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Select Committee on Trade and Industry Minutes of Evidence

Annex B


Funding Source Fund TitleObjective of Funding Level of Funding
MoDPATHFINDERResearch and Technology Demonstration using:— Usual max. 50% of project costs which are let on a yearly basis.
     (a)The Applied Research Programme (ARP) Budget subject to change after the SDR.
     (b)The Corporate Research Programme (CRP) At the end of 1996, £24m worth of contracts let, with £20m in
     (c)Technology Demonstration Programmes (TDP) preparation
  Future Systems, Air-FS (Air) Miscellaneous—agreed on a case-by-case basis Variable-dependent on project
  Private Finance Initiative (PFI) Industry financed initiatives, with agreed pay-back downstream. (PFI allows HMG to defer major financial commitments for large projects). Limit is dependent on project
DTICARADThis is an initiative to promote R&T for civil and some dual use aerospace applications. £20m pa. (£2.6m available for "Avionics and Mechanical Systems")
  Technology Foresight Foresight Action-to promote the aerospace sector R&T relating to the Technology Foresight initiative (originally part of CARAD which has insufficient budget-the new budget has yet to be identified). No separate budget allocated-still part of CARAD. Industry requires more than is available if the proposed Foresight Action projects are to start.
  Launch Aid To invest in R&T of UK civil aerospace strategic importance which cannot be funded by industry. (There must always be a long term business case). Dependent on project—can be>£200m eg Rolls-Royce for Trent development for A340-600 aircraft.
  Sector Challenge To improve competitiveness and long term profitability of business sectors eg Aerospace.
NOTE: This was a one-off programme.
N/A-a one off programme.
NB. The SBAC was awarded £1.5m for the Competitiveness Challenge which runs from June 1997 to May 2000.
  Local Challenge To enhance competitiveness by assisting local partnerships to design high quality business support services. Bids invited annually, usually for 3 years of funding. Typical award £TBD
Engineering and Physical Sciences Research Council (EPSRC) Integrated Aerospace Manufacture Programme To support high quality strategic and applied university research in response to the need for more innovative manufacturing within UK industry. -50% max of total project. No funding for Industrial Partners.
  UK Lean and Agile Aerospace Programme (Lean Aerospace Initiative (LAI)) To bring together the various strands of aerospace initiatives into a coherent umbrella framework based on emerging models of lean and agile (reduce time/cost) enterprises. DTI providing £50K to fund SBAC based programme manager.
EPSRC and Industry co-funding (50:50) Academia with -£400K
  LINKTo manage the transition between the research base and industry for the benefit of the UK economy. Total of £0.5M available via CARAD
DTI Local OfficesSMART—Small Firms Merit Award for Research & Technology To promote and fund technical or commercial feasibility studies for innovative projects lasting 6 to 18 months. All technology fields eligible. max. £45K. per award = 75% of eligible costs
  SPUR—Support for Products under Research To assist SMEs with the development of new products and processes which involve significant innovative technological advance. max. £150K per award = 30% of eligible costs
Civil Aviation Authority (CAA)   To research areas relating to regulatory issues. Low!

  Source:  SBAC.



  The UK aerospace and defence industries are amongst the primary users of ECGD facilities. Civil aerospace and defence together accounted for 62 per cent of ECGD's new business in 1999-2000. More than $450 million of support was given to Rolls-Royce's aerospace customers alone in 2000. Further support was extended to BAE SYSTEMS both in its own right and as part of the UK's contribution to the marketing and sale of Airbus products. The aerospace industry uses a number of ECGD products, including cover under the OECD's Large Aircraft Sector Understanding ("LASU") for commercial aerospace transactions and cover under the OECD's Commercial Interest Reference Rate ("CIRR") system for other exports.

  Export credit is a vital element in overseas sales of large commercial and military aerospace systems. ECGD represents the only viable means by which many large medium- and long-term overseas contracts receive support. All of the UK's major competitors and collaborators deploy similar mechanisms and any loss or degradation of the terms of UK support would have a serious affect on the UK aerospace industry.

  The UK Aerospace and defence industry is highly dependent on exports. In 1999, 60 per cent of total aerospace turnover was exported (nearly £12 billion), contributing £2.1 billion to the UK balance of trade. Indeed, the UK is perhaps the most export dependent of the major aerospace producing states. While the direct users of ECGD are large companies such as BAE SYSTEMS, Rolls-Royce and GKN-Westland, the business generated by their overseas sales has a direct impact on UK companies (including many SMEs) who constitute overall around two-thirds of their supply chain business. The availability of competitive export credit systems is also vital to maintaining the UK share of collaborative programmes such as Airbus where the Airbus company may begin to place work according to the support they receive in selling the end product.


  The full Mission and Status Review as finally published on 25 July 2000 but it left a number of significant areas open for further consultation including Business Principles, the revised Environmental Impact Assessments (now called Project Impact Questionnaires or "PIQs") and Capitalisation. Despite assurances from the TGovernment that reform to the ECGD system would not put UK exporters at a disadvantage, this is clearly not the case as can be seen from the examples below.

Changes to ECGD's products

  ECGD unilaterally introduced a differential pricing policy last year in relation to LASU funding. The agreed premium between export credit agencies ("ECAs") for commercial aircraft transactions is 50 basis points. ECGD withdrew from this agreement and now either charges a higher premium for those deals where it perceives the risks to warrant it or it lowers the supported amount to achieve the same result. This immediately affected a Rolls-Royce Airbus transaction that was in documentation with Sri Lanka and caused considerable embarrassment for both Airbus and Rolls-Royce with the other participating European ECAs as well as the customer when ECGD reduced the advance rate shortly before closing. In another Airbus transaction, involving an Irish leasing company, ECGD unilaterally increased the premium.

  A further unilateral change to LASU was announced in December 2000. As of 31 March 2001 ECGD will have withdrawn from the fixed interest rate hold arrangements that had provided UK customers with free interest rate options for up to three years prior to an aircraft delivery. UK companies were warned that this was being contemplated but had been reassured that it would not be implemented until 31 March 2002 to allow for alternative arrangements to be agreed. Neither of the other two European ECAs have followed suit. ECGD have tried to justify the withdrawal by saying that the options are expensive (yet at current market to market rates their book breaks even and the German ECA has actually made a profit on their hedging) and that the US EXIM does not offer them. The latter point is true but the US EXIM product is already a cheaper one and US exporters may also access tax-based export leases to support their products which UK exporters cannot. Qantas have told Rolls-Royce, for example, that they believed that the interest rate options merely kept the European product on a level playing field with the US one.

  It has long been a contentious issue that the three European ECAs will provide support for US engines in Airbus airframes in their pro-rata proportions. The two unilateral changes to LASU described above now mean that Airbus customers are better off minimising the portion of the UK export credit by buying US engines so that they can access a larger proportion of their cover on the original attractive terms from the French and German ECAs. This is a significant disadvantage for Rolls-Royce.

  For new contracts Airbus now has no certainty of an ECA mechanism to match the support offered by US EXIM. This is damaging Airbus's competitive position. Feedback from existing customers of Airbus is that they feel deceived by the planned changes to LASU announced by ECGD when no new ECA product has been agreed to replace it.

  The announced abolition of CIRR interest rate holds as of 31 March 2001 is another unilateral move by ECGD and will not be followed by other OECD countries in the near term. Two banks confirmed that they had already been refused fixed rates by ECGD on transactions that would qualify for them but had been given no official explanation as to why.

  In the defence and aerospace sectors projects as a rule require committed proposals to be submitted to customers many months before contracts are entered into. In the past ECGD has provided firm offers of support for such projects but have now indicated that their capitalisation structure will prevent them from giving such support in the future.

  The capitalisation structure will, it is believed, lead to pre-set capital limits being applied to particular territories, irrespective of credit considerations. If this occurs it will penalise large projects in particular, including those from the defence and aerospace sectors.

  The changes to ECGD's products appear to be primarily driven by ECGD's pending capitalisation and a requirement not only to break even (which is what international agreements require of all ECAs) but to make sufficient profit to pay a return on that capital. So far ECGD has refused to divulge at what level the return on capital will be set. This is very important as it will drive the premium levels that ECGD will charge. We understand that the break even assessment is to be carried out on a three-year rolling basis which is not appropriate for the long-term cyclical nature of the exporting business and goes against the recommendations of the Mission and Status Review.

  There is also a concern that the imposition of ECGD's bureaucratic "hurdles" on certain Customers—including governments—where administrative resources might not be readily available—may cause those Customers to shy away from even making an Application; and yet on a prima facie basis the project would have been one which ECGD and the UK Government would very likely have wished to have been associated with. An example would be the planned acquisition of two BAE SYSTEMS Regional Jets ("RJs") by the National Airline of Bhutan, Druk Air. Air transport is a vital communications/trade link for Bhutan to the outside world and the Avro RJ is the only aircraft capable of operating in the country.

  Following an explanation as to ECGD's requirements for supporting documentation, the Bhutanese have not submitted an Application.

  UK companies have also been advised that ECGD's dummy run of the capitalisation will not run in parallel with the current scheme, as they had previously told, but will replace it as of 31 March 2001 and that the consultation process that should have been in hand prior to the implementation will not take place until the middle of this year ie after the scheme has been implemented. ECGD has tried to reassure exporters that this is a "trial" and is therefore capable of being changed. Unfortunately ECGD's record to date of immediate implementation of new or modified requirements that then remain as originally instated, despite repeated representations by exporters, leads us to believe that once in place it will remain cast in stone.

Changes to ECGD's processes

  ECGD unilaterally increased the number of countries on the Highly Indebted Poorer Countries list in the middle of last year adding 20 new ones including jurisdictions such as Sri Lanka and Kenya. This means that UK exporters to those countries now have to go through a longer approval process including input from DfID, FCO and HMT and demonstrating for example that the ECGD support is for "productive expenditure". These are not hurdles that the UK's overseas competitors have to jump and no other country has yet followed suit.


  The aerospace industry is making every effort to reduce the environmental impact of air travel. Technological developments over the last two decades have already led to substantial improvements in noise levels and fuel efficiency. The latter has also led to reductions in CO2 emissions. The industry world-wide is seeking to make further improvements, especially in emissions control and noise. By its very nature, however, civil aviation is a global issue and lessening its environmental impact involves many other parties such as the airlines, airport operators and air traffic control services, as well as the manufacturing sector.

  The multi-sectoral, international nature of the problem has led the SBAC to join the Royal Aeronautical Society, the British Air Transport Association and the Air Operators Association to investigate the environmental impact of aviation and to recommend solutions. At an international level, the European aerospace trade association, AECMA and its US counterpart, AIA, have also identified the environment as a key area for joint action.

  Unilateral action on the part the UK Government or any UK agency would not only threaten the competitiveness of the UK civil aviation industry, including the aerospace industry, but would be largely nugatory. Internationally operating carriers could circumvent increased fuel taxes and might damage their ability to pay for new, greener equipment. The UK aerospace industry does not seek to evade its responsibility for environmental improvement merely to ensure that regulation and taxation is covered by an enforceable and internationally agreed regime. In this respect, the International Civil Aviation Organisation (ICAO) is the most appropriate forum for international decisions on civil aviation environmental regulation.

  ECGD undertook a consultation process on their business plan in November 2000 but UK companies received no feedback to their input and the principles were published in very much their original form. These do not place sufficient emphasis upon either UK exports or UK jobs although they do clearly reflect the Government's ethical foreign policy objectives which now form a large part of ECGD's new Mission Statement.


  The main comparable organisations to the ECGD are the US EXIMBANK, Coface (France) and Hermes (Germany). BAE SYSTEMS Regional Jet products also face very difficult competition from Brazilian and Canadian companies who are aggressively supported by export credit packages from their Government agencies. Generalised comparisons of competitiveness are not possible, as terms and conditions vary deal by deal. EXIMBANK are generally a cheaper alternative than ECGD and the other European ECAs but they charge an up front premium which is usually added into the financing cost. It is also possible to securitise EXIM transactions and pass the financial benefit on to the customer so they have that added benefit. This is not possible on Airbus deals where three agencies are involved and has only been done once where ECGD was there on their own. Additionally US exporters have access to export lease products which UK exporters do not so they have an attractive alternative to EXIM to fall back on subsidised by the IRS rather than the Treasury.

  It also appears that applying for EXIM is simpler and less bureaucratic than the ECGD's procedures. Experience suggests that ECGD is now by far the most time-consuming. Aerospace deals are exempt from some requirements, eg Project Impact Questionnaires, but ECGD's extended list of HIPCs does affect aerospace transaction to those countries and necessitates a demonstration that the supported equipment qualifies as "productive" expenditure. As yet, none of the other OECD ECAs have yet to follow suit.

  EXIM does not deal with defence goods, the support for those is dealt with by another US government department, so they do not suffer the adverse publicity that ECGD may attract in supporting military sales. This also means that defence manufacturers in the US seeking support do not have to jump through the same ethical foreign policy/sustainable development hoops that UK exporters of defence equipment seeking ECGD support must face.


    —  Postponing the abolition of LASU fixed rate options for 12 months would enable workable alternatives to be discussed and implemented. UK firms will lose business if this is not addressed now. The Airbus/Rolls-Royce deal with Qantas is a prime example.

    —  Representations need to be made to ECGD and the DTI in relation to setting a realistic return on capital rate for ECGD that will enable premium rates to remain competitive.

    —  ECGD's ability to offer support for large projects, and to provide firm offers of support prior to contact signature should not be compromised by the proposed capitalisation structure.

    —  No further unilateral changes should be imposed by ECGD as UK exporters have already been significantly disadvantaged by the number of stealth changes that have been implemented over the past 12-18 months.


  In your pre-Budget Statement last November, you announced you were considering proposals to extend research and development tax credits in the upcoming March Budget. Further to the discussion that we had on that subject on 29 November last year, between yourself and the Director General of the Engineers' Employers' Federation, I am writing to expand on the benefits to UK Aerospace of extending the current system to include medium and large companies, and why we believe this would greatly help an important—and growing—part of the UK's world-class aerospace industry.

  I should first reiterate that we very much welcome the R&D tax credit for SMEs which you introduced last April. While it is too soon to see exactly how many companies will make use of this facility in this its first financial year of operation, we are sure that the credit will go some way to addressing the seriously low levels of R&D spending among SMEs in aerospace.

  We recognise that the trade association has a key role to play in ensuring the success of this policy by promoting it within the industry. On this point you will be pleased to note that in addition to the regular seminars that we hold advising SMEs of European R&D funding sources, we have now decided to establish a R&D helpdesk which will enable SMEs to source and access funds such as R&D tax credits.

  Research and development is perhaps the most critical factor in ensuring the continued success of UK Aerospace, as Ken Maciver, Executive Vice-President of TRW and President of the SBAC, recently highlighted before the Trade and Industry Select Committee:

    "The absolutely fundamental issue in determining whether this country has a continuing successful aerospace industry is that the technology is based here."

  Without the UK's heavy up-front commitment to the R&D phase of many large-scale projects, such as the Eurofighter, the A380 and the JSF, UK aerospace would not now be at the forefront of the industry's major developments.

  Despite the criticality of R&D, however, the UK's R&D spend has fallen dramatically in the last 20 years, compared with steep rises in the R&D budgets of our competitors. By 1997, France's R&D spending in aerospace was double the UK's, and Germany's almost 50 per cent more [see Annex]. As a consequence, UK aerospace is living off the results of past investment in new technology. There is an increasing risk that companies will focus core research activities in countries with a more supportive regime.

  It is within this context that the Society especially welcomed the Government's R&D tax credits for SMEs last April. However, the problem of under-investment in R&D in UK Aerospace, indeed in the entire manufacturing base, is not restricted to SMEs. In fact, SBAC figures clearly highlight a significant under-investment in R&D for all companies with turnovers under £100 million [see annex].

  Companies above SMEs but with turnovers under £100 million, namely those companies that would stand to benefit from an extension of the R&D tax credit, spend only 4 per cent of turnover on R&D—down from 6 per cent three years ago. By contrast, those companies with a turnover in excess of £100 million increased their R&D spend from 10 per cent to 12 per cent turnover. An extension of R&D tax credits to this specific part of the industry would go a long way to improving the overall climate for R&D investment in UK Aerospace.

  This picture of under-investment in R&D is taking place alongside two important associated trends: firstly, the drive to stimulate competitiveness and consolidation throughout the supply chain; and secondly the increasing disparities in R&D spending and support between the UK and its key competitors.

  Firstly, the drive to improve competitiveness throughout the industry has fundamentally altered the relationship between the primes and their suppliers. Primes are increasing pressures on suppliers to provide more technologically sophisticated and integrated products at a more competitive price, with concomitant increases in risk and investment.

  Richard Wood, Managing Director of Weston Aerospace, one of the companies which would benefit from a tax extension, observes:

    "Customers are coming to us expecting to have technology on the shelf. If we do not have technology on the shelf we simply do not get the opportunity to bid."

  But despite these pressures to increase R&D spend, R&D spend for these medium-sized companies has fallen by 44 per cent in the last four years alone [see Annex].

  The need to cut costs and provide complete solutions has intensified the pressure to consolidate. Aerospace primes across the world are reducing the number of suppliers they deal with. BAE SYSTEMS, for instance, aims to reduce its supply chain for the Eurofighter programme from 340 to 25 in three years.

  This ongoing process of consolidation has a number of implications for R&D investment. Firstly, rationalisation inevitably brings pressure on profit margins, making R&D especially vulnerable to cost-cutting exercises. R&D is a soft target, where short-term cost savings will reap long-term damage.

  In particular, the research and technology aspects of R&D, which form the more abstract but still essential research base on which future development programmes are based, are especially susceptible to cost-cutting:

    "Any areas of R&D that were being done "ex gratia" as it were will no longer be done due to the harsh business environment. Smaller companies are especially nervous about investing in an area where the return is unclear and far off." Sean O'Connor, Chief Executive, CJ Fox & Sons

  Another effect of consolidation is that as SMEs merge and grow, so many of them drop out of the technical SME bracket, rendering them ineligible for R&D tax credits. A look at the SBAC's membership clearly demonstrates that over the past two years alone the number of companies moving out of the SME bracket has been substantial. The consequence of this trend is that the technical definition of an SME is applying to a smaller and smaller proportion of the industry. In effect, the invaluable R&D tax support is in danger of becoming redundant. We are therefore asking that R&D tax credits develop in line with the industry.

  Against this backdrop it is important to appreciate the impact of the increased mobility of capital over the last five years. International acquisitions and mergers are creating transnational aerospace companies with a global reach and matching commercial strategies. Aerospace companies now have a choice where to locate investment. As in other key knowledge-driven industries, government policies and choices will have a decisive impact on the future of UK aerospace.

  However, despite the importance of R&D to the industry and the key role played by Government, the UK's R&D support is widely accepted as amongst the lowest in the global aerospace community. A recent study by the Conference Board of Canada concluded that the US, Canada and France all had a more favourable treatment of R&D support than the UK. [see EEF Budget submission[3]]. With high capital mobility, the consequences are dramatic. Research by the EEF and the FEI all point to the mobility of R&D activities of international companies and to the role that tax incentives play in their decisions.

  The fall in R&D support explains in part the decline in R&D spend in UK aerospace compared with our competitors. Between 1980 and 1998, UK aerospace R&D fell in real terms by 45 per cent. In France and the USA, R&D rose by 33 per cent, and in Germany by 196 per cent. In 1980 the UK spent around 50 per cent more on R&D than France, and three times Germany. But now both countries heavily outstrip the UK's spending [see Annex]. R&D in aerospace has a characteristically long cycle before the benefits are felt. The full consequences of these stark disparities in national R&D spending will only be fully felt over the coming years.

  National R&D support is provided through a variety of mechanisms. However, studies by the OECD, the Institute for Fiscal Studies and the National Bureau of Economic Research all point to the effectiveness of tax incentives in raising R&D expenditure. The availability of secure, long-term fiscal support will provide companies with a strong platform on which to build a sustained high-value R&D strategy. R&D activities are characteristically very labour-intensive. Reliable fiscal support will encourage companies to invest in high-value long-term jobs, as one such medium-sized company told us:

    "Our specific need is to train graduates in product design and application engineering. Tax credits would encourage us to recruit and train more graduate engineers and other key laboratory staff which would enable us to match the staffing levels in French and US companies. The tax credit would have to be long-term to support such a commitment to R&D overhead and product development." Douglas Dunbar, Managing Director, Muirhead Aerospace

  The labour intensity of R&D activities also plays a part in minimising the impact on the Treasury of supporting R&D. A 50 per cent incremental tax credit for R&D spending by large firms would have very little cost for Exchequer, particularly after allowing for the increased income tax and national insurance revenues that would result from increased spending on R&D, which is very labour intensive.

  We believe that extending R&D tax credits to the growing but crucial middle section of the supply chain will help plug the gap in the industry's world-class R&D capability—at an affordable cost to the Treasury. Furthermore, raising R&D levels in aerospace is entirely consistent with your Government's key fiscal objective to promote sustainable investment in our economy.

  I hope you will find this information useful and relevant in relation to the upcoming Budget. Of course, I welcome any comments or further dialogue with the Treasury on how we can together build on the success of UK's aerospace industry.

5 February 2001

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