Commission staff working document accompanying document to the interpretative communication on the application of Article 296 of the Treaty in the field of defence procurement Impact assessment {COM(2006) 779 final} {SEC(2006) 1555}
Date: 2006-12-07
Institutions: European Commission
Subjects: European arms policy, application of EU law, arms industry, arms trade, award of contract, impact study, public contract

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 7.12.2006 
SEC(2006) 1554 

COMMISSION STAFF WORKING DOCUMENT  

Accompanying document to the 

INTERPRETATIVE COMMUNICATION 

on the application of Article 296 of the Treaty in the field of defence procurement  

Impact assessment 

{COM(2006) 779 final} 
{SEC(2006) 1555} 

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IMPACT ASSESSMENT 

0. 

1. 

Procedural issues and consultation of interested parties .............................................. 3 

Background information and problem definition......................................................... 4 

1.1. 

Background information .............................................................................................. 4 

1.1.1.  Specificities of defence markets................................................................................... 4 

1.1.2.  Market fragmentation................................................................................................... 4 

1.1.3.  Defence spending ......................................................................................................... 5 

1.1.4. 

Industrial landscape...................................................................................................... 8 

1.1.5.  Procurement law........................................................................................................... 9 

1.2. 

Problem definition........................................................................................................ 9 

1.2.1.  Specific problem: extensive use of Article 296 ........................................................... 9 

1.2.2.  Causes of the problem................................................................................................ 10 

1.2.3.  Consequences of the problem .................................................................................... 10 

2. 

3. 

4. 

4.1. 

4.2. 

4.3. 

4.4. 

4.5. 

5. 

5.1. 

5.2. 

5.3. 

5.4. 

5.5. 

6. 

7. 

Objectives................................................................................................................... 11 

Subsidiarity ................................................................................................................ 11 

Policy options............................................................................................................. 11 

Option 1: No action at Community level ................................................................... 11 

Option 2: Revision of the 1958 list ............................................................................ 12 

Option 3: Specifying "essential security interests" .................................................... 12 

Option 4: Clarifying the use of Article 296 by an Interpretative Communication .... 13 

Conclusion.................................................................................................................. 13 

Analysis of the impact................................................................................................ 13 

Legal impact............................................................................................................... 13 

Economic and financial impact.................................................................................. 13 

Impact on competitiveness......................................................................................... 14 

Impact on administrative costs................................................................................... 14 

Political aand institional impact ................................................................................. 14 

monitoring and evaluation.......................................................................................... 15 

Conclusion.................................................................................................................. 15 

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INTRODUCTION 

The present Impact Assessment accompanies the draft "Interpretative Communication on the 
application of Article 296 of the Treaty in the field of defence procurement". The study first 
recalls the context of the Commission's current initiatives in the field of defence procurement. 
The analytical part starts with a description of the situation in Europe's defence markets, with 
a  special  focus  on  market  fragmentation  and  its  negative  consequences.  This  serves  as  the 
background  for  the  identification  of  the  problem  and  the  definition  of  the  Commission's 
objectives. In the following part, various options for tackling the problem are discussed and 
the impact of an Interpretative Communication assessed. The focus of this Impact Assessment 
lies  on  the  problem  analysis,  the  objectives  and  the  policy  options.  It  remains  essentially 
qualitative. 

0. 

PROCEDURAL ISSUES AND CONSULTATION OF INTERESTED PARTIES 

In 2003, the Commission issued a Communication "European defence – Industrial and market 
issues – Towards an EU defence equipment policy",1 which launched a set of seven initiatives 
aimed at gradually setting up a European Defence Equipment Market (EDEM) in support of 
the European Security and Defence Policy (ESDP). 

In  the  area  of  defence  procurement,  this  led  to  the  publication  in  2004  of  a  Green  Paper2 
which invited stakeholders to comment on options for enhancing transparency and openness 
of defence markets between EU Member States. In parallel a series of meetings and contacts 
took  place.  At  the  end  of  the  consultation  period,  40  contributions  were  received,  including 
from 16 Member States, European institutions (Parliament), bodies (the Economic and Social 
Committee)  and  agencies  (Institute  of  Security  Studies,  European  Defence  Agency), 
representative  organisations  of  industries  (UNICE,  ASD  Aeronautic  Space  and  Defence 
Industries Association of Europe), and experts in the field. 

The  findings  of  the  Green  Paper  consultation,  published  in  a  Communication  in  December 
2005,3 confirmed that the legal framework for defence procurement at European level is not 
working  properly.  This  leads  in  particular  to  an  extensive  use  of  Article  296  TEC,  which 
allows  Member  states  to  exempt  defence  procurement  from  community  rules  if  this  is 
necessary  for  the  protection  of  their  essential  security  interests.  According  to  stakeholders, 
there are mainly two reasons for this: 

1) the conditions for the use of Article 296 TEC are not clear, 

2) the current Public Procurement Directive is ill-suited to many defence contracts. 

Based  on  these  findings,  the  Communication  announced  two  further  initiatives:  an 
Interpretative Communication to clarify the conditions for the  use of Article  296 TEC, and, 
considering  that  a  clarification  may  not  be  sufficient,  a  possible  new  sector-specific 
procurement Directive adapted to the specificities of defence contracts. 

According to the principles of better regulation, both initiatives will be accompanied by the 
relevant Impact Assessments: 

1 
2 
3 

COM(2003) 113, 11 March 2003. 
COM(2004) 608, 23 September 2004. 
COM(2005) 626, 6 December 2005. 

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–  the present Impact Assessment accompanies the Interpretative Communication. It analyses 
in  particular  how  the  conditions  for  the  use  of  Article  296  TEC  can  be  clarified,  and 
whether such clarification can enhance the openness of defence markets. 

–  a  further  Impact  Assessment  will  be  completed  for  the  beginning  of  2007,  prior  to  any 
decision to undertake the drafting of a specific directive. It will ask in particular whether 
new,  defence  specific  European  procurement  rules  can  improve  compliance  with  the 
Treaty  and  enhance  intra-European  competition  for  defence  contracts  not  covered  by 
Article 296 TEC. Studies aimed at collecting facts and figures on the administrative costs 
and economic benefits of a directive have been outsourced and are currently ongoing. The 
findings of those studies will be integrated into the future Impact Assessment. 

The Interpretative Communication on the application of Article 296 TEC will be adopted by 
the  end  of  2006.  A  proposal  for  a  defence  specific  directive  could  be  drafted  by  the  end  of 
2007, subject to the outcome of the future Impact Assessment. 

1. 

BACKGROUND INFORMATION AND PROBLEM DEFINITION 

Defence procurement law is one element of defence markets. The following section gives an 
overview  of  the  characteristics  and  problems  of  European  defence  markets,  before  entering 
into the main issue of the present Impact assessment, namely the use of Article 296 TEC and 
its implications for the openness of defence markets in the EU.  

1.1.  Background information 

1.1.1.  Specificities of defence markets 

Defence  markets  cover  a  broad  spectrum  of  products  and  services,  ranging  from  non-war 
material,  such  as  office  equipment  and  catering,  to  complex  weapon  systems  and  highly 
sensitive  material,  such  as  nuclear,  biological  and  chemical  equipment.  The  sensitivity  of 
defence equipment for Member States' security interests can vary depending on political and 
military circumstances. In general, however, its sensitivity is proportional to its technological 
and strategic importance. 

At the upper end of the technological spectrum, weapon systems are often developed for the 
specific  demands  of  a  very  small  number  of  customers.  These  systems  normally  have  long 
development and life cycles and high non-recurring costs. This, in turn, makes it necessary for 
governments of producing countries to bear a large share of research and development costs. 

Given  the  importance  of  military  equipment  for  security,  national  governments  play  a 
predominant role in the organisation and operation of defence markets. As sole clients, they 
determine  the  demand  for  products  and  thus  define  both  the  size  of  the  market  and  the 
technological  portfolio  of  the  industry.  As  regulators,  they  control  arms  trade  via  export 
licences and shape the way companies operate and organise themselves. State control can also 
include industrial restructuring and ownership. In many cases, States are still shareholders in 
defence  companies  and/or  hold  "golden  shares",  which  provide  influence  over  strategic 
business decisions. 

1.1.2.  Market fragmentation 

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Defence expenditure in the EU is worth about €170 billion (1.7% of GDP),4 which includes 
about €82 billion for defence procurement in general and about €30 billion for the acquisition 
of new equipment. Most of this expenditure is split into relatively small and closed national 
markets; fragmentation at national level remains the main feature of Europe's defence sector:  

(1) 

(2) 

(3) 

on  the  demand  side,  25  national  customers  have  great  difficulties  in  harmonising 
their  military  requirements  and  pooling  their  purchasing  power  into  common 
procurement projects; 

the  regulatory  framework  consists  of  25  different  sets  of  national  rules  and 
procedures for all relevant areas (exports, transfers, procurement, etc.), plus specific 
arrangements for cooperative programmes; 

on the supply side, defence industries remain fragmented along the lines of (national) 
market structures. 

Given the relatively small size of Europe's defence markets, this fragmentation is increasingly 
problematic. It is generally regarded as a costly and inefficient obstacle to both competition 
and  cooperation.  It  hinders  industry  from  restructuring  and  cooperating  across  national 
borders, accessing other EU markets and reaching production volumes big enough to remain 
competitive. This, in turn, makes it difficult for governments to maintain a sound and viable 
Defence  Industrial  and  Technological  Base  (DTIB),  but  also  to  develop  the  military 
capabilities necessary for implementing the ESDP.  

The  growing  awareness  of  these  problems  has  led  to  various  initiatives  under  both  the  first 
and the second pillar: in March 2003, the Commission launched seven Community initiatives 
in  defence-related  areas  (standardisation,  intra-Community  transfers,  mapping/monitoring, 
research, public procurement, export of dual-use goods and competition). All these initiatives 
are aimed at supporting the gradual establishment of a European Defence Equipment Market. 
A few months later, at the European Council meeting in Thessaloniki, Member States decided 
to create an intergovernmental agency to support the development of military capabilities in 
the framework of the ESDP. This European Defence Agency (EDA) was set up in July 2004, 
working  in  particular  on  military  capabilities,  armaments  cooperation,  research  and 
technology, and defence industrial and market issues. 

1.1.3.  Defence spending 

Defence expenditure in the European Union is not only limited, but also unevenly distributed 
across the EU Member States. The four Member States with the largest defence procurement 
budget in nominal terms - UK, FR, DE, IT - account for approximately €61 billion, which is 
around  75%  of  overall  defence  procurement  in  the  EU.  On  the  other  hand,  the  combined 
defence procurement of the ten new Member States amounts to little more than 3.3% of the 
total  for  the  EU25.  The  large  differences  in  the  nominal  values  of  defence  procurement  are 
related to the size of the economy, but also to diverging political priorities.  

Figure 1: National defence procurement 20045 

4 
5 

Source: ESTAT and Commission calculations. 
Source: ESTAT; calculations by DG MARKT. 

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9
,
9
5
1
.
8
2

30.000,0

25.000,0

20.000,0

15.000,0

10.000,0

5.000,0

0,0

€

.
l
l
i

m

0
,
8
3
9
.
5
1

0
,
0
1
1
.
1
1

Defence procurement

0
,
5
9
9
.
5

0
,
3
0
3
.
4

0
,
8
4
3
.
3

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1
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1
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3

0
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4
9
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1

7
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6
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0
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2
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9
6
7

0
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4
5
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5
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7
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7
1

5
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9

4
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8
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2

3
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3
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1
1

0
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5
0
1

9
,
8
8

9
,
4
6

3
,
5
1

United Kingdom

Germany
France

Italy

Spain
Greece
Denmark
Netherlands
Sweden

Finland

Belgium

Austria
Portugal

Hungary
Poland
Ireland
Luxembourg
Czech Republic

Slovakia

Slovenia

Cyprus
Lithuania

Estonia

Latvia

Malta

Table  1  shows  that  most  EU  Member  States  spend  less  than  1%  of  GDP  on  defence 
procurement. Only in the UK, SE and HE is the share higher (ranging from 1.2% to 1.6% of 
GDP). Moreover, considerable differences exist between the four largest countries, the share 
being three times higher in the UK and two times higher in FR than in DE or IT. Last but not 
least,  the  ratio  between  defence  procurement  expenditure  and  GDP  does  not  change  much 
over time. Even in those countries where the absolute value of defence procurement increased 
considerably  between  2001  and  2004  (like  the  UK),  the  defence  expenditure/GDP  ratio 
remained fairly constant. Thus the development of defence procurement appears to be closely 
connected to changes in GDP. 

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Table 1: Defence procurement in the EU6 

Defence procurement 

(mill. of current EUR) 

Defence procurement 

(percentage of GDP) 

2000 

2001 

2002 

2003 

2004 

2000 

2001 

2002 

2003 

2004 

United Kingdom 

27.909,1  25.268,8  26.670,1  27.803,7  28.159,9 

1,8%  1,6%  1,6%  1,7%  1,6% 

France 

Germany 

Italy 

Spain 

Sweden 

   13.190,0  14.284,0  15.039,0  14.657,0  15.938,0 

   0,9%  1,0%  1,0%  0,9%  1,0% 

11.050,0  11.160,0  11.440,0  11.250,0  11.110,0 

0,5%  0,5%  0,5%  0,5%  0,5% 

5.616,0 

5.871,0 

6.036,0 

7.601,0 

5.995,0 

   0,5%  0,5%  0,5%  0,6%  0,4% 

2.633,0 

2.887,0 

3.419,0 

3.700,0 

4.303,0 

0,4%  0,4%  0,5%  0,5%  0,5% 

4.079,6 

3.645,1 

3.545,2 

3.457,6 

3.348,0 

   1,6%  1,5%  1,4%  1,3%  1,2% 

Netherlands 

3.189,0 

3.136,0 

3.027,0 

3.086,0 

3.101,0 

0,8%  0,7%  0,7%  0,6%  0,6% 

Greece 

Denmark 

Finland 

Belgium 

Austria 

Portugal 

Ireland 

Luxembourg 

4.308,1 

3.204,0 

3.727,0 

3.115,0 

1.940,0 

   3,4%  2,4%  2,6%  2,0%  1,2% 

1.281,5 

1.457,3 

1.403,4 

1.423,7 

1.518,7 

0,7%  0,8%  0,8%  0,8%  0,8% 

1.162,0 

1.087,0 

1.196,0 

1.315,0 

1.497,0 

   0,9%  0,8%  0,8%  0,9%  1,0% 

931,7 

706,7 

749,4 

158,2 

15,1 

952,8 

635,0 

584,0 

229,0 

14,1 

899,4 

649,5 

443,1 

170,8 

17,9 

804,6 

711,3 

423,5 

152,9 

19,1 

804,6 

0,4%  0,4%  0,3%  0,3%  0,3% 

769,2 

   0,3%  0,3%  0,3%  0,3%  0,3% 

454,0 

0,6%  0,5%  0,3%  0,3%  0,3% 

158,5 

   0,2%  0,2%  0,1%  0,1%  0,1% 

17,7 

0,1%  0,1%  0,1%  0,1%  0,1% 

EU-15 Total 

   76.979,4  74.415,1  77.683,4  79.520,4  79.114,6 

EU-15 Average 

Poland 

Czech Republic 

Hungary 

Slovakia 

Slovenia 

Cyprus 

Lithuania 

Estonia 

Latvia 

Malta 

NMS-10 Total 
NMS-10 
Average 

EU-25 Total 

EU-25 Average 

1.042,4 

856,1 

474,4 

284,1 

133,5 

218,1 

111,9 

89,7 

50,1 

9,4 

905,5 

593,4 

486,5 

205,4 

153,3 

115,3 

105,0 

88,9 

64,9 

15,3 

3.269,7 

2.733,5 

   82.790,1  81.848,1 

0,9%  0,8%  0,8%  0,8%  0,8% 

0,5%  0,4% 

1,1%  0,7% 

0,6%  0,6% 

1,0%  0,6% 

0,5%  0,6% 

1,9%  0,9% 

0,7%  0,6% 

1,1%  1,0% 

0,5%  0,6% 

0,2%  0,4% 

0,7%  0,6% 

0,8%  0,8% 

Differences  between  countries  are  even  more  striking  when  it  comes  to  military  R&D 
spending (see Table 2). In 2001, the combined R&D budget in DE, FR and UK accounted for 
more than 90% of overall R&D expenditure in the EU15; for the six signatories of the Letter-

6 

Source:  ESTAT;  calculations  by  DG  MARKT.*  For  Belgium,  no  data  was  available  for  2004. 
However, the values for the previous year (2003) can serve as a conservative estimate for procurement 
in 2004. 

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of-Intent (LoI)7 Framework Agreement – FR, DE, IT, ES, SE and UK – the share is almost 
99%. 

Table 2: Military R&D spending8 

Military R&D Spending 
(mill of current national currency)
1998
2,619
3,580
1,551
587
218
1,618
109
25
11
11
4
1
39
0
0

1999
2,488
2,674
1,161
274
156
790
58
19
9
12
4
2
33
0
0

2000
2,197
2,454
1,044
175
141
763
53
19
8
6
3
1
6
0
0

2001
2,158
2,512
1,027
232
139
757
52
21
8
6
3
1
6
0
0

Military R&D Spending 
(mill of current EUR)

1998
4,165
3,580
1,551
587
218
177
109
25
11
11
4
1
5
0
0

10,443
696

1999
3,595
2,674
1,161
274
156
87
58
19
9
12
4
2
4
0
0

8,056
537

2000
3,237
2,454
1,044
175
141
84
53
19
8
6
3
1
1
0
0

7,226
482

2001
3,184
2,512
1,027
232
139
82
52
21
8
6
3
1
1
0
0

7,268
485

Military R&D 
(in ‰ of GDP)
1999
2.62
1.96
0.58
0.25
0.28
0.37
0.16
0.13
0.04
0.10
0.03
0.01
0.03
0.00
0.00

2000
2.07
1.70
0.51
0.15
0.22
0.32
0.13
0.12
0.04
0.05
0.03
0.00
0.00
0.00
0.00

2001
1.99
1.68
0.49
0.19
0.20
0.34
0.12
0.12
0.04
0.05
0.03
0.00
0.00
0.00
0.00

1998
3.27
2.72
0.79
0.55
0.41
0.80
0.31
0.18
0.06
0.09
0.04
0.00
0.03
0.00
0.00

0.09

0.07

0.06

0.05

United Kingdom
France
Germany
Italy
Spain
Sweden
Netherlands
Greece
Austria 
Finland
Portugal 
Belgium
Denmark
Ireland
Luxembourg

EU-15 Total
EU-15 Average

1.1.4.  Industrial landscape 

The  high  concentration  of  R&D  spending  is  directly  related  to  the  distribution  of  defence 
industrial  capabilities,  with  the  six  LoI  countries  representing  more  than  90%  of  European 
production.  In  particular,  research-intensive  high-technology  and  system 
integration 
capabilities  are  concentrated  in  the  LoI  countries,  whereas  many  other  Member  States  have 
only some small and technologically less sophisticated industrial capabilities. 

Driven by rising costs for complex weapon systems, on the one hand, and shrinking – or at 
best  stagnating  –  defence  budgets  on  the  other,  defence  industries  in  Europe  have  gone 
through  a  major  consolidation  process  over  the  last  10  years.  All  sectors  have  witnessed 
downsizing and restructuring, but only in aerospace and electronics have companies merged 
across  national  borders  (BAE  Systems,  Thales  and  EADS,  plus  a  dense  network  of  joint 
ventures). However, the fragmentation of the market makes it difficult for these companies to 
optimise  their  internal  processes  and  to  function  as  truly  transnational  companies.  In  naval 
and land armaments, consolidation is less advanced and cross-border industrial ties remain an 
exception.  

The  "right"  balance  between  consolidation  (necessary  to  reach  the  critical  mass  to  become 
competitive  on  a  global  scale)  and  competition  (desirable  to  avoid  the  negative  effects  of 
oligopolies  or  monopolies)  varies  between  the  sectors  and  depends  on  the  specific  market 
situation. It is generally agreed, however, that Member States' defence budgets are too small 
for them individually to maintain a viable industrial base. Access to other markets is therefore 
crucial  for  most  producers,  through  either  cooperation  (joint  programmes,  subcontracting, 

7 

8 

The Framework Agreement was signed in July 2000 between the six main arms producing countries in 
Europe.  It  is  an  international  Treaty  outside  the  EU  context  and  is  aimed  at  facilitating  cross-border 
cooperation and restructuring of defence industries. 
Source:  International  Institute  for  Strategic  Studies  (IISS);  calculations  by  DG  MARKT.  Data  was 
available  for  EU15  and  until  2001  only.  For  Euro  zone  countries,  “national  currency”  refers  to  “euro 
fixed” series. 

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etc.)  or  competition  (participation  in  foreign  tenders).  Here  again,  market  fragmentation 
becomes the major obstacle. 

The  existence  and  importance  of  defence  industrial  capabilities  are  also  key  determining 
factors  for  Member  States'  procurement  policies.  If  Member  States  have  the  industrial 
capabilities  within  their  territory  to  develop  and  produce  weapon  systems  they  need,  they 
normally give preference to local manufacturers (which can also be in foreign ownership). For 
low-tech products, many Member States have national capabilities and often pursue a policy 
of national preference. For complex systems, the situation is different: only the LoI countries 
have  the  necessary  assets  to  develop  (individually  or  collectively)  these  systems.  The  other 
Member States buy them off-the-shelf and on a competitive basis from non-national suppliers, 
often  from  the  United  States.  However,  this  does  not  mean  that  competition  is  necessarily 
transparent and fair, since procurement rules differ considerably between Member States, and 
procurement decisions are often influenced by political considerations with offsets playing a 
crucial role.9 

1.1.5.  Procurement law 

At Community level, there is – in contrast to other sectors such as energy or transport – no 
specific  directive  coordinating  national  procurement  rules  in  the  defence  sector.  It  is  thus 
Directive  2004/18/EC  on  the  procurement  of  goods,  works  and  services  which  applies  to 
public contracts awarded by authorities in the field of defence, subject to Article 296 of the 
Treaty.  

Article 296 TEC allows Member States to exempt the procurement of arms, ammunition and 
war  material  from  Community  rules,  if  this  is  necessary  for  the  protection  of  their  essential 
security interests.  

Defence  contracts  exempted  under  Article  296  TEC  are  awarded  on  the  basis  of  national 
legislation. For defence procurement, most national legislation provides for exemptions from 
the application of public procurement rules, with differing degrees of transparency. Defence 
specific  procurement  rules,  however,  differ  greatly  between  Member  States  with  regard  to 
publication  systems,  standards  for  technical  specifications,  selection  criteria,  tendering 
procedures  and  award  criteria.  On  top  of  that  come  special  procedures  for  cooperative 
programmes.  This  diversity  of  regulatory  frameworks  is  an  important  factor  in  Europe's 
market fragmentation.  

1.2. 

Problem definition 

The  previous  section  has  shown  that  fragmentation  of  defence  markets  in  the  EU  creates 
problems  with  major  financial  and  economic  consequences  in  a  variety  of  areas.  The 
following sections will focus on one area – defence procurement – and one specific problem, 
namely the extensive use of Article 296 TEC.  

1.2.1.  Specific problem: extensive use of Article 296 

9 

Offsets  are  compensations  that  governments  require  from  non-national  contractors  as  a  condition  for 
purchasing  defence  articles  or  services.  These  compensations  can  cover  a  wide  range  of  activities 
directly or indirectly related to the object of the procurement contract. Indirect offsets, in turn, can be 
defence related or non-defence related. 

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According  to  the  Court,  the  exemption  provided  under  Article  296  TEC  is  limited  to 
exceptional cases and does not lend itself to a wide interpretation. In practice, however, many 
Member  States  have  used  Article  296  TEC  extensively,  exempting  from  Community  rules 
also  defence  contracts  which  do  not  fulfil  the  conditions  for  the  use  of  Article  296  TEC, 
namely non-war material and equipment which does not concern essential security interests.  

One indicator for the extensive use of Article 296 TEC is the low publication rate for defence 
procurement (an average ratio of 10 between the value of defence contracts published in the 
OJEU and the total amount of defence procurement expenditure). Even more telling, however, 
are  the  great  differences  in  publication  rates  between  Member  States,  ranging  from  1%  to 
20%.  This  clearly  illustrates  that  (a)  Member  States  have  very  different  views  on  how  to 
interpret the possibility of exempting defence contracts from Community rules, and (b) many 
of  them  could  probably  use  the  exemption  more  restrictively  without  putting  their  essential 
security interests at risk. 

1.2.2.  Causes of the problem 

According to the findings of the Green Paper consultation, application of Article 296 TEC is 
problematic mainly for two reasons: 

(1) 

The conditions for the use of Article 296 TEC are not clear. There are several 
reasons for this: 

(a)  The concept of "essential security interests" is vague and can lead to different 

judgments on the strategic and military importance of equipment; 

(b)  Paragraph 2 of Article 296 TEC mentions a list of war material which can be 
exempted. However, this list is not very precise and has never been published 
or revised since it was established in 1958; 

©  New threats and technologies have blurred the dividing line between military 
and  non-military  security.  This  makes  the  decision  on  what  is  "defence"  and 
what is "essential for security" even more complex. 

As a result of all this, there is an important grey zone in defence markets where it is 
not  clear  whether  procurement  contracts  fulfil  the  conditions  for  the  use  of  Article 
296 TEC or not. 

(2) 

its  revised  version 
The  current  Public  Procurement  Directive,  even 
(2004/18/EC), is considered ill-suited to many defence contracts, since it does not 
take  into  account  defence  specific  features.  This  concerns  in  particular  the 
publication  system,  award  procedures  and  selection  criteria.  Consequently,  many 
Member States are reluctant to use the PP Directive for defence equipment. In order 
to  be  able  to  incorporate  those  special  features  in  defence  contracts,  they  declare 
them exempt from public procurement rules on the basis of Article 296 TEC, even if 
the conditions for the application of that provision are in fact not met. 

in 

1.2.3.  Consequences of the problem 

As a result of the excessive application of Article 296, the majority of defence contracts in the 
EU  are  awarded  on  the  basis  of  national  procurement  rules,  which  differ  greatly  between 
Member  States.  This  hampers  transparency  and  creates  extra  transaction  costs  for  foreign 

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bidders  (identification  of  calls  for  tender,  adaptation  to  local  contracting  conditions).  The 
result  is  less  openness  than  there  should  (and  could)  be  in  those  defence  market  segments 
which are de jure not covered by the exemption provided for in Article 296 TEC.  

This  has  a  negative  impact  for  both  the  supply  and  the  demand  side:  production  volumes 
remain  limited,  which  reduces  economies  of  scale  and  has  a  negative  impact  on  industries' 
competitiveness. For Member States, the lack of competition causes overspending in defence 
procurement. Higher prices for specific procurements, in turn, can lead to reductions of orders 
and, consequently, further reduction of production (either under the programme concerned or 
under other procurement programmes). Last but not least, lack of competition can also lead to 
lower  quality,  which  means  that  Europe's  armed  forces  risk  not  getting  the  best  value  for 
money.  

2. 

OBJECTIVES 

The  Commission's  overall  objective  is  gradually  to  establish  a  common  European  Defence 
Equipment Market (EDEM).  

The  Commission's  activities  in  the  area  of  defence  procurement  are  part  of  this  wider 
initiative. Their objective is to ensure compliance with the principles of the Treaty and foster 
transparency,  equality  of  treatment  and  non-discrimination  in  those  parts  of  the  defence 
markets where Community rules (should) apply.  

To achieve this objective, the Commission's policy is to make sure that the legal framework 
for  defence  procurement  at  Community  level  works  properly.  This  makes  it  necessary  to 
tackle the two causes of the problem, i.e. the lack of certainty regarding the scope of Article 
296 TEC and the lack of Community rules suited to defence procurement.  

As  a  first  step,  the  Commission  will  therefore  clarify  the  conditions  for  the  use  of  the 
exemption provided for by Article 296 TEC. The present Impact Assessment focuses on this 
initiative. 

3. 

SUBSIDIARITY 

As guardian of the Treaty, it is the Commission's duty to ensure compliance with European 
law.  This  is  also  the  case  for  Article  296  TEC  and  its  application  in  the  field  of  defence 
procurement. It is thus for the Commission to examine, if necessary, in specific procurement 
cases whether the conditions for the use of Article 296 TEC are met, but also to ensure that 
the provisions of that Article are applied throughout the Union. 

It is the Member States' prerogative to define their security interests and their duty to protect 
them.  However,  the  differences  in  their  way  of  using  the  exemption  from  Community rules 
show the need to clarify the legal framework at EU level and give some guidance on how to 
interpret Article 296 TEC. Given its role as guardian of the Treaty, only the Commission can 
do this. 

4. 

POLICY OPTIONS 

4.1.  Option 1: No action at Community level 

Without an initiative from the Commission, the only remaining initiatives to foster openness 
of  defence  markets  in  Europe  would  be  the  "Code  of  Conduct"  (CoC)  of  the  European 

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Defence Agency (EDA), which entered into force on 1 July 2006. The CoC is a non-legally 
binding  instrument  aimed  at  securing  greater  transparency  (through  publication  on  the  so-
called Electronic Bulletin Board) and accountability (through an obligation of reporting to the 
Steering Board of the Agency) for certain national procurement contracts covered by Article 
296 TEC.  

However,  the  scope  of  the  CoC  is  limited  to  certain  defence  equipment  covered  by  Article 
296 TEC. In other words, it applies only to contracts which are exempted from Community 
rules and does not clarify the conditions for the use of Article 296 TEC.  

Without action at Community level, the current uncertainty and all its negative consequences 
would thus persist. It therefore comes as no surprise that, in the Green Paper consultation, all 
stakeholders ruled out "no Community action" as an option. 

4.2.  Option 2: Revision of the 1958 list 

The list mentioned in Article 296(2) TEC includes military equipment to which the exemption 
can apply if the conditions for the use of that Article are met. Although the list has never been 
officially published, it is available in the public domain. It is generally acknowledged that this 
list  is  not  very  precise.  Moreover,  being  established  in  1958,  it  has  never  been  adapted  to 
technological developments and is therefore often considered somewhat outdated.  

In principle, the Commission could present a proposal for a more precise and possibly more 
exhaustive  list  in  order  to  better  define  the  scope  of  Article  296  TEC.  However,  the 
stakeholder consultation confirmed that this approach is not advisable:  

•  First, the Council would have to approve the Commission's proposal by unanimity, which 

seems unlikely, since many Member States see no need for a revision.  

•  An  updated  and  more  precise  list  on  which  all  25  Member  States  could  agree  could 
become  very  comprehensive,  since  each  Member  State  would  probably  try  to  include  as 
many (of its national industrial) products as possible in order to keep at least the option of 
exempting them from Community rules. A modification of the list could thus turn out to be 
counter-productive, potentially leading to even less intra-European competition.  

•  The more technological details a list contains, the sooner it would be outdated again. From 
that point of view, the vagueness of the current list is an advantage, since it allows for a 
flexible interpretation covering new technological developments. 

•  The  current  list  may  be  rather  generic,  but  it  clearly  includes  only  equipment  of  specific 
military nature and purpose. This appears sufficient to limit the type of equipment which 
can  be  exempted  on  the  basis  of  Article  296  TEC.  The  question  is  then  whether  an 
exemption is necessary to protect essential security interests. 

To  sum  up:  revision  of  the  1958  list  would  be  a  politically  difficult  and  awkward  exercise 
with high potential for an unsatisfactory outcome.  

4.3.  Option 3: Specifying "essential security interests" 

Another  possibility  to  clarify  the  conditions  for  the  use  of  Article  296  TEC  would  be  to 
establish a commonly agreed and precise definition of "essential security interests". However, 

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since defence policy is not a Community policy, it is the Member States' prerogative to define 
their essential security interests. It is therefore not within the Commission's remit to propose 
such specification.  

4.4.  Option 4: Clarifying the use of Article 296 by an Interpretative Communication 

Recalling the principles of the Treaty and the relevant case law of the Court, an Interpretative 
Communication can explain the conditions for the use of Article 296 TEC and give guidance 
to awarding authorities for assessing the applicability of the exemption. It can it make clear, in 
particular, that: 

•  the use of Article 296 TEC for the exemption of defence contracts from Community rules 

should be limited to exceptional cases; 

•  Article 296 TEC allows exemption from Community rules only for purely military items 
included  in  the  1958  list  and  only  if  the  exemption  is  necessary  for  the  protection  of  a 
Member State's essential security interests; 

•  it is within the competence of Member States to define and protect their security interests. 
To reconcile this prerogative with their Treaty obligations, they must assess carefully case 
by case whether the exemption is necessary; 

•  as guardian of the Treaty, the Commission may verify whether the conditions for the use of 
Article  296  TEC  are  fulfilled.  In  this  case,  Member  States  have  to  demonstrate  that  the 
exception from Community rules is necessary for the protection of their essential security 
interests. 

4.5.  Conclusion 

The Interpretative Communication is thus the only available instrument to shed some light on 
the conditions for the use of Article 296 TEC. It could be adopted by the Commission on its 
own.  Naturally,  consultation  of  the  Member  States  is  politically  desirable,  albeit  not 
mandatory. 

5. 

ANALYSIS OF THE IMPACT 

5.1.  Legal impact 

The Interpretative Communication clarifies the conditions for the use of the derogation under 
Article 296 TEC, as defined by the relevant case law.  

As a non-legislative measure, the Interpretative Communication does not modify existing law. 
It does not coordinate national procurement rules and thus does not contribute to rationalising 
Europe's fragmented regulatory framework.  

5.2.  Economic and financial impact 

The impact of the Interpretative Communication on the openness of defence markets probably 
varies between the various market segments: 

– 

for non-warlike products, the Interpretative Communication may have a significant 
impact.  Since  this  market  segment  lies  at  the  periphery  of  defence  markets  and 

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clearly outside the scope of Article 296 TEC, the Communication can give sufficient 
guidance  to  make  sure  that  contract  awarding  authorities  systematically  use  the 
existing  PP  Directive  for  such  contracts.  This  can  enhance  transparency  and 
openness  of  markets.  More  competition  certainly  results  in  better  value  for  money, 
since  this  market  segment  covers  a  broad  spectrum  of  goods  and  services,  ranging 
from  catering  and  cleaning  to  uniforms  and  construction.  However,  actual  cost 
savings  also  depend  on  a  more  rigorous  enforcement  policy  being  pursued  by  the 
Commission. 

– 

– 

for  warlike  items  not  concerning  essential  security  interests,  the  impact  is 
probably limited. Faced with the choice between the use of Article 296 TEC or the 
PP  Directive,  which  they  consider  ill-suited  to  the  procurement  of  most  military 
equipment, Member States may well try to interpret Article 296 TEC as broadly as 
possible  to  cover  all  warlike  items.  In  this  market  segment,  the  impact  on 
transparency and openness will therefore be modest.  

for  warlike  products  concerning  essential  security  interests,  the  impact  is  zero, 
because they fall within the scope of application of Article 296 TEC. 

5.3. 

Impact on competitiveness 

The Interpretative Communication would have an impact mainly on non-warlike items, which 
represent  normally  the  lower  end  of  the  technological  spectrum.  In  consequence,  it  would 
contribute little to the competitiveness of defence industries. 

5.4. 

Impact on administrative costs 

A  more  rigorous  implementation  of  existing  law  should  not  involve  organisational  or 
structural  changes  for  national  administrations.  Moreover,  a  case-by-case  assessment  of  the 
applicability of Article 296 TEC is probably very similar to verification of the applicability of 
the  CoC,  on  which  Member  States  have  already  agreed.  Administrative  costs  should 
consequently  be  close  to  zero.  The  same  is  true  for  industry,  which  will  be  only  indirectly 
concerned and will therefore not face additional administrative burdens. 

5.5. 

Political and institutional impact 

Explaining how to use Article 296 TEC, the Interpretative Communication is a useful adjunct 
both to the EDA's attempt via the CoC to increase transparency for defence market segments 
covered by Article 296 TEC, and to possible Commission measures to improve the suitability 
of Community rules to defence contracts not covered by Article 296 TEC.  

As  such,  the  Interpretative  Communication  contributes  to  better  functioning  of  the  legal 
framework surrounding defence procurement in Europe and constitutes an important step on 
the way towards a future European Defence Equipment Market.  

From  an  institutional  point  of  view,  the  Interpretative  Communication  is  also  useful  for 
establishing a clear distribution of responsibilities between the two pillars (EDA for defence 
contracts  to  which  Article  296  TEC  applies,  and  the  Commission  for  those  to  which 
community rules apply). Furthermore, the Communication demonstrates that the Commission 
plays  its  role  as  guardian  of  the  Treaty,  ensuring  compliance  with  the  provisions  of  Article 
296 TEC. 

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6. 

MONITORING AND EVALUATION 

The Commission, assisted by the Advisory Committee for Public Procurement, will monitor 
the  implementation  of  the  recommendations  set  out  in  the  Interpretative  Communication.  It 
will in particular: 

– 

– 

– 

– 

pay attention to developments in case law related to defence procurement, 

follow the evolution of the rate of publication as an indicator of transparency, 

continue its dialogue with the relevant stakeholders, 

verify,  in  the  case  of  complaints,  whether  the  use  of  the  exemption  is  justified  for 
specific procurement contracts. 

Moreover,  possible  exchange  of  information  on  the  use  of  Article  296  TEC  between  the 
Commission and the EDA, which has established a monitoring system in support of the CoC, 
may  also  be  useful  for  actively  monitoring  compliance  with  the  recommendations  in  the 
Communication.  

7. 

CONCLUSION 

Clarification  of  the  use  of  Article  296  TEC  is  a  necessary  first  step  towards  a  functioning 
legal framework for defence procurement at EU level. 

In particular, since the concept of essential security interests remains vague, the Interpretative 
Communication  cannot  clarify  ex  ante  to  which  procurement  contracts  Article  296  TEC 
applies.  However,  it  reduces  the  uncertainty  concerning  the  conditions  for  the  use  of  the 
exemption and gives guidance to awarding authorities on how to use the possibility to exempt. 
As such, it is a useful contribution to ensuring better compliance with EU law.  

A  Communication  should  be  able  to  limit  the  worst  cases  of  misuse  of  Article  296  TEC, 
namely the exemption of non-warlike material. However, it might not resolve the problem of 
equipment  which  is  of  military  nature,  but  which  does  not  (necessarily)  concern  essential 
security  interests.  As  long  as  the  use  of  the  current  PP  Directive  is  the  only  alternative, 
Member States might continue to exploit the flexibility which lies in the concept of essential 
security  interests  and  stick  to  an  extensive  interpretation  of  Article 296  TEC  for  this 
equipment.  A  new  Directive  adapted  to  the  specificities  of  defence  seems  an  appropriate 
instrument  to  tackle  this  problem.  The  Commission  will  therefore  continue  its  work  on  an 
Impact  Assessment  for  such  a  Directive  and,  subject  to  the  results  of  this  Assessment,  take 
further initiatives in 2007.  

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