Part 26: What needs to change?

Inquiry into the Mangawhai community wastewater scheme.

What has already changed?

This report covers events dating back to 1996. Many things that we might have commented on as needing to change have already changed in the intervening years. As part of understanding how to prevent such problems arising again, it is worth specifically noting what has already changed.

Kaipara District Council

KDC is now quite a different organisation to the one that embarked on the wastewater project. In recent years, it has been restructured and has employed new senior management, including a new chief executive. The Minister has appointed Commissioners to replace the previous elected members. The Commissioners are "to work with the community and other stakeholders to develop and implement enduring solutions to the challenges currently facing the Council". Commissioners are expected to hold office until October 2015. The Auditor-General has also appointed a new audit service provider to carry out the audits of the information in the Council's annual reports and LTPs.

At a management level, the Council has instituted many reviews and implemented new systems.

Guidance on PPPs

When the Council first decided to embark on a PPP arrangement, there was very little experience of them in New Zealand and little local guidance available. Looking overseas, the state of Victoria in Australia had the most experience and the most developed public guidance, but even that was in its early stages.

Since then, many countries have tried PPP arrangements in different contexts and much has been written about when they do and do not work well. There is now a great deal of experience to draw on and accessible advice and guidance.

In New Zealand, the National Infrastructure Unit was established within the Treasury in 2010. One of its roles is to provide support and guidance to government agencies when they prepare PPPs. It has produced several publications on PPPs. These include some general guidance on PPPs, which covers when and how to go about establishing and managing a PPP arrangement, and a draft PPP contract with model terms. The National Infrastructure Unit's practical support for PPP contracting is confined to central government, but its publications and advice are publicly available for any public entity to use.

Reporting requirements for financial and service performance

During the last decade, there have been significant changes to financial reporting standards and practices internationally and in New Zealand. The general direction of change is not just towards more disclosure of information but also towards more disclosure of more meaningful information. These changes are continuing. The changes to standards automatically apply to most public entities, including local authorities, because the governing legislation requires them to report in accordance with generally accepted accounting practice, or GAAP.

The requirements within GAAP relating to accounting for PPP arrangements changed with the adoption of the New Zealand equivalents to the International Financial Reporting Standards (NZIFRS). The changes meant that, in many cases, public entities were required to recognise both the asset and the associated debt arising from the PPP on the balance sheet. Local authorities adopted NZIFRS in 2006/07. However, the changes relating to PPPs became effective in 2008/09.

When the wastewater project began, the statutory requirements on local authorities to prepare LTPs for the next 10 years were still new. The local government sector was learning how to best carry out such forecasting and planning, and how to present the information to communities for meaningful engagement. Ten years on, the sector has gained considerable experience, which shows in the quality of the information and documents it now produces. We also note that the legislative requirements have been refined to help focus the information provided to the community.

Alongside the changes in the law, standards, and practice that govern how information is prepared for the public, the standards and practice governing the auditing of that information have also developed significantly. There have been recent reforms to how auditing standards are set and how the auditing profession is regulated. More are being debated.

One imminent change that is likely to be relevant to public sector audits is a proposed change to the standards governing the form and content of audit reports. The standards tightly prescribe the form and content of these documents, which accompany an entity's annual report. The proposed changes would require auditors to include a description of the main matters that had arisen during the audit, rather than just the auditor's overall conclusion.

Intervention powers

Another recent change occurred in 2012, with the enactment of a significant set of amendments to the Local Government Act 2002. Those amendments made significant changes to the Minister's powers to intervene in local authorities. Previously, the powers had been reasonably blunt. If a local authority was in difficulty, the Minister's main power was to replace the elected members with appointed Commissioners. The process and grounds for doing so were constrained.

The Act now contains a more graduated set of powers that enable a response that is more tailored to the nature and scale of the problems. The Minister's options include requiring information; appointing a Crown Review Team, Crown Observer, or Crown Manager; replacing the Council with a Commission; or calling a fresh election.

Permanent risks that need to be managed

Capacity and capability in public entities

In a small country such as New Zealand, maintaining capacity and capability is a challenge for many organisations in both the public and private sectors. The challenge is arguably greater in the public sector. For example, it can be difficult for public entities to pay the market rate for scarce specialist expertise or to keep enough specialists in one location to make a particular function viable. Local authorities operating in remote and rural settings can have particular problems in attracting and keeping specialist staff. There are also limits to what entities with limited funding bases can afford in terms of the number of staff and their skill level. Public sector accountability disciplines and risks can also reduce the pool of people willing to take on governance or senior management roles.

There are no easy answers to this risk. It is simply something that all New Zealand organisations have to find ways to manage. Common strategies include collaborating with other entities to create critical mass or pool scarce resources, contracting out of some functions (with appropriate oversight and safeguards), and realistic appreciation of what is and is not possible for an organisation of that size and sophistication. For example, the obvious question from this report is whether it is sensible for small organisations with limited internal resources to contemplate sophisticated commercial arrangements such as PPPs.

We also suggest that good long-term forecasting and planning can help. If an entity has good quality information about its current and future role and responsibilities, the assets it holds, its current capability, and the assets and capability it will need in the future, then it is well positioned for an open discussion with its community about the funding that will be needed. In the local authority context, the direction of recent and proposed reforms is towards improving the quality of this type of information. Better information of this kind should enable a better discussion with the ratepaying community about any choices or trade-offs that need to be made.

The community response when councils make controversial decisions

Sometimes public entities must make decisions that are controversial. Decisions to invest significant sums in major infrastructure, whether a sports stadium or a sewerage system, will often attract strong supporters and opponents. Emotions can run high, and opponents will often seek a range of ways to attack what is being done.

When a local authority knows that a project will be controversial, it can do some things to encourage public debate to remain focused on the real issues. It needs to recognise from the outset that every aspect of such a project will be scrutinised closely. As a result, the entity needs to take care to ensure that its work on the project is of a high quality and that it can demonstrate this. For example, the entity can work to ensure that it:

  • has good quality information and analysis on which to base decisions;
  • follows all legal and administrative requirements carefully;
  • maintains good records that are easily accessible when information is requested; and
  • takes a broad view when it identifies and manages risks associated with the project.

Obviously, a public entity cannot and should not neutralise public debate. The better approach is to welcome scrutiny and debate. Local authorities can prepare for that scrutiny and debate by ensuring that good quality, factual information is regularly and easily available to anyone who is interested. Local authorities should also be prepared to explain and account for the actions that they are taking. These types of steps can help focus debate on the substantive issues and minimise the risk of attacks on the entity's management or integrity.

Misunderstanding the assurance provided by an audit

Even when there are no concerns about the quality of the audit work performed, it is common for there to be an "expectation gap". This describes the gulf between the popular impression of what an audit involves and the level of assurance that an audit actually provides. In the local government sector, there are regular illustrations of this gap when entities with an unqualified audit opinion are described as having "got the big tick" or similar. The suggestion is that an unqualified audit opinion means that everything in the organisation has been checked and is fine.

In fact, an annual audit has a much narrower and more technical focus. The basic task of an auditor is to give an opinion on whether the financial statements that the entity has produced are reasonably reliable. In the public sector, that task is broadened to cover information about the entity's service performance as well as the information in the financial statements. All of the work of an auditor is directed towards being able to give this opinion. Auditors do not check everything in an organisation. They check the systems and processes that help produce the information that is subject to audit and check samples of transactions within those systems. The work is also based on the concept of "materiality". An auditor does not need to be concerned with transactions or areas of business that are too small to have a material effect on the information being audited.

Auditors report on their work to the governing body of the organisation and to the public in the audit report that accompanies the entity's annual report.

In the commercial world, the role of the auditor is well understood because people pay careful attention to any comments from an auditor when they make investment decisions. Company directors usually have a good understanding of the role of the auditor and the matters that auditors consider and provide assurance on.

In the public sector, understanding is often much more limited. There is a popular misconception that auditors check every aspect of how an organisation works and have checked that every transaction has been properly entered into and recorded. Auditors cannot and do not do this. Although every audit report and the supporting correspondence and contractual documents spell out what an audit involves and the limits of an audit opinion, there remains a risk that the governors and managers of a public entity do not have a good understanding of the audit function. The risk is that the entity places too much reliance on the work of an auditor and does not take adequate steps to manage its own risks.

From the perspective of those governing or working in public entities, it is important that they take the time to ensure that they understand what comfort, or assurance, they can take from the work of the entity's auditor. Public sector auditors also need to keep working with the entities they audit to ensure that the entities understand what an audit involves.

The responsible entity needs to have an opportunity to solve its own problems first

We have already noted that accountability agencies will generally not investigate a matter if the correspondent has not raised it with the responsible entity. This deference is not simply a way of ensuring that resources are used efficiently; it is also constitutionally appropriate.

The entity is responsible for carrying out its functions and for addressing any problems in the way it delivers services. Many entities that provide services directly to the public maintain their own internal complaints functions, to make it easy for people to raise concerns so that mistakes can be corrected quickly and easily.

Agencies such as the OAG and the Office of the Ombudsman generally see themselves as avenues that are available when ordinary complaints and corrections mechanisms have not been able to resolve the problem. For such agencies, the first stage is always to assess whether there is likely to be an issue of substance and whether the responsible entity has or will fix the problem itself. This initial assessment does not usually involve fully investigating the detail and merits of an issue. Rather, it involves assessing, from the limited information initially available, whether the matter appears to be being dealt with appropriately. These agencies will fully consider the substance of an issue only if it becomes clear that the matter is unlikely to resolve itself and the agency decides that substantive involvement is warranted.

The risk that requires constant management is that members of the public who are unhappy with a public entity will be impatient with this approach. Not surprisingly, they will often hope that the accountability agency will function as a superior authority that will intervene immediately to "put the matter right". As we have explained, there is no agency in the local government sector that sits above local authorities with capacity to intervene in their work and apply discipline when it may be warranted. The roles of the public sector accountability agencies are specific and limited. The ultimate discipline on local authorities is the electoral process and the power wielded by the electorate.

This is a matter that requires constant and careful explanation if accountability agencies are to avoid being seen as frustrating or ineffective.

Challenges that need further thought

Do current public sector structures and allocation of responsibilities support effective development and maintenance of infrastructure?

This report has highlighted two obvious challenges for local authorities that are responsible for building, maintaining, and renewing much of the infrastructure that our communities need. Those challenges are:

  • capability, because infrastructure projects are often technical, large, and complex; and
  • affordability, because good quality infrastructure can cost a lot and small local authorities have limited ability to raise funds.

Under the current distribution of responsibilities between central government, regional authorities, and territorial local authorities, it is often central and regional agencies that drive the need for infrastructure. They do so when they set regulatory standards – for example, for the quality of drinking water or for acceptable levels of discharge to the environment. Local authorities must then build and maintain infrastructure assets to meet those standards. The risk is that the standards set by one part of government cannot be delivered by another.

In terms of capability, the question is how to give local authorities access to more support, advice, and appropriately skilled expertise. Options include strengthening the support available from sectoral groups such as Local Government New Zealand and the Society of Local Government Managers, promoting collaboration between authorities, and structural reform through the reorganisation and merger of existing authorities. No doubt there are other solutions too. These are matters of current debate within the public sector.

In relation to affordability, the question is how to ensure that the funding tools available to local authorities are able to generate income that matches the scale and cost of their responsibilities. There have been periodic reviews of the funding tools available to local authorities in the form of rates and charges. These questions continue to be challenging and warrant ongoing consideration. These are policy questions, and they are not new. It is not the role of the Auditor-General to attempt to solve them. However, this inquiry highlights that these challenges for local authorities are real and that the consequences can be very significant when local authorities do not carry out their responsibilities well. We encourage the sector and the Government to continue to discuss them.

Does New Zealand need more effective remedies for holding local authorities to account?

During the last few years, we have been acutely conscious of the frustration felt by those in Mangawhai who tried to attract some attention to their concerns about the Council. Those concerns evolved and grew as those individuals learned more, but it took some time before the wider system acknowledged and responded to the emerging problems. In Section D, we reflected on whether there was more that we or other accountability agencies could have done in response to the correspondence we received.

This issue is not confined to Mangawhai and KDC. We are aware that it is often difficult to find the right forum for exploring concerns about the conduct of local authorities. We regularly receive correspondence expressing concern or looking for assistance about matters that we have no ability to consider. There is often no obvious other agency to refer the correspondent to.

In Section D, we briefly described the different accountability arrangements that operate in the local government sector. The question that we are left with, at the end of this inquiry, is whether those existing avenues are adequate. Is there an accountability gap?

In particular, we note the difficulty that ratepayers have faced in raising their concerns about the legality of KDC's actions. In formal terms, the proper answer is that it is the role of the High Court to rule on whether public entities are acting lawfully. However, in practice, it is rare for a community to have the willpower or resources to bring proceedings in the High Court against its local authority. We encounter this issue regularly, across the full range of public sector entities.

Many correspondents are looking for a more accessible way of obtaining an independent view on whether a public entity is acting lawfully. However, it is not a natural or obvious role for the OAG or the Office of the Ombudsman. Although both offices will look into legal questions in appropriate cases, it has to be a matter that is within their legal mandate and area of expertise. Neither agency provides a general forum for looking at questions of legal compliance.

Two recent reforms might provide new avenues for investigating issues of this kind. They are the recent changes to the Minister's powers to review and intervene in the work of local authorities and the creation of new inquiry mechanisms under the Inquiries Act 2013.

Again, these are not matters that we can or should attempt to solve on our own. They raise policy questions about the accountability system that central and local government might wish to consider. For current purposes, we simply draw attention to these questions and suggest that the matters might warrant consideration and debate.

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