Documents considered by the Committee on 24 October 2018 Contents

7European Defence Fund 2021–27

Summary and Committee conclusions

Committee’s assessment

Politically important

Committee’s decision

Not cleared from scrutiny; further information requested; drawn to the attention of the Business, Energy and Industrial Strategy and Defence Committees

Document details

Proposal for a Regulation establishing the European Defence Fund 2021–2027

Legal base

Articles 173(3), 182(4), 183 and 188 TFEU; ordinary legislative procedure; QMV

Department

Ministry of Defence

Document Number

(39894), 10084/18 + ADDs 1–2, COM(18) 476

Summary

7.1The EU’s Member States and the European Parliament are currently considering a Regulation establishing a European Defence Fund for the 2021–2027 period. With a budget of €13 billion, it would finance research into, and development of, new military technologies for acquisition by the armed forces of EU Member States. The Minister for Defence Procurement (Andrew Stuart) wrote to us on 10 October 2018 with an update on the legislative deliberations, explaining that the Member States are due to adopt their position on the proposal on 20 November with a view to its formal adoption in spring 2019.

7.2The Minister also reiterated that the UK is seeking some form of participation in the European Defence Fund after Brexit, but added that the exact legal parameters—and, consequently any (potential) UK financial or material contribution to the Fund—remain unclear given that the EDF Regulation is still subject to change. The Committee has asked to be kept informed of further developments in the legislative process and will assess the potential political and financial implications of the Fund for the UK accordingly.

Background

7.3Since 2017, the EU has been setting aside part of its budget for investment in research and development of military technology, such as encrypted software and drone technology, as part of a wider effort to make the Union a more cohesive actor in military affairs.106 This ‘European Defence Fund’ is due to be fully operational from 1 January 2021, under the EU’s next Multiannual Financial Framework.107

7.4The European Commission presented a formal Regulation to establish the Defence Fund in June 2018, recommending a budget of €13 billion (£11.6 billion) for the period from 2021 until 2027 for investment in the “competitiveness, efficiency and innovation capacity of the European defence industry”. Financial assistance would normally take the form of grants, although it could also take the form of a public procurement exercise (after which the resulting results would be owned by the European Union).

7.5Despite the UK’s exit from the EU, the Government has supported the establishment of the Defence Fund, citing the benefits to Europe’s defensive capabilities, and the Ministry of Defence is actively seeking ways for the British defence industry to be eligible for funding despite the UK’s impending exit from the EU and its new status as a ‘third country’.108 However, UK participation in the Fund would be complicated, as it is due to have left the European Union by the time it becomes operational. As such, it would not have automatic right that EU Member States do to be involved in the Fund. Even during the post-Brexit transitional period, when the UK will be a ‘third country’ while still making budgetary contributions and accepting the supremacy of EU law, the UK’s status under the Fund’s precursor—the Defence Industrial Development Programme (EDIDP)—is not guaranteed.109

7.6That is not to say that UK participation in the European Defence Fund as a ‘third country’ is not possible. If the post-Brexit transitional period were to be extended beyond its current proposed end date of 31 December 2020, the UK defence industry might be eligible for participation in the Fund—subject to certain restrictions, which we have elaborated previously—so long as the UK also remained a contributor to the EU budget for the duration of that extension.110 Once the UK exits the transitional arrangement, there are two theoretical options for its involvement in the Fund.

7.7Firstly, the Commission proposal contains an explicit provision permitting non-EU countries to seek ‘association’ with the Fund: in return for a financial contribution, and subject to the EU’s agreement, their defence industry would be eligible for funding on the same terms as those of EU Member States. ‘Association’ does not provide voting rights over the work programme and individual funding decisions, which would be taken by EU Member States only. However, the Commission has proposed to restrict the ability to seek ‘association’ only to the three EFTA-EEA countries (Norway, Iceland and Liechtenstein).111 The UK, considering the Government’s policy on the future UK-EU relationship, would therefore not qualify. Limiting the scope of the ‘association’ process is not, it appears, being challenged by the remaining Member States (see paragraph 7.11 below).

7.8Secondly, for ‘third countries’ that cannot seek association under the Commission proposal, eligibility for EDF funding would exist but in a limited form: only EU-based subsidiaries of parent undertakings controlled from that third country would be eligible. Furthermore, these subsidiaries would only be able to access funding “if this is necessary for achieving the objectives of the [project] and provided that […] participation will not put at risk the security interests of the Union and its Member States”. They would also need to guarantee that any classified information that forms part of the EDF project is not shared with any entity outside the EU or an ‘associated country’.112 In addition, under the Commission proposal, “infrastructure, facilities assets, and resources” located outside of the EU could only be used for EDF projects in a narrowly-prescribed range of circumstances,113 and ex-post use of technology developed with EDF funding by a non-EU country like the UK could be restricted.114

7.9In August 2018, the Minister for Defence Procurement (Andrew Stuart) confirmed that the Government was working to persuade the European Parliament and the other Member States to make it easier for ‘third countries’ like the UK to be involved in EDF-funded projects.115 We also set out the substance of the Commission proposal in some detail in our Report of 12 September 2018, in which we raised concerns about the UK’s potential participation in the Fund and the fact that the EU would own any results of procurement exercises financed from it.

The Minister’s letter of 10 October 2018

7.10On 10 October, the Minister wrote to the Committee with further information on the position taken by the Member States on the Commission proposal for the EDF. He noted that the Council’s starting point is to copy for the most part the legal text underpinning the 2019–20 European Defence Industrial Development Programme (the pilot phase for the Fund), and focussing discussions on the new elements such as financial instruments—use of the Fund’s resources to guarantee risky private investment in defence projects116—and funding priorities (like disruptive military technologies).

UK participation in the European Defence Fund after Brexit

7.11The Minister also provided an update on the possibility for the UK to be involved in the Fund—and for its industry to receive funding from it—as a ‘third country’. He explained that the other Member States are seeking to remove some of the additional restrictions the Commission had put in place for ‘third country’ involvement and facilitate such cooperation within the Fund, for example with the UK. On this basis, the Austrian Presidency of the Council circulated proposed revision to the draft legal text in early October, which, the Minister says, “is now broadly acceptable to the UK”.117

7.12We understand that full ‘association’ with the Defence Fund, even under this revised text, would be an option only for the EFTA-EEA countries and therefore not for the UK.118 British defence industry would therefore be subject to the restrictions and limitations on participation we described in paragraph 0.x above and in more detail in our Report of 12 September 2018. Notably, any such participation would have to be self-funded (as UK entities would be ineligible for EDF funding) and take place on a case-by-case basis.

7.13Since we received the Minister’s letter, the Prime Minister has said the UK is considering an extension of the post-Brexit transitional period into 2021.119 During that transition, which under the current draft of the Withdrawal Agreement is due to last until 31 December 2020, the UK is required to make budgetary contributions as if it were still an EU Member State (albeit with limited representation in the EU institutions and no voting rights over EU policy or funding decisions). Any such extension would mean the UK were still in the transitional arrangement when the next Multiannual Financial Framework, and the new European Defence Fund, become operational. In that case, the UK might have no choice but to contribute to the Instrument until the transitional period ended, but with little influence over how its money was spent.

EU ownership of defence procurement exercises

7.14In our last Report on the European Defence Fund, the Committee raised concerns about two provisions of the proposed EDF Regulation that would make the EU the owner of any procurement exercises—whether for defence research (article 22.2 of the Regulation) or development of military technology (article 25.4)—financed by the Defence Fund.

7.15The Minister acknowledged in his letter that this”inevitably gives rise to concerns over the EU ownership of defence capabilities”, but added that under the legal base for the Regulation,120 the Commission would be “unable to procure military equipment”. He added that EDF funding is “generally expected” to take the form of grants rather than procurement, and that the European Commission had assured the Member States that “it would use public procurement in limited circumstances such as to procure studies, either for Commission policy making or of general value and to procure their secure IT system for managing the [Fund]”.

Legislative timetable for adoption of the EDF Regulation

7.16As regards the legislative timetable, the Minister explains the Austrian Presidency is hoping to secure a partial general approach on the Regulation at the meeting of EU Defence Ministers on 20 November 2018.121 This would establish the Member States’ common position on the European Defence Fund for negotiations with the European Parliament on the final legal text, with the exception of the Fund’s budget (which will be decided as part of the wider negotiations on the EU’s spending priorities under the next Multiannual Financial Framework).

7.17The European Parliament is expected to finalise its position around the same time,122 with the aim of agreement on the European Defence Fund Regulation between the Parliament and the Member States before the 2019 European elections.

Our assessment

7.18We thank the Minister for his timely update on the negotiations for the post-2020 European Defence Fund. The Government has strongly hinted that it wants to maximise opportunities for UK involvement in the new European Defence Fund after post-Brexit the transitional period as a ‘third country’. The legal text underpinning the Fund, even taking into account the amendments proposed by the Member States, would severely restrict the scope of participation by the British defence industry in projects funded by the EDFIt appears that the remaining Member States support the Commission proposal that full ‘association’ with the Fund—making a non-EU country’s defence industry generally eligible for EDF funding in return for an annual financial contribution from its Government—will be available only to the EFTA-EEA countries. Organisations from non-associated countries could be involved in EDF projects via EU-based subsidiaries, or on a very limited scale from a base in their home country.

7.19While the current draft of the EDF legal text would therefore restrict the opportunities for UK participation after Brexit, it also assuages concerns we have voiced before about the potential downsides were the UK to seek ‘association’ with the European Defence Fund. In particular, as a non-associated ‘third country’, UK defence industry would participate in EDF projects only a case-by-case basis at its own volition, removing the need for an annual financial contribution from the UK taxpayer to the Fund—a requirement of association—with only limited influence over the way that money would be spent, or how any resulting technology could be used.

7.20We also note the remaining Member States are seeking to remove some of the restrictions proposed by the Commission on participation by non-associated ‘third countries’. These changes may relate to the granting of licences for the use of EDF-funded military technology by ‘third countries’, which would make it easier for the UK to benefit from the Fund’s successes (especially where EU-based subsidiaries of UK organisations were involved in the original EDF project).123 However, we have not been able to assess the substance of the Council’s efforts to facilitate third country involvement in the Fund, as we have not been able to view the latest Presidency legal text in which they are set out. Clearly, the more restrictive the intellectual property provisions of the Regulation in relation to transfers, or licences for use, of EDF-funded technology by ‘third countries’, the less value there would be for the UK to contribute to such projects.

7.21In any event, the possibility of UK involvement in the European Defence Fund in any guise after the end of any extended transitional period will also depend on the overall political context: if the negotiations on the Withdrawal Agreement were to collapse, resulting in a disorderly UK exit from the EU, it is unlikely there would be a possibility of UK participation in any EU funding programmes until the outstanding issues related to UK withdrawal—not least its financial obligations vis-à-vis the EU budget accrued during its membership—were resolved.

7.22Finally, the possibility that the post-Brexit transitional period could be extended — a suggestion made explicitly by the Prime Minister at the European Council summit on 17 October 2018 — could require the UK to remain a financial contributor to the European Defence Fund for the duration of the transition after 1 January 2021. In that eventuality, the same controversial restrictions on UK eligibility for participation in ‘sensitive’ projects — to which we objected in our scrutiny of the EDF’s precursor programme, the EDIDP — could apply, despite the Fund being part-financed by UK taxpayers.124

7.23Given the Government’s desire to secure some form of UK participation in the Defence Fund after Brexit, and the consequent uncertainty about the legal and financial conditions for such involvement, we again retain the proposal under scrutiny. The Committee will in particular keep the legal provisions relating to ‘third country’ participation in the Fund under review, and assess the Government’s position on post-Brexit participation accordingly. We will also reassess the potential financial and political implications of the EDF proposal for the UK if the draft Withdrawal Agreement is amended to include a mechanism for extension of the transitional period.

7.24The Minister notes the Presidency of the Council hopes to secure a partial general approach—an agreement among the Member States on all aspects of the Regulation establishing the European Defence Fund with the exception of its budget—at the meeting of EU Defence Ministers on 20 November 2018. We ask him to provide a further update, accompanied by the draft legal text, in good time before that meeting so that we can consider the granting of a scrutiny waiver. We will report the substance of any partial general approach to the House in due course.

7.25We draw these developments to the attention of the Defence and Business, Energy & Industrial Strategy Committees.

Full details of the documents:

Proposal for a Regulation establishing the European Defence Fund: (39894), 10084/18 + ADDs 1–2, COM(18) 476.

Previous Committee Reports

See (39894), 10084/18: Thirty-eighth Report HC 301–xxxvii (2017–19), chapter 26 (12 September 2018).

The Committee also considered the predecessor, the European Defence Industrial Development Programme, on five occasions. See: (38831), 10589/17: First Report HC 301–i (2017–19), chapter 30 (13 November 2017); Twelfth Report HC 301–xii (2017–19), chapter 10 (31 January 2018); Twenty-seventh Report HC 301–xxvi (2017–19), chapter 7 (9 May 2018); Thirty-second Report HC 301–xxxi (2017–19), chapter 8 (20 June 2018); and Thirty-fifth Report HC 301–xxxiv (2017–19), chapter 14 (11 July 2018).


106 For example, as part of the ‘European Defence Union’, Member States have launched Permanent Structured Cooperation on defence and established a centralised Military Planning & Conduct Capability unit for the EU’s advisory military missions. The European Commission is also proposing to use the EU’s post-2020 Connecting Europe Facility to invest in dual-use infrastructure that can be used by armed forces to move troops and equipment around Europe more efficiently, and has proposed the establishment of a ‘European Peace Facility’ (considered in a separate Chapter of this Report).

107 The Fund is currently effectively in a pilot phase: a small-scale defence research programme was launched in 2017, and a two-year industrial development fund for the defence industry— the EDIDP—is due to become operational in early 2019. Both strands are linked to the EU’s current budgetary cycle, and will therefore end in December 2020.

108 See for example the Ministry of Defence’s first Explanatory Memorandum on the European Defence Fund (July 2017). A May 2018 policy paper also confirmed that the Government wanted to discuss “models for participation of the UK, and UK entities” in the European Defence Fund after Brexit.

109 UK participation during the transitional period can be restricted unilaterally by the EU if a project funded under the EDIDP or the defence research programme lasted beyond the end of the transitional period. We have expressed concern about this aspect of the Withdrawal Agreement in more detail in our recent Reports on the European Defence Industrial Development Programme, most recently on 11 July 2018.

110 For more information on the potential restrictions on UK eligibility for EDF projects during an extended transition, please refer to our Report of 20 June 2018 on the EDIDP

111 In practice this would have limited non-EU participation to Norway.

112 This partial derogation to the eligibility criteria—based in the EU, but controlled from elsewhere—is not available to subcontractors: to be eligible for funding, they must be based in, and controlled from, the EU or an associated country. There appears to be some very limited leeway for UK-based or controlled companies to act as sub-contractors vis-à-vis a beneficiary from the European Defence Fund, provided the costs of their contribution are not paid for by the Fund and they do not have access to classified information related to the project.

113 Use of non-EU facilities would have to be “necessary for achieving the objectives of an action”, a new test that does not apply under the current EDIDP Regulation for use of beneficiaries’ resources or infrastructure located outside the EU; the non-EU ‘infrastructure, facilities, assets and resources’ must be owned by the beneficiary of EDF funding, or their subcontractor, either of which must by definition be based in the EU or an associated country; and the costs of using any non-EU assets cannot be defrayed against the grant from the European Defence Fund.

114 Under article 25 of the draft Regulation, the Commission has to be notified of “any transfer of ownership or grant of a licence to non-associated third countries”. If the transfer or licence contravened the “defence and security interests of the Union and its Member States”, this would “necessitate reimbursement of the funding provided under the Fund”.

115 The Ministry of Defence acknowledged the limitations of the ‘association’ mechanism in a letter to the House of Lords dated 1 August 2018. The proposal to establish the European Defence Fund is subject to the ordinary legislative procedure, and as such the European Parliament and the Member States in the Council must jointly agree on its legal text.

116 See for more information on the use of financial instruments to mobilise private investment our recent Report on the InvestEU proposal.

117 The Presidency text is classified as LIMITE and therefore not publicly accessible at this stage.

118 The Minister notes the UK is also pushing for a provision allowing for the participation of international organisations (such as the Joint Research Centre) with the same rights and obligations as a legal entity established in an EU Member State or associated country.

120 The legal base for the proposed EDF Regulation is Articles 173(3), 182(4), 183 and 188 TFEU, and as such it will be financed from the general EU budget. Under Article 41(2) TEU, the general EU budget cannot be used for “operations having military or defence implications”.

121 The Council meeting on 20 November 2018 would be preceded by a final Working Party meeting on 7 November, followed by diplomatic sign-off at the meeting of COREPER on 14 November.

122 The Industry, Research & Energy (ITRE) Committee has scheduled a vote on the Regulation for 21 November 2018.

123 In its proposal for the EDF Regulation, the Commission proposed to revive a restriction, mooted but ultimately not included in the EDIDP precursor programme, that even the granting of a licence to a ‘third country’—like the UK— to use defensive technology developed with EU funding could be subject to “all funding….. be[ing] reimbursed” if the licence contravene[s] the defence and security interests of the Union and its Member States. This could limit the extent to which technology developed with support from the EDF could be licensed to the UK defence industry, even if British companies had been involved in the original project via an EU-based subsidiary.

124 Under Article 127 of the draft Withdrawal Agreement, the EU during the transitional period can unilaterally exclude the UK from participating in EU-funded projects which are considered too ‘sensitive’ for involvement by a non-Member State. That provision can be invoked against the UK in relation to any projects funded from the European Defence Industrial Development Programme (EDIDP), and therefore by extension also to the European Defence Fund if the transitional arrangement is still active when the Fund goes ‘live’ in January 2021. We have described the implications of Article 127 in more detail in a series of Reports on the EDIDP in spring and summer 2018.




Published: 30 October 2018