Chapter 3
Role of central agencies
3.1
Although not stakeholders in the normal sense, the central agencies—Department
of the Prime Minister and Cabinet (PM&C), the Department of Finance
(Finance) and the Treasury—have an important part in the consideration and
approval of major capability proposals.[1]
In this chapter, the committee considers the role of the central agencies in
the government's decision to exclude Australian defence industry from tendering
for the AORs replacement project.
First Pass Consideration
3.2
Before a project, such as SEA 1654, Phase 3, can be submitted to
government for first pass approval, it must undergo a comprehensive process of
refinement and reach a stage 'where a new capability can be acquired.' This
phase includes the creation of 'Capability Definition Documents' to support
progression through Defence committees to government approval.[2]
3.3
The Capability Systems Division in Defence leads the development of the
capability proposals and the supporting documents that form the basis of the ministerial
or cabinet submission that is presented to government.[3]
The relevant project manager in the Capability Systems Division manages a particular
project and coordinates the development of the suite of project documents that
underpin the project. The project manager 'uses this information to produce a
complete and well-argued capability proposal and all supporting evidence'.[4]
The Defence Capability Development Handbook stipulates that the project manager
should only engage central agencies in consultation with the Capability
Investment and Resources Division in Defence.[5]
3.4
This Division has the lead role for engagement with the central agencies.
It provides independent analysis and review of capability proposals and related
costs, including the overall balance of investment in current and future
capability, major investment proposals and priorities. The Division is
responsible for: 'ensuring that the DCP is appropriately programmed,
independently reviewing capital and operating costs for all projects going to
the Defence committees, and managing Net Personnel and Operating Costs (NPOC)
estimates for all DCP projects...'[6]
The First Assistant Secretary Capability Investment and Resources heads the
division.[7]
3.5
Key responsible authorities within Defence review the draft ministerial
or cabinet submission before it is submitted to the Secretary of the Department
and the Chief of the Defence Force for clearance to go to government. The
authorities do so in order 'to ensure that the detail is correct and aligns
with departmental policies and allocations'. The role of the CEO of the Defence
Materiel Organisation (DMO) is
to concur with the summary acquisition strategy and cost, schedule and risk
estimates. The CEO also 'provides independent written advice on the cost,
schedule and commercial aspects as an attachment to the submission'.[8]
Mr Warren King, CEO DMO, explained that his organisation can spend a limited amount
of money in the lead-up to first pass doing market research—'understanding what
is available: understanding the market'. He explained further that Defence
rarely undertakes industry solicitation of DCP projects prior to first pass
approval and the assessment of capability options and other options is
conducted through open market research.[9] He noted, however, that:
...genuine approaches to market—approaches that may lead to the
award of a contract or future work—cannot be pursued until we have first-pass
approval.[10]
3.6
With regard to the acquisition of the new supply ships, Defence informed
the committee that it had developed estimated cost, capability and schedule
information for the project based on its open market research, unsolicited
proposals and other recent approaches to market. These approaches included the
exchange of information from similar Canadian and New Zealand projects, and
reports into Australian shipbuilding available capacity.[11]
Defence explained that notwithstanding the limitations of its research:
...the level of information available on the various ship
options in the marketplace was widely available through open source information
and sufficiently detailed to enable Defence to obtain information on available
options to meet the capability requirement.[12]
3.7
After the government's first pass approval, the DMO becomes
progressively more involved in the procurement process and is responsible for
the acquisition strategy.
3.8
The central agencies provide an additional level of scrutiny and advice
on capability development proposals from a whole-of-government perspective. The
Department of Finance informed the committee that it has:
...developed specific expertise in providing advice to
government on defence capability matters. In addition to the Department's role
in advising on whole of government procurement matters, and in advising the
Finance Minister on the cost and quality of new policy proposals put forward by
agencies, Finance has developed a specialised defence capability assessment
role.
Expertise at the Senior Executive Service Band 1 level is
dedicated to this role with support provided by the Defence, Capability and
Intelligence Branch. The work undertaken by Finance in this regard includes
advising the Finance Minister on: priority cost and risk issues; cost
contingency, cost models and supporting documentation; and other policy matters
raised in Submissions.[13]
3.9
At first pass, Finance is required to endorse the detailed acquisition
and operating costs and financial risk assessment. The Defence Capability
Development Handbook states further that this requirement is especially
important in 'the case for decisions on DCP capabilities or decisions having
important political, workforce and/or financial implications for Government'.[14]
Commonwealth Procurement Rules (CPRs)
3.10
Mr John Sheridan, Business Procurement and Asset Management Group, Department
of Finance, informed the committee that a procurement needs to be considered in
the context of the Commonwealth Procurement Rules (CPRs).[15]
Commonwealth officials must comply with the rules.
3.11
Paragraph 10.3 of the CPRs stipulates that a relevant entity must only
conduct a procurement at or above the relevant procurement threshold
through limited tender in certain strict circumstances. The procurement
threshold for non-corporate Commonwealth entities is $80,000, other than for
procurements of construction services (for procurement of construction services
the threshold is $7.5 million).[16]
3.12
Mr King, DMO, informed the committee that he understood that the CPRs
required DMO not to discriminate for a procurement over $80,000: that DMO would
have to go to the open market if the acquisition were over $80,000.[17]
Indeed,
the Defence Procurement Policy Manual stipulates that, in accordance with the
CPRs, it is mandatory for an open tendering process to be used for 'all procurements
at or above the relevant procurement threshold (other than Exempt Procurements)'.
This requirement applies 'unless the conditions for limited tendering or
prequalified tendering can be satisfied'.[18]
3.13
With the acquisition cost for the supply vessels expected to exceed $1
billion, the Commonwealth procurement rules would generally require that the
tender for the supply ships be open unless an exemption applies.
Exemptions
3.14
Defence defines a limited tender as a procurement process in which
Defence has invited either a single potential supplier or a number of potential
suppliers to submit a response without using an open procurement process.[19]
Defence's procurement policy recognises that in some circumstances it may be
appropriate to limit the number of potential suppliers to whom a Request for
Tender (RFT) is released. Defence's Procurement Policy Manual states:
Limited tendering should only be used where there is a sound
basis for identifying interested and eligible potential suppliers. When using a
limited tendering approach the process must be non-discriminatory and ensure
that a sufficient number of potential suppliers are invited to participate so
as to ensure a sound value for money outcome.[20]
3.15
The CPRs allow for an exemption from having to adhere to the rules. Paragraph
2.6 of the CPRs provides an overarching exemption which removes the need to
apply the CPRs where, for clearly defined reasons, an Accountability Authority
has determined it was necessary. Paragraph 2.6 states that:
Nothing in any part of these CPRs prevents an official from
applying measures determined by their Accountable Authority to be
necessary for the maintenance or restoration of international peace and
security, to protect human health, for the protection of essential security
interests, or to protect national treasures of artistic, historic or
archaeological value.[21]
3.16
Finance explained that, in practice, this exemption 'allows an entity to
undertake an alternative form of procurement, such as a limited tender, should
they choose'.[22]
Under paragraph 2.6, the Secretary and CEO DMO have determined that the
procurement of certain goods be categorised as Defence Exempt Procurements, which
includes ships and marine equipment.[23]
3.17
Speaking generally about the application of this exemption, Mr King
explained that a limited tender did not mean limited to Australia; it meant
that limitations are placed on the tender. He elaborated on this point:
It is an exemption simply to go to a limited tender. That
does not mean a limited tender to overseas; it just means a limited tender.
Sometimes I have used that exemption to be a limited tender for Australia. For
example, ...although it is not yet at a tender stage, there will be tendered
work—the work to be done to see if we can build a future frigate in Australia
will rely on that exemption. I will have to exercise that exemption to say, if
the government so chooses, that the only place we are going to build the future
frigate is in Australia. Otherwise, I would have to go to the world market and
see who wanted to supply us with a frigate.[24]
3.18
Mr King explained that, if DMO in any way undertook a limited tender,
the exemption had to apply. According to Mr King, whenever he limits a 'tender
in any way, shape or form, whether as to country of supply or type of supply', he
has
to use the exemption that was used for the two supply ships.[25]
He explained that the purpose of the exemption was to make sure that the DMO could
'provide essential defence equipment'.[26]
3.19
Mr Sheridan informed the committee that the exemption would also allow
for a rapid acquisition.[27]
Central agencies and DMO's role in decision for restricted tender
3.20
As noted earlier, the Minister announced that the government had given
first pass approval for Defence to conduct a limited competitive tender process
between Navantia of Spain and Daewoo Shipbuilding and Marine Engineering of
South Korea for the construction of two replenishment vessels based on existing
designs. Mr King explained his role in advising government on the tender
process for the supply ships:
I am the executive within DMO and within the department who
formed the opinion that the exemption could apply and should apply to these ships.[28]
3.21
Mr Sheridan understood that this procurement would be conducted under
the exemption provided in paragraph 2.6 of the Commonwealth Procurement Rules
that permit exemptions for national security measures. According to Mr Sheridan,
the procurement rules reflect the US free trade agreement that allows carve
outs for particular purposes including matters related to security.
3.22
In this regard, Chapter 15 of the Australia–United States Free Trade
Agreement sets out the specific rules, procedures and transparency standards to
be applied in the conduct of government procurement, consistent with
non-discrimination. Both the US and Australia, however, have exempted
procurement of items that are critical to their national security such as military
equipment, systems and essential supplies. Australia has also reserved the
right to maintain the Australian Industry Involvement Program for defence
procurement.[29]
Mr Sheridan's understanding of the application of this exemption is consistent
with the Defence Procurement Policy Manual which states that:
If a procurement is subject to Division 2 of the CPRs due to
its estimated procurement value, it may...still be exempt from the operation of
this Division for 'essential security' reasons if it is a Defence Exempt
Procurement in accordance with paragraphs 28–30 of this chapter.[30]
3.23
One of the two methods by which a procurement may be deemed an exempt
procurement is where a Defence exemption may apply a measure under paragraph
2.6 of the CPRs as pre-determined by the Chief Executive. As noted above,
paragraph 2.6 of the CPRs permits the Chief Executive of an agency to determine
that a measure is necessary for, among other things, the protection of ‘essential
security’ interests. Paragraph 27 of the Defence Procurement Policy Manual lists
the procurement of goods and services that the Secretary and CEO DMO have
determined to be categorised as Defence Exempt Procurements under the measure.
The list contains
25 categories of goods and services and include the following US Federal Supply
Codes (FSC) FSC 19—Ships, Small Craft, Pontoons and Floating Docks; and
FSC 20—Ships and Marine Equipment.[31]
In effect, under the carve-out provision in the CPRs, the acquisition of the
replenishment vessels was eligible for exemption from the Commonwealth
procurement requirement for an open tender.[32]
3.24
Mr Sheridan understood that the Secretary of Defence and the CEO of DMO made
the decision to apply through the defence procurement mechanism to use the
exemption provided under paragraph 2.6 in respect of procuring the supply ships.
Further, that Budget Group in the Department of Finance, whose responsibilities
involve liaison with Commonwealth agencies around spending proposals and budget
issues, made enquiries as to whether this exemption would be applicable in
these particular circumstances.[33]
Mr Sheridan informed the committee that on 1 April 2014, Finance officers
in the Budget Group asked his division whether paragraph 2.6 of the CPRs applied
in these circumstances.[34]
According to Finance, the Budget Group initiated contact with the Business
Procurement and Asset Management Group
to establish the conditions under which the proposed procurement may be exempt
under paragraph 2.6. This request emanated from Budget Group and not the
Minister for Finance.[35]
Mr Sheridan explained that his response was simply a matter of fact—the
exemption was 'applicable to the procurement of ships':[36]
...the procurement of ships is an exemption. That is really a
matter of fact. It does not need much context for me to interpret that. Is it a
ship? Yes. That is it.[37]
3.25
Mr John Edge, Finance, explained that Defence was 'responsible for forming
the view that they did around the application of that exemption'.[38]
He stated further:
Ultimately it is Defence's assessment and Defence's decision
to use an exemption that may exist in the Commonwealth Procurement Rules for a
particular project. So, while we will obviously talk internally to our
colleagues in budget group and we will, on occasions, talk to agencies about
the application of the Commonwealth Procurement Rules, as Mr Sheridan
said, ultimately it is a decision for the agency involved as to whether to
apply those rules.[39]
3.26
Mr King stated that, under the rules, clearly he was the responsible officer
for forming the opinion that it should be a limited tender, which became part
of the departmental submission and was ultimately reflected in the government's
decision. He explained:
The department formulates advice for the ministers, and the
ministers then take it to the government, but our advice to the minister was
that this should be pursued by a limited tender.[40]
3.27
According to Mr King, the central agencies review all cabinet
submissions, but he could not say how it was handled inside Finance. In his
view, the Department of Finance or others could have rejected the advice, but 'I
am saying I take accountability for forming that opinion'.[41]
The Department of Finance informed the committee that it provided advice on the
submission dealing with the acquisition of the new supply ships and to the
Minister for Finance 'in the usual way'.[42]
Government approval—first pass
3.28
When the government considers submissions relating to major
acquisitions,
it typically approves 'a solution-class option (comprising a number of options)
for further investigation'.[43]
According to the Defence Capability Development Handbook, the level at which first
pass approval is 'required with Government depends on the estimated cost of the
proposal and on whether there are any political or diplomatic sensitivities
associated with the proposal'. It states:
The level of Government consideration required is one
Minister (ie the Minister for Defence) for projects up to $20
million, two Ministers (ie Minister for Defence plus Minister for Finance)
for projects between $20 million and $100 million and the NSC [National
Security Committee of Cabinet] for projects over $100 million. The Minister for
Defence will often determine the appropriate mechanism for approval depending
on a project's sensitivity, previous considerations, etc.[44]
3.29
The submission on the acquisition of the new replenishment vessels, with
its estimated costs well over $100 million, would necessarily have gone before
the National Security Committee for final decision.
3.30
According to the Department of Finance, the NSC gave first pass
consideration of the proposed new replenishment ships on 4 April 2014, which
was followed by the Minister for Defence's announcement of the government's
decision on 6 June to go to a limited tender.[45]
Conclusion
3.31
The Defence Capability Development Handbook sets out clearly the
procedures and documents that must be prepared in readiness to submit an
acquisition proposal to cabinet. The CEO of DMO, Mr King, made clear that he
was responsible for advising the government on the preferred tender process,
which in this case was
to proceed with a restricted tender between Navantia of Spain and Daewoo
Shipbuilding and Marine Engineering of South Korea. He formed the view that the
government could do so consistent with the exemption provided in the Commonwealth
Procurement Rules. The relevant section in the Department of Finance confirmed
that the rules allowed for such an exemption.
3.32
There is no evidence to suggest that the proposed limited tender for the
two supply ships contravenes the Commonwealth Procurement Rules. Furthermore,
although Mr King's advice to the Minister was to opt for a restricted tender,
the decision was ultimately one for government.
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