Offset arrangements

Offsets are compensation practices that are required as a condition of a purchase of equipment or services from a foreign company.^[1]

According to Transparency International (TI), offset arrangements are arrangements in which the purchasing government of the importing country obliges the supplying company of the exporting country to reinvest some proportion of the contract in the importing country. This can be done through defence-related projects, for example, by sub-contracting, or through a defence-unrelated enterprise such as purchase of goods or services. The percentage of the offsets contract in relation to the original defence contract is large; often more than a 100% of the defence contract value.^[2]

TI warns that offset arrangements are often large in value and highly susceptible to corruption. Also, offsets are under much less scrutiny during their negotiation than the main arms deal itself. Additionally, in many countries there is almost no due diligence, no monitoring, no audits and no publication of offset results, benefits or performance.

What are offset arrangements?

TI explains that defence offsets are a counter-trade mechanism agreed between purchasing governments and supplying companies when the former acquire military equipment or related services from the latter. They are frequently used as industrial (sometimes even social and economic) policy tools aimed at improving balance-of-payments accounts and compensating the purchaser’s economy (and tax payers) for a public investment that will not have an immediate direct impact on the wellbeing of the population.

Why is it important to include offsets in security sector oversight frameworks?

According to the European Defence Agency (EDA), not only has the use of offset arrangements increased, but also their percentage in proportion to the contract. It is believed that around 130 countries are currently using offsets arrangements. TI emphasises that the impact of these arrangements remains unknown as there has been a general lack of governmental monitoring. In fact, it is impossible to determine the real economic impact of offset arrangements since there is almost no data on their performance.

The World Trade Organisation’s Agreement on Government Procurement, which binds almost forty countries, prohibits offsets. However, this agreement also includes exception clauses that provide loopholes for their use. There is a similar effect when it comes to EU’s legislation that prohibits the general use of offsets, with some exceptions. Therefore, additional measures such as monitoring, auditing, transparency and accountability must be adopted in order to prevent corruption and its consequences. Also, there are non-binding standards, directives and codes of conduct on procurement^[3] and offsets (as developed, for example, by the European Defence Agency (EDA)^[4]) that should be taken into account.

Offsets pose a number of risks to an importing country. When used as industrial policy tools in order to influence the country’s economic development by supporting selected companies, they can lead to unsustainability of those companies once the support is withdrawn. Additionally, these companies may be supported by corrupt interest groups. Moreover, offset arrangements often include capital-intensive industries which are already prone to corruption. Corruption may then spread to other public sectors via offsets. Also, projects that occur under offset arrangements rather than the general government procurement procedures frequently bypass transparency and anti-corruption mechanisms.^[5]

How do they work?

As TI describes, offsets consist of packages valued to a percentage of the acquisition contract. They may take many forms, such as agreements for co-production, licensed production, subcontracting, training, technology transfer, or other investments in the purchasing country’s economy. Depending on whether they are related or not to the subject of the acquisition contract, they are considered direct or indirect.

Offsets are highly opaque instruments with little to no oversight, adequate legal standards, transparency, monitoring, nor accountability. As TI explains, they are complex contracts dealing with long-term investments that offer particularly attractive opportunities for corruption.

Who is involved?

The two main actors in offset arrangements are the importing countries that acquire the equipment and demand an offset package along with it and the suppliers of the equipment or service who agree to a particular offset package. There are also numerous third-party entities, such as brokers, consultants, third party offset executors, as well as the beneficiaries of offset arrangements, including local companies, research and development centres, and, sometimes, the armed forces. These myriad actors increase the risk of corruption because it is more difficult to control and oversee all the elements and activities within the offset arrangements.^[6]

Recommendations

In order to counter corruption risks inherent to offset arrangements, TI insists that sound policies introducing transparency, integrity and accountability to the process are needed. National governments must ensure that offset arrangements, as part of defence and security purchases, are in line with the strategic security requirements. Offsets personnel should be highly qualified, competent, experienced and bound by a sound code of conduct. TI reminds that offsets are a specialist area unsuitable for defence ministry officials and military officers without experience in that field. There should be regulations for the disclosure of conflicts of interests, oversight mechanisms such as monitoring of offset management process, and performance audits. Due diligence should be carried out prior to offset agreements in order to avoid and disclose any potential conflicts of interest and improper beneficiaries. Offset contracts should specify monitoring mechanisms and procedures and establish incentives and penalties for performance. Finally, the progress, effects, and results of offset arrangements should be published annually by the Government in order to ensure obligations are fulfilled. Where there are no strict measures to control and oversee offsets, these practices should be abandoned.