requisite human resources, budgets and equipment,
for the enforcement of the legislation that has been trans-
posed;

(d)

it necessitates the building of institutions at central, regional
and local levels with the administrative capacity for the over-
all management of the transposition, implementation and
enforcement of the environmental acquis.

2.
Candidate countries were required to have transposed and
enacted all the environmental acquis prior to accession. However,
given the enormous investment needs of the environment sector,
it has always been clear that candidate countries need to be granted
long transitional periods to construct the infrastructure needed to
comply with certain investment-intensive directives in the context
of the Chapter 22 negotiations. Therefore no specific minimum
level of implementation of these directives was set for the provi-

(1) Communication from the Commission ‘The challenge of environ-
mental financing in candidate countries’ (COM (2001) 304 final).

sional closure of the environment chapter although the Commis-
sion did require candidate countries to submit implementation
plans. On the other hand, as far as enforcement structures and
general administrative capacity were concerned, the candidate
countries are required to demonstrate that the relevant institu-
tions will be operating satisfactorily by the time of the accession.

3.
During the period covered by the Court’s audit there were
several developments in the Commission’s approach to its fund-
ing of the environment sector:

(a)

for the years 1995 to 1997 the Commission’s financing con-
tinued to be based, as from the outset of the PHARE pro-
gramme in 1989, on a demand-driven approach whereby
each candidate country was free to allocate its PHARE funds
according to national priorities;

(b)

(c)

following the December 1997 Luxembourg European Coun-
cil which launched the present enlargement process, the
PHARE programme was reoriented to focus entirely on the
pre-accession priorities set out in each country’s Accession
Partnership. In addition, the Commission issued a Commu-
nication setting out its strategy for the environment sec-
tor (2);

Funding for environmental infrastructure projects was greatly
increased in 2000 with the introduction of the Instrument
for Structural Policies for Pre-Accession (ISPA) which made
available 1 040 million euro (3) per year over the period
2000-2006 for large infrastructure investments in the envi-
ronment and transport sectors (4). PHARE funding, which
over the period 1995-99 had amounted to approximately
368 million euro, or on average 73,6 million euro per annum,
from 2000 onwards was intended to be directed mainly to
institution-building. PHARE and ISPA commitments by coun-
try over the period 1995-2000 in the environment sector
are set out in Table 1.

(2) Communication from the Commission to the Council, the European
Parliament, the Economic and Social Committee, the Committee of
the Regions and the candidate countries in central and eastern Europe
on ‘Accession strategies for environment: Meeting the challenge of
enlargement with the candidate countries in central and eastern
Europe’ [COM(1998) 294 final].
In 1999 prices.

(3)
(4) Article 2.3 of the ISPA Regulation requires a ‘balance to be struck’

between the funding of these two sectors.

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Table 1

Phare and ISPA commitments in the environment sector 1995-2000

(EUR Million)

Bulgaria

Czech Republic

Estonia

Hungary

Latvia

Lithuania

Poland

Romania

Slovakia

Slovenia

Phare

35,2

26,6

24,5

55,1

27,4

33,5

99,7

60,3

20,9

15,0

Total

398,2

Source: European Court of Auditors.

ISPA

52,0

27,9

15,8

42,6

26,6

18,2

133,7

120,6

11,6

11,2

460,2

Total

87,2

54,5

40,3

97,7

54,0

51,7

233,4

180,9

32,5

26,2

858,4

The Court’s audit

4.
The objective of the Court’s audit was to examine the
effectiveness of PHARE and ISPA funding to the environment sec-
tor, particularly in relation to preparing candidate countries for
accession. The audit sub-objectives were designed both to assess
the effectiveness of the strategic and financing framework estab-
lished by the Commission and the candidate countries and the
economy, efficiency and effectiveness of individual institution-
building and investment projects. The audit covered the commit-
ment and implementation up to the end of 2001 of PHARE and
ISPA funding for the environment sectors from the 1995 to 2000
budgets and included an audit of projects in all ten candidate
countries benefiting from PHARE and ISPA assistance. File reviews
and interviews were carried out both at the Commission head-
quarters and Commission Delegations and meetings held with the
Ministries of Environment, regional and local authorities, as well
as final beneficiaries in the candidate countries.

environmental programmes (1). In addition, 22 of the 39 ISPA
environment measures committed in 2000 were subject to site
visits. The commitments for the ISPA measures audited amounted
to 307 million euro, or approximately two thirds of total ISPA
environment commitments. The audit of ISPA was designed to
build on the Court’s observations on the setting up of the ISPA
instrument contained in its Annual Report 2000 (2). All the
supreme audit institutions in the candidate countries participated
in the audit to varying degrees, either through auditing part of the
sample of projects selected by the Court using the Court’s meth-
odology or supporting the Court’s auditors in preparing and dur-
ing their on-the-spot missions.

6.

The report’s findings are focused on three main areas:

(a)

the continued significant need for institution-building;

(b)

the need to target scarce grant financing more effectively;

5.
In total PHARE projects amounting to 270 million euro
were audited. This represented approximately 67 % of the total
value of funding for PHARE environment projects over this period
excluding environment infrastructure projects funded under the
PHARE cross-border cooperation (CBC) programme and regional

(1) The PHARE cross-border cooperation programme was excluded from
the scope of the audit because the Court had already issued a special
report on this programme, including its environmental aspects. The
regional programmes were not examined because these played a
greatly reduced role under the new 1998 PHARE guidelines.

(2) OJ C 359, 15.12.2001, p. 290 to 300.

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(c)

the need to increase absorption capacity by strengthening
project preparation and tendering capabilities.

INSTITUTION-BUILDING PROJECTS IN THE ENVIRONMENT
SECTOR

Limited scale of PHARE funding committed to
institution-building in the environment sector

7.
From its inception in 1989 the PHARE programme has
supported institution-building. The Commission recognised the
particular importance of institution-building in preparing for the
accession in its new PHARE guidelines issued in 1998 which
stated that henceforth 30 % of the annual PHARE budget should
be allocated to this area. Institution-building for the purposes of
this 30 % allocation was defined by the Commission as ‘the pro-
cess of helping the candidate countries to develop the structures,
strategies, human resources and management skills to strengthen
their economic, social, regulatory and administrative capacity’ (1).
In the environment sector institution-building is essential both to
ensure that environmental authorities are operating satisfactorily
by the time of accession and to enable them to efficiently and
effectively implement the huge investment programmes required
to comply with the acquis (see paragraph 2). Furthermore,
institution-building is a particular challenge in the environment
sector because Ministries of Environment are relatively new, while
regional and local authorities as well as environmental agencies
also require assistance to meet their responsibilities in relation to
the acquis. Moreover, both coordination between the Ministry of
Environment and these other institutions and coordination
between the Ministry and other ministries is often very difficult
and has to be developed.

8.
The main conclusion on the environment sector in the
Commission’s 2001 Strategy Paper on enlargement was the ‘need
to further strengthen administrative, monitoring and enforcement
capacity’. The Commission’s 2002 Strategy Paper reiterated this
message stating that ‘candidate countries needed to focus their

efforts on reinforcing their overall administrative capacity.’ The
Court’s audit of the PHARE and ISPA programmes confirms the
Commission’s conclusions in view of the findings presented in the
following paragraphs (9 to 17).

9.
The problems described by the Commission partly reflect
the limited scale of funding committed to institution-building in
the environment sector over the period 1995 to 2000. Until 1998
funding priorities were established by the candidate countries,
which generally did not attach a high priority to using PHARE for
institution-building (see paragraph 10). The Commission’s
increased focus on institution-building in 1998 gave an impetus
to the systematic commitment of funds to environment institution-
building projects that year. However, in 1999 and 2000, although
the accession partnerships and national programmes for the adop-
tion of the acquis provided a strategic framework for program-
ming PHARE according to the priorities for complying with the
acquis, several countries had only either very small or no institution-
building projects in this sector. The average annual amount com-
mitted to environment Twinning projects, the main instrument
for institution-building, in these two years was 30 % less than in
1998 (see Table 2). This is particularly problematic as 2000 in fact
proved to be the last year to commit funds to projects in order to
ensure their full implementation before accession in 2004.

10.
The limited funding committed by the Commission over
the period 1995 to 2000 in conjunction with the candidate coun-
tries to institution-building in the environment sector partly
reflects the higher priority attached by candidate countries to
environment infrastructure projects, notwithstanding the impera-
tive need to ensure environmental institutions were functioning
adequately by the time of accession. In addition, it can be linked
to the fact that the Ministries of the Environment in most candi-
date countries do not have a strong influence, other longer-
established ministries often being given preference when it came
to allocating PHARE resources between competing projects. Fur-
thermore, some environment ministries had difficulty in drawing
up institution-building project proposals for PHARE funding to
the standard required for approval by the Commission. In its
PHARE programming guidelines for 2002 the Commission
insisted that candidate countries make institution-building their
number one priority and detailed Action Plans for addressing
institutional weaknesses were drawn up. However, projects funded
from the 2002 budget will generally not be completed until 2005.

(1)

‘Guidelines for PHARE programme implementation in candidate coun-
tries for the period 2000 to 2006 in application of Article 8 of Regu-
lation 3906/89’; Commission Decision SEC(1999) 1596 final. Brus-
sels, 13 October1999.

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Phare commitments for twinning projects in the environment sector 1998-2000

Table 2

(EUR Million)

Bulgaria

Czech Republic

Estonia

Hungary

Latvia

Lithuania

Poland

Romania

Slovakia

Slovenia

1998

1,75

0,85

0,81

1,89

0,65

1,30

2,97

1,20

1,22

0,49

Total

13,13

Source: European Court of Auditors.

Limited impact of PHARE twinning and technical assistance
projects

Up until 1998 institution-building projects were carried
11.
out through technical assistance. In 1998 the Commission intro-
duced ‘twinning’ as its main instrument to support the increased
importance it gave to institution-building (1). Twinning involves
the secondment of civil servants from Member States to candidate
country ministries to advise on accession preparations. The instru-
ment has two key features:

(a)

(b)

the Commission stated that twinning would ‘guarantee’ fully
operational results. This is to be seen in contrast to the pre-
vious reliance on technical assistance which was frequently
criticised for simply producing long and unusable reports;

twinning would be based on closer cooperation with the
candidate countries, reflecting the changed status of these
countries as they moved nearer to accession, the intention
being that senior counterparts from candidate countries’
ministries would work alongside representatives of Member
State administrations rather than be simply recipients of
consultancy services.

(1) The Court’s Special Report 6/2003 on ‘twinning’ (see page 21 of this
Official Journal) gives a comprehensive assessment of the twinning
instrument.

1999

2,60

0,85

0,00

0,00

0,00

1,00

2,02

0,00

1,20

0,00

7,67

2000

3,16

2,39

0,00

1,11

0,00

0,00

2,79

0,80

0,70

0,00

10,95

12.
The Court audited 19 of the 42 environment sector twin-
ning projects financed between 1998 and 2000, focusing on those
where implementation was ongoing or completed and a further
15 technical assistance contracts. For 12 of the 14 twinning
projects which had been completed it was found that while the
twinning project had achieved at least some of the results fore-
seen for the project, particularly in relation to the transposition
of the acquis, it had not comprehensively met all the objectives set
out under the related covenant. Thus twinning, while contribut-
ing to institution-building, was not an instrument which brought
guaranteed results.

A major factor hindering the achievement of results was
13.
the administrative capacities of the candidate countries. In most
cases, staff in the Ministries of Environment were unable to dedi-
cate themselves full-time to working alongside representatives of
the Member State, often because the Ministries were under-
resourced and could not find the time to integrate the additional
tasks associated with the twinning covenant into their regular
work. The Court’s audit of technical assistance contracts found
similar problems to those identified for twinning projects. In sev-
eral countries, the contracts examined showed that the ministries
relied heavily on technical assistance inputs because of their own
limited resources. This lack of resources made it difficult to ensure
an adequate transfer of knowledge. Personnel that had been trained
often left the ministries, either due to the better pay in the private
sector or because of political changes following elections.

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The Commission’s institution-building strategy has placed
14.
too much reliance on the twinning instrument which cannot be
expected to overcome many of the underlying structural prob-
lems faced by candidate countries’ administrations, particularly in
the tight accession timeframe. Moreover, the successful imple-
mentation of twinning projects depends heavily on Member State
and candidate country inputs and cooperation rather than on the
Commission’s own management. In so far as the Commission has
sought to attach conditions to its funding of PHARE programmes,
to try to ensure adequate staffing arrangements by beneficiaries,
such conditions have generally not been strictly followed-up. The
fact that there is no acquis in relation to institution-building means
that the standards to be achieved by public administrations are
not specified and the Commission has not established objective
and measurable criteria to define the level of ‘adequate’ adminis-
trative capacity in the environmental sector although it has done
this in other areas to the extent that the acquis enables it to do so.

At the level of the final beneficiary there was also a wide-
17.
spread need for more institutional strengthening. Since the main
objective of ISPA is the financing of construction contracts for
infrastructure projects, it did not systematically provide assistance
for institution-building measures to support the beneficiaries of
these projects. Of particular importance was the need to provide
technical assistance to water companies to improve their opera-
tional and financial management. The experience of the Cohesion
Funds points to the risk of financing infrastructure such as waste
water treatment plants, for which beneficiaries do not have suf-
ficient funds to cover the operating and maintenance costs after
the project has been completed.

THE FINANCING OF ENVIRONMENTAL INFRASTRUCTURE
PROJECTS

The need for institution-building in the context of ISPA

Shortcomings in environmental strategies

15.
The institutional weaknesses described also affected the
management of ISPA by candidate countries. Even at the end of
2001 the majority of countries did not have fully functioning
structures for managing ISPA. These weaknesses were reflected in
the poor quality of some of the National ISPA strategies (see para-
graph 18) and the problems in submitting priority projects pre-
pared to the required standards which the Court already referred
to in its Annual Report 2000 (1) (see paragraphs 30 and 31). In
most countries there was a lack of technical engineering expertise
in the Ministry of the Environment.

In common with other institutions in the candidate coun-
16.
tries, none of the institutions involved in ISPA environment
projects had progressed to the point where they were deemed
capable by the Commission of operating the Commission’s
Extended Decentralised Implementation System (EDIS). EDIS
involves the Commission moving from the ex ante to ex post con-
trol of tendering and contracting on the assumption that it will
be able to rely on the financial management and control systems
in the candidate countries. It had been planned for EDIS to be
introduced at the beginning of 2002 but the Commission did not
begin to systematically provide technical assistance to help can-
didate countries to prepare for EDIS until December 2001. It is
unlikely that EDIS will be introduced in any country until 2003
at the earliest.

(1) Annual Report concerning the financial year 2000, paragraph 6.23

(2001/C359/01, OJ C 359, 15.12.2001, p. 295).

18.
PHARE and ISPA funding represents only a small frac-
tion of the huge financing needs of the environment sector in the
candidate countries as Table 2 shows. In order to ensure that the
scarce resources available for environment projects are used as
effectively as possible there is a need to prioritise projects and
fund those with the greatest potential impact first. In practice,
national environment strategies have too often contained long
lists of different projects to be implemented without any ranking
or prioritisation for their preparation and implementation. In
addition, even when the Commission moved away from a demand-
driven to an accession-driven approach to PHARE in 1998 (see
paragraph 3(b)) too much attention was given to projects’ readi-
ness for implementation and not enough to how high the project
ranked as a priority compared with others. In fact, project readi-
ness often depended more on regional and local initiatives to pre-
pare projects than on national priorities. Similarly, while for ISPA
the Commission has required each country to submit a ‘National
ISPA Strategy’, these documents were in some cases built up
around projects under preparation rather than necessarily the
highest priority projects.

19.
PHARE and ISPA funding of environmental infrastruc-
ture has largely been allocated to the water sector (see Table 3).
Despite the huge needs for investment in the air sector, very little
has been funded by PHARE and ISPA, even though this sector was
identified as a priority in all the National ISPA strategies. This is
above all because most of the investment needs for the air sector
relate to privately owned large combustion plants and the Com-
mission has not yet developed an approach to funding such
projects which would respect the requirements of the ISPA Regu-
lation, notably in regard to compliance with competition rules.

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Phare and ISPA commitments 1995-2000 for environment infrastructure projects by environmental sub sector compared with
estimated total needs

Table 3

Sector

Water and wastewater

Solid and hazardous

Air

Phare

225,0

18,7

15,0

Total

258,7

ISPA

366,8

94,0

0,0

460,8

PHARE and ISPA
Total

Estimated Total
Needs (1)

PHARE and ISPA
as % of total needs

(EUR Million)

591,8

112,7

15,0

719,5

54 000

15 000

53 000

122 000

1,10

0,75

0,03

0,59

(1) EDC: Compliance costing for approximation of EU environmental legislation in the CEEC, April 1997.
Source: European Court of Auditors.

20.
Approximately 14 % of funding has been used for waste
management projects. However, although a key priority in this
area is the creation of larger regional landfill sites and the closure
of smaller often unplanned landfills, PHARE and ISPA have fre-
quently financed new landfills in the absence of national and
regional waste management plans. For example, although the
Commission approved three ISPA projects for solid waste in Hun-
gary in 2000, for which the estimated total ISPA contribution
amounted to 29,6 million euro, the national waste management
plan was only adopted in September 2001, and the regional and
local waste management plans were still under preparation in
2002. Moreover, two PHARE projects on waste management
which were to be used as inputs into these plans only started at
the beginning of 2001. In several other countries, waste manage-
ment plans were also only developed at a very late stage.

Co-financing of PHARE and ISPA grants

Delays in establishing financing strategies

the three main sectors (water, waste and air) had become ‘even
more urgent’.

Reducing grant levels for income generating projects

22.
Since infrastructure projects relating to water/wastewater
and solid waste are income generating, a key factor in deciding
whether and, if so, how much grant financing is necessary is to
establish how far such projects can be financed by local consum-
ers through increases in tariffs for the services. Revenue from tar-
iffs may either directly fund projects or be used to finance loans.
However, this key aspect of income generation potential was not
systematically addressed in the project fiches used for appraising
PHARE projects.

21.
Given the amount of funding required and the scarcity of
such funding, there was also a need for the candidate countries to
establish financing strategies at an early stage to identify other
sources of finance (national and local budgets, tariff increases,
loans, etc.) as co-finance for the PHARE and ISPA grants. How-
ever, as late as June 2001 the Commission still found it necessary
to issue a formal communication on the challenge of environ-
mental financing in the candidate countries’ to assist candidate
countries ‘to define clear and credible financing plans for their
accession needs’ (1). The Communication concluded by stressing
that the need for continuing to develop financing strategies for

(1) Communication from the Commission: the challenge of environmen-
financing in the candidate countries, Brussels 8 June 2001

tal
(COM(2001) 304 final).

23.
In contrast, for ISPA specific attention has been paid to
income generation issues when determining what percentage of
the measure should be financed through an ISPA grant. Although
it is in the interests of final beneficiaries to maximise the propor-
tion of grant financing received, one of the main achievements of
the Commission in managing ISPA has been to avoid setting all
grants at the maximum percentage of 75 % stipulated in the ISPA
Regulation. By bringing in other forms of financing from national
sources and international loans, ISPA can be compared favour-
ably with the Cohesion Fund, for which grants to Member States
have often been set in practice at the maximum allowable level of
85 %. Nevertheless, as shown in the following paragraphs, there
remains further scope for reducing the grant level which would
then enable more projects to be financed.

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The basic cited by the Commission, when considering
24.
the appropriate level of tariffs for determining the part of the
project which could be financed by loans instead of ISPA grants,
is that for water tariffs the upper limit of affordability for consum-
ers is 4 % of average household income (1). Nevertheless, the jus-
tification for the level at which the ISPA grant was set for a given
measure has not always been clear. For several measures the ISPA
documentation did not state what the new tariff levels would be
as a percentage of household income. For measures where this
percentage was clearly stated, with the exception of Romania
where tariff levels were actually over 4,0 %, the average water tar-
iff levels for ISPA measures were only approximately 3,0 % of
average household income and varied considerably between
projects. As rises in tariff levels of as little as 0,1 % can signifi-
cantly increase the capacity of local authorities and water com-
panies to finance infrastructure projects from their own resources,
ISPA grant levels could have been lower if tariff rates nearer to the
limit of affordability of 4 % had been adopted.

World Bank. In 2000 this MoU was extended to include the Nor-
dic Investment Bank (NIB) and the Nordic Environmental Finance
Corporation (NEFCO). Cooperation with the European Invest-
ment Bank (EIB) was also intensified, particularly in the context
of the EIB’s pre-accession facility.

The establishment of the PHARE large-scale infrastruc-
27.
ture facility (LSIF) for the period 1998/1999 enabled such coop-
eration to take on a more concrete form. However, although the
LSIF placed special emphasis on financing projects which would
lever maximum additional financing from IFIs, in some cases it
was used to help complete existing IFI projects (e.g. Romania, Bal-
tic States).

25.
In Lithuania the tariff level for the Vilnius sewerage mea-
sure, where ISPA’s contribution was 20 million euro, was fore-
seen to be as low as 1,8 % of average household income. In Poland,
ISPA made a contribution of 47,5 million euro in Torun which
had the lowest water tariffs of Poland’s sixteen district capitals and
where tariffs, even after the project, were only planned to rise to
2,5 % of average household income. In the nearby town of Byd-
goszcz, where ISPA provided financing of 66,2 million euro, rep-
resenting a grant level of 49 %, the financial analysis prepared by
technical consultants showed there was scope for a significantly
lower percentage of grant financing by raising tariffs.

28.
In the framework of ISPA, the Commission has estab-
lished effective cooperation with the EIB, the EBRD, the NIB and
NEFCO. Even if it was not always clear whether the optimal ratio
of grant to loan financing had been achieved (see paragraphs 24
and 25 above), the availability of ISPA grants enabled banks to
finance projects which would not generally have gone ahead oth-
erwise.

29.
A further important potential source of financing was
public-private partnerships (PPP). However, such financing also
carried with it the risk of ISPA subsidising private companies. Up
until 2002 the Commission was still in the process of defining
guidelines on PPP which would enable ISPA to use PPP while
minimising this risk. There is a need to work closely with IFIs in
this area too.

Effective cooperation with international finance institutions

Following the 1993 Copenhagen Council, PHARE funds
26.
were made available for financing infrastructure projects, includ-
ing environmental ones, in conjunction with the International
Financial Institutions (IFIs). It was intended that PHARE funds
would have a multiplier effect by attracting IFI finance to projects
which would not otherwise receive it. While initially such coop-
eration largely took place on a project-by-project basis, a more
systematic approach was introduced in 1998 with the signing of
a Memorandum of Understanding (MoU) on pre-accession prepa-
ration between the European Commission, the EBRD and the

(1) These figures are based on World Bank studies carried out in Poland.

THE MANAGEMENT OF ENVIRONMENTAL INFRASTRUCTURE
PROJECTS

Difficulties in preparing projects for ISPA funding

30.
The very large increase in funding for environment sec-
tor infrastructure projects resulting from the introduction of ISPA
in fact led to absorption problems in most candidate countries,
despite their huge needs. One indication of this is the estimated
total value of environment measures committed under ISPA in
2000. As Table 4 shows, in four countries less than 35 % of the
estimated total ISPA contribution related to environmental mea-
sures (Czech Republic, Hungary, Lithuania, Romania)

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Estimated total ISPA contribution for environment sector as a % of estimated

Table 4

Total ISPA contribution for all
measures
Estimated total ISPA contribution
for environment sector
(EUR million)

Estimated total ISPA contribution
for environment and transport
sectors
(EUR million)

Estimated total ISPA contribution
for environment sector as a % of
estimated total ISPA contribution
for all measures

Bulgaria

Czech Republic

Estonia

Hungary

Latvia

Lithuania

Poland

Romania

Slovakia

Slovenia

Total

Source: European Court of Auditors.

78,0

34,5

19,8

70,1

37,7

22,8

250,0

181,4

27,2

14,0

735,5

158,0

100,1

33,9

259,8

80,8

65,3

527,2

528,3

65,8

23,3

1 842,5

49,40

34,50

58,40

27,00

46,70

34,90

47,40

34,30

41,30

60,10

39,90

31.
Project applications submitted by the administrations of
the candidate countries were often not prepared to the standard
required to receive ISPA funding. As a result the Commission
required the candidate countries to employ significant technical
assistance financed from a PHARE framework contract to try to
improve the quality of the proposals and thus enable the budget
to be committed. However, because the technical assistance was
taken on at a relatively late stage and was overburdened by the
sheer amount of work to be carried out in a very short space of
time, it did not always provide the results expected. As a result, in
several countries (e.g. the Czech Republic, Latvia) the national
authorities had instead to fund national experts to perform the
work. Moreover, the Commission was obliged to insert condi-
tions into Financing Memoranda concerning the completion of
preparatory work which had to be met before project implemen-
tation could begin.

of experience of Cohesion Fund projects. However, the Commis-
sion could not make systematic use of this high quality assistance
because of the limited budget available for this purpose.

33.
From 2000 ISPA replaced PHARE funds as a source of
financing for project preparation. However, despite the limited
project preparation capacity in beneficiary countries, their take-up
of these funds was slow. Thus only two technical assistance
projects in candidate countries were committed in 2000 for a
total of 3,7 million euro.

32.
The Commission’s own capacity to appraise applications
and supplementary work carried out by consultants was initially
limited by the fact that in January 2000 it had allocated only five
A grade officials to ISPA. For by far the largest beneficiary coun-
try, Poland, (ISPA environment commitments of 133 million euro
in 2000) only one official was allocated to the environment sec-
tor until November 2001. A further constraint was the lack of
engineering expertise in the Commission. To help overcome this,
a framework contract was made with the European Investment
Bank, whose engineers and economists already had a large amount

34.
A major technical issue at the project design stage for the
most common type of infrastructure project, wastewater treat-
ment plants (WWTP) and their related networks, is the capacity
of the WWTP. Designs were often established during the Com-
munist era and based on a much higher demand for water due
mainly to the very low tariffs. The delays in using LSIF technical
assistance to appraise projects (see paragraph 31) meant that there
was little time to appraise the WWTP designs while some of the
factors influencing the optimal size of the capacity were difficult
to estimate given the rapid changes taking place in the economies

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concerned (1). Several cases were identified where the Commis-
sion had approved projects where there was a clear risk that the
capacity foreseen would prove too large, which would result not
only in the PHARE/ISPA grants being uneconomically used but
also that the subsequent operating costs would be greater than
necessary:

(a)

(b)

(c)

In Bulgaria the reasons and justifications for increasing the
Sofia WWTP from 500 000 m3/day to 700 000 m3/day
(17,3 million euro) were unclear. The PHARE financed con-
sultants stated that there was a lack of certainty concerning
the need to increase plant capacity to 700 000 m3/day. They
estimated that the average daily flow would fall by 40 %
from a maximum of 468 368 m3 per day in 2004 to
280 800 m3 in 2020;

In Lithuania, where there had been a particularly sharp drop
in water consumption, there were strong indications that the
Jurbarkas WWTP (PHARE: 2 million euro) had been designed
with an overly large capacity. In Kaunas PHARE-funded
pumping stations were also too large for current and pro-
jected needs (PHARE: 7,75 million euro);

In Poland, the Szczecin Maritime WWTP (PHARE: 1,1 mil-
lion euro) had only been functioning at only 40 % of its
capacity since its opening in April 2000. Also in Poland it
was noted that the LSIF had co-financed (5 million euro)
with the World Bank a water supply project in Bielsko Biala
providing support for water tanks which had a combined
capacity of 80 000 m3/day whereas current demand was
approximately 55 000 m3/day;

(d)

For two ISPA projects in Hungary (Györ: 14,5 million euro)
and Romania (Braila: 44,9 million euro) there were strong
indications that the proposals submitted for the WWTP
capacity would lead to a plant that was too large for current
and future needs.

Weaknesses in tendering and supervision

35.
Since 1998 a key criterion for selecting PHARE projects
has been their readiness for implementation. In reality projects
approved for funding often required significant further prepara-
tion. When combined with the inexperience of beneficiaries in
organising tenders, this led to more than half of the PHARE infra-
structure projects audited only being contracted in the last quarter
of the period for contracting laid down in the Financing Memo-
randa.

The contracting of ISPA measures was also considerably
36.
delayed when compared with the timetables set in the Financing
Memoranda. At the end of 2001 only one ISPA works contract
had been concluded for 1,9 million euro in Slovenia. While the
preparation of tenders for large infrastructure projects is a com-
plex undertaking, and the time schedule established by the Com-
mission in the Financing Memoranda was generally not realistic,
there are a number of other reasons why tendering is behind
schedule:

(a)

(b)

(c)

(d)

(e)

the lack of experience of most beneficiaries, both at central
and local level, in the preparation of tender documentation
using Commission and FIDIC (2) procedures;

although the Commission committed 7 million euro in 2000
to finance posts in its Delegations for engineers to supervise
ISPA implementation, including tendering, in half of the
Delegations the engineer took up his post only in Septem-
ber 2001 or later;

in some cases projects suffered from delayed and inadequate
work by consultants financed by the Commission to draw
up the tender documentation;

initial problems related to different provisions for tender
evaluation in the Commission’s decentralised implementa-
tion system procedure manual and the new Practical Guide
which it introduced in January 2001;

problems with EBRD co-financing, mainly in Poland and
Romania, because of differences between EBRD and Com-
mission procurement procedures which were eventually
resolved when the ISPA Regulation was modified in Decem-
ber 2001; and

(f)

in some cases the need for beneficiaries to meet certain con-
ditions, usually resulting from incomplete project prepara-
tion (see paragraph 31), before implementation could begin.

37.
The Commission and the beneficiary countries have
favoured the use of ‘design and build’ over ‘measured works’ con-
tracts. The former type of contracts have the advantage of plac-
ing the responsibility for the design of the infrastructure on the
contractor, with the result that cost overruns are borne by the
contractor rather than the beneficiary. On the other hand, because
the contractor must cover this risk, the costs of such contracts can
be expected to be higher than for measured works contracts, and
these higher costs are borne by the PHARE and ISPA programmes
rather than directly by the beneficiary. It is also noted that the
Commission has not systematically required financial evaluations
of tender bids involving ‘design and build’ contracts to take
account of the long term operating costs of the project resulting
from a particular design as well as the capital costs.

(1) Such factors included household water consumption levels which
were falling in response to tariff increases, the prospects of local
industries, estimated population change and likely income growth.

(2) Federation Internationale des Ingenieurs-Conseils.

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Infrastructure projects have not always had an engineer
38.
of an international standard to supervise them. In the candidate
countries, staff employed by the beneficiary itself have tradition-
ally carried out the supervision and the Commission has not sys-
tematically ensured that the project includes the necessary budget
to finance effective supervision. While the ISPA measures exam-
ined generally did include a budget for supervision, in several
cases the amount concerned was less than 2 % of the budget.

39.
Although in most cases, once the tendering had been
completed, construction works were carried out as foreseen in the
Financing Memoranda, the following projects proved problematic
in their implementation:

(a)

(b)

(c)

in Lithuania, the implementation of the Klaipeda Water
Treatment project (PHARE LSIF: 7,2 million euro) experi-
enced serious difficulties because of poor project prepara-
tion and disputes between the beneficiary and the contrac-
tor
(see
in the absence of an independent engineer
paragraph 38). Construction works had not yet begun at the
time of the Court’s audit in October 2001, 24 months after
the contract had been scheduled to begin;

in Bulgaria, the original budget of 34 million euro for the
rehabilitation of the Sofia Wastewater Treatment Plant was
below the amount which the consultant considered ‘to be
the necessary minimum’ to carry out the works adequately.
Nevertheless the Commission subsequently reduced the bud-
get to 22,4 million euro. As a result, the limited scope of the
project meant that there continued to be a real risk that the
plant would break down, posing a serious threat of pollu-
tion to local rivers and ultimately the Danube;

in Poland under the Podhale Geothermal Project (1999
PHARE LSIF: 14 million euro), which was designed to reduce
air pollution, 4,82 million euro (34,4 % of the programme)
was contracted for the construction of a ‘spa centre’ build-
ing. This construction project cannot be considered as con-
tributing to the implementation of the environmental acquis
nor is it an integral part of the PHARE project, which focuses
on linking together the different elements of the heating sys-
tem through the installation of pipelines. While the project
fiche does refer to the extension of the project to green-
houses and spa hotels, the implication was that pipelines
would be extended to existing facilities and not that a new
spa centre would actually be constructed. Moreover, given
the amount of funding devoted to this purpose, the project
fiche should have clearly shown the budget for this compo-
nent which it did not.

CONCLUSIONS AND RECOMMENDATIONS

There continues to be a significant need for
institution-building

40.
The audit found that the PHARE programme has only
been partially successful in developing institutional capacity. Not
only were in some cases the funds committed by the Commis-
sion insufficient, but the Commission’s main instrument for
institution-building, twinning, by no means always achieved the
so-called ‘guaranteed’ results foreseen, mainly because of the insti-
tutional weaknesses the projects were intended to tackle. More
generally, there were clearly limits to what the PHARE programme
could achieve within the tight accession timeframe and the Com-
mission’s institution-building strategy placed too much reliance
on the twinning instrument, which cannot be expected to over-
come many of the underlying structural problems faced by can-
didate countries’ administrations. Thus significant efforts remain
to be made in institution-building, not least because of the key
role national, regional and local authorities and operators have to
play in meeting the environmental acquis through both planning
infrastructure projects and
and implementing environmental
ensuring the sustainability of projects after construction.

It is recommended that the continued significant need for

41.
institution-building should be addressed as follows:

(a)

particular attention should be paid to the institution-building
needs of national and local authorities in the environment
sector when allocating further pre-accession or post-
accession assistance. Such assistance should be based on a
common strategy agreed between the Commission and the
candidate countries for public administration reform;

(b) more ISPA resources should be devoted to providing techni-
cal assistance at the level of the final beneficiary to improve
the chances of operational and financial sustainability of
infrastructure investments;

(c)

additional assistance should be given to introducing the
extended decentralised implementation system (EDIS) for
ISPA measures in candidate countries as much in advance of
accession as possible in order to prepare them for manag-
ing the Structural Funds.

Scarce grant financing can be targeted more effectively

42.
The audit found that PHARE and ISPA funding could
have been more effectively targeted if candidate countries had
designed environmental and financing strategies at an earlier
stage. While the Commission has generally kept ISPA grants

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below the maximum level of 75 %, partly due to effective coop-
eration with the EIB and IFIs, there is further scope for reducing
grant levels. Despite the enormous needs of the environment sec-
tor, the absorption capacity of the candidate countries is limited
due to the continuing need for institution-building and for
improvements in project cycle management.

To more effectively target scarce grant financing it is rec-

43.
ommended that:

(a)

the Commission should increase support to the develop-
ment of financing strategies and closely monitor their imple-
mentation;

(b) more efforts should be made to develop projects in the air
sector while it should be ensured that solid waste projects
are based on national and regional strategies;

(c)

(d)

the Commission should seek to further increase the lever-
age of ISPA grants and establish and respect clearer criteria
for setting the grant level;

the Commission should continue to develop its cooperation
with the EIB, the EBRD and other IFIs and further explore
possibilities for public-private partnerships.

Absorption capacity should be increased by strengthening
project preparation and tendering capabilities

The following specific steps are recommended to

45.
strengthen project cycle management and absorption capacity:

(a)

the Commission should support and encourage candidate
countries to invest the considerable resources necessary to
develop a pipeline of projects to use the remaining ISPA and
future Cohesion Fund financing;

(b)

the Commission should allocate sufficient staff and make
full and timely use of technical assistance for the technical,
financial and institutional appraisal of investment projects;

(c)

(d)

the Commission should provide candidate countries with
significant technical assistance support to strengthen candi-
date countries’ capacities to arrange competitive tendering
for works contracts;

consideration should be given to making more use of mea-
sured works contracts for relatively simple environmental
infrastructure projects and tender evaluation criteria should
be developed to ensure that the economically most advanta-
geous bids are selected for the design and build contracts
required for more complex projects;

44.
Difficulties in preparing project proposals and drawing
up tendering documentation on the part of the candidate coun-
tries have resulted in delays and reduced their capacity to absorb
the large increase in environmental funding provided by ISPA.

(e)

the Commission should ensure that the necessary funds are
systematically included in the budgets of ISPA measures to
enable them to be supervised by engineers of sufficient expe-
rience.

This report was adopted by the Court of Auditors in Luxembourg at its meeting of 10 April 2003.

For the Court of Auditors

Juan Manuel FABRA VALLÉS

President

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THE COMMISSION’S REPLIES

SUMMARY

I.
The Court’s audit covers the first year of ISPA program-
ming. Since 2001, the Commission already has undertaken vari-
ous initiatives to redress the weaknesses identified by the Court.

II.
Since establishment of the Copenhagen criteria, address-
ing institutional constraints has been a constant priority. The
Madrid Council conclusions in 1995 indicated administrative
capacity to implement the acquis as a key area of concern. In the
absence of any specific acquis on overall public administration
reform and in the context of subsidiarity, the Commission adopted
an adaptive and innovative strategy in an area at the limit of its
competence. By any historical standards, the PHARE assisted pace
of change has been rapid. The Commission notes the Court’s
agreement that further institution-building is required and assis-
tance will continue beyond accession, through the delivery of
both the 2002 PHARE Action Plans, which mobilised 1 billion
euro and through the transition facility. The observation on lim-
ited funding in this sector overlooks the impact of PHARE invest-
ment in regulatory institutions after 1999. Furthermore the obser-
vation hides the historical fact that for three years of the audit
period, PHARE was demand driven during which the candidate
countries preferred infrastructure projects to either addressing
administrative capacity or investment in institutions. This was
completely changed by the Commission opinion, which formed
the basis of the Luxembourg Council conclusions in 1997. These
accession-driven developments made it possible to massively
increase PHARE (and later ISPA) allocations to projects and to
progressively increase both capacity building and investment in
institutions, which became 65 % of overall annual allocations
after 1999. The Regular Reports became strategic tools for iden-
tifying institutional and administrative constraints and allowed
assistance to be tactically targeted within the framework of the
Accession Partnerships, the Action Plans and the negotiations.

In the context of ISPA, the Commission already responded to the
Court’s observations by providing technical assistance to
strengthen the administrative capacity of final beneficiary where
needed.

Since the beginning of ISPA in 2000, the Commission has
IV.
undertaken various initiatives to overcome these weaknesses. It
has signed several framework contracts, including with the Euro-
pean Investment Bank (EIB), has asked for further studies to review
the design capacity, provided training for public procurement (the
Commission agrees with the Court’s observations that procure-
ment deficiencies in candidate countries are a major bottleneck),
and as a rule includes funds for supervising engineers in projects.

Given the earlier demand driven context of PHARE, prior to the
1997 Luxembourg Council conclusions, the Commission could
not address institutional weaknesses unless a candidate country
requested it to do so as the Court observes in 3 (a) and (b) below.
Furthermore, the unsatisfactory record of consultants in this regard
compelled the Commission to launch an instrument that mobil-
ised public sector expertise in the specific areas of the acquis.

See Commission comments on paragraph 39 on these exceptions
to the satisfactory implementation of most projects.

INTRODUCTION

2.
Implementation plans were useful for the negotiation and
for domestic planning in the countries. Any transitional measures
granted have been based on close scrutiny of these plans. After
this scrutiny, the EU has accepted limited Transition Periods in
time and scope. The latter also include intermediate targets and
are based on financing strategies contained in the implementa-
tion plans.

3. (c) Since 2000 PHARE funding in this sector is exclusively
focussed on capacity building mainly through twinning
and investment in regulatory institutions.

INSTITUTION-BUILDING PROJECTS IN THE ENVIRONMENT
SECTOR

III.
The Commission considers that the scope for reducing
the grant levels is extremely limited. Many parameters need to be
taken into account when calculating the grant rate, not least the
income levels, which as substantially below the levels in the cur-
rent EU, and access to international financial institutions (IFI) cofi-
nancing. Any further reduction of grant levels may result in unac-
ceptable burdens, in particular on low-income households.

9.
From 1995 to 1997, PHARE was indeed demand driven.
Priorities were established by the Candidate Countries who pre-
ferred infrastructure projects to institution-building. However,
after the Luxembourg Council Conclusions in 1997, under the

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Accession Partnerships 30 % of PHARE funding was allocated to
institution-building overall, mainly through twinning. The PHARE
Guidelines of 1998 established institution-building as the first pri-
ority. After the 1999 PHARE Guidelines, approximately 35 % of
PHARE was also allocated toinvestment in regulatory infrastruc-
ture . Environmental ministries and agencies were able to use this
allocation to purchase general and specialised equipment needed
to implement the acquis.

The post-communist structures and administrative cultures
bequeathed to the candidate countries presented a daunting pros-
pect. There were many competing priorities to be addressed. Fur-
thermore, in many countries essential regional or other reforms
necessary for the implementation of he environmental acquis had
not even been started and the Commission could not assist insti-
tutions that did not exist.

The limited funding committed by the Commission in
10.
conjunction with the candidate countries in the years 1995 to
1997 to institution-building and investment in regulatory infra-
structure in the environment sector primarily reflects the higher
priority attached by Candidate Countries to environment infra-
structure projects.

Indeed the action plans were launched in 2002 and will not be
completed until 2005. However, the 2000 projects will be com-
pleted before accession and the 2001 projects will be completed
in 2004 the year of accession.

Through twinning the Commission pioneered an unprec-
12.
edented transfer of know-how on complex and technical issues
from the diverse administrative traditions in Member States to
equally diverse Candidate Countries. Only the basic concept under-
lying the notion of ‘guaranteed result’ is outlined in paragraph 11.
It was also essential in mobilising political will and resources in
the candidate countries. Furthermore, the positive feedback from
administrations engaged in twinning was essential in building
Member State’s confidence and secured closure of the negotia-
tions in Copenhagen. This widely acclaimed success was the ulti-
mate result delivered by twinning

13.
The Commission agrees with the observations of the
Court (personnel leaving the ministries once trained, reliance on
foreign consultants, and similar consequences of lack of adequate
administrative capacity and low salaries in the public sector of
candidate countries). The Commission has undertaken several
training activities in particular in the field of public procurement,
but the risk remains that qualified staff leave the administration
to take up jobs in the private sector (or in EU Institutions). The
acute human resource constraints in public administration can

only be fully overcome through growth and development, under-
pinned by the economic security and solidarity provided through
membership.

14.
In the absence of any specific acquis as the Court observes
and in the context of subsidiarity the Commission has not estab-
lished criteria to define overall levels of capacity, as this is not
applied to the diverse administrative cultures of Member States.
Consequently, it is not possible to invent separate standards for
candidate countries. This is precisely why twinning was so essen-
tial in exposing the candidate countries to existing practices, par-
ticularly given the fact that the Commission does not implement
or manage the main body of the acquis but Member States do.
Thus, the Commission pioneered an unprecedented strategy in an
area at the limit of its competence to transfer know-how on com-
plex technical issues from diverse administrative traditions to
equally diverse candidate countries. Within this strategy the Regu-
lar Reports (on which the strategy papers and Accession Partner-
ships are based) tactically targeted the priorities and mobilised
political will and resources in the Candidate Countries. The posi-
tive feedback from EU administrations engaged in twinning was
essential in building the confidence that secured closure of the
negotiations in Copenhagen. This evident success was one of the
results undeniably delivered by twinning.

15.
Various initiatives have been undertaken since 2000 to
strengthen the administrative capacity in candidate countries (e.g.
technical assistance provided through ISPA for project prepara-
tion or public procurement). As regards the Court’s observations
related to the quality of strategies and projects, the Commission
already responded to these concerns when they where expressed
in the Court’s Annual Report 2000 (the preparation of strategies
started already in 1999. There was a sufficient number of sound
projects that complied with the ISPA Regulation and strategic
objectives for accession).

16.
The Commission has encouraged candidate countries to
use ISPA technical assistance funds for preparation for the Com-
mission’s Extended Decentralised Implementation System (EDIS).
By 2002, all ten ISPA beneficiary countries received technical
assistance funds for the preparation of EDIS. This technical assis-
tance also provides support for the financial management of
Implementing Agencies. By the end of 2002, all ten countries had
initiated the first step towards EDIS (Gap assessment), three had
moved to the second phase (Gap plugging) and one country had
finished phase three (Compliance assessment) by end of 2002.

The Commission in 2000 was concerned to ensure that the bod-
ies responsible were setting up structures necessary to manage
ISPA in accordance with the requirements of the existing system.

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The Commission agrees that the primary objective of
17.
ISPA is to finance infrastructure. Institutional strengthening initia-
tives are included in ISPA measures only in case it relates to spe-
cific projects and implementing agencies. When applying for
funds, candidate countries must provide information on the insti-
tutional setting for the implementation of the project. In some
cases where this is considered necessary, ISPA measures include a
component of technical assistance aiming to improve the finan-
cial and operational performance of final beneficiaries. During the
project appraisal stage, but also during implementation, techni-
cal assistance is frequently provided through the framework con-
tracts signed by the Commission, for example in the case of com-
plex public-private partnership schemes for which institutional
capacity is frequently lacking. Furthermore, the modulation of the
ISPA grant rate takes also account of the capacity to cover operat-
ing and maintenance costs.

THE FINANCING OF ENVIRONMENTAL INFRASTRUCTURE
PROJECTS

18.
The Court expressed a similar concern in its Annual
Report 2000, to which the Commission responded that the prepa-
ration of applicant countries for ISPA started already in 1999
with the negotiations of the strategies and the provision of guid-
ance. These strategies define the priorities for ISPA financing, tak-
ing account when selecting high-priority projects of regulatory
requirements, the investment needs, the impact or the availability
of cofinancing. The aim of ISPA is to finance priority projects,
which are mature enough to obtain financing and meet the fund-
ing requirements and standards. The projects financed in 2000
were projects designed to tackle the most urgent investment needs
in the environmental sector.

Ranking is not more important than readiness. If a project is not
‘mature’ it cannot be financed.

cific condition in the Financing Memorandum concerning the
consortium agreements to be defined between the municipalities
involved in each project. These agreements are the contractual
basis between the municipalities for handling properly the munici-
pal waste produced in the region.

21.
In discussions of environment sub-committees under the
Association Agreements and in all activities related with acces-
sion negotiations the Commission has emphasised the need for
countries to identify early their infrastructure needs to comply
with EU environment acquis and prepare detailed investment pro-
grammes. The June 2001 Communication was based on the evi-
dence that countries still needed concrete guidance to prepare
their Directive specific implementation plans to in support of
their requests for transitional periods for investment-heavy direc-
tives and also required support in developing their financing strat-
egies and project pipelines to ensure implementation of their
commitments. Elaboration of such plans and project pipelines for
the environment sector is a very demanding and complex task
given the high number of stakeholders involved (from national to
local authorities, from donors and grant agencies to private funders
etc.).

22.
Income generation is not the only key factor in appraisal
of investment in public goods such as sewage systems. For the
Commission, what is important is that commitment, ownership
and sustainability of the project is assured by co-financing from
public funds whatever the source. Furthermore, the Commission
advises neither Member States nor candidate countries on what
charges or tariffs consumers must pay for water services.

No air pollution measures have yet been decided by the
19.
Commission which is essentially due to the complexity of such
projects and consequently the lack of admissible funding applica-
tions. Although the national ISPA strategies for environment indi-
cate for some countries air pollution projects as a priority, the
Commission has not yet received an application that meets the
eligibility criteria of the ISPA Regulation, including compliance
with competition and State aid rules.

23.
The Commission considers that the scope for reducing
the grant level is extremely limited. The financial analysis which
is an essential component of the project applications forms the
basis for the calculation of the grant rate, taking account, inter
alia, of the affordability levels and household income which is
substantially lower than in the EU. In some cases any further
reduction in the grant level would mean that the project would
not get off the ground.

20.
In the case of Hungary, delays were principally political
in origin. The National Plan had been at Parliament since mid-
2001 but was not approved because of differences between gov-
ernment and opposition on the financing of the National, the
Local and the Regional Plans. Moreover, Chapter 22 (Environ-
ment) gives the Hungarian authorities time until accession to pre-
pare regional plans. In order to start financing projects in this sec-
tor which is essential
for compliance with the acquis, the
Commission adopted a pragmatic approach by introducing a spe-

24.
The guideline target for affordability (4 % for water, 1,5 %
for solid waste) is not a legal requirement, and in any case it is
based on average household. The burden on low-income house-
holds is certainly much higher, in particular in countries where
average income is substantially below the EU average.

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Moreover, there are other criteria which also need to be taken into
account, such as the municipality’s access to loan financing or to
sources from the national budget, or the municipal expenditure
programme. These factors combined allow the Commission to
decide on an appropriate grant level. A lower grant level can
make the project unaffordable for the municipality and thus delay
urgent environmental investment.

The Commission agrees that in the running-in phase cer-
31.
tain applications were not up to the standard to obtain financing
from the Community budget, or IFIs, or in fact any funding insti-
tution.

25.
Tariffs levels vary in Polish cities and there is no require-
ment to equalise them across all cities. In Torun, the city has
already built a major treatment plant and the Commission grant
(at 60 %) is only for an extension of the sewer network plus a
small amount for drinking water treatment. Tariffs of 2,5 % of
average household income in Torun are equivalent to 3,5 % of the
income of the poorest 20 % of the population.

Since 2000, when ISPA funds became available, the Commission
has encouraged Candidate Countries to make use of these funds
to prepare a strong project pipeline. Until the end of 2002, the
Commission approved 14 of such technical assistance projects
(equivalent to an ISPA grant of euro 232 million). These measures
were essentially for improving project preparation capacities of
Implementing Agencies, including financial analysis and Environ-
mental Impact Assessment.

In relation to Bydgoszcz, there was no scope to lower the grant
rate. None of the IFIs would lend more than 50 % (the availability
of cofinancing is one of the criteria to take into account for the
calculation of the grant rate).

The fact that candidate countries augmented PHARE technical
assistance with their own funded expertise was a positive response
to their lack of capacity.

28.
As regards the Court’s observation concerning adequacy
of the grant rate, the Commission refers to its comments to para-
graphs 24 and 25.

29.
The Commission realised quite early in 2000 when it
received some project applications that certain safeguards need to
be put in place when grants are provided to public-private part-
nerships (PPP) schemes to ensure that basic principles are applied
to protect the Community interest and that of the population
concerned. Consequently, the Commission signed in 2001 a
framework contract to obtain access to relevant financial and
legal expertise and to provide advice beneficiaries in their deal-
ings with private utility firms on a case basis. Furthermore, guide-
lines were developed in 2002 — in coordination with the EIB and
the EBRD — with the view to assist beneficiary countries to tailor
PPP schemes, and dissemination seminars are being organised in
the Candidate Countries for early 2003 in which EIB and EDRB
participate.

32.
To overcome the difficulties described by the Court, the
Commission not only concluded a contract with the EIB for
project appraisal, but also two framework contracts with consul-
tancy firms for engineering expertise in the environmental and
transport sectors (in 2000) and a further framework contract for
legal, financial and institutional matters for PPP (in 2001). The
contracts are used systematically during the appraisal process but
also for institutional advice to the national authorities.

However, the Commission could only make limited use of this
high-quality assistance because of ceilings set by the EIB.

33.
In 2000, PHARE resources were still available for the
preparation of ISPA measures. Between 2000 and the end of
2002, 14 technical assistance measures for project preparation
were decided by the Commission (see reply to paragraph 31).

THE MANAGEMENT OF ENVIRONMENTAL INFRASTRUCTURE
PROJECTS

30.
Difficulties in achieving a balance between environmen-
tal and transport projects existed for two countries. The balance
is to be achieved over the total seven years period, and the Com-
mission is correcting this imbalance in a particular year during
the whole seven years period.

34.
The Commission shares the concern expressed by the
Court as regards design deficiency and excess capacity, due largely
to price-induced reduction of water consumption and industrial
decline. Feasibility studies generally contain demand analysis, tak-
ing account of price elasticities, demographic developments and
structural change. It is, however, true that some of the provisional
design parameters for first-wave ISPA projects might have led to
oversizing if no further measures were taken. The use of the
‘Design and Build’ type of contract allows in such cases to
re-calibrate the design parameters.

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(a)

The design parameter based on the peak storm flow con-
firmed by two independent consultants is 680 000 m3/day.
The measured peak storm flow was 671 000 m3/day in Feb-
ruary 1998. The same report of the PHARE financed con-
sultants indicate that a typical storm or snow melt event can
increase daily flow by about 250 000 m3/day. The average
daily flow design parameter is 480 000 m3

(b) As the Court observes, water consumption had declined for
several years. This will not last. Although oversize may seem
apparent (at the water consumption norm 50-80 l/capita)
due to difficult social conditions, the economy will revive
with accession and original design capacities will be reached.
Furthermore, extension of the wastewater collection systems
in Jurbarkas, will contribute to meeting the designed capac-
ity. Similarly, extension of sewage collection in Kaunas will
be financed through ISPA 2001 and help meet design capac-
ity there.

The Commission agrees with the Court’s assessment that
36.
the implementation of large infrastructure projects is a complex
undertaking. The Commission would like to emphasise that the
preparation of high-quality tender documents requires highly
skilled expertise, which needs to be built up in candidate coun-
tries, and the tender process for large infrastructure contracts
takes, in the best case, at least nine months from publication of
procurement notice to the signing of the contract. Most of the
Financing Memoranda for projects decided in 2000 where only
counter-signed very late in 2000 with the majority in 2001.

(a) The Commission has been and is addressing these deficien-
cies. It initiated various actions in 2001 and 2002, includ-
ing training seminars in the candidate countries to enhance
the capacity of the national authorities involved in the ISPA
process in the field of public procurement. These activities
are continuing in 2003.

The assumptions in the project fiche were correct and took
into account the possibility of a decrease in shipping move-
ment in the Port of Szczecin. Thus the project remained
viable even with a 60 % drop in shipping. Irrespective of the
fact that the plant operates at 40 % of its capacity it should
be born in mind that this is the only such facility in Poland
able to handle this type of waste. In Bielsko Biala, there is an
expectation that demand will rise, particularly as other neigh-
bouring municipalities are foreseen to be connected to the
water supply system.

(b)

(f)

(c)

(d)

ISPA implementation relied in 2000 and early 2001 largely
on staff in Delegations responsible for PHARE. The recruit-
ment of experts under the ISPA technical assistance budget
commenced in 2001, before ISPA implementation became
in full swing. The recruitment for these posts was largely
completed by early 2002.

These conditions essentially relate to compliance with provi-
sions of the EIA Directives, with which candidate countries
had difficulties in 2000, given the complexity of this Direc-
tive. In 2001, the Commission undertook as series of train-
ing seminars to enhance the capacity of national authorities
to implement the requirements of the EIA Directive.

For the Györ project, the Commission did have doubts about
the capacity of the plant when approving the project in 2000
as the results of the studies undergone within the PHARE
framework contract were not yet final. Therefore, the Com-
mission required an assessment of the industrial load and
the final capacity of the plant. This assessment confirmed
the capacity of the plant. The Commission therefore does
not consider that the capacity of the plant is too large.

In the case of Braila (Romania), the consultant contracted
under the technical assistance/Supervision contract is cur-
rently undertaking a review of the design assumption in
terms both of hydraulic flow and pollution load as it becomes
evident that water consumptions and hence sewage dis-
charges are reducing rapidly. This will have an effect upon
the final sizing of the WWTP.

37.
The decision between the ‘design and build’ contract and
the ‘measured works/construction’ contract depends on many
parameters, one essential being the readiness and capacity of the
employer to design. The ‘design and build’ contract price nor-
mally stay throughout the works as tendered (risks are mainly on
the tenderer), but the ‘construction’ contract price tends to rise
from the tender price due to unavoidable need of variations (risks
are mainly on the employer). Price may rise to 20 % or more com-
pared to the originally awarded tender price for construction con-
tracts. Therefore, it is not predictable, which model gives the lower
final price. Furthermore, any higher costs would be shared between
ISPA and the final beneficiary proportionally to the grant rate.

Despite the inexperience of the beneficiaries and the
35.
project maturity constraint the Commission notes the Court obser-
vation that the projects were contracted within the legally required
period. This is a considerable achievement of both Commission
assistance and of the Delegations support to the candidate coun-
tries.

Taking appropriately account of operating costs is a very complex
matter, which is under investigation by the Commission. As an
interim solution, tender dossiers specify in detail the requirements
influencing the operating costs and these will then be discounted
so that they can be compared between the different offers.

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The Commission recognises that in some early projects
38.
the budget provisions for supervision have been too low. In the
case of Romania, where this has been the case for some measures
approved in 2000, the amount for supervision has been increased
prior to tendering through reallocation between budget headings
(to around 6 %).

39. (a) The difficulties are limited to the late start of works and
extension of the contract duration. There is no related
risk to implementation. The participation of an indepen-
dent engineer would not have resolved difficulties that
were unrelated to procedural and adjudication matters.
Moreover, an independent engineerwas not required as
this contract follows the FIDIC Orange Book, where
responsibility for project management lies with the
employers representative, the functions and mandate of
which are different to those of the FIDIC Engineer under
the Red Book, to which the Court presumably refers.

(b) The estimated budget for rehabilitation was indeed 33
million euro. Available PHARE funds were 23 million
euro and essential works were undertaken within this
budget precisely to avert any immediate risk of pollution
mentioned by the Court. Nevertheless, the Commission
intended further work to be undertaken as an integral
element of overall reconstruction of the drinking water
and sewage systems to be funded by ISPA. However,
despite guidance in this regard the beneficiary never made
a proposal that met ISPA eligibility rules. Furthermore,
the concessionaire is required by the 1999 contract to
invest a further 140 million euro in the system. Follow-
ing the Court’s observation the Commission consulted
with engineers working on the plant there is no evidence
that there is a significant or immediate risk of breakdown
or related pollution of the Danube.

(c) As has been identified in the text the problem in this case
relates to the content of the project fiche. No problem
exists regarding implementation since this has been car-
ried out according to the requirements of the project
fiche.

changed this approach. In the absence of any specific acquis and
in the context of subsidiarity the Commission has not established
criteria to define overall levels of administrative-capacity, as this
is not acceptable to the diverse administrative traditions of Mem-
ber States. Thus, it is not possible to invent separate standards for
candidate countries. This is why twinning was so essential in
exposing the candidate countries to existing practices, as Member
States implement the main body of the acquis. Thus the Commis-
sion pioneered an unprecedented strategy to transfer know-how
on complex issues from diverse administrative traditions to the
equally diverse candidate countries. Within this strategy the Regu-
lar Reports tactically targeted the priorities and mobilised politi-
cal will and resources in the candidate countries. The positive
feedback from EU administrations engaged in twinning was essen-
tial in building the confidence that secured closure of the negotia-
tions in Copenhagen. This widely acclaimed success was one of
the results undeniably delivered by twinning.

41. (a)

In the framework of the negotiation of Chapter 21
(Regional policy) candidate countries committed them-
selves to increase their efforts to bring the administrative
capacity of the bodies responsible for the management of
the Cohesion and Structural Funds. The development of
the human resources for Cohesion and Structural Funds
management will be closely monitored.

Both PHARE and the transition facility after accession
will provide further institution-building assistance in this
field. Given the limits of Commission competence, as
with current Member States, public administrative reform
is a responsibility of the candidate countries.

(b) The financial analysis which forms the basis for the cal-
culation of the grant rates assesses the capacity to ensure
financial viability; further technical assistance is provided
to strengthen the capacity of the final beneficiary on a
case by case basis.

(c) By end of 2002, all candidate countries received techni-

cal assistance funds for the preparation for EDIS.

CONCLUSIONS AND RECOMMENDATIONS

42.
The Commission considers that the scope for reducing
the grant level is extremely limited, given the low income levels
in candidate countries, the need for urgent investment and their
macroeconomic weakness.

40.
The development of horizontal institutional capacity is
beyond the remit of the PHARE programme. The remark on
insufficient funding omits the impact of directly related invest-
ment in regulatory infrastructure in the overall context of
institution-building after 1999 and hides historical aspects. In
1995 to 1997, PHARE was demand driven and the candidate
countries preferred projects to institution building. The Commis-
sion opinion and the Luxembourg conclusions in 1997 radically

The Commission shares the concerns expressed by the Court. It
has made available technical assistance funds under ISPA to
strengthen the capacity of candidate countries to prepare envi-
ronmental projects (also for the Cohesion Fund) and for imple-
mentation.

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43. (a) Elaboration of such strategies is a very demanding and
complex task given the high number of stakeholders
involved (national and local authorities, donors, the pri-
vate sector, etc…). Support activities from the Commis-
sion which started in the framework of the Priority Envi-
ronment Projects for Accession (PEPA) programme in
2000 continue within a new PHARE multi-country
project, inspired on the PEPA programme, which will
run during 2003.

(b) The Commission has not yet received funding applica-
tions for air pollution projects that meet the required eli-
gibility criteria; solid waste projects need to meet the
requirements of the relevant EC Directives and be con-
sistent with sectoral plans.

(c) On average, the grant rate is 65 %. The Commission con-
siders the criteria for establishing an adequate grant rate
are clear: they include the application of the polluters
pays principle, availability of own sources for covering
operating and maintenance costs, affordability, credit-
worthiness of the company benefiting form the ISPA
grant, availability of IFI cofinancing.

(d) The Commission cooperates with the EIB, the EBRD and
other IFIs as appropriate during the entire project cycle;
the Commission has recently prepared guidelines for
public-private partnership schemes which should facili-
tate the preparation of PPP schemes that are suitable for
Community funding.

Weaknesses in some funding applications did not result
44.
in difficulties to absorb the environmental funding in 2000. How-
ever, the Commission agrees with the Court that candidate coun-
tries have difficulties in tendering and contracting. The Commis-
sion provides assistance to reduce these deficiencies.

45. (a)

In its dialogue with Candidate Countries, the Commis-
sion encourages them to use ISPA technical assistance for
preparing a project pipeline for ISPA and the Cohesion
Fund. This has been taken up by Candidate Countries,
but continued efforts are required to ensure a sufficient
project pipeline, in particular for the Cohesion Fund.

(b) The Commission concluded in 2000 two technical assis-
tance contracts and in 2001 a further contract for pro-
viding advice on public-private partnership issues.

(c) The Commission is providing advice and technical assis-
tance to strengthen the public procurement capabilities
in candidate countries.

(d) The choice of the contract model is based on technical

considerations.

(e) The Commission agrees with the Court. Service contracts
for supervising engineers are included in ISPA measures
as rule.