Reforming the Single Source Regulatory Framework: a more strategic approach?
The reform agenda
A significant reform agenda relating to the single source regulatory framework (including the Defence Reform Act 2014 and the Single Source Contract Regulations 2014 (SSCRs)) has been proposed by the UK Ministry of Defence (MOD) in a Command Paper titled “Defence and Security Industrial Strategy: reform of the Single Source Contract Regulations” published on 4 April 2022 (Command Paper). If the proposed reforms are implemented, it will mark a continued move towards a more “strategic” role for single source procurement.
The proposed reforms seek to ensure that the single source regulatory framework supports the delivery of the “Defence and Security Industrial Strategy” published by HM Government in March 2021 (DSIS) (which builds on the Integrated Review, and a Command Paper titled “Defence in a competitive age” published by the MOD on 22 March 2021). The proposals would establish a more strategic relationship between Government and the defence and security industries, and take into account the recommendations published by the SSRO in June 2021.
The proposed reforms are of pivotal importance to the wider defence sector in light of the current MOD spend of GBP9 billion per year on non-competitive defence procurement; and as of December 2021, the single source regulatory framework capturing over 365 contracts with a combined value of GBP62.1bn.
In alignment with and in addition to the DSIS, and more specifically the National Shipbuilding and Combat Air strategies, many of the proposed reforms further clarify the MOD’s acquisition and procurement policy position going forward, which focusses largely on domestic production of defence assets for reasons relating to national security, and national economic interests in the form of exports purchased domestically and globally.
Significantly, although the MOD has reaffirmed that it recognises that the single source regulatory framework continues to play a key role in ensuring value for money for taxpayers is obtained in the absence of competition, it has also recognised the importance of the single source regulatory framework in ensuring that the UK defence sector remains an area which attracts investment and innovation. The reform proposals appear to indicate that the MOD sees value in developing long-term strategic partnerships which represent value for money and support wider national strategic and security objectives.
Please see below a short summary of some of the key proposed reforms, which focus on three main themes: (1) choice and flexibility, (2) speed and simplicity, and (3) stimulating innovation and exploiting technology.
Summary of proposed reforms
- Choice and flexibility – reforms have been proposed to ensure that the single source regulatory framework can be applied to a wider range of contracts, including those relating to off-the-shelf software and engineering commodities. Proposals include:
- specifying in the SSCRs specific circumstances under which a fair price may be demonstrated without applying the pricing formula, and allowing assurance on fairness and value for money by reference to market prices rather than application of the pricing formula (given that, in respect of some contracts, it is difficult to apportion to the MOD part of a wider costs pool);
- enabling the pricing formula in the SSCR to apply to new elements of a contract only (such that the pricing formula is disapplied in respect of part of the contract), given that it may be impracticable to re-price a whole contract when a contract is converted by amendment into a Qualifying Defence Contract (QDC) which falls within the ambit of the SSCRs;
- amending the current six-step contract profit formula to ensure that the adjustment reflects all the financial risks taken by the contractor, to state the activity type that can be taken into account, and to allow the SSCRs to set out how and when an incentive fee can be used;
- allowing contracts to be split into different segments, each of which will have its own approach to pricing, profit rate, and calculation of final price (and defining how the various segments must be aggregated);
- ensuring that, for contracts where a rate has been competed but a volume has not (for example, in framework agreements), the reasonableness test required by the legislation need only be applied to volume, and not the rate; and
- changing the legislation to ensure that profit is not paid on costs more than once where the prime contractor has a significant interest in the sub-contract (or vice versa).
- Speed and simplicity – reforms have been proposed to speed up and simplify the single source regulatory framework. Proposals include:
- reducing the “six step” contract profit formula by:
- amending the legislation to grant more powers to the SSRO to issue guidance on all aspects of the regime and to:
- reforming MOD policies and procedures relating to the referral of matters to the SSRO; and
- simplifying aspects of the single source regulatory framework relating to certain reporting requirements.
– removing the Profit on Costs Once (POCO) adjustment, which will continue to be applied through allowable costs;
– addressing inter-group profits where they arise in costs, rather than by adjusting the contract profit rate;
– removing the SSRO Funding Adjustment – the SSRO will instead be fully funded by the MOD;
– give opinions upon request about the operation of the regulatory framework without the need for a referral to be made jointly with another interested party or parties or for the referral to identify a specific contract to take these recommendations forward;
– make a determination in relation to all of the contract profit steps;
– make a determination in relation to whether a contract or proposed contract meets the conditions to be a QDC or Qualifying Sub-Contract (QSC); and
– make a determination in relation to the agreement of rates that may be used in the pricing of QDCs and QSCs;
- Stimulating innovation and exploiting technology - reforms have been proposed to cater for new contracting approaches. Proposals include:
- updating legislation and statutory guidance to ensure that costs incurred in pursuit of the Government’s innovation and technology aims can be allowable;
- updating legislation and statutory guidance to enable the MOD and the contractor to enter into joint funding for innovation without quantifying the financial benefits that each party expects to accrue; and
- introducing sufficient flexibility to the legislation to ensure that it can take account of new ways of funding innovation, if necessary.
The statutory review of the legislation is due to be completed before December 2022 and has been timed to ensure that any reforms help to deliver the DSIS.
Although to date the MOD has engaged extensively with key stakeholders regarding the proposed reforms, the Secretary of State for Defence will consider any additional views from stakeholders submitted in response to the Command Paper by noon on 3 May 2022 to: Steve Davies.
It should be noted that, although the Command Paper sets out the proposed reforms, it does not provide any detail regarding how most of the proposed reforms will be implemented, which will be of critical importance to the workings of the single source regulatory framework.
In terms of next steps, the MOD expects to implement changes to the single source regulatory framework in stages, and to work with the SSRO and internal policy experts to update statutory guidance and policy in parallel with changes to the legislation. With respect to secondary legislation, the MOD anticipates reforms will be introduced in two tranches: (1) which will implement key flexibilities such as alternative pricing methods, and (2) which will address the remaining changes. Some of the proposed reforms could therefore, in theory, be implemented quite quickly. The MOD notes, however, that necessary changes to primary legislation would only be delivered when parliamentary time allows such that some of the proposed reforms are unlikely to be enacted in the immediate future.
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