Europe: Can Defense Industries Still Go On without G2G Agreements?
(Source: Special to Defense-Aerospace.com; posted Feb. 09, 2022)
By Comité Rochefort
As a result of the increasing competition in defense markets, some countries are looking for new ways to foster their industries’ export, which is vital for their survival and thus their strategic autonomy. In that process, the US Foreign Military Sales (FMS) model seems to inspire a new breed of contracts in Europe in which Governments are parties to provide customers countries with rock solid financial guarantee and equipment quality insurance.
Indeed, the corona virus crisis, coupled with the increasing difficulty to get funding from private operators for defense contracts, could be a prop for this export strategy.
If industry players used to rely on themselves or, for some, on domestic public tenders, they should benefit from this new enlarged support, as it could allow them to access and win new markets that require such procedures. Those State-to-State contracts can also be an opportunity to reduce offsets or industrial compensation demands. Due to the sanitary crisis, those demands are expected to increase in the short and medium terms. Therefore, considering the burden offsets imply for defense industries, such G2G contracts could prove much more popular in the coming years.
Foreign Military Sales: the golden standard
FMS are a type of contract signed by the US government with a foreign country that implies the purchase of equipment already in US stocks, or that will be purchased on the behalf of the client, to a US provider by the US government. As FMS unambiguously support and promote US defense industries, they are a unique tool for US foreign policy as it allows the country to serve its interests by reinforcing interoperability and military-to-military relations with partner-countries.
Although FMS are the best example of successful Government to Government contracts (even a model on its own), few countries – except may be China or Russia –can replicate this model as is. This is mainly due to the gigantic resources than the US have in terms of influence, industrial capabilities and military stocks that are required for such contracts.
Furthermore, the FMS process is already well-proven and known by foreign countries, at every stage of the process. From the “Price and Availability” request (which is optional but widely used as, between 2014 and 2018, 3098 such requests have been issued by 93 countries), to the “Letter of Request” (LOR) that initiates the process, then the “Letter of Offer & Acceptance” (LOA) delivered by the US, the acceptance notification of the client that formalizes the contract, and finally the initial deposit that actually implements the contract.
The entire process is supervised by a dedicated DOD structure - the Defense and Security Cooperation Agency (DSCA) – in connection with Congress, the State Department as well as each armed service involved, among other stakeholders. In short, FMS are a well-known, strictly formalized, carefully managed, and increasingly popular sales process:
“The overall value of State Department-authorized government-to-government FMS (Foreign Military Sales) cases implemented by the Defense Security Cooperation Agency decreased 8.3 percent from $55.39 billion in Fiscal Year 2019 to $50.78 billion in Fiscal Year 2020. However, the three-year rolling average, which is the more accurate measure of trends in defense trade, rose to $54 billion. This is for a 5.8 percent increase in sales volume.”
DOS and DOD Officials Brief Reporters on Fiscal 2020 Arms Transfer Figures
In fiscal year 2020, the US State Department cleared for $83.5 billion spread over 68 FMS cases. And in FY 2021, which ended Sept. 30, potential sales announced by DSCA totaled $87 billion. (Although $4 billion higher than the previous fiscal year, the average FMS sales volume actually slightly decrease under the Biden administration, but this is mainly due to the unusually large Middle arms contracts announced by President Trump.)
In addition to FMS, another process known as Foreign Military Financing (FMF), is also widely used by the US Government to allow foreign countries to purchase their equipment through attractive, zero interest loans (as the US administration refuses to get benefits from those mechanisms). From 2010 to 2017, FMF represented around $41,7b, so approximatively $5,7b per year.
That said, FMS are not a miracle solution. FMS do offer greater security and proximity as well as a more consistent U.S. presence and easier program management (the DSCA manages the entire contract on behalf of the customer, and ensure timely delivery).
However, they are more rigid and place more responsibility on the customer for both the costs and risks associated with the program. Therefore, G2G agreements should be considered as complementary to traditional direct commercial sales (DCS) or an addition to the export strategy of defense manufacturers in order to address a need for such contract by some customers. In short, if a country asks for such program, it should be possible for industry players to offer it, with the agreement of its government.
If the FMS way out of reach for smaller exporting countries, it can still be an example to inspire another State-sponsored sale process more in line with local capabilities. In that regard, Israel proposes an interesting adaption of G2G agreements.
Israel: an alternative model for FMS-like agreements
What’s interesting with Israel is that, regardless to its influence and size in comparison with the US, the country managed to propose a G2G process that support its small and medium size industries exports effectively, but with less resources. Again, it comes from a political will, as the Israeli government needs a competitive defense industry to defend its interest in a very specific and demanding geopolitical context, whilst Jerusalem – in spite of US FMF support - cannot afford to support its defense industry through domestic orders only. As such, the G2G route appeared as an appropriate way support its defense industrial base, and preserving strategic autonomy and innovation potential.
In lieu of DSCA, they created the SIBAT, which not only promotes local industry products abroad, but also proposes, manages, and monitors G2G agreements. To that extent, SIBAT has elaborated a list of 41 countries that could be eligible to such contracts, most of them being in Europe.
As a result, an increasing part of arms exports comes from this tool. In 2017, the value of exports through this channel was around $276m (3% of total arms export of the country), in 2018 this amount increased to $421m (5,6%) and in 2019 to $635m (8,8%). According to Yair Kulas, Head of SIBAT, that figure was expected to grow even more in 2020, but that the pandemic of covid 19 had slowed down this effort considerably.
Another key aspect of their policy is the dedicated suppor towards its small and medium industries, which must grab 20% of the value of those contracts, once signed by the primes (usually IAI, Rafael, Elbit Systems…).
What does it show?
First, FMS, or G2G, tend to be more and more popular, as they address a need by foreign governments to strengthen military cooperation, and finance defense imports. Those contracts also supports export industry players as it gets more and more difficult for them to find ways to secure loans through banks to finance export. G2G agreements elude this problem as the signature of the State provides such guarantee. Among other advantages that can be underlined can be mentioned the ability, for the industry, to avoid offsets often required by foreign government.
As such, and officially, through FMS, no offsets are recognized, even if some can be finally made or demanded (but then, they are managed but the industry, not the US government).
The recent Defense Acquisition procedure of India (DAP 2020) illustrated this trend, as government to government agreements won’t trigger offsets any more (in theory). Also, it allows industries to propose another type of contract that can attract foreign governments and, thus, increase their chance to win a contract. They make useless the use of third-parties or entities, and reduce corruption risks. Ultimately, and as the Israeli example shows, those contracts can support in the meantime SMEs to exports.
However, it must be underlined that among the negative aspects, the industries are not able, most of the time, to negotiate their margin and other contractual aspects as they would do through DCSs. Finally, another FMS drawback is that you buy your equipment off-the-shelf, according to US specifications with no room for customization.
Anyway, the demand is here, and exporting countries needs to imagine and formalize appropriate mechanisms to address it. If well presented, such mechanisms may offer genuinely win-win agreements: for buyers, as well as selling industry and the State.
A new burden for the State, a reward for its industries
For political reasons, becoming an export contract broker is a commitment that some governments might try to avoid. For example, if Berlin provides some political support for export campaigns, and some Länders are active to favor local defenses industries, defense exports still have a bad reputation in Germany. And in general, such support is a burden for the State, and sometimes for the armed services.
But such involvement can also be seen as a reward, depending on the country. Indeed, some countries are, in a way, responsible for export challenges faced by their own defense industry, especially those that produce platforms. France, for example, demands equipment with a very high level of technology with the intent to deploy their military forces on the field, with a specific doctrine and particular requirements. Such platforms are often expensive, and sometimes appear as an overkill to some customers. In that regard, G2G contracts is a way to open “off the shelf” markets, where the State sells to a foreign country from its own stocks, and then places new order to its industry to fill the gap created. The main advantage here being to propose these platforms at more affordable price. That has been the case for Dassault with two recent contracts with Greece and Croatia for its Rafale fighter jet.
An alternative path towards “European Defense”
G2G contracts appears to have interesting political and industrial potential as well, especially in Europe. As the “European Defense” concept is often mentioned as a goal, it tends to be shaped around “iconic” common platforms such as the Future Combat Air System, the Eurodrone or the Main Ground Combat System, among others.
However, such programs seem to mix different operational requirements, different export second-thoughts, and different levels of technology capabilities (with associated intellectual propriety risk). Among them, the first point is the most problematic: without common operational requirements, those programs rely more on a political ambition than military sense. As a result, some might think that those common programs won’t shape a healthy basis for a “European Defense”
But, with a different logic, G2G agreements between member states could bring many related benefits. First, G2G agreements, if understood as the sale of an equipment with the same specs as the State of origin, allow the development of interoperability between countries. This can ease common deployments of forces on the field and common future system developments based on shared feed-backs. Among recent contracts, CaMo (Capacités Motorisée), a G2G between France and Belgium, could be one of those opportunities.
This could also call for future contracts that would deepen the ties between their respective industries, and armies. In that sense, G2G agreement can be seen as a way to support the industry through a first order that could generate others. Such bonds are interesting for the development of the “European Defense” idea that would rely on natural common interests (that is to say operational needs) shared within several circles of alliances.
Such circles would be built around common platforms and equipment, interoperability, military cooperation on several war theatre and bilateral / multilateral trainings. Form an industry point of view, those ties could ease the pooling of resources between stakeholders for R&D efforts and collaboration and integration of systems and sub systems according to the strengths of each industry player.
FMS “à la française”
After several years of internal debate and fine-tuning, France has been pretty active on this field lately, with Belgium (Nexter), as well as Croatia and Greece (Dassault Aviation). Again, those contracts are not FMS strictly speaking, but show what Paris can do and propose on this basis.
More recently, at the end of 2021, Italy launched its own G2G model (that was already discussed in 2019), after a Leonardo C-27J Spartan contract with Slovenia. Other similar sales should be signed in a near future.
In other words, two of the main European producer of military equipment have passed the G2G step, which could bring a bright future for cooperation on the military field on several levels, but maybe also the competition between defense “leaders” on the old continent…
In this regard, there are few doubts that the UK could join the race, especially since they are on their own after Brexit. Germany will be a question mark as the Federal Government uses of its influence to promote export, but does not seem ready for a higher, more open level of involvement.
But at the end of the day, there are few doubts that G2G will gain traction in the main export campaigns to come. Maybe not a silver bullet, but certainly a promising path to explore for opening-up and snapping more markets.