Single Source Contract Regulations 2014

Baroness Jolly Excerpts

Tuesday 9th December 2014 Grand Committee

Moved by

[Baroness Jolly]

That the Grand Committee do consider the Single Source Contract Regulations 2014.

Relevant document: 15th Report from the Joint Committee on Statutory Instruments (Special attention drawn to the instrument)

[Baroness Jolly (LD)]

My Lords, in moving that the draft regulations laid before the House on 29 October 2014 be considered, before I begin I should make the Committee aware of the report by the Joint Committee on Statutory Instruments. I will return to this later in my speech.

Before addressing the draft regulations, I would like to set out the context for this fundamental reform to Ministry of Defence procurement. Open competition remains the best way of ensuring value for money for the taxpayer but there are inevitably occasions where there is only a single provider of a capability we require. Equally, there are situations where we need to maintain critical national industrial capabilities or, indeed, control over intellectual property. This may be achievable only by placing contracts with UK companies without a competitive process. Clearly, in the absence of the disciplines of the marketplace, we need rules governing single source procurement to protect the taxpayers and to ensure our Armed Forces get the most out of every pound spent on defence.

The current framework—the so-called Yellow Book—has remained unchanged for 45 years. It fails to address inherent failures in single source procurement and the lack of competition undermines market pressure to reduce costs and improve efficiency. The lack of an alternative supplier means that we cannot walk away without also walking away from the capability we need. Our suppliers know this, which undermines our ability to drive a hard bargain. Put bluntly, this does not serve the best interests of the taxpayer, nor does it encourage industry to maintain a competitive edge in export markets.

In the Defence Reform Act 2014, the MoD set out the new statutory replacement for the Yellow Book, which we are calling the Orange Book. At the core of this lies the principle that industry should get a fair price in exchange for providing the MoD with much greater transparency on its costs and with the protections we need to ensure value for money. This new framework requires single source suppliers to operate on a truly open book basis. Before we sign a contract, suppliers will be required to provide us with extensive information outlining their pricing assumptions. Suppliers will be required to maintain extensive records on cost and performance and to share these records and explain them to us. Even before the DRA received Royal Assent, the MoD had been consulting with industry and Parliament on the draft regulations. While the Act establishes the principles behind the new framework, the regulations give the detail. This gives us the flexibility to adapt the new framework if required.

I should stress that in developing the regulations we have been consulting closely with the defence industry. We have listened carefully to the views of industry and—where appropriate—we have made changes to the regulations. It is simply not in our interests to have a system that is unworkable for industry.

By developing the draft regulations early, we were also able to take Parliament’s view on board. Here I thank noble Lords for the excellence of their scrutiny, and in particular I thank the noble Lord, Lord Tunnicliffe, for his interest and expert engagement on these issues. I have had many detailed conversations with him on these very complex questions and have always found his insights extremely useful. Following a meeting with him last week, I wrote to inform him how the regulations had changed since they were issued in January 2014. It might be useful if I read out this letter.

The letter states:

“At the meeting which I had with you on 3rd December, you raised a number of technical issues on the Single Source Contract Regulations which MOD officials responded to during the meeting. In addition, you asked for a note outlining the key changes made to the draft regulations since they were provided to Parliament prior to the House of Lords scrutiny of the Defence Reform Act in January of this year. I agreed that I would send you a note outlining these changes prior to the debate in Grand Committee.

As you are aware, the regulations were laid in draft before Parliament on 29 October 2014 following extensive consultations with stakeholders and legal scrutiny and assurance. The vast majority of the changes from the version provided in January were made for legal drafting reasons rather than policy changes. These changes reflect the high level of internal legal assurance, input from legal advisors representing the defence industry following consultation, and scrutiny by the Counsel for Joint Committee of Statutory Instruments (JCSI). It would be onerous to list all of these changes: most were made to make the regulations clearer and more effective, to avoid repetition and to fill in the detail, in particular, with regard to reporting requirements. Individual regulations and parts have also been re-ordered.

The main changes of note primarily for legal drafting are as follows.

a. To provide a better definition of the contract end date (Reg 4).

b. To make better provision for calculating the value of a contract (Reg 5).

c. To provide for qualifying defence contracts and qualifying subcontracts made under framework contracts (Reg 9 and Reg 60).

d. To remove duplication in regard to information required from contract reports (Reg 22-Reg 30).

e. To re-work the provisions, e.g. with reference to the obligation to provide supplier-level reports under Reg 34-Reg 39 (Reg 31 and Reg 32).

f. removal of duplication in regard to information required from supplier reports (Reg 33-Reg 45).

In addition, a number of changes have been made for policy reasons. The main changes made are as follows.

(a) The Coming into Force (CIF) date (Reg 1) has changed from ‘1 October 2014’ to ‘on the day after the day on which they are made’. In practical terms this means, subject to Parliamentary approval, a few days after debates in both Houses have concluded. This change was made because, given the detailed and technical nature of the regulations and restraints on Parliamentary time, the Oct 2014 date could not be met.

(b) The definition of ‘defence purposes’ (Reg 3) has been changed from the previous draft which referred to contracts where ‘Secretary of State for Defence is party to the contract’ to the current wording for contracts that are for ‘the purposes of defence (whether or not of the United Kingdom), or related purposes’. This has been done because a strict legal interpretation of the Act requires us to define defence purposes, and the original definition was a description of circumstances rather than a definition. Legal advice is that the new definition achieves the same policy effect.

(c) The introduction of a two-tier approach to value thresholds for qualifying defence contracts (Reg 6). Between CIF and the end of March 2015, the value threshold for a qualifying defence contract is £500m. After this date, this drops to £5m. This ensures the most material contracts are caught as soon as possible, while limiting the number of early adopters to a practical level, which will assist the Single Source Regulations Office (SSRO) to prepare for increasing volumes of qualifying contracts from April 2015.

(d) The introduction of two new regulated pricing methods (Reg 10). The ‘estimate-based fee pricing method’ allows for a form of cost-plus contract where the profit is agreed in advance rather than being proportional to costs. This removes a financial incentive on suppliers to increase their costs so as to receive a greater profit. The ‘volume-driven pricing method’ allows for availability contracts where the price is agreed as a price per unit output (e.g. £x per flying hour).

(e) The initial profit rates (Reg 11). The SSRO will recommend its first set of profit rates by 31 Jan 2015, and the Secretary of State will publish the final rates in the London Gazette by 15 Mar 2015. Between the CIF and the end of March 2015, there is no profit rate published in the London Gazette. During this period, transitional rates will be used which are those recommended by the Review Board for Government Contracts (the arms-length body who currently recommend profit rates for single source contracts, and who are being replaced in due course by the SSRO).

(f) The introduction of a minimum threshold for subcontracts to be considered when making an adjustment under step 3 of the calculation of the Contract Profit Rate (see section 15 of the Act) (Reg 12). The step 3 adjustment ensures that suppliers do not get multiple layers of profit by virtue of subcontracting to other suppliers within the same corporate group. Although simple in theory, in practice calculating this adjustment is complex and resource intensive, so we have introduced a value threshold of £100,000. Subcontracts below this value are not to be considered when making a step 3 adjustment.

(g) Greater contract-level reporting requirements for the ‘Interim contract report’ (ICR) (Reg 27). To avoid duplication, the information asked for in the ‘Quarterly Contract Report’ (QCR, see Reg 26) was removed from the ICR. The QCR is, however, only required for contracts above £50m, meaning contracts between £5m and £50m did not provide all information we wanted. Additional information requirements have been thus been added to the ICR for contracts between £5m and £50m.

(h) The introduction of a two-tier approach to the value thresholds for supplier-level reporting (Reg 31). As soon as a supplier signs a QDC in excess of this threshold, the supplier reporting requirement outlined in Part 6 applies to all the business units involved in single source procurement within that supplier’s corporate group. The value has been set to an initially lower level of £20 million until 1 April 2017, when it rises to £50 million. This is to expedite the introduction of the new supplier-level reporting and overhead recovery requirements.

(i) Increased supplier-level reporting information requirements (Regs 40-44). The ‘long-term overhead report’ (Reg 48 in the previous draft version provided to the House of Lords) has been replaced by the ‘Strategic industry capacity report’. Additional information requirements have been identified which support the MoD in getting value for money from single source procurement.

(j) Maximum penalties (Reg 50). The Act requires the regulations to set out maximum civil penalty amounts for reporting failures (see section 33(1)). These have now been included.

(k) Qualifying Subcontracts (Reg 58). To be a qualifying subcontract, the majority of the work done under a single source subcontract has to relate to qualifying defence contracts or subcontracts (current or prospective). This is to exclude subcontracts that are predominantly to support competitive contracts, for which there should be sufficient market pressure to encourage the supplier to get value for money from their subcontracts”.

Although the form and wording of the regulations have evolved since January, there have been limited substantial changes to the underlying policy. The regulations describe how the new framework will operate. It would be onerous to go into this in detail but I will draw the Committee’s attention to a few key elements.

First, I note that one of the main functions of the regulations is to set out the scope, frequency and nature of the information required from our suppliers. The Committee will understand why this needs to be spelt out in detail to remove any ambiguity.

Secondly, I will highlight our intention to bring the new framework into force with effect as soon as it has been cleared by Parliament. However, this will be implemented in two phases. Between the coming into force date and the end of March 2015, the value threshold for a qualifying defence contract will be £500 million and above. After this date, this threshold will drop to £5 million and above. This phased approach maximises the benefits from the new system while limiting the number of early adopters to a practical level. This will assist the SSRO to prepare for increasing volumes of qualifying contracts from April 2015 and will allow it the opportunity to issue guidance on the new framework.

--- Later in debate ---

It is worth stressing for the record that we are talking about something in the order of £7 billion-worth of expenditure per annum—a very considerable sum of money. Everyone who has been involved in defence procurement has been deeply uncomfortable for years, and probably decades, about whether the taxpayer was getting value for money with these contracts because of the sheer difficulty of seeing into them and the limited powers we had from the Yellow Book. I applaud the emergence of the Orange Book and I look forward to getting a copy, if only for the colour.

[Baroness Jolly]

I thank the noble Lord for his interesting and valuable comments and I shall address the points he raised as far as I can. We shall be in touch with him on any unaddressed points.

On his comment about the regulations being difficult for a lay audience to understand, and that the way they are laid out bears no relationship to the Act and that the cross-referencing of the two proved quite a challenge, we have done everything we can to make them as clear and comprehensible as possible. However, inevitably, they are highly technical and dry. They relate to a complex and specialist subject and it is necessary that they are accurate and precise. Everything in the regulations addresses specific issues in providing for the new framework for single source procurement.

When we had our meeting last week we discussed the intention that industry would probably not use the regulations but that the SSRO would produce specialist toolkits to guide industry through the morass of legislation and regulation. So, although those of us who enjoy reading these sorts of things might have had a problem, the department is doing all it can to smooth them out.

On the issue of training for industry, extensive briefing material has been provided. We have discussed this extensively in consultation with industry. We are providing workshops, briefing early adopters—including industry—and much of our guidance is on the internet, visible to industry and transparent.

“Mays” and “musts” is a good House of Lords regulation issue. I can confirm that the “may” in Section 18(2)(a) and (b) has not been used in the regulations. “May” does not mean “must”. I hope that the noble Lord is happy about that.

I thank the noble Lord for his comments and I hope that I have answered the main points raised during the debate. I further hope that Members of the Committee appreciate the Government’s commitment to improving this key component of our approach to procurement. This is a fundamental reform to a system which is well overdue for change. We continue to work with the SSRO and industry to ensure that implementation of the new approach is pursued as effectively and smoothly as possible.

Before I finish, I will not only repeat my thanks to the noble Lord, Lord Tunnicliffe, but thank the officials who not only had to teach me the intricacies of single source procurement—

[Lord Tunnicliffe]

Before the noble Baroness sits down, does she have any comments about the future of transparency? I think she does.

[Baroness Jolly]

My Lords, it is important that we should understand how any taxpayers’ money is being spent. How will Parliament know? The SSRO will publish an annual adherence report that will be laid before Parliament—helpfully, the officials, who I am praising to the hilt, have told me this—in the usual way. It may be that the noble Lord and I will have to google for press releases.

[Lord Tunnicliffe]

I know that it is extremely difficult to pick up on this point at the moment. I wonder whether, if the Minister can add a little more, she will write me a letter and place a copy in the Library.

[Baroness Jolly]

I will willingly do that and pop a copy into the Library. Finally, I commend the regulations to the Committee.

Motion agreed.