23/07/2013
FEATURE BY TONY PURNELL
Step Five: The feasibility and practicalities of a Budget Cap
One thing that surprised me when the idea of a budget cap was first mooted was the almost universal view that it could never be implemented nor enforced. Had the criticism been that it could never be agreed politically among the teams perhaps I would have wholeheartedly concurred, as this proved to be the case.
Let’s try and answer this here. Could financial rules be successfully implemented in Formula One even if the political issues could be placed aside or if the FIA was strong enough to implement such regulations simply because they concluded it was the right thing to do for Formula One?
I’m not sure when tax was first mooted, certainly the ancient Roman government taxed its citizens.
(According to HM Revenue & Customs own website: "Income Tax was announced in 1798, and introduced in 1799, as a means of paying for the war against the French forces under Napoleon". The Napoleonic Wars ended in 1815. - Editor).
Whenever a government tax began, the idea stuck. I doubt that it was considered popular nor 100% enforceable when first mooted, but it is an important idea in allowing the human race to advance. Human society without government is anarchy and government is pretty much impossible without tax. Successful taxation tends to need a complex set of rules. People accept tax, see the need for it, on the whole abide by the regulations, and look down on folks who cheat the system. People who do get caught cheating get punished and this punishment reflects the strength of the government in question. In China, chief executives and politicians alike get shot for corruption. In the UK, one can go to prison. In Italy, well it’s more grey, but even there fashion icons Dolce & Gabbana appear to be in some trouble over tax evasion.
Society is way, way more complex than sport. In Formula One each team does the same thing, making the application of financial rules hugely more simple than anything the government does. It’s important to keep this in mind as there is no thought of trying to do the impossible here. My point is that we are dealing with an idea much easier to implement than taxation, yet with marked similarities in the preparation of accounts.
First of all one has to understand that measuring spend is not as easy as measuring, say, the cubic capacity of an engine or indeed any technical rules. Actually some aspects are easy, but only with a view from the FIA that ‘these are the rules, either abide by them or don’t enter’.
For example, say that part of the budget cap rules were that one could only spend £10m on salaries and £15m on out-of-pocket expenses like travel, materials, and sub-contract services. Seems to me that it would do the job to insist on a single bank account that the FIA could inspect at any time, with the understanding that more than £25m must never come into it, nor more than £25m come out during a financial year. Pretty easy to understand that one. Then the regulations simply have to say that any payment made on behalf of the team in question, to anyone or any company must be from this account. Therefore any service towards the team that is not accounted for via this account is cheating. The cash spend could be regulated pretty well in this way, but there is a lot more to consider than just cash.
Here are some examples of problems. Suppose one team owns a factory and another leases theirs. It would be unfair for the latter to have that much less to spend because of the rent. Then what of team accountants who wish to run accounts in dollars and another in euros, perhaps offshore to lower their tax bill? Why should a team in Switzerland who pays most of its expenses in Euros and Swiss francs be subject to a constraint defined in British pounds? Suppose one team makes a big mistake one year and needs to spend an extra million to regain any kind of competitiveness? Surely one should be allowed to borrow against future years rather than just write off the season? What do we do with repairs and dilapidations? Buildings could look really shabby if spending on them hurt the car. Suppose a sponsor supplies their sponsorship in kind rather than cash, say free team clothing, or free machines for the factory as long as customers can have a tour three times a year? What about a team which doesn’t have a great wind tunnel? All the cash will disappear in a moment if they want one, and yet without one they are at a disadvantage. I’m sure you are getting the picture. There are all kinds of problems.
Thing is, all the problems are essentially solvable. Consider that every significant company in the western world has to undergo an audit by an independent firm of accountants to prepare annual accounts. They face much the same problem, although driven by a different issue (firms want to avoid paying tax on the whole). Over the years, sets of internationally recognized procedures have guided accountants to a system that works across the board, for all types of different companies working in all types of differing businesses. Again don’t forget all Formula One teams do the same thing. It’s a much simpler task for which to devise accounting regulations.
In 2008 I chaired a group of team financial directors to try to work up a set of budget cap regulations. Here it was clear that these international standards provided solutions to many issues. This Financial Working Group was a good constructive affair and for the most part there were ready solutions to most of the issues brought up. However there were also some really difficult issues. Valuing wind tunnels was one. The teams had vastly different resources here: some had two of the best tunnels humanity could offer while some didn’t have a tunnel of their own at all. Salaries were also a difficult area, especially for drivers and top engineers. The overwhelming showstopper, however, was none of these things. It was discussion of any form of policing that sent folks into either emotional arguments with little rationale or simply a ‘no way’ without any explanation.
It was here that the FIA initiative stumbled (although really it stumbled because Max Mosley had lost his power base due to the News of the World scandal). It just was unacceptable for one or two of the usual suspects to allow an FIA official to have free access to the teams’ financial accounts. Some teams clearly could not countenance the idea of someone snooping around their accounts. I naively couldn’t get my head around this, as one team is very likely to operate much the same as another. Additionally all the teams had to have auditors from outside the company prepare the annual accounts and the law tends to allow auditors completely free access to all systems. I began to think that perhaps it was the source of the money coming in, rather than the spending of the money that was the sensitive point. However, many of the manufacturer teams voiced as much of an opposition as the independent teams and the source of their funding was without question. (The manufacturer teams didn’t like the idea of the FIA having access to their financial systems because they were integrated into the larger accounting system of the parent. Hardly an insurmountable problem to separate them I always thought.)
Unfortunately policing remains a big issue. I can’t really see how financial rules can be implemented without the ability to police them rigorously. This means free access to team accounts. Given this the whole idea is clearly possible. Indeed the Resource Restriction Agreement by all accounts was a workable and sensible arrangement. It has many fudges on difficult issues, but this was outweighed by other sensible and pragmatic rules. Some, on the one hand, curtail spending through restrictions on cash spend in a straightforward manner. Some, on the other hand, ran into trouble. The best example of this is in side-stepping all the issues with respect to financially accounting for very different wind tunnel arrangements. Instead rules were adopted to simply restrict the size of the model, wind speed, and number of hours per year allowed. Similar (in terms of pragmatism) regulations were developed for value-in-kind sponsorship, land and building costs, testing costs, etc. The Resource Restriction Agreement is a good framework and although it is policed by a sort of self-assessment ‘honesty’ arrangement, it was at least a first step. The jungle drums tell me that there has been a great deal of mistrust in regard to folks adhering to this gentlemen’s arrangement and a common belief that one or two of the teams flouted the rule set. Evolution into something really good takes time however, so let’s not be too critical.
Unfortunately the RRA is way, way off being something that comes close to the original aims of the FIA’s financial restrictions. This is because it has fallen to the traditional failing among Formula One teams in that the top teams are masters of getting their own way. This has meant that the level of spending is still much higher than the vast majority of teams, perhaps 70% of them, can afford. Indeed it is pushed high enough so that the big teams (Ferrari and Red Bull) can maintain an advantage over the lesser teams (Lotus, Force India, Sauber, etc). That advantage is of course the ability to spend more. The original (FIA) idea was to set the level at something at least 70% of the teams could afford, and to make sure it was very well policed.
There are those who view the RRA as a successful initiative. This goes some way to answering the question as to whether financial regulations are possible in Formula One. The RRA was agreed, and did work for quite a while. The majority of the teams probably abided by the rules. There were difficulties, but nothing really insurmountable. However there are people in Formula One who believe that Red Bull, in particular, flouted the agreement, but of course Red Bull thought that they followed the rules and that was that. The real question therefore that should be asked is ‘are policed financial regulations possible?’ The answer is of course yes, but it will need a great deal of diplomacy and skillful politics to bring this about as it is pretty much inconceivable that everyone would agree to them being brought in.
The answer is for the FIA to take control and grab the opportunity, especially when contractually there are opportunities to push things through, notably when Concorde is being renegotiated. This is an unlikely event (unlikely because it is in the hands of President Todt who seems to have no stomach for any kind of a fight on this).
There are a number of things that make it possible to police any kind of budget cap. In policing financial rules one needs to bear in mind that if the five to one spending ratio was reduced to, say, 1.15 to 1 it would be a brilliant success in terms of allowing the benefits of a cap to work. Yes, one team spending 15% more than another because of regulation and policing failure isn’t ideal yet it is likely that loopholes and irregularities would become ironed out over the years to either reduce this, or more likely change which team found such an advantage.
The other thing to bear in mind is that Formula One would remain a big money sport. If the total spend was €60m, then a 15% advantage due to poor regulations would give a team €9m more than the others to spend, a huge amount. Hiding the spend of such a large sum is not easy. It is particularly not easy in the modern age where every email, every text can be traced (I saw this first hand when at the FIA during the McLaren-Ferrari spygate scandal and can say that IT forensics are truly amazing). Moreover disgruntled employees do tip off the authorities and these tip offs would certainly not be discouraged. Make no mistake, investigations could be successfully carried out, although it would need complete access to each team’s financial IT system and the ability to spot check on any item from time to time. Indeed it would in some aspects resemble the dope testing of athletes by WADA, the World Anti-Doping Authority, who can test pretty much at any time, any place. It’s certainly taken some while for cycling to accept that self-regulation by the teams will never work, and that the governing agency needs real policing power to make the sport clean. Let’s hope that in Formula One the RRA evolves to something as powerful and as effective.
To learn more about Tony and check out his previous features, click here