public accounts committee - ni water report

Public Accounts Committee

Session 2010/2011 Fifth and Sixth Report

Measuring the Performance of NI Water

and

Procurement and Governance in NI Water

Volume OneTogether with the Minutes of Proceedings of the Committee Relating to the Report

and the Minutes of Evidence

Ordered by The Public Accounts Committee to be printed 27 January 2011

Report: NIA 37/10/11R Public Accounts Committee

Ordered by The Public Accounts Committee to be printed 3 February 2011

Report: NIA 40/10/11R Public Accounts Committee

REPORT EMBARGOEDUNTIL 00.01 AM ON 3 March 2011

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Membership and Powers

Membership and Powers

The Public Accounts Committee is a Standing Committee established in accordance with Standing Orders under Section 60(3) of the Northern Ireland Act 1998. It is the statutory function of the Public Accounts Committee to consider the accounts, and reports on accounts laid before the Assembly.

The Public Accounts Committee is appointed under Assembly Standing Order No. 56 of the Standing Orders for the Northern Ireland Assembly. It has the power to send for persons, papers and records and to report from time to time. Neither the Chairperson nor Deputy Chairperson of the Committee shall be a member of the same political party as the Minister of Finance and Personnel or of any junior minister appointed to the Department of Finance and Personnel.

The Committee has 11 members including a Chairperson and Deputy Chairperson and a quorum of 5.

The membership of the Committee since 9 May 2007 has been as follows:

Mr Paul Maskey 5 (Chairperson) Mr Roy Beggs (Deputy Chairperson)

Mr Gregory Campbell MP 16 Mr John Dallat Mr William Irwin 14 Mr Trevor Lunn Mr Patsy McGlone 2 & 8 Mr Mitchel McLaughlin Mr Adrian McQuillan 15 Mr Stephen Moutray 12 Ms Dawn Purvis

1 Mr Mickey Brady replaced Mr Willie Clarke on 1 October 20072 Mr Ian McCrea replaced Mr Mickey Brady on 21 January 20083 Mr Jim Wells replaced Mr Ian McCrea on 26 May 20084 Mr Thomas Burns replaced Mr Patsy McGlone on 4 March 20085 Mr Paul Maskey replaced Mr John O’Dowd on 20 May 20086 Mr George Robinson replaced Mr Simon Hamilton on 15 September 20087 Mr Jim Shannon replaced Mr David Hilditch on 15 September 20088 Mr Patsy McGlone replaced Mr Thomas Burns on 29 June 20099 Mr David Hilditch replaced Mr George Robinson on 18 September 200910 Rt Hon Jeffrey Donaldson replaced Mr Jim Wells on 18 September 2009

11 The Lord Browne replaced Rt Hon Jeffrey Donaldson on 19 April 201012 Mr Stephen Moutray replaced Mr Jonathan Craig on 19 April 201013 Mr Jim Shannon resigned from the Public Accounts Committee on 1 August 201014 Mr William Irwin replaced Mr David Hilditch on 13 September 201015 Mr Adrian McQuillan replaced The Lord Browne on 13 September 201016 Mr Gregory Campbell MP was appointed as a member of the Committee on 13 September 2010

Measuring the Performance of NI Water and Procurement and Governance in NI Water

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List of Abbreviations used in the Report

C&AG Comptroller and Auditor General

DRD/the Department Department for Regional Development

GB Great Britain

IWRP Independent Water Review Panel

PC10 Price Control

NI Water Northern Ireland Water

the Regulator Northern Ireland Authority for Utility Regulation

OPA Overall Performance Assessment

TOA Treasury Officer of Accounts

Measuring the

Performance of

Northern Ireland Water

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Executive Summary

Executive Summary

1. Under the Water Reform process, responsibility for water and sewerage services transferred from the Department for Regional Development’s Water Service to Northern Ireland Water (NI Water), a government owned company (GoCo), in April 2007. A system of economic regulation similar to the rest of the UK was also put in place. This process was intended to improve both quality and efficiency of service provision and has major implications for public expenditure in Northern Ireland.

2. Although increased investment has resulted in service improvements in recent years, benchmarking NI Water with other GB companies continues to identify performance gaps in most areas and indicates scope to improve efficiency. To match GB performance NI Water would need to provide a better service at about half the cost.

3. It is not clear if there is a need for further improvements to drinking water quality, which is better than ever and is less than one percent below GB compliance levels. The Department believes that further marginal improvements would not be of benefit to public health and would be too expensive.

4. It is difficult to reconcile these views with those of the Drinking Water Inspectorate, which has stated that further projects are needed to improve compliance with EU standards and to address localised issues relating to trihalomethanes, iron, aluminium and lead. It is also difficult to justify a further investment of £100 million under the Regulator’s price control when the associated target of 99.7 per cent compliance by 2013 has already been exceeded.

5. Waste water has been the “Cinderella service” in comparison with drinking water, and although there have been improvements in recent years, standards are not as good as in England and Wales where there is virtually 100 per cent compliance. Some works operate to relaxed standards, and if these works were assessed against current environmental standards this would further reduce compliance.

6. When capacity is exceeded during storm conditions, sewers discharge untreated sewage and rainfall run-off. These intermittent discharges can cause damaging pollution in rivers and are still not subject to proper control despite assurances given to the Committee in 2002. NI Water has completed 90 Drainage Area Studies, and Northern Ireland Environment Agency (NIEA) has identified a large numbers of unsatisfactory discharges. However, further studies are outstanding, and not all completed studies have been reviewed by the NIEA.

7. Despite its very poor performance, NI Water has no target to reduce serious pollution incidents. The Committee believes that NI Water is too complacent about the polluting effect of its discharges both in terms of the number of pollution incidents and its effect on bathing water quality.

8. In response to criticism from the Regulator, NI Water improved the accuracy of its leakage measurement. This resulted in an increase from the previously reported 157 million litres a day to 181 million litres a day. The Committee previously queried the accuracy of leakage measures in a 2002 report and considers NI Water to have been negligent in ignoring the obvious problems for so long. This also underlines the wider problems of poor quality management information and the difficulties this causes in setting targets and priorities across many service areas.

9. The increased estimate of supply pipe leakage has again raised the possibility that a free or subsidised repair of customer supply pipes may make an economic contribution to leakage reduction. The problems experienced by NI Water in maintaining supply over the Christmas 2010 freeze highlight the importance of leakage management and consideration of the economic case for subsidising repair to customer supply pipes.


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10. Too many customers are experiencing difficulties with core services and in getting adequate responses when problems are reported. The former Chief Executive acknowledged that it was often difficult for customers to contact the right people in NI Water and indicated that improve-ments to customer service are at the top of the agenda. The issue of poor customer service also came to the fore in the Christmas 2010 freeze and needs to be addressed urgently.

11. Benchmarking is a widely used process to determine the scope for improvement by comparing company performance with industry best. The Department argued strongly that both the Audit Office’s and the Regulator’s comparisons with GB performance were not valid because of a legacy of underinvestment in Northern Ireland. The Committee requested evidence to support this position but found a considerable disconnect between the oral and written evidence. The Committee does not accept the Department’s objections and believes that it needs to show a greater level of maturity in actively pursuing improvements rather than trying to justify existing poor levels of performance.

12. NI Water has the potential to reduce its operating costs by around 40 per cent and additional scope for capital savings. The Regulator has set a target to close about 65 per cent of this efficiency gap by 2013, but the Department has not signed up to the second and third years of this plan because of an uncertain funding position. The Committee believes that there is an urgent need to address this issue.

13. Economic regulation of the water industry in GB has delivered consistent efficiency improvements, and under Water Reform a similar role was envisaged for the Northern Ireland Regulator. However, it is clear that the current hybrid governance arrangements and the lack of customer charging provide a set of circumstances for the Regulator which is unique in a UK context. Nevertheless, irrespective of how the service is funded, an independent regulatory regime has the potential to play an important role in the identification and delivery of real and meaningful efficiencies. The precise role and nature of the regulatory regime will need to be clearly defined to ensure the system operates for the benefit of both the taxpayer and the customer.

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Summary of Recommendations


Recommendation 1

1. There needs to be a clearer link between planned investments and improvements to drinking water quality. The Committee recommends that, in future, drinking water quality targets are supported by a clearly articulated assessment of:

! existing water quality, based on the most up to date information available;

! further improvements needed based on Drinking Water Inspectorate and consumer assessments; and

! the rate of improvement achievable under a range of alternative funding allocations.

Recommendation 2

2. The Committee recommends that NI Water in conjunction with the Northern Ireland Environment Agency should investigate the respective measures used in Northern Ireland and Great Britain to assess compliance with discharge standards, with a view to ensuring that performance can be compared on a like-for-like basis in future.

Recommendation 3

3. In addition to existing performance measures, the Committee recommends that, so long as significant numbers of works operate to relaxed standards, NI Water should also report the level of compliance with full environmental needs standards. In this way it will be possible to monitor the improvement in compliance as works are completed.

Recommendation 4

4. It is not helpful for new information to be introduced into evidence when a report has been only recently published and subject to formal clearance with the Comptroller and Auditor General (C&AG). The Committee recommends that DFP reminds departments of the need to agree all material facts with the C&AG in a prompt, timely and comprehensive manner.

Recommendation 5

5. The Committee recommends that NI Water reviews the effectiveness of its current approach to smaller, unsatisfactory waste water treatment works and assesses whether value for money would be better served by a more thorough rationalisation of the currently piecemeal provision.

Recommendation 6

6. Priority should now be given to reducing pollution from sewer networks. The Committee recommends that NI Water sets a formal timescale for completion of the remaining Drainage Area Studies and that NIEA completes its assessment of discharges identified. Only when this work is completed, will there be a proper basis for future investment decisions in this area.

Recommendation 7

7. NI Water needs to acknowledge that it is the cause of too much pollution and needs to improve performance in this area. The Committee recommends that the Company reviews its strategy and sets challenging targets to reduce medium and high severity pollution incidents.

Recommendation 8

8. There is a relatively high level of leakage from customer supply pipes. The Committee recommends that the Regulator in conjunction with NI Water reconsider the economic case for implementing a free or subsidised repair policy to reduce this component of leakage. The Committee would like to see a copy of the economic assessment in due course.


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Recommendation 9

9. The former Water Service did not have to produce the level of management information now required by the Regulator. However, improvements in many areas of customer service are dependent on this information. The Committee recommends that NI Water, in consultation with the Regulator, clearly defines what additional information is required in the key performance areas of supply interruptions, billing, telephone contacts, water pressure and sewer flooding, and that NI Water establishes a time-bound programme to deliver it.

Recommendation 10

10. NI Water must do more to ensure that its customers are dealt with efficiently and professionally by the Company. The Committee recommends that improving the quality of customer service is set as a priority and would like to be kept informed of plans made to improve performance in this area.

Recommendation 11

11. NI Water needs to take a benchmarking approach which compares with industry best, explaining the gaps and accepting responsibility for improvement. The Committee recommends that NI Water sets up a formal programme of performance and process benchmarking with immediate effect.

Recommendation 12

12. The very substantial efficiency savings proposed by the Regulator need to be delivered within an agreed timescale. The Committee recommends that the Department, the Regulator and NI Water, in conjunction with DFP, should develop a range of options for the consideration of the Executive with a view to providing NI Water with more certainty of funding over the three year period of PC10.

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Introduction

Introduction

1. The Public Accounts Committee met on 24 June 2010 to consider the Comptroller and Auditor General’s report “Measuring the Performance of Northern Ireland Water”. The main witnesses were:

! Mr Paul Priestly, Accounting Officer, Department for Regional Development;

! Mr John Mills, Director of Water Policy, Department for Regional Development;

! Mr Laurence MacKenzie, Chief Executive, Northern Ireland Water;

! Mr George Butler, Director of Asset Management, Northern Ireland Water;

! Mr Iain Osborne, Chief Executive, Northern Ireland Authority for Utility Regulation;

! Mrs Jo Aston, Director of Water Regulation, Northern Ireland Authority for Utility Regulation;

! Ms Fiona Hamill, Treasury Officer of Accounts, Department of Finance and Personnel; and

! Mr Kieran Donnelly, Comptroller and Auditor General.

2. Since 1973, water and sewerage services in Northern Ireland have been delivered by central government, in contrast to the position in England and Wales where water utilities were privatised in 1989. Water Reform was first suggested around 2002 as a means to improve both standards of service and efficiency in line with Great Britain (GB).

3. In April 2007, responsibility transferred from Water Service to Northern Ireland Water (NI Water) a company owned solely by Government with the Department for Regional Development (the Department) representing the Government’s shareholder interests. A system of economic regulation similar to the rest of the UK was also put in place under the Northern Ireland Authority for Utility Regulation (the Regulator). It was originally intended that NI Water would be financed by domestic charges. To date, however, the Executive has not introduced charging, and the Department continues to fund about three quarters of NI Water’s expenditure.

4. NI Water has an annual budget in excess of £400 million and a fixed asset valuation of £1.1 billion. The Water Reform process is therefore, one of the largest transformation projects in the public sector. Its success has the potential to improve a vital service and has major implications for the budgets of the Executive, businesses and households in Northern Ireland.

5. Over the last decade NI Water and its predecessor Water Service invested in excess of £1 billion in water and waste water treatment, and this has resulted in significant quality improvements in recent years. While this improvement in performance is welcome, benchmarking NI Water against GB companies continues to identify performance gaps in most service areas and also highlights scope to further improve efficiency. The Regulator has estimated that, to match GB performance, NI Water would need to provide a better service at about half the cost.

6. In taking evidence on the C&AG’s report, the Committee focused on:

! Drinking Water and Waste Water Quality;

! Leakage and Customer Service; and

! Benchmarking, Efficiency and Regulation.


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Drinking Water and Waste Water Quality

Targets for drinking water quality have already been exceeded yet £100

million further investment is planned

7. Drinking water quality in Northern Ireland is at its highest level ever and is only marginally (less than one per cent) below GB levels. Both the Department and NI Water state that Northern Ireland is at no risk of EU infraction proceedings in this area and that there are no public health risks associated with the low levels of non-compliance. The Department believes that seeking further marginal quality improvements would cost a disproportionate amount of money that would be better spent on waste water, which has historically received less investment.

8. On this basis, the Department’s Social and Environmental Guidance set a target to maintain drinking water quality at 99.7 per cent compliance until 2013. However, NI Water stated at the hearing that this target had already been exceeded and compliance was around 99.88 per cent1. Despite this, £100 million has been allocated for drinking water projects in the three years to 2013.

9. The amount of further investment in drinking water needs to be very carefully assessed and explained, particularly where there are competing priorities. There is a lack of clarity about the significance of the current level of performance and why so much additional investment is needed. Given the Department’s views that there are no risks to public health or of EU infraction proceedings, it is difficult to justify a £100 million investment when the target has already been exceeded.

Recommendation 1

10. There needs to be a clearer link between planned investments and improvements to drinking water quality. The Committee recommends that, in future, drinking water quality targets are supported by a clearly articulated assessment of:

! existing water quality, based on the most up to date information available;

! further improvements needed based on Drinking Water Inspectorate and consumer assessments; and

! the rate of improvement achievable under a range of alternative funding allocations.

Waste water quality is below European standards and needs to

be improved

11. Although there has been an improvement over recent years, witnesses candidly admitted that the treatment of waste water had been a “Cinderella service” in the past. As a result, NI Water’s levels of compliance with the relevant standards are running at 90 per cent compared with virtually 100 per cent in England and Wales. In addition, some works are operating to relaxed standards while upgrades are completed. If these works were assessed against normal environmental standards, this would reduce compliance further to 84 per cent.

12. NI Water explained that some waste water treatment works were still operating to older discharge standards based on what the works could achieve and that these would transfer to more stringent environmental needs standards when upgrade works were completed. It

1 The Drinking Water Inspectorate’s latest report published in October 2010 reports water quality at customers’ taps in 2009 as 99.74 per cent compliant.

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Drinking Water and Waste Water Quality

is disappointing to note that when the Committee examined the control of Water Service discharges in 2000 it was told that this practice would be phased out by 20052.

13. NI Water also told the Committee that compliance with discharge standards is measured on a more stringent basis in Northern Ireland compared with GB and that using the less stringent basis, NI Water performance would increase to 97 or 98 per cent compliance. The Committee notes that this represents new information, and was not agreed with the C&AG in the preparation of his report. The introduction of new and uncorroborated material of this kind at a hearing is not helpful and should have been raised during the extensive clearance process on this report.

Recommendation 2

14. The Committee recommends that NI Water in conjunction with the Northern Ireland Environment Agency should investigate the respective measures used in Northern Ireland and Great Britain to assess compliance with discharge standards, with a view to ensuring that performance can be compared on a like-for-like basis in future.

Recommendation 3

15. In addition to existing performance measures, the Committee recommends that, so long as significant numbers of works operate to relaxed standards, NI Water should also report the level of compliance with full environmental needs standards. In this way it will be possible to monitor the improvement in compliance as works are completed.

Recommendation 4

16. It is not helpful for new information to be introduced into evidence when a report has been only recently published and subject to formal clearance with the C&AG. The Committee recommends that DFP reminds departments of the need to agree all material facts with the C&AG in a prompt, timely and comprehensive manner.

17. In addition to the 250 larger treatment works where compliance is reported, NI Water has 800 smaller treatment works where compliance is not reported. Three hundred of these have been identified by NIEA as “unsatisfactory”, with 181 warning letters issued in 2009. NI Water is spending £5 million a year to improve these works on a priority basis. The Department told us that many of these works are very small, in some cases consisting only of shared septic tanks serving two houses. It is not clear whether this approach is capable of resolving these issues within a reasonable timescale or whether a more coordinated approach would provide better value for money.

Recommendation 5

18. The Committee recommends that NI Water reviews the effectiveness of its current approach to smaller, unsatisfactory waste water treatment works and assesses whether value for money would be better served by a more thorough rationalisation of the currently piecemeal provision.

19. When capacity is exceeded, usually during storm conditions, sewers discharge untreated sewage and rainfall run-off. These intermittent discharges can cause damaging pollution in rivers and the Committee was told at a previous hearing in 2000 that they would be subject to full regulation by the end of 2005. It is disappointing therefore that many of these discharges have still not been identified and assessed. NI Water has completed 90 out of 109 Drainage Area Studies to identify discharges. NIEA has identified large numbers of unsatisfactory discharges but has not yet reviewed all of the completed studies.

2 ‘Public Accounts Committee Report on Control of River Pollution in Northern Ireland 3/00r Session 2001’


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Recommendation 6

20. Priority should now be given to reducing pollution from sewer networks. The Committee recommends that NI Water sets a formal timescale for completion of the remaining Drainage Area Studies and that NIEA completes its assessment of discharges identified. Only when this work is completed will there be a proper basis for future investment decisions in this area.

21. NI Water is responsible for almost a quarter of all pollution incidents in Northern Ireland and has by far the worst record compared with companies in England and Wales. The impact of polluting discharges is also apparent in the fluctuating quality of Northern Ireland’s bathing water, and there have been specific instances where beaches have failed to meet even minimum European standards because of waste water problems.

22. There is a worrying degree of complacency in NI Water’s approach to this issue. For example, having been responsible for 56 serious pollution incidents in 2008, the Company simply increased its 2009 target from 11 to 56 incidents. This response shows no recognition whatsoever of the environmental responsibility which should attach to NI Water’s functions, and it is totally unacceptable. The extent of the damage caused by these pollution incidents is illustrated by an out-of-court settlement of £500,000 paid to the Loughs Agency in 2009-2010, in compensation for pollution to the River Strule. The Committee also notes that this payment was covered by a confidentiality agreement and contradicts an assurance given in oral evidence that NI Water does not do out-of-court settlements (see also fig 1 of the Procurement Governance report).

Recommendation 7

23. NI Water needs to acknowledge that it is the cause of too much pollution and needs to improve performance in this area. The Committee recommends that the Company reviews its strategy and sets challenging targets to reduce medium and high severity pollution incidents.

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Leakage and Customer Service

Leakage and Customer Service

NI Water does not have a proper basis for leakage reduction targets

24. In its 2002 report on Leakage Management in Water Service3 the Committee emphasised the importance of an accurate measure of leakage as a basis for its proper management. The Committee also queried the accuracy of measures in use at that time. It was not until 2008-09, however, and in response to criticism from the Regulator, that NI Water seems to have taken this seriously, “rebasing” its leakage figure and reporting an increase from 157 million litres a day to 181 million litres a day. Although the Department has emphasised that this is not an actual increase in leakage, the fact remains that it has been under-reported for a long time.

25. The Committee understands the complexity of leakage measurement, but this should be a bread and butter issue for water utilities, and both Water Service and NI Water have been negligent in ignoring obvious problems for so long. The issue of leakage measurement and the production of targets based on a properly calculated economic level of leakage must be addressed much more effectively if NI Water is to improve overall efficiency.

Free repair of leaks on customer supply pipes could be a cost-effective

means of reducing leakage

26. Revised estimates of leakage indicate that more than a quarter of losses occur on supply pipes which are the responsibility of customers. This is one of the highest levels of supply pipe leakage in the UK. The Committee’s 2002 Report suggested that free or subsidised repair, as used in England and Wales, might provide a cost-effective means of reducing leakage, but Water Service’s review concluded that it was not economically justified at that time. This option has again been put forward4, and NI Water indicated that this would be a policy decision which would need to be addressed in the future.

27. The Committee agrees that this is a policy decision, but one which must be informed by a robust economic assessment. If it can be shown that this option is economically viable based on the higher levels of leakage now indicated, it should be introduced sooner rather than later.

Recommendation 8

28. There is a relatively high level of leakage from customer supply pipes. The Committee recommends that the Regulator in conjunction with NI Water reconsider the economic case for implementing a free or subsidised repair policy to reduce this component of leakage. The Committee would like to see a copy of this economic assessment in due course.

There is a need to improve the quality of management information

across all service areas

29. The inaccurate and misleading information used for so long as a basis for leakage management also serves to underline the wider problem of poor quality management information and lack of data in NI Water (see also paras 70 and 75 of the Procurement Governance report). This was a recurrent theme throughout the hearing: NI Water does not have robust registers of sewer flooding incidents, low water pressure and combined sewer overflows; business cases were undermined because information on asset conditions was not available and benefits could not be quantified; and poor information systems were the source of inaccurate billing of test meters.

3 Water Service: Leakage Management and Water Efficiency

4 “NI Water Audit of Leakage and ELL” Halcrow Management Sciences Ltd, July 2009 (Independent Reporter)


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Recommendation 9

30. The former Water Service did not have to produce the level of management information now required by the Regulator. However, improvements in many areas of customer service are dependent on this information. The Committee recommends that NI Water, in consultation with the Regulator, clearly defines what additional information is required in the key performance areas of supply interruptions, billing, telephone contacts, water pressure and sewer flooding, and that NI Water establishes a time-bound programme to deliver these measures.

There is scope to significantly improve standards of customer service

31. Too many NI Water customers are experiencing difficulties in terms of core services such as low water pressure and supply interruptions. In addition, members of this Committee have numerous examples of poor quality customer service:

! inaccurate billing of test meters;

! 24 hours to respond to sewer flooding incidents;

! poor quality of telephone handling: and

! long times taken to install water meters.

Unlike in GB, there are currently no guaranteed customer service standards, although NI Water insists that it does operate to, and measure performance against, these standards. There have also been difficulties in getting adequate responses when problems have been reported and, as the Chief Executive acknowledged, it is often difficult for customers to contact the right people in NI Water.

Recommendation 10

32. NI Water must do more to ensure that its customers are dealt with efficiently and professionally by the Company. The Committee recommends that improving the quality of customer service is set as a priority and would like to be kept informed of plans made to improve performance in this area.

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Benchmarking, Efficiency and Regulation


The Department and NI Water need to take a much more positive

approach to benchmarking as a means of improving performance

33. Benchmarking is a widely used process of comparing an organisation’s processes and performance to the industry best, to determine what scope there is for improvement and how that improvement might be achieved. The C&AG’s report took this approach, comparing NI Water’s performance with the rest of the UK industry, using standard performance indicators.

34. The water industry is especially amenable to benchmarking in this way, given that all companies provide the same services to agreed standards. Indeed the model of economic regulation is premised on benchmarking as a proxy for competition to drive efficiency and improved services. The Regulator in its 2007-08 Costs and Performance Report took a similar approach, using a standard marking system known as the overall performance assessment (OPA). The results of both benchmarking exercises indicated that NI Water’s performance on almost all measures was not as good as other water companies.

35. The Department argued strongly, both in the C&AG’s Report and at the hearing, that comparison with current GB performance was not valid because of a legacy of underinvestment in Northern Ireland. It proposed instead comparison with Scottish Water five years ago when it was at a similar stage of development. It also told the Committee that NI Water compared its performance at a detailed level with companies at the forefront to see what could be learned from them. The Committee requested evidence to support this position but found a considerable disconnect between the oral and written evidence.

36. The Department referred to the work of the Independent Water Review Panel5 (IWRP) to support its position on underinvestment. The Committee considers that the Department considerably overstated this case in its oral evidence. There had been an investment gap but this has progressively closed over the past ten years. The Review Panel stated that the investment gap in 2006-07 equated to less than five per cent of investment spend over the previous eight years and despite this “small gap” , the “substantial gap” in sewage compliance “suggests that our investments may have been less efficient than our comparators”.

37. The Department stated in oral evidence that it had looked at the performance of Scottish Water when it was at a similar stage of development to NI Water and considered this to be a more realistic benchmark than English companies. However, when the Department subsequently provided details of Scottish Water’s 2004-05 performance6, NI Water did not compare well, and the Department then stated that this was not a “true like-for-like comparison”.

38. Although in oral evidence the Department and NI Water referred to a number of benchmarking approaches, the supplementary written submission was less than compelling and, in the Committee’s view, did not address how service delivery and efficiency could be improved in key operational areas.

39. The Department’s views on benchmarking are unnecessarily defensive and will do nothing to help NI Water in achieving the improvements in efficiency and service quality which are badly needed. The Department has wasted too much time and energy trying to rebut the benchmarking efforts of both the C&AG and the Regulator. It needs to show a greater level of maturity in actively pursuing improvements rather than trying to justify the historical reasons for poor performance.

5 In 2007, the NI Executive established an independent panel to review the financing of water and sewerage services. The Panel reported on Costs and Funding in October 2007 and on Management Governance and Delivery in January 2008.

6 As measured by the Scottish Regulator’s assessment of its Overall Performance Assessment (OPA)


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40. The Committee does not expect NI Water to be in the same place after three years that it has taken other companies twenty years to achieve. However the Regulator believes that a step change in performance is possible in a relatively short time and has set a trajectory for NI Water to reach levels of performance comparable with the industry best in five years. This challenge needs to be embraced for the benefit of both taxpayers and paying customers.

Recommendation 11

41. NI Water needs to take a benchmarking approach which compares with industry best, explaining the gaps and accepting responsibility for improvement. The Committee recommends that NI Water sets up a formal programme of performance and process benchmarking with immediate effect.

There is very considerable potential for efficiency savings in NI Water

42. The Department stated that good progress has already been made in improving efficiency, with £40 million of savings achieved to date. While this is welcome, there remains much to be done. The Regulator has estimated that NI Water’s operating costs are around 50 per cent greater than they should be (although updated figures show that the gap has subsequently reduced to 40 per cent), and there is also scope for capital savings. The Regulator considers that, building on experience in GB, this gap can be closed relatively quickly and has set a trajectory of closing about 65 per cent of the cost gap by 2013. There are clear benefits from delivering such efficiencies. Under the current public funding regime this money could be released to the Northern Ireland Block to be used elsewhere; if domestic charging was introduced, consumer bills would be reduced. It is therefore vital that this efficiency gap is addressed.

43. The Department acknowledges a shared interest with the Regulator in driving out inefficiency and has accepted the first year of the Regulator’s Price Control (PC10). Delivering efficiencies in the water industry requires a degree of certainty in terms of available funding. However the current Public Expenditure system does not provide this level of certainty. The Committee believes there is an urgent need to address this issue.

Recommendation 12

44. The very substantial efficiency savings proposed by the Regulator need to be delivered within an agreed timescale. The Committee recommends that the Department, the Regulator and NI Water, in conjunction with DFP, should develop a range of options for the consideration of the Executive with a view to providing NI Water with more certainty of funding over the three year period of PC10.

Economic regulation can make a major contribution to efficiency

irrespective of the source of funding

45. The model of economic regulation has been very successful for the water and sewerage industry in Great Britain. Companies in England and Wales have consistently exceeded efficiency targets, and Scottish Water has reduced its operating spend by over 37 per cent in just four years. The Water Reform process envisaged a similar role for the Regulator in Northern Ireland, setting efficiency targets by comparing operating and capital costs with companies in England and Wales.

46. Independent regulation has brought greater transparency and accountability to NI Water’s performance and this was recognised by the Department at the session. It provides a proxy for competition and an incentive to provide better and more efficient services.

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47. However, it is clear that the current hybrid governance arrangements create difficulties, and the lack of customer charging provides a set of circumstances for the Regulator which are unique in a UK context. Nevertheless, irrespective of how the service is funded, an independent regulatory regime has the potential to play an important role in the identification and delivery of real and meaningful efficiencies. However, the precise role and nature of the regulatory regime will need to be clearly defined to ensure the system operates for the benefit of both the taxpayer and the customer.

Procurement and

Governance in

Northern Ireland Water

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Executive Summary

Executive Summary

1. This is a landmark report that exposes serious failings in procurement, inappropriate and ineffective governance arrangements over an important arm’s-length body, and a failure to observe the high standards expected of senior public officials.

Background

2. In January 2010, an independent review team was commissioned to investigate governance arrangements at Northern Ireland Water (NI Water) in light of procurement problems identified in a number of internal audit reports. Four NI Water non-executive directors were dismissed in March 2010.

3. At the evidence session on 1 July 2010, the Committee focused on the assessment of the nature and cause of procurement failures, the governance arrangements at Northern Ireland Water and the oversight role by the Department for Regional Development. Concerns also emerged over the quality of the evidence provided by witnesses; the proper conduct and actions of the Department’s and NI Water’s Accounting Officers; and also over the independence of those appointed to carry out the review.

4. Following the evidence session, the Committee received correspondence from a member of the review team criticising the Committee’s “disgraceful line of questioning”. It emerged that Mr Paul Priestly, the Permanent Secretary and the Committee’s main witness, had a role in drafting this letter. Mr Priestly was subsequently suspended from his position by the Head of the Northern Ireland Civil Service (NICS), who has assured the Committee that progress is being made with an internal management process under NICS disciplinary policy.

5. The Committee obtained extensive additional documentation from a variety of sources, and it was on the basis of this information that this report was prepared.

Standards in Public Life

6. Public officials are required to act, at all times, with selflessness, integrity, objectivity, accountability, openness, honesty and leadership. It is the responsibility of the Head of the Northern Ireland Civil Service and his Permanent Secretaries to set the example in applying these values.

7. The actions of a number of senior officials in this case has undoubtedly undermined confidence in the integrity of the public sector, but it is important to remember that there are good and honourable people at all levels in public bodies. For confidence to be regained, the highest standards in public life must be applied, but those at the top must lead by example.

8. The conduct of Mr Priestly, the DRD Permanent Secretary, towards this Committee was unacceptable. The role of the Committee in questioning witnesses is to hold them to account for their actions. In his role in drafting this letter, Mr Priestly sought to undermine the Committee; this intervention was utterly disgraceful.

9. There are concerns over the independence of the investigation of NI Water’s procurement problems. There were three potential conflicts of interest, involving two of the three review team members. There were also clear indications that the Department inappropriately influenced a small number of key findings in what was supposed to be an independent review.

10. The review team’s report failed to provide, as requested, a detailed and considered assignment of individual responsibility for the governance failures. The review team was unable to fulfil its terms of reference because of the undue haste with which Mr Priestly pressed for the report to be completed. The speed with which this review was handled was


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completely out of character for the Northern Ireland Civil Service. Mr Priestly may have acted with such haste as a result of Mr MacKenzie’s threat of resignation, which he later withdrew, citing the positive support of DRD.

11. The Committee was not satisfied with the quality of the evidence provided by witnesses at the evidence session. This Committee should not have to seek to draw out relevant and important facts through cross examination.

Procurement in NI Water

12. The failure of NI Water to adhere to the basic principles of procurement is inexcusable. Between December 2005 and August 2010, there were 75 procurement failures totalling £45.9 million, of which 41 (£14.8 million) originated in the Water Service. These failures resulted from widespread abuse of single tender awards (STAs), unapproved contract extensions, and circumvention of financial controls.

13. There was a deeply embedded culture at all levels that made it acceptable to bypass rules to get the job done. In addition to weak financial controls and wholly deficient management information systems, there was no clear set of ground rules setting out who was responsible for authorising expenditure, something which any well run organisation should have. Even NI Water’s central Procurement Unit, which should have been championing best practice, did not itself apply basic financial controls.

14. Many of the procurement problems arose in 2006-07, the final year of Water Service, when 273 staff (14% of the workforce) opted to remain in the NI Civil Service rather than move to NI Water. To address this, Water Service, and then NI Water, appointed significant numbers of consultants and temporary contract staff. While the Committee recognised that this was necessary to manage the short term staffing problems, it was, nevertheless, astonished to learn that in the three years up to 2009-2010, NI Water spent over £42 million on consultants and temporary staff. It seems to the Committee that it must have been difficult to tell who was an employee and who was a consultant.

15. While Internal Audit had serious concerns about the overall control environment within NI Water from the outset, it did not identify the procurement failures highlighted in this report. Indeed, in 2008-09 it was asked not to look at procurement, as new processes were being put in place. Even when it did identify weaknesses in the procurement process (in September 2009), it failed to recognise the significance of these problems.

16. Despite the procurement failings, the most recent CoPE accreditation exercise, which was carried out in 2009, found that all CoPEs, including NI Water, achieved the highest possible rating - that is “exemplar” status. The Committee therefore questions — not for the first time — the value of this accreditation process. It further questions the independence of this exercise, given that the review was carried out by PricewaterhouseCoopers (PwC), despite that company having received £27.1million in fees between March 2006 and August 2010 from Water Service and NI Water (including £2.2 million from contracts which were improperly authorised STAs).

Governance in NI Water

17. The governance arrangements established by DRD for NI Water represented the worst of all worlds – NI Water was not a fully-fledged commercial organisation subject to the usual market disciplines nor was it a conventional public body operating under tried and tested public sector rules and procedures. The governance model was devised for a self-financing commercial company and was inadequate for a body whose income derived mainly from public funds. The current governance arrangements should now be revised to incorporate the level of oversight necessary for a public body delivering a service of fundamental importance to the people of Northern Ireland.

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Executive Summary

18. Departmental oversight of NI Water was clearly deficient:

! Until it signed a confidentiality agreement with the private sector internal auditors, DRD was unable to access key audit information on its own arm’s-length body and as a consequence it effectively denied the C&AG access to internal audit reports. This is appalling;

! DRD failed to appoint an NI Water Accounting Officer (from May 2008 to September 2009). A public body of the scale of NI Water should never have been permitted to function without its Chief Executive fulfilling this crucial role; and

! DRD failed to ensure NI Water implemented the recommendations of relevant Public Accounts Committee reports. In 2008 the Committee recommended that any decisions to procure without competitive tendering, above a minimal level, must be reported to the Audit Committee. If this had happened, the procurement failings in the company might have been identified much earlier.

19. DRD failed to ensure that NI Water complied with some of the most basic principles of good corporate governance. It did not ensure that NI Water had a full complement of non-executive board members until July 2008. In June 2008, the DRD Accounting Officer approved the appointment of the NI Water Chair as interim Chief Executive in direct contravention of established good practice. The separation of roles and responsibilities at the top of an organisation is fundamental to good governance. It is astonishing that the Accounting Officer failed to adhere to this key principle.

20. The Board of NI Water was badly let down by senior executives; management information was poor and the internal audit of procurement was deficient. However, these serious defects do not absolve the Board from its own responsibilities. The Board is required to hold management to account and should call for any information necessary. It also has a responsibility for directing and reviewing the work of internal audit. In failing to provide an appropriate level of audit coverage NI Water management and its Board had demonstrated a poor understanding of the significant risks the organisation faced.

21. The responsibilities of a non-executive director of a public body are demanding, but the role is crucial in ensuring such bodies properly manage public funds. What has happened in NI Water must not be allowed to deflect from the ability of public bodies to attract high calibre candidates to such important positions.

22. Throughout this report, the Committee makes a number of significant recommendations. These must be implemented with urgency and vigour if NI Water, and the wider public sector, is to prevent a recurrence of this unprecedented catalogue of serious failings.


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Recommendation 1

1. The Committee recommends that the Head of the Civil Service completes his assessment of Mr Priestly’s role in this matter as soon as possible and advises this Committee of the outcome. The Committee expects him to communicate, in the strongest terms, to all permanent secretaries and senior civil servants the need to adhere to the Nolan principles and to respect the role of this Committee and all other Committees of the Assembly.

Recommendation 2

2. The Committee recommends that when departments commission external review panels to investigate major irregularities, there should be very stringent guidelines around the independence of panel members. Any prospective panel member with potential or perceived conflicts of interest should be excluded from consideration. This is all the more crucial in circumstances where the remit of the panel includes apportionment of blame and where there is potential for reputational damage to those subject to investigation.

Recommendation 3

3. The Committee recommends that, as a point of principle, only the facts contained in independent reviews should be agreed. Ownership of conclusions and recommendations must firmly lie with those selected to carry out the independent review.

Recommendation 4

4. The IRT Report was deficient in terms of process, and was used as a basis of advice which led to the dismissal of Board members. Major investigations where blame may be apportioned should never be rushed. The Committee therefore recommends that reviews of this significance must always be given sufficient time to fully meet their terms of reference and come to a proper and complete conclusion on the facts.

Recommendation 5

5. NI Water made use of confidentiality clauses to keep embarrassing transactions secret. The Committee recommends that, as a point of principle, confidentiality agreements should not be used anywhere in the public sector. However, if in exceptional circumstances their use proves to be unavoidable, the Committee considers that these cases should be approved by the relevant departmental Accounting Officer and by DFP.

Recommendation 6

6. The Committee recommends that DFP reviews the use of confidentiality undertakings given to interviewees, sets out the circumstances where they should be used and issues appropriate guidance. The Committee expects this guidance to be principle based, requiring all public officials to follow and apply, at all times, the principles of honesty, openness, integrity and accountability.

Recommendation 7

7. The Committee strongly recommends that DFP issues clear guidance to all departments that any contracts, for the purpose of an inquiry or investigation, should provide the sponsor with ownership of the contractor’s supporting documentation and the C&AG with full access to these papers.

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Recommendation 8

8. The Committee recommends that all witnesses to this Committee must not only answer all questions put to them accurately, but also should not omit relevant and important facts. This Committee should not have to seek to draw out this information through cross examination. Only by receiving open, honest and full responses can this Committee make effective recommendations that help to improve the way the public sector serves the people of Northern Ireland.

Recommendation 9

9. To improve transparency and accountability in the use of STAs the Committee recommends that each departmental Accounting Officer should provide a statement of non-competitive contracts to both the relevant statutory Committee and to the C&AG on an annual basis. These statements should set out details of the subject or purpose of the contract, its value and the reasons for not having a competitive process.

Recommendation 10

10. The Committee recommends that there is a root and branch overhaul of the procurement function in the NI public sector to prevent the circumvention of financial controls and ensure transparency and value for money.

Recommendation 11

11. The Committee recommends that DFP considers the methodology employed by internal audit in the public sector, which should retain a risk-based approach but introduce an increased level of detailed testing.

Recommendation 12

12. The Committee recommended in its February 2009 report on the legal practitioner fraud1 that internal audit, throughout the health sector, should give sufficient weight to the audit of contracts. Clearly this is a significant issue throughout the public sector. The Committee therefore recommends that contract audit is given greater prominence in the audit programmes of all government departments and NDPBs.

Recommendation 13

13. It is not good enough for the CoPE accreditation process just to consider whether proper procedures existed. There should be testing to ensure that the procedures are applied in practice. The Committee recommends that this issue is taken into account in the ongoing review of the CoPE assessment methodology.

Recommendation 14

14. The Committee recommends that, before appointing consultants to conduct reviews or investigations, CPD should check with departments and confirm that the preferred bidder does not have a potential conflict of interest.

Recommendation 15

15. The Committee recommends that DFP ensures that, in future, the external auditors of NI Water and any other arm’s-length bodies constituted as companies not audited by the C&AG, should be required to provide an opinion on the regularity of income and expenditure.

1 PAC Report ‘Brangham, Bagnall and Co. Legal Practitioner fraud Perpetrated against the Health and Personal Social Services, 26/08/09R, 5 February 2009


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Recommendation 16

16. The Committee recommends that a new governance agreement in the form of a Management Statement/Financial Memorandum should be put in place between DRD and NI Water for as long as NI Water continues to receive large amounts of public funding. This would provide the degree of oversight normally expected between a sponsoring department and an NDPB. The Committee is aware that such documents often take an inordinately long time to prepare; therefore DRD should work with DFP to fast track this process for NI Water.

Recommendation 17

17. The Committee recommends that DRD require NI Water to immediately implement, in full, all DFP guidance on the management of public money which is applicable to public bodies in Northern Ireland.

Recommendation 18

18. The Committee recommends that, as a priority, DRD conduct a fundamental review of governance arrangements in all its arm’s-length bodies. This review should revisit and reinforce the recommendations of the Committee’s report on Good Governance.

Recommendation 19

19. Given the ongoing dynamic environment in the public sector, there is a clear need for due diligence in the transfer of functions from one organisation to another. The Committee recommends that DFP considers the adequacy of guidance on due diligence and on human resource planning. Guidance should aim to minimise the risks associated with change management, particularly the risk of developing an over-reliance on the use of consultants.

Recommendation 20

20. The Committee recommends that departments, as well as board members and senior managers of public companies, should ensure that the degree of internal audit coverage corresponds with the level of risk as determined by a comprehensive risk assessment. This is particularly crucial in circumstances where the audited body is engaged in significant organisational change.

Recommendation 21

21. The recognised procedure for handling internal audit recommendations is to allocate responsibility for action to individual managers or directors and to set a challenging timetable for implementation. Progress is monitored by senior management and overseen by the Audit Committee. The Committee recommends that, for this process to work effectively, Accounting Officers must ensure that there are appropriate sanctions for those individuals who consistently fail to deliver.

Recommendation 22

22. The Committee recommends that all public bodies constituted as companies and subject to companies legislation must be required to adhere fully to the good governance requirements now set out in the UK Corporate Governance Code. It should fall to the departmental Accounting Officer to ensure that this happens.

Recommendation 23

23. The Committee recommends that departments ensure that non-executive directors are properly supported by all stakeholders in the governance model. Board members must receive accurate information from management, accurate independent assurance from auditors, and the support of the Department. However, Board members must recognise that they have a responsibility to challenge management, auditors and the information put before them.

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Introduction

Introduction

1. The Public Accounts Committee met on 1 July 2010 to consider the “Northern Ireland Audit Office Memorandum on Governance of Northern Ireland Water”. The main witnesses were:

! Mr Paul Priestly, Accounting Officer, Department for Regional Development;

! Ms Lian Patterson, Senior Finance Director, Department for Regional Development;

! Mr Laurence MacKenzie, Chief Executive, Northern Ireland Water;

! Ms Nicola Brennan, Head of Internal Audit, Northern Ireland Water;

! Ms Fiona Hamill, Treasury Officer of Accounts, Department of Finance and Personnel;

! Mr Kieran Donnelly, Comptroller and Auditor General.

2. Northern Ireland Water (NI Water) was established on 1 April 2007 as a Government owned company (“GoCo”), subject to companies’ legislation, with the Department for Regional Development (DRD) as the sole shareholder. NI Water was appointed2 as the provider of water and sewerage services in Northern Ireland, operating under licence issued by DRD and subject to regulation by the Northern Ireland Authority for Utility Regulation (the Regulator).

3. NI Water was formed as a GoCo on the basis that income would be generated from industrial, commercial and domestic water charges and that, eventually, NI Water would become self-financing. However, in April 2007, the NI Secretary of State postponed introduction of domestic water charging pending restoration of devolution. Since the restoration of devolution in May 2007, the Executive has deferred the introduction of the proposed domestic charges. NI Water continues to be funded by DRD, largely in the form of revenue subsidy (NI Water’s main source of funding), some seventy-five per cent of its revenue income. In 2009-2010, DRD’s subsidy to NI Water was £258 million.

4. NI Water is one of eight Centres of Procurement Expertise (CoPEs) in Northern Ireland’s public sector. Procurement through a CoPE is intended to ensure that there is a professional influence on all procurement activity in order to maximise value for money3 and ensure compliance with EU and UK legislation.

5. In January 2010, DRD and NI Water commissioned an independent review of governance arrangements in light of various procurement problems identified in a number of internal audit reports. The Comptroller and Auditor General (C&AG) prepared a memorandum4 for the Committee on the review’s findings, on which the Committee took evidence.

6. At the evidence session, the Committee focused on:

! standards in public life and the actions of the Accounting Officers;

! the assessment of the nature and cause of procurement issues identified by the independent report;

! the use of consultants to fill staff posts;

! the award and confirmation of CoPE status;

! the governance arrangements; and

! the oversight role of the Department for Regional Development.

2 Under the Water and Sewerage Services (Northern Ireland) Order 2006

3 Value for money is to be achieved through compliance with the 12 Principles of Public Sector Procurement. The Principles are accountability, competitive supply, consistency, effectiveness, efficiency, fair dealing, integration, integrity, informed decision making, legality, responsiveness and transparency.

4 ‘NIAO Memorandum on Procurement and Governance in NI Water’, laid at the NI Assembly on 18 June, 2010


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7. The Committee was not satisfied with the quality of the evidence provided by witnesses at the evidence session. Concerns were also raised about the independence of those carrying out the review of procurement.

8. Following the evidence session, the Committee received correspondence from a member of the review team criticising the Committee’s line of questioning. This led to a chain of events culminating in the suspension on 17 August 2010 of the Permanent Secretary of DRD, the main witness at the evidence session.

9. In light of emerging concerns, the Committee obtained further documentation from DRD and NI Water and received a significant amount of additional information from a number of other sources. The Committee also asked the C&AG to independently evaluate the procurement failures identified and report back on his findings. The Committee has prepared this report on the basis of the NIAO Memorandum5 and the other evidence it obtained.

10. A comprehensive timeline of events is included in the reference chapter.

5 NIAO Memorandum on ‘Examination of Procurement Breaches in Northern Ireland Water’, laid at the NI Assembly on 9 December 2010

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Section 1: Standards in Public Life


The Conduct of the DRD Permanent Secretary towards

the Committee was unacceptable

11. It is essential that the general public and their elected representatives have full confidence in the way that Northern Ireland civil servants conduct public business. All public officials, from the top down, are required to behave, at all times:

! within the spirit as well as the letter of the law;

! in the public interest; and

! to high ethical standards.

12. The benchmark for ethical behaviour in the public sector was set by the Committee on Standards in Public Life at Westminster through its “Seven Principles of Public Life”6. Often referred to as “the Nolan Principles”, these principles require public officials to act, at all times, with selflessness, integrity, objectivity, accountability, openness, honesty and leadership. The Committee has always championed the application of these principles in its work and plays an important role, on behalf of the Assembly, in holding public officials to account for their decisions.

13. The Committee expects all public officials from the top down to know these ethical principles so well that they should apply them instinctively in every decision they make. The Committee also expects that, as Accounting Officers, top officials must demonstrate that, in taking responsibility for public spending decisions, they have ensured regularity, value for money and propriety. Not only must they spend wisely and well, but their behaviour should be beyond reproach. This Committee acknowledges that the vast majority of civil servants strive to uphold these principles.

14. It is the responsibility of the Head of the Northern Ireland Civil Service (the Civil Service) and his Permanent Secretaries to set the tone at the top, ensuring that integrity and honesty are at the heart of all that they do and say. The Committee was therefore appalled to learn that the DRD Permanent Secretary, Paul Priestly, had a role in preparing a draft letter of complaint7 to this Committee on behalf of Peter Dixon, a member of the Independent Review Team (IRT), which investigated procurement failings in NI Water. Mr Dixon is the Group Chief Executive of Phoenix Energy Holdings. In this letter Mr Dixon stated that there was a ”disgraceful line of questioning” at the Committee’s evidence session of 1 July 2010. The letter attacked the role of the Committee in questioning witnesses called to account for their actions in relation to the significant procurement problems at NI Water. The fact that Mr Priestly — the principal witness and the person required to set an example to the many public officials under his direction — had had a role in preparing this letter was utterly disgraceful. This letter clearly sought to undermine the role played by this Committee in holding public officials to account. The Committee is both shocked and angry at the duplicity of such a senior public servant.

15. Prior to the identification of the real author of the letter, the Chairman of Phoenix Energy Holdings Sir Gerry Loughran, a former Head of the Civil Service, distanced his company from Mr Dixon’s comments. In doing so, he accepted that this Committee was pursuing perfectly legitimate questions which were both reasonable and evidence-based. Interestingly, Sir Gerry noted that Mr Dixon had “very little knowledge of the Assembly’s accountability processes and in particular the work of the PAC [Public Accounts Committee]”. The irony is that it was an

6 The Seven Principles of Public Life - Standards in Public Life: First Report of the Committee on Standards in Public Life (1995) Cm2850. See reference chapter

7 See appendix 1.


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Accounting Officer, supposedly expert in the accountability process, who had been involved in scripting the comments.

16. The Head of the Civil Service acted appropriately by suspending Mr Priestly when new information revealed his role in drafting the letter. Sir Jon Shortridge KCB, former Permanent Secretary of the Welsh Assembly Government, was appointed to investigate the actions of Mr Priestly in this matter. The Committee understands that this investigation has been completed. An announcement on Mr Priestly’s future has not yet been made and he remains suspended on full pay. The Head of the Civil Service told the Committee that “the matter is being taken forward as an internal management process conducted in accordance with Northern Ireland Civil Service (NICS) disciplinary policy”. He has given his personal assurance to the Committee that progress is being made in relation to the matter. The Committee will monitor the outcome.

17. While this case has undoubtedly undermined public confidence in the integrity of the Civil Service, it is important to remember that there are good and honourable people at all levels of the Civil Service. For confidence to be regained, not only must the Civil Service rigorously apply the highest standards in public life, but those at the top must lead by example. The Committee’s report on the Hospitality Association of Northern Ireland8 called on senior public officials to exercise moral leadership in maintaining public standards. The need for this to happen has never been greater. Holders of public office are accountable for their decisions and actions to the public and must submit themselves to whatever scrutiny is appropriate to their office.

Recommendation 1

18. The Committee recommends that the Head of the Civil Service completes his assessment of Mr Priestly’s role in this matter as soon as possible and advises this Committee of the outcome. The Committee expects him to communicate, in the strongest terms, to all permanent secretaries and senior civil servants the need to adhere to the Nolan principles and to respect the role of this Committee and all other Committees of the Assembly.

Independence: Appointment of the Independent Review Team

19. In January 2010 Mr Priestly established an Independent Review Team (IRT) to examine procurement governance breaches in NI Water. The membership of the IRT was Peter Dixon, Group Chief Executive, Phoenix Holdings Ltd.; Jackie Henry, Public Sector Partner in Deloitte; and Glenn Thompson, business consultant and former senior civil servant and Accounting Officer9. In selecting Mr Dixon, Paul Priestly told the Committee that he was keen to have someone with commercial experience who could directly address whether NI Water was operating commercially. He had also wanted someone with accountancy skills and someone who had Accounting Officer experience. Mr Dixon did not charge for his contribution; Deloitte was paid some £36,00010 and Mr Thompson, £21,00011.

20. The Department told the Committee that in selecting the IRT members it had to take account of the fact that all but one of the big four accountancy firms were conflicted: Ernst and Young were NI Water’s internal auditors; KPMG were its external auditors; PricewaterhouseCoopers (PwC) had significantly benefited from NI Water consultancy contracts, a number of which were not properly procured; therefore only Deloitte was not involved in the matter. However, the Committee’s subsequent enquiries revealed that Deloitte had potential conflicts of interest.

8 15th Report of Committee of Public Accounts 2007-08 Report on’ Hospitality Association of Northern Ireland: A Case Study in financial management and the public appointments process’ (36/07/08R)

9 Mr Thompson was a former Accounting Officer of the Northern Ireland Court Service.

10 Deloitte’s costs of £36,443 included 20 days of Ms Henry’s time, £22,000, 7 days of secretarial time £2,450, a review of NI Water’s internal audit methodology £6,525 (fixed fee) and VAT.

11 Mr Thompson’s costs included £17,840 for 22.3 days time incurred, £66 for expenses and VAT of £3,122.

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21. Indeed, the Committee discovered that there were three potential conflicts of interest involving IRT members, none of which were properly handled. The first involved business relationships between Ms Henry and those who appointed her. Deloitte had been awarded consultancy work of £2.7 million by DRD and £804,000 by NI Water in the three years prior to Ms Henry’s appointment to the IRT. In correspondence, the Department informed the Committee that Deloitte had been instrumental in establishing the NI Water governance framework on its formation and a partner from that firm was therefore considered to be an appropriate team member.

22. The NIAO Memorandum of 9 December 2010 disclosed that 11 days before Ms Henry’s appointment to the IRT, her firm, Deloitte, was appointed to provide expert witnesses and forensic accountants to the Steria contractual dispute at a cost of £389,000. Ms Henry and Lian Patterson, the senior DRD Finance Director who had, with the Accounting Officer, selected the IRT members, were former colleagues at Deloitte. The relationships between Deloitte, DRD and NI Water were so extensive that those appointing Ms Henry should have been aware of the risk of a perception of conflict of interest.

23. It was entirely wrong to appoint someone whose own firm had carried out such a large amount of work for NI Water, including assisting with setting up the very governance structure which was now being reviewed for failing to prevent and detect the significant procurement breaches.

24. The second potential conflict concerns the relationship between the NI Water Chief Executive and Peter Dixon of the IRT. Mr MacKenzie told the Committee that Mr Dixon was a business acquaintance — ”no more than that” — and he had made this relationship known to Mr Priestly, who did not consider that the relationship constituted a conflict of interest. Information emerging since the Committee’s evidence session suggested a closer connection. The Committee has obtained an email between Mr MacKenzie and Mr Dixon where he sought to meet Mr Dixon as he needed help from friends.

25. The third potential conflict concerned the relationship between Mr Dixon and Don Price, a Board member and Chair of the Audit Committee. The IRT interview notes revealed that Mr Dixon had declared at the IRT’s interview with Mr Price, the only non-executive not dismissed, that he knew Mr Price but he had no conversations with him in relation to the review. This declaration had no value when it was contained in interview notes never made publicly available. The connection should have been recorded in the report for all to see.

26. The Board of NI Water was clearly not convinced that the IRT members were independent and raised these concerns with the Department at an early stage of the review. These concerns were understandable, given that press reports as early as 8 February 2010 suggested that “heads could roll”12 as a result of the review. However, Mr Priestly maintained that there was no basis on which to question the independence of the review.

27. DRD should not have appointed individuals to the IRT who could be perceived as having a conflict of interest. Indeed, it is abundantly clear that from the start of the IRT review, that certain members were clearly perceived as partial by those being investigated. The Department failed to appreciate that those tasked with apportioning blame for the procurement failures would have to be beyond reproach in terms of their independence.

12 Article in Belfast Telegraph.


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Recommendation 2

28. The Committee recommends that when departments commission external review panels to investigate major irregularities, there should be very stringent guidelines around the independence of panel members. Any prospective panel member with potential or perceived conflicts of interest should be excluded from consideration. This is all the more crucial in circumstances where the remit of the panel includes apportionment of blame and where there is potential for reputational damage to those subject to investigation.

Independence of the Review Team Report

29. Two significant changes were made by the Review Team as a result of representations from the Department. The first draft referred to a serious “disconnect” between the NI Water Board and its Chief Executive, Mr MacKenzie. Mr Priestly suggested that the IRT change ”disconnect” to ”breakdown”, which was accepted. Mr Priestly also suggested that the IRT should include that it considered the breakdown in the relationship to be “irreconcilable”. The IRT did not go as far as Mr Priestly wanted. It stated that it was the view of the Chairman of the Board, Mr Mellor, that “the position is now irreconcilable”. This Committee believes that this change, recommended by Mr Priestly and agreed to by the IRT, overstated the facts, in that there was ample evidence, from Board members, that the relationships were not irreconcilable. This is particularly important given that the Department’s own assessment that the breakdown was irreconcilable was a factor in the dismissal of the board members.

30. The second key change made was in relation to the IRT findings on the assessment of DRD failures. Mr Priestly suggested that the IRT’s finding, that DRD procrastination contributed to the creation of a weak governance environment, should be caveated with “This is no excuse for the failures in procurement which have been identified within NI Water.” The IRT accepted this change to their findings. It was wrong for DRD to suggest and unwise of IRT to accept an amendment which was made simply to dilute the responsibility of the Department and should not have been made.

31. As part of its fact finding approach, the IRT interviewed 27 key officials including the NI Water Board. All interviews were minuted and all but one interviewee agreed those minutes. The interviewee who did not agree the minutes taken by the IRT was Declan Gormley. Mr Gormley questioned, among other things, what he perceived to be the negative bias of the IRT questioning and the partial minuting of his meeting. The Committee is shocked to learn that, not only did IRT decide not to include Mr Gormley’s assessment in the report, but it failed to disclose that his comments had not been included.

32. The lack of agreement between Mr Gormley and the IRT is significant because he was the only Board member whose behaviour towards the IRT was taken into account when considering his dismissal. The Department considered that he had “communicated aggressively with the IRT”. Mr Gormley was the only interviewee who failed to accept the IRT notes of his meeting. DRD concluded that his actions demonstrated a lack of judgement and determined that NI Water had lost confidence in him.

33. There are clear indications that the Department inappropriately influenced a small number of key findings in what was supposed to be an independent review. It is right that facts must be agreed: this is a necessary and valuable process to validate conclusions which must be evidence-based. But independent reporters should rarely amend their conclusions on the suggestion of those being reported upon.

34. Given the difficulties in the relationships between the Board and the Chief Executive, the Committee is disappointed that Mr Priestly did not do enough, at this time, to bring the parties together to resolve this. Indeed by his lack of action, he may have exacerbated already stressed relationships.

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Recommendation 3

35. The Committee recommends that, as a point of principle, only the facts contained in independent reviews should be agreed. Ownership of conclusions and recommendations must firmly lie with those selected to carry out the independent review.

IRT did not make Recommendations on the Position of NI Water Board

Members and other Senior Managers

36. The IRT’s overall conclusion on the culpability of the Board members and, in particular, the non-executives was far too general and was deficient in that it did not contain a detailed, considered and independent assignment of individual responsibility for the governance failures.

37. The IRT’s overall conclusion was that procurement failings in NI Water represented a serious “breakdown in the application of the governance and control framework” of NI Water, and that this was “a serious matter for those responsible and accountable, primarily the Board of NI Water and the executives responsible for ensuring compliance”. This view is particularly important in that it was given significant weight by DRD in the decision to dismiss board members.

38. The IRT terms of reference included the requirement to make recommendations in relation to the position of NI Water Board members (executive and non executive) and other senior managers involved in allowing the procurement breaches.

39. However, IRT failed to meet its terms of reference stating that “we have found it impossible, within our timeframe, to establish which executives within NI Water should be held responsible for the failures noted to date.” The IRT recommended that the Chief Executive should initiate a detailed mapping of executive responsibility for procurement failures and this should lead, where necessary, to disciplinary action13.

40. The report should have more closely considered the respective roles, responsibilities and actions of the Chairman of the Board, the Chairman of the Audit Committee, other non-executives, the executive directors and relevant senior managers in not preventing, detecting and correcting significant procurement breaches. The role of the Chairman of NI Water, for example, in providing effective strategic leadership14 on matters including the encouragement of high standards of propriety and promoting value for money should have been considered by the review.

41. The Department undertook in March 2010 to consider the position of the two executive members of the Board following a review by NI Water of executive responsibilities. This review has yet to be completed. The Committee awaits the outcome of this process. The Committee understands that disciplinary proceedings were taken against five NI Water employees. This process has been completed in four cases; one case remains ongoing, and DRD told the Committee that it is being progressed as quickly as possible.

42. The Committee considers that, leaving aside the concerns above about the composition of the IRT, Mr Priestly should have provided more time to complete the review. The IRT investigation was completed with undue haste, particularly given that the purpose of the investigation was of such significance. The first draft of the IRT Review was completed three weeks from commencement. It was cleared ten days later following the production of two further drafts. However, not all internal audit reports were completed on procurement, even in draft, prior to finalisation of the IRT Review. Furthermore, the IRT found it impossible to allocate responsibility for the procurement problems to executives within the timeframe set.

13 This process did not include non-executive directors

14 Guidance on Codes of Practice for Board members of Public Bodies (Cabinet Office’ October 2004)


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43. It seems to the Committee that the speed with which this was handled was completely out of character for the NI Civil Service. Mr Priestly may have acted with such undue haste as a result of Mr MacKenzie’s threat of resignation, which he later withdrew, citing the positive support from DRD.

Recommendation 4

44. The IRT Report was deficient in terms of process, and was used as a basis of advice which led to the dismissal of Board members. Major investigations where blame may be apportioned should never be rushed. The Committee therefore recommends that reviews of this significance must always be given sufficient time to fully meet their terms of reference and come to a proper and complete conclusion on the facts.

Confidentiality Clauses on Contractual Settlements

45. In accordance with the Nolan Principles, public officials should be as open as possible about all the decisions and actions they take and are accountable to the public for them. There was an unacceptable and widespread use of confidentiality clauses in NI Water that restricted openness and accountability. Such clauses were clearly intended to keep embarrassing payments out of the public view.

46. The Department would not disclose to the Committee details of the NI Water settlement with Steria15. The C&AG subsequently used his statutory powers to obtain this information. The NIAO Memorandum of 9 December 2010 disclosed that NI Water paid Steria £10.6 million including VAT and paid a Steria sub-contractor £2.1 million. In addition NI Water agreed to pay Steria’s reasonable legal costs.

47. Other examples of confidentiality agreements at NI Water included:

Figure 1: NI Water Confidentiality Agreements

Year Confidentiality agreement £ Reference

2008-09 Compensation for loss of office to Katharine Bryan, former Chief Executive

162,000 Para 46 below

2009-10 Settlement with Contracting Out LLP 243,550* Para 47 below

2009-10 Settlement to Loughs Agency for river pollution 500,000 Para 22 of Volume 1

"# $%&#'()*+,--#./01&23#4/5#1/6&#7.#89#/#5&33:&1&23#;<7=&#89#'(--+---+#>23&=&53#89#'?*+,,-#/26#VAT of £30,000.

48. Senior Executives leaving NI Water have received settlements which have also been subject to confidentiality agreements, including Ms Katharine Bryan, the first Chief Executive of NI Water. While the 2008-09 NI Water accounts disclose a compensation for loss of office settlement of £162,000, the reason for her early departure is subject to a confidentiality clause which was approved by the Department.

49. Contracting Out LLP was paid £527,000 for work on the termination of the Steria Contract. This included a settlement payment of £200,000 in respect of a six per cent bonus clause. Contracting Out told this Committee that the confidentiality clause was required by NI Water, but NI Water subsequently breached the clause in e-mails sent to a newspaper.

15 Steria was contracted by NI Water to provide a customer billing system but the contract was terminated early.

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Recommendation 5

50. NI Water made use of confidentiality clauses to keep embarrassing transactions secret. The Committee recommends that, as a point of principle, confidentiality agreements should not be used anywhere in the public sector. However, if in exceptional circumstances their use proves to be unavoidable, the Committee considers that these cases should be approved by the relevant departmental Accounting Officer and by DFP.

The Department entered into Contracts which attempted to place

Evidence outside of the Reach of PAC and NIAO

51. In order to ensure public accountability, the Committee requires full access to persons and papers relevant to its enquiries. The Committee requested from DRD copies of the IRT interview notes. The Department said that it was unable to release the papers following legal advice that this material was both sensitive and personal. Each interviewee had been advised by the IRT that the record of their interview would remain confidential. Consequently, DRD and DFP considered that any disclosure of the information within the papers ”may facilitate an unwarranted invasion of privacy”. Both the Department and DFP were concerned that disclosure of such information might harm the conduct of future investigations through discouraging open and candid provision of information.

52. The C&AG sought access to the papers from DRD using his statutory powers, but DRD could not provide them as they were held by Deloitte who initially refused to release them. The contract had given Deloitte ownership and retention rights over all supporting documentation. Only after court action to retrieve the papers was threatened were they finally released and examined by NIAO as part of their procurement review.

53. The Committee is appalled that DRD agreed to the transfer of ownership of supporting papers to a publicly funded report to a private sector consultancy firm. This flies in the face of transparency. The presumption must be that public officials will give open and honest disclosure to departmental enquiries and investigations without the cover of a promise of confidentiality. The Committee also considers that public bodies must retain ownership and access to all evidence supporting investigations they have commissioned.

Recommendation 6

54. The Committee recommends that DFP reviews the use of confidentiality undertakings given to interviewees, sets out the circumstances where they should be used and issues appropriate guidance. The Committee expects this guidance to be principle based, requiring all public officials to follow and apply, at all times, the principles of honesty, openness, integrity and accountability.

Recommendation 7

55. The Committee strongly recommends that DFP issues clear guidance to all departments that any contracts, for the purpose of an inquiry or investigation, should provide the sponsor with ownership of the contractor’s supporting documentation and the C&AG with full access to these papers.

The Accounting Officers’ Evidence to PAC

56. Accounting Officers are well aware from guidance issued to them on their appointment that, except for situations in which a ministerial direction is sought and obtained, they and they alone are accountable for the actions of their departments to this Committee. The Committee should not have to remind any permanent secretary of this principle. When the Committee questioned Mr Priestly’s decision to approve the appointment of the Chair as acting Chief Executive, he said that this step had been approved by the Minister. It was only when pressed


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on the point that he acknowledged that this had been his recommendation. This indicated a clear abdication by the Accounting Officer of his personal responsibility.

57. Managing Public Money Northern Ireland16 requires witnesses at this Committee to give clear, accurate and complete evidence. Mr MacKenzie made great play of the fact that the contract with Contracting Out LLP was on the basis of a six per cent bonus which could have resulted in a payment of £1.4 million. He failed to mention, however, that NI Water had already17 reached a settlement with Contracting Out LLP for £200,000 (plus VAT and interest) which bought out any potential bonus. Mr MacKenzie’s answers on this matter failed to meet the standard required by the Committee.

58. In assessing the independence of the members of the IRT, the Committee questioned Mr MacKenzie about the nature of his relationship with Mr Dixon. Mr MacKenzie initially told the Committee that he was a business acquaintance, “no more than that”. When an email from Mr MacKenzie to Mr Dixon was produced, which stated “I need help from my friends at the minute”, Mr MacKenzie revised the description of this relationship, stating “he is a good friend, in the sense that he is a business acquaintance”. The Committee was not convinced of the veracity of Mr MacKenzie’s answers in this regard.

59. The previous Public Accounts Committee’s 2002 report on the Northern Ireland Tourist Board18 was quite clear on the quality of evidence it required from witnesses. It said that, “the blunt message that we have for any Accounting Officer who is tempted not to answer our questions fully is that we will insist on further investigation by the C&AG and exercise our full powers to call for papers and additional witnesses until we are satisfied that all the relevant facts have been revealed.” This Committee remains of this view and considers that it is entirely appropriate to repeat the message.

Recommendation 8

60. The Committee recommends that all witnesses to this Committee must not only answer all questions put to them accurately, but also should not omit relevant and important facts. This Committee should not have to seek to draw out this information through cross examination. Only by receiving open, honest and full responses can this Committee make effective recommendations that help to improve the way the public sector serves the people of Northern Ireland.

16 Chapter 3, paragraph 3.5.3 and paragraph 3.5.2 of Managing Public Money Northern Ireland (DFP, June 2008)

17 The settlement was approved by DRD on 23 October 2009, and paid 30 March 2010

18 First Report of the Public Accounts Committee, ‘Report on the Northern Ireland Tourist Board’, Session 2002/2003 (01/02R)

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Section 2: Procurement in NI Water


The Scale of the Procurement Failures was Significant

61. Between September 2009 and June 2010, NI Water Internal Audit produced three reports on procurement irregularities. These reports identified extensive non-compliance with procurement rules and regulations in the procurement of goods and services19. The Committee subsequently requested, and the C&AG agreed, that NIAO carry out an examination of the procurement failures on goods and services in NI Water which had been highlighted in the Internal Audit reports. One of the key issues which the Committee was keen to determine was the extent to which the procurement failures pre-dated the inception of NI Water. From its review, NIAO identified £45.9 million in 75 procurement failures over the period 1 December 2005 to 31 August 2010, 41 (£14.8 million) of which originated in Water Service.

62. The C&AG’s review has confirmed that there were serious failings in procurement procedures in NI Water. These include:

! the widespread abuse of single tender awards (STAs) in circumstances where major contracts should have been put out to competition;

! a large number of unapproved contract extensions (in one case a three-year contract was extended by a further eight years, without proper approval, during which an additional £10 million of business was awarded); and

! circumvention of financial controls.

The Use of Single Tender Actions (STAs)

63. EU Utilities Procurement Regulations permit non-competitive contracts (Single Tender Action contracts) when the contractor is the sole supplier of certain goods and services. There was scant evidence that STAs were awarded to sole suppliers. NI Water’s own internal rules state that all STAs over £250,000 require approval by the Department and any STAs under £250,000 require Chief Executive approval. Again, there was no evidence that appropriate approvals had been sought for those STAs identified by Internal Audit.

64. The failure of NI Water to adhere to these basic rules is inexcusable; they are there for good reason, namely:

! to ensure fairness in the award of contracts;

! to ensure value for money; and

! to minimise the potential for fraud and corruption.

65. As a direct result of STA abuse, suppliers have been prevented from bidding for NI Water contracts. If NI Water is to retrieve this situation and restore the confidence of potential suppliers, it will have to clearly demonstrate that there are no favoured suppliers and that all firms operate on a level playing field.

66. Inappropriate use of STAs is a problem which reaches beyond NI Water and into the wider public sector. The Committee welcomes the new substantive guidance on STAs20 issued by DFP in June 2010. It is a concern that this guidance on the interpretation of procurement

19 These issues did not relate to capital expenditure, except in one case which was the extension of a contract initially awarded for consultancy services.

20 Central Procurement Directorate Procurement Guidance Note 02/10, Award of Contracts without a Competition (Also known as Single Tender Action): Issue date: 17th June 2010.


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regulations was issued four years after the regulations were introduced21. It should not have taken a Committee hearing on this matter to prompt the circulation of relevant guidance.

Recommendation 9

67. To improve transparency and accountability in the use of STAs the Committee recommends that each departmental Accounting Officer should provide a statement of non-competitive contracts to both the relevant statutory Committee and to the C&AG on an annual basis. These statements should set out details of the subject or purpose of the contract, its value and the reasons for not having a competitive process.

Circumvention of Financial Controls

68. One of the most worrying audit findings was that a contractor was asked to keep his invoices below £20,000 so that these invoices would not be brought to senior management for approval. Internal Audit investigated this case as a potential fraud. While no fraud was found, Internal Audit concluded that there was a deliberate attempt to circumvent financial delegations. Given this conclusion, the Committee was astonished to learn that no disciplinary action was taken. The C&AG has concerns over how this potential fraud was investigated and has therefore decided to report further on this.

Recommendation 10

69. The Committee recommends that there is a root and branch overhaul of the procurement function in the NI public sector to prevent the circumvention of financial controls and ensure transparency and value for money.

Why were there such fundamental failings in procurement in NI Water?

70. It is clear that there was a combination of factors which led to the procurement failures, including:

! a deeply embedded culture at all levels of the organisation that made it acceptable to bypass rules to get the job done;

! weak financial controls; and

! wholly deficient management information systems.

Culture

71. One of the reasons advanced for the failure to obtain proper approvals for contracts was that this would have caused significant delays. There are indications that managers at all levels broke the rules, in what they regarded to be the best interests of NI Water, to speed up the process when appropriate authorisation would have caused significant delays.

72. The Committee wants to be very clear on this matter. It is never acceptable to breach the rules to get things done, simply because forward planning was inadequate. Also, there are already well established procedures to deal with emergency situations. The Committee does not and will not condone breaking the rules to get the job done quickly.

Basic Financial Controls were either not in place or not applied

73. Any well run organisation, whether it is in the private, public or voluntary sector, will have a clear set of ground rules setting out who is responsible for authorising expenditure. Such

21 The Public Contracts Regulations 2006 and The Utilities Contracts Regulations 2006

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basic controls were not in place when the company was created. NI Water had simply rolled forward the inadequate delegated limits which were in place in Water Service to the new company. These controls, which were not reviewed or revised for a further 12 months, were recorded on NI Water’s intranet, and were not sufficiently communicated to staff. It was all the more important that these ground rules should have been properly communicated, given the high turnover of staff and the widespread use of consultants and temporary contract staff.

74. NI Water’s central Procurement Unit, which should have been championing best practice, did not itself apply basic financial controls. For example, it was:

! authorising contract extensions which required competitive tendering;

! signing award letters after the commencement of the contract period; and

! heavily reliant on consultants, who were, in turn, themselves signing off unapproved extensions.

Poor Management Information and IT Capability

75. Board members made the point that the procurement problems could have been addressed sooner had an electronic procurement system for goods and services been introduced when originally planned. The Committee considers that, while the electronic system may have addressed many of the problems in the procurement of goods and supplies earlier (as it would not have permitted transactions to proceed without the proper authorisation in place), this was no excuse for not having alternative procedures and systems for controlling and authorising contracts.

Laxity in the Control of Consultancy Expenditure

99. Many of the procurement problems arose in 2006-07, the final year of Water Service, as the body was preparing to move to GoCo status. 273 staff had opted to remain in the NI Civil Service rather than move to NI Water. This represented almost 14% of the workforce. To address both the need for expertise in the development and implementation of business transformation programme and the staff shortfall, Water Service appointed consultants and used temporary contract staff. This same practice was carried forward into NI Water.

76. The Committee recognises that the use of consultants and temporary contract staff was necessary to manage the short-term staffing problems. However, in the three years up to 2009-2010, NI Water spent over £42 million on consultants and temporary staff. This level of expenditure over such a prolonged period is astonishing.

77. The procurement failings within NI Water have raised concerns over the extensive and inappropriate use of consultants. For example, Water Service entered into an agreement with a specialist recruitment company for a consultant to lead a transition project. Following the establishment of NI Water, this same consultant recommended and employed at least three temporary staff from his own firm. In one of these cases there was the almost farcical situation where the consultant signed the contract schedule with his own company, acting as the NI Water Client Representative. It seems to the Committee that it must have been difficult to tell who was an employee and who was a consultant.

78. Consultancy appointments should have been time-bound. Instead, we have seen instances where, not only were consultants retained for up to four years, but also, in some cases, were themselves signing irregular contract extensions. Furthermore, there should have been a planned transfer of knowledge and expertise from consultants to NI Water staff. The Committee raised a similar issue in a previous report22.

22 Transforming Land Registers: The LandWeb Project, 3 August 2010, (Session 2009-2010).


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79. The use of consultants is also an expensive option which should not be seen as a long-term solution for any public sector organisation. The Department told the Committee that NI Water could have saved over £4 million between 2007-08 and 2009-2010 by employing full-time staff rather than using temporary contract staff.

Why were the Procurement Failures not picked up sooner?

80. Between April 2007 and September 2009, various internal and external reviews were carried out on procurement in NI Water. All of these failed to identify the extent of the procurement problems.

Internal Audit failed to raise concerns

81. From the formation of NI Water, it is evident that Internal Audit had serious concerns about the overall control environment within NI Water. However, Internal Audit was asked not to carry out any procurement audit in 2008-09, as new processes were being put in place. This was approved by the Board. As a result, expenditure of goods and services, by its nature high risk, was excluded from scrutiny for over 12 months in an organisation going through a process of transition. This Committee believes that this was a serious error in judgement by all involved.

82. Furthermore, given the widespread use of consultants and temporary staff, particularly since the last year of Water Service in 2006-07, those charged with governance, and in particular the company’s audit committee, failed to adequately identify and address this area of risk. As a direct result, this risk was not given the necessary weight in the consideration of the internal audit programmes.

83. Ironically, when Internal Audit did eventually carry out a review of procurement, it did identify weaknesses in the procurement process but failed to recognise the significance of these problems. Internal Audit identified 29 unapproved contract extensions, but failed to realise that these were potential breaches of procurement regulations.

84. At the evidence session, the Committee was told that the internal audit approach involved a minimal level of testing and that more in-depth substantive work would only take place if Internal Audit was aware of a particular issue. This approach is flawed as the low level of testing increases the risk that Internal Audit may not identify significant failings in the systems under review.

Recommendation 11

85. The Committee recommends that DFP considers the methodology employed by internal audit in the public sector, which should retain a risk-based approach but introduce an increased level of detailed testing.

Recommendation 12

86. The Committee recommended in its February 2009 report on the legal practitioner fraud23 that internal audit, throughout the health sector, should give sufficient weight to the audit of contracts. Clearly this is a significant issue throughout the public sector. The Committee therefore recommends that contract audit is given greater prominence in the audit programmes of all government departments and NDPBs.

23 PAC Report ‘Brangham, Bagnall and Co. Legal Practitioner fraud Perpetrated against the Health and Personal Social Services, 26/08/09R, 5 February 2009

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The CoPE Review failed to raise concerns

87. NI Water is one of eight accredited CoPEs in Northern Ireland’s public sector24. Such accreditation25 is intended to ensure that there is a professional influence on all procurement activity in order to maximise value for money and confirm compliance with EU and UK legislation. The most recent accreditation exercise was carried out by PwC in 2009. In this review, all CoPEs, including NI Water, achieved the highest possible rating - that is “exemplar” status.

88. The Committee questions the value of an accreditation process which fails to detect such fundamental procurement problems. The Committee is therefore greatly concerned, not just with the assessment of NI Water, but the wider assessments of CoPEs across the public sector.

89. This is not the first time that this Committee has expressed concerns over CoPE status26. Two years ago the Committee recommended that, “CoPEs which demonstrate persistent poor practice should have their status removed, if the concept of a “Centre of Procurement Expertise” is to mean anything.” The Committee remains unconvinced that NI Water should have ever received CoPE status on the basis of the evidence provided to this Committee.

90. The Committee learned that, subsequent to our evidence session, a “gateway-type” review was carried out to determine whether NI Water should retain CoPE status27. Although the review found no evidence to justify removal of the CoPE status, it considered that the current process for the accreditation of CoPEs was no longer sufficiently robust. The Procurement Board has asked Central Procurement Directorate to review the CoPE assessment methodology. This decision is long overdue.

Recommendation 13

91. It is not good enough for the CoPE accreditation process just to consider whether proper procedures existed. There should be testing to ensure that the procedures are applied in practice. The Committee recommends that this issue is taken into account in the ongoing review of the CoPE assessment methodology.

Independence of CoPE Review

92. The external review of CoPE status, including NI Water, was carried out by PricewaterhouseCoopers (PWC). This appointment was made despite PwC having received £27.1 million in fees between March 2006 and August 2010 from Water Service and NI Water (including £2.2 million from contracts which were improperly authorised STAs). PwC had also carried out a Strategic Review of NI Water Procurement in 2007. In light of these clear conflicts of interest, the Committee was surprised that PwC, in applying its own ethical standards, bid for this assignment.

93. The Treasury Officer of Accounts was unable to explain why Central Procurement Directorate (CPD) would award work to PwC in these circumstances. It is no excuse that CPD was not aware of the conflict; CPD should have completed its own checks. Such an exercise would have excluded PwC from the bidding.

24 The eight COPEs in the NI public sector are, Construction & Advisory Division; CPD – Supplies & Service Division; Roads Service; Health Estates; Procurement and Logistics Service; Education and Library Boards; Northern Ireland Housing Executive and NI Water.

25 Central Procurement Directorate’s “Public Procurement Policy Management Information Guide”

26 PAC First Report (Session 2009/2010) - Report on the Investigation of Suspected Contract Fraud

27 Peer Review – NI Water Procurement Processes Action Plan, carried out 18-22 October 2010


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Recommendation 14

94. The Committee recommends that, before appointing consultants to conduct reviews or investigations, CPD should check with departments and confirm that the preferred bidder does not have a potential conflict of interest.

Reports on Procurement provided to the Regulator did not raise concerns

95. Under the Water Licence (Condition F1) NI Water must ensure effective and fair competitive tendering and comply with relevant procurement legislation. NI Water must submit a Procurement Plan to the Regulator setting out how it intends to fulfil these obligations. Each year, it must also submit a report on its procurement activities setting out the extent of compliance with the plan. This report is reviewed by an appointed Reporter who, in turn, submits his findings to the Northern Ireland Authority for Utility Regulation (the Regulator). However, neither the compliance report nor the Reporter’s review raised any issues of note in the procurement of goods and services in NI Water.

96. The Regulator told the Committee that, in such reports, a balance must be struck between providing his Office with sufficient assurance while also ensuring that the NI Water management and DRD take responsibility for putting in place robust operational processes for procurement activity across NI Water. He considered that ensuring compliance with procurement processes was primarily the responsibility of management and would expect any areas of past non-compliance to be highlighted and addressed as a consequence of the company’s normal audit processes.

External audit does not address the issue of regularity

97. The procurement failures have not affected the clean audit opinion provided to NI Water by its external auditors. As a limited company, the external auditors of NI Water are not, and were not, required to provide an opinion on whether its spending is in line with the relevant rules and regulations (the regularity28 opinion). This is a serious omission, as bodies largely funded from the public purse need to be audited to a higher standard than those set for private companies.

98. The Committee is extremely disappointed to learn that, despite ongoing internal and external audits, the development of procurement plans and the production of annual reports on procurement compliance, none of these reviews identified the fundamental procurement failings within NI Water.

Recommendation 15

99. The Committee recommends that DFP ensures that, in future, the external auditors of NI Water and any other arm’s-length bodies constituted as companies not audited by the C&AG, should be required to provide an opinion on the regularity of income and expenditure.

28 Regularity is defined as the requirement for all items of expenditure and receipts to be dealt with in accordance with the legislation authorising them, any applicable delegated authority and the rules of government accounting, DAO(DPF) 06/05 http://www.aasdni.gov.uk/pubs/DAOs/dao0605v2.doc

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Section 3: Governance


The Governance Model is Inadequate

NI Water Governance Arrangements were designed for a

commercial company

100. NI Water’s governance arrangements were designed in 2007 on the basis that the organisation would be a sustainable self-financing commercial company29 operating under company law30. DRD’s Accounting Officer holds ultimate responsibility for the Department’s 100 per cent shareholding in NI Water. Within DRD a Shareholder Unit was established as the prime mechanism by which the Department was to manage its shareholding interest in NI Water. NI Water’s Board, appointed by the Minister and composed of executive and non-executive members, was delegated the responsibility for the company’s operations, delivery of the approved Strategic Business Plan and compliance with relevant legislation and regulatory requirements.

101. DRD put in place a standard governance model for a GoCo. However, the circumstances in which NI Water operated had significantly changed since the framework was designed. The governance model assumed that NI Water would be financed through the payment of domestic water charges. In April 2007 the Secretary of State postponed the introduction of water charges pending restoration of devolution. Since the restoration of devolution in May 2007, the Executive has deferred the introduction of the proposed domestic charges for water. NI Water’s main source of income therefore continues to be the DRD subsidy which amounts to seventy-five per cent of its revenue income.

102. In January 2009, following the Executive’s decision to further defer domestic water charges, NI Water was reclassified by the Office of National Statistics31 as a Non Departmental Public Body (NDPB) for public expenditure purposes with effect from the 2008-09 financial year. Reclassification was on the basis that an insufficient amount of NI Water’s income was derived from charges for it to be considered self-financing and therefore a Public Corporation. The advice DRD received from DFP was that this would have no impact on the governance arrangements for NI Water.

103. The Committee considers that the governance arrangements established by DRD for NI Water represented the worst of all possible worlds – NI Water was not a fully-fledged commercial organisation subject to the usual market disciplines, nor was it a conventional public body operating under tried and tested public sector rules and procedures.

There were deficiencies and ambiguities in key documents setting out

the Governance Arrangements

104. In addition to the requirements of companies’ legislation, the governance framework for NI Water is set out in two key documents:

! the March 2007 Governance Letter which sets out the terms of the relationship between DRD, as shareholder, and NI Water; and

29 Governance Letter issued by the then NIO Minister David Cairns on 20 March 2007 to the Chair Chris Mellor.

30 The Companies Act 2006

31 The Office of National Statistics is the executive office of the UK Statistics Authority, a non-ministerial department which reports directly to Parliament. One of its functions is to decide on the classification of all entities and transactions for the purpose of producing national accounts


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! the NI Water Licence setting out the conditions under which NI Water provides water and sewerage services across Northern Ireland.

105. The March 2007 Governance Letter describes a much looser degree of oversight than would have been the case had NI Water been regarded as an NDPB for accountability purposes. For example, the sponsoring department of an NDPB is required32 to “periodically carry out a risk assessment of the NDPB’s activities to inform the sponsor Department’s oversight”. NDPB status would also have provided for greater departmental oversight of the internal audit function.

106. The Governance Letter explicitly states that the company need not comply with the key principles for handling public resources set out in the Government Accounting Northern Ireland33 manual. The Governance Letter provides, for example, for only limited audit information to be provided by NI Water to DRD as of right and is also completely silent on the access rights of the C&AG. Moreover, the Governance Letter does not set out the rights of the Department and the circumstances in which it could intervene in the affairs of NI Water.

107. The Governance Letter does, however, allow for the governance arrangements to be revisited in the event of a material change to the business. The Committee’s view is that that the decision to defer the introduction of water charges was a material change which ought to have been reflected in revised governance arrangements. It is astonishing that this did not happen. The Committee considers that the Governance Letter was completely deficient in setting out proper oversight arrangements for NI Water.

108. The Accounting Officer told the Committee that he decided to stiffen governance arrangements in May 2008. These new governance arrangements required NI Water to provide the Department with more audit information including, for the first time, access to internal audit reports although these were not made available until August 2008. These steps to tighten departmental oversight appear to have been too little too late.

DRD was slow to react to the reclassification of NI Water as an NDPB

109. The Department told the Committee that, as a result of reclassification, there was a need to carry out closer monitoring of NI Water. DRD therefore introduced what it considered to be stricter governance arrangements, including the appointment of the new Chief Executive as Accounting Officer (in September 2009, nine months after re-classification). DRD accepted that this appointment appeared to take a long time, but told the Committee that there was a great deal of uncertainty around NDPB status and that a number of complex issues had to be worked through. A key point for the Committee is that DRD should not have put the Accounting Officer appointment on hold until the issue of NDPB status was worked through.

The NI Water Board’s concerns regarding the Accounting Officer

appointment were not adequately handled by DRD

110. The NI Water Board had concerns about the appropriateness of the appointment of its Chief Executive (who was also a Board member) as an Accounting Officer in September 2009. These concerns centred around the Board’s view that there was a conflict between the responsibilities34 of an Accounting Officer, and the requirement under the Licence that the directors act independently of the shareholder and exclusively in the interests of the

32 A Model MS/FM is provided at Annex 7.4 of the DFP manual “Managing Public Money Northern Ireland”

33 “NI Water and NI Water’s Board do not need to comply with the requirements of GANI (Government Accounting Northern Ireland)”. GANI was replaced in June 2008 by Managing Public Money Northern Ireland (MPMNI).

34 MPMNI, Chapter 3, Box 3.1 - to ensure the organisation makes all decisions in line with the strategy, aims and objectives set by ministers and/or in legislation

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company35. However valid the Board’s concerns may have been, this contradiction is yet a further example of the confusion and ambiguity in the governance arrangements established for NI Water by DRD.

111. The Board accepted36 the Chief Executive’s appointment as an Accounting Officer on the understanding that his duties as a Board member take precedence in legal terms. However, while acknowledging the Board’s concerns, the Department’s response37 failed to settle the matter definitively, merely stating that to avoid potential conflict there was a need for ongoing co-operation between the Chief Executive, the Board and the Department. This fudge on the part of the Permanent Secretary had serious consequences for NI Water, as the Board subsequently came to consider that the understanding which gave precedence to the Board member role had been breached. The Committee notes that DFP guidance38 requires that a subsidiary Accounting Officer notifies the sponsoring Department of any significant problem in a timely fashion.

112. It is entirely appropriate that the Chief Executive was appointed as NI Water’s Accounting Officer given that DFP guidance39 requires that an Accounting Officer is appointed to all significant arm’s-length bodies. However, it was entirely unsatisfactory that the Board’s concerns about this appointment, although acknowledged, were never properly resolved.

113. The letter appointing the Chief Executive as Accounting Officer40 requires him to adhere to the principles outlined in Managing Public Money, Northern Ireland (MPMNI). The Committee has already established that the NI Water Governance Letter expressly exempted NI Water from the requirement to implement MPMNI’s predecessor GANI. This contradiction highlights the confusing nature of the governance arrangements that DRD and DFP had drawn up.

114. The governance arrangements established for NI Water were inadequate for a body whose funding derived mainly from public resources. The circumstances in which NI Water operated were clearly substantially different from those envisaged when its governance arrangements were devised. This should have resulted in a fundamental rethink and redesign of the governance framework rather than tinkering at the margins.

115. In its January 2008 report41 on “Management, Governance and Delivery” the Independent Water Review Panel stated that the governance system needed “positive leadership” and highlighted that “it must be clear to all concerned who is accountable to whom and for what”. The Committee is of the view that this remains a fundamental problem for DRD, one which it needs to address.

116. DRD announced a review of overall governance arrangements in NI Water on 30 June 2010. The Committee considers that it is now well past time for the governance arrangements to be revised to deliver the level of oversight expected of a public body delivering a service of fundamental importance to the people of Northern Ireland.

35 NI Water Licence, Condition F Accounts and Accounting Information, paragraph 6A.5A

36 NI Water General Counsel’s letter to DRD Accounting Officer of 4 December 2009

37 Dated 18 December 2009

38 MPMNI Annex 7, A.7.4, paragraph 3.6

39 MPMNI, Chapter 3, paragraph 3.1.1

40 15 September 2009

41 IWRP Strand Two Report “Management, Governance and Delivery”, January 2008, also referred to as the Hillyard Report. The report was produced prior to the reclassification of NI Water as a Non Departmental Public Body (NDPB).


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Recommendation 16

117. The Committee recommends that a new governance agreement in the form of a Management Statement/Financial Memorandum should be put in place between DRD and NI Water for as long as NI Water continues to receive large amounts of public funding. This would provide the degree of oversight normally expected between a sponsoring department and an NDPB. The Committee is aware that such documents often take an inordinately long time to prepare; therefore DRD should work with DFP to fast track this process for NI Water.

Recommendation 17

118. The Committee recommends that DRD require NI Water to immediately implement, in full, all DFP guidance on the management of public money which is applicable to public bodies in Northern Ireland.

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DRD failed to provide the necessary oversight of NI Water

119. Although it had drawn up inadequate governance arrangements, the Department was still closely involved in oversight of NI Water. Despite this, the Committee considers that the outworking of departmental oversight was clearly insufficient.

There are indications that the Shareholder Unit had limited skills

and capacity

120. Concerns have been expressed regarding the role and skills of the Shareholder Unit within DRD. In his meeting with the IRT, the Regulator advised that DRD did not understand the company properly, that the Shareholder role in particular was not sufficiently rigorous and that staff in the Shareholder Unit did not have appropriate skills. The C&AG has informed the Committee42 that the IRT was told by an NI Water Executive that DRD would have benefited from setting up the Shareholder Unit on a shadow basis (the shadow year of the Company was 2006-07).

DRD Oversight of NI Water Internal Audit was inadequate

121. The Accounting Officer told the Committee that DRD had been denied access to the company’s internal audit reports; nor did it receive assurance statements on a timely basis. It was not until May 2008 that the Accounting Officer wrote to the Chair of NI Water requiring access to all Internal Audit reports, Audit Committee minutes, the external auditor’s management letter and details of the Internal Audit programme, as well as other key documentation relating to risk management in NI Water. The Accounting Officer told the Committee that he had met with resistance from the Board in accessing this information. For example, internal audit reports were not made available to the Shareholder Unit until August 2008 and then only on signing a confidentiality agreement which effectively prevented the C&AG from accessing these reports. This is despite the fact that two months earlier, Mr Priestly arranged with the former C&AG, John Dowdall, to meet with the Board to reinforce the arguments he was making, that is that public money was involved and that expenditure of public funds was subject to review by the Audit Office.

122. DRD assured the Committee that “at no time was a ”red flag” raised to the Department” on procurement issues. However, significant weaknesses in internal control in other areas of the organisation were being identified by internal audit. As DRD did not access internal audit reports until August 2008 it was not in a position to challenge the extensive number of internal audit reports which received a ”red” rating - the most severe level of control weakness. Even when access was gained, the Department failed to take sufficient action.

123. The Department did have access, although not on a timely basis, to the annual internal audit opinion which is the main source of advice to the NI Water Board and Executives on the control environment. This has remained at Category 4 “requires immediate improvement” from 2007-08 to 2009-2010. Category 4 is the lowest level of assurance possible, short of the extremely rare disclaimer opinion, and indicates that action needs to taken in a short time frame to address material risks and issues. However, the Board and Executive Team were slow to address the significant number of high priority actions, and DRD did not ensure that these were addressed.

124. The Committee is appalled that the Department had put itself in the position of being unable to access key audit information on its own arm’s-length body. Had NI Water been treated as an NDPB for accountability purposes, the Department could have secured access to such information as well as access to carry out its own independent reviews of internal audit and the right to be consulted on the competence and qualifications of the Head of Internal Audit.

42 Letter of 15 December 2010 from the C&AG to PAC Chairperson


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DRD failed to appoint an NI Water Accounting Officer

(May 2008 to September 2009)

125. The Committee notes that the former Chief Executive, who resigned in May 2008, had been appointed as an Accounting Officer. The Department failed to appoint her successor, the Interim Chief Executive (Chris Mellor), as an Accounting Officer. Mr MacKenzie was appointed Accounting Officer in September 2009. An Accounting Officer should certainly have been appointed immediately upon reclassification as an NDPB in January 2009. Indeed, the Committee considers that the appointment should have been made prior to reclassification given that NI Water was receiving significant public funds from the outset.

DRD failed to ensure NIAO access to Internal Audit reports

126. In June 2009, as part of its audit of the DRD Resource Account, NIAO requested sight of NI Water internal audit reports. The NI Water Board decided43 that it would not authorise the release of these reports to NIAO. DRD told NIAO that it was unable to grant it access to the reports it held as the Acting Director of the Shareholder Unit had signed a confidentiality agreement with NI Water’s internal auditors, Ernst and Young. The Department told the Committee that these arrangements were based on the presumption that NI Water would be a GoCo and it had not been anticipated that Internal Audit reports would have been required by NIAO. This action was wrong regardless of the status of NI Water. In order to access these reports NIAO was asked to sign an agreement which it considered contained unacceptably restrictive clauses. NIAO did not obtain unrestricted access to Internal Audit Reports until April 2010, following the intervention of the DRD Accounting Officer.

127. The Committee is appalled that the Department could only gain access to Internal Audit reports by signing a restrictive agreement. The Committee finds it totally unacceptable for DRD to have signed this agreement as it effectively limited the C&AG’s access rights and so, yet again, put key documentation outside the reach of NIAO (see paragraph 51).

DRD failed to implement the recommendations of relevant PAC reports

128. The Committee’s April 2008 Report44 on Good Governance, recommended that “Departments should always be represented at Audit Committees of Arm’s-Length Bodies”. This recommendation was accepted by DFP in July 2008. Despite this, DRD was not represented on NI Water’s Audit Committee until March 2010. The Committee is astonished that the Department chose to ignore this recommendation on the basis that it was not appropriate under the GoCo arrangements set out in the Governance Letter.

129. In November 2007 at an evidence session on the Use of Consultants45 the Committee was told that DFP guidance on the use of consultants did not apply to NI Water. In its report, the Committee recommended that DFP guidance should apply in full on the grounds that “DRD completely owns the company and the Northern Ireland taxpayers pick up the bill for any failure to ensure value for money in NI Water.”

130. The Department did not accept the Committee’s recommendation. Instead, it undertook through its monitoring of governance arrangements and through the quarterly Shareholder Meetings, to “put in place a specific mechanism to monitor NI Water’s use of external management consultants..”. It is disgraceful that, having ignored the Committee’s recommendation, the Department has clearly failed to implement effective alternative arrangements.

43 In 2009-10 Internal Audit’s key areas of concern were: poor data quality/management information; weaknesses in IT Strategy and governance; and in the governance of Alpha and Omega PPP Contracts.

44 “Report on Good Governance – Effective Relationships between Departments and their Arm’s Length Bodies” 24 April 2008, 28/07/08r

45 Report on the Use of Consultants, Report: 16/07/08R, 10 January 2008

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131. The Committee also recommended in its report on the Use of Consultants that any decisions to procure without competitive tendering, above a minimal threshold, must be reported to the Audit Committee. If this had happened in NI Water the procurement breaches might have been identified much earlier. The Committee was also of the view that non-competitive tendering should be authorised by Accounting Officers who would be aware that they might be required to explain such decisions to this Committee. This reinforces the point that a public body of the scale of NI Water should not have been permitted to function without its Chief Executive fulfilling the role of Accounting Officer.

132. In August 2010 DFP issued the closing report46 of the Arm’s-Length Review Team. The Team had been established in September 2008 in response to the recommendations of this Committee’s report on Good Governance, particularly as a result of governance failings in the Northern Ireland Events Company. The Team worked with a number of Departments to review their sponsorship arrangements with their arm’s-length bodies. The Committee notes that DRD is not listed as having completed such a review.

Recommendation 18

133. The Committee recommends that, as a priority, DRD conducts a fundamental review of governance arrangements in all its arm’s-length bodies. This review should revisit and reinforce the recommendations of the Committee’s report on Good Governance.

DRD failed to ensure effective change management in the

transfer from Water Service to NI Water

134. The increased use of consultants and temporary contract staff was as a result, at least in part, of the 273 Water Service employees choosing to remain civil servants rather than transfer to NI Water on its establishment. Better human resource planning and change management in the transition between Water Service and NI Water could well have avoided the increased use of consultants and dependence on temporary contract staff which has proved to be so costly to NI Water.

135. Given that many of procurement problems originated within Water Service, the Committee considers that the failure to identify this as an issue for NI Water points to a failure in due diligence47 leading up to the establishment of the company.

Recommendation 19

136. Given the ongoing dynamic environment in the public sector, there is a clear need for due diligence in the transfer of functions from one organisation to another. The Committee recommends that DFP considers the adequacy of guidance on due diligence and on human resource planning. Guidance should aim to minimise the risks associated with change management, particularly the risk of developing an over-reliance on the use of consultants.

There was not a strong or effective Internal Audit Function

137. The internal audit of Water Service had been undertaken by DRD’s own Internal Audit Unit. Initially, the internal audit function in NI Water was contracted out to a private sector company. Ernst & Young were appointed under a three year contract in April 2007. During the contracted-out period NI Water built an in-house internal audit capability, appointing a Head of Internal Audit designate from January 2010, the post being made substantive from April 2010.

46 DFP 17 August 2010, DF1/10/318812

47 Most commonly, a due diligence check is an investigation into an organisation’s financial and organisational health and capacity prior to a decision to invest in, fund or purchase that organisation.


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138. Best practice guidance on public sector internal audit emphasises that audit planning should be based on a documented assessment of risk. In addition, audit coverage should cover both the extent to which management controls address the risks identified and how well they operate in practice. The guidance emphasises that a key consideration in assessing risk is the extent of change taking place in an organisation, as changing processes can be inherently more risky than established and known processes.

139. The internal contract with Ernst & Young provided for 350 man days per year48. This was based on the number of audit days provided by DRD Internal Audit to Water Service. However, the risks within NI Water during the period of transformation were considerably higher and justified greater audit coverage. Indeed, the Committee notes that the Ernst & Young partner responsible for NI Water internal audit told the IRT that this level of coverage was “low/insufficient” given the transitional changes and the scale of transformation to be undertaken. This strongly suggests that NI Water management and its Board had demonstrated a poor understanding of the significant risks the organisation faced in failing to provide for an appropriate level of audit coverage. This is also demonstrated by management’s decision, agreed by the Board, not to conduct procurement audits in 2008-09. DRD, who told the Committee it had influence over the audit plan, should have ensured adequate audit coverage was in place.

Recommendation 20

140. The Committee recommends that departments, as well as board members and senior managers of public companies, should ensure that the degree of internal audit coverage corresponds with the level of risk as determined by a comprehensive risk assessment. This is particularly crucial in circumstances where the audited body is engaged in significant organisational change.

141. From the outset, internal audit identified significant audit concerns; an extensive number of internal audit reports, particularly in the first year of NI Water’s operation, received a ”red” rating - the most severe level of control weakness. The annual internal audit opinion has remained at Category 4 “requires immediate improvement” from 2007-08 to 2009-2010 based, in the main, on concerns about data quality and management information. A Category 4 rating indicates that action needs to be taken in a short timeframe to address material risks and issues. It is a matter of grave concern that NI Water has, so far, failed to improve this unacceptably poor assurance rating.

Recommendation 21

142. The recognised procedure for handling internal audit recommendations is to allocate responsibility for action to individual managers or directors and to set a challenging timetable for implementation. Progress is monitored by senior management and overseen by the Audit Committee. The Committee recommends that, for this process to work effectively, Accounting Officers must ensure that there are appropriate sanctions for those individuals who consistently fail to deliver.

DRD failed to ensure there was a properly constituted Board

143. It is a matter of concern that, from the outset, the Department failed to ensure that non-executives were properly represented on the Board, in line with best practice. When the shadow board was appointed in 2006 and its members were appointed to the Board in 2007, only four non-executives (including the Chair) were in post, despite DRD having identified the optimum number of non-executives as five. When one of the remaining non-executives resigned in July 2007, she was not replaced. Indeed the Board was so short of non-executive

48 Correspondence from C&AG to PAC Chairperson, 15 December 2010

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members that the Chair, on three occasions49 when attending the Audit Committee in his capacity as interim Chief Executive, was included in the non-executive count in forming a quorum.

144. It was not until July 2008, when two new members were appointed, that the Board had a full complement of non-executives. The Accounting Officer explained that this delay was due to a decision to await the outcome of the Hillyard Report50 of January 2008, and to the time required to go through the appointment process. While the Committee accepts this was a valid consideration, the Department should have taken steps to address the pressures on non-executive members for example, by appointing interim board members. DRD should have realised that overloading non-executive board members in this way put at risk the successful operation of the Board.

145. In addition, the failure to appoint new non-executive board members meant that in the period July 2007 to July 2008 NI Water was not compliant with the Combined Code on Corporate Governance51 which requires that non-executives should form at least half the board. The failure of a publicly owned company to adhere to the most basic principles of good corporate governance as set out in the Combined Code is totally unacceptable and must never be permitted by any Accounting Officer.

DRD appointed NI Water’s Chair as its interim Chief Executive

146. In the PAC evidence session of 29 May 200852 Mr Priestly had said that “I have taken steps to reinforce my role as the departmental accounting officer and to seek further assurances from the company that it is spending public money wisely and that it has in place proper systems of internal control and risk management”. Despite this assurance, only one day later, the Accounting Officer approved the appointment of the NI Water Chair as interim Chief Executive. The dual role continued until Mr MacKenzie took up the position on 27 July 2009.

147. The 2006 Combined Code, which sets out standards of good governance for Boards, clearly states: “The roles of chairman and chief executive should not be exercised by the same individual”. The Accounting Officer told the Committee “that is not best practice, but it is not unusual for a short period in such circumstances.” NIAO raised concerns about this appointment, but DRD dismissed these concerns stating that this was a short-term measure and that the appointment process would take six to nine months; in the end it took 14 months. In appointing the Chair as interim Chief Executive, the Board had, in effect, ”lost” a further non-executive director, reducing the number available to two in June 2008 and to four between July 2008 and July 2009.

148. The separation of roles and responsibilities at the top of the organisation is fundamental to good governance. It is astonishing that the DRD Accounting Officer considered adherence to this basic principle to be optional.

Recommendation 22

149. The Committee recommends that all public bodies constituted as companies and subject to companies legislation must be required to adhere fully to the good governance requirements now set out in the UK Corporate Governance Code. It should fall to the departmental Accounting Officer to ensure that this happens.

49 Letter from Paul Priestly to Paul Maskey, Chairperson PAC dated 2 August 2010

50 Independent Water Review Panel’s Strand 2 Report on Management, Governance and Delivery of January 2008

51 The UK Corporate Governance Code (formerly the Combined Code) sets out standards of good practice in relation to board leadership and effectiveness, remuneration, accountability and relations with shareholders.

52 Evidence Session 29 May 2008 - Managing Sickness Absence in The Northern Ireland Civil Service


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The Board failed to identify weaknesses in the

procurement control framework

150. The Board is responsible53 for ensuring that there are effective management/internal controls and internal approval processes within NI Water and, crucially, that these are operating in practice (a summary of the responsibilities of Board Members is at Appendix 3). There is no doubt that this is far from an easy task in an organisation as large and complex as NI Water and this is reflected in the relatively high level of remuneration54 provided.

151. In fulfilling their responsibilities, Board members can generally rely on receiving clear and accurate management information and on assurances provided by internal audit. The Committee considers that management information within NI Water was poor and that the internal audit of procurement was deficient. In this regard, the Board was badly let down by the management of NI Water.

152. However, these serious defects do not absolve the Board from its own responsibilities. The Board is required to hold management to account, and should call for any management information it considers appropriate on the basis of a thorough knowledge of the business. The Board, through the Audit Committee, also has a responsibility for directing and reviewing the work of internal audit.

153. There are a number of other important factors which increased the risks surrounding the procurement of goods and services in NI Water of which the Board should have been aware. These include:

! the risks inherent in a large and complex body going through a period of significant organisational change;

! the low overall assurance rating provided by internal auditors and the extent of the ”red flags” raised by internal audit across other areas of the business;

! the absence of a procurement audit in 2008-09 (to which the Board had agreed);

! the extent to which the Board was dependent on consultants and the use of temporary staff (some of whom were themselves involved in procurement); and

! the absence of proper financial delegations on the establishment of NI Water and for a period following this.

154. Set against this, it was not unreasonable for the Board to take some assurance from the fact that neither auditors nor external assessors had raised concerns in relation to procurement.

155. The responsibilities of a Non-Executive Director of a public body are demanding, but the role is crucial in ensuring that such bodies properly manage public funds. What has happened in NI Water must not be allowed to deflect from the ability of public bodies to attract high calibre candidates to these positions.

156. The three-way relationship between a sponsoring department, the board of an arm’s-length public body and its chief executive are complex and need to be handled with sensitivity by all involved. The role of the permanent secretary is central in ensuring that these relationships work.

Recommendation 23

157. The Committee recommends that departments ensure that non-executive directors are properly supported by all stakeholders in the governance model. Board members must receive accurate information from management, accurate independent assurance from auditors, and the support of the Department. However, Board members must recognise that they have a responsibility to challenge management, auditors and the information put before them.

53 NI Water Governance Letter, March 2007

54 Non-executive board members to be appointed in 2011 will receive £18,000 per annum based on attendance on 2 days per month. The Chair will receive £40,000 per annum based on attendance for 4 days per month.

public accounts committee - ni water report

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