Good morning all.
Many thanks to Professor Louth for his introduction. The SSRO has enjoyed invaluable engagement with RUSI and we look forward to developing this relationship further.
It is a privilege to have been invited to speak today – and I’d like to share my views on:
- First, the benefits the new single source procurement regime has brought; and that it will continue to bring.
- Secondly, what we have found so far from our monitoring of qualifying defence contracts.
- Thirdly, how we at the SSRO work with industry and government, and how we represent the taxpayer’s interest.
- And finally, what the future may hold – looking in particular at the forthcoming review of the single source regulatory framework.
2014 was a watershed year for single source defence procurement – it brought the Defence Reform Act and the Single Source Contract Regulations.
Before this, the regime for managing single source defence procurement had barely changed for half a century.
And I’d like to thank parliamentarians for grasping the importance of Lord Currie’s 2011 Review. The Defence Reform Act has reformed procurement for the better and its impact has yet to be fully realised.
The new regime didn’t just create the SSRO. We are part of a wider change, requiring the government and industry to deliver single source defence procurement in a different way.
So first: the current picture.
As the regulator of single source defence procurement in the UK, it is essential that we have a detailed overview of all qualifying defence contracts (or “QDCs”) and the costs and profit that make up each contract.
We initially had concerns about the slow trickle of QDCs being reported as part of the new regime. My predecessor as Chair of the SSRO raised this issue with the government, with industry and through the media.
Now the tap has been turned on and there is a steady flow of QDCs.
During the financial year 2015/16, the SSRO was notified of 31 QDCs and 3 qualifying sub contracts, worth a total of £11.5 billion. However, in that same year the MOD signed 127 single source contracts that were not classed as QDCs. The total value of those contracts is £840 million.
As of yesterday, for the financial year 2016/17 we have been informed of four more QDCs, with a total value of £231.7 million.
Our ambition is that we reach a situation where all single source defence contracts are subject to the regime.
The benefits include:
- Greater certainty, with the SSRO’s guidance letting all parties know what costs are allowable or not allowable.
- Better value for money secured for the MOD and the taxpayer.
- The possibility of recourse, for both sides in a dispute, to an independent adjudicator in the form of the SSRO.
And, crucially for everyone involved:
- Credibility for single source procurement as a fair and value for money alternative to competition.
Secondly, what has the SSRO found so far?
One of our statutory duties is to recommend a baseline profit rate to the Secretary of State for Defence, to be used for all qualifying contracts worth over £5 million.
The baseline profit rate we recommended for 2016/17 was 8.95 per cent. It was determined by looking at the profit rates achieved by a more international and a more appropriate range of companies than had been considered under the old ‘Yellow Book’ arrangements. Previously only companies headquartered in the UK were considered, including some with little or no relevance to defence, such as retail, pharmaceuticals and tobacco companies.
This new baseline profit rate now strikes the right balance between delivering a fair return for industry and ensuring value for money for the taxpayer.
But the baseline profit rate is only a starting point in determining the contract profit rate for each QDC. We recently published an analysis of the planned contract profit rates for the QDCs entered into during the financial year 2015/16. This showed that, on average, the planned profit is 11.7 per cent – significantly above the baseline rate of 10.6 per cent for that year.
We have also recently updated our guidance on Allowable Costs. This sets out what kind of costs incurred by companies may be passed onto the MOD, and ultimately the taxpayer, through single source contracts.
From our reviews of the QDCs notified to the SSRO so far, we have identified a number of cases of non-Allowable Costs being claimed. These include faulty workmanship resulting in rework; contingency funding not actually used; and marketing costs incurred on export campaigns in anticipation of future sales that might not materialise.
In identifying these non-Allowable costs we are ensuring that savings can be made on contracts funded by the taxpayer.
We currently have around £56 million of costs under investigation. This amount of money could fund two-thirds of the money the MOD has spent to help 5,600 service personnel buy a home through the Forces Help to Buy Scheme. Or to look at it another way, it would pay the annual salary of over 2,000 NCOs.
If a disagreement on costs or level of profit can’t be settled through negotiation, the Act provides the SSRO with the power to issue a legally binding determination, which both sides in the dispute (the MOD and the defence contractor) must comply with.
You may have seen that our first determination was announced in mid-May. It removed £1.27 million from a contract. The determination found that the contractor failed to demonstrate the potential for sales arising from marketing activity to benefit the MOD, and the taxpayer, by reducing the cost base of the contract. It also found an overstatement of risk of future cost variation.
Contractors have usually been willing to remove any non-Allowable Costs we identify. The binding determination showed that if contractors don’t follow the guidance, we are able to come to our own decision.
One of the main ways that we have been bringing a light to bear on single source defence procurement is through our compliance work, and our annual Compliance Report.
Our first annual report, published in January this year, highlighted the types of non-Allowable activity we had seen. Given the low volume of QDCs at that point the report was narrative in nature – focusing on compliance trends and themes.
With more QDCs having been signed since January, we are now in a position to release an interim statement – and that will be published at the end of this month.
For too long single source defence procurement went without effective scrutiny. We want to encourage, and drive, improvements in procurement and contracting from both industry and the MOD.
The third theme I want to cover is engagement.
We are under “no express obligation” to consult on our work, but we do – because it is the right thing to do.
We continue to engage with many different stakeholders directly through events, workshops, conferences, correspondence and site visits.
This is particularly critical for an organisation making decisions that may not always be welcomed by some of its stakeholders, many of whom are influential and well resourced.
We have held a number of stakeholder workshops to accompany our consultations – and we are listening to concerns from industry that we could improve the way we consult. You may not always like what we do, but we want you to be confident that we have listened to what you have to say and considered your view before coming to our conclusions.
We are also aware of the need to engage beyond the MOD and the UK defence industry. We have met and continue to build relationships with other regulators in the UK and with similar government agencies in other countries, who are often working with the same multi-national defence companies and single source procurement issues as the UK government. We would risk missing out on learning from our equivalent organisations in ally nations if we did not meet our international partners.
The SSRO is fully committed continuing its site visits to MOD and contractors’ facilities, responding to questions asked by industry, and maintaining dialogue in order to strengthen the relationships between the SSRO and industry, and the MOD respectively.
Again, you may not like what we do, but we want you to understand what we are doing. We will always abide by our core values – and those are to be transparent, independent and professional in everything we do.
Finally then, what does the future hold?
We have already made it clear that it is the SSRO’s view that having a number of baseline profit rates, for different types of activities, would better reflect the risk and reward balance related to different contracts.
We believe that one rate is too blunt an instrument. No other country has a single rate. Why should a contract for grass cutting make the same profit as a contract for building and maintaining a nuclear submarine?
Although the SSRO recommended only one baseline profit rate this year, we will recommend multiple profit rates from 2017/18, and will be consulting soon on how that will work in practice.
A second major priority is for the SSRO to review the Act and Regulations that established us, and recommend changes to the Secretary of State. The aim of this work is to ensure the legislation remains fit for purpose, and that the SSRO has the powers to be an effective regulator.
The Secretary of State for Defence is required to conduct periodic reviews of the framework, with the SSRO providing our recommendations for the first of these by June 2017.
This may seem a long way off, but it is a substantial piece of work as it is the first time the legislative framework has been reviewed since it came into force in December 2014.
There is an issue for us at the heart of this review. The current regulatory framework gives the SSRO an oversight role, but no power to take any enforcement action.
We can offer guidance and support to the MOD and defence contractors.
We can also report on breaches of the regulatory scheme, highlighting cases where our guidance and support has not led to effective remedial action.
But we have no powers to enforce our views.
The SSRO may only make determinations when asked to do so by one of the contracting parties and we have no powers to issue compliance or penalty notices.
If the single source regulatory framework is to fulfil its potential, then the right single source defence contracts need to be brought within the framework, pricing controls must be correctly applied and data robustly collected.
We believe that there are compelling reasons for giving the SSRO the power to take enforcement action.
- We are uniquely placed to identify where action needs to be taken to ensure compliance.
- We are independent and not subject to the sorts of pressures that the MOD may face as the buyer under single source defence contracts.
- Other economic regulators have power to take enforcement action in support of the schemes they oversee.
Can you imagine if the Financial Conduct Authority was aware of market abuse but was unable to prosecute?
We are concerned that the regulatory framework should achieve its aims efficiently, and the call for input into the review we have issued also invites views on a range of other issues. These include:
- removing minimum thresholds for QDCs, which would avoid the operation of separate regimes and the need for anti-avoidance provisions around contract value;
- clarifying exclusion definitions;
- simplifying the way the SSRO is funded; and
- reducing reporting requirements for low-value contracts.
I would very much welcome (and encourage) your input into this fundamental review on how single source defence procurement is regulated. You can find the call for input, and details on how to respond, on our website.
In conclusion, we passionately believe that an effective single source procurement regime – which carries the confidence of all involved – is beneficial to the defence industry and to the taxpayer.
It has to achieve its aims efficiently. It is clear that the existence of a regulator that is independent but works closely with industry and government (and provides clear and comprehensive guidance) leads to more efficient single source procurement; provides single source suppliers with a fair and reasonable price; and ensures that good value for money is obtained for the UK taxpayer.
Thank you again for inviting me to speak, and I’m happy to answer questions.