Single Source Contract (Amendment) Regulations 2024
(7 months, 2 weeks ago)
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The Earl of Minto
That the Grand Committee do consider the Single Source Contract (Amendment) Regulations 2024.
The Minister of State, Ministry of Defence (The Earl of Minto) (Con)
My Lords, since their introduction through the Defence Reform Act 2014, the Single Source Contract Regulations have generally worked well and helped ensure that the prices paid for single source contracts both are reasonable and reflect good value for taxpayers’ money.
There are now some 575 contracts under the regime, with a total value of more than £90 billion. However, any set of regulations needs to adapt as the environment changes. In this case, we have found that the rules continue to work well for traditional defence procurement —for ships, submarines, aircraft and so on—but less well for sectors such as software. Moreover, the imperative to procure things more quickly means that we sometimes need to buy “off the shelf” items without running a competition, either because we need compatibility with existing systems or because we simply do not have any time.
To address this, we completed a detailed statutory review of the regime in 2022. It proposed a series of reforms in a Command Paper, Defence and Security Industrial Strategy: Reforms to the Single Source Contract Regulations, which was published for consultation in April 2022. The changes made by these amendment regulations are the next stage of implementing those reforms. They will deliver improvements to the regime in three key ways.
First, they will increase flexibility around where the regime can be used to ensure that more defence contracts can be single sourced without compromising assurance on value for money and fair prices. The amendment regulations introduce a number of alternative ways of pricing a single source defence contract, most significantly by allowing prices to be set with reference to market rates rather than always having to use the bottom-up default pricing formula. Another example is where existing UK or overseas laws constrain the way prices are set in a way that is inconsistent with the single source regime. In such circumstance, the amendments will allow the disapplication of the pricing formula to the minimum extent necessary to comply with the other law.
There are also cases where it would be useful to disapply the pricing formula to part of a contract, particularly where a contract comes under the regulations significantly after it was signed. This will avoid the need to re-open the pricing of work that may have been completed and paid for years in the past, and will increase suppliers’ willingness to bring long-running contracts under the regime. The amendments will allow the pricing formula to be applied only to new elements of the contract.
Secondly, the reforms will speed up and simplify the way the regulations work in practice. The legislation currently states that, for contracts that fall under the regulations, a single profit rate needs to be applied to the entirety of the contract when it is signed. For some larger single source contracts, it makes commercial sense to use different pricing types for different elements of the contract, meaning that a single profit rate might be too high or too low for some elements.
These amendment regulations will explicitly allow contracts to be split into different components where it makes sense to do so. They will also simplify the determination of an appropriate profit rate for a contract by reducing the number of steps in the profit rate calculation from six to four. The Single Source Regulations Office funding adjustment will be abolished, and the adjustment made to ensure that profit is earned on a contract only once will be moved from a profit calculation and be considered as part of the assessment of allowable costs for contracts.
Baroness Smith of Newnham (LD)
My Lords, I am grateful to the Minister for introducing this statutory instrument and explaining very clearly the purposes of the regulations being proposed.
Unlike so many of the statutory instruments linked to defence, this is quite a weighty document. Some of the amendments are relatively straightforward, although one wonders why nobody scrutinising the 2014 Act spotted the difference between percentages and percentage points. The Minister and I can be exonerated because I joined your Lordships’ House only in October 2014 so I was not party to any scrutiny at that point. I suspect that the Minister was not in the House at that time either and I am sure that the noble Lord, Lord Tunnicliffe, bears no responsibility. However, we clearly always find things that have been omitted. We have already heard that another slight error was found even when these regulations were being laid; that makes it clear how important it is that we scrutinise things properly.
First, what sort of reporting is envisaged for the single source procurements that are being talked about? The Explanatory Memorandum makes reference to
“reports to the Secretary of State”
but is there any scope for parliamentary scrutiny of the procurements that will be in place?
A second major item that I want to ask about is the substitution of Regulation 3, on the meaning of “defence purposes”, with Regulation 4, on the meaning of “defence purposes” and “substantially for defence purposes”. Something that puzzles and worries me somewhat is this statement:
“‘Defence purposes’ means the purposes of defence (whether or not of the United Kingdom), or related purposes”.
Can the Minister explain to the Committee how extensive that can be? Does it relate to the procurement of defence capabilities that we would then export as part of our defence industrial strategy and defence exports? Should we be concerned about aspects of this that could be linked to the export of arms to regimes about which Parliament might have some reservations, for example? Some clarity on that would be most welcome.
The general points that the Minister outlined on flexibility, speed and clarification in the light of the users of single source contracts are sensible, but I wonder whether we could hear more about the extent of the changes; they are to bring in not just “defence purposes” but “substantially for defence purposes”, which can mean 30% or more of a contract. What is that likely to mean for the number of contracts that might be brought within the purview of these regulations and the scale of the value that we would be looking at? Will a significant change arise from the Procurement Act?
On primary contracts and subcontractors, the changes to profitability and moving things to the cost line make a lot of sense, but could we understand a bit more about how the decisions on what should be dealt with at market rate are determined? If we look at market rates and the defence supply chain, where is the competition? Are we looking internationally? Are we looking to comparators—for example, if we buy a widget, are we looking at what it costs in Germany, the United States and South Korea—or are we looking at a wider civilian market? All these things, almost by definition, are not outlined in the regulations but it would be useful for the Grand Committee to have sight of them.
Lord Tunnicliffe (Lab)
I rise with a heavy burden because I was the party spokesman in 2014 when this document was created. If you think that this document is a problem, you should compare it to the Yellow Book that preceded it. I thank the Minister for presenting this instrument, but I must confess that I am not going to say anything terribly new. He has touched on the issues already; in a sense, all I am going to do is ask for a few comments on the converse of the goodness, where we are raising problems. I am also responsible because I was a founding director of DE&S, which managed this. It is an old friend; it requires old glasses as well.
The Government recently made a Statement in which, at long last, they admitted to a number of problems in defence procurement and set out some rather vague ambitions to fix them. Although these regulations are not relevant to the whole of defence procurement—just those contracts that are awarded to a single supplier without competition—there are, as the Minister said, 575 single sources adding up to a total spend of around £90 billion. These are sizeable chunks, and it is important that they are taken in the wider context. We know that there are times when single source contracts work well, particularly for more traditional procurements such as ships, aircraft carriers and submarines. However, for less traditional contracts, such as in the digital sphere, they are less effective; in this case, I expect that the respective difficulties in establishing precise timeframes, specifications and knock-on effects are a big reason for that, but I would welcome the Minister’s further thoughts.
I will not spend too long reflecting on last week’s Statement but, as the noble Lord, Lord Coaker, said in his response, it is important that we get defence procurement right not just for the sake of being careful with taxpayers’ money—although that is of course important—but because of the message that it sends to the world in terms of our sovereignty, economy and obligations to our allies. This may sound slightly ridiculous in the context of a single statutory instrument but it is an important principle.
I turn to the specific details of these regulations. As the Minister explained, they amend the Defence Reform Act 2014 and the Single Source Contract Regulations from the same year, which, in combination, provide the rules for these single source contracts to ensure a fair agreement between the taxpayer and the supplier. This instrument intends to increase the flexibility of these contracts so that more can be done without compromising that fair agreement. So far, so good.
The regulations achieve this in three ways. The first relates to pricing. Currently, there is a bottom-up formula. Reasonably simply, you determine the costs, add a profit margin and there is your price. These regulations allow for a contract to be priced in relation to market rates instead. This is where things get a bit more complicated, with seven new pricing mechanisms. This will certainly bring additional flexibility, but it is hard to see a situation where it does not come by trading off the simplicity of the previous system.
I ask the Minister: how exactly will the Government quantify this trade-off, when there is a loss of simplicity, which is in itself a rather abstract concept? How can the Government be sure that it is beneficial? This was raised during the consultation, to which the Government’s answer was that additional clarity and further explanation of how this will work in practice will follow in guidance. That is not ideal either for the suppliers that are responding to the consultation or for those of us contributing to this debate and attempting to scrutinise this instrument. What is the Government’s plan if, in practice, these new mechanisms do not work as intended? I understand that this dilemma has been shared with the industry and will be published in a few weeks, but perhaps the Minister will take this opportunity to set out a bit more detail and even share any feedback received from those with whom it has been shared.
I have fewer concerns about the other two ways in which flexibility is increased. Allowing contracts to be split up into different components so that they can benefit from different profit rates may again reduce simplicity, but it certainly seems to make sense. Have the Government made any assessment of the negative impact of not allowing this in the past 10 years? Would this apply only to bottom-up pricing or to the new mechanisms too? Could different components be priced entirely differently? Can the Minister assure the Committee that the pricing is the full extent of how components are split? I ask these questions on a similar basis to my previous concerns that every layer of additional complexity could undermine the benefits of additional flexibility. To check against this, what steps are the Government taking to ensure that, in practice, the mechanisms work as they hoped?
The third key change is widening the definition to qualify under the 2014 Act. As I see it, this has the potential of making quite substantial differences to the significance of this instrument. Even a reasonably small adjustment in the number of contracts could be worth many millions. Given the variability of how well single sourcing contracts work, which this instrument may improve through additional flexibility, our biggest concern, which the instrument does not necessarily address, is that widening this scope could draw in contracts that have no benefit being processed in this way. Have the Government considered this? Have they made any assessment of the qualitative widening in this way and, if they accept it, are other steps being taken to prevent it, or is it also an accepted trade-off?
Finally, and more generally, it is not long at all until these regulations come into effect on 1 April. When they were considered in the other place just under two weeks ago, the Minister for Defence Procurement said that the guidance will be published in four weeks. I put it to the Minister that that is after the implementation date. Whether that is correct or otherwise, if a movement on the contract needed to be made, nothing has been taken away from the old regime, so I am sure that this would not be a critical issue, but it raises a wider question. Consultations on these changes began in 2019 and a lot has happened since then. After all that time and all that has happened, it is not exactly reassuring for things to be pushed so close to the wire. Will the Minister comment on that and perhaps reassure us that this SI will work as planned?
From what I hear, the regime that we are talking about has been a great success. It is a vast improvement on what happened before 2014, and therefore my comments are not meant to be unsupportive. To be even more supportive, I shall be entirely content with a longish letter.
The Earl of Minto (Con)
My Lords, I thank noble Lords for their contributions to this debate and say to the noble Lord, Lord Tunnicliffe, in particular that this is a very complicated set of contracts and it took me some time and quite a bit of reading to understand them. But I do understand them and, with great respect, they are very effective indeed.
I think it is worth reiterating that the MoD’s preferred approach to procurement remains through open competition in the domestic and global market. But we are often limited to a single supplier to provide the capability that our Armed Forces need, particularly when we have to produce equipment quickly, as I said earlier, in the face of rapidly evolving threats.
The single source contract regulations are a fundamental part of defence procurement and are key to ensuring value for money. The statutory framework, which has been running for eight years now, sets out clear rules on pricing single source defence contracts that place the onus on suppliers to demonstrate that their costs are appropriate, attributable and reasonable, and defines the level of profit that can be applied. It is only right that we ensure that this framework continues to function effectively for all parties and adapts to changes in what we buy and how we buy it.
As mentioned at the opening of this debate, and by other noble Lords, these reforms are necessary. Adjustments to pricing methods, simplification of processes, correcting profit calculations and ensuring competitiveness with taxpayers’ money are all good reasons why we are here today.
We also need to preserve key industrial and technological capabilities within the UK for strategic reasons. The combination of these factors means that single source procurement amounts to around 50% of defence procurement spent on equipment and services—or some £13 billion per annum. Where there is a lack of competitive pressure, the MoD needs alternative ways of assuring value for money for the taxpayer, while ensuring that our suppliers are paid the fair returns required to preserve their long-term viability.
These amendment regulations, as the noble Baroness pointed out, which are primarily about pricing, will clearly require changes to reporting requirements. Those changes are in this statutory instrument. They should not be conflated with the broader changes to reporting requirements that will be made in the second set of amendment regulations in the autumn. Where it is not appropriate to set out the requirements in legislation, the SSRO is providing two sets of guidance. The first, which covers how suppliers in the MoD should meet the new pricing requirements, was made available to industry on 12 February—pretty recently. The second covers the changes to reporting contained in the statutory instrument, which includes detailed provisions on how contracts that use the new flexibilities must be reported on—including to Parliament.
I reassure noble Lords that we have consulted extensively with our suppliers on the policy underpinning these amendments—a point raised by the noble Lord, Lord Tunnicliffe. I thank them for their contributions, which have led to some useful improvements. Overall, the amendments are designed to make the regulations easier and quicker to apply in practice—which must be the right thing to do.
To ease the initial implementation of the amendments, we will be flexible in the way we apply the reforms, particularly for the first contracts that will use them. For example, we are waiving many of the reporting requirements on componentised contracts—contracts that are cut up into different pieces—before the beginning of 2025. We will continue to work with those in industry to address their specific concerns.
The regulations currently apply only to single source defence contracts over £5 million, so their impact on SMEs is already limited. The Government are very keen not to impose unnecessary burdens on SMEs and, to this end, committed to reviewing that threshold in our response to the consultation on these amendment regulations, with a particular view to the impact on SMEs. We expect to put further regulations before Parliament in the next year.
On the question of pricing disputes, where there is a dispute about the price, either party can make a referral on the matter to the impartial Single Source Regulations Office for a legally binding decision.
On the question of whether we are trading value for money for pace, I reassure noble Lords that this is absolutely not the case. One of the key intents of these reforms is to provide the full weight of the regulatory protections under all circumstances. For example, allowing use of alternative pricing methods, such as commercial pricing, will support rapid procurement and provide protection on value for money.
If I have not answered any questions, I will write following this Committee. I thank noble Lords for their interest in the matter and I hope that the Committee will welcome these important and necessary amendment regulations. I beg to move.