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Royal Mail — Strictly Confidential
ROYAL MAIL HOLDINGS plc
(Company no. 4074919)
AUDIT AND RISK COMMITTEE
Minutes of the meeting held at 100 Victoria Embankment London on
17’ November 2011
Members of the Committee Present:
Paul Murray
Donald Brydon
Nick Horler
Cath Keers
Apologies:
David Currie
Orna Ni Chionna
Les Owen
In attendance:
Derek Foster
Moya Greene
Matthew Lester
Jon Millidge
Mike Prince
Andrew Poole
Alex Smith
Richard Wilson
Kath Barrow
Ben Marle
ARC11/44
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Non Executive Director, Chair of the Committee
Chairman
Non Executive Director
Non Executive Director — by Telephone
Non Executive Director
Non Executive Director
Non Executive Director
Internal Audit & Risk Management Director
Group CEO for ARC(11) 44-48
Chief Finance Officer for ARC(11)44-48
Company Secretary
Financial Management & Control Director
Deputy Company Secretary
Director, Business Development and Technology for ARC(11)/44
Ernst &Young
Ernst &Young
Ernst &Young
The Chairman welcomed everyone to the meeting
MINUTES
The minutes of the meeting of the 7" July 2011 were
considered and approved as an accurate record of the
meetings;
the Committee noted the minutes of the Risk Management
Committee held on 30" September 2011 and the minutes of
the GLS Group Audit & Risk Committee held on the 3°
October 2011. Paul Murray commented on the excellent
report from the Risk Management Committee which he had
found particularly helpful especially in describing how the risk
issues were being thought about by management.
Derek Foster explained how the risk workshops operated in
facilitating discussion on risk and the areas of the business
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that had been covered to date;
Matthew Lester noted that the GLS Audit & Risk Committee
would modify its approach to follow the Group and would
consequently focus less on operational matters. He felt that
the audit approach in GLS was effective and noted that
management was given an opportunity to interview the
auditor and raise any concerns.
STATUS REPORT ARC(11)44
The Committee noted the status of actions from the previous
meetings, in particular:-
AC11/31(f) Group Risk Profile: It was noted that this would be
considered as an agenda item at the July ARC.
Paul Murray noted that the recent Modernisation day had
proved useful and asked management to consider ways in
which the board could be introduced to risk in a more
dynamic way. Matthew Lester agreed to consider the
request.
iRED UPDATE ARC(11)45
Alex Smith was welcomed to the meeting. Moya Greene
introduced a paper outlining issues arising from the
investigation into iRed activities. It provided some
background to the investigation, the main conclusions of the
investigations and the closure plan arising from those
conclusions;
iRed had been established as a separate business unit in
2007 (initially called Royal Mail Document Services),
reporting to the Strategy Director (Alex Smith) and with its
own Board. From its inception, the business was managed by
Ray Huntzinger and was created to provide new innovative
products that looked at the interface of digital and physical
communications. It had been explicitly agreed that iRed
would operate outside of the normal policies /procedures of
the Royal Mail - the belief was that these would stifle the
entrepreneurial culture that iRed would need to grow its
business;
iRed had not made a profit since it was created (total losses
£32m). For a number of years it had managed only one
external contract, with Nationwide, but it had also managed
the print function for Royal Mail Group over recent years. In
March 2011 Ray Huntzinger claimed major contract wins with
Sainsbury and Weight Watchers, and confirmed its budget
for 2011-12 was to grow top line revenue by over £30m. The
iRed management team were aware that if this could not be
achieved then the business model would be re-appraised:
In September 2011, the Company Secretary had had a
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Royal Mail — Strictly Confidential
discussion with a supplier of iRed that triggered some
concerns regarding the controls within the organisation and
that precipitated an enquiry by Royal Mail Internal Audit
which was followed by investigations by Royal Mail Security
As a result of those investigations, Ray Huntzinger was
suspended on 29" September 201 1and Declan Salter, a
turnaround specialist, was appointed to manage the company
in the interim;
The initial recommendations from Declan Salter were as
follows:-
i. close iRed and transfer existing work into the Royal Mail;
ii. investigations into the conduct with iRed suppliers would
continue;
iii. ensure that similar errors are not occurring elsewhere
(and similar reviews would include Specialist Services,
Parcelforce, Stamps & Collectables and China office
initially);
iv. consider a programme for external review of
divisions/companies, perhaps one organisation per
quarter;
v. review the senior management structures in all
divisions/subsidiaries such that there are appropriate
internal management structures that are not controlled
by one individual and where the majority of members
must be full-time employees (not contractors);
vi. review the Corporate Governance for all
divisions/subsidiaries; and
vil. review the processes for allowing concerns to be raised
(and perhaps its ‘whistle-blowing’ policies).
The Committee noted the main learning points, in particular
the lack of formal business reviews by the iRed Board. Paul
Murray asked Derek Foster to include details of any business
areas not covered by the annual audit plan to help the Audit
& Risk Committee understand any residual risk.
INTERIM REPORT & ACCOUNTS = ARC(11) 46- 48
Sign Off Process ARC (11)46b: The Committee noted a
paper setting out the formal sign off procedure that
management had followed for the interim financial
statements 2011-12. For the half year a formal compliance
statement was not required. However the paper outlined a
number of actions that had been undertaken to assure the
Audit & Risk Committee that the financial position at 25
September 2011 and the financial performance in the first
half of 2011-12 were fairly presented in the Interim Financial
Statements;
The Committee noted the balance sheet review performed as
at September 2011;
Matthew Lester asked the Committee to note that
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management had selected a set of long term pension
assumptions which were not ‘middle of the pack’ but
remained within the normal distribution used by other
corporates. This resulted in a pension deficit of £4.6bn
compared to £3.7bn had the mid-range assumption been
selected. These assumptions had been approved at the
Pension Committee and given these were interim results and
the long-term trend assumption for cpi still had to settle
down, proposed that a more conservative position, consistent
with the year end, be adopted.
The Committee agreed these assumptions. The Committee
noted that the actuarial deficit was some £11bn and
recognised that it was almost impossible to explain why
accounting deficits and actuarial deficits moved in different
ways to stakeholders. Donald Brydon asked the external
auditors to work with the actuaries to produce a presentation
which explained this in simple terms:
Matthew Lester introduced the Half -Year results
presentation, a pro-forma results presentation pack which
provided a summary of the interim results versus last year.
He highlighted the key messages around revenue growth,
cost control and cash generation.
The Committee noted the full draft interim report for the half
year ended 25” September 2011:
Summary Briefing Book: The Committee noted the summary
briefing book for the half year ended 25" September 2011.
Fines Compensation & Material Litigation: The Committee
noted a paper providing an update on accruals and
provisions covering potential fines, quality of service
compensation and current material litigation and
environmental issues and agreed they were reasonable in
light of the risks and factors that had emerged since March
2011; and
agreed that the Horizon claims were a contingent liability
which was considered remote at this stage which meant no
accrual would be booked and no disclosure made.
Cash & Going Concern: The Committee noted the update on
cash headroom management in RMG ex POL and its status
as a going concern based on October 2011 actuals, together
with an indicative forecast for 2011-12 and 2012-13 obtained
via the Quarterly Business Review process. The range of
forecasts included a “realistic but pessimistic downside case”
which assumed no pension deficit relief and a recession in
2012 similar to that of 2008. In this downside case headroom
ran out in August 2012;
at period 7, the actual headroom was £516m higher than
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Royal Mail — Strictly Confidential
budget. This was better than expected:
the Audit and Risk Committee noted the year to date actual
position and the forecast cash ranges for 2011-12 and 2012-
13;
and agreed that RMG ex POL remained a going concern at
September 2011 and that the two material uncertainties with
respect to this position that existed at the year end still
remained (as disclosed in the interim accounts).
E&Y REPORT ON INTERIM REPORT & ACCOUNTS
ARC(11)49
The Committee noted a report from E&Y setting out their
summary of the review findings and conclusion in relation to
the Royal Mail's financial position and results for the 6
months ended 25 September 2011:
E&Y concurred with the Going Concern basis of preparation
for the Group accounts and had reviewed the draft basis of
the preparation note. The report would include an emphasis
of matter paragraph which would draw attention to
fundamental uncertainties and key assumptions highlighted
by management in the basis of preparation paragraph in the
notes to the accounts;
Subject to receiving outstanding documentation and
completing the audit review E&Y anticipated issuing an
unqualified review conclusion for the six months ended 25"
September 2011;
Letter of Representation: The Committee noted the proposed
letter of representation.
AUDIT APPROACH 2011-12 AND PROPOSED FEES
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Kath Burrows introduced the 2011-2012 Audit planning
report. The purpose of the report was to provide the
committee with a basis to review and validate the proposed
approach and scope for the 2011-12 audit, but also to align
the audit with the Committee's service expectations:
Paul Murray said that E&Y should be able to demonstrate
that the audit approach was robust, effective and sceptical,
as E&Y were by now very familiar with the business and its
processes. The Committee noted that E&Y were seen to be
playing a critical role in helping non-executives understand
how the business was performing during a significant
transformation and regulatory change. Donald Brydon
confirmed that he believed there was an emerging risk
around the setting of prices in a de-regulated mail market:
Donald Brydon also enquired as to the audit activity
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undertaken in relation to Procurement. E&Y confirmed that
they took a ‘controls & process’ view of the activity, by
undertaking a walk through test. E&Y would consider this
area further and revert back to the Committee but felt that the
Process was fit for purpose in terms of the accuracy of the
numbers;
Jon Millidge was asked to review the Separation Agreement
with POL to see if the requirements around a SAS 70 report
with respect to the POL Horizon system were adequate;
The Committee discussed the level of audit materiality, noting
that for the purpose of determining whether the accounts
were free from material error, E&Y defined materiality as the
magnitude of an omission or misstatement that, individually
or in the aggregate, in light of the surrounding circumstances,
could reasonably be expected to influence the economic
decisions of the users of the financial statements.
E&Y reported that the raising of their materiality limit back to
normal practice would still provide assurance on key routine
controls but would allow them to re-invest time saved into
higher risk areas;
The Committee were interested to understand which risks
were reviewed by Ernst & Young. Mike Prince provided one
example of a risk that not covered by the audit: revenue
protection. It was Managements responsibility to prepare the
accounts and E&Y audit the revenues that are shown in the
books: the revenue protection risk was that Royal Mail should
be paid more than it records. The Committee asked E&Y to
Prepare a summary of the areas that are and are not covered
as part of the year end audit:
Fees: The Committee noted the audit fee for the UK statutory
and regulatory audit had been agreed at £1,395,000
consistent with the fee for the last two years. A further fee of
£303,000 had been agreed to perform a one-off procedure to
mitigate the risks from the PSP system migration and to gain
comfort that adequate controls were in place in the new
system.
The Committee noted the summary of the non-audit services
provided and billed by E&Y for the period 28" March 2011
through to 25” September 2011:
The Committee noted the report
DATE OF NEXT MEETING
8" December 2011
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