FINAL INTERNAL AUDIT REPORT Market Conditions and Costs (IA 13 513F) Andrew Wolstenholme, Chief Executive Audit Conclusion: Well Controlled and Audit Closed 22 January 2014 Number of issues Priority 1 0 Priority 2 0 Priority 3 0 CROSSRAIL RESTRICTED
CONTENTS EXECUTIVE SUMMARY... 3 APPENDIX 1 DISTRIBUTION LIST... 7 Version 1 Draft versions issued 1 Fieldwork started 25 November 2013 Fieldwork completed 21 December 2013 Draft report issued 16 January 2014 Follow-up date N/A CROSSRAIL RESTRICTED Page 2
EXECUTIVE SUMMARY Introduction and background The following macro-economic factors could affect Crossrail s ability to deliver the Project within its funding limits: fluctuations in foreign exchange rates; commodity prices; interest rates; and inflation. There is a risk that these factors increase the outturn cost of the programme or, in the case of interest rates, reduce the available funding. This would be particularly problematic were all the effects to occur simultaneously or for a sustained period. All Strategic Risks and Programme Risks are reviewed by the Risk Sub-Committee every period. Risk 1806 on Combined effect of macro-economic factors was last updated on the risk register (ARM) on the 24th October 2013. The risk has current and forecast scores of 4000 (High). There is no reduction in the forecast score because the remaining mitigation actions are only monitoring the above factors. This is appropriate because Crossrail cannot control the macro-economic factors that affect the economy as a whole. Objective The audit objective was to provide assurance that Crossrail has assessed the risk impact of macro-economic factors that could affect its ability to deliver the Crossrail Project and has built in adequate controls and implemented mitigations. Scope The audit focused on the controls in relation to the following key risk areas: Fluctuations in foreign exchange rates, commodities, and bulk purchasing strategies; Supply chain credit risk; Interest; Potential collapse of the Euro; Work with TfL to make longer term investments with funds in the Sponsor Funding Account (SFA); and Inflation CROSSRAIL RESTRICTED Page 3
Summary of findings All aspects of the scope were examined during the audit. A summary of the findings under each scope area is set out in the following paragraphs: Foreign Exchange Rates Fluctuations, Commodities and Bulk Purchasing Strategies Three papers were presented to the Audit Committee between May 2010 and December 2011. These summarised the development of Crossrail s proposed approach to currency and commodity hedging. The potential for steel price hedging was investigated by Crossrail Finance with TfL Group Treasury and it was concluded that an economic case could not be made for hedging. The potential for copper hedging was investigated as part of the relevant procurement process and it was decided that no copper hedging would be undertaken by TfL on behalf of Crossrail. Foreign Exchange (FX) hedging was reviewed by Crossrail Finance on Tunnel contracts, station contracts and other contracts. Contractors bear the FX risk on tunnel contracts. Conversely, Crossrail bears the FX risk on station contracts. These station contracts are reviewed by Crossrail Finance to ensure that no material exposure is identified. Since April 2013, Crossrail has only made total foreign currency payments amounting to US$8,700, confirming that CRL has a very low foreign exchange risk. The commodity and bulk purchasing strategy in Crossrail was reviewed in 2010. A number of components and commodities were considered including steel rail and ballast. It was concluded that supply chain intervention could adversely affect Crossrail in terms of delivery, timing and programme. However, frameworks were procured from which the Tier 1 contractors could procure directly. The four main common components selected for this strategy were Lifts & Escalators, Building Maintenance Systems (BMS), DALI lighting controls and Uninterruptable Power Supply (UPS). Invoicing between the framework supplier and the tier 1 contractor is done directly. This allows Crossrail to be removed from the supply chain but have control of the product, or supplier, selection for commonality. The lifts and escalator frameworks were procured jointly with TfL and yielded significant benefits for both parties in terms of capital cost and long term maintenance. Supply chain credit risk The Crossrail Programme Supply Chain Team (PSCT) provides a non-contractual overview of the critical suppliers across the programme with the objective of identifying potential failure risk within the supply chain. This activity has been used to support the Tier 1 contractors, who have the responsibility to manage risk within their own supply chains. The PSCT use a Dun and Bradstreet (D&B) business failure score management tool to identify likely failure rates or adverse financial ratings. Evidence is available to CROSSRAIL RESTRICTED Page 4
demonstrate that the PSCT has a good process in place to identify supply chain business failure risks and that they communicate these to Crossrail project managers and the Tier 1 contractors. One high risk contractor was identified by this process and provided with support. Unfortunately, the contractor did not improve and Crossrail has since terminated the contract. Interest on Project Bank Accounts Crossrail earns interest on the balances held in the Crossrail Project Bank Accounts (PBA). Interest from the PBAs is averaging around 10k per period. The cumulative amount for the financial year 2013-14 is 85k. Any risk to Crossrail is low because of the materiality of the interest paid. Longer term investments with funds in the Sponsor Funding Account The Sponsor Funding Account (SFA) is a TfL bank account used for funding the Crossrail project and is owned by TfL and the Department of Transport. Interest is earned on the balance held in the SFA. The balance is invested in a range of investments approved annually by the TfL board. The investments are low risk, short-term, and AAA rated. The investment summary report was reviewed which confirmed that the majority of investments made are shortterm. This short-term approach is appropriate because it is not always possible to forecast project spend up to 12 months in advance. In addition, the difference in interest paid between six and twelve month investments is negligible. TfL Treasury manages the funds in the SFA, all Crossrail bank accounts, and its own funds. The money is pooled and interest applied to funds in the SFA. The interest received on the SFA balance from 1 April 2013 to 6 December 2013 amounted to 6,157,000. Potential collapse of Euro It is difficult to anticipate the effect of a Euro collapse on Crossrail. Were a collapse to occur, it would affect both Crossrail and the economy as a whole. The risk is also partially mitigated because: Crossrail has parent company guarantees from all major suppliers; and trading transactions are limited to companies based in UK, thereby reducing exposure. No insurance is available that covers the collapse of Euro. This is one risk for which mitigation action cannot be taken. CROSSRAIL RESTRICTED Page 5
Inflation The National Economic Research Association (NERA), a consultancy, provides inflation assessments to Crossrail that outline the extent to which the costs of building, maintaining, and operating Crossrail will be subject to cost escalation. Any deviation from the agreed level of inflation is borne by the Sponsors (TfL and Department of Transport). Due to this reason, the Crossrail contingency fund does not pay for inflation risk. NERA reports were reviewed for 12th March 2013 and 9th August 2013, which provided: NERA s assessment of the likely effect of cost escalation and tender price inflation on Crossrail s costs; and forecasts of cost escalation for capital expenditure. A Semi Annual Construction Report is circulated every six months by Crossrail. The report shows that the current forecast cost of inflation is 221m below the level forecast at RP4.2 baseline. This variance is favourable for Crossrail which means that the inflation risk has a low effect on the project. The audit did not identify any issues. Conclusion Based on the work carried out, we have concluded that processes to assess risk and mitigate the impact of macro-economic factors on the delivery of the Crossrail Project are well controlled and as a result no follow-up is required. We would like to thank all those who were involved in and contributed to this audit. CROSSRAIL RESTRICTED Page 6
APPENDIX 1 Distribution list This report was sent to Andrew Wolstenholme, Chief Executive, by Clive Walker, Director of TfL Internal Audit, and copied to: David Allen Andy Mitchell Robert Flanagan Martin Buck Martin Rowark Kevin Lloyd-Davies Simon Adams Simon Kilonback Simon Loh Rob Halstead Richard Brown Nigel Blore Andrea Clarke David Goldstone Steve Allen Howard Carter Robert Brent Finance Director Programme Director Finance Operations Director Commercial Director Procurement Director Procurement Strategy Manager Head of Commercial Services Director of Group Treasury, TfL Head of Analysis & Planning Head of Risk Management Audit Manager Head of Group Insurance, TfL Director of Legal, TfL Chief Finance Officer, TfL MD, Finance, TfL General Counsel, TfL KPMG CROSSRAIL RESTRICTED Page 7