Communication from the Commission to the European Parliament, THE Council and the Court of Auditors - More or less controls? Striking the right balance between the administrative costs of control and the risk of error {SEC(2010) 640} {SEC(2010) 641}
Date: 2010-06-02
Institutions: European Commission
Subjects: EU expenditure, budgetary control, cost analysis, general budget (EU), implementation of the budget

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EUROPEAN COMMISSION 

Brussels, 26.5.2010 
COM(2010) 261 final 

COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN 
PARLIAMENT, THE COUNCIL AND THE COURT OF AUDITORS 

More or less controls? Striking the right balance between 
the administrative costs of control and the risk of error 

{SEC(2010) 640} 
{SEC(2010) 641} 

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COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN 
PARLIAMENT, THE COUNCIL AND THE COURT OF AUDITORS 

More or less controls? Striking the right balance between 
the administrative costs of control and the risk of error 

1. 

BACKGROUND AND OBJECTIVE OF THE PRESENT COMMUNICATION 

The Commission is responsible for the execution of the budget, paying each year some €130 
billion to beneficiaries in the Member States and throughout the world across a wide range of 
policy  areas.  While  the  Commission  directly  manages  around  one  fifth  of  the  budget,  the 
remainder  is  executed  in  conjunction  with  partner  bodies,  including  the  Member  States, 
through which some 75% of the budget passes. 

The risk profiles of these activities differ according to the complexity of the legislation, the 
length  and  complexity  of  the  control  chain,  the  types  of  beneficiaries  and  other  factors.  To 
ensure compliance with rules and the achievement of policy objectives, control strategies need 
to  be  tailored  to  the  risks  and  specificities  of  each  policy  area,  setting  out  the  nature  and 
timing  of  controls  to  be  exercised  (preventive,  detective  and  corrective)  taking  into  account 
the different risks profiles of beneficiaries. 

For expenditure managed centrally, the Commission made over 500,000 individual payments 
in 2009 to a total of 85,000 different entities or individuals (including staff). Typically, grant 
expenditure comprises pre-financing followed by cost claims which "clear" the pre-financing, 
mainly  on  the  basis  of  costs  actually  incurred.  In  many  cases,  the  final  control  by  the 
Commission on the eligibility of costs is carried out at the time of or after the final payment 
- in some areas this may be several years after the initial pre-financing. This control is often 
executed on a sample basis and may comprise desk-based and/or on-the-spot controls. 

For  expenditure  in  shared  management,  the  Commission  makes  payments  to  Member  State 
authorities  which  manage  and  disburse  funds  to  beneficiaries.  The  Member  States  are 
responsible  for  the  control  of  these  numerous  final  beneficiaries  (both  administrative  for 
100%  of  beneficiaries  and  on-the-spot  normally  of  at  least  5%  annually).  For  rural 
development  alone  (Pillar  2  of  the  Common  Agricultural  Policy)  the  total  number  of 
beneficiaries  in  2008  was  some  3.6  million,  receiving  some  €13.7  billion  of  public 
expenditure, € 8.5 billion in EU contributions.  

Each  grant  scheme  is  governed  by  the  Financial  Regulation  and  in  most  cases  by  specific 
sectorial legislation setting eligibility conditions for reimbursement of expenditure. Sectorial 
legislation is designed to target the achievement of often highly-specific policy objectives. It 
often  has  a  certain  level  of  complexity.  This  complexity  can  result  in  erroneous  financial 
claims  by  beneficiaries  who  may  misunderstand  or  misinterpret  eligibility  conditions:  such 
financial errors are for the overwhelming majority involuntary and are not fraudulent.  

Legal complexity, coupled with the potentially long gap between pre-financing and the final 
cost  claim,  increases  the  risk  of  error.  Such  errors  occur  for  a  variety  of  reasons  and  take 
different  forms  depending  on  the  specific  rule  or  contractual  requirement  broken  and  the 
nature  of  the  breach.  The  guiding  principle  in  the  public  sector  has  traditionally  been 

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compliance with rules with "zero risk taking" and no explicit recognition of the level of error 
which controls do not correct or cannot correct in a timely fashion. The responsibility of the 
manager of funds is to put in place a credible control strategy which directs control resources 
to the best effect, focusing on high-value and high-risk beneficiaries while not neglecting the 
rest. Such a strategy aims to provide reasonable assurance that money has been used for the 
intended purposes while ensuring an appropriate balance between the costs and the benefits of 
control  (principally  error-reduction/  recovery  and  the  deterrent  effect).  In  practice  a  certain 
amount of risk will be justified or "tolerable" as reducing error to "zero" is too costly or quite 
simply impossible. 

Until now, this acceptance of a justified risk of error has not been explicit. The Court applies a 
standard  2%  materiality  level  for  the  legality  and  regularity  of  underlying  transactions  (a 
"green light"). Above this, if the error rate calculated by the Court is between 2% and 5% it 
gives  a  "yellow"  assessment  and  if  it  is  over  5%  a  "red"  assessment.  The  Commission  has 
received  discharge  each  year  although  error  rates  have  exceeded  2%  in  some  areas.  The 
outcome of the Court's annual assessment of the Commission's management of EU funds has 
improved in recent years: however the level of error is still above the 2% threshold in some 
areas.  The  Commission  will  continue  improving  control  systems,  including  those  of  its 
implementation partners, to ensure "the right control at the right time". Nevertheless as risk 
varies  between  the  activities  managed,  the  Commission  considers  it  important  to  set 
reasonable and challenging benchmarks against which to judge its management of risk in line 
with a cost-benefit analysis. The Discharge Authority has also recognised this and invited the 
Commission to present tolerable risk proposals for all areas of the budget1. 

This  Communication  follows  a  2008  Communication  Towards  a  common  understanding  of 
the  concept  of  tolerable  risk  of  error  (COM(2008)866)  and  aims  to  fulfil  commitments 
there-in and the expectations of the Parliament and the Council. It presents the Commission's 
proposals  for  levels  of  tolerable  risk  of  error  (TRE)  for  the  policies  "Research,  energy  and 
transport" and "Rural development". Proposals for TRE in other areas will follow by the end 
of 2011. 

This  communication  is  presented  along  with  the  Commission's  proposal  for  the  triennial 
revision of the Financial Regulation, which includes an article on the concept of tolerable risk 
of error. Two staff working documents are annexed to the present communication providing 
technical detail on the methodologies and the results of the analysis underlying the proposals. 
They present detailed information on costs of control and on error rates and examine the link 
between  the  amount  of  control  carried  out  and  the  level  of  error  which  may  remain 
undetected. 

1 

European  Parliament  resolution  of  23  April  2009  (P6_TA(2009)0289)  with  observations  forming  an 
integral  part  of  the  Decisions  on  the  discharge  for  implementation  of  the  European  Union  general 
budget  for  the  financial  year  2007,  Section  III  –  Commission  and  executive  agencies,  point 48 
"[…]expects the Commission to take this work further when preparing its proposal on tolerable level of 
risk by budgetary area […]" 

European  Parliament  resolution  of  5  May  2010  (P7_TA(2010)0134)  with  observations  forming  an 
integral  part  of  the  Decisions  on  the  discharge  for  implementation  of  the  European  Union  general 
budget for the financial year 2008, Section III – Commission and executive agencies, points 59-60. 

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2. 

WHY DECIDE A TOLERABLE RISK OF ERROR? 

At  the  time  2007-13  legislation  was  adopted,  neither  the  costs  of  verifying  the  respect  of 
eligibility  conditions  nor  the  risk  of  error  were  explicitly  considered.  For  this  period,  the 
Commission  has  already  implemented  simplifications  in  the  Common  Agricultural  Policy, 
including rural development, and will continue to do so in future. However, any such further 
simplification  will  not  be  enough  to  reduce  the  error  rate  in  rural  development  below  the 
Court's 2% threshold without the risk of jeopardising policy objectives. 

In  the  area  of  Research  the  Commission  has  recently  issued  a  communication  on 
simplification aimed at launching an inter-institutional discussion on the issue2. However, the 
scope for further simplification of current legislation is limited given the time needed for this 
to  be  debated,  adopted  and  to  enter  into  force.  Adoption  of  a  TRE  would  allow  the 
Commission to optimise control in FP7 (striking the right balance between control costs and 
recoveries and minimising the reputational risk) prior to the implementation of simplification 
which it is determined to propose for FP8. 

TRE would recognise that in some areas, complex rules, extended control chains and control 
costs do not permit a 2% error level to be attained without incurring higher than justified costs 
(Figure 1 shows this relationship).  

Figure  1:  there  is  an  interdependency  between  legislative  complexity,  error  rates  and 
cost of controls 

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Simplifying the implementation of the research framework programmes: (COM(2010)187). 

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The  Commission  is  committed  to  implementing  sound  and  efficient  control  strategies, 
targeting risk and high-value activities without neglecting the rest. A decision on TRE will not 
result in a given rate of error being tolerated at beneficiary level: all errors detected will be 
corrected.  TRE  makes  explicit  a  judgement  which  is  already  implicit  by  recognising  the 
relationship  between  legislative  complexity  and  error  rates  as  well  as  the  fact  that  controls 
cannot  systematically  be  carried  out  on  the  spot,  all  meaning  that  some  errors  will  remain 
undetected. 

A tolerable risk approach gives a clear view of the balance between the financial impact of 
errors, the costs of control and related recoveries, and sound and efficient stewardship of EU 
funds. TRE levels per policy area, or significant parts thereof, should be based on a detailed 
review by all institutional stakeholders of the cost of control and the results of these controls 
and those of the Court. The added value obtained from expenditure (the right policy results at 
the right cost) is however at least as important in this context, since expenditure which does 
not achieve its objectives has limited value, even if perfectly controlled. As a result, political 
imperatives form part of the TRE discussion, notably the benefits of a policy and reputational 
aspects. 

3. 

HOW TRE LEVELS COULD BE DECIDED 

the 

the  proposal  for 

triennial  revision  of 

To establish a legal framework for the adoption of TRE levels, the concept of TRE is included 
in 
the  Financial  Regulation.  Following 
inter-institutional  discussion  on  the  content  of  this  Communication,  TRE  levels  could  be 
adopted by the co-legislator (the Parliament and the Council) after having consulted the Court 
of Auditors, on the basis of legislative proposals made by the Commission. The Commission 
would then take account of the co-legislator's decision in executing the budget and controlling 
expenditure. It would propose revisions to the TRE levels in the light of any major changes in 
the  control  environment  (for  example  simplification  of  eligibility  rules  reducing  the  risk  of 
error). 

Decisions on control levels and TRE go beyond a pure financial analysis. Controls are often 
considered burdensome by beneficiaries and may reach levels which discourage participation 
in programmes, thus jeopardising the objective of attracting the most appropriate beneficiaries 
and consequently the achievement of policy objectives. The tolerable error rate may also be 
influenced by political imperatives or by the level of reputational risk. 

Once  TRE  levels  are  decided,  the  Commission  will  continue  to  apply  effective  control 
strategies, to minimise error rates on the basis of a cost-benefit analysis and will be alert to the 
need to feed results back into the control cycle to ensure key risks are addressed. To reduce 
the risk of error it will propose further simplification for the post-2013 period. Simplification 
is however a responsibility the Commission shares with the co-legislator and Member States. 

4. 

COMMISSION PROPOSALS 

The  Commission  will  progressively  propose  TRE  levels  for  each  policy  area,  or  significant 
part  thereof.  This  Communication  covers  "Research,  energy  and  transport"  and  "Rural 
development" based on an analysis of the costs and benefits of controls and the link between a 

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given  management  and  control  cost3  and  the  residual  error.  Compared  to  the  2008 
Communication,  the  methodology  and  quality  of  underlying  data  have  improved.  However, 
any model necessarily includes assumptions, as set out in the detailed Commission working 
documents. 

4.1. 

Research, energy and transport 

This policy area is mainly implemented in centralised direct management. Payments in 2008 
were  some  €7.2  billion.  Some  76%  of  this  was  on  research  projects  in  multi-annual 
framework  programmes  and  around  12%  was  for  energy  and  transport  projects,  notably 
trans-European  networks.  This  Commission  proposal  is  based  on  an  analysis  of  costs  of 
control data collected by Commission services, payment data for 2008 and errors detected by 
the  Court  of  Auditors  (DAS  2008).  Based  on  the  DAS  data,  the  Commission  estimated  an 
error  rate  of  3%  (yellow  light)  for  this  chapter  in  2008.  The  cost  of  Commission  control 
activities in this area is some €267  million (3.6% of 2008 payments).  

The  analysis,  explained  in  detail  in  the  annexed  working  document,  shows  that  the  cost  of 
attaining  a  2%  error  level  could  be  prohibitive:  an  extra  €150  million  would  virtually 
guarantee an error rate below 2% and even attaining a reasonable probability of achieving 2% 
(most likely error) could cost an extra €90 m illion (model 1). The 1% reduction in error rate 
that  such  a  level  of  control  would  entail  is  some  €72  million,  assuming  all  error  is  fully 
recovered.  A  further  analysis  (model  2ab)  shows  that  decreasing  the  error  rate  from  the 
current  3%  to  2.5%  would  still  be  costly:  €55  million  assuming  that  errors  are  removed 
randomly from the population. A third analysis was carried out to examine the impact on the 
error rate of reducing the number (and cost) of on the spot controls (model 2c). The results 
showed  that  accepting  a  higher  error  rate  of  3.5%,  the  control  costs  would  decrease  more 
rapidly  than  the  amount  of  expected  recoveries  from  controls.  For  a  4%  error  rate  this 
reduction could be almost one-third of current costs. The results of the analysis are presented 
in the figure below.  

Figure 2: Summary of the estimated impact of attaining a given error rate  

Error rate changed to 

Change in estimated control 
costs (€million) 

Estimated possible change 
in recovered amounts 
(€million) 

4% (model 2c) 

3.5% (model 2c) 

- €15.5 

- €8.0 

2.5% (model 2ab) 

+ €0.9 to €55 – median €28 

2% (model 1) 

+ €90 to + €150 

-€3.1 

-€1.5 

+€36 

+€72 

The figures above show that the cost of reducing the error rate to 2% could be more than the 
value of that reduction (€72 million). Reducing th e rate to 2.5% could be cost-effective, but 
this  could  involve  some  500  additional  audits.  Increasing  the  error  rate  could  result  in  a 

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Such costs include the administration of programmes and financial control activities. 

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reduction  in  control  costs  in  excess  of  the  associated  reduction  in  the  value  of  errors 
recovered.  

All  statistical  models  imply  a  level  of  uncertainty  as  they  are  founded  on  sample-based 
estimates and can be expected to vary to a limited extent over time. To cater for this potential 
variation, the Commission's proposal is based on a range: the co-legislator may set an upper 
limit  in  this  range.  Using  a  range  is  even  more  important  as  the  DAS  2008  was  based 
essentially  on  FP6  payments,  while  FP7  will  be  predominant  from  2010.  Information 
currently available suggests FP7 expenditure will continue to be affected by error rates above 
2% and comparable to, or slightly higher than, those in FP6 as: 

•  grants  will  continue  to  be  based  on  beneficiaries'  actual  costs:  overstatement  is 

likely to remain the main cause of error; and 

•  the  reduction  of  the  number  of  required  audit  certificates,  as  a  result  of 
simplification  efforts,  and  the  relative  low  number  of  beneficiaries  opting  for 
ex-ante  certification  of  their  cost  methodology  are  likely  to  increase  the  risk  of 
error. 

For  FP6,  the  Commission  significantly  exceeded  the  number  of  audits  originally  planned. 
These additional controls placed a heavy burden on beneficiaries and on Commission services 
but have still not brought multi-annual error levels below 2%. 

If  the  co-legislator  sets  a  higher  level  of  TRE,  the  Commission  could  review  its  control 
strategy  and  focus  on  targeted  risk-based  audits  and  fraud  prevention.  This  would  create  a 
solid  accountability  framework,  with  appropriate  emphasis  on  prevention  and  the  timing  of 
controls, while maintaining an appropriate deterrent to irregular use of funds. 

The  Commission  proposes  a  TRE  level  in  the  yellow  range  (2%-5%).  A  DAS  error  rate 
around  the  middle  of  this  range  would  be  acceptable  and  justified.  Beyond  this  level, 
additional  action  would  be  taken  to  reduce  the  error  rate  through  increased  controls 
addressing  the  major  causes  of  error  and  taking  into  account  the  multi-annual  nature  of 
the expenditure. This rate should cover all Research Framework Programmes irrespective 
of  the  Chapter  of  the  Court's  annual  report  in  which  they  are  included  as  well  as  all 
activities  included  in  this  analysis  even  if  they  are  reallocated  to  other  Chapters  of  the 
Court's annual report in future. 

This  level  could  be  revised  in  the  light  of  major  changes  in  the  control  environment  that 
would have an effect on the DAS error rate. 

4.2. 

European Agricultural Fund for Rural Development  

The  European  Agricultural  Fund  for  Rural  Development  (EAFRD)  is  implemented  by  the 
Member States in shared management and is part of Chapter 5 of the Court's annual report. 
Given  the  different  management  mode  and  data  available  (controls  at  beneficiary  level  are 
carried out mainly by Member States), the analysis for this area is different to that used for 
Research,  energy  and  transport.  Payments  in  2008  were  some  €13.7  billion  total  public 
expenditure, of which € 8.5 billi on from the EU (including advances). The area accounted for 
some  16%  of  total  agricultural  expenditure.  The  Court  concluded  in  its  annual  report  2008 
that  the  error  rate  for  rural  development  exceeded  2%,  while  that  for  the  European 
Agricultural Guarantee Fund (EAGF) was below 2%. 

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This Commission proposal is based on error rates and costs of control reported by Member 
States  for  2008,  which  essentially  impact  on  2009  expenditure.  The  analysis  was  based  on 
Member  States'  error  rates  because  the  Court's  DAS  sample,  while  representative  for  the 
whole  Chapter,  is  not  representative  for  EAFRD  alone.  Member  States'  statistics,  covering 
some  300.000  on  the  spot  controls,  are  sufficiently  extensive  to  give  a  reasonable 
approximation of the situation in the whole population. To a very large extent they have been 
verified and validated by Member State certification bodies. 

The  analysis,  explained  in  detail  in  the  annexed  working  document,  shows  that  the  relative 
cost  of  control  for  EAFRD  is  nearly  three  times  as  high  as  for  EAGF  (7.3 %  of  the 
programme  budget  for  the  year  compared  to  2.7 %).  Despite  this  high  control  cost,  the 
cumulative error rate reported by Member States is 2.8 % for EAFRD. This is explained by 
complex  rules  and  eligibility  conditions,  set  to  achieve  environmental  and  other  policy 
impacts which are challenging to verify. 

Given  the  high  cost  of  control,  any  increase  of  the  level  of  on-the-spot  controls  beyond 
current  levels  would  not  be  cost-effective  –  the  costs  of  these  controls  would  be  five  times 
higher than the recovery which on average can be expected (average error rate multiplied by 
the average amount received per beneficiary). 

The  EU's  rural  development  policy  recognises  the  need  to  pursue  economic,  environmental 
and social progress as three cords of a rope which reinforce each other. It aims to boost the 
competitiveness  of  the  agricultural  sector,  care  for  the  environment  and  preserve  natural 
resources,  and  develop  rural  areas  economically  and  socially.  However,  any  further 
simplification of eligibility rules in rural development will not be enough to reduce the error 
rate in rural development below the 2% threshold presently used by the Court without the risk 
of jeopardising policy objectives. 

While  the  Commission  and  Member  States  need  to  maximise  the  effectiveness  of 
management  and  control  systems  to  prevent,  detect  and  correct  errors,  the  Commission 
considers  it  would  be  uneconomic  to  increase  controls  in  EAFRD.  Member  States'  data 
support the Court's conclusion that the error rate in this area is higher than 2%. 

The  Commission  proposes,  for  EAFRD  expenditure,  a  TRE  level  in  the  yellow  range 
(2%-5%).  A  DAS  error  rate  around  the  middle  of  this  range  would  be  acceptable  and 
justified. Above this level, additional action would be taken to reduce the error rate through 
increased controls and addressing the major causes of error. The target for the first pillar 
of the CAP would remain in the green zone (2%). 

5. 

CONCLUSION 

When the Court introduced the 2% materiality threshold the Commission did not have reliable 
information on the cost of controls. The threshold was decided by the Court in the absence of 
any indication to the contrary at political level. However, information on cost of controls is 
the 
now  available  which  allows  a  concrete  discussion  between  stakeholders  on 
cost-effectiveness of controls. 

Significant progress was made by the Commission and the 2008 DAS was the best ever. This 
improvement  was  secured  by  improving  control  systems  and  by  doing  more  controls, 
increasing costs and the burden on beneficiaries (DG Research alone carried out 20% more on 

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the  spot  controls  of  beneficiaries  than  originally  planned  in  the  period  2007-2009  for  FP6). 
The  Commission  will  continue  to  develop  and  implement  credible  control  strategies, 
providing for efficient and timely control, focusing on risk and feeding back results into the 
control cycle. The  current levels of control are high, including in rural development, and in 
the  two  areas  covered  above,  the  DAS  error  rate  may  have  been  reduced  towards  the 
minimum cost-effective level. 

Commission  services  need  to  continue  to  demonstrate  the  effectiveness  of  their  control 
strategies in their AARs, tailoring strategies to the risks and specificities of each policy area, 
ensuring that these are refined to reflect real risks and experiences and allowing for informed 
decisions  on  the  cost/benefits  of  controls.  However,  once  such  due  diligence  has  been 
demonstrated,  tolerable  risk  is  a  sound  investment  and  the  co-legislator  may  set  a  TRE 
threshold higher than the current error rate in this light. This would provide a firm basis for 
the Discharge Authority to judge the Commission's management of risk. 

While  TRE  would  be  an  annual  benchmark  (in  line  with  the  DAS)  where  the  Commission 
operates multi-annual control systems, the error rates at the end of a programme will be lower 
than  the  DAS  due  to  financial  corrections  and  recovery  of  unduly  paid  amounts.  The 
Commission will work to identify such residual error rates as appropriate and will continue to 
correct  all  errors  detected.  However,  the  large  number  of  beneficiaries  means  that  controls 
cannot systematically be carried out on the spot and that errors will remain undetected. The 
Commission considers that: 

–  a TRE level for both policy areas covered by this Communication should be fixed in the 

yellow zone: 2% to 5%; 

–  a  DAS  error  rate  around  the  middle  of  this  range  in  both  areas  would  be  acceptable  and 
justified.  Beyond  this  level,  additional  action  would  be  taken  to  reduce  the  error  rate 
through increased controls and addressing the major causes of error; and 

–  in parallel to the adoption of a justified annual TRE level, it should monitor multi-annual 
error  rates  and  report  to  the  Budgetary  Authority  at  appropriate  times  in  programme 
lifecycles. 

The Commission has proposed to enshrine the concept of TRE in its proposal for the triennial 
revision  of  the  Financial  Regulation.  Given  the  time  necessary  for  the  inter-institutional 
discussions  on  the  latter  prior  to  its  entry  into  force,  and  following  discussion  of  this 
Communication with the co-legislator, the Commission will put forward legislative proposals 
in  view  of  formalising  the  TRE  levels  for  "Research,  energy  and  transport"  and  "Rural 
development". The Commission will present concrete proposals for TRE for "Administrative 
expenditure"  and  "External  aid,  development  and  enlargement"  before  the  end  of  2010  and 
progressively  for  the  remaining  sectors  in  2011.  It  will  propose  simplification  of  sectorial 
legislation for the next round of basic acts to reduce the risk of error in the post 2013 period. 

The Commission is committed to demonstrate the effective functioning of its control systems 
and  will  advise  its  Services  for  the  next  AAR  round  to  enhance  the  reporting  on  systems 
effectiveness. 

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