Foreign Involvement in the Defence Supply Chain Contents

---

The Extent of Foreign Involvement in the Defence Supply Chain

Defining a ‘Defence Supply Chain’ and ‘Foreign Involvement’

2.It is important to recognise, as the Ministry of Defence’s (MOD) written evidence points out, there is no single recognised definition of the ‘defence sector’ and that there is no ‘defence’ category in the Standard Industrial Classification used for national statistics purposes’. In addition, organisations contracted by the MOD are active in a wide range of different business sectors, including, for example, construction, facilities and estates management, and IT. Many of these organisations obtain only a minority of their revenue from defence customers.6 However for the purposes of this inquiry we consider a broad definition desirable, and define the defence supply chain as any companies contracted by the MOD or the Armed Forces to provide a service, with a particular focus on those providing materials to military equipment programmes.

3.Defining foreign involvement is similarly difficult, as it can be complicated to determine an organisation’s status as foreign owned or not. The MOD told us that the majority of its top suppliers by spend are Public Limited Companies, with diverse international shareholder bases, and shares freely traded on the stock exchange. This means that companies of this type are predominantly privately owned by shareholders from the UK and across the rest of the world. Airbus’ written evidence illustrated the point that private ownership of the defence supply chain is widespread: they argued that whilst several countries maintain ownership stakes in companies supplying their defence and security needs, private ownership usually exceeds the stake owned by states. Airbus is 74% privately owned, with French and German national investment funds owning 11% each and Spain having a 4% stake.7

4.In addition, many overseas domiciled suppliers to Defence have UK registered subsidiaries, which may be members of UK trade associations, and which contract directly with the MOD.8 The MOD’s evidence further added that privately held companies are more common in the lower tiers of the defence supply chain and that information on their ownership is not so readily accessible, making it more difficult to clearly define whether they are subject to foreign involvement.9

5.Foreign involvement also extends beyond ownership into links between companies and Governments. During the course of our inquiry we heard evidence about links specifically between the Chinese state and Chinese companies, with Francis Tusa, Editor of Defence Analysis, explaining that China’s commercial companies and its military (as a part of its Government) are “inextricably linked”.10 Even amongst liberal democracies, such as the United Kingdom, there is close collaboration between the defence sector and the Government and military, for example through loaning of staff.11

6.It is difficult to define what constitutes foreign involvement in the UK defence supply chain. However, regardless of the level of foreign ownership or the closeness of a company’s relationship with another Government, any foreign domiciled company, or subsidiary owned by a foreign domiciled company, will be subject to influence from outside the United Kingdom.

The Ministry of Defence’s current approach and the extent of foreign involvement in UK Defence

7.MOD doctrine appears to be that ownership, country of domicile, or links to foreign governments are not a concern or consideration in its approach to industry and contracting. Huw Walters, Director, Economic Security and Prosperity at the MOD, told us that the MOD “very much welcome foreign investment” and its evidence stated that its current approach continues to draw on definitions set out in the 2002 Defence Industrial Policy, which described the UK defence industry as:

“Embracing all defence suppliers that create value, employment, technology or intellectual assets in the UK. This includes both UK and foreign-owned companies.”

and:

“The UK defence industry should … be defined in terms of where the technology is created, where the skills and the intellectual property reside, where jobs are created and sustained and where the investment is made.”12

8.ADS Group, the trade organisation for companies operating in the UK Aerospace, Defence, Security and Space sectors, noted that the UK Government has pursued international competition as a primary means for delivering value for money.13 This is echoed by Jag Patel, a researcher focusing on procurement matters, who argued that the Government’s approach to foreign investment was motivated by a desire to enhance the competitiveness of the defence market and increase value for money.14

9.This approach has meant that foreign involvement, no matter how defined, is widespread in the UK defence industry. The UK’s defence and security sectors host a broad range of UK-based and international suppliers, headquartered in a range of countries.15 Andrew Kinniburgh, Director General of NDI, told us that foreign ownership is relatively widespread in defence at 19%.16

10.The MOD provided an overview of its most significant suppliers, outlining the country of domicile, key stakeholders, percentage of UK ownership of shares and the percentage of their total revenue which comes from the UK.17 This information showed that ten of the UK’s top twenty-three defence suppliers by MOD spend are domiciled in the UK. Eight of the others are domiciled in the United States, with one each domiciled in the Netherlands, Italy, Spain, France and Japan. The average percentage UK ownership across these companies, where data was available, was 17.7%.

11.We were told that this approach of encouraging inward investment has brought many benefits to UK defence and the wider economy. ADS Group’s written evidence argued that most defence and security suppliers to the UK national security community invest in the UK on a long-term basis. ADS Group argued that these organisations contribute significantly to the UK’s national prosperity by establishing UK businesses, investing in the local economy and creating jobs and fostering research and development activities.18 Their evidence additionally claimed that international involvement enables greater opportunities for trade and strengthening ties with the UK’s allies.19 Andrew Kinniburgh told the Committee that the UK has “benefited hugely” from foreign direct investment.20 Jeremy Quin MP, the Minister for Defence Procurement, echoed these comments arguing that foreign companies invest strongly in skills, research and development, apprenticeships and generate jobs in the UK.21 Huw Walters added that these companies generate intellectual property in the UK and are a positive for other companies in the UK supply chain as “it gives them a route to market and easier access to some of the primes”.22

12.The Minister for Defence Procurement made the point that the MOD’s approach to encouraging inward investment is reflected across Government:

“I think there has just been a general UK willingness to see foreign direct investment across our industries. That is something that we have obviously gained from as a country, and that is global Britain at work.”23

13.As a result of the Ministry of Defence’s approach of encouraging inward investment, foreign involvement in the UK defence supply chain is widespread, with the UK hosting a broad range of UK-based and international suppliers. This approach has brought many benefits to the UK defence industry and wider economy.

Differentiating between friendly and hostile foreign involvement

14.It is, however, necessary to distinguish between friendly foreign involvement, that from our closest allies, which brings benefits to the UK defence and to the economy more broadly, and hostile foreign involvement, which brings risks to the UK’s national security.

15.We heard concerns relating to disruption of the supply chain for sensitive technologies or capabilities. MOD evidence accepted that certain types of foreign investment in companies with sensitive technologies or capabilities or within the UK’s Critical National Infrastructure can raise national security concerns.24 Specific concerns have been articulated about the involvement of companies linked to states such as China, which could result in British high-technology and equipment featuring in foreign military technology. Elisabeth Braw, a defence industry analyst formerly at RUSI and now with the American Enterprise Institute, argued that cutting-edge tech takeovers are a strategic threat to the West.25 She told us about two of China’s strategies—Made in China 2025 and Military-Civil Fusion—which mean that it seeks to incorporate civilian innovation into the defence supply chain to improve its own defence industrial capabilities and, by extension, its own armed forces.26 She explained that Chinese companies therefore started investing in Western companies to get access to their innovations. Francis Tusa added that commercial companies and the military are “inextricably linked” in China: “In everything China is doing … it will end up in the defence sphere.”27 ADS Group highlighted another national security concern, that hostile foreign ownership can pose a risk to the UK’s international supply chains by disrupting industrial support to the UK’s national security.28

16.Understanding and identifying which organisations are likely to pose these risks is a difficult task, as illustrated by the volume and depth of work conducted by the MOD. Huw Walters said that the MOD recognise that “there are some sorts of hostile foreign investment that come in”. He explained that the MOD has had a team in place since 2017 to look specifically at investment screening.29 The Minister for Defence Procurement explained that the MOD operate a “risk-based approach”.30 The MOD described the procedures that it has in place by explaining that companies with a direct contract with the MOD are mandated to provide advance notification of any change of control (either within the UK or to a foreign owner). The MOD explained that upon notification it will co-ordinate a due diligence exercise designed to establish whether the change creates concerns over security of supply, proximity risk, or other national security implications that need to be considered alongside any competition issues. In such cases, the Department can choose to transfer work to an alternative supplier.31 Huw Walters explained that the process followed by the MOD is “basically” the same regardless of the purchaser’s country of origin:

“So we will be doing a national security assessment and look at things like who the acquirer is and what their links are. We will look at the target company, what they do and what capabilities they have, and we will look at what programmes of ours they might be involved in. Then we will look at whether they could have an impact in providing insight to our potential adversaries about the capabilities we have and how those might be countered or whether they might give a capability uplift to our adversaries.”32

17.Unfortunately, this approach, whilst recognising that the vast majority of investment into UK defence has been friendly and is to be welcomed, has resulted in investments being permitted which risk UK national security. The Henry Jackson Society has created a database with examples of such investments.33 This lists companies that have been acquired by Chinese-owned firms since 2010 and includes six which list defence as a key business area:

• FDM Digital Solutions, acquired by Shaanxi Ligeance Mineral Resources in 2019, which specialises in thermoplastics for engineering applications and work in ‘Space and Defence’ industries.
• Gardner Aerospace, acquired by Shaanxi Mineral Resources in 2017, is an international manufacturer of aerospace finished components and are included in military platforms for A400M’s and engine platforms for RTM322’s.
• CAV Aerospace, acquired by Shaanxi Mineral Resources in 2018, a provider of ice protection and drag reduction technology, and states on their website that they provide such services to “general aviation, commercial aerospace and defence markets worldwide.”
• The Sepura Group, acquired by Hytera Communications in 2017, design, manufacture and supply digital radio products, systems and applications and state on their website that they are “working on several projects with armed forces in Europe and America.”
• eXception PCB, acquired by Fineline Global in 2016, a manufacturer of time critical and technology driven printed circuit boards, and produced circuit boards for F-35s.
• Specialist Machine Development (SMD), acquired by CRRC Zhuzhou in 2015, a global designer and manufacturer of subsea remotely operated and autonomous power and control solutions. Their products include Defence remote operated vehicle systems, aimed at and designed for defence customers.

18.In addition to these examples, a 2018 report claimed that British semiconductor technology ended up in a Chinese naval railgun. Reports suggested that the acquisition of Dynex Semiconductor by Chinese railway firm CRRC Zhouzhou in 2008 “could have helped the development” of the Chinese navy’s railguns with Dynex’s high-powered semiconductors being supplied to China’s military.34

19.Witnesses before the sub-committee specifically highlighted the risks posed by the acquisition of eXception PCB. The company was the subject of a 2019 report by Sky News which explained that the printed circuit board manufacturer, based in Gloucestershire, produced circuit boards that “control many of the F-35’s core capabilities” and were Chinese owned through its parent company Shenzhen Fastprint. Defence experts at the time expressed concerns that a Chinese owned company was producing any parts for a classified British and American programme.35 Francis Tusa told us that the MOD did not know about the purchase for six years, until the 2019 report, and that the information that this company had access to about the F-35 included:

“ … what g-force that circuit board is due to take, and the voltages, power and temperature range. Quite frankly, if you gave an electrical engineer all that data, they would be able to start to reverse engineer the capabilities of the overall system.”36

The Minister for Defence Procurement disputed this claim, stating that “an approach was made to the MoD back in 2013 - six years before it appeared on Sky - where this was flagged up.” He argued that the components provided were “bare plastic boards” that were then supplied further up the supply chain for more advanced production stages.37

20.Involvement by companies with links to China could represent a risk throughout the defence supply chain. China is well known to engage in large scale intellectual property theft.38 The Defence Committee heard about the extent of Chinese espionage and property theft during its recent inquiry into the Security of 5G.39 This behaviour raises concerns that any company working alongside another company with links to China could be subject to theft of its intellectual property.

21.It is possible that the MOD does not have full sight of the defence supply chain, as suggested by Francis Tusa, and was therefore unaware of the acquisitions listed above.40 However, the Minister for Defence Procurement said that the MOD are:

“extremely mindful of the need to maintain a clear vision of our supply chain, and we are working through a Department-wide supply chain resilience and risk programme.”41

Air Marshal Richard Knighton, Deputy Chief of the Defence Staff (Financial and Military Capability) at the MOD, told us that the MOD recently launched this supply chain resilience and risk programme, which built on work undertaken in recent years to understand and map the supply chain of the MOD. The purpose of this exercise, he explained, was to have a better understanding of where vulnerability and risks might lie and therefore take action to mitigate them.42 The Minister for Defence Procurement built on the Air Marshall’s comments and explained that through a “risk-based approach” the MOD can go down through the entire supply chain and understand it with “some 37 projects going through that supply chain mapping”.43

22.This work therefore suggests that the MOD knew about the acquisitions and are relaxed about Chinese ownership of companies operating in defence. Indeed, when asked how the MOD would react to efforts from a Chinese company to purchase a company within the British defence sector, the Minister for Defence Procurement maintained that it is “agnostic in terms of particular states”.44

23.If the Ministry of Defence has the level of oversight of the defence supply chain that it claims, then it is clear that it was aware of purchases by Chinese companies into the UK defence supply chain and decided that such involvement was an acceptable risk. We do not agree.

24.The Ministry of Defence should urgently assess the implications of Chinese ownership of the companies listed within this report.

25.The UK is involved in a number of military alliances with likeminded partners across the globe and these alliances could form the basis for distinguishing between friendly and hostile investment. The UK’s current primary military and intelligence alliances are those with NATO and Five Eyes partners.45 The Minister for Defence Procurement told us that there is “without any doubt” a level of involvement from companies sourced outside of NATO and outside of Five eyes.46 Indeed, according to data provided by the MOD, one of the top twenty-three defence suppliers in the UK is domiciled outside these alliances (Fujitsu Limited in Japan).47 There is no evidence to suggest that investment from Japan poses the risks described above and it may be beneficial to expand the friendly grouping of investors to include those nations not in NATO or Five Eyes but featuring in the D-10 grouping, previously discussed in our report on the Security of 5G.48

26.But any country outside these groupings, or another formal alliance with the UK, may be considered as a potential adversary. Additionally, countries which consistently involve themselves in intellectual property theft, and regularly behave contrary to the UK’s values, such as China under the Chinese Communist Party, should be categorised as hostile.49 Investments from countries, such as Russia, that regularly engage in espionage against the UK, or its allies, should also be classified as hostile.50

27.The Ministry of Defence’s open and country-agnostic approach to foreign involvement means that the defence supply chain has been open to potentially hostile foreign involvement, with reports of companies being owned and influenced by foreign Governments whose values and behaviours are at odds with our own and who are known to engage in intellectual property theft. The Ministry of Defence should publish a list of countries it considers friendly and from whom investment should be encouraged. All those countries falling outside of this list should be barred from investing in the UK’s defence supply chain, including China and Russia.

28.This report has focused on the level of foreign involvement in the UK defence industry. Reports have highlighted a risk of another kind, the purchase of Chinese equipment for use within the UK military. The Government has recently purchased two second hand Chinese 737 airliners to convert into E-7 Wedgetail planes to deliver the UK’s Airborne Early Warning and Control Capacity. Commentators have raised concerns as to the security of the equipment, which some suggest may have been defective or actively sabotaged before transfer. The Minister for Defence Procurement has defended the decision, insisting that the airframes will be stripped down and thoroughly checked to ensure that it meets security requirements.51

29.Recent reports have highlighted the purchase of second-hand Chinese equipment by the Ministry of Defence. This is deeply concerning. The purchase of equipment from China for use by the Armed Forces should not be considered a viable option by the Ministry of Defence.

30.In late 2018 and 2019 concerns were raised about the future of the General Electric site in Rugby responsible for manufacturing Type 26 frigate motors, which General Electric had previously said would be moved to Nancy in France. A previous Defence Committee, and the Unite trade union, raised concerns that this would have national security implications, with MOD classified work leaving the country, and that it represented a “hollowing out of the UK’s defence industrial capacity.”52

31.Commentators criticised the MOD’s relative indifference to the maintenance of the industrial capacity in the UK, with an MOD official at the time stating that the future of the facility was a decision for General Electric.53 Following the intervention of a previous defence committee, a long-term agreement was reached between the MOD and General Electric, confirming the long-term future of the site.54

32.The relative indifference of the Ministry of Defence to the possible relocation of General Electric’s Rugby facility was concerning. We are pleased that this important industrial capacity ultimately remained in the UK. The Ministry of Defence should prioritise the maintenance of sovereign capability within the UK defence industry.