Labour received £14m in secret loans

Downing Street today announced that a former Whitehall mandarin has been appointed to look into the future of party funding as Labour confirmed it had received almost £14m in secret loans before last year's election.

Sir Hayden Phillips, a former permanent secretary at the Department for Constitutional Affairs, will look into the future of party funding in liaison with the political parties, following Mr Blair's promise to review existing arrangements.

The prime minister's official spokesman said his terms of reference would be announced next week and he was expected to bring forward proposals in a "reasonably short period of time".

"The prime minister has always said that it is better and more likely to be acceptable to the public if we progress this matter on the basis of consensus," the spokesman said.

The appointment comes after Labour officials confirmed that the party had received £13,950,000 in commercial loans.

"These loans were taken out in full compliance with the rules of the Political Parties, Elections and Referendums Act," a Labour spokesman said.

"As set out in our statement yesterday, the national executive committee officers will next week propose that all future commercial loans agreed by the party be declared publicly, including their sources. The loans will be recorded in our annual accounts 2006 [covering January to December 2005] in the usual way. These accounts will be published in June."

The prime minister, Tony Blair, confirmed yesterday that he was aware of the secret loans, which circumvented the need to name the lenders on the political donations list, as he vowed to tighten up the rules for on party funding, including a possible cap on the level of party donations.

The controversy over secret loans first emerged after three millionaire donors were nominated by the prime minister for political seats in the House of Lords

Their appointment has so far been stalled by the independent appointments commission that vets applications. Two have since asked for their names to be withdrawn from consideration.

As well as an overhaul of party funding, Mr Blair also signalled a string of changes ministers' private interests and the honours system. The Conservatives came on board last night by promising to declare all loans in the future.

The health secretary, Patricia Hewitt, joined the fray over "cash for peerages" earlier today as she dismissed the suggestion that financial party backers should not receive political seats in the House of Lords.

Those people who fund political parties should be seen as "doing a public service for our democracy", not treated with suspicion and disdain, said the health secretary.

"There is no evidence at all for this outrageous suggestion that people have been buying peerages or have been offered peerages for sale."

Labour's reforms have made Britain's political culture "one of the most transparent and honest systems of political party finance in the developed world," Ms Hewitt insisted.

"There is now more for us to do, not only in the Labour party ... but right across the political system, so that everybody agrees on the best way forward, which I believe has to do with electing the House of Lords on the one hand and having the combination of state funding and stricter controls on individual donations and on party campaign spending," she said.

The affair has raised the hackles of many within the party. Labour's former deputy leader Lord Hattersley last night said he was "horrified" by the sums taken by the party in loans without the knowledge of its treasurer, Jack Dromey.

"It all demonstrates that the Labour party leadership is too obsessed with the world of money. The Labour party should not behave in this way," he told BBC2's Newsnight.

"Labour party supporters will be horrified, and quite rightly so."

Under Electoral Commission rules, loans at commercial rates of interest do not have to be declared by political parties, while straightforward donations do.

The commission yesterday issued a statement urging all parties to declare loans, which prompted promises from both Labour and the Tories that they would.

An internal investigation into the "cash for peerages' affair was launched on Wednesday by Mr Dromey, who revealed he had been "kept in the dark" about the secret loans.