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Enhancing aid effectiveness by managing Fiduciary Risks

The governments of most countries and international agencies have recognized that robust public financial management systems – from national to local government levels – are essential for the effective delivery of basic public services, and that increasing domestic resource mobilization is critical for achieving self-reliance and sustainable solutions.

Therefore, more efforts are channeled towards enhancing own-source revenue and improving tax administration in recent years. Traditionally, public financial management (PFM) reform strategies of developing countries focused on components of the PFM cycle from planning and budgeting to internal controls, procurement, treasury, accounting, reporting, audit, public oversight and evaluation. Ad-hoc PFM reform programs were concurrently designed and implemented to meet governance, grant or loan requirements of international agencies.

The use of country’s PFM cycle and systems plays an important factor in designing an implementation strategy of any donor-funded programs. Multilateral agencies including the World Bank and African Development Bank mostly provide funding for development programs through the PFM systems of an economy. On the other hand, bilateral agencies, including USAID, Australia’s Department of Foreign Affairs and Trade (DFAT), and Millennium Challenge Corporation (MCC) mostly disburse funds directly or through local implementing entities or program management units established by recipients’ governments. However, the approach of direct disbursement is also adopted by multilateral agencies such as the United Nations agencies, the Global Fund, and Gavi.

Donor funding channeled through country’s disbursement cycle provides an added opportunity to strengthen that country’s PFM systems. When it comes to direct disbursement or donor required arrangements, there are contrary opinions including that such approach can impair strengthening of PFM capacity.

Whether through a country’s PFM systems or parallel PFM systems, all risks are managed through different scheme of fiduciary services on need basis -- those associated with:

  • effective use of funds,
  • compliance with donors and in-country regulations,
  • fraud,
  • corruption,
  • abuse,
  • questionable costs and unallowable costs.

Certain risks are shared or transferred to providers of fiduciary services. There is increasing dependency on fiduciary services as donor organizations and governments are increasingly accountable for aid effectiveness to their stakeholders, beneficiaries and taxpayers, which comes at an additional cost to development programs. However, the benefits far outweigh the cost of fiduciary services, as it protects against identified risks. Beyond the PFM systems, there are situations where benefits of specific program management units also outweigh costs of establishing and maintaining such units even though such parallel arrangements reduce funds available for program implementation.  

Fiduciary services can range from limited oversight, review and verification services to a range of procurement, contract and financial management services. Like an auditor uses a risk-based audit approach to form a true and fair view opinion on financial statements, the concept of fiduciary services is tailored and adapted to mitigate risks identified by the stakeholders. International donors are also mindful of their commitment to use a country’s PFM systems and procedures to the maximum extent possible, under the Paris Declaration to Aid Effectiveness. And, where use of country’s PFM systems is not feasible, establish additional safeguards and measures in ways that strengthen country capacity. It is observed that as the fiduciary risks level scale from low to high, the scope of fiduciary services extend from limited assistance to extended services covering a majority of procurement and financial management processes.

Development agencies commonly use the World Bank, Public Expenditure and Financial Accountability (PEFA[1]) framework and its results in combination with their own tools to assess fiduciary risks associated with a particular program. No donor entirely depends upon the PEFA to decide on a country’s PFM systems and assess fiduciary risks. Per the World Bank study released in 2018, there are 45 PFM diagnostic tools broadly categorized into three categories:

  • tools covering all aspects of the PFM cycle;
  • tools focusing on individual aspect of the PFM cycle or institutions or governments; and
  • tools used by development agencies to assess fiduciary risk.

The tools under the third category include the World Bank assessment of country financial management systems in bank-financed projects, DFID Fiduciary Risk Assessment, USAID PFM Risk Assessment Framework (PFMRAF), etc.

In implementation of an infrastructure program, MCC mainly uses PEFA framework to determine whether to use country systems to perform fiduciary tasks or to engage an external procurement agent[2] or fiscal agent[3].

For instance, fiscal agent tasks of MCC funded Cape Verde, El Salvador, Honduras, Jordan, Tanzania and Vanuatu compacts were performed using country’s PFM infrastructure; and procurement tasks of Georgia’s second compact were managed internally by a government-established accountable entity. In most of remaining compact countries, MCC requires having an external procurement agent or/and fiscal agent as one of the conditions of the grant agreement.

In assessing fiduciary risks, the Global Fund relies on its internal or external capacity assessment, the Office of the Inspector General Report, or reports of the external auditor and Local Fund Agent.

Depending upon the risks identified and their scales, the Global Fund implements appropriate risk mitigation strategies including different ranges of fiduciary services from limited assistance (procurement agent and payment agent) to comprehensive support (fiscal agent and fiduciary agent). Even within the fiscal agent category, there are three levels of escalating services level – standard, enhanced and premium. Although the Global Fund operates in more than 140 countries, third party independent fiscal or fiduciary agents are engaged in about 15 countries only. Depending upon the identified risks, World Bank, United Nation agencies, and Gavi engages external agent to provide procurement and/or financial oversight or management services.

Hiring of external procurement or/and fiscal agents by the MCC and the Global Fund have significantly minimized fiduciary risks and increased efficiency, transparency and accountability of the use of funds. This is evident from increased bidder’s participation in procurement opportunities of these programs due to open, fair and transparent procurement process; value for money through effective procurement implementation strategy; and timely completion of procurement process and disbursement of funds. Programs also benefited from compliance with all regulations, better financial management practices, accurate and complete financial reporting, proper recordkeeping, audit reports with less findings, and reduced instances of fraud, corruption, abuse, questionable costs and unallowable costs. All these benefits provide significant value as against minimal cost incurred for performing fiduciary tasks. On an average, such cost varies between 1.5% and 3% of total grant amount in case of MCC grants, whereas it is between 3% and 5% for Global Fund grants.

There are instances where governments do not use their own PFM systems, particularly in case of pooled funds or co-funding by two or more development agencies or countries, in order to maintain independence, trust and transparency. Certain governments acknowledged a need for external agents either due to weaknesses in the current systems or lack of capacity in specialized procurement, contract and financial management tasks.

In line with most donors’ commitment to strengthen PFM capacity of partner countries, training is one of the key tasks of the fiduciary agent and with measurable performance indicators. In addition, there is requirement to provide a transition plan whereby external agents enhance the institutional and operational capacity of their stakeholders over the period and then change their roles from extensive management support to limited oversight assistance. Continuous collaboration and co-location at premises of counterpart goes a long way in building their practical skills and confidence in performing fiduciary processes themselves. Even in case of parallel or donor-specific arrangements, it requires participation from different levels of government and its entities as it cannot be implemented in isolation without country ownership.

In the case of an accountable entity, Millennium Challenge Account (MCA), established under the MCC-funded compacts, procurement agent engages with number of stakeholders including with MCA management and project teams as well as with government entities while assisting with preparation of the terms of reference, bidding documents and evaluation reports, and with contract negotiations, finalization and administration. Co-location also offers the advantages of establishing trust and confidence as these arrangements when imposed upon by donors are perceived hostile at the beginning due to overlapping and competing roles and responsibilities.

There are instances where counterparts are glad to have someone perform such fiduciary responsibilities and build PFM capacity so that they can focus on technical implementation and achieving the objectives of a program. Although disjointed, knowledge, skills and capacity developed through program-specific implementation units are absorbed either on other ongoing projects in an economy, by the government itself or government entities, or by a successor entity. In Lesotho, MCA-Lesotho continues as Lesotho Millennium Development Agency after the end of the Compact in 2014, with a mandate to maintain health facilities developed by the Compact and to develop the second Compact.  

To conclude, not necessarily parallel PFM systems adopted to manage fiduciary risk shall lead to duplication of efforts, inefficiency and undermine enhancement of current capacity. Benefits from fiduciary services will far outweigh the cost of such services as long as there is direct correlation between risks level and extent of services.

[1] PEFA provides a framework for assessing strengths and weaknesses of PFM systems of an economy using quantitative indicators.
[2] Procurement Agent manages the procurement process for acquisition of goods, works and services required by a program and provide related contract administration services
[3] Fiscal Agent provides broad range of financial management services from budgeting, commitment, financial management systems, cash management, disbursements, accounting, reconciliations, reporting and record keeping.