House of Commons - Defence

Select Committee on Defence First Report

7 GAPS IN THE LEGISLATION

226. In the 2007 Consultation Document the Government defined licensed production overseas as:

a) where a business based outside the UK produces goods under a licence granted by, or contract or other agreement with a UK company; and

b) an overseas company which is institutionally controlled by a UK parent (for example, the UK parent has a majority shareholding).[305]

227. During pre-legislative scrutiny of the draft Export Control Bill our predecessor Committees concluded:

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228. During the Commons Committee Stage of the Bill the then Minister of State at the Department of Trade and Industry, Nigel Griffiths MP, said:

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229. The Government's approach was to control the export of equipment and technology, which would usually be required to set up a production facility overseas. In its view the new controls on the export of technology by electronic means, and on the provision of technical assistance "would also affect licensed production overseas". In the words of the then Secretary of State for Trade and Industry these indirect controls would be "very powerful controls on the supply chain on which licensed production almost always depends".[308]

230. In reviewing the secondary legislation in 2003 our predecessor Committees considered the need for specific regulation of overseas production and recommended that, within two years of its introduction, the Government should assess the effectiveness of the secondary legislation in regulating licensed production facilities, and that it should take steps to introduce direct controls on such facilities if these proved to be warranted in the light of this assessment.[309] There is no evidence that the Government has carried out an assessment.

231. There is a subsidiary issue which our predecessor Committees examined in 2003: whether the Government has enough information about licensed production facilities abroad to assess the likely impact of these facilities on the proliferation of military equipment.[310] In reply to the Committees' Report the Government said:

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232. During our current inquiry we asked the Government what control it had over an overseas production facility once technology had been transferred overseas under licence and whether the Government could prevent an overseas facility selling equipment made in the plant to irresponsible or objectionable parties. The Government replied that it assessed all applications on a case by case basis. Where it had concerns about the transfer of equipment or technology for the establishment or ongoing supply of an overseas production facility, it could refuse an export licence application. It added:

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233. In a subsequent memorandum the Government explained the licensing process in more detail:

When they apply for a licence to export controlled goods or technology, exporters are expected to place all relevant facts before the Export Control Organisation. Where it is apparent that the export will pass through one end user on its way to another destination, or will be used by the initial end user to make controlled goods that will then be re-exported, the Government will need to consider the risks posed by both the initial end user and any known or potential end users after that. A more extended risk assessment is therefore necessary in these cases than in many others and ECO may need to contact the exporter to establish the details of onward supplies more fully.

In the context of overseas production, the Government would wish to examine any risks posed by the known or potential end users of the licensed goods that will be produced overseas (i.e. whether they are likely to use the licensed goods in ways that might breach the Consolidated EU and National Arms Export Licensing Criteria), plus, more generally to consider the extent to which the country hosting the licensed production has any links with countries or programmes of concern or represents a risk of onward diversion. The Government therefore concurs that "what the likely end-use is going to be of whatever it is that is produced overseas" is examined as part of the risk assessment process involved in granting or refusing a licence. […]

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234. In its written evidence EGAD said that licensed production was "not totally outside of control" as there were UK export controls, for instance, on the transfer of technology and plant to allow licensed production to be undertaken overseas.[314] EGAD also argued that with the globalisation of industrial activity, coupled with the growing desire of countries not wanting to be seen "merely to be markets for the goods of companies from other nations, but as partners", the aspiration to see in-country industrial participation in major defence programmes had grown. This phenomenon, and that of offset which very frequently drove it, was constantly growing. EGAD stated that licensed production, as part of an offset package, was crucial to competitiveness and quoted the fifth annual report to the US Congress by the US Dept of Commerce:[315] "The importance of Offset now transcends the traditional technical ones [i.e. quality, price and delivery] in the procurement decision making process".[316]

235. The UK Working Group on Arms took a different view. It argued that the "role of Turkish—supplied and—built Land Rover Defender vehicles in the Andijan massacre in May 2005 graphically demonstrates the particular challenges thrown up by inadequately regulated licensed production agreements". It seemed very unlikely to the Working Group "that Landrover Defender vehicles to this specification would have been licensed for direct export to Uzbekistan from the UK". The Working Group drew the conclusion that the current practice of only licensing the technology associated with production or specific military components supplied as a result of the deal was not sufficient to regulate such re-exports. It suggested that controls "need to be applied to the licensed production agreement itself, placing clear and binding contractual obligations on production ceilings and permitted export markets".[317]

236. We asked the Government whether tailored provisions could be inserted into licences, for example, to regulate the overseas manufacture of products with a potential military end-use. The Government replied that the Export Control Organisation (ECO) did, in a small number of applications, insert special provisos into licences. This happened where the ECO risk assessment of the end user and destination was satisfactory but certain steps needed to be taken by the UK exporter to reduce specific risk elements or protect the security of UK equipment before it reached its destination. Provisos might then be inserted by the ECO to advise the exporter to, for example, remove sensitive elements of the equipment prior to export or ensure that the export moved through agreed routes and methods. The ECO would insert provisos only where they could be discharged by the UK exporter, and related to events within that exporter's control. Provisos could not be used where they could only be discharged by overseas entities.[318] The Government added:

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237. In its 2007 Consultation Document the Government was alert to globalisation "with international collaboration firmly to the fore" and to the "additional challenges for export controls".[320] In particular, that it would conflict with the Government's counter proliferation aims, and its broader support for international human rights, if UK exporters were able to use systematically overseas linked companies or production facilities to supply destinations or end users where the same supplies would undoubtedly have been refused if applications had been put before the UK authorities. The Government acknowledged that there had been some recent examples where equipment or components originating from the UK had been exported to destinations of concern. These had involved goods for which (when they left the UK for further processing overseas) no UK licence was required, but which would have required a licence if exported from the UK in the form in which they subsequently left the overseas production facility. These cases raised difficult questions about what was reasonable and practical in terms of both due diligence and the reach of UK jurisdiction. The Government put forward a number of options which would require the UK company to take a close interest in the ultimate output of the production facility:

a) treat overseas production or subsidiaries as if they were UK exporters and oblige them to apply to the UK for licences to export their products from the overseas destination;

b) control the licensed production agreement itself;

c) make export licences for supplies to licensed production facilities or subsidiaries subject to conditions relating to the relevant commercial contracts; or

d) make no change.[321]

238. We have not taken detailed evidence on the Government's proposals. On the basis of the evidence we have received this year and the work done by our predecessor Committees we conclude that the current controls over licensed production overseas are inadequate and need to be extended. We conclude that there are advantages in pursuing the third option put forward by the Government in the 2007 Consultation Document: the Government make export licences for supplies to licensed production facilities or subsidiaries subject to conditions relating to the relevant commercial contracts. Under this approach, any UK export licence could include a condition requiring the commercial contract underpinning the production agreement to satisfy certain conditions, which might, for example, state that the contract should require the licensed production facility or subsidiary to seek permission from the UK company before making any onward supplies, or onward supplies to specified high risk destinations. The UK company would then be obliged to seek approval, in the form of a Standard Individual Export Licence, to supply the listed goods or technology that the licensed production overseas or subsidiary would need to fulfil those orders. Any changes to a contract would also require the UK exporter to submit a new application. In our view this option therefore has the advantage of requiring the UK exporter to review the activities and customers of the overseas company and if necessary seek a fresh export licence. In addition, we recommend that where licences encompass overseas production the Government make it a condition of the license that the contract underpinning the agreement prevent exports from the overseas facilities in breach of EU and UN embargoes and allow inspection. In addition, the contract should include a subrogation clause allowing the UK Government to stand in the place of the exporter to enforce the contract in British or foreign courts.

239. We are disappointed that the Government was not able to provide us with a sample case to enable us to scrutinise an application for an export licence which encompassed licensed production overseas and we are concerned too that it cannot identify such applications from its database. We recommend that the Government ensure that its database identifies licences which encompass overseas production.

OVERSEAS SUBSIDIARY COMPANIES

240. On the position of overseas subsidiary companies, the UK Working Group started from two principles: that every "country is responsible for ensuring that the arms and the military equipment it exports are not used in contravention of international humanitarian law or human rights law";[322] and that "parent companies do control the activities of subsidiary companies".[323] It reasoned that in a globalised defence market "it is quite logical to see if you can apply these principles along the supply chain where there is the UK connection"[324] and that if a "subsidiary is planning transferring controlled goods or strategic goods then it must seek the permission of the parent company to do so".[325] The UK Working Group argued that "at the very minimum, embargo legislation should be amended to include transfers from subsidiary companies. If it would be illegal to supply the equipment from the UK, it is clearly a loophole to allow UK-owned companies to bypass embargo legislation via the activities of their overseas subsidiaries."[326]

241. The Working Group also urged the Government to look again at whether re-export controls could be applied in these cases. It was clear that overseas subsidiary companies had supplied, and were likely to continue to supply, military equipment to a variety of destinations in cases where the UK parent would not receive an export licence to export similar equipment directly from the UK.[327]

242. We recommend that the Government extend export controls to encompass exports of goods and destinations subject to EU or UN embargo by overseas subsidiary companies, in which a majority shareholding is held by a UK parent or where UK beneficial ownership can be established. In such cases the parent company would be required to obtain a UK export licence or, in the absence of a licence, would be in breach of the Export Control Act 2002.

Military End-Use Control (or "catch-all")

243. There is currently a Military End-Use Control that applies only where the UK exporter has been informed by the UK authorities, that the proposed exports are or may be intended for:

a) incorporation in a third country into military list equipment;

b) for the development, production or maintenance of such equipment; or

c) for use in a plant for production of such equipment;

d) in an embargoed destination or incorporated into a piece of larger Military List equipment that has been exported without a valid export licence to any destination. If the exporter is aware that the proposed export is or may be intended for any of the uses described above, they must inform the ECO, which will decide whether they must apply for a licence and inform them accordingly.[328]

244. In the 2007 Consultation Document the Government pointed out that the Military End-Use Control was an area of EU competence. The scope for unilateral UK changes was therefore limited, and in its view it would be preferable to negotiate changes at EU level to ensure all Member States were applying the same standard of control, and to avoid the risk of exporters exploiting differences in approach by exporting through Member States with less stringent controls.[329] As EU dual-use regulation is currently being revised now is a prime opportunity to propose a change.

245. The Government set out a number of options for change:

a) extend the control to cover specifically listed items of complete equipment that might be of significant operational value to the military in an embargoed destination (under this option, the control would still apply only where the exporter has been informed that a licence is required);

b) extend country coverage beyond embargoed destinations, which has the advantage that as the principle has already been accepted, only the range of sensitive destinations would be extended;

c) extend coverage to both non-controlled components (as now) and specifically listed items of complete equipment that might be of significant value to the military in an embargoed destination or other agreed destination of concern;

d) extend coverage to include both non-controlled components (as now) and any significant non-controlled complete item where the exporter knew, or had been informed by the Government, that the item was for use by the military in an embargoed destination or other destination of concern; or

e) no change.

246. The UK Working Group proposed that the legislation be amended to provide a military end-use "catch-all" requirement.[330] It explained that the "globalisation of the arms trade means that occasionally goods that are of critical importance to the operation of the weapons system will by-pass the licensing system as they are not falling into any of the definitions or specifications on the control lists themselves".[331] The Working Group pointed out that the Government already expected exporters who were producing and exporting goods which they think could be intended for use in weapons of mass destruction (WMD) in military systems destined for countries under embargo to report the matter.[332]

247. In its memorandum the Working Group cited the example of a US Predator unmanned aerial vehicle (UAV) which reportedly fired a Hellfire missile seven kilometres across the Afghan border into Pakistan in January 2006. It appeared to the Working Group that the Department of Trade and Industry (DTI) had classified the "electronic" brain of the Predator UAV as civilian off-the-shelf (COTS) technology, and thus not a licensable product and so not subject to export controls, despite the fact that the end product—a UAV—was subject to some of the most restrictive controls under the Export Control Act 2002.[333] The Working Group argued that with "the trends towards globalisation and the increasing importance of dual-use and COTS goods in the development of modern weapons systems […] more and more goods critical to the operation of these systems will bypass the licensing system as they do not fall within the definitions or specification of the control lists".[334] The UK Working Group proposed the expansion of "the concept of military end-use catch-all clauses to capture such goods and technologies". While acknowledging that there were complications, it argued that the system "must clearly be able to differentiate between 'mission critical' components and mundane goods like nuts and washers, wiper blades and fan belts" [and] "it must be possible to develop either threshold systems (as happens in the US) or significance criteria for the role of the component in the finished item".[335] The Working Group cited the example of the US threshold system:

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248. As was the case with the other "catch-all" provisions the question of the knowledge of the exporter was relevant. The Working Group said that there was "clearly a reasonableness issue: is it reasonable for the supplier to have known that its goods are going to end up in military systems?" The Working Group pointed out that there were "all sorts of guidance notes on the DTI website mainly around the WMD side of things, which is essentially a whole trigger list of questions that exporters can ask themselves about a particular customer, the nature of the payment, all of those things which might help". It stressed, however, that it was not arguing that "every item that could have a dual-use that is not on the list should be licensed".[337]

249. The Government was not convinced of the merits of extending UK controls to duplicate the export controls of other nations, "thus subjecting overseas customers to the need to get approval from two licensing authorities for the same transaction". The Government explained that it took account of known subsequent supplies when initially assessing the application to export goods or technology from the UK. Where those subsequent supplies would, in its view, be likely to result in breach of the Consolidated EU and National Arms Export Licensing Criteria, the Government did not issue a licence. The Government believed that this system was both simpler and more effective.[338]

250. On practical issues, HM Revenue and Customs (HMRC) said that

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251. The Predator case raised by the UK Working Group in our view highlights a serious issue: whether components outside export control should be brought within control if their intended use is incorporation into military goods.[340] We are attracted to the arguments that the UK Working Group advanced but we have reservations. First, it is not clear that a system of control based on a threshold for the value of UK goods in the final product, along the lines of that used in the USA, would have brought the IT used in Predator UAV within control. Second, as we have noted already, the imposition of a duty on exporters to enquire into the intended use of their goods—and in this case also ascertain the value of the end product—will impose a burden on industry. Third, in contrast to other suggested "catch-all" provisions such as that for items that could be used for torture, we cannot see that there is a leading responsibility that the Government could play to collect and disseminate intelligence to exporters. Without such a role played by the Government enforcement will be problematic. As HMRC pointed out, the goods brought within control would no longer be defined on control lists and potentially more goods would be held up while rating decisions were made. On the basis of the evidence we received we conclude that the feasibility and practicability of a Military End-Use Control "catch-all" provision has not yet been established. We recommend that the Government examine other countries' experience with Military End-Use Control "catch-all" provisions before reaching its conclusions.

Transportation and other services

252. In reviewing the secondary legislation our predecessor Committees considered whether transportation services, financing and financial services, insurances services and general promotion and advertising should be brought within strategic controls. They recommended bringing transportation agents within control in certain circumstances.[341] The Government replied to the Committee:

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253. In its evidence to our current inquiry the Government said that ancillary services had been brought within export controls only where those services were provided in relation to restricted goods or to the supply of controlled goods to embargoed destinations but that such services were specifically exempted from controls when provided in relation to other controlled goods. The legislation defined ancillary services as;

a) transportation services;

b) financing or financial services;

c) insurance or reinsurance services; and

d) general advertising services.[343]

254. In their memorandum drawing out lessons from other EU countries, Dr Bauer and Ms Wetter concluded that to "be comprehensive, [sanctions] should apply to all actors in the supply chain, e.g. producers, traders, financers, freight forwarders".[344] They explained that

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255. The Government said that there had been no HMRC prosecutions of transport companies or finance companies in relation to strategic export controls and neither had HMRC issued any formal warning letters to transport companies or finance companies. However, if, during the course of an investigation, it were found that a UK transport company or finance company had committed an offence, the Government said HMRC would take appropriate action up to and including reporting the case to the Revenue and Customs Prosecutions Office.[346]

256. The UK Working Group argued in their written evidence that there was an urgent need to bring those involved in the transportation and the financing of the defence transfers more into the transfer control process. It advanced several reasons.

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257. The Working Group added in its oral evidence:

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258. We consider that bringing ancillary services beyond those services that are provided in relation to restricted goods and to the supply of controlled goods to embargoed destinations or for WMD end-use within export control would improve the regulation of strategic export transfers. But a general extension would add to UK service providers' costs and, as services are increasingly globalised, could place them at a competitive disadvantage.[350] As Dr Bauer and Ms Wetter point out, the provision will need to address the question of intent, which may be difficult to establish.[351] Before, however, any extension of the controls on ancillary services could be made, an evaluation of the controls currently in place needs to be made. We recommend that the Government in responding to this Report explain how the existing WMD end-use controls work and why no prosecutions have been initiated.

CROWN EXEMPTION

259. When it reviewed the draft Bill our predecessor Committees recommended "that consideration be given to the desirability of ending the blanket exemption from controls of Government and its agencies as exporters of licensable goods and technology".[352]

260. The UK Working Group submitted that the "Government should apply and should be seen to apply the same transfer criteria when involved as a principal in a strategic transfer".[353] It pointed out that the Government was not obliged when involved as a principal in an arms transfer to apply the licensing process as it would for a sale by a defence manufacturing or trading company. The UK Working Group understood that the power at section 7 of the 2002 Act empowering the Government to "make provision binding the Crown" was included to ensure the UK could comply with international legal commitments, for example EU Dual-Use regulations, but that, where only national laws applied, the Government had not used this power.[354]

261. The then Minister of State for Trade and Industry, Nigel Griffiths MP, justified the Government's approach during the Commons Committee Stage of the Export Control Bill:

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262. The UK Working Group acknowledged this argument at the time, and proposed that the power to bind the Crown could be subject to certain exceptions, but maintained and still maintained in its evidence to our current inquiry that there were many circumstances where the Crown should be bound—for example, government-to-government sales, disposal sales and gifts—and for which a strict application of the Consolidated Criteria was essential. In the UK Working Group's view the most obvious of these was the al-Yamamah contracts for sales to Saudi Arabia, which were then in the process of being supplemented by the sale of a further 72 "Typhoon" aircraft. Other government-to-government transfers of note included the transfer of 226 Challenger battle tanks to Jordan between 2002 and 2004, and the gifting to Nepal of two Mi17 helicopters in 2002 and of two STOL aircraft in 2004.[356]

263. The Working Group understood that the Government applied the same standards to government-to-government transfers as to commercial transactions, in which case it could see no reason why it refused to allow the use of the same formal process. The Working Group said that changing the legislation to bind the Crown, while providing for some exceptions, would simply guarantee that, at both the contract-negotiation stage and in terms of public and parliamentary scrutiny, the same standards were applied across the board. The Working Group also suggested that the current arrangements could be changed by governmental discretion. In the interests of transparency reporting on commercial transfers, which was centred on licences (both awarded and refused), was more revealing of government policy than reporting on government dealings. The specific information contained in the annual reports on government-to government transfers related only to physical transfers, not to the amount that the Government was willing to transfer or to deals the Government refused.[357]

264. In its oral evidence the Working Group added that there was also a timing issue: "now we have quarterly reporting on licenses it takes longer to get information on Crown exemption transfers than licensed transfers" as Crown exemption transfers are only published in the annual report.[358]

265. In its written evidence the Government confirmed that "all forms of government-to-government transfers are subject to rigorous examination against the Consolidated EU and National Arms Export Licensing Criteria before being approved". In addition, F680[359] applications were considered case-by-case against the Consolidated Criteria.[360] The Government contended that there would be significant practical difficulties if Crown immunity were revoked:

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266. We raised the treatment of non-government purchases with the Foreign and Commonwealth Office, which replied:

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267. The Committee in carrying out its recent inquiries has received no evidence that the Crown exemption has covered any exports which have ended up in irresponsible hands (other than as the result of theft in Iraq). The key issues are transparency and consistency of treatment. The EU Code of Conduct on Arms Exports increasingly sets the standard for countries outside the EU such as those in the Balkans. It could undermine the force of the Code and its Criteria which is supposed to apply to all a country's strategic exports if the UK's Crown exemption were to provide a precedent for exemption of government-to-government sales. Unless it is clear that the Code is also applied to government-to-government transfers, it sends out the wrong message and could encourage States with significant state manufacturers and large stockpiles of armaments under government control to dump surpluses on the market and export them to sensitive destinations. In the interest of communicating a clear message to other governments we consider there should be no broadly drawn Crown exemption. We consider that all strategic exports should be treated in the same manner unless there are compelling reasons for an exception.

268. Having now seen the new system operate for three years we cannot see convincing reasons for separate treatment, with one exception, of the government and industry as exporters. We recommend that the blanket exemption from controls of Government and its agencies as exporters of licensable goods and technology be ended and that details of the Government's and its agencies' exports be reported on the same basis as those of industry. There should, however, be one exception. In order to ensure that exports by the Government and its agencies to UK forces overseas are made expeditiously they should continue to be covered by Crown exemption.

Prior scrutiny and end-use verification

269. During inquiries into recent annual reports on strategic export controls we and our predecessor Committees have called for the prior scrutiny of certain export licences by Parliament. We reiterate the conclusion we set out in our Report last year that a prior scrutiny model for certain sensitive (or precedent-setting) arms export decisions should be developed on a trial basis for transfers to countries under, or recently under, embargo. We recommend that the Government examine this proposal in detail as part of its review of export controls.

Future Proofing

270. We asked both Miss Kidd and Dr Bauer to scan the horizon for any matter that might affect export controls in the future and to consider whether the legislation needed any revisions to address likely future developments. Miss Kidd and Dr Hobbs pointed out that "since the Act came into force in 2002 there have been a number of IT developments and changes in common practice which have increased the ease with which information can be transferred and shared globally". They noted increases in computer power and ease of access to the Internet, and use of resources such as blogs, podcasts, wikis and online forums had become increasingly mainstream. Miss Kidd and Dr Hobbs considered that online resources were by their definition of use available in the public domain and that "any information posted using these resources will come under the public domain exemption of the Act". They were concerned, however, about the increasing use of e-mail as a means to transfer large documents in electronic format and that with most e-mail servers now able to cope easily with attachments of 10Mb or more this was of a large enough size to facilitate the instant transfer of entire software packages or detailed technical manuals between groups. They pointed out that "developments in this area have substantially increased the ease in which the Act could be circumvented".[363]

271. Dr Bauer and Ms Wetter considered that there needed to be a regular legal revision to harmonise and streamline laws, which might have become a "patchwork after successive amendments, and to take political, legal and technological developments, as well as changes in trade patterns and threats into consideration". The need for specific amendments might also become obvious through loopholes detected through prosecutions (in particular failed ones). They commented that, ideally, loopholes should be detected before proliferators found them.[364]

272. We recommend that the Government consider whether the development of e-mail to allow it to be used as a means to transfer entire software packages or detailed technical manuals between groups comes within export control and, if it does not, whether it should be brought within control. Given the pace of technological change and globalisation of industry we recommend that the Government carry out a further review of the legislation in five years. In the meantime we recommend that the Government set up an ongoing internal review which responds to technological and global developments and examines best practice and innovative ideas that enhance the effectiveness of export controls in other countries.

305 2007 Consultation Document, para 2.3.1 Back

306 HC (2000-01) 445, para 106 Back

307 Stg Co Deb, Standing Committee B, Export Control Bill, 18 October 2001 on NC no. 2 Back

308 HC (2002-03) 620, para 59, Cm 5988, para 10, HC Deb 9 July 2001, col. 628 Back

309 HC (2002-03) 620, para 65 Back

310 HC (2002-03) 620, para 66 Back

311 Cm 5988, para 11 Back

312 Ev 100, para 9 Back

313 Ev 104, para 15 See also 2007 Consultation Document, para 2.3.2. Back

314 Ev 57 Back

315 "Offsets in Defense Trade", May 2001 Back

316 Ev 57 Back