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The hidden price tag of defence contracts - offsets

Thomson Reuters Foundation - Thu, 9 Feb 2012 15:50 GMT
Author: Tiffany Clarke
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By Tiffany Clarke of Transparency International's Defence and Security Programme

The Indian government’s recent $11 billion decision to purchase the Rafale fighter jet from Dassault Aviation brings with it an accompanying $6 billion offset contract. Given the large risk for corruption in offset agreements, both parties should be stringent about applying the highest levels of transparency and accountability in the offset contract as they finalise the agreement.  

An opaque part of the defence industrial landscape, defence offset programmes pose a significant risk for corruption that is largely over-looked and poorly understood.  Often unconnected to the main defence contract, offset contracts outline a set of additional investments in the country that the defence company agrees to make with the purchasing company’s government. These investments range from direct technology transfers and producing some of the parts in the purchasing company’s own country to building roads and other projects unrelated to the defence procurement. Offsets are often worth just as much or even more than the main contract to which they are attached, but lack scrutiny and monitoring.

Governments, defence companies, and most importantly the public should be concerned about offsets. Offsets agreements can be easy places to conceal bribes to reward corrupt officials and to improperly influence the main acquisition. Since countries and defence companies usually negotiate offset contracts behind closed doors with little transparency, the public cannot hold governments and companies accountable for fulfilling the terms of the contracts. This lack of visibility leads to undocumented waste at a time of scarce public resources.  Offset contracts and programmes need to be much more transparent. The substantial variation in due diligence practice across the defence industry compounds the problem and makes defence companies and governments more vulnerable to corruption risk.

Despite an increasing number of alleged corruption cases in offsets contracts over the past decade—such as Patria’s sales of tanks to the Slovenian government or the sale of submarines to Portugal and Greece by the German Submarine Consortium—the defence sector demonstrates little awareness of the corruption risk associated with offset contracts. At a time of record-breaking Foreign Corrupt Practices Act (FCPA) fines for defence corruption, however, it is clearly in every government and defence company’s interest to address offset-related corruption risk.

Transparency International UK’s Defence and Security team has today released a new report “Due Diligence and Corruption Risk”, which examines current due diligence practices in offset programmes by defence companies and brokers. On the plus side, it finds that some defence companies have thorough and well-founded offset due diligence programmes. For example, these companies thoroughly followed up on ‘red flags’—such as the adviser represents a company with a questionable reputation or the adviser has no significant business presence in the territory—found during the due diligence process to ensure agents were clean.  These good practices are noted in the report and should be picked up and copied rapidly by the rest of the industry. 

However, despite reaching out constructively to 150 defence companies—and with the global offsets industry association GOCA, to their credit, supporting company participation in the study – 123 of the companies did not respond to requests to participate. Since it is highly likely that those who responded had better programmes than most, the majority of defence companies and their brokers and sub-contractors have a long way to go to move beyond a ‘box-ticking’ mindset. Companies can no longer conduct superficial due diligence which is solely designed to protect the corporation and does not address the real issues.

Transparency International UK is not against offsets in principle, but the defence industry needs to raise its game if it is to argue credibly for their continuation. We call for greater transparency and accountability in offset programmes, and for the international defence industry to rapidly improve its practices in this area. In particular, this requires putting robust policies and procedures in place, and being more energetic in addressing the  ‘red flags’ that are triggered during the due diligence. Companies should incorporate offsets into their main business code of conduct requirements to demonstrate that they are serious about getting offsets right.

Governments also need to be more energetic in demanding higher industry standards. They should promote greater transparency of the offset programmes by requiring defence bids to be made both with and without offset contracts costs and that detailed offset performance reports be published regularly. They also should issue a standard set of guidelines that all companies are expected to follow when conducting due diligence in offsets.

Civil Society too can play an active role in pressing governments to be more open about the offset contracts, and indeed about defence contracts in general.

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