INTOSAI Working Group on the Audit of Privatisation

Papers for the Eighth Meeting
Budapest, 11 and 12 June 2001

State Audit Office, Hungary

Auditing concession contracts - paper by the State Audit Office, Hungary

by Gejza Zs. Halász, Hungary

The President of the Hungarian State Audit Office launched an audit of the concession-bound state functions of highways and telecommunications in 2000. According to the planned timetable this audit has been carried out since the very beginning of January 2001, and it should be finalised by the time when the eighth meeting of the INTOSAI Working Group on the Audit of Privatisation takes place in Budapest, 11-12 June, 2001.

It should be noted that the Hungarian State Audit Office has never carried out an investigation of such a kind. The planners of this audit have been encouraged by the existence of the draft Guidelines on the Audit of Public/Private Finance and Concessions elaborated by this Working Group.

In this paper the author gives a short outline about the reasons, background, major aspects and the findings likely to develop from this audit relating to these above-mentioned guidelines as follows.

Only one year after the change in the social and economic system in Hungary an Act on Concessions was adopted by the Parliament in 1991. With this legal institution the concession retook its place in state assets-management after more than five decades. This law enables those organisations which exercise the ownership over the absolute state-owned property to enter into contracts with the private sector as an option among alternative project mechanisms in managing and developing state-owned assets.

The state Audit Office identified its audit responsibilities in relation to concessions and decided how to carry these out. Our SAI has the necessary legal authority to audit both for managing the state-owned assets and for carrying out performance audit.

Preliminary study

Since auditors had not enough knowledge, experience and professional skills ha decision was made to bring together a preliminary study on this topic to establish the planned audit.

A preliminary study does not fully correspond in its meaning to the practice of U.K. National Audit Office. We practice it in a wider sense, it is a detailed analysis about the subject to be audited, moreover it includes practically all the entries as usual prior to a value for money audit in the everyday routine of many audit offices.

This preliminary study served as a basis for the planning of audit. It was found that

• tendering was necessary for awarding a concession contract;
• investors did not show much interest in certain sectors;
• the revenue from concession fees was smaller than hoped for;
• the government concepts on concessions have been changed from 1991 onward; we have witnessed a narrowing space for concessions;
• there was an example of the assumption of debt by the government in the case of managing a newly built highway.

Public and private sectors can work together to get better value for money in delivering public services. It was the case of the concessioned company of highway M1/M15. The private sector, an international consortium, took responsibility for a mixture of the construction, development and financing assets to provide the required services. However, the toll proved to be the highest in Europe. This was the reason why the demand remained much less than expected in the most crucial track between Vienna and Budapest. The low income resulted in an imminent danger of bankruptcy. The solution was a kind of nationalisation.

The expected output of an audit stressed some well-defined issues as follows:

• whether the government intention to manage the absolute state-owned properties proved to be economic and effective;
• helping the government in the careful examination of conception on concession in preparing for the accession to the European Union;
• disclosing risks to value for money when awarding a concession to a private sector supplier;
• revealing the accomplishment of concession contracts, as well as the features of financial control, etc.

The state Audit Office has wished to audit the accomplishment of concession contracts to establish whether the public sector has got the best possible deal for the taypayers.

Acquiring the necessary skills

State Audit Office has the necessary professional staff and also has the basic legal skills. Many courses in financial and value for money auditing were given recently to a large number of auditors. Hiring an expert as external support was necessary.

Concession deals should be examined prior to the end of the contracts. This involvement enables the State Audit Office to take a view on how well the deals are likely to succeed in meeting the requirements in the future. Special attention has to be given to the practice of the Member States of the European Union so as to help the Government’s effort to examine the further tasks in harmonising the Hungarian law on concession.

Since the State Audit Office is subject only to Parliament and laws, it is essential to take into consideration the Parliament’s consent in issues like the annual audit plan consisting of approximately half-and-half "obligatory" (it means prescribed by law) and other audits on which the President decides at his option. Before rendering this draft annual audit plan to be implemented the President asked the Standing Committee on State Audit Office of Parliament for their comments. The planned audit on concessions attracted the MPs’ attention.

The overall objective of the audit was to form an opinion on whether the legal institution of concession made possible the economic, efficient, and effective management of activities determined by the Act on Concessions.

The audit focused on two major sectors, concessions on highways, and telecommunication because

1. one of the two concession contracts for managing highways had been basically modified, and the extent of state covenant was increased in both cases against the original tender specifications;
2. the concession of telecommunication services has to be replaced by the management practice followed by the European Union.

The audit was carried out having regard to value for money auditing methodologies developed by the U.K. National Audit Office. The detailed auditors’ instructions followed a sub-level system of questions. Nevertheless, the audit included elements of compliance audit too.

The structured, consecutive questions to be decided form the basis of the audit plan. The author wants to highlight only the most important issues mainly on the uppermost level of the questions.

• Whether the tender process for concessions served as a basis for the efficient and effective management of those activities which fall under the scope of the Act on Concessions.

"The Guidelines" include issues about the selection of the most suitable form of partnership. (Alternative project mechanisms: privatisation, contracting out, public/private finance, joint venture, franchising, sponsorship, partnering and framework agreements, separate contracts for design and construction, and operation). Moreover, whether the auditees assessed the project against any publicly funded alternative.

• What kind of rentability estimates were prepared for supporting the tender specifications.

"The Guidelines" include issues on whether the auditees made preliminary evaluations of the benefits they sought. (E.g. value for money, provisions for flexibility and contract length, bidder reputation and financial standing, bidder ability and technical capacity, degree of risk transfer, service start-up date).

This relates also to:

• Whether any directives were expressed for settling the duration of concession management.
• Whether the tender process complied with the legal stipulations.

"The Guidelines" advise how the procuring organisations selected private sector partners and negotiated the final contracts and whether the organisations properly evaluated all aspects of the bids received.

• Did unsuccessful tender specification occur?

It is essential to examine how the organisations chose projects. "The Guidelines" recommend examining whether the auditees made preliminary assessments of the private sector’s capabilities for delivering the requirements. It is useful to take into consideration whether the audited body set out a clear specification of the requirements.

• Whether the concessionnaires perform their obligations efficiently and effectively taken upon in contracts.

"The Guidelines" writes about the issues on how the procuring organisations managed the contracts once signed.

• Whether any change in the composition of owners took place.
• Whether the extent and use of state covenant can be determined.

• Whether the method of fixing concession fees can be assessed. Was the actual payments of fees in accordance with the contracts?

"The Guidelines" suggests taking into consideration whether during the procurement the auditees regularly reassessed whether the projects continued to offer value for money. It is also important to review the auditee’s management of changes during the contract period to its requirements.

"The Guidelines" have not been taken into consideration in their entirety in the audit of the State Audit Office. We did not go into revealing the risks in sub-level form. There are guidelines on whether the auditees investigated in advance the appropriate allocation of projects risks between the public sector and private sector parties affected by the projects (E.g. fraud, contract renewal risk), and on whether the auditee has succeeded in maintaining the allocation of risk laid down and has managed effectively those risks it retained.

Our audit plan does not include questions for the situation when bidders submitted different proposals for the allocation of risk between themselves and the auditees.

The audit covers the scope of concession deals to examine how the organisations (the auditees) structured the projects to meet their needs. The guidelines show us that prior to tendering the procuring organisation needs to demonstrate that the proposed project is likely to provide value for money when compared to other choices. The evaluation of value for money involves the assessment not only of financial benefits and costs but also non-financial factors. I am convinced that we can draw the conclusion to build in elements of value for money aspects also for the project planning work of the authorities.

As I explained there was not too much experience on how to organise tenders for concession in Hungary. This is why the responsible ministries and authorities did not carry out market investigation to ensure that there were suppliers who were willing and competent to bid for the work. It is valid for the whole issue of what we call tender strategy. Assembling a properly qualified project team was almost out of question in terms of concession. I think it is an explanation why the State Audit Office did not also investigate these questions and many more, e.g. what happens when the bidders’ proposals included different ways of financing the project.

• The Act on Concessions serves a good framework for the original purpose.
• There are sectors which proved to be economic, others not. The concessions in the field of telecommunications are successful, however, those of highways were a failure. The concessions in mining are successful although the effectiveness is poor because of the low quality of government work in this field.
• The unsuccessful output of highway concessions gives an evidence that public and private partnership is essential in this field. This sector gives also an example of how the importance of government control for this activity was "forgotten" by the respective authorities.
• Investments can be accomplished through other forms of private and public partnership in all the sectors.

The suggestions will be directed at different ministers to make the rules of tendering more detailed and transparent, and to take care of basic requirements, e.g. internal control, rules of decision-making.

Concluding remarks

As a preliminary consequence of this audit the lesson we should learn is that value for money evaluation can be the second layer of building a framework for concessions. Looking at the guidelines we can assume that assessing the results of a concession postulates demand on the part of investors. If there is a lack of bidders, we cannot speak of financial and non-financial evaluations and audit respectively.

The value for money evaluation done by either the authorities and the auditors is a reasonable idea in every respect. Nevertheless, I have to draw the conclusion: it is more important to make the decision-makers understand this idea than to audit it. It stipulates that the procuring organisations gain reassurance that the deals met their objectives, were affordable, and offered value for money. If we will be successful to accomplish this goal, we gain more than one can expect.

April 2001

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