Note by the Chairman

1 One of the tasks given to the Group by the XVI INCOSAI was to monitor the effectiveness of the guidelines on best practice for the audit of privatisations which had just been adopted. In his December 1998 letter to members of the Group Sir John Bourn therefore asked whether SAIs were already using them in their audit work, and sharing them with practitioners, and whether the guidelines were being found to be useful, leading to positive results in both the conduct and audit of sales.

2 In reply, a number of members highlighted a number of initiatives they had launched aimed at putting the guidelines into practice. The action being taken can be grouped under three broad headings: planning audits, carrying out audits and sharing with practitioners.

Planning Audits

3 Ten SAIs - those of Argentina, Austria, Denmark, Hungary, India, Russia, Saudi Arabia, United Kingdom, Yemen and Zambia - said they were using the guidelines in planning privatisation audits. In some cases (eg Hungary) this had enabled the SAI to identify new and important points for investigation. This SAI, as well as the SAI of India, found the structured approach of the guidelines to be of great help in the planning phase, as did the SAI of Saudi Arabia which has found that the guidelines added more fruitful and useful dimensions to those already in use. In a similar vein, the SAI of Egypt noted that many of the approaches set out in the guidelines corresponded with their experience.

4 The audit of privatisations and corporations is a major focus of audit for the Austrian Court of Audit which is making the guidelines available to all audit departments. The Danish SAI has found the guidelines to be well structured and coherent and intends using them at the audit stage. And the United Kingdom SAI found the guidelines on selling shares in stages particularly helpful in formulating audit questions in studying a major sale in which all the shares had been sold at once.

Carrying Out Audits

5 The Australian SAI is applying the guidelines in the context of asset sales audits and notes that among those found to be most helpful are Section 8: Sale Costs and Section 3: Trade Sales, particularly guideline 17 (Bid Evaluation). In Russia the Accounts Chamber is using the guidelines for the planning and audit of effectiveness and expediency of usage and management of public property.

6 In Argentina the guidelines have been in use since last year and the SAI is aiming to strengthen and promote their use. In Zambia too the SAI already used the guidelines in their draft form, in their 1998 audit of the Zambian Privatisation Agency. As a result they identified a number of issues on a series of sales, eg some bidders failing to meet the conditions of the sale, leakage of inside information to prospective bidders, failure of some vendors to surrender proceeds to the Agency, failure of some MBOs following privatisation and weakness in post sale monitoring of undertakings.

7 The paper from the Polish SAI on their experience in auditing the performance of state Treasury representatives in commercial companies sets out the conclusions from a number of major privatisation audits from 1994 to 1998. These conclusions underline the importance of the issues addressed in a number of the guidelines, including the skills required by those managing the sale, the fulfilment of undertakings by the new owners, deficiencies in the valuation of the businesses offered for sale, rules for the participation of employees in the sale, and irregularities in the sales process.

Sharing the Guidelines

8 Many SAIs are sharing the guidelines with practitioners and government departments such as Finance Ministries (Denmark, New Zealand, United Kingdom) as well as other institutions (Argentina, United Kingdom). In Hungary the SAI has asked the internal control department of the Hungarian Privatisation and State Holding Company to test the guidelines in their work, thereby also creating a possibility for the SAI to test the effectiveness of the guidelines in application when they next audit the company.

9 In the Yemen the SAI have found the guidelines helpful for both planning and executing the audit of privatisation, and are going to hold a workshop to enhance auditing in this area, having regard to the guidelines. The United Kingdom SAI has found the guidelines very useful in contributing to the development of central government departments' own sales guidance, and to parliamentary reports.

Points for Discussion

10 This widespread and positive experience in applying and sharing the guidelines is encouraging. The Group might wish to discuss the following points

• are there any other instances of the use of the guidelines to be noted?
• are there any other examples of instances where the use of the guidelines by (a) auditors, and (b) practitioners has led to positive and measurable benefits in the conduct of sales?

1    At the XVI INCOSAI it was agreed that the Working Group should develop guidance on the audit of the increasingly important subject of public/private finance and concessions.

Purpose of this Note

2    This note invites the Group to consider how best to address INCOSAI’s remit to develop audit guidance. It suggests that guidelines be produced in a similar format to the successful guidelines on best practice for the audit of privatisations. Paragraph 11 also discusses the case for a variant on this format, which would enable the guideline document to be shortened. It sets out suggested contents for the guidelines together with drafts of each individual guideline (see Annex).

3    In the light of comments from many members of the Working Group in response to Sir John Bourn's letter of December 1998 the following provisional main categories and guidelines have been identified. Within each audit category a number of potential issues have been identified and a draft guideline proposed.

Section 1: The General Approach of the SAI

4    This section would relate to the way the SAI equips itself to carry out the audit. The suggested guidelines are:

1 SAI requirements

2 Acquiring the necessary skills

3 Involvement of the SAI

4 Planning the audit

5    This section would relate to planning of the launch of the project by the audited body. The suggested guidelines are:

5 Selection of the project

6 Definition of project deliveries

7 Private sector capabilities

8 Evaluation of potential project benefits

9 Wider policy objectives

10 Selection of most suitable form of partnerships

11 Innovation

12 Risk transfer

13 Affordability and likely value for money

14 Outline business case

Section 3: Project Management

6    This section would relate to the effectiveness of the management of the procurement process itself by the audited body. The suggested guidelines are:

15 Project team

16 Market investigation

17 Contractual matters

18 Tender strategy

19 Project timetable

20 Public sector comparators

21 Tender list

22 Specification of requirements

23 Maintaining competition

24 Regular reviews

25 Budgets for project costs

26 Appointment of advisers

27 Cost management

Section 4: Procurement

7    This section would relate to the outcome of the procurement process and the quality of the resulting contract, with the following guidelines:

28 Bidders' design proposals

29 Bidders' operational proposals

30 Financing the deal

31 Bidders' suggestions for varying deliverables

32 Allocation of risk

33 Financial assessment

34 Assessment of risk allocation

35 Assessment of bidders' capabilities

36 Quality of service proposed by bidders

37 Choice of bidder

38 Changes during negotion with winning bidder

Section 5: Value for Money

8    This section would relate to the extent to which the contract achieves the objectives of the audited body, both initially and over the duration of the contract, as compared to alternatives. The proposed guidelines are:

39 Achievement of objectives

40 Evaluation of alternatives

41 Ensuring service delivery

42 Confirmation of affordability

Format of Guidelines

9    If the Working Group agree, it might be sensible to consider at our meeting in Warsaw how the guidelines might be structured. In drafting the guidelines on the audit of privatisation the Group identified each audit issue, why this matters, the guideline and the reasons for the guideline. This approach was commended by INCOSAI when the privatisation guidelines were adopted, and so the Group might find it appropriate to use this format when drafting the guidelines on the audit of economic regulation.

10    Drawing on suggestions from members of the Group, the Annex to this note sets out draft issues, guidelines, and reasons for the guideline for each of the issues in the key audit categories and guidelines suggested in paragraphs 4 to 8 above. Additionally there are illustrative draft paragraphs on why this matters for the first guideline in each section.

11    A variant on this format would be to focus the audit guidance to be adopted by INTOSAI on the first three aspects: the audit issue, why this matters, and the guideline. Under this variant the reasons for the guideline could be separately presented as a Working Group document that would also be available on the Working Group's website on the Internet (http://www.open.gov.uk/nao/intosai/home.htm) where it could be supplemented from time to time with additional experiences from Working Group members. In this way we could produce both a document for adoption by INCOSAI which was as focussed and as short as possible, plus background material for those INTOSAI members who were interested in more detail.

12    The Working Group are invited to consider

• Whether the key issues suggested above should be covered in the guidelines
• Whether there are any other categories or issues which should be covered
• Whether they have any comments on the draft guidelines on these issues (see Annex)
• The format of the guidelines and any supporting material
• Timetable and sharing of drafting work

JULY 1998

1. At the XVI INCOSAI the emerging findings from the 1998 survey questionnaire to INTOSAI members were noted and it was agreed that the Working Group should develop guidance on the audit of economic regulation.

2. This note invites the Group to approve the report on the results of the 1998 survey of SAIs on the audit of regulation and to consider, in the light of the picture revealed by the replies to the survey, how best to address INCOSAI’s remit to develop audit guidance. It suggests five key categories concerning the audit of economic regulation: how economic regulators carry out their responsibilities; supply of services; protection of consumers; development of competition; and the skills required by the SAI. Within each category a number of issues are identified which could form the subject of detailed audit guidelines.

3. The report shows that economic regulation affects many of the most important parts of the economy, both in the public and private sectors, and demonstrates that SAIs are carrying out audits and reviews of the work of economic regulators, with beneficial results for consumers and regulated businesses. Analysis of the replies also shows that there are useful experiences to be shared among SAIs in the audit of regulation.

4. The Group will wish to identify the key categories and issues which those guidelines should address. Of course there are variations between member countries in the way regulatory functions are exercised, whether directly by the state, or though a separate regulatory body, and in the constitutional and legal environment in which economic regulation operates. Some countries have industry-specific regulatory arrangements; others rely, for some industries at any rate, on general competition law and regulation. Nevertheless the report shows that many of the problems faced by the regulatory bodies in the member states, and correspondingly by the SAIs when they audit these processes, are similar. SAIs can learn much from each other as they carry out their audits in these important areas.

5. The survey results set out in the report, in particular the achievements of regulators and SAIs in promoting beneficial regulation, are an important source of information in identifying key categories for the audit of regulation. The detailed experiences and ideas produced by members of the Working Group both through correspondence and in past meetings have also been invaluable.

6.The key audit categories could include the following:

• Skills required by the SAI
• How economic regulators carry out their responsibilities
• Supply of services
• Protection of consumers
• Development of competition

7. Within each audit category a number of audit issues have been identified.

Section 1: SAI Skills

8. The evaluation of the efficiency and effectiveness of the economic regulators in pursuit of their objectives requires thorough knowledge of the complex environment in which the regulators are operating. The two key issues appear to be:

1 SAI skill requirements

2 Acquiring the skills

9. The following audit issues were considered significant by SAIs:

3 Organisation

4 Impartiality and integrity

5 Technical competence

6 Consultation

Section 3: Supply of Services

10. In commenting on the key objectives of economic regulators, SAIs considered that ensuring that the regulated businesses supplied essential services was the most important objective. Many economic regulators also have responsibility for protecting customers in specific ways other than through price and profit controls. The Group may wish to examine the following key audit issues under this category:

7 Security of supply to consumers

8 Consumer access to services

9 Supplying vulnerable consumers

10 Service standards

11 Monitoring suppliers' performance

12 Benchmarking suppliers' performance

13 Dealing with consumer complaints

14 Control and encouragement of investment

15 Environmental standards

Section 4: Protection of Consumers

11. Where a monopoly supplier provides a utility service such as water, gas or electricity, the regulator may be responsible for controlling the supplier's profits and/or the price paid by the consumer. Many SAIs mentioned the importance of stabilising or even reducing prices. A number of audit issues arise:

16 Control of profits or prices

17 Linking price to quality of service

18 Encouraging greater efficiency to secure price reductions

19 Ensuring that laws and procedures which protect consumers are applied

20 Rates of return for suppliers

21 Asymmetries of information

Section 5: Development of Competition

12. In many countries one of the objectives of economic regulation is to encourage the development of competition. SAIs have attested to the benefit of increasing competition in terms of securing lower prices, improved service standards, leading to a reduction in regulation. Issues identified are:

22 Reducing the monopoly power of suppliers

23 Enabling new suppliers to enter an industry

24 Promoting choice in the marketplace

25 Combating anti-competitive practices

Format of Guidelines

13. If the Working Group agree, it might be sensible to consider at our meeting in Warsaw how the guidelines might be structured. In drafting the guidelines on the audit of privatisation the Group identified each audit issue, why this matters, the guideline and the reasons for the guideline. This approach was commended by INCOSAI when the privatisation guidelines were adopted, and so the Group might find it appropriate to use this tried and tested format when drafting the guidelines on the audit of economic regulation.

14. A variant on this format would be to focus the audit guidance to be adopted by INTOSAI on the first three aspects: the audit issue, why this matters, and the guideline. Under the variant, the reasons for the guideline could be separately presented as a Working Group document that would also be available on the Group's website on the Internet: http://www.open.gov.uk/nao/intosai/home.htm. It could be supplemented from time to time with additional experiences from Working Group members. In this way we could produce both a document for formal adoption by INCOSAI which was as focussed and as short as possible, plus background material for those INTOSAI members who were interested in more detail.

15. Drawing on suggestions from members of the Group, the Annex to this note sets out draft issues and guidelines for each of the issues in the key audit categories suggested in paragraphs 6 to 12 above. Additionally there are draft paragraphs on why this matters and reasons for the guideline for two sections of the guidelines: Section 1 (SAI Skills) - two guidelines, Section 2 (How Economic Regulators Carry Out Their Responsibilities) - four guidelines and for guideline 14 (control and encouragement of investment).

16. The Working Group are invited to consider

1. Whether they are content that the report on the survey should now be made available to the INTOSAI membership at large
2. Whether the Group should produce guidelines on the audit of economic regulation
3. If so, whether the key audit categories and issues suggested above should be covered in the guidelines
4. Whether they have any comments on the draft guidelines on these issues (see Annex)
5. Whether there are any other categories or issues which should be covered
6. The format of the guidelines, and of supporting material
7. Timetable and sharing of drafting work

July 1999

Note by the Chairman

1 At the fifth meeting of the Working Group, in Jerusalem in June 1998, the Group agreed to consider, at their sixth meeting, the role and responsibility of the state as minority shareholder in privatised businesses. Members of the Group were invited to contribute papers on this subject (Sir John Bourn's letter of 16 December 1998). Subsequently, at their 46^th meeting in Vienna in May 1999, the INTOSAI Governing Board welcomed the consideration the Group were giving to this subject. By 14 July 1999 the Working Group Secretariat had received papers from seven SAIs (those of Austria, Egypt, Hungary, Israel, Poland, Saudi Arabia and Zambia). These are attached.

2 Minority shareholdings are typically defined in terms of the percentage of shares owned (for example Egypt, Hungary, Saudi Arabia and Zambia). In general, privatised companies in which the state retains a shareholding are subject to the normal companies legislation (for example Egypt, Poland, Saudi Arabia), although these may be supplemented by specific legislative provisions, for example providing for special or "golden" shares to be retained by the state, typically requiring the state's agreement, eg in the interests of preserving the company's independence, to any shareholder acquiring more than a specified proportion of the shares (eg Hungary). Not all countries however have special share provisions (Austria). In Poland ownership of the state's minority shareholdings is vested in the State Treasury which appoints representatives to exercise the rights on the government's behalf. In Zambia the shares have been transferred to the Zambia Privatisation Trust Fund, which has appointed trustees drawn from various professional organisations to the boards of privatised companies.

3 Whether or not the state has retained special powers as a minority shareholder on privatisation, the state - in theory - also enjoys the legal protection, and market options, available to any other shareholder, including the freedom to dispose of its shareholding if it is dissatisfied with the way the company is being run by those in control. In practice, it may not be able to walk away from the investment as easily as a private shareholder - where, for instance, it has retained the minority shareholding for strategic economic reasons for example, to support a vital utility or industry (eg Zambia). And in such cases it may be in double jeopardy, because the actions of others may create additional obligations for the state, going beyond its original investments and the concept of limited liability - the moral hazard of implicit guarantees (Israel). The state's margin of manoeuvre is further restricted by the attitude of the market which can be suspicious of retained minority shareholdings by the state, because of political uncertainty (Austria); market pressure will be for these shareholdings, including golden shares, to be exercised passively (Hungary); and the state may find it difficult to protect the consumers from the adverse effects of market forces such as unfavourable price increases (Zambia).

4 There is also likely to be market pressure on the state to say whether its minority shareholding is being retained on a long term basis (Austria) or temporarily (privatisation in stages). Some countries are considering whether, without upsetting the market, the state can handle its minority portfolio in a more efficient way (Hungary) or find some way - eg by having a holding company to handle its investments - of dampening down expectations that the state will intervene to support the business if it gets into difficulties (Israel). If the state decides to dispose of the shares there is the issue of timing of sale to get best value (Hungary). In Zambia, where the Privatisation Trust Fund is responsible for facilitating the sale of retained shares to the public, the attraction of the shares and the ability of the public to absorb them are key factors. The question also arises as to what steps the state may justifiably take to support the market price of the shares already quoted (so as to get a good price when it sells more shares) without risking being accused of rigging the market.

5 SAIs are considering how the state's interests can best be protected. In some countries, the SAI has the right to audit the privatised companies where the state's holding exceeds a specified percentage eg 25 per cent (Egypt and Saudi Arabia). In carrying out such audits SAIs take care not to disrupt the operations of the company (Saudi Arabia). In the light of audits they have carried out on the performance of State Treasury representatives the Polish SAI has identified a need for better monitoring of companies' performance, and setting up a collective register of the shares concerned. The issue also arises whether the audit of the state's residual holdings in business which are now in the private sector should continue to be regarded as part of the SAI's core business, with the commitment to maintaining in-house expertise to audit such businesses which this implies. If not, this may be an instance where it might make sense to contract out the audit work to private sector firms with appropriate experience (Australia - see Mr Barrett's paper on Accountability and Audit - Post Privatisation).

6 In discussing how the SAI should examine the role of the state as a minority shareholder in privatised business the Working Group may wish to address the following questions:

• what special conditions/powers could be attached to a state's minority shareholding on privatisation, without alarming the market and so jeopardising the privatisation?
• in what circumstances should the state give undertakings as to the likely duration of its minority shareholding?
• how can the state as minority shareholder protect itself against moral hazard?
• how can the state seek to get a reasonable price if it decides to sell all or part of its minority holding?
• where the SAI has audit access to privatised companies, on account of the state's minority shareholding, what factors should govern its exercise of these rights?