[pic] | COMMISSION OF THE EUROPEAN COMMUNITIES |

Brussels, 5.12.2007

SEC(2007) 1593

COMMISSION STAFF WORKING DOCUMENT Accompanying document to the Proposal for a DIRECTIVE OF THE EUROPEAN PARLIAMENT AND OF THE COUNCIL

on simplifying terms and conditions of transfers of defence-related products within the Community IMPACT ASSESSMENT

{COM(2007) 765 final}{SEC(2007) 1594}

TABLE OF CONTENTS

1. Executive summary 4

2. Introduction 8

2.1. Legal and political context 8

2.2. Procedural issues 9

2.3. Stakeholder consultations 10

3. Problem definition 11

3.1. Scope 11

3.2. Obstacles to intra-community transfers of defence-related products 11

3.2.1. Different kinds of transfers of defence-related products 11

3.2.2. Exports of defence-related products under strict controls 12

3.2.3. Licences at the heart of all national export control schemes 12

3.2.4. Intra-community transfers of defence-related goods hindered by cumbersome and disproportionate procedures 13

3.2.5. Obstacles to intra-community transfers impede the creation of a European Defence Industrial and Technological Base (EDITB) and undermine security of supply for EU procuring governments 15

3.2.6. Additional obstacles arising from third country restrictions 17

3.3. Existing intergovernmental arrangements do not appropriately reduce the current obstacles to intra-community transfers 17

3.3.1. The LoI and the Farnborough Framework Agreement 17

3.3.2. The European Defence Agency 18

3.4. Legal scope for action at Community level 19

3.5. Problem summary 20

3.6. Is the EU best suited to act? 20

4. Objectives 20

4.1. General objective 20

4.2. Specific objective 21

5. Policy Options 22

5.1. Introduction 22

5.2. No EU initiative (option 1) 22

5.3. Non legislative measures (option 2) 23

5.4. Legislative measures 24

5.4.1. Creating a EU licence-free zone (option 3) 24

5.4.2. Managing the issuing of intra-community transfer licences at EU level (option 4) 25

5.4.3. Simplifying and approximating national licensing schemes (option 5) 25

5.4.3.1. Type of licence issued (option 5 A x ) 26

5.4.3.2. Guarantees concerning the reliability of the recipients (option 5 B y ) 26

5.4.3.3. Guarantees concerning the management of re-exportation to third countries (option 5 C z ) 27

5.5. Summary of options 28

6. Analysis of impact 29

6.1. No EU initiative 29

6.1.1. Direct and indirect costs associated to the existing obstacles to intra-community transfers 29

6.1.2. Likely industrial developments 29

6.1.3. Social impact 31

6.1.4. Impact on the environment 31

6.2. EU legislative initiative to facilitate intra-community transfers 31

6.2.1. Social and environmental impacts 32

6.2.2. Easier outsourcing for the main benefit of SME 33

6.2.3. Foreign trade impact 33

6.2.3.1. A comparative advantage to EU defence products in terms of security of supply 33

6.2.3.2. The ITAR burden mostly lies in complete systems 34

6.2.4. Type of licence 34

6.2.4.1. Option A1: general licence only 34

6.2.4.2. Option A2: global licence only 35

6.2.4.3. Option A3: combination of A1 and A2 36

6.2.5. Certification 36

6.2.5.1. Option B1: No EU certification scheme 38

6.2.5.2. Option B2: Mandatory certification 38

6.2.5.3. Option B3: Optional certification 40

6.2.6. Re-exportation 41

6.2.6.1. Option C1: regulatory information requirements 41

6.2.6.2. Option C2: IT traceability system 42

7. Comparing the Options 43

7.1. Summary table 43

7.2. Preferred option 47

8. Monitoring and evaluation 48

ANNEX I - The EU defence industry 49

ANNEX II - Assessment of the costs of intra-community transfers barriers 53

ANNEX III - Summary of national licensing requirements 65

ANNEX IV - Example of implementation of a traceability system 73

ANNEX V - Summary of the consultation process 74

EXECUTIVE SUMMARY

All Member States implement their own legislation to regulate the import, export and transit of defence-related products. Ex ante licensing schemes are at the heart of these control regimes. All Member States basically implement one, or several of the following three main types of licences:

- an individual licence corresponds to an authorisation granted by a national authority on the request of an individual supplier for one transfer to one recipient,

- a global licence corresponds to an authorisation granted by a national authority on the request of an individual supplier for one or several transfers to one or several recipients within the European Community

- a general licence is an authorisation enacted in a general administrative or legislative act and allowing the transfer by any exporter of controlled goods to certain destinations both specified in the licence itself.

Despite similarities in the means employed, national rules significantly differ in terms of scope, competent authorities, procedures and timing. Furthermore, they typically do not establish any distinction between transfers to another Member State and exports to third countries.

National licensing schemes impose a significant administrative burden on companies, and require long lead times – up to several months. The corresponding administrative burden and indirect impact have been estimated respectively at € 433 million/year and € 2,73 billion / year.

This patchwork of licensing requirements - and the corresponding administrative burden – clearly appear to be out of proportion with actual control needs, given that license applications for intra-Community transfers are almost never rejected (whilst around 11500 licences for such transfers are issued annually, not a single request has been formally denied since 2003).

Furthermore, there is growing consensus amongst both industry and governmental stakeholders that these obstacles to intra-Community transfers impede the creation of a European Defence Industrial and Technological Base (EDTIB) and undermine security of supply between Member States:

- at industrial level, the need to conform to disparate national licensing regimes will continue hampering the optimization of supply chains. To avoid time–consuming, uncertain and costly procedures, companies indeed tend to prefer national suppliers. This impedes the specialisation of European defence industries and hurdles the creation of economies of scale. Furthermore, pan-European companies cannot enjoy the full benefits of cross-border integration, as long as data transfers between a company based in one Member State with its subsidiary in another remain subject to complex and lengthy prior approval schemes,

- a EU tendering governmental authority cannot take it for granted that export licences will be issued if it wants to procure defence equipment from a supplier established in another Member State. Although licences are hardly ever refused, the "theoretical" possibility that this may happen is an incentive for Member States to prefer sourcing sensitive military equipment to a national producer rather than to its (possibly more advantageous) European competitors.

To address these obstacles, a number of bilateral or multilateral agreements and initiatives aimed at structuring and regulating the international trade in defence-related products have been developed on an inter-governmental basis. Even the most prominent of these, namely the Letter of Intent and the subsequent Farnborough Framework Agreement signed by the six main arms producing Member States, have achieved rather limited results to date. As far as the European Defence Agency is concerned, it has no mandate for dealing with transfers.

As regards a possible initiative, the Commission’s general objective is to contribute the establishment of European Defence Equipment Market, whilst its specific objective is to facilitate intra-Community transfers of defence-related products (ICTDP). Facilitating intra-community transfers of defence-related goods is presumed to improve security of supply for EU procuring governments and positively contribute to the EDITB competitiveness by allowing better conditions for industrial specialisation, secured and smooth-operating supply chains and economies of scale.

An extensive consultation process has paved the way for this initiative. Besides an on-line consultation and the commissioning of two preparatory studies involving a series of interviews with relevant stakeholders, several workshops with industry stakeholders and Member States representatives have been organised since July 2005. These consultations have revealed some areas of possible agreement on which a future Community initiative could be based, whilst at the same time also enabled the Commission to clearly identify the relevant constraints and limitations pertaining to this sensitive domain.

Different policy approaches were considered and discussed with interested parties during the preparatory phase. Five main options have been considered:

Option 1 | No action (business-as-usual scenario) |

Option 2 | Non-legislative measures, taking the form of an interpretative Communication on Article 296 or confidence building measures |

Option 3 | Complete liberalisation of all defence-related products transfers |

Option 4 | Management of intra-community transfers at EU level via an Agency |

Option 5 | Simplification and approximation of national licensing schemes. These simplification elements pertain to: the type of licence issued (3 sub-options: A1 = general licences only, A2 = global licences only, A3 = combinations of general and global licences), the guarantees provided concerning the reliability of the recipients (3 sub-options: B1 = no EU certification for companies, B2= mandatory certification, B3 = certification for transfers under a general licence), the guarantees provided concerning the management of re-exportation to third countries (2 sub-options: C1 = regulatory information requirements, C2 = traceability system based on a centralized database). |

In line with the principle of proportionate analysis, options 2, 3 and 4 have not been retained for further detailed analysis, given either their unlikelihood to effectively meet the identified objectives, or their unrealistic nature from a political acceptability perspective . A thorough impact analysis has been performed for the business-as-usual scenario, as well as each sub-option of the simplification scenario. For all scenarios, this analysis concluded that no noticeable environmental impact is to be expected.

Option 1: no EU action

The absence of action at Community level to address intra-Community transfers of defence-related products does not necessarily imply a frozen status quo. A certain number of Member States are likely to continue reviewing their national licensing regimes with a view to simplifying them, and (ongoing or future) initiatives developed in an intergovernmental context will continue to endeavour achieving a genuine facilitation of transfers between participating countries. Given the observed difficulty in extending such arrangements to additional participating members, the potential discrimination between participating and non participating Member States would at best be maintained, or be even amplified.

Such situation would hinder the exploitation of all European competencies and niche expertise (in particular those located in new Member States). Excluded Member States will continue to see little complementary incentive to buy European defence products given that (a) their defence industry companies (mostly SME) will be less integrated in major defence programmes, and (b) the absence of any greater security of supply compared to alternative third country suppliers. In the medium to long run, if deprived from the benefits of deeper cooperation and integration, European industry will lose competitiveness and its role could be reduced to that of niche players and suppliers to mostly non-European prime contractors, thereby jeopardising its capacity to autonomously develop the capabilities needed for the European security and defence policy. Any such exclusion from the highest value-added market segments would also have a negative impact on returns available from European defence companies, creating difficulties in attracting investment as opposed to other, more profitable economic sectors. If not halted, the progressive erosion of EU industry’s competitive edge will ineluctably negatively influence both the level and the quality of employment in the sector.

Option 5: Simplification and approximation of national licensing schemes

It clearly emerged during the consultation phase that the overall prevailing level of security interests protection should be maintained. Concretely, this implies that any simplification / facilitation of intraEU transfers needs to be complemented by measures fostering a climate of mutual confidence, notably as regards re-exportations to third countries. The cost efficiency of the various above-mentioned sub-options as regards the facilitation means (type of licence) and the guarantees (certification and re-exportation control) have been screened in detail.

The analysis concludes that an EU scheme based on both global and general licences would constitute the most adequate compromise between the efficiency objectives of the measure (i.e. meeting the objective of genuinely facilitating ICTDP) and the required flexibility for Member States to fine-tune possible re-exportation or end-use restrictions on the most sensitive products.

EU certification of recipient companies appears to constitute a powerful means of raising mutual confidence at minimum marginal cost. Given however the potential disproportionate impact of making certification mandatory (notably for SMEs), the sub-option linking the use of a general licence and certification appeared to represent an efficient confidence-building incentive for Member States to make the widest possible use of the least burdensome licences.

Finally, as regards re-exportation control, a double control IT traceability system would manifestly generate significant burdensome new obligations for both companies and administrations. The more conventional regulatory technique based on information requirements and effective enforcement policies are therefore deemed as more cost-efficient.

Combining the estimates of the corresponding sub-scenarios leads to an estimated net benefit in administrative burden comprised in a range stretching from € 190 mio and € 405 mio / year . But even more significantly, the expected indirect benefits of simplified transfers as a contribution to a well functioning European Defence Equipment Market and a strong European Defence Technological and Industrial Base are deemed to considerably exceed these direct net benefits.

Direct social impacts are expected to be minimal, whilst by contrast, indirect impacts are likely to be much more significant. The strengthening of a pan-European Defence and Technological Industrial Base could in the short term lead to rationalisation of structures, and hence, job cuts in redundant programmes and in poorly-competitive companies. Such restructuring is however a prerequisite for keeping the EU defence industry abreast of technological developments, a necessary condition both for being able to face the competition of new entrants and to avoid any further widening of the technological gap with its most advanced competitors. This scenario thereby offers the best guarantee to maintain or develop both in qualitative and quantitative terms, employment in the medium to long run.

As part of the Commission’s commitment to improving the quality of Impact Assessments, an independent internal Impact Assessment Board (IAB) has been set up. The current Impact Assessment has been reviewed by the IAB during a meeting on 18 July 2007.

The recommendations for improvements are detailed below, with a short commentary indicating how and where these recommendations have been accommodated within the current version of the report:

(1) The problem definition should better articulate and analyse the obstacles to effective intra-community transfers of defence-related products: Problems caused by the current patchwork of national licensing procedures and the resulting implications on administrative burden and product lead times have been explained in depth under 3.2.4.

(2) The continued need for intra-community transfer licences needs to be better explained: the revised IA provides further information in 3.2.4. and 5.4.1. on the need for keeping intra-EU licences to form the “vehicle” for carrying possible limitations on the end-use and/or the end-user and to allow for the mandatory reporting and transparency obligations imposed on national governments.

(3) The international dimension of the proposed measures requires further analysis, in particular the detrimental effects of US ITAR rules: additional information on the way European defence companies deal with ITAR-flagged material has been provided in 6.2.3. The summary table in chapter 7 also reports on the expected benefits associated to the preferred option concerning ITAR rules and the impact on third country producers.

(4) Employment, social, regional and sectoral impacts need to be assessed more thoroughly: the section discussing the impacts on employment (6.2.1.) has been complemented with additional elements (drawing on general theory as well as practical observation) and a new dedicated section on SMEs (6.2.2.) with a focus on geographical impacts in the EU has been added. The summary table in chapter 7 has been revised accordingly. A more detailed overview of EU defence industries has been added in annex I.

(5) The IA report should review the robustness of certain cost/benefit parameters when calculating administrative costs: Assumptions about cost/benefit calculations have been reassessed and a more thorough explanation, where relevant and appropriate, is provided in annex II.

INTRODUCTION

Legal and political context

This Impact Assessment (IA) accompanies the initiative on intra-community transfers of defence-related products, as included in the 2007 Commission Legislative and Work Programme (subheading “strategic initiative”) under item 2007/ENTR/010. It belongs to a package of two complementary instruments aiming at completing the internal market for defence-related products and at reinforcing the EU defence industry’s competitiveness. The second component of this “defence package” is constituted by the proposed instrument on defence and security public procurement.[1] Both initiatives will be accompanied by an umbrella Communication on "A Strategy for a stronger and more competitive European Defence Industry".

This initiative builds upon earlier steps taken by the Commission to encourage restructuring and setting up a genuine EU defence equipment market:

- the 1996 Commission Communication addressing “ The challenges facing the European defence-related industry – a contribution for action at European level ”[2],

- the 1997 Commission Communication on “ Implementing European Union strategy on defence-related industries ”[3];

- the 2003 Commission Communication entitled “ Towards a European Defence Equipment Policy ”[4], which sets out guidelines to strengthen and reinforce the competitiveness of the EU defence industry. One of these guidelines specifically addressed the need for simplifying intra-community transfers of defence-related products, whilst respecting Member States prerogatives in this highly sensitive sector.

The Council welcomed the latter Communication “ as a valuable contribution towards creating the necessary conditions for strengthening the industrial and market situation of European businesses, which are directly or indirectly connected with the defence equipment market, enhancing defence related research and improving international competitiveness of the industries concerned ”[5].

Reacting for its part on the same Communication, the European Parliament advocated “ a reduction in controls on intra-Community transfers of defence equipment, the simplification of administrative procedures, and the approximation of national licence systems ” whilst recognising “ the complexity and political sensitivity of this sector ”[6] . Furthermore, in its 2006 resolution on the implementation of the European Security Strategy [7] , the European Parliament indicated that it was inter alia looking forward to the “ creation of a binding legal instrument on the facilitation of intra-Community transfers of defence-related products that will substitute a simplified common system in place of the existing national export licences ”.

At intergovernmental level, some limited initiatives have already been taken. The main developments relate to the Letter of Intent (LoI) signed by six Member States and the subsequent Framework Agreement adopted in Farnborough in 2000[8]. Restricted to its participating Member States and impeded by the rule of unanimity and the weakness of its coordination mechanisms, the LoI has brought limited results.

The examination of the likely impacts of any proposal concerning such a sensitive area as trade in defence-related products (i.e. war material) cannot be confined to the traditional compartments of sustainable development (i.e. economic, social and environmental impacts). Indeed, these elements must necessarily be balanced with a broader global and geo-strategic perspective, taking due account of security requirements and notably the need to control the final use of defence-related products.

Procedural issues

The production of this impact assessment has been supported by:

- a first fact-finding study led on behalf of DG-Enterprise (DG ENTR) by consultants UNISYS entitled “ Intra-Community Transfers of Defence Products ”[9] (hereafter referred to as the “ February 2005 study ”). Its terms of reference included the assessment of all national obstacles to such intra-community transfers (be they of administrative, legal, technical or economic nature), the evaluation of existing intergovernmental initiatives aiming at facilitating intra-community and international trade in defence products, and the identification of possible additional measures at Community level. The February 2005 study was presented on 12 July 2005 at a workshop co-chaired by EU HR J. Solana and Commissioner G. Verheugen.

- a second study, led by the same consultants, entitled “ Intra-Community Transfers of Defence Products- impact assessment ”[10] (hereby referred to as the “ February 2007 study ”) which provided further elements for the assessment of the desirability and likely impacts of a series of options to reduce the burden associated with intra-community transfers of defence-related products.

Both studies have been monitored by a steering Committee, chaired by DG ENTR and consisting of representatives of key interested Commission departments: DG MARKT (responsible for the Internal Market), DG TRADE (responsible for external trade), DG RELEX (responsible for external relations), DG RDT (responsible for research), DG COMP (responsible for competition policy), DG TAXUD (notably responsible for the Customs Union), DG INFSO (notably responsible for ICT), the Legal Service and the Secretariat General.

Stakeholder consultations

The consultation process has been launched in the framework of the July 2005 conference “Europe Defence Industries and market place” organised by the European Commission in co-operation with the European Defence Agency[11], during which the findings of UNISYS’ “February 2005 study” were first presented.

An on-line consultation, published on the Commission single access point “Your voice in Europe”[12], was carried out between March 2006 and September 2006 on the basis of a Commission consultation paper. Seven Member States, ten industry associations and companies, five NGOs and three other organisations seized the opportunity to present their views. A summary can be found on the Commission website[13].

In the run-up to the “ February 2007 study ”, the consultant carried out a series of interviews with experts, public bodies, enterprises, stakeholders and EU institutions representatives covering the period between August and December 2006.

Finally, throughout the consultation phase between July 2005 and April 2007, a total of 7 workshops (4 with Member States and 3 with industry representatives) have been organised in Brussels by the Commission. These enabled the Commission services to widen and refine their knowledge basis, collect the views of those stakeholders and Member States which had abstained from contributing to the on-line consultation, and test options, from a technical, economic and political feasibility perspective, for the envisaged features of a possible initiative.

To sum up, the consultations undertaken with the Member States and industry have revealed four areas of possible agreement on which a future Community initiative could be based:

- the instrument should cover intra-community transfers from industry to governments as well as transfers from industry to industry;

- the scope of the instrument should primarily rely on the common military list (CML) contained in the EU Code of Conduct on arms exports;

- the introduction of a general / global licence scheme would provide for a significant simplification of intra-community transfers;

- mutual trust could be forged on guarantees by the recipient Member State as to security concerns (certification of companies, control customs in view of re-exports, reporting, mutual information, etc.). This seems particularly important for transfers from industry to industry.

The outcome of this extensive consultation process is elaborated in more details in Annex V.

PROBLEM DEFINITION

Scope

Defence-related cover a broad spectrum of military goods and services, ranging from lowly sensitive components and light arms to complex weapon systems, such as combat aircraft or war vessels, as well as highly sensitive material, such as nuclear, biological and chemical gear. Those products are subject to national ex ante licensing before they can be transferred due to their registration on national or common ammunition lists.

Defence-related products are characterised by their exclusive military nature and purpose , in contrast to the so-called “dual-use” products which are, in principle, civil in nature but can (also) be used for military purposes (for example toxic chemicals, electronic and telecom components). Given this exclusive military nature and purpose, defence-related products also differ from security products (e.g. biometrics identification devices) mostly used in civil cases (police, customs, local authorities…) and void of prior licensing requirements.

Annex I provides an overview of the European defence industry and the defence market.

Obstacles to intra-community transfers of defence-related products

Different kinds of transfers of defence-related products

Transferring defence-related products from one Member State to another Member State can be manifold:

- Transfers from industry to industry: such transfers encompass components transferred from a supplier to an integrator that incorporates the received component in a larger sub-system (ex: a sonar) or in a larger system (ex: a submarine). Possible related-services (like repair) and complementary transfers (like a software update) can be then implied.

- Transfers from industry to government: such transfers mostly encompass complete material but also services and goods related to these complete materials (related services like repair and overhaul and related goods like spare parts and maintenance equipment).

- Transfers from government to government: such transfers typically relate to the sale of decommissioned equipment (e.g. old aircrafts) to another government. However, such transfers are rather infrequent, and do not raise any problem in terms of licensing procedures, in so far as the government seller is at the same time the licensing authority.

[pic]

Source: EU Code of Conduct on Arms Exports 2005.

(For a LoI description, see footnote n°8 and 3.3.1)

Exports of defence-related products under strict controls

All Member States restrict the circulation of defence-related products within the Internal Market. Controlling the dissemination of defence equipments to ensure that such material does not end up in hostile hands or “rogue governments” is a key concern - and a matter of political and/or legal responsibility- shared by all democratic governments. The rational of such dissemination controls remains acutely valid today with the threat of terrorism and the risks of proliferation of weapons of mass destruction. Moreover, civil society’s analysis of the human rights and democratic credentials of the country of destination increasingly reinforces the need for a strict and effective export discipline[14]. All Member States are thus implementing a series of control tools to balance non-dissemination imperatives with the necessities of production and circulation of defence material with trusted partners.

Annex III provides a summary table of the various national export regimes.

Licences at the heart of all national export control schemes

All Member States have their own legislation to regulate the import, export and transit of military goods. Although the means prescribed in these national rules are generally similar, they do present a significant number of important differences in terms of scope, competent authorities, procedures and timing. A common feature shared by all Member States is the reliance on prior licence schemes to manage such transfers. Practically, this means that exporters have to obtain a national ex ante export licence for shipping defence-related goods outside the national borders of each Member State. No distinction is being made whether the destination is another Member State or a third country.

There are basically three main different types of licenses that can be issued for the export of defence-related goods:

- Individual license: An individual license covers one or several consignments from a specific exporter of specific goods to a specific consignee / end-user . Thus, granted on the request of the manufacturer, an individual license must be applied for each transaction, implying that a case-by-case evaluation will take place. Such licenses are either valid for a pre-defined period or when a quantified limit has been reached. If a license expires without having yet been entirely fulfilled, it is usually possible, to apply for a time extension. In some countries however, it is easier to submit a new application for the remaining quantity.

- Global license: The global license can be granted on request to a specific exporter for specific goods to one or several recipients . The global licence is granted for a defined period but is not limited in quantity, hence covering shipments that were unexpected when the exporter applied for the licence. This type of license is typically issued in cases where a prohibitive number of licenses would otherwise be required, in order to prevent the creation of an undue administrative burden for the exporter. The license can require the exporter to submit the details of the consignees to whom the items listed have been exported on a regular basis (e.g. every three months).

- General license: General licenses, or national general authorisations, are laid down by a general administrative or legislative act. They offer a simplified procedure for the export by any exporter of controlled goods to certain destinations . The conditions for the use of this type of license, the covered goods and the authorized destinations are specified within the license itself. This type of license does not exist in most Member States.

Intra-community transfers of defence-related goods hindered by cumbersome and disproportionate procedures

Each individual or global licence application is normally dealt on a case-by-case basis, taking of course into account the relevant UN and EU arms embargoes as well as relevant multilaterally binding restrictions. Both for economic operators and authorities, the licence granting procedure is time-consuming and resource-intensive. The underlying factors are detailed in the following box:

- Overlapping competencies : there is a wide diversity of administrative national arrangements for issuing export licences. Their complexity is often the reason for delays and bottlenecks in some countries. The relevant authority for approving licence applications may also depend on the type of good or technology involved.

- Inter-agency process : the competent authority issuing the licences is typically required to consult other governmental departments to reach its final decision. This final decision can also be taken at the level of an intergovernmental board.

- Lack of transparency in licensing criteria : in some countries, the criteria that need to be fulfilled to obtain a license are not defined by law and are entirely left to the discretionary assessment of the competent authority. For the supplier and the receiver, this lack of transparency jeopardises the predictability of transfers and can imply additional delays in finalising incomplete applications.

- Administrative licensing fees : some countries impose a fee for covering the cost of the administrative procedure.

- Additional licensing and pre-licensing requirements : in some countries additional licenses/permits need to be secured before being able to apply for an export/import/transit license[15].

- Diversity in control lists: for defining which products are considered as military material, most Member States have their own national list. Whilst usually based on the Wassenaar Arrangement, most of these national lists contain a series of added items. These differences can lead to complex situations (e.g.: a specific item can be freely traded in one country but is subject to controls in another country). A pan-European company transferring defence components between its subsidiaries located in three countries must deal with three different control lists.

The duration of the administrative licensing process may vary from one week to several months, depending on countries and circumstances. These delays have clearly a negative impact on the defence industry, as efficient time management is nowadays a cornerstone of any industrial project. According to the assessment made in the 2005 UNYSIS report, obtaining an ex ante export licence represents for a company on average an investment above 20.000 € in terms of administrative burden[16].

Overall, the licensing requirements impose significant administrative burdens on companies, and imply long lead times – up to several months.

As a general rule, all “exports” of military goods are submitted to the same rules, without making a difference between intra-community transfers and extra-community exports . Although in practice the scrutiny level for export applications within the European Community (or destined to NATO countries) are no doubt lower than for exports to third countries, the requirements for submitting an application are formally the same regardless of the country of destination.

The licensing requirements for intra-community transfers appear to be disproportionate to the actual control needs. The EU Code of Conduct on Arms Exports statistics provide a clear idea of the ratio of rejected intra-community “export licences” in recent years:

Year | 2003 | 2004 | 2005 |

Total number of licences | 31,038 | 28,716 | 31,550 |

Intra-community transfer licences | 12,627 | 11,360 | 11,409 |

Declared Value (billion Euro) | 8.9 | 10.4 | 9.4 |

Rejected intra-community transfer licences | 15 | 0 | 0 |

Rejection rate | 0,12 % | 0 % | 0 % |

It should be noted that all the 15 denials registered in 2003 concerned exports to the three Baltic States (not yet EU Members at that time). The categories where refusals occurred (small, light arms) concerned equipment with potentially higher risks of uncontrolled dissemination (re-export). There are indications that these refusals were primarily linked to the lack of awareness on the legislation in “new” Member States and the lack of established trust concerning the actual enforcement of re-exportation controls by these new occasional buyers. No intra-community transfer of defence equipment has been denied since.

Some Member States however justify the maintenance of their licensing systems arguing that these statistics underestimate the real denial rate, given that certain applications are never officially filed following a negative signal registered from prior informal contacts with the competent authorities. They also point out that the negligible refusal rate also ignores the possible specific conditions or restrictions attached to some transfers. For instance, for some complex defence-related products (weapons systems), licences can curtail technical functions of the product to be transferred or can include conditions (e.g. the product can be transferred on the condition that some of its features are downgraded or provided that its technology is not transferred).

Furthermore, certain Member States argue that a licensing scheme is needed to provide them with the necessary data for respecting their transparency and information obligations or commitments towards various stakeholders (national Parliaments, NGOs, international or EU agreements…). However, those Member States already implementing global and general licensing bring evidence that all necessary reporting data can also be gathered via a posteriori reporting requirements from suppliers located on their territories.

As far as controls are concerned, no distinction is being made between intra-community ‘transfers’ and ‘exports’ to third countries. Given the negligible level of denials, the level of intra-community transfers’ control, mostly enforced through individual licensing, is disproportionate.

O bstacles to intra-community transfers impede the creation of a European Defence Industrial and Technological Base (EDITB) and undermine security of supply for EU procuring governments

There is a growing consensus amongst both industry and governmental stakeholders that reforms have become indispensable for Europe to maintain a viable European Defence Industrial and Technological Base (EDITB) and equip its armed forces adequately[17].

In this regard, the very existence of obstacles to intra-community transfer of defence-related products is incompatible with any genuine integration of the EU defence industrial and technological base. The widely acknowledged need for closer cooperation between European defence industries and rationalisation of their supply chains is impeded by current obstacles on transfers.

Indeed, a prerequisite for such a deeper industrial integration is the reasonable guarantee to benefit from an efficient, seamless and reliable supply chain whenever acquiring equipment in another Member State.

Furthermore, security of supply is of paramount strategic importance not only for industrial supply chains, but also for procuring governments. Indeed, the adequate and timely supply of defence equipment is essential to the success of military operations. This implies that suppliers must have the capacity to deliver defence equipment (including spare parts, maintenance and upgrades) over a long period of time (because of the long life cycles of many defence systems). In addition, in times of crisis or war, suppliers must be able to meet urgent additional demands for incremental or accelerated deliveries.

As long as intra-community transfers are hindered by such barriers:

- At industrial level, the need to conform to disparate national licensing regimes will continue hampering the optimization of supply chains. To avoid time–consuming, uncertain and costly procedures, companies indeed tend to prefer national suppliers. This impedes the specialisation of European defence industries and hurdles the creation of economies of scale. Furthermore, pan-European companies cannot enjoy the full benefits of cross-border integration, as long as data transfers between a company based in one Member State with its subsidiary in another remain subject to complex and lengthy prior approval schemes.

- a EU tendering governmental authority can not take it for granted that export licences will be issued if it wants to procure defence equipment from a supplier established in another Member State. Although licences are hardly ever refused, the "theoretical" possibility that this may happen is an incentive for Member States to prefer sourcing sensitive military equipment to a national producer rather than to its (possibly more advantageous) European competitors.

Therefore, besides the direct cost linked to the preparation and management of licences themselves, which is estimated in UNISYS’ 2005 report to represent about € 430 million in 2004[18], the bulk of the “costs of non-Europe” in the defence-industry are of an indirect nature. The same report actually concluded at an indirect yearly impact of € 2.73 Billion, although some authors have suggested even much larger figures[19].

Additional obstacles arising from third country restrictions

Restrictions on trade of defense equipment imposed by third countries indirectly impact intra-community transfers. The most prominent of such restrictions is undoubtedly US rules. International Traffic in Arms Regulations (ITAR)[20] is a set of US government regulations that control the export and import of defense-related articles and services under the Arms Export Control Act. Its goal is to advance national strategic objectives and U.S. foreign policy via the trade controls. This export control regime, which covers both transactions with the countries receiving the articles or services and any further re-export of those articles or services to third countries, is administrated by the Department of State.

In practice, ITAR impose on European industries relying on US components to request prior US government approval when US components are moved onto other countries. EU companies have to fill end-user statements when they sell products containing US ITAR-flagged components. This end-user statement is then sent to the US supplier that, in turn, submits it to the US administration for approval. With ITAR, orders cannot be made until the final customer identity is known to the US authorities[21].

The ITAR approval procedure can be very lengthy and burdensome. Furthermore, its intrinsic extraterritorial nature has an obvious restrictive impact for EU integrators both on market access to third countries (for example, the US has blocked in 2006 the planned sale of EADS CASA's military aircraft to Venezuela[22]) and on intra-community transfers (in so far as prior US agreement has to be sought for intra-Community transfers containing ITAR-components).

Existing intergovernmental arrangements do not appropriately reduce the current obstacles to intra-community transfers

The LoI and the Farnborough Framework Agreement

To address these obstacles, a number of bilateral or multilateral agreements and initiatives aimed at structuring and regulating the international trade in defence-related products have been developed on an inter-governmental basis. The most prominent of these is no doubt the Letter of Intent (LoI) and the subsequent Farnborough Framework Agreement [23], which aims at facilitating cross-border restructuring and cooperation of defence industries between the six participating countries: United Kingdom, France, Germany, Spain, Italy and Sweden. One of the areas the Framework Agreement is covering is transfers and exports in the framework of cooperative projects and Trans-national defence Companies (TDCs).

The genesis of the LoI has been quite difficult: indeed, the actual ratification of the Framework Agreement and the preparation of its subsequent Implementation Arrangements have proved extremely slow to set up (given that it is a purely intergovernmental agreement, unanimity is required for any decision). Moreover, LoI solutions are often considered as too complex, vague and insufficiently binding. It has therefore yielded little concrete results yet. In particular, it is not aiming at establishing a unique set of export procedures and regulations but only tries to make persisting national procedures compatible and agree on common principles for cooperative projects and TDCs.

Moreover, the LoI intrinsically creates a potential distortion within the internal market. It potentially confers an advantage to sub-contractors located within the boundaries of the agreement and thereby penalises competitors located in “excluded” EU Member States, thus bearing a significant risk of excluding in particular SMEs from non-LoI Member States from the process of industrial integration.

The LoI agreement is limited in its membership and scope. Consequently, it implies the risk of excluding companies of non-LoI countries to get access to the supply chains of the big prime contractors and hardly ensures security of supply at the EU level.

The European Defence Agency

Created under second pillar joint action 2004/551 of 12 July 2004, the European Defence Agency (EDA) is designed "to support the Council and the Member States in their effort to improve European defence capabilities and to foster the European defence industrial base”. More specifically, the Agency is ascribed four functions, relating to (a) defence capabilities development, (b) armaments cooperation (c) the European defence technological and industrial base and defence equipment market and (d) research and technology. The EDA has however no mandate for dealing with transfers.

Furthermore, when asked which possible role EDA could play in the implementation of a simplified transfers regime, most stakeholders objected that EDA stems from Ministries of Defence whilst export control schemes are under the responsibility of other departments in most Member States. Some stakeholders also pointed that it would take a lot of time and resources for the EDA to develop a competence in export controls.

While investigating ways to foster the European defence industrial base, the EDA has highlighted the issue of transfers as very relevant, though abstaining from further involvement. Considering the characteristics of a strong future European Defence Technological and Industrial Base, the EDA Steering Board in September 2006 settled that “In order to develop and sustain a capability driven, competent and competitive European Defence Technological Industrial Base, Europe needs to work towards more consolidation, work-sharing and interdependencies on a European-wide basis, based on Security of Supply and drastically simplified procedures for Intra-Community Transfer”. This has been thoroughly recalled in the recent “EDTIB Strategy” adopted by the EDA steering Board in May 2007.

In September 2006, EDA members also agreed on the “Framework Arrangement for security of supply between subscribing Member States in circumstances of operational urgency”. This Framework Arrangement states that “the subscribing Member states will support efforts to simplify amongst them intra-community transfers and transits of defence goods and technologies”.

Legal scope for action at Community level

Besides the legitimate concern to control defence equipment dissemination, armaments policy and the trade related to such equipment are linked to considerations of national sovereignty and foreign policy.

Member States typically invoke Article 296 of the EC Treaty[24] (national essential security interests) as a justification for their licensing and control requirements on the movements of military equipment.

According to the case-law of the Court of Justice of the European Communities, Community law applies to defence-related products , as it does to all other products. In particular, the principle of free movement of goods and services and commercial policy (Articles 28, 49, 133 TEC) are applicable. By their very nature, export authorisations are one of the measures which create quantitative restrictions or measures having equivalent effect which Community law aims to eliminate with regard to intra-Community trade.

Article 296 TEC allows Member States to take restrictive measures on the condition that they demonstrate on a case-by-case basis that these measures are necessary and proportional to protect essential national security interests. However, it is not possible to infer from this article that there is inherent in the Treaty a general proviso covering all measures taken by Member States[25]. Thus Article 296 has no effect on the Community’s legislative power to lay down measures concerning the approximation of the provisions laid down by law, regulation or administrative action in Member States which have as their object the establishment and functioning of the internal market (Article 95(1)).

This jurisprudence evidently contradicts the current Member States practice of claiming generic, unsubstantiated ‘national security’ interests to justify restrictions on the movement of defence-related products.

The existence of the - albeit limited - possibilities provided for in Article 296 can only justify derogations from the direct application of the TEC’s principles. The Community is empowered to reduce obstacles to these principles by way of adopting legislative measures concerning the approximation of the provisions laid down by law, regulation or administrative action in Member States which have as their object the establishment and functioning of the internal market (Article 95(1)).

Problem summary

Overall the licensing requirements for transferring defence material challenge security of supply for procuring governments, which is hardly compatible with the inherent solidarity of the EU, and curtail industrial cooperation. They impose a significant administrative burden on companies, and require long lead times – up to several months – in order to obtain transfer licenses. The licensing requirements - and the corresponding administrative burden – clearly appear to be out of proportion with actual control needs, given that license applications for intra-community transfers are almost never rejected.

The current intergovernmental arrangements do not provide a satisfactory basis for the simplification of intra-community transfers. Their intergovernmental nature (i.e. unanimity rule, absence of a body to check their implementation) limits their effectiveness and their potential for significant progress seems questionable. Moreover, they are intrinsically ‘exclusive clubs’, which potentially implies prejudicial consequences for any operator located outside their geographical boundaries.

Is the EU best suited to act?

A reinforced security of supply constitutes a prerequisite for the correct functioning of the Internal Market in the area of public procurement. Moreover, a genuine European Defence Technological and Industrial Base (EDTIB) requires exploiting the full range of Europe's competencies and niche capabilities, in particular SMEs’ competencies.

The current intergovernmental arrangements imply a serious risk of excluding companies of non participating countries to get access to the supply chains of the big prime contractors, and do not contribute to improve security of supply at EU level.

Furthermore, the EDA has no mandate to deal with transfers issues, and stakeholders unanimously discarded its possible involvement in the matter.

The general use of the essential security interest exemption in the field of intra-community transfers of defence material is incompatible with the Treaty, as consistently confirmed by the related Court of Justice jurisprudence. In this regard, the Community is not only the best suited, but the only possible player to address this problem.

Proportionate action at Community level is therefore necessary to facilitate intra-community transfers of defence equipments, hence contributing to the emergence of a European defence equipment market which can support a truly European Defence Technological and Industrial Base.

OBJECTIVES

General objective

In line with Member States commitments, the Commission's overarching objective in this field is to establish an open and competitive European Defence Equipment Market (EDEM) in the EU. A well functioning EDEM requires a coherent regulatory framework in the various policy areas, such as procurement and transfers. In order to protect Member States’ security interests, this framework needs to take into account the specific nature of defence equipment (strategic importance, complexity, security of supply and security of information requirements).

The expected benefits of a properly working EDEM would be the following:

- from a supply side perspective : substantial economies can be expected to arise from access to a much larger ‘home’ market and longer production runs. More competition and market disciplines would encourage the sector to optimise production capacity and thus help lower production costs. Lifting existing disincentives to restructure and cooperate across national boundaries will contribute to the emergence of a Europe-wide Defence Industrial and Technological Base (EDITB), hence reducing the costly duplication and fragmentation of production capacities. Less fragmentation or more rational resource allocation would also provide the sector with the necessary critical mass in terms of business and research investments, thus leading to the creation of centres of excellence. This in turn would mean a more economically and technologically competitive EU defence industry on both domestic and third markets.

- from a demand side perspective : better guarantees of supply provided by the easier circulation of defence-related products would reinforce the attractiveness of defence manufacturers located in another Member State, facilitate the adoption of best practices regarding trans-European military procurement (including the purchase of similar / compatible material), and ultimately improve the efficiency of defence spending (less duplication of defence stocks, more material pooling). A greater security of supply on EU defence-related products would favour European goods compared to goods sourced from third countries.

- This proposal’s general objective also fits into the broader pictures of the Lisbon agenda given its contribution to the development of a competent and competitive European Defence Technological and Industrial Base (EDTIB). A competent and competitive European defence industry may in its turn foster the Common Foreign Security Policy (CFSP).

Specific objective

The specific objective pursued by the Commission in the framework of this initiative is the facilitation of intra-community transfers of defence-related products to reduce the complexity - and the related administrative burden - associated with the existing web of diverging national licensing schemes. To that extent, reaching this specific objective will complement the forthcoming directive on defence procurement. Because most transfers of defence-related products destined for Member States’ armed forces will be facilitated, procuring governments will enjoy more predictability and consequently much greater security of supply, which will reduce current reluctance to cross-border purchases. It will make it easier for cross-border suppliers to “demonstrate” their ability to timely deliver defence-related products.

POLICY OPTIONS

Introduction

This chapter identifies and examines different ways to tackle the problems outlined in chapter 3 and achieve the objectives defined in chapter 4. Different policy approaches were considered and discussed with interested parties during the consultation process. Some of these will be considered here but however not retained for further analysis, given either their unlikelihood to effectively meet the identified objectives, or their unrealistic nature from a political acceptability perspective . The potential impacts associated with the key measures of the remaining options are analysed in detail in the following chapter.

Achieving concrete steps in trade facilitation of intra-community transfers of defence materials fundamentally presupposes the establishment of a climate of trust and mutual confidence in the capacity of the recipient’s authorities to safeguard the crucial security dimension associated with the transferred good and notably guarantees in the case of re-exportation to third countries. It is also a necessary condition for featuring a credible common defence market as a secure space, notably towards extra-territorial regulations imposed by third countries (mainly the US) and thus avoiding discriminating Member States based on the assumption that some of them could be “less trust-worthy” than others.

No EU initiative (option 1)

The absence of action at Community level to address intra-Community transfers of defence-related products does not necessarily imply a frozen status quo :

- A certain number of Member States are likely to review their national licensing regimes with a view to simplifying them (probably making a more widespread use of global or general licences, and by opening the possibility for derogations to licensing in certain specific cases). Such national simplifications will however not substantially improve the current fragmentation and patchy implementation.

- Ongoing intergovernmental initiatives – in particular the LoI - have been mandated to simplify transfers between the participating Member States. However, these initiatives have not been very successful up to now. Given the observed difficulty in extending such arrangements to additional participating members, the potential discrimination between participating and non participating Member States would at best be maintained, or be even amplified.

- Smaller initiatives on a bilateral or tripartite basis could continue to develop for certain specific cooperation programmes. Past experience shows that bilateral agreements have sometimes been concluded with third countries (very often the US), hence making the consolidation of the EDITB potentially even more difficult[26]. Again, whilst facilitating cross-border transfers between mutually trusted countries sharing common interests, such developments do not fundamentally rationalise the patchwork of licensing schemes and bear the risks of discrimination against operators located in non-participating countries.

This option will constitute the ‘baseline scenario’ to which the alternative options will be compared to.

Non legislative measures (option 2)

Given that mutual confidence appears as a prerequisite for Member States to simplify transfers, the Commission could promote a better understanding of the intra-Community transfer issue through non legislative measures, such as:

1. Building confidence through information sharing and exchanging of best practices

The Commission could consider playing a leading role in fostering information sharing and exchanges of best practices via meetings, workshops, data-bases… Whilst no doubt acceptable to Member States, such a soft information exchange option is however highly unlikely to lead to concrete tangible effects on national “hard law” licensing practices, and therefore, would in effect not substantially differ from the “business as usual scenario”.

2. Framing the interpretation of Art. 296 of the Treaty

Member States have traditionally invoked Article 296 for justifying their de facto blanket exclusion of defence-related products from the internal market rules. The Commission could undertake to frame more tightly the currently wide use of this derogation. This could take the form of an interpretative communication on the use of Article 296 in the field of intra-community transfers of defence-related products. While acknowledging the legitimacy under Article 296 of transfer control procedures for defence-related products, such a document could inter alia stress the need for any derogation to the Treaty to respect the principle of proportionality, be it in relation to the licensing procedure itself, or in relation to the corresponding costs and delays entailed by individual administrative procedures.

In the absence of jurisprudence on the Court’s reading of Article 296 in the context of intra-Community transfers of defence-related products, it is however doubtful that such an interpretative Communication would go as far as setting out criteria that may allow national licensing authorities to duly resort to the “essential security interests” derogation. Practically, Member States would have to conduct a case-by-case assessment to ascertain whether Article 296 is applicable. Such a case-by-case procedural approach would definitely not streamline current practices.

As there is no Community framework dealing with the core security issues pertaining to transfers of defence-related products, the most likely outcome is continued recourse by Member States to Article 296, thus leaving the Commission with the task of demonstrating possible misuses. At the end of the day, enforcement would therefore continue relying on infringement procedures, a route that may prove to be rather arduous for the Commission services due to the considerable number of licences to monitor. Besides its practical dimension, such a legalistic case-by-case approach would fail to efficiently meet businesses industrial needs, given the intrinsic procedural delays involved.

Furthermore, such an interpretative approach would not address obstacles resulting from divergences of national systems and procedures, and therefore would not lead to a lean regulatory framework nor would it lead to a general enhancement of mutual trust.

Taking into account that they would not in the short to medium term substantially differ from the current situation, non-legislative measures are therefore discarded and will not be subject to further impact analysis.

Legislative measures

Whatever their nature and the associated procedural requirements, licences constitute a common feature of the diverse national schemes both for managing intra-community transfers and exports of defence-related products. Exporting and transferring defence materials implies States’ responsibility that is materialized by the issuance of licences. All Member States have retained this licensing option to secure reassurances on the likely use and final destination of defence-related products leaving their territory. These licences also promote transparency and allow for reporting requirements, for instance towards national Parliaments and NGOs. Any scheme implemented at Community level should at minimum preserve the prevailing degree of security and transparency.

The Commission could propose a legislative initiative to facilitate such intra-community transfers. It should be noted that, according to the afore-mentioned objectives (i.e. contribute to the establishment of an EDEM inspired by the internal market rules), national regimes regulating exports to third countries would not be affected by this instrument . National licensing schemes for such exports would remain in place, although Member States could eventually implement certain features of the simplified intra-community scheme to maximise synergies and cut costs.

Creating a EU licence-free zone (option 3)

Such an option would basically consist of a Community instrument prohibiting all national licensing schemes for the transfers of defence-related products. Such a tool should however provide for a kind of ‘safeguard clause’ reflecting the terms of the Treaty, notably Article 296. In essence, such full liberalisation scenario would imply that defence goods should be treated in exactly the same way as any other manufactured good or service in accordance to the ‘normal’ internal market rules, and should thus be entitled to circulate within the Community almost without restriction.

By and large, the economic benefits of this option would mirror the corresponding costs of the ‘business as usual’ scenario.

Promoting a licence-free zone in the EU would however clearly go beyond what is politically achievable in the present context, with a common foreign policy still at an infant stage and uneven levels of trust concerning the watertightness of certain external borders. The issue of reexportation outside the EU would undermine such an approch insofar as Member States do not always share identical views on third countries, despite coordination efforts in the framework of the EU code of conduct on arms exports. Besides, full liberalisation even limited to intra-community tranfers, would contradict current national and Community commitments taken in international control regimes (e.g Wassenaar, MTCR)[27]. Licensing is therefore still needed as the “vehicle” to carry possible reexportation limitations enacted by the Member States originating the transfer.

This option is therefore politically too unrealistic to deserve further detailed analysis. It is thus discarded.

Managing the issuing of intra-community transfer licences at EU level (option 4)

Under this scenario, the principle of licences for authorizing intra-community movements of defence goods would be kept (thus preserving the ‘guarantees’ associated to this tool), but the responsibility for issuing and managing such licences would be transferred to a centralized body, such as a dedicated Agency (possibly via the extension of the mandate of the European Defence Agency – such a move could however raise delicate institutional issues).

The advantages of such a scenario would be inter alia the setting up of a truly non-discriminatory and homogeneous regulatory framework, probable economies of scale resulting from the pooling of scattered authorities (although the budgetary authorities would obviously be different, the costs for implementing and running a Community Agency would clearly be lower than those related to the set of existing national/sub national licensing authorities).

During the consultation phase however, Member States unanimously and firmly rejected any such delegation of power to the Community sphere. Again, given that this scenario is clearly unacceptable for all Member States, the principle of proportionate analysis suggests not furthering this option, which is therefore also discarded.

Simplifying and approximating national licensing schemes (option 5)

On the basis of the above discussion, it appears that there is hardly any room for a Community instrument that would not maintain the principle where licences are issued on a national level basis. Similarly, it emerged during the consultation phase that the overall prevailing level of security interests protection should be maintained. Concretely, this implies that any facilitation of EU transfers should be complemented by measures fostering a climate of mutual confidence in the capacity of the recipient companies to respect possible export restrictions and, where appropriate, to provide evidence of such respect to their competent authorities.

Taking into account these prerequisites and constraints, there remains however substantial scope for rationalising and simplifying the currently complex and heterogeneous regulatory framework, whilst preserving the pursued legitimate security objectives. These simplification elements pertain to:

- the type of licence issued (A),

- the guarantees provided concerning the reliability of the recipients (B),

- the guarantees provided concerning the management of re-exportation to third countries (C).

Type of licence issued (option 5 A x )

Currently most national licensing schemes primarily rely on individual licences, which are granted on request to authorise specific shipments in specific quantities concerning specified products to a precisely-identified recipient. Given their more restrictive nature, such individual licences are by far the most burdensome (and hence costly) type of licence. Moving towards a more systematic use of global or general licences[28] would prompt substantial reductions in administrative costs associated to such controls.

A Community instrument could therefore stipulate that Member States use :

- general licences (A1) or

- global licences (A2) or

- a combination of general and global licences (A3).

Guarantees concerning the reliability of the recipients (option 5 B y )

For national control authorities, the reliability of a recipient is first and foremost gauged at the light of its capacity to prevent undesired re-exportation to third parties or to demonstrate that it is the end-user of the transferred product.

Recipients of defence-related products belong to two different categories:

- Member States’ defence ministries buying arms, munitions, war material, plus related services (such as maintenance, repair including relevant spare parts and overhaul). As end-users, public contracting authorities in the EU are by definition reliable.

- Integrating companies: these usually produce large weapon systems incorporating components sourced from a supplier possibly located in another Member State (e.g connectors to be incorporated in an aircraft). The final destination of the resulting equipment may not be in the EU. The reliability of the company thus becomes a crucial issue.

Moving away from the concept of individual licences necessarily implies a lower level of monitoring on individual consignments and, in the case of general licences, no prior identification of the recipients. Indeed, when it comes to transferring components under a general licence, the national authority, at the time it issues it, ignores which company will finally receive components covered by the licence nor does it know the final destination of the system incorporating the component. In order to preserve the degree of security under a simplified framework, the authority of the country of origin needs “guaranties” as regards the “reliability” of the recipient companies (e.g.: provide information on the end-user, comply with possible restrictions on the transferred component etc…).

This ‘quality insurance’ could be formalised in the form of the certification of the recipient companies , which would address issues such as:

- proven experience and reputation as producer or integrator of defence material,

- proven record of compliance to Community and national export rules, as well as all specific conditions related to end-use and re-exportation of received component or product,

- implementation and documentation of appropriate internal control programmes and structures (for example the appointment of a dedicated high-level executive officer, covering in particular export management controls),

- implementation and documentation of appropriate risk prevention measures to protect goods and technology (including intangible goods).

Whilst no certification at EU level represents the status quo (B1), certification of recipient companies of defence material could be made uniformly mandatory at EU level (B2). During the consultation phase, it however emerged that certain stakeholders were reluctant to impose mandatory certification to all defence companies, fearing that such a scheme would generate disproportionate administrative burden.

An alternative option would be to leave certification voluntary, but with some kind of associated ‘reward’. Conceptually, a defence certification is a means for a company to provide credentials as a trustworthy defence operator. Hence the logical idea of linking certification with the general licensing scheme, where the recipient company is unknown a priori to the authorities issuing the said licence (B3). Indeed, such reinforced guarantees associated to certification will provide an additional incentive to Member States to make the widest possible use of general licence, which is by far the least burdensome licensing scheme. As end-users, EU public contracting authorities provide satisfactory security guarantees, thus justifying the opening of general licensing for transfers to EU procuring governments.

Guarantees concerning the management of re-exportation to third countries (option 5 C z )

The fundamental issue here is to give satisfactory assurance to the country of origin of a transferred product that the conditions that it might have attached to the transfer (e.g. “ do not re-export the transferred product to countries X, Y and W without my prior consent ”, “ do not re-export to any third country the transferred component unless integrated into another product in such a way that it is not detachable ”) will be respected by the recipient companies, should the product (or the component integrated into a more complex product) be re-exported. It is also important to keep in mind that most components lose their identity and/or sensitivity when integrated in larger systems, thus “deleting” the responsibility of the country originating the components.

Current controls on transferred components widely vary among Member States. As to the re-exportation of the final product, certain Member States largely delegate their responsibility to the country where the exporter is located. This is all the more acceptable that all EU Member States are coordinating their export policies in the framework of the EU Code of conduct on arms exports and have committed themselves to make this Code legally-binding as soon as some interpretative issues are clarified. By contrast, some other Member States explicitly require to be consulted, especially when the transferred component makes a substantial part of the final product. Different national practices can be explained by different transparency obligations and a different level of confidence towards receiving countries and companies.

There are basically two policy options to address this issue:

- reporting and ex-post enquiries (C1) : the recipient of a transferred good would be required by Community law to inform its authorities on the respect of any export limitation attached to the product it intends to export outside the EU. Member States should implement effective enforcement measures to ensure that recipient companies are respecting any possible export limitation enacted by the Member State of origin before applying for an export licence.

- double control with the implementation of an IT traceability system (C2) : A central database, accessible by the Member States authorities (including the customs authorities) would keep track of all licences and their eventual restrictions[29].

Summary of options

Option 1 | No action (business-as-usual scenario) |

Option 2 | Non-legislative measures, taking the form of an interpretative Communication on Article 296 or actions aiming at exchanging best practices DISCARDED |

Legislative instrument |

Option 3 | Complete liberalisation of all defence-related products transfers DISCARDED |

Option 4 | Management of intra-community transfers at EU level via an Agency DISCARDED |

Option 5 | Simplification and approximation of national licensing schemes |

Licence | Certification | Re-exportation |

A1: General licence only A2: Global licence only A3: Global or general licence | B1: No certification scheme at EU level B2: Mandatory for all recipients of a transfer B3: Optional certification: only certified companies (and EU governments) can source material transferred under a general licence | C1: Regulatory information requirements C2: Traceability system based on a centralized database |

Note : Option 5 is made up of one of the sub-options for each column (A x +B y +C z ). Sub-option B3 however conceptually only makes sense when combined with sub-option A3 – All other combinations are possible.

Legislative option Licence Certification Re-exportation | [pic] |

ANALYSIS OF IMPACT

Despite the theoretically wide set of possible options, it emerged from the analysis made in the previous chapter that, when bringing into the picture the constraints pertaining to the related overarching security dimension of the issue, the range of ‘politically acceptable’ options is significantly narrower. This chapter will evaluate the main direct and indirect incidences, from the social, environmental and economic perspectives, of the various sub-options that could frame a possible EU initiative for facilitating intra-Community transfers of defence-related products, compared with the business-as-usual scenario of ‘doing nothing’.

It should be stressed at the outset that, when it comes to defence and security matters or protection of human rights issues, “informed political judgement” will always continue taking precedence over purely economic quantification and optimization.

No EU initiative

Direct and indirect costs associated to the existing obstacles to intra-community transfers

The cost for preparing, submitting, and managing the 11.400 annual licence requests for intra-Community transfers represents a good proxy of the administrative burden associated to the current patchy regulatory landscape. Annex 2 (section E §1) provides the methodology, assumptions and detailed calculations for assessing the corresponding burden, which has been assessed at the level of € 433 million / year (respectively € 251 mio for industry and € 182 mio for the public authorities).

However, indirect costs by far surpass such direct costs. Various studies have tried to assess this “cost of non-Europe”. The study carried out by Unisys for the European Commission in 2005 has estimated this indirect impact to be close to € 2.73 billion / year (see annex 2 for details and comparison with other publicly available material).

Likely industrial developments

As noted earlier, refraining from tackling intra-Community transfers of defence-related products at Community level does not necessarily imply the persistence of the status quo :

- individual Member States, in particular those pursuing a pro-active Better Regulation agenda, keep all latitude to simplify their own licensing schemes. Such national simplifications however will not fundamentally improve the current fragmented and patchy EU regulatory pattern, hence making no contribution to the EDEM development;

- one can not fully exclude that (ongoing or future) initiatives developed in an intergovernmental context could achieve a genuine facilitation of transfers between a limited number of participating countries (potentially embracing third countries). Experience with such intergovernmental arrangements however shows that:

- progress is extremely slow: albeit the most ambitious attempt to simplify transfers, the six-country LoI process has yet shown no tangible results despite its signature in 2000 and its full implementation since 2003.

- the potential of extending them to other EU Member States (especially the new ones) is very weak, since they have been designed for the specific needs of big producing countries and have high political barriers for newcomers. The LoI is indeed a comprehensive arrangement covering six different areas which are normally only of interest to producer countries. For potential candidate Member States, the political trade-off for joining the LoI solely to benefit from lighter transfer procedures is therefore high. It is therefore not astonishing that no other Member State has to date officially applied for joining the LoI club.

Consequently, whilst no breakthrough is to be expected in the short term, the most likely path of development in the medium to long term is a scenario where one of several clusters of trusted countries (e.g. the LoI) deal with the issue of transfers. As a result, deprived of the benefits of facilitated trade, industries located outside those “restricted clubs” will de facto be further marginalised, for example when it comes to biding for participation in cooperative programmes. Such situation would hinder the exploitation of all European competencies and niche expertise (in particular those located in new Member States).

Excluded Member States will continue to see little complementary incentive to buy European defence-related products given that (a) their defence industry companies (mostly SME) will be less integrated in major defence programmes, and (b) the absence of any greater security of supply compared to alternative third country suppliers. This would go against reinforcing European solidarity as advocated, for instance, by the EDA[30]. On the contrary, the uncertainty for procuring authorities as to whether export licences are granted would continue to be a major obstacle for suppliers to access other defence markets in the EU: this uncertainty could still be used to discriminate non-national suppliers and thus have a negative impact on the effectiveness of the proposed defence procurement Directive.

The umbrella communication entitled “A Strategy for a stronger and more competitive European Defence Industry" provides an in-depth analysis of the rather bleak prognosis for the EU defence sector in the absence of appropriate policy measures to curb the “business-as-usual” scenario. It inter alia concludes that European industry will lose competitiveness and its role could be reduced to that of niche players and suppliers to mostly non-European prime contractors thereby jeopardising the industrial capacities to autonomously develop the capabilities needed for the European security and defence policy. Any such exclusion from the highest value-added market segments would also hit the returns available from European defence companies creating difficulties in attracting investment in competition with other, more profitable economic sectors.

Social impact

The cumulated effect of (i) increasing productivity and (ii) stagnating (or decreasing) government defence budgets (and thus purchases of equipment) experienced over the last 15 years is definitively not favourable to long-term employment in the sector.

The medium to long term trajectory for EU jobs derives by and large from the industrial policy scenario described above. If not halted, the progressive erosion of EU industry’s competitive edge will ineluctably negatively influence both the level and the quality of employment in the sector. In this regard, the current fragmentation of the Internal Market (and the protection that national firms and contractors continue enjoying) rather contributes to delay and damp the structural adjustments that would otherwise take place, should the sector be subject to more conventional internal market rules.

Given the level of uncertainty linked to the influence of external parameters (e.g. deterioration of the international climate, break up of crisis), quantification of social impacts would however constitute a highly speculative exercise.

Impact on the environment

There is anecdotic evidence of possible environmental impacts that can be directly attributed to intra-community barriers[31]. Preventive oversized stocks built up to anticipate possible breaks in the supply chain when a specific material (the equipment itself, its spare parts and its ammunitions) is purchased in another Member State no doubt also tend to duplication of material indirectly implying a sub-optimal use of environmental resources. However, such impacts are deemed to be extremely marginal when compared to the overall “environmental footprint” of the defence sector (production of the defence product, training of the troops operating it, maintenance of the equipment, not to mention its possible use in operational conditions). It is therefore reasonable to assume the overall environmental impact of defence activities is primarily linked to the ‘consumption’ of military material (and hence to the global evolution of military budgets) and, as a second order parameter, to the evolution of the turnover of the corresponding EU industry (European companies’ market share is expected to grow both domestically and on third markets if its products are technologically up-to-date and competitive). Given the rather thin indirect relationship with intra-community transfers, the matter is not further investigated, and it can be safely concluded that no significant environmental net impact is to be expected from any Community action - or lack of action - as regards the facilitation of intra-community transfers.

EU legislative initiative to facilitate intra-community transfers

Facilitating intra-community transfers of defence-related goods is presumed to improve security of supply for procuring EU Member States and positively contribute to the EDTIB competitiveness by allowing better conditions for industrial specialisation, secured and smooth-operating supply chains and economies of scale.

Under this section, the cost efficiency of the various sub-options identified in Chapter 5 as regards the facilitation means (type of licence) and the guarantees (certification and re-exportation control) will be screened in detail. As for their social and environmental impacts, the analysis nevertheless remains at a more aggregated level, without distinguishing between these sub-options.

Social and environmental impacts

By itself, the removal of barriers to intra-community barriers is unlikely to lead to any significant direct impact of the level of employment:

- for national administrations: the shift from individual to global / general licences will undoubtedly lighten the administration’s routine management of intra-community transfers. However, as requests for intra-community transfer overall only represent about 1/3 of all licence requests (exports to third countries should in principle remain unaffected by the new Community instrument), reallocation of staff in the corresponding departments is expected to remain limited. It is more likely that resources freed from routine handling of intra-community transfers will be fruitfully re-affected to the handling of the most sensible exports.

- for defence companies: a simplification of intra-community transfers will mechanically reduce the need to prepare submissions for obtaining individual licences. Whilst some reduction in the corresponding clerical needs might be observed, the most significant impact is expected to be the reduction in executive time diversion (paperwork, contacts and negotiations with competent authorities). Consequently, the net impact on employment is deemed to be very low.

By contrast, indirect impacts are expected to be more significant, notably in the medium and long term. The macroeconomic reasoning underpinning the internal market for goods is by and large transposable mutatis mutandis to defence-related goods. The creation of a pan-European Defence and Technological Industrial Base could in the short term lead to rationalisation of structures, and hence, job cuts in redundant programmes and in poorly-competitive companies that mainly owe their survival to the fragmentation of markets along national line. Certain uncompetitive locations might have to close, causing unemployment and other economic and social costs in the country/location concerned. Steps would need to be taken at national level in order to mitigate the social costs for the loosing companies and regions and their workers, for example through industrial policy and labour market measures. Such restructuring is however a prerequisite for keeping the EU defence industry abreast of technological developments, a necessary condition both for being able to face the competition of new entrants (Brazil, India…) and to avoid any further widening of the technological gap with its most advanced competitors (notably the US). The reinforcement of its competitiveness would in turn better profile it both on the domestic market and on third markets.

An outlook can be inferred from the civil aeronautic sector where employment grew following successful consolidation (Airbus for large aircrafts, ATR for turbo propellers, Eurocopter for helicopters…). Such comparison must however be viewed with some caution as the European civil aeronautic sector benefited at the same time from a steady global demand. Restructuring nevertheless enabled the sector to efficiently meet such demand in a context of fierce competition.

Quantification of the net impact is extremely difficult in military matters because the overall social impact depends on many more decisive factors, the combination of which is hardly predictable (procurement, state aids, ongoing redundancy of weapons programs or rationalisation, evolution of military budgets…). A major international crisis, for example, could boost defence budgets. In other words, defence markets are driven by a great variety of factors, which makes it by definition almost impossible to measure the economic impact of one specific legislative measure in one isolated area.

As already explained above, no significant environmental net impact is to be expected from any action - or lack of action - of the Community as regards the facilitation of intra-community transfers.

Easier outsourcing for the main benefit of SMEs

It is widely acknowledged that EU SME’s current industrial defence capabilities are not fully exploited. Among the factors explaining such under-exploitation are the long delays needed for reorganizing supply chains and the lack of mutual awareness of both suppliers and system integrators (whose working methods and legal obligations have long compelled to domestic-oriented outlooks). But burdens on transfers however also play a role. Smoother and more predictable transfers will incite defence system integrators to outsource the production of certain sub-components to specialised SMEs with niche capabilities rather than to resort to in-house developments. In terms of regional distribution, such outsourcing by system integrators to subcontractors could not only benefit to EU-15 small defence-industry Member States but also represent genuine opportunities for SMEs located in the new Member States. For instance, niche capabilities in these new Member States have now emerged as subcontractor in the civil aeronautics sector.

Furthermore, SMEs are expected to greatly benefit from facilitated intra-EU transfers: SMEs are indeed typically disproportionately affected by licensing burdens, given, that they have more limited resources and expertise to tackle with complex rules.

Foreign trade impact

A comparative advantage to EU defence-related products in terms of security of supply

Facilitating intra-community transfers could provide European system integrators with a further incentive to work with EU rather than third-country suppliers because of the improved guarantee on security of supply when they source components in the EU. This would be consistent with current efforts of some EU defence companies to promote “ITAR-free” defence items in order to elude the complexity and restrictive impacts of US ITAR rules, and thereby enlarge their access potential on third markets (see also 3.2.6). This is also mirrored in the EU governments’ new momentum looking for greater autonomy[32].

The ITAR burden mostly lies in complete systems

It has been objected that facilitated intra-EU transfers could bump against ITAR restrictions, thereby damping the facilitation potential. However, ITAR rules essentially concern final weapons systems that account for a slight minority of intra-EU transfers (the probability that a transferred good includes a US ITAR-flagged component grows with the number of components and technologies that it integrates, and is thus higher for complete weapon systems). Conversely, transfers of components are little affected by ITAR rules (unless the component itself stems from an US supplier).

Type of licence

In spite of isolated simplification initiatives undertaken at national level, the bulk of intra-community transfer licences remains largely based on individual licences. Imposing lighter authorisation schemes would substantially reduce the corresponding administrative burden, whilst meeting the legitimate security objectives.

Option A1: general licence only

General licenses, or national general authorisations, provide for a simplified procedure for the export of controlled goods to certain destinations. Such licences are promulgated in a legal or administrative general act. The scope, the possible use conditions and any potential destination restriction are specified within the license itself. Any exporter fulfilling the prescribed conditions can avail itself of the authorisation to perform the corresponding transfer without further prior administrative demarche.

Interviews with the Member States have shown that most countries do not provide for this type of license and that some of those which have foreseen this type of licence do not use it in practice. The United Kingdom, however, is widely implementing general licensing for military goods under Open General Export Licences (OGELs). These OGEL allow the export of specified controlled items by any exporter, removing the need for them to apply for an individual licence, provided the shipment and destinations are eligible and the conditions[33] are met. All OGELs remain in force until they are revoked.

Under this scenario, general licences would de facto substitute the more than 11.000 annual licences associated to intra-community transfers (if we ignore the occurrences of clearly identified transfers where Member States would still invoke - and duly justify - an exemption under Article 296 of the Treaty).

On the other hand, the preparation, adoption and enforcement of general licenses also involve some legislative and enforcement costs both for national authorities as well as certain compliance costs for companies. Given on the one hand the variety of legal and administrative traditions in Member States and, on the other hand, the impossibility to foresee at this stage the degree of details and the number of such general licences, quantification of this legal and administrative work is hardly possible.. The corresponding costs are however deemed to be negligible in comparison with the current bulk of individual licences’ applications and processes.

Consequently, the direct gain for industry can broadly be assimilated to the administrative burden associated to the corresponding individual licences (see option 1), i.e. an annual benefit capped at € 251 mio . minus the cost of implementing possible additional control provisions linked to general licensing (e.g. notification to the authorities at the first time a company makes use of a general licence, requirement to affix to the transport document a reference to the specific general licence used for that shipment for the customs authorities, recordkeeping obligations, etc).

As far as public authorities as concerned, the potential annual gain would be in the area of € 182 mio minus the regulatory / legislative work associated to drafting and publication of those general licences. The shift from individual prior authorisations to a general “prior consent regime” might also entail some slightly higher control and enforcement costs (for example at the customs point).

This option of general licensing only might raise proportionality issues for those Member States having a limited defence industry sector, as the obligation to issue a set of general licences might indeed exceed the cost of issuing individual licences.

Another question mark relates to the ability of such general scheme to satisfactory cover any transfer of defence-related products, notably the most sensitive ones. As a matter of fact, at the time it issues a general licence, the national authority ignores a priori the identity of the recipients of the products covered by the licence. A framework relying exclusively on general licences does not seem to provide Member States with the necessary flexibility when it comes to discriminating recipient companies according to the guarantee they offer against possible misuses or re-exportation of the transferred products. As a consequence, such a scenario could lead to a non-negligible rate of cases where Member States would invoke the exceptions provided under Article 296.

Option A2: global licence only

Global licences are company-specific prior authorisations for shipping specific products (typically the products listed in the company’s catalogue) to one or several specified recipients. Their main simplification potential resides in the fact that they are not specific to a precise shipment and thus can be used several times to covers similar transfers. Global licences are typically not associated to quantitative limits and are valid over a relatively long period (typically 2 or 3 years). They are particularly helpful in the case of routine shipments of equipments to habitual customers or for SMEs with a limited catalogue.

Experience in certain Member States has shown the substantial simplification potential of global licences schemes. France has for example introduced in 2002 the option of global licences based on the catalogue of the participating companies (targeting more specifically SMEs). The first 35 licences delivered replaced not less than 1.250 individual licences, thus representing a red-tape cut by a ratio of 36. Similarly, during the preparatory phase, Romania quoted its national experience where 7 global licences have replaced over 700 individual licences.

The level of aggregation of publicly available data (notably via the annual report of EU Code of Conduct of Arms Exports) does not however provide the necessary elements to assess with reasonable accuracy the ‘compression rate’ achievable with the substitution of all individual licences by global licences. Such calculations would indeed require access to detailed confidential information about individual transfers. What can be reasonably assumed is that the red-tape gains will substantially differ according to each Member State. Logically, these gains will be minimal in those Member States that have already introduced - and are making a standard use of - such simplified global licence schemes, whilst a reduction of the number of licence by at least a factor 10 could reasonably be expected in those Member States starting from scratch. In this context, the assumption of a 50% reduction of the overall associated administrative burden appears to be a very conservative minimum figure.

The main drawbacks of this ‘global licences only’ scenario lie:

- in the risk that certain Member States define in such restrictive terms their global licences that these remain in essence very close to individual licences. There is nevertheless little reason to fear such abuses, as a Member State acting so would necessary place its own industry into a difficult competitive position for no reason;

- in the risk of obliging those Member States which are already making a wide use of general licence to backtracking.

Compared to option A1, a much more limited number of Article 296 case should arise given the higher potential of control available to Member States authorities under this scenario.

Option A3: combination of A1 and A2

This intermediary scenario presents the dual advantage of delivering the full benefits of the general licence option for routine non-sensitive intra-community transfers, whilst providing at the same time the necessary flexibility for Member States to handle more sensitive transfers. It also addresses the main drawbacks related to the mandatory ‘one size fits all’ models described in scenarios A1 and A2.

The exact ratio between global and general licences seems d