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Timely Affordability Reminders From Public Accounts Committee By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

In the wake of serious risk concerns expressed earlier this year in a report published by the National Audit Office (NAO) that had looked in detail at the MOD’s 2016-2026 Defence Equipment Support plan together with its earlier ‘qualification’ in respect of ‘signing-off’ the Defence Equipment & Support’s 2015/16 accounts, few will be surprised that against a background of widely expressed budget and affordability concerns the House of Commons Public Accounts Committee (PAC) should have yesterday expressed further serious doubts about the viability of the current Defence Equipment Plan.

It is a pity that inquiries such as those mentioned above do not cover the wider implications of defence capacity constraint and shortfall that is so very evident today. Denied as it may well be by the Ministry of Defence and despite additional capability now being provided, the UK as the largest European contributor to NATO and the nation that is always first to support our allies is struggling to cope with the demands that are placed on it.

Defence in the UK isn’t just about defending our islands it is also about defending our dependent territories, our trade routes as well as supporting our allies through all that we do within NATO. We have the will but we lack capacity and resilience.

As yet, ignoring the regrettable pretense of the leader of the Labour Party who in respect of his views on Trident replacement and of its potential use in the context of defence diplomacy are hardly worth mentioning, it is probably true to say that defence has so far not become a real issue in the General Election campaign. They say that there are no votes in defence and while that may be right in peacetime I doubt that it would still be true when the enemy is on the doorstep.

Defence should in my view be pushed forward to be seen as being a very serious issue in the General Election campaign not least because of the many capability shortfalls and issues that cause alarm within defence, the additional uncertainty caused by rising levels of threat against us, the impact of increased terrorism and wider global concerns to peace, stability and harmony internationally plus understandable post Brexit defence related concerns.

The reality of UK defence today no matter what any politician might say, is that in respect of capacity and propensity to deliver sound defence and of the much reduced levels of resilience in our armed forces, UK defence is weaker today that it has been through any period in my own lifetime.

While we all recognise that affordability combined with good value for the taxpayer must be recognised within defence just as they also must be through other government departments sound defence that is properly resourced and implemented should be the priority of any government. Notwithstanding claims that Britain is spending more on defence each year, that unlike many of our peers in Europe we are spending 2% of GDP on defence combined with other aspects of homeland security and military pensions, we are short of funding, physical resource and capacity. No longer can it be said that UK defence is flexible and quickly able to meet demands that appear from nowhere. We are desperately short of specialist trades such as engineers and technicians and the Royal Navy has never had so few capital ships. Yes, we have a level of air and maritime power that may be deemed sufficient in peacetime and we are making small impact to remedy the failings of SDSR 2010 which began the process of serious capacity restraints that our military suffer today.

Moreover, such has been the pressure placed on industry by the customer MOD and the lack of understanding by Government of the vital importance of maintaining strong sovereign manufacturing capability and of the MOD to invest in the UK that it is a wonder that more of our specialist industries and those that provide hugely important support services in respect of defence capability have not already thrown in the towel.

Yet another example of the damage that we do to ourselves and our own sovereign capability is that in respect of what are known as Single Source contracts we force our own companies to go through a ridiculous process of damaging regulation imposed by the new Single Source Regulations Office and worse, place a highly contentious limitation on allowable costs that are used by this parasite body to determine such an unacceptably low baseline profit level that companies supply the MOD are now forced to work to. The legislation that allowed for the creation of the SSRO should in my view be quickly repealed by the next Government. The current legislation is both unfair and seriously damaging to remaining UK sovereign capability.

The PAC Report makes interesting reading as it highlights similar views to the NAO that the MOD Equipment Plan is now at a greater risk of becoming unaffordable. The report emphasises that “Maintaining affordability is now heavily reliant on a highly ambitious, yet still under-developed programmes, requirements for efficiency savings writ large within the Plan and wider Defence budget and that the Equipment plan continues to be vulnerable to cost growth due to uncertainties around the costs of new projects, continued problems with cost control on some long-standing projects, and the significant fall in the value of the pound against the US dollar”.

The PAC Report notes that the MOD has used more than £10 billion previously set aside to meet new requirements to help fund existing core programme and which the PAC believes “leaves little flexibility to deal with changing military priorities”. The report reminds that over the past five years the MOD has transformed its financial management of large projects but expresses doubts that the increase in commitments without a commensurate increase in funding puts stability and the ability of the MOD to deliver what the military need to operate effectively at real risk.

In its own report on the 2016 – 2026 Defence Equipment Plan the NAO had concluded that the “affordability of the Plan was now at greater risk than at any time since reporting was introduced in 2012 and the MOD faced risks that in future it may lead to a situation where affordability of the portfolio can only be maintained by delaying or reducing the scope of projects. The NAO report emphasised that cost of the new [equipment] commitments included in the 2016 -2016 Defence Equipment plan considerably exceeds the net increase in funding for the Plan and that the MOD had agreed to fund these new commitments partly through demanding efficiency targets, from both within the existing Plan and from the wider Defence budget. Notably, the NAO report highlighted that all existing headroom has had now been allocated to meet the new commitments arising from the Review, with the result that this money is not now available to fund newly emerging requirements during the period covered by the Plan.

Moreover, the NAO report emphasised that risk of cost growth is still evident in the equipment plan, both in existing projects and also because a greater proportion of large projects are at an early stage of development (largely due to a number of new high-value commitments introduced by the Review). This risk is further increased as the Department’s current costing policy has historically underestimated the cost of projects in their early stage of development. The Department also faces a significant potential threat to affordability as a result of exchange rate movements against the pound

 

In its report the Public Accounts Committee reminds that spending on defence equipment and associated defence related support in the 2016 Plan is projected to be £178 billion, an increase of 7%, compared to an increase of just 1.2% between 2013 and 2015. The PAC reminds that the 2015 Strategic Defence and Security Review added £24.4 billion of new commitments to the MoD budget, including the Mechanised Infantry Vehicle, the Poseidon Maritime Patrol Aircraft and an acceleration of purchases of the F-35 Joint Strike Fighter aircraft.

As the NAO report had done, the PAC report emphasises that In order to meet the funding requirements proposed by the 2016 – 2026 Defence Equipment Review, the MoD will need to use the entirety of the £10.7 billion headroom previously set aside to meet emerging requirements in future years. If affordability is to be assured this will mean that the MoD will need to find an additional £5.8 billion of savings from existing projects through the next 10 years. While the PAC recognises that plans for achieving these [savings] are still under development it suggests that of the requirement, £1.5 billion will be provided from savings elsewhere in the Defence budget – e.g. through military and civilian pay restraint, or savings from the running of the defence estate, the latter of which the NAO reported in November 2016 would be extremely challenging. These savings targets are in addition to £7.1 billion of brought forward savings already assumed in the Plan, £2.5 billion of which have yet to be generated. Finally, the PAC reminds that the level of cost uncertainty in the Plan has also increased considerably, with 15% of additional commitments yet to go through detailed costing at project level.

In its conclusions and recommendations the Public Accounts Committee suggests that the MOD committed itself to new equipment purchases arising from the 2015 Strategic Defence and Security Review before it had established how these would be paid for. It says that the 2016 – 2016 Equipment Plan contains £24.4 billion of additional commitments [and yet] only £6.4 billion of the increase [is planned] to be met by additional funding from outside the MoD. To meet a significant element of these new commitments, the PAC suggests that the MOD must generate £5.8 billion of new savings from projects within the Plan, in addition to further savings of £1.5 billion from the wider Defence budget, which is itself already under increasing cost pressure.

The PAC emphasises that while over a year has passed since the publication of the 2015 Strategic Defence and Security Review (SDSR 2015) the MoD has not yet identified how all the required savings will be achieved calling into question the affordability of the Plan and whether all current commitments can be met. This risk is exacerbated by the fact that the Department has yet to realise £2.5 billion of savings brought forward from last year’s Plan. To these points the PAC recommends that: When the Department presents the next Equipment Plan to Parliament, it should report on progress being made against its 2015 and 2016 plan targets, and detail the impact on the Plan of any shortfall in available funding resulting from a failure to meet these targets, including any resulting time slippages or cost increases on individual projects

In respect of its view of uncertainties and over-optimism [arising] in project costs the PAC suggests that the cost of the Equipment Plan might be significantly understated. It suggests that the MOD’s current costing practice do not adequately take account of the inherent uncertainties in the costs of projects at an early stage of development and that this can lead to significant understatement in the likely cost at a time when the Review has resulted in [early commitment] of a higher proportion of large, early-stage projects in the Plan. The PAC says in its report that that MOD’s Cost Assurance and Analysis Service reported that the costs in the 2016 Plan were understated by £4.8 billion, without taking into account cost uncertainty inherent in the new commitments introduced by the Review. In respect of recommendation the PAC believes that the MOD must ensure that costings for the new projects introduced into the Plan by the Review are put on a firm footing as quickly as possible, with appropriate input from the Cost Assurance and Analysis Service (CASS), and incorporate any increase in cost into next year’s Plan.

Importantly, the PAC emphasises that the recent fall in the value of the pound against the US dollar may lead to significant cost increases for equipment purchased in US dollars. It suggests that the pound sterling is currently trading at more than 30 cents below the exchange rate used by the MOD in its cost estimates for the 2016 – 2026 Plan (US$1.55 to the pound) and that the Equipment Plan contains expenditure of 28.8 billion in US dollars over the next 10 years. While the MOD has partly mitigated the risk of currency fluctuations through entering into forward purchase contracts, the PAC suggests that these will expire in the 2018–19 financial year. Consequently, if current exchange rates persist, the cost of the Plan will increase by approximately £5 billion pounds. The Department and the Treasury have not yet decided whether such additional costs would be met by the Treasury, or whether some projects would have to be curtailed to accommodate the increased costs. In respect of recommendation the PAC suggests that “before the MOD presents the next Defence Equipment Plan to Parliament it should establish whether the Treasury will fill the funding gap created by exchange rate fluctuations, or whether the Department will have to find the money from its own budget. The PAC suggests that such discussions should also focus on the current forward purchase policy, and whether a three year window gives sufficient protection given the long-term nature of MOD equipment projects.

The PAC suggests that there is no longer any scope within the Plan to cope with new equipment requirements resulting from emerging threats. In previous years, it says that the MOD has maintained ‘headroom’ within the Plan to fund new projects – should these be required to meet emerging threats or new requirements.

However, in the 2016 – 2026 Defence Equipment Plan the PAC suggests that all of the MOD’s £10.7 billion headroom has [already] been used to contribute to the funding of the new commitments arising from the Review. The MOD maintains that headroom was always intended for situations such as the new commitments in the SDSR 2015 Review, but that it accepts that there is now less scope for emerging requirements. The PAC is very concerned that the MOD can no longer accommodate new requirements to meet a change in the nature of threats without disrupting the existing equipment programme, meaning that any new capabilities that need to be included in the Plan in future years can only be funded at the expense of existing projects. To that end it recommends that future Equipment Plans presented to Parliament should show the impact of accommodating any new requirements on existing plans. As well as indicating what capability has been changed, the Department should show the incremental costs associated with any decisions to re-scope, cancel or delay existing projects, even where these occur beyond the current Plan.

The PAC has raised a number of concerns in respect of warship and submarine build plans in relation to cost and risk and which, ahead of publication of the Government’s views on the National Shipbuilding Strategy, the awaited appointment of Director General Nuclear and creation of a separate Submarine Delivery Authority with its own CEO and the cutting of steel on the first of what will be eight Type 26 frigates later this year, may no longer be relevant.

Back at the ranch, the MOD’s bespoke trading entity responsible for providing equipment and support had been warned last November that it too faced parliamentary scrutiny by the PAC over accounting practices. Unless I missed it, this unfortunate delight is yet to come.

(Note that there will be no Commentary on 27th April)

CHW (London – 26th April 2017)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype:chwheeldon

hwheeldon@wheeldonstrategic.com

@AirSeaRescue

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