Memorandum submitted by the Ministry of
Defence (January 2003)
INTRODUCTION
1. The Committee has indicated that it wishes
to take further evidence on the PPP in January 2003. In advance
of this it has requested information on a number of specific issues,
which are addressed in this memorandum.
Details of the arrangements being
negotiated with the Carlyle Group and the timescales involved.
This should include details of ownership and management control
of QinetiQ that will be exercised by the MoD, Carlyle and others
once the deal is in place.
2. Following public consultation in April-June
2000 the MoD announced that it would implement the Core Competence
model for the DERA PPP. This involved the creation of a new plc
(subsequently named "QinetiQ") containing around 75%
of DERA's assets and staff, with the rest being retained within
MoD to form the Defence Science and Technology Laboratory (Dstl)
Trading Fund. Following a period of shadow operation, during which
the arrangements and infrastructure for both organisations were
extensively tested, QinetiQ and Dstl were formally vested on 1
July 2001.
3. Both organisations were then given a
further period to settle into their roles whilst work continued
to prepare for the sale of a stake in QinetiQ. Following a review
carried out in conjunction with specialist advisers MoD announced
in February 2002 that it would pursue a strategic partnership
route as the way forward for QinetiQ rather than seek to float
the company directly on the stock market. Following an open competition
MoD announced in August 2002 that The Carlyle Group had been chosen
as preferred bidder to acquire a stake in QinetiQ and become MoD's
strategic partner. Detailed negotiations on the terms of the deal
took place between August and December, and signature of the legal
agreements was announced to Parliament on 5 December 2002.
4. At the point at which QinetiQ was created
as a plc, MoD put in place a compliance regime, enforced by a
special share, to protect UK defence and security interests. These
arrangements remain in place and are unaffected by the transaction
with the Carlyle Group.
5. In line with the Department's original
PPP objectives, MoD has negotiated a framework that allows its
strategic partner the freedoms necessary to help QinetiQ make
the most of the expertise and technology within the company, and
to make appropriate decisions to grow the value of the business.
Consequently under the provisions of the Shareholders' Agreement
with Carlyle MoD has explicitly determined that operational control
and responsibility for setting the future commercial strategy
for the business should lie with QinetiQ's management and with
Carlyle.
6. As part of the arrangements, MoD has
agreed to give Carlyle a voting majority and thus control of the
Board and the ability to change Directors and the Chairman. However,
MoD retains the right to ensure that Directors meet certain security
clearance requirements and have no conflicts of interest which
could prejudice QinetiQ's impartiality. MoD will also have the
right to appoint two non-executive Directors to monitor the MoD's
residual shareholding and, if needed, exercise the Government's
rights under the special share.
7. Although passing over control of the
company to Carlyle, MoD has sought to ensure that it retains a
substantial economic interest in QinetiQ in order to share in
the expected growth in the value of the company following the
initial sale. Consequently, as announced to Parliament on 5 December,
MoD will retain just over 62% of the financial interest in QinetiQ,
with Carlyle acquiring around 34% of the company. Around 4% of
the shares are available for QinetiQ's staff (the details of the
share scheme are described below). To protect the value of its
continuing stake in QinetiQ, MoD has also retained those protections
which would be conventional for a major shareholder. The legal
agreements identify a list of reserved areas (including: major
capital restructuring, disposal of material assets and potential
new corporate acquisitions) which could have a major impact on
the overall value of the company. In these areas decisions can
only be implemented with the mutual consent of both MoD and Carlyle.
8. As is normal in any major transaction
there are a number of conditions that must be satisfied between
signing and formal completion. These include: laying before Parliament
of a Departmental Minute describing any contingent liabilities
from the transaction; receipt of EC commission merger clearance;
local authority searches and other legal issues relating to property
and confirmation of the purchaser's financing arrangements. We
anticipate that all the conditions should be satisfied early in
the new year with formal completion taking place around the end
of January.
Changes in remuneration, share options and other
terms and conditions that have been introduced, or are being examined,
for QinetiQ's personnel (including specifically QinetiQ's senior
management).
9. Remuneration. Remuneration of
all directors were disclosed in QinetiQ's Annual Report. This
is now a matter for the company and Carlyle (as controlling shareholder).
It is not a matter for Ministers or the MoD. Future salaries will
be set in accordance with normal commercial criteria.
10. Although as a Trading Fund DERA had
some additional flexibility in relation to pay, it had experienced
difficulties in the past as a result of constraints which made
it difficult to attract staff with expertise in certain areas
of technology. In order to recruit and retain the calibre of staff
it needs to develop its position in the commercial market QinetiQ's
longer term aim is to offer a total remuneration package (which
includes pension benefits) which compares acceptably with the
bench-marked levels for its sector.
11. For QinetiQ's senior management (around
230 staff in total) there are three benchmark salary levels, depending
on their role and seniority. In addition, there is potential for
staff in these categories to receive a bonus of up to 25% of salary
for achieving their targets, plus another possible 25% for achieving
defined stretch targets. Higher levels of discretionary bonus
could also be paid.
12. Share Options. In accordance
with the Government's stated objectives for the PPP a share scheme
has been established which involves all staff within QinetiQ.
There are a number of separate elements to this scheme.
(a) Free Share Options. The scheme
will grant a small free share option worth £40 to all staff
at completion. This may be exercised when the Government and Carlyle
sell their shares, probably through a flotation, at which point
shares will be issued. The option ensures that all employees share
in the benefit of growth in the company between completion of
the sale to Carlyle and the time of a flotation.
(b) A Co-investment Scheme. At completion,
all staff (with the exception of the ten most senior executives)
will be able to purchase shares at the same price, and on largely
the same terms, as Carlyle. Staff will enjoy the same potential
for return on their investment as Carlyle and MoD. Employees will
be able to invest up to a defined limit, determined according
to their role in the organisation.
(c) Senior Management Incentive Scheme.
There is a separate scheme for the top 230 managers. At completion,
they may purchase shares which have the potential to provide high
returns if the company does well, but at the same time they are
exposed to a higher degree of risk than other employees. If the
company does not meet defined minimum growth targets, senior staff
will lose all of the money they have invested. The strong linkage
between this scheme and the value of the company means that senior
staff will only make significant gains if they have delivered
substantial growth in the value of MoD's retained stake in the
business.
13. At completion, the precise proportion
of the company's total share capital which will be allocated to
staff will depend on the extent to which employees choose to invest
in the various parts of the scheme. We anticipate that the total
fraction held by employees at completion will be around 4%.
14. Terms & Conditions. Staff
moving to QinetiQ from DERA at vesting were transferred under
TUPE legislation. The terms and conditions for these staff remain
therefore unchanged, though there are variations in these terms
and conditions reflecting historic differences between the various
organisations which came together to form DERA. Any subsequent
changes that QinetiQ wishes to implement will involve consultation
and negotiation with staff representatives and recognised Trades
Unions. Since its creation in 2001, QinetiQ has recruited a significant
number of new employees, who are offered a relatively standard
(with some variations possible) set of terms and conditions.
15. Terms and conditions for senior management
vary considerably, with terms being tailored to fit the individual's
role in QinetiQ. All new senior executive contracts must be approved
by the Remuneration Committee of the Board, and senior executives
all receive a standardised agreement detailing their individual
terms.
Options being considered for the longer-term status
and ownership of QinetiQ and in what timescales.
16. QinetiQ was established as a plc on
1 July 2001. Following the transaction it will be re-registered
as QinetiQ Ltd. As a result of the MoD's continuing interests
in the company it will, for Government accounting purposes, be
reported as a Self Financing Public Corporation. This classification
does not, however, affect the transfer of operational control
from the MoD to Carlyle and QinetiQ's management.
17. As previously announced, the MoD does
not intend to retain a financial stake in QinetiQ over the longer
term. The precise timing and route for the sale of its remaining
shares will depend on value for money considerations. However,
at present it is likely that this will occur through a flotation
of the company on the stock market within 3-5 years. The special
share protections are not time-limited and can continue to operate
even after a flotation.
The result of the exercise to identify intellectual
property rights and how they would be divided between Dstl, QinetiQ
and industry, and what areas are still to be resolved between
the relevant parties.
18. When DERA was split into Dstl and QinetiQ,
the Intellectual Property (IP) was essentially allocated between
the two organisations in accordance with the division of the individual
business streams and work programmes. The IP transferred from
MoD to QinetiQ has been agreed between interested parties and
is listed in three legal documents: the Patent Agreement, the
Trademark Assignment and the Crown Copyright Assignment.
19. Prior to the vesting of QinetiQ as a
plc MoD conducted a major programme (Records Audit and Segregation
(RASP)) to identify and segregate records of third party origins
and prevent QinetiQ from having continuing access to such information
unless it had a legitimate right to do so. The RASP process involved
the scrutiny by MoD of 160,000 records. As part of RASP a mechanism
has been put in place between MoD and industry to address any
issues relating to protection of third party IP. To date MoD has
received only two specific challenges to the RASP adjudications,
although one of these involves around 500 records. MoD is in contact
with the companies concerned to resolve these cases. QinetiQ has
a process to ensure that it does not attempt to exploit third-party
information that it does not own, or which may have been provided
to it as a result of its government status, unless this has been
agreed with the owner of the information. In common with all other
companies QinetiQ has a legal obligation not to make use of IP
which it does not have rights to exploit.
20. On request from third parties, we have
made details available of third-party owned information that has
remained with QinetiQ in support of MoD contracts; some companies
are carrying out a detailed review of these details. Only two
US companies have expressed any interest in receiving the details
but no direct reaction to the details contained in the lists has
been received from them.
21. Arrangements with QinetiQ for IP generated
since vesting will be the same as those adopted with any other
contractor carrying out similar work for MoD. These arrangements
will protect third parties' information and will allow MoD to
meet all its international and national obligations and, in particular,
ensure that technology continues to be available to bidders for
UK defence projects.
The main areas in which QinetiQ has a continuing
role as "Technical Authority" for MoD and the areas
in which industry (including US industry) have raised particular
concerns about this.
22. MoD will treat QinetiQ as any other
private sector supplier. Whilst MoD has no immediate plans to
delegate any of its responsibilities and powers to its suppliers
(including QinetiQ), MoD would not wish to give firm assurances
that it will not do so at some time in the future, since this
might restrict future procurement and support options. However,
should such steps be taken, it is likely that this would not be
restricted to QinetiQ but would be applicable to other suppliers
in appropriate circumstances. In keeping with MoD's current practice,
developments of this nature would certainly be discussed with
the parties concerned and affected.
23. Shortly after the formation of QinetiQ
an issue was raised by US industry in relation to the need for
approvals under the International Trafficking in Arms Regulations
(ITARs) for work in support of the Apache Helicopter programme.
The issue largely arose because MoD had no direct relationship
with Boeing (the original equipment manufacturer) as the procurement
by MoD was under licence from Westlands. Boeing were seeking to
ensure that there were formal agreements in place to protect US
proprietary information and therefore a process was put in place
to identify all such information contained within QinetiQ in their
role as technical advisers to the Authority. This included putting
in place a Non Disclosure Agreement (NDA).
24. UK industry has in the past raised a
concern about the potential for a conflict of interest if QinetiQ
were advising the Defence Procurement Agency (DPA) on a competitive
procurement where another Carlyle controlled company was one of
the bidders. This is not a new issue nor is it unique to QinetiQ.
It has been dealt with successfully in the past in cases where
there has been common ownership of an advisor to the DPA and a
bidder in a competition. In such cases DPA's policy, which will
continue to apply, is to ensure that they are satisfied that the
organisations operate independently with no scope for bias. The
safeguards established for QinetiQ, which include the establishment
by Carlyle of a separate investment vehicle for their shares in
QinetiQ, fully satisfy this requirement. If, however, the characteristics
of a specific competition meant that bidders were especially sensitive
to the involvement of QinetiQ then the DPA would consider whether
any additional measures were appropriate. Under these circumstances
it would be anticipated that they would wish to seek the views
of the other bidders. These protections are in addition to the
legal obligations enshrined in the special share, and backed by
significant penalties, that QinetiQ must at all times act impartially
in advising MoD.
How much MoD R&D work is exposed to competition
and how much is placed with QinetiQ without competiton, and the
MoD future plans for this mix. Also, the extent of any consultation
that takes place with QinetiQ in reaching decisions about what
programmes will be competed and which programme will be placed
with QinetiQ.
25. The Department began to open both the
Applied Research Programme (ARP) and the Corporate Research Programme
(CRP) to competition two years ago. Work which is placed with
Dstl, representing around 30% of the Research Building Block (RBB),
will not be subject to competition. In 2001-02 MoD spent £9m
of the RBB on competitively let work, and the target for the current
year is £18m (6% of the non-Dstl part of the RBB). Typically,
the amount placed through competitions will approximately double
every year for the next four to five years. By 2007 it is expected
that 70% of the non-Dstl part of the research programme will be
let competitively.
26. When determining which elements of the
research programme to compete, the MoD (principally the Research
Acquisition Organisation) makes the decision using its internal
processes (which include the use of Dstl) and does not use QinetiQ
in any form of consultative role about which programmes are competed
and which are placed with QinetiQ.
Any major long term contracts that have been awarded
to QinetiQ including those for use of its ranges and test facilities.
27. Prior to the formation of QinetiQ the
vast majority of MoD's research programmes were contracted directly
to DERA as part of the Department's CRP and ARP programmes. In
FY 01/02 the total combined value of these programmes was £416m
of which £245m went to QinetiQ. Generally projects within
the CRP and ARP do not extend beyond 3 years. As described above
these programmes are being progressively opened to competition
with much greater flexibility in the timing of contract placement
and programme duration.
28. With the exception of the new arrangements
(described below) for Ranges and Aircraft Test and Evaluation,
the bulk of QinetiQ's remaining non-research work for MoD comes
from a wide range of diverse sources including 147 Integrated
Project Teams and approximately 180 other customers within the
Department. A large proportion of these are of relatively short
duration and low value. Almost all of the work in these areas
has been available for competition for a number years.
29. Long-Term Partnering Agreement (LTPA)
for Ranges and Aircraft Test and Evaluation. On 1 March 2002
MoD announced that it had selected QinetiQ as preferred bidder
for the 25 year LTPA to run the MoD Test and Evaluation and Aircraft
Test and Evaluation Ranges. This followed a detailed review by
MoD customers of their current and likely future requirements.
The review concluded that placing a long term contract with QinetiQ
for the provision of these services was the option most likely
to deliver value for money and also to encourage the infrastructure
investment necessary to ensure that MoD's future requirements
would be met. Responsibility for negotiating a value for money
LTPA sits with the Facilities Team within the Defence Procurement
Agency. Heads of Terms have been agreed for the LTPA. It is expected
that detailed contractual negotiations will be concluded early
in the New Year and a contract placed to follow on from the current,
short-term facilities management contract with QinetiQ, which
expires in March 2003.
Any Consideration being given to the long-term
structure and status of Dstl, including its continued trading
fund status.
30. Dstl exists to provide independent,
high quality scientific and technological services to the UK Armed
Forces and Government, principally in areas inappropriate for
the private sector. Consequently, it will not directly compete
with industry for the provision of advice to MoD. Dstl has no
plans to move away from these aims, which are encapsulated in
its Framework Document and Corporate Plan, signed by Ministers
seven months after Dstl was created in July 2001. As a result,
it is unlikely that there will be significant changes to Dstl's
structure, unless the needs of MoD as a customer require significant
change in the capabilities within Dstl.
31. Following its formation, a review was
undertaken of Dstl's continuing role as part of MoD. The review
also considered the funding status of the organisation, and looked
at a range of options, including retaining its existing status
as a Trading Fund. The MoD and the Treasury concluded that continued
trading fund status, providing the correct incentives on Dstl,
which effectively acts as a supplier organisation, by subjecting
its relationship with MoD to a rigorous commercial framework that
aims to provide value for money and seeks to reduce costs was
the best model.
32. The Department will review Dstl on a
regular basis, at least every five years. The process for reviewing
agencies such as Dstl is driven by the Agency Service Delivery
Team, a part of the Cabinet Office. The MoD will follow the Cabinet
Office guidance, and the reviews will include an assessment of
all possible future options, including whether remaining a trading
fund best meets MoD's longer term needs. These reviews replace
the quinquennial reviews, which were formerly instigated by Treasury.
Details of any Dstl rationalisation/relocation
plans, any consequential site disposals and the possible impact
on Dstl staff. Also, any QinetiQ rationalisation/relocation plans,
site disposals and to whom disposal receipts would go.
33. Dstl. In July 2002 Ministers
approved Dstl's rationalisation plan to concentrate its activities
from the 15 locations it occupied at the time of the split from
QinetiQ, to three core sites—Portsdown Main, Fort Halstead
and Porton Down. This decision was taken after a rationalisation
study and an investment appraisal of six options ranging from
doing nothing to moving to one site only. All but two of the 15
sites are leased with break clauses and will be vacated, as accommodation
is made available at the core sites. It is planned to sell the
two freehold sites being vacated—an undeveloped plot at
Farnborough and Portsdown West.
34. Trades Unions have been consulted on
the agreed way forward, with a separate consultation exercise
with staff at Glasgow due to begin in January. The Trades Unions
provided a formal response to the proposals in September 2002.
Whilst highlighting their concern at the impact on staff, the
Unions have indicated that they will accept the proposals and
work with Dstl to enable the rationalisation programme to proceed
with the minimum of confrontation. Non-mobile staff will be offered
bulk-move relocation terms or civil service posts in their travel
to work area. Mobile staff will have to relocate, but the intention
is to retain as many as possible, if not all, existing personnel
and relocation packages under bulk move terms will be available.
35. QinetiQ. It was announced on
24 July 2002 that QinetiQ, as the preferred bidder for MoD's 25
year Long-Term Partnering Agreement (LTPA) for Ranges and Aircraft
Test and Evaluation, had identified three major rationalisation
proposals for the air ranges. The proposals are QinetiQ's response
to MoD setting challenging targets to ensure that the future T&E
structure is more closely aligned with MoD's requirement for T&E
capabilities.
36. QinetiQ's proposals involve: the conversion
of the Aberporth range to an instrumented training range, the
closure of Llanbedr Airfield, and the reduction to campaign operation
status of the West Freugh Range. MoD has approved the proposals
which will potentially deliver net savings in excess of £300
million across the life of the 25 year contract. Furthermore,
they will remove excess capacity, duplication and obsolete facilities
whilst transforming the T&E business into the effective, modern
organisation that we require.
37. The main QinetiQ sites being sold are
Chertsey, Aquila, West Drayton. As part of the PPP transaction
the majority of the proceeds after costs from the sale of Chertsey
and Aquila will pass directly back to MoD. The receipts from other
disposals will pass to QinetiQ unless the proceeds reach a level
which triggers the MoD's clawback provisions. As a major shareholder
in QinetiQ, MoD benefits from the value of any property sales
which are accrued by the company.
Progress in implementing the measures needed to
separate Dstl's and QinetiQ's staff, information systems and other
infrastructure.
38. QinetiQ and Dstl staff and accommodation
were physically separated to MoD's usual security accreditation
standards prior to vesting in July 2001. The two organisations
still share some sites, but there is complete separation of their
respective areas by physical and electronic access control measures.
QinetiQ staff cannot access Dstl areas and vice versa.
39. DERA's Information Systems were physically
separated in May 2001. MoD was fully involved in the drawing up
of the system architecture and provides security accreditation
for the systems. Data is physically separated on dedicated servers,
they continue to use the same Wide Area and Local Area Networks
infrastructure on shared sites, with firewalls protecting each
from the other and from external threats. Work is in progress
to provide a total physical separation of QinetiQ's Wide Area
and Local Area Networks and financial servers; this work is expected
to be complete by 31 March 2003.
40. Other infrastructure, such as telephones,
is maintained separately by each organisation.
What potential future liabilities the MoD retains
in terms of QinetiQ's facilities and staff.
41. Decisions on whether to retain liabilities
within Government were taken on value for money grounds and were
based on advice and discussions with specialist external advisers.
In general MoD's approach has been to retain a contingent liability
only in cases where this represents better overall value than
the alternative, which would be to accept a significant, and disproportionate,
reduction in the PPP receipt. The MoD has submitted three Departmental
Minutes to Parliament dated 4 December 2001, 8 July 2002 and 17
December 2002 respectively.
42. The first two Minutes inform of the
allocation of liabilities between QinetiQ and the MoD when QinetiQ
was vested as a company. The most recent minute describes the
indemnities/warranties provided by MoD to The Carlyle Group in
respect of specific liabilities relating to the QinetiQ business.
Such warranties are a normal requirement for transactions of this
nature, MoD has given few absolute warranties to Carlyle and in
general is only liable if it was aware of a potential liability
and failed to provide Carlyle with the appropriate information.
A copy of each of the Departmental Minutes is annex A.
The latest position on the initiative to identify
and agree "Towers of Excellence".
43. In the 1998 Strategic Defence Review
White Paper, the Government made clear its commitment to a strong
and healthy UK defence industry and a commitment to forces equipped
with a decisive technological edge in critical capability areas.
Towers of Excellence represent an innovative approach to defence
technology development. They are built upon a new level of co-operation
and interaction between the MoD and the UK's leading equipment
supplier base and also draw upon particular strengths of UK academia.
44. In September 2001 the priority areas
for the first six Towers of Excellence (ToEs) were announced,
as part of the first tranche of some 20 ToEs. These six are intended
to act as a group of pilot Towers for the remainder of tranche
one. The first ToE (Guided Weapons) was launched on 23 July 2002.
On 20 December MoD announced the launch of the second ToE, covering
Radar technology.
45. The launch of the Radar ToE is further
evidence of MoD's commitment to partnering with industry. QinetiQ
will be a member of the radar ToE and, along with other industrial
companies, will have a seat on its steering committee. Consultation
with industry and other research providers will continue, in order
to identify the subject areas and participants for subsequent
ToEs.
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