76210 Accountability in State Noncommercial Organizations in Armenia: an Approach Arman Vatyan figure 1), these SNCOs include primary and secondary Key Messages schools, colleges and universities, museums, libraries,  A World Bank-supported project in Armenia research institutes, and laboratories. The law defined the was successful in developing a control framework status and characteristics of SNCO activities, providing that balances the need to increase the transparency them with considerable managerial and financial autonomy and accountability of the country’s state compared to former budgetary institutions. As separate legal noncommercial organizations (SNCOs), while also entities, they exercise significant decision-making recognizing their financial, administrative, and autonomy from their authorized public bodies (ABs)1 in managerial independence. operational, managerial, and financial matters, including the right to conduct income-generating activities.  An innovative approach involving the use of earlier results to guide later ones was used to address Since 2001, SNCOs have been able to assume financial the dire need for SNCOs, which account for 70 commitments and place their funds, previously held in the percent of the total number of state organizations, to treasury, in commercial banks. This poses a potential but make greater efforts to responsibly administer and unquantifiable fiscal risk to the government, since liabilities safeguard the government’s assets. incurred and unpaid could become the government’s.2 In  The existing legal structure governing the Figure 1. Distribution of SNCOs by Economic Sectors establishment of SNCOs was improved, and the weak control and performance management systems were strengthened in order to address the ineffective monitoring of SNCOs’ activities.  The aim was to reduce the market distortions caused by SNCOs that are engaged in significant commercial activities by addressing SNCOs’ heterogeneity and the need for specific fiduciary control requirements for distinct groups. Background As a result of the privatization and decentralization process launched in Armenia in the 1990s, most budgetary institutions directly involved in the delivery of social Source: Republic of Armenia, Ministry of Finance services to the population were reorganized into state noncommercial organizations (SNCOs) under a 2001 law. 1 Authorized public bodies are the formal institutions that own each This law led to the creation of over 1,800 SNCOs currently SNCO on behalf of the state and are formally responsible for the SNCOs’ operating in Armenia, which account for a significant general management. 2 proportion of public sector spending. Most SNCOs provide public services that should be continuously rendered. Liquidation of SNCOs with unpaid liabilities is politically Operating mainly in the education sector and, to a lesser sensitive, as the SNCOs often provide services that are costly to replace (e.g., theaters, museums, schools, etc.). Recent evidence has confirmed extent, in the culture, healthcare, and social sectors (see this point. ECA Knowledge Brief general, SNCOs circulate considerable financial resources, experience from a number of countries of the Organisation and in 2008,3 their total revenues amounted to dram 129 for Economic Co-operation and Development (OECD). The billion, of which dram 89 billion (69 percent of the total) government was then provided with a theoretical model, was received from budgetary sources, and the remaining along with a package of required legislative amendments dram 40 billion (about 31 percent of the total) from and a draft strategy for their introduction. In the final stage, nonbudgetary sources. In comparison, the total annual state the World Bank supported the government in applying this budget expenditure was roughly dram 810 billion in 2008. framework in 20 pilot entities (12 SNCOs, 7 ABs, and the Ministry of Finance (MoF)), with the goal of improving the Challenges model and its practical application. Piloting included the introduction of key elements, including reporting and An initial gap analysis of SNCO operations highlighted key monitoring mechanisms, in selected SNCOs and ABs. challenges inherent in their operation and oversight, including: Clarification of the Legal Basis  A lack of clarity as to the legal basis for granting SNCO status to an entity, with ramifications for the expediency The project indentified a number of criteria to clearly of establishing and reorganizing SNCOs and the related distinguish SNCOs from other public sector bodies: decision-making process.  SNCOs were restricted from offering commercial  The risks to government caused by the lack of services unless they were related to their main activities, comprehensive fiduciary controls, transparency, and with no adverse impact on the outputs from primary accountability, all of which are specifically linked to the services. management and effectiveness of financial activities.  SNCOs should render their services where there is no Contrary to the intent of the SNCO reforms, many developed competitive market, and the revenue from SNCOs conduct a substantial number of commercial their commercial activities should not exceed 40 activities, leading to government concern that SNCO percent4 of total revenue. managers may as a result overlook their official role of  To ensure medium-term viability, (i) the SNCO’s main noncommercial public service provider in the public services should be sustainable for the foreseeable sector. In addition, the significant commercial projects future, (ii) the organization must be financially viable, undertaken by larger SNCOs (for example, projects to (iii) a reliable results system should be established, and construct new building facilities from (iv) SNCO activities should not result in high political own/nonbudgetary sources) could expose the state to and fiscal risks.5 significant and unknown financial liabilities. Moreover, SNCOs have free access to government assets and Further, to differentiate SNCOs from other public receive grants/transfers directly from the government, administrative bodies (PABs), establishing an SNCO must thereby avoiding the public procurement process and be justified by one of the following criteria: distorting competitive markets.  Beneficiaries of SNCO services should have a wide geographical distribution that makes it essential to have Overall, weak financial accountability and the lack of the service provision as close to the end user as possible control and performance management systems within (for instance, provision of general education services in SNCOs have led, inter alia, to unreliable information, fiscal schools). risk from poor commitment controls, and an absence of  Units should be autonomous, with management at arm’s clarity over these organizations’ effective and efficient length and accountability for the delivery of public delivery of public services. services outlined according to clear, transparent specifications, so as to avoid the direct involvement of Developing an SNCO Fiduciary Control Framework political appointees (e.g., ministers) in the operational To address these key challenges, from 2006 to 2012 the 4 Armenian government, supported by the World Bank, The significant increase in commercial activities on the part of SNCOs may negatively affect the achievement of their objectives and dilute the developed a comprehensive fiduciary control framework for attention of their management. Studies show that beyond the level of SNCOs. First, a typology identifying the different types and approximately 40 percent commercial services, those management activities of SNCOs was prepared, providing the behavior risks may increase significantly. 5 government with a clearer understanding of the risk these Usually, fiscal risks are higher when the service provided is linked to the turnover of large funds and management of large assets. Political entities posed to the overarching goal of improving public risks are greater when there is a high probability that decisions made service delivery. Second, the project drew on international about particular services could lead to a reshuffling of political forces, or could jeopardize the implementation of the main provisions of the given government program. According to international practice, such services 3 This is the latest official information available, and there has been no are rendered by PABs, rather than other bodies with arm’s -length major change since then. management. ECA Knowledge Brief decision-making process, in line with international best SNCOs with participatory management, that is, they practice. have large social groups as their beneficiaries, and  A narrowly specialized service should be provided that society is interested in participating in their could not be practically or efficiently supplied through management and the evaluation of their results the civil service (for example, where salaries are not (secondary schools, other educational institutions, etc.), attractive or civil service eligibility criteria and and (iii) autonomous SNCOs not included in the above procedures are not applicable). groups (theaters, libraries, etc.). 2) By level of fiscal risks, based on the amount of an Overcoming Peculiarities of Fiduciary Control for SNCO’s financial flows relative to its assets and the Specific SNCO Groups size of the state budget: (i) large SNCOs that have significant fixed assets and resources, (ii) medium-size Because SNCOs are not homogenous units, the government SNCOs that have fewer resources but with funding that recognized that they would require a differentiated approach exceeds the predetermined level of state budget with regard to fiduciary controls. In order to establish the spending, and (iii) small SNCOs that have a modest framework, three dimensions or groupings of SNCOs were turnover of funds not exceeding predetermined levels of proposed (table 1): state budget spending. 1) By the corporate governance arrangements (degree of 3) By depth of commercial activities: SNCOs with a share management flexibility): (i) independent SNCOs, where of commercial activities that exceeds 40 percent of the independent decision making is vital for service SNCO’s total income. delivery (forensic, environmental expertise, etc.), (ii) Table 1. Distribution of SNCOs by Types By level of fiscal risks Medium SNCO Large SNCO TOTAL Small SNCO By level of Independent SNCOs 0 9 10 19 fiduciary Publically control 7 32 1502 1541 administered SNCOs flexibility Autonomous SNCOs 4 34 242 280 TOTAL, 11 75 1754 1840 out of which By depth of SNCOs with commercial significant share of 8 17 72 97 activity commercial activities Specific fiduciary control mechanisms were established for  Level of SNCO’s financial turnover: This involves the each group, along with general requirements for planning, establishment of an ex-ante control regime by ABs reporting, and monitoring, based on the following criteria: over the significant transactions of SNCOs, including  The existence of output indicators: Where output authorization of transactions exceeding predetermined indicators are missing or appropriate performance thresholds. For large SNCOs, centralized ex-ante reporting and monitoring systems are not present, control arrangements are foreseen, suggesting that bank restrictions and ex-ante controls over the SNCO’s accounts of large SNCOs should be transferred to the expenditures on inputs should be included in the treasury system, which will implement this ex-ante relevant purchase agreements. control. A key challenge will be balancing the development of a robust fiduciary control framework ECA Knowledge Brief while retaining the level of flexibility envisaged when In summary, the aim of the project was to focus on the the SNCO law was passed in 2001. nonfinancial performance indicators of SNCOs while  Level of SNCO revenues received from nonbudgetary concurrently improving the quality of financial reporting. sources: This means awarding government contracts to In addition, as the level of new SNCO reporting and SNCOs with a large share of commercial activities only monitoring requirements was linked to the relative risks on the basis of open competition so as to promote associated with the organization’s activities, more detailed competition in the market. To ensure equal conditions disclosure requirements were envisaged for SNCOs for competition and increase efficiency in public asset engaged in higher risk activities. management, rental fees should be levied on the use of government-owned assets, including buildings, This project has provided the government with an facilities, and equipment, where currently they are innovative SNCO fiduciary control framework that targets assigned free of charge to such SNCOs. Fees levied are accountability and transparency concerns as well as fiscal to be based on the value of the fixed assets provided or risk management. The government has generally assigned to SNCOs, and transferred to the state budget. demonstrated extensive reform ownership and approved the proposals and concepts. After project completion, the A New Reporting and M&E Framework for SNCOs government circulated a draft strategy to introduce the model in all 1,800 SCNOs over the next three years, with Overall, this World Bank-supported project established a the objective of a launch after some fine-tuning in response modern planning and monitoring and evaluation (M&E) to testing. system that addressed the accountability, fiscal discipline, and transparency of SNCO activities. Throughout, the main Conclusion underlying principle was to differentiate between the functions of the government as “client� (user of services) Lessons learned from the experience of SNCO reforms in and “owner� (of public assets). As “client,� the government Armenia demonstrated that such complex reforms should allocates funds for the procurement of specific services; as be well planned and based on a study early in the process “owner,� the government manages the entity, making of existing challenges, international practice, and local capital investments to improve the quality of services specificities and peculiarities (such as the diversity of rendered. This distinction in the budgetary system is crucial SNCOs and the need for specific fiduciary control because managerial behaviors and M&E systems are mechanisms in order to reduce market distortions caused different. To account for this, the evolving framework has by some categories of SNCOs). Another lesson was the the following features: importance of implementing extensive change in a  Each SNCO must develop a three-year Action Plan (AP) systematic and phased manner, using the results of earlier outlining medium-term and annual objectives, priorities, stages to guide later ones. For example, addressing gaps in and performance indicators for measuring its activities. the legal system was pivotal in tackling other key areas, The AP is the main instrument for the planning and including clarification of the legal basis of SNCOs. management of the organization’s activities, regulation of Key results of the project include: a new framework for relations with the owner, and M&E of organizational enhanced monitoring and control of SNCOs to provide performance. better transparency and accountability of their activities;  A process is foreseen whereby SNCOs develop APs, improvement of the existing legal system; and a means of have them approved by their ABs (owners), and submit reducing overall fiscal risks without significantly impacting regular reports based on which ABs will conduct the current level of SNCOs’ financial, administrative, and performance monitoring. operational independence. The framework and  The MoF, in its role as custodian of good governance and methodology are applicable to other countries with similar financial accountability within government, has an conditions like Armenia’s. important oversight role in ensuring that ABs effectively monitor SNCOs, beginning with addressing weaknesses About the Author in SNCO management, fiduciary control, and M&E Arman Vatyan, is a Senior Financial Management systems. Under the new model, the MoF will monitor Specialist in the Financial Management Sector Unit of the ABs’ performance as well as submit consolidated reports Europe and Central Asia Region of the World Bank. on the performance of SNCOs to the government. “ECA Knowledge Brief� is a regular series of notes highlighting recent analyses, good practices , and lessons learned from the development work program of the World Bank’s Euro pe and Central Asia Region http://www.worldbank.org/eca .