Reporting and Follow-up of Audit Findings

173. – In Audit Guideline 202, the Panel of External Auditors has agreed with the following audit criterion for evaluating internal audit as a basic standard for reporting and follow-up of audit findings.

• “Criterion No. 6: The internal audit group should document the results of the audit in a formal report to provide a constructive vehicle for change, discuss it with the managers affected and present the report on a timely basis to the entity’s head and/or the audit committee. To achieve this end:

-  audit reports should be as clear and objective as possible and limitations on the scope of the audit should be disclosed; and

-  audit findings should be systematically followed up to determine and report on the extent and appropriateness of corrective action taken.”

174. – The following deficiencies were noted as far as the reporting was concerned:

• Contrary to the standard mentioned above, a report was not always formalised for each audit assignment. Such was especially the case for the group in charge of special management assignments, which handled all requests for enquiries, inspections, special audits and investigations. In many cases, the results of the assignment were only reflected in informal briefings or confidential memoranda.
• The reports issued did not follow a prescribed format, even in the case of routine of repetitive audits. This was particular manifest for audits conducted by the regional auditors based in the field. For all reports, basic information such as the amount of audit man-days dedicated to the assignment, the use of external experts, if any, was never included. Information on the limitations on the scope of the audit, the methodology followed was often missing.
• The relative importance of the recommendations issued and a suggested timeframe for implementation were very rarely included. The cost implication of the recommendations’ implementation was never addressed.
• Good practices followed by some auditors and reflected in their reports were not generalised. As a result, the overall quality of the reports varied greatly. Some of them, usually produced by recently hired auditors were quite good while others were below generally accepted standards. This inconsistency raised the issue of quality control and seemed to indicate a very low level of innovation.

175. – In view of the above, I recommend the following:

• The results of all audit assignments should be documented in a formal report.
• For each type of audit assignment a standard report should be developed. Compliance to the agreed content and format should be closely monitored.
• Relative importance and timeframe for implementation should be duly mentioned for all recommendations and, if applicable, the cost implication of their implementation should be estimated.
• Procedures should be established and duly followed to ensure quality control on the audits conducted and reports issued.

176. – At the time of writing this report, my staff were informed that due consideration would be given to the third and fourth recommendations. It was pointed out, however, that the establishment of quality control procedures would necessitate the allocation of additional resources and that the cost implication would have to be reviewed. Regarding the first recommendation, the Organization argued that in some cases, a formal report would not be appropriate. For the second recommendation, it was pointed out that there was some merit in standardisation, but there was also equal or greater merit in encouraging initiative, creativity and individualism in report presentation.

177. – Concerning follow-up of audit findings, according to Article 15 of the Charter “the Director-General shall ensure that all recommendations from the Inspector-General are responded to by the responsible functional unit and implemented as deemed appropriate”. In my opinion, such a provision is not in line with the agreed standard mentioned above as well as with the ones prescribed by the Internal Auditors of UN organisations. In this regard, UN standard 440 states that “internal auditors should follow up to ascertain that appropriate action is taken on reported audit findings”. While the Director-General is ultimately responsible for the implementation of both internal and external audit recommendations, the primary responsibility should be at the Inspector-General level. Therefore, I recommend that a section be included in the AUD annual report regarding the implementation of all recommendations issued.

Review of the Internal Controls over the Use of the Organization’s Resources

178. – As already mentioned in the introduction, one of the cases of fraud disclosed in my previous report on the 1998-99 biennium [paras 211 to 219] raised the issue of internal controls on the use of the Organization’s resources. I concluded on this issue by considering “that the announcement by the Director-General in March 2000 of an internal investigation on the matter to be a necessary step”.

179. – The terms of reference for the investigation, my staff were provided with on 14 February 2001, were as follows: “As instructed by the Director-General, the Inspector-General is to conduct an Organization-wide inquiry and report to me on whether FAO Staff Members avail or have availed themselves of expert services from agents of the Organization for personal purposes during working hours. The above review should exclude instances of mere courtesy among colleagues and friends.” The Job Planning Memorandum that was prepared did not indicate any timeframe for the audit. A total amount of 395 units (of half an hour each) was, however, forecasted and broken-down as follows: 44 units for planning, 165 units for execution and 186 units for reporting. In fact, the audit was conducted in the second semester of 2001 and my staff were provided with the report dated December 2001 on 11 January 2002.

180. – The following methodology was used. According to the report, AUD first reviewed “the authoritative pronouncements that represent the body of written policy, procedures and guidelines and form the basis for the Organization’s operations”. The existing rules, regulations and procedures regarding the following were reviewed: policy and communication, segregation of duties, accountability over assets, hierarchical structure and supervision and oversight function. The conclusion in this regard, was as follows: “Overall, [...] the Organization had designed and put in place an adequate system of internal controls for the proper use of both human and material resources. However, there is room for improvement, particularly with regard to periodically reminding staff of what the Organization considers to be acceptable and unacceptable practices. In addition, there is a need for responsible entities in AF to update some basic policies in FAO’s Administrative Manual and other authoritative circulars and to consolidate several rules, regulations and guidelines now dispersed among different sources into one authoritative source of information such as the FAO’s Administrative Manual.”

181. – In addition, AUD “conducted a survey [...] in order to determine the extent to which FAO staff have used or use the Organization’s resources (both human and material) for private purposes. Instances of mere courtesy among colleagues and friends were excluded from the scope of the survey.” In fact, three distinct questionnaires were addressed, in July 2001, respectively, to a selected list of D-1 and higher category staff members (196 in total), all staff in the Administrative Services Division – AFS (154 in total) and the Legal Office - LEG (16 in total).

182. – Out of the total of 366 staff members concerned, 222, or 61 %, replied. However, the rate of replies varied for the different questionnaires. It amounted to 86% for D-1 and above categories, 88% for LEG staff but only 27% for AFS. According to the report, “there may be different reasons for the low response from AFS staff: (i) they may have misunderstood the terms and objectives of the survey. However, very few AFS staff requested clarification from AUD, despite AUD’s explicit invitation in this regard conveyed in the memorandum that accompanied the questionnaire, or (ii) they did not attach sufficient importance to it”. In my opinion, this could have been avoided should the questionnaire have been tested in line with best practices.

183. – Still according to the report, “the survey did not disclose any significant problems but only minor issues such as the ‘discreet’ use of telecommunications facilities for personal purposes”. It was, however, mentioned that “the reported use of secretaries for personal purposes [was] of concern, although the low number of such cases (6 out of 168 respondents in the D-1 and above categories and the existence of some mitigating circumstances in each case (i.e. instance in which secretaries agreed to help in full knowledge of their right to refuse, and situations where the officer was very busy), lead us to conclude that there were isolated cases.” It was also added “some 35% of the surveyed officers in decentralised offices reported instances of use of official cars and drivers for personal purposes.”

184. – On the issue of the survey, the report concluded with the following: “AUD’s survey served to raise staff awareness about what FAO considers acceptable and unacceptable and sent a strong message that the Organization is determined to detect and eliminate any improper conduct. In this regard, responsible entities [...] should use the means of communication at their disposal (Administrative Circulars, Director-General’s Bulletins, the Intranet) to periodically remind staff of the conduct expected of them.”

185. – In my opinion, the audit methodology used calls for the following comments:

• The usefulness of the survey was questionable for the following reasons. To start with, the use of the Organization’s resources had already been demonstrated in my previous report. I agree that it might have been valuable to determine if this use went beyond the cases already reported. However, I cannot concur with the method used, which was to send a questionnaire to the staff members themselves, especially in view of the nature of the questions asked. It was naïve, to say the least, to expect that all staff members would admit to having used the Organization’s resources or report more than “minor” use. As a result, I do not regard the results as reliable.
• As for the review of “the authoritative pronouncements that represent the body of written policy, procedures and guidelines and form the basis for the Organisation’s operations”, I noted that it was limited to the theoretical examination of the existing texts. The way these texts were indeed applied was not examined. For instance, in the case of segregation of duties (only one paragraph in the AUD report), no review was done on how the Oracle system was set up in this regard. The same applied to accountability over assets. The only paragraph in the AUD report just summarised the provisions under the section of the FAO Manual that dealt with property accountability. No reference was made to the year-end physical inventory actually performed and its reconciliation with the records. Numerous deficiencies were, however, reported in the field missions conducted by my staff in this regard.

186. – In addition, I did not consider the time schedule appropriate in view of the seriousness of the matter. As previously mentioned, the terms of reference were conveyed by the Director-General to the Inspector-General in February 2001. Although they did not indicate any deadline for the review to be completed, which was regrettable, AUD should have given it priority. The survey was, however, only sent in July 2001 and the review completed in December 2001. Since the total time spent, as per the DTS system amounted to 386 units only, or the equivalent of around 24 man/days on the basis of eight hours a day, there was no reason why ten months had elapsed between the issuance of the terms of reference and the report.

187. – In view of the deficiencies of the review conducted and the unreliability of the results, I recommend that another review be conducted as soon as possible with an appropriate methodology, namely a risk assessment. The assessment should first look back at past cases of fraud and misuse of the Organization’s resources in order to determine the factors that facilitated their occurrence. On the basis of how existing rules, regulations and procedures were indeed applied, the assessment should then look ahead and try to predict the possible risks of misuse of the Organization’s resources and recommend ways of preventing them. At the time of writing this report, my staff were informed that AUD would take all these comments and recommendations into account as part of an extensive follow-up to its report on “Review of the Internal Controls over the Use of the Organization’s Resources”.

Overall Appreciation

188. – As mentioned in the introduction, the criteria to evaluate AUD were the ones adopted by the Panel of External Auditors, which were largely similar to the ones adopted by the UN Internal Auditors themselves. As recapitulated in table 8 that follows, I considered that only two criteria, out of eight, were met, namely organisational status and mandate and coordination with the External Auditor. One criterion relating to the use of an audit committee was not met at all. For the rest, it ranged from “mostly met” (professional resources) to “mostly not met” (audit planning) with two criteria partly met (audit responsibilities and audit coverage and performance of audit work).

189. – As a result of the evaluation conducted, I cannot concur with the following positive self-assessment included in AUD audit manual: “The audit regime at FAO, with the “text book” arrangement of both internal and external audit would be considered ideal under virtually any jurisdiction. With the addition of the well placed, high quality evaluation function, the audit regime is transformed into a “state of the art” oversight function second to none. When the arrangements with local audit firms are added to this oversight mechanism, FAO can be considered as employing and enjoying the most complete and comprehensive oversight machinery in the United Nations (or any other) system.”

190. – On the specific issue on local audits, I would like to recall my previous observations. In my report on the 1996-97 biennium, I recommended that “in order for local audits of field expenditure to support a decentralised accounting structure at a reasonable cost, [...] the periodicity of reporting be lengthened (one or two reports a year), the number of contracting auditors reduced and the auditors required to provide audit assurance that imprest reports convey a true and fair view of field transactions”. This recommendation was only partially implemented in 1998-99. If audits in 1999 and thereafter had been carried out on a six-monthly or yearly basis, the plan to identify a suitable firm in each region with correspondents in countries where the FAO had Representations was not implemented. Likewise the requirement of an audit assurance was not addressed. On the basis of what my staff observed during their field missions conducted in 2001 and 2002, I am definitely of the opinion that the Organization is not getting value for the money spent for these local audits. I recommend that the present arrangements be evaluated by AUD together with AFF with regards to their costs and that alternatives be sought. In view of the presence of one internal auditor in each RO, the Organization might consider having the work performed by its own staff. At the time of writing this report, my staff were informed that the Director-General agreed that a thorough review of the local audit scheme be undertaken with a view to determining whether the bulk of the work can be carried out efficiently by the outposted AUD officers, considering that they were only four.

191. – To conclude on the review of AUD, I recommend that the deficiencies identified above in terms of audit planning and coverage, professional resources, performance of audit work, reporting and follow-up be addressed. A detailed plan of action should be prepared and closely monitored under the authority of the audit committee, if established as recommended.

Review of the set-up of controls in Oracle

192. – As mentioned in the introduction, I hired an Oracle specialist in order to conduct a review of FAO information systems (Oracle set up, bespoke developments, interfaces, etc.). Since he was the one that had conducted a similar review at the time of the 1998-99 accounts closure, he was in a position to determine if improvements had been made since. The main conclusion of the review was that no weaknesses that could lead to a severe disruption of FAO operations or have a material impact on the 2000-01 financial statements were identified. However, although processes and level of control had improved since the last review of the systems in March 2000, there was an urgent need to focus on the following areas:

• enhance existing and develop/adopt new and comprehensive norms and methods for systems-development process;
• enforce the end to end controls on interfaces;
• further strengthen system security;
• complete the exercise currently underway to improve management of system responsibilities; and
• make better use of the functionalities provided by Oracle.

Systems-development Process

193. – A formal systems-development process provides an environment that is conducive to successful systems development. It includes the following:

• a strategy that guides developers in building systems that are consistent with the organisation’s technical and operational goals;
• standards and methodology that guide in the selection of hardware and software and in developing new systems;
• policies and procedures that support the organisation’s goals and objectives; and
• project management that ensures projects are completed on time and within budget.

194. – For the FAO, shortcomings were identified for all the four points mentioned above but were mostly related to methodology, policies and procedures. In my opinion, this was partly due to the strategy made for the implementation of Oracle. The choice was made, in 1995, to acquire, on the one hand, the Oracle licence and to contract, on the other hand, with consultancy firms for its installation. The alternative would have been to conclude a single contract with an Implementing Partner (IP), which would have provided, at the same time, the software package and the consultants to install it. According to the Organization, this would have led to higher costs. In my opinion, the benefits of contracting an IP are that it provides notably a well-tested and proven methodology. The FAO, which did not have that advantage, failed to adopt a given methodology in a comprehensive manner across all systems being developed and impose it on the various consultants it contracted. As a result, there was no homogeneity in the ways various parts of the current systems were developed, validated, tested and documented.

195. – I recommend that priority be given to the following:

• an overall strategy should be formalised;
• a well-proven project methodology should be adopted for the Human Resources and Budget projects and any other future projects;
• existing documentation should be completed and/or updated (especially all parameters’ guides) and procedures defined for their maintenance;
• all controls carried out either at the level of AFI or AFFS should be formally documented.

Interfaces

196. – As the FAO’s new information systems did not rely solely on Oracle, various and complex interfaces had to be built between Oracle Financials modules and the other systems (Finsys/Persys, FAS and Atlas). The complexity was especially due to the existence of two different technical environments (UNIX and IBM) and the fact that no common reference tables were used. As a result, any update had to be done simultaneously in the different systems (especially between Finsys/Persys and Oracle HR). A relatively high amount of rejects was also noted. Although I acknowledge that the Controls Branch has started to address these problems through the monitoring and reporting of interface activity and follow up of issues arising, I recommend that efforts be continued to establish procedures for the following: frequency of up-dates; regular analysis of rejects; recycling and audit trail.

System Security

197. – In terms of systems’ security, the same deficiencies already pointed out in the AUD report 6401 entitled “Aspects of information security” were observed, namely: absence, in some cases, of a cut-off date for access rights, lack of formal documentation of regular checks on access rights and responsibilities granted. My staff acknowledged the improvements made in the area (current review of all access rights to Atlas, which would be generalised to other systems) and the plans to streamline and reinforce the control over access rights by having only one password to be changed periodically for the whole systems (AFI “Common Security and Single Sign On” project). My staff concurred with these plans and recommended that they be implemented as soon as possible. They further recommended that all failed attempts to access the systems be formally recorded and reviewed on a regular basis to detect any attempted intrusion by unauthorised persons.

Management of System Responsibilities

198. – With regard to the management of system responsibilities, my staff noted that a significant exercise was currently being undertaken by the Controls Branch in this area. The exercise should address the deficiencies pointed out during the review: need to streamline the high number of present responsibilities and the high number of users for certain given responsibilities (opening and closing of accounting periods for posting, for instance).

Use of Oracle Functionalities

199. – It was also noted that Oracle was not used to its potential especially for accounts payable and receivable modules. For the former, the following was noted:

• The suppliers’ bank account information was entered for each supplier, which resulted in duplication of work and a higher risk of errors at the time of the data input. With the upgrade to version 11i of Oracle, my staff recommended that the “Use Structured Supplier Banks Payable” option be used. Therefore, the bank details could be entered only once, for each bank, in the Banks window with the bank accounting information being subsequently assigned to each supplier. The same should also apply to the staff or any other third parties concerned with payables.
• The payment cycle had been partially automated. There was a three-way match before authorising a payment: purchase order, goods receipt and invoice. However, if the match for the purchase order and the invoice was carried out with the accounts payable module, the goods received was not done through the system. My staff recommended that the possibility of having the receiving function performed by Oracle be investigated.
• Oracle AP module can be integrated with other Oracle Financials modules. At the time of the review, there was no integration with the Fixed Assets (FA) module. In fact, very little use of the FA module was made. This was notably due to the fact that, like other UN organisations, the FAO charged all non-expendable equipment as expenditures on purchase and, therefore, did not amortise them. However, since the Organization has to disclose, in line with the UNAS, “the inventory value at the beginning and end of the financial period of non-expendable equipment, furniture and motor vehicles”, an integration of AP module into the FA module might help for inventory control, management and reporting.

200. – For Oracle accounts receivable module, the following was notably suggested:

• use of the Dunning Letter Generate programme to sent reminders of overdue invoices;
• set up of limits for adjustments;
• more sophisticated reporting with ageing balances.

201. – As far as the responsibilities were concerned for both accounts payables and receivable, a proper segregation of functions was implemented for respectively orders and invoices, and invoices and payments, except for the responsibilities granted to supervisors. However, they were instructed not to effect both invoice and payment steps in relation to any given transaction. My staff further recommended that the list of users who were granted a supervisor responsibility and the transactions they processed be reviewed on a regular basis. To control the transactions actually processed by supervisors, reports could be run. However, the Oracle Alert application, for which the licence was acquired in 1995, could be used in place of reports, with the following benefits:

• Alerts send information only when needed, whereas reports are usually produced on a periodic basis, and may not always be read promptly.
• Alerts send just the relevant information, not a whole report and just target the people who need to know.
• Alerts are easy for programmers to implement. They justify their cost by making the Organization more responsive and reducing the paper costs induced by reports.

In view of the above, my staff recommended that Oracle Alert be used to send an “event alert” through e-mail whenever breaches to the principle of segregation of duties occur. At the time of writing this report, my staff were informed that the above-mentioned recommendations would be considered for implementation following the completion of the up-grade to version 11i of Oracle.

Future Projects

202. – To conclude on the review of Oracle, I would just like to issue some words of caution regarding on-going projects.

• Regarding version 11i of Oracle, I stress the importance of putting in place the proper procedures and documentation as recommended above and evaluating the levels of access to be granted to decentralised offices, considering, in particular, the availability of an adequate telecommunication infrastructure and each FAOR capabilities.
• For the replacement of Finsys/Persys, my staff were recently informed that a review considering the pros and cons of the Oracle solution versus other options was conducted by external consultants and that it had confirmed that Oracle HR and Payroll modules were the most appropriate avenue for FAO. It was recognised that some bespoke developments would be needed to adapt the payroll module to meet specific FAO needs in terms of staff entitlements. In view of the recent experience of the WFP, I am of the opinion that the scope of bespoke developments and the corresponding cost should not be underestimated. Needless to say that the FAO should not embark on the project without proper funding, including a provision for contingency.

FOLLOW UP REVIEW OF THE TREASURY MANAGEMENT

Objectives, Scope and Method of the Audit

203. – As indicated in the introduction, a follow-up review of the Treasury management was conducted during the 2000-01 biennium to determine, in particular, if the recommendations issued in my previous report [paras. 40 to 71] had been implemented. The following was examined:

• organisational arrangements;
• banking arrangements;
• short and long-term investment;
• investment monitoring services; and
• foreign exchange issues.

Organisational Arrangements

Treasury Unit

204. – In my report on the 1996-97 biennium [para. 43], I had commented on the inadequacy of the Treasury Unit organisation and recommended its revamping and upgrading. As mentioned in my report on the 1998-99 biennium [para. 207], no steps were taken in this direction during the previous biennium. The two professional staff members left the Organization in January (P-5 Investment Officer and Unit’s Chief) and April 2000 (P-3 Treasury Officer), respectively. The post of the latter was even abolished for the 2000-01 biennium.

205. – As a result the consultant, whose services had already been contracted to assist the Organization on investment issues starting February 2000, ended up running the Treasury Unit until the position of Unit Chief was temporarily filled by a transfer of an internal staff member (P-4) in June 2000. After the discussions initiated for a direct recruitment failed, a vacancy announcement was issued on 23 July 2001. Out of 169 applications received, 11 candidates short-listed and four candidates interviewed, a senior Finance Officer (P-5) was eventually appointed, on 1 July 2002, as Chief, Treasury Unit. More than two and a half years had in fact elapsed since the position became vacant in January 2000.

Investment Advisory Services

206. – As already mentioned in my previous report, the Organization had contracted out a consulting firm for the provision of the following investment advisory services for an annual fee of US$24,000 for a 12-month period beginning 1 February 1999:

• “Access to investment and financial data drawn from [its] investment and financial research databases;
• Access to detailed data, including analysis and exhibits on capital markets; policies, financial statements and performance of comparable institutions and investors; managers, partnerships and special investments of all kinds;
• A variety of written research reports and working papers on key investment and financial issues;
• Up to 36 hours of consulting time to be used for miscellaneous consultation and inquiries, brief reports on asset allocation and attendance at quarterly meetings in Rome.”

207. – The contract was concluded by the FAO but on behalf of the WFP as well. Both organisations agreed that they would equally share the fees, which was the case for three consecutive periods. Considering, however, its increased need for advice on investment matters, the WFP concluded, on 25 February 2002, a separate agreement with the firm. The FAO did the same, on 26 April 2002, for an annual fee of US$18,000 for a 12-month period beginning 1 February 2002. The service to be provided would especially include 18 hours of consulting time.

Investment Committee

208. – In my previous report, I commented on the fact that the Investment Committee (IC), which was meant to meet four times a year, had only three sessions in 1999 and none in 2000. My recommendation that the IC convene as soon as possible was duly implemented and four meetings were organised for 2001. However, as recapitulated in table 9 that follows, the meeting minutes were not issued in a timely manner. Furthermore, my staff noted that they did not follow a standard format. For instance, absent members were not always duly recorded.

209. – As per the terms of reference, which were reviewed at the March 2001 meeting, the IC “shall be composed of at least three and up to five members, two of whom may be outside experts. The Committee shall meet at least two times a year to review performance and any other issues”. As far as the external members were concerned, only the Treasurer of the International Fund for Agricultural Development (IFAD) attended the first meeting in 2001. Although I acknowledge that, as per the terms of reference, the IC would “also have available to it the services of expert consulting advice where required”, I am of the opinion that it would benefit by having another external member. Therefore, I recommend that a second member be appointed and that FAO continue the discussions with the WFP regarding the possibility of having its Treasurer participate in the functions of the FAO Investment Committee.

Advisory Committee on Investments

210. – In my previous report, I observed that the Advisory Committee on Investments (ACI), which was meant to meet twice a year, had only met once in recent years. Furthermore, the committee members had little opportunity to follow up on the implementation of their recommendations since the minutes of the ACI were transmitted to them usually months after the meeting. In addition, the external committee members received no additional information in between annual meetings. I recommended that consideration be given to reinforce the role of the ACI by reviewing its terms of reference, re-examining its composition and limiting its membership to external members only and issuing the minutes in a timely manner.

211. – As mentioned in the “Progress Report on the implementation of the External Auditor’s recommendations” that was examined by the Finance Committee at its 97^th Session in September 2001¹⁰, the following actions were subsequently taken:

• The terms of reference for the ACI were reviewed and submitted to the FAO Director-General for his approval.
• Membership of the ACI was limited to the following external members appointed by the Director-General: three Representatives from the Bank for International Settlements, the European Bank for Reconstruction and Development and the International Monetary Fund, respectively, plus the FAO’s consultant.

212. – I noted these improvements, but I am still concerned that, as per the revised terms of reference, the frequency of the meetings had not been increased. In fact, the ACI would only be required “to meet each year to review the annual report on investments and make recommendations to the Director-General”. My staff noted that the members of the Committee were consulted by telephone, in July 2001, when the Organization was considering a forward purchase of Euro for the 2002-03 biennium. However, only two members could be reached and their oral advice was not confirmed in writing. At the 28^th Session on 24 May 2002, the possibility of holding an additional meeting was discussed. However, since the external members pointed out the difficulties in coming to Rome more than once a year, it was decided that an additional meeting should be discussed on a case-by-case basis and organised through conference call or video conference.

213. – Regarding the timely distribution of the meeting minutes, the ones of the 27^th Session of the ACI held on 25 May 2001 were distributed to the Committee members in June 2001. However, my staff noted that the minutes of the 28^th Session of the ACI held on 24 May 2002 were only sent to the Director-General for approval on 25 June 2002 and approved on 10 July 2002. In view of the above, I recommend that the ACI meet twice a year, by teleconference and that informal consultations be encouraged in between. Minutes should be prepared in all cases, even for informal consultations, and promptly issued, as previously recommended.

Banking Arrangements

214. – In my previous report, I had commented on the fact that the Organization had formulated, for its banking arrangements, a three-tiered strategy, which would involve the following:

• a banking relationship to manage Headquarters payments in Lire, Euro and staff accounts held in Italy;
• a banking relationship with a major international bank to handle international payments outside of Italy;
• several banking relationships with other international banks with strong retail presence in particular regions of the world, to operate other field banking required.

At the time of writing my report on the 1998-99 biennium, only the first tier of the strategy was in place with a contract concluded in May 2000.

215. – At the time of writing the present report, limited progress had been made.

• Regarding the bank contracted for the first tier of the strategy, all requests for payment (payroll excepted) were still transferred manually, which increased the risk of errors. The project for Electronic Data Interchange (EDI) between the Organization and the bank was well underway but implementation was not expected before the end of 2002.
• For the bank contracted for the second tier of the strategy, many technical problems were encountered with the electronic interface with the bank’s software and because of inaccurate or insufficient bank details in Oracle. As a result, a high level of rejection of bank transfers, which subsequently required manual intervention, was noted throughout 2001 (close to 50%). Therefore, it took more than a year and a half to fully implement the agreement concluded in September 2000. However, the recent implementation, in April 2002, of the SWIFT code database, led to an improvement.
• As far as the third tier of the strategy was concerned for field bank accounts, no progress was made since the Organization considered that it would not be prudent to move forward on this issue before the implementation of the second tier of the strategy. As a result, the number of field bank accounts did not decrease. It amounted to 474 as at 30 June 2002, broken-down into 249 projects’ accounts, 165 imprest accounts and 60 Zero Balance Accounts (ZBAs). However, following an extensive analysis, the banks concerned had been instructed to close a total of 133 accounts to be subsequently disabled into FAO’s books of accounts. A total of 97 additional accounts were expected to be closed in the course of 2002. I commend these efforts and recommend prompt action to implement the third tier of the strategy in order to further streamline the number of retail banking relationships and reduce the cost of banking.

Short-term Investments

2000-01 Performance

216. – As noted in my previous report, during 1999, whilst reviewing the appointment of external managers, FAO placed its short-term investments in a commingled Short-Term Investment Fund (STIF) managed by the Custodian of the Organization’s long-term investments. Since the contracts with the two investment managers were still to be finalised, the short-term investments remained placed in the Custodian’s STIF during the whole 2000-01 biennium. According to the current Investment Guidelines, “the primary objective of the Organization is preservation of capital and the earning of income on a calendar year basis of at least 80 percent of the ninety-day US Treasury Bill and the three-month US Dollar LIBOR rate plus 25 basis points net of cost”. As recapitulated in table 10 that follows, returns fell between upper and lower benchmarks for both years. As at 31 December 2001, the balance of the investments amounted to US$276.7 million.

2002 Up-date

217. – At its 28^th Session (24 May 2002), the ACI again discussed the strategy of placing the short-term investments with two fixed-income managers and concluded that the FAO “could proceed with this change as the strategy was both reasonable and safe, yet would require additional efforts to monitor the performance of several portfolio managers”. As for the benchmark, several suggestions were made and the ACI recommended that the FAO review them with the advice of the consulting firm and propose specific changes. The contracts with the investment managers were finally signed by the FAO on 21 February 2002. However, they were only sent to the respective investment managers for signature after LEG had given its clearance on 13 June 2002. At the time of writing this report, only one of the managers had returned the contract signed. For the execution of the investment managers’ contracts, two “Futures and Options Account Agreements” were also signed by the FAO on 28 June 2002. At the time of writing this report, the transfer of the funds to the investment managers was expected to be made by the end of 2002. As recommended by the ACI, a share of the total short-term portfolio would remain invested in the Custodian’s STIF. I recommend that the transfer only be made once all the arrangements for the monitoring of the investments are in place as detailed below.

Long-term Investments

Background Information

218. – Long term investments were set up to enable the Organization to meet the long-term liabilities resulting from the Separation Payment Scheme (SPS), the Compensation Plan Reserve Fund (CPRF) and After Service Medical Care (ASMC). Since their establishment, these funds had been managed by the same long-term manager, which was operating under a balanced mandate that allowed investing in both stocks and bonds with a split of 65% - 35%, respectively. At its 25^th Session (28 May 1999), the ACI had recommended that all fixed income assets, for which the manager’s performance was below the average, be transferred to a specialist fixed income manager. For prudence reasons, it also proposed that part of the equity assets be transferred to an equity manager, considering that superior equity performance of the current manager was linked to growth stock in which it specialised, but that could become less profitable.

219. – As a result of lack of staff resources and other priorities, FAO had not been able to transfer the long term asset portfolio to new managers as recommended by the ACI. While I did acknowledge in my previous report that the current manager had, overall, exceeded its benchmark in 1999 and 2000, I still reiterated my previous recommendation to review the existing arrangements through a competitive process. I also added the following: “The diversification, which had also been recommended by the ACI, would minimise the risks of having all long-term assets with the same manager implementing its own strategy, which might not be successful under all market conditions. It might also lead to a further reduction of the present fees.” The response of the Organization at the time was that it “did not intend to move forward until it had: (i) completed the placement of the short-term portfolio; (ii) concluded the agreement with IFAD on investment management support; and (iii) reviewed the issue of long-term investments at the May 2001 Session of the ACI.”

2000-01 Performance

220. – The issue of long-term investments was indeed reviewed by the ACI at its 27^th Session (25 May 2001). The Committee felt that the recommendation to diversify the portfolio by shifting the fixed income assets to a specialised fixed income manager and appointing another equity manager still made sense. However, it “cautioned against making these moves until FAO had a proper monitoring operation in place and could effectively control the placement of the portfolios with a number of different managers”. Last but not least, since there was “some concern that the 65/35 split might be too aggressive for an Organization like FAO” the Committee recommended that it be reviewed by the consulting firm while conducting its review of the equity and fixed income benchmarks.

221. – Since the FAO was not in the position to make the transfer of the long-term funds, they remained with the same manager throughout the 2000-01 biennium. The returns achieved were much lower than the benchmark, because of its concentrated growth style, especially in 2001, as recapitulated in table 11 that follows. As commented on by the ACI at its 28^th Session (24 May 2002), the manager had moved to cut its equity exposure when the markets had started to decline. “However, they had been slow to bring their overall equity exposure more in line with broad market indices by reducing their exposure to growth stocks. The failure to reduce the growth stock exposure had offset most of the savings achieved by reducing overall equity exposure. The [manager’s] report also showed that their performance relative to growth stock indices and hence other growth managers had suffered in recent years. This raised questions on the recommendation to use the firm only as a growth stock manager.”

222. – As at 31 December 2001, realised losses amounted to US$16.5 million originating mostly from equities as indicated in table 12 that follows. In particular, a loss of US$1.7 million was incurred from the sale, on 30 November 2001, of 23,800 Enron shares at US$0.35 each (unit cost price of US$69.87). It should be noted though, that this late sale was due, according to the manager, to an “operational oversight” since its intention was to sell them on 8 November 2001 together with the ones of the UNJSPF (sale price of US$8.55 net of commission). Once the difference was pointed out to the manager, it indicated that the FAO would be compensated for the difference of US$195 thousands in 2002. Other losses were incurred also with another company in the utilities sector and several US and non-US based companies in the information technology sector.

223. – As at 31 December 2001, the market value of the long-term investments was of US$179.8 million. Unrealised gains came to US$11.6 million, while they amounted to US$80.6 at the end of the previous biennium as recapitulated in table 13 that follows.

2002 Up-date

224. – At its 28^th Session (24 May 2002), the ACI was asked to re-examine outstanding parts of the strategy initially adopted in 1999. The Committee felt it was still valid. It considered, however, that “the fixed income change was less necessary than the equity change in that there was less difference between fixed income managers’ results. Moreover, the recent poor performance of the [current manager] especially in their core growth stock performance, their staff losses in the World Trade Center disaster and their merger [with another firm] dictated that a detailed review of the advisability of continuing the relationship be undertaken as soon as possible”. Since the existing arrangements were not reviewed earlier, as recommended in my previous report, I urge the Organization to progress on this issue as soon as possible now that a Chief, Treasury Unit has been appointed.

225. – On the issue of the 65/35 split, the consulting firm pointed out that it was not out of line with the majority of pension funds. However, it was emphasised that it would be necessary to carry out an asset allocation study to properly address the issue. While recommending to do so, the ACI also stressed the dilemma the Organization was facing in the sense that the Member States did “not appear ready to make any additional contributions for prior past service costs associated with [the ASMC]. This posed a conceptual problem since medical cost inflation was running at a much higher rate than other costs in the economy.” Since the only source of funding was excess returns on the portfolio set aside for the SPS and the CPRF, the ACI “did not think this was a realistic funding plan and probably inconsistent with the risk tolerance of the Finance Committee”. In addition, “another problem that had to be faced in the asset liability study were the current high valuations in most equity and fixed income markets”. Last but not least, “the asset liability study should also address the issue of the currency composition of the liabilities and the associated effects on plans for the assets”. The ACI concluded its discussion by recommending that the Organization, assisted by its investment advisor, undertake an asset/liability study as soon as FAO had the human resources to do so.

Investment Monitoring Services

226. – As previously indicated, the FAO’s initial intention was to outsource the monitoring of its investments to the IFAD following a proposal made by the latter. A similar approach, in line with the UN concept of “common services” had been made, in June 1999, towards the WFP. The IFAD’s two-fold suggestions were as follows:

• The pooling of investments into one single portfolio was suggested in order to take advantage of the lower fee structure it would create.
• A combined approach to monitoring the performance of investments outsourced to external managers was also suggested to reduce staff and overhead costs. The IFAD proposed to have its existing Investment Section, which was composed of two Professionals and two general service staff, reinforced by two from the FAO and the WFP (one staff member each).

227. – Like the WFP, the FAO was interested in the second proposal with the preference, however, for the payment of a fee rather than the outposting of one staff member. Since the IC did not convene at all in 2000, it could not review the matter. The advice of the ACI was not sought either, although at the time of its 26^th Session (26 May 2000) the FAO had received a cost proposal. Negotiations with the IFAD continued until May 2001 after the Finance Committee had expressed concerns, at its 96^th Session, about the IFAD capability to provide external assistance at the time when it had to address several shortcomings in its own monitoring of investments.

228. – No advice was sought earlier from the IC and the ACI and the FAO never requested access to audit information on IFAD’s Investment Section, which would have saved time. While I commend the initiative to set up UN “common services”, I regret that no alternatives to the outsourcing of monitoring services to the IFAD were envisaged. At the time of writing this report, my staff were informed that the FAO had re-examined the possibility of having its Treasury Unit perform the investment monitoring and decided to so now that a Chief, Treasury Unit has been appointed.

Foreign Exchange Issues

Applicable Rules and Regulations

229. – As per Financial Regulation 11.4 “the final and any interim accounts of the Organization shall be presented in United States Dollars. The accounting records may, however, be kept in such currency or currencies as the Director-General may deem necessary”. For the conversion of other currencies in US Dollars, the UN Accounting Standards (UNAS) are not prescriptive since they allow the choice between three different rates for the recording of transactions that occur in a currency other than the currency of account. As per UNAS 27, the rate to be applied should be:
“(i) the United Nations operational rate of exchange,
(ii) the budget rate of exchange or other rate of exchange approved by the legislative authority of the organization, or
(iii) the actual rate of exchange yielded at the time of the transaction”.
However, “the United Nations operational rate of exchange [UNORE] should be the benchmark rate of exchange for the determination of exchange gains and losses”.

230. – As disclosed in Note 2 to the financial statements, the FAO chose to use the UNORE.

• “Income and expenditure in currencies other than US Dollars are translated into US Dollars at the UN operational rate of exchange, which approximate the market rate in effect at the date of the underlying transactions.
• Assets and liabilities in currencies other than US Dollars are translated at the UN operational rate of exchange in effect art 31 December 2001. Exchange differences are taken to the income and expenditure account.”

Means of Protection against Exchange Fluctuations

231. – Financial Regulation 5.6 states that “annual contributions to the budget shall be assessed in United States dollars”. While it also allows for contributions to be paid in convertible local currencies, its essence is that the assessments are made in US Dollars and that Member Nations’ obligations are determined in US Dollars regardless of the currency of payment. Consequently, all the Organization’s income is effectively in US Dollars while expenditure can be in many currencies, in particular the currency of the host country (Lire and Euro since 1 January 2002 for around 50% of payments). As a result, the Organization is exposed to exchange rate fluctuations.

232. – Conference Resolution 27/77 established the SRA to protect the Organization’s PWB against the effect of unbudgeted extra costs arising, in particular, from adverse currency fluctuations. Net gains or losses on exchange in addition to the currency variance on staff standard costs are charged to the SRA. The currency variance on staff standard costs represents the difference between staff costs expressed in US Dollars at the budget rate for the biennium (Lire 1875 to US$1 for the 2000-01 biennium) and the UNORE at the time of payment. The authorised level of the SRA was set by Conference Resolution 13/81 at 5% of the effective working budget for the respective subsequent biennium.

233. – Up until the 1990-91 biennium, the SRA represented the only means of protecting the PWB against foreign exchange fluctuations. However, the losses of US$31.2 million incurred for the 1986-87 biennium eliminated the balance of the SRA at the time and forced the General Fund to absorb the remainder of the loss for US$ 9.4 million. The technique of forward purchase to meet future needs in Lire was subsequently adopted as an additional means of protection and endorsed by the Finance Committee. In my report on the 1996-97 biennium [paras. 34 to 36], however, I had recommended that the FAO review its current policy for hedging against changes in exchange rates (flat two-year forward purchase contract) with a view to better taking into consideration the new, more unstable, international exchange environment. As a result, the Organization established a Working Group, which was given the mandate to review not only the current practice of forward currency purchase but also the impact of the introduction of the Euro.

234. – If the differences between the forward contract rate and the average UNORE were favourable for the 1996-97 biennium, this was not the case for the successive biennia. As recapitulated in table 14 that follows, the SRA was indeed credited, for the 1996-97 biennium, of an overall exchange gain of US$9.1 million in addition to US$1.5 million of positive currency variance on staff standard costs. However, for the 1998-99 biennium, the SRA was charged with an overall exchange loss of US$17.4 million, partly compensated by a positive currency variance on staff standard cost of US$10.5 million. For the 2000-01 biennium, the situation even deteriorated since the overall exchange loss amounted to US$47 million out of which US$43.7 million was due to the unfavourable forward purchase contract rate. It was only partly offset by a positive variance on the staff standard cost variance of US$24 million. In addition, however, a further effect of the strengthening Dollar, outside the SRA, was that foreign currency denominated non-staff cost related expenditure was some US$20 million lower in Dollar terms than budgeted.

235. – The results of the Working Group mentioned above were presented to the Finance Committee at its 95^th Session in September 2000¹¹. In the document entitled “Protection of the Organization’s Programme of Work against Exchange Rate Fluctuations”, the following two options were briefly described with the aim of seeking the Committee’s guidance on the most acceptable solution:

• establishment of a split assessment system whereby part of the contributions would be called and paid in Euro (around 50%) and the balance in US Dollars.
• setting the budget rate at the forward rate combined with a forward purchase contract.

236. – As reflected in its report to the Council¹², the Finance Committee recognised that the current arrangements for protecting the PWB were no longer sustainable in the long-term. It noted that further discussion was required between its members and appropriate experts and welcomed the offer made by my staff to provide some details on the approach followed by other UN organisations. The Finance Committee had initially envisaged to re-visit the matter at its 96^th Session in May 2001. At the time, it considered it, however, preferable to defer the matter so as to benefit from the expert opinions before reaching its final decision.

237. – On 8 December 2000, my staff had provided the President of the Finance Committee with the promised information on other UN organisations’ experience. Details were, in particular, given regarding the UN Educational, Scientific and Cultural organization (UNESCO) positive experience with a split assessment system adopted in 1988 and the UN Industrial Development Organization (UNIDO) 1999 decision to adopt the Euro as its reporting currency. On 20 June 2001, my staff sent, to the President of the Finance Committee, additional information regarding the practice of the International Atomic Energy Agency.

238. – When the Finance Committee re-examined the matter at its 97^th Session in September 2001, it was informed of the decision taken by the Director-General in July 2001 to enter into a forward contract to cover the Organization’s Euro requirements for the entire 2002-03 biennium (the equivalent of US$300 million). The Committee noted that the contract was concluded at an average blended rate of €1 = US$0.880 and that the budget rate for the biennium was set at the same rate. According to the experts who were contacted for advice, the contract was considered a sensible decision in view of the current exchange rate anticipations.

239. – While the situation for the 2002-03 biennium has been resolved, it should be noted, though, that this only proved feasible because of the strength of the US Dollar and the relative interest rate spread across the Euro and the Dollar. For the future, the issue of protecting the PWB in the long term still remained to be addressed as stressed by my staff at the 99^th Session of the Finance Committee. Following the Finance Committee’s reminder, in May 2002, that the issue must be resolved, particularly in view of the near depletion of the SRA, the Organization took the commitment of presenting a comprehensive proposal at the September 2002 Session of the Finance Committee. In order to do so, it contracted, in June 2002, a consulting firm, which had been asked to look at all options, including the adoption of the Euro as the reporting currency.

________________________________

¹⁰ Cf. FC97/12 document.

¹¹ Cf. FC95/9 document.

¹² Cf. CL119/13 document.