Select Committee on Defence Fifth Report



FIFTH REPORT

The Defence Committee has agreed to the following Report:—

THE DRAFT DEFENCE SCIENCE AND TECHNOLOGY LABORATORY

TRADING FUND ORDER 2001

1. On 17 January this year, the Secretary of State for Defence laid before the House a draft Order to establish the Defence Science and Technology Laboratory (DSTL) as a trading fund of the MoD. If approved by both Houses, the made Order will come into effect on 1 July 2001. Under the provisions of the draft Order, the Defence Evaluation and Research Agency (DERA) will at the same time cease to be a trading fund, and the Order would remove from the fund those assets that will not be allocated to DSTL. 'New-DERA'—most of the remainder of DERA—will become a public limited company (initially wholly government-owned). The Government's intention is that at a later date—possibly later this year[8]—New-DERA will be floated on the stock exchange. This will bring into effect the MoD's programme to create a public-private partnership for DERA, begun in 1998.[9]

2. The Defence Committee has monitored the implementation of this plan throughout the current parliament. We have produced three Reports—

·  Sixth Report, Session 1997-98, The Defence Evaluation and Research Agency, HC 621

·  Ninth Report, Session 1998-99, Defence Research, HC 616

·  Ninth Report, Session 1999-2000, The Future of DERA, HC 462

Our first Report was prompted when rumours first circulated of a possible 'part privatisation' of DERA, rumours which were subsequently confirmed in the Strategic Defence Review.[10] The second of our Reports examined the MoD's (by then published) proposals for what the MoD called a 'Reliance' model of public-private partnership, and highlighted the concerns of key stakeholders—industry, the trade unions and the US authorities (who are important partners in collaborative defence research programmes), as well as our own. We concluded that—

    The risks of failure associated with the current proposals for the future status and ownership of DERA far outweigh the value of capital receipts anticipated. We conclude that the proposals for the future structure of DERA contained in the [first] consultation document are fatally flawed and should not proceed.[11]

3. The MoD abandoned those plans, and launched a second consultation in April 2000, on an alternative 'Core Competence' approach. 'Core Competence' involved a much bigger proportion of DERA staying within the MoD (in 'Retained-DERA', now to be retitled the Defence Science and Technology Laboratory), leaving about three-quarters to be assigned to a privatised 'New-DERA'. Our third, and most recent Report, published last June, welcomed the improvements of that 'Core Competence' proposal over its 'Reliance' predecessor, but warned that the fundamental weaknesses of the public-private partnership had not been removed. We also highlighted five areas where there was still significant uncertainty which the MoD had then yet to resolve:

      (a)  New-DERA would not be permitted to undertake defence 'manufacturing', but there remained uncertainty about what exactly the MoD meant by that term.[12] The MoD seemed to be suggesting that New-DERA would be barred from 'manufacturing' equipment but could be a 'systems integrator', and in its response to our Report stated that 'we accept that clarification is required to define the parameters of defence manufacturing'.[13]

      (b)  The MoD had not made a final decision on which of New-DERA's assets would be regarded as of 'strategic' importance, and thereby falling under the special measures afforded by the MoD's golden share in the privatised firm (the MoD would have first refusal to acquire such assets if New-DERA were to dispose of them).[14]

      (c)  There remained uncertainty about the extent of controls on foreign and individual share-ownership of New-DERA, that would be introduced in its 'compliance framework'.[15]

      (d)  With the bulk of DERA's research work to be put in New-DERA, there were doubts about how the scientific foundation of DSTL would be maintained in the long term.[16]

      (e)  The future of the Defence Diversification Agency remained unclear. In our report last June, we highlighted how the Defence Diversification Agency did not fit comfortably within the public-private partnership initiative.[17] The Agency was set up (in line with a Manifesto commitment) in January 1999 and placed in DERA's organisation pending a final decision on its long-term home once the public-private partnership was implemented.[18]

4. The MoD nevertheless announced its intention of proceeding with its revised model of public-private partnership on 24 July 2000.[19] The timetable, the MoD had told us, would involve the separation of DSTL and New-DERA around the end of 2000, followed by a three month period of 'shadow operation' to ensure that 'both organisations and their supporting infrastructure are robust.'[20] New-DERA would then be established as a government-owned public limited company, and DSTL would continue as a trading fund.[21]

5. In our most recent report on the future of DERA we indicated our intention to return to the subject when any secondary legislation was presented to the House to take the public-private partnership forward.[22] With the draft trading fund Order having now been published, we decided to take evidence on it from the Minister for Defence Procurement, Baroness Symons, on 28 February, and to revisit the issues that remained outstanding from our last inquiry (paragraph 3). That evidence is published with this Report.[23] Our principal aim in making this brief Report to the House is to make available the information that we have gathered, before the draft Order is debated in Standing Committee or on the floor of the House. The Government's business managers were able to give us a commitment that this would not take place before the week commencing 12 March 2001.

6. When we took evidence from the Minister and her officials,[24] we examined:

  • The results of the MoD's consultation exercise on the revised model ('Core Competence') for the public-private partnership.[25]

  • The rationale for establishing DSTL as a trading fund.[26]
  • The preparations for the vesting day for New-DERA and DSTL, and its delay from 1 April to 1 July 2001.[27]

  • Progress with dividing DERA into its two new parts,[28] including the assessment of the intellectual property that will be placed in New-DERA.[29]

  • The appointment of New-DERA's directors and their likely remuneration packages, including that of the Chief Executive.[30]

  • The prospective restrictions on the ownership of New-DERA, the likely level of market interest in the new company,[31] and the possible use of 'strategic partners'.[32]
  • The definition of 'strategic assets' in New-DERA.[33]

  • The cost of DERA's division, and where those costs will fall;[34] and the implications for DERA's financial performance in the current year.[35]

  • The latest views of the US authorities.[36]

  • The MoD's research work that will be allocated to New-DERA, and the Department's latest plans for opening up its research programme to competition.[37]

  • The MoD's progress in resolving the ambiguity in its plans concerning the bar on New-DERA being able to undertake 'manufacturing'.[38]

  • The prospects for DSTL to be able to maintain in the long term the scientific expertise needed for its knowledge integration capability.[39]

  • The MoD's latest plans for the Defence Diversification Agency.[40]

7. We are disappointed that that evidence shows that four of the outstanding areas of uncertainty that we had previously identified (points (a) to (d) in paragraph 3 above) remain unresolved.[41] The fifth area—the fate of the Defence Diversification Agency—has seen some progress, with the publication earlier this month of a consultation document on its future.[42] Our initial assessment of those proposals raises further doubts, however, about the viability of an organisation that will apparently be divided between the MoD, DSTL and New-DERA—concerns which we raised with the Minister.[43]

8. Our more general misgivings about many aspects of the part-privatisation of DERA were also not dispelled. Indeed, new issues now arise, including further uncertainty about the financial implications of New-DERA's sale. In our earlier reports we had made clear our disappointment about the division of the spoils of this privatisation. On the plans then in place, the MoD were not to benefit from the full receipt from New-DERA's sale, funds which we believe will be needed to cover the likely additional costs of contracting research from a private sector New-DERA.[44] The 2000 Spending Review allocated £250 million from the sale to the defence budget for 2001-2, with the remainder going to the Treasury.[45] In her evidence last month, however, the Minister suggested that the division of the sale receipt between the MoD and the Treasury had not been finally decided. There is also the question of which budget will bear the significant costs of preparing for and implementing the proposed division of DERA and its sale—perhaps £80 million.[46] Worryingly, the Minister did suggest that some of the significant costs of implementing the public-private partnership could fall on the MoD.[47] This could effectively wipe out the benefit to the MoD of the sale. We trust that the Minister will seek to secure the full sale receipt for the MoD and the reimbursement from the Treasury of the MoD's costs of implementing the public-private partnership.

9. We have noted above that, in addition to these financial matters, several other of the crucial decisions on which the viability of the two future parts of DERA will depend still have not been made—even at this point when the House is being invited to take a decision which will irreversibly lead to the break-up of DERA as it presently exists. The next decision point for the public-private partnership, at which the Minister will review the programme, will be in March/April 2001 when the viability of the prospective New-DERA will be re-assessed.[48] We expect the outstanding issues and uncertainties to have been resolved before then and the decisions set out in the reply to this Report.

10. Beyond that, the next important date will be in October/November 2001 when the Minister expected to consider New-DERA's 'route to market'.[49] We will continue to monitor developments closely, as we would hope will our successors in the next Parliament.

11. The trading fund Order is an inevitable step on the way to the division of DERA—clearly New-DERA cannot be established as a public limited company while it remains a trading fund. If the Government is resolutely set on the misguided change of status for the Agency, a delay in approving the trading fund Order would only serve to undermine the prospects for a successful subsequent flotation and to further damage DERA's already brittle staff morale, neither of which we would wish to see. It is because the Order takes forward the partial privatisation of DERA, however, that we cannot lend our positive support to it. Though now at the eleventh hour, we would still prefer that the proposed public-private partnership for the Defence Evaluation and Research Agency—one of the MoD's successful sectors under its present status—was abandoned.


8  Q23 Back
9  Sixth Report, Session 1997-98, The Defence Evaluation and Research Agency, HC 621, para 3 (first bullet point) Back
10  Eighth Report, Session 1997-98,The Strategic Defence Review, HC 138-I, para 342 Back
11  Ninth Report, Session 1998-99, Defence Research, HC 616, para 121 Back
12  Ninth Report, Session 1999-2000, The Future of DERA, HC 462, paras 22 and 48 Back
13  Twelfth Special Report, Session 1999-2000, HC 901, para 23 Back
14  Ninth Report, Session 1999-2000, op cit, para 48 Back
15  ibid Back
16  Ninth Report, Session 1999-2000, op cit, paras 33-35 Back
17  Ninth Report, Session 1999-2000, op cit, paras 29, 30 Back
18  Ninth Report, Session 1999-2000, op cit, para 27 Back
19  Ev p1 Back
20  ibid Back
21  ibid Back
22  Ninth Report, Session 1999-2000, op cit, para 64 Back
23  Oral evidence at Ev pp 1-24; written evidence at Ev pp 25-34 Back
24  The Minister was accompanied by Sir John Chisholm and Mr Bill Clifford (the prospective heads of New-DERA and DSTL respectively), and Mr Terence Jagger, the Director of the DERA Partnering Team in the MoD Back
25  QQ 2-21 Back
26  QQ 30-44 Back
27  QQ 22-29, 45-49 Back
28  QQ 123-140 Back
29  QQ 106-108, 152-166 Back
30  QQ 50-53, 56-58, 63-85, 95-98 Back
31  QQ 54-55, 59-62, 90 Back
32  QQ 92-93 Back
33  QQ 185-187 Back
34  QQ 141-151 Back
35  QQ 99-105 Back
36  QQ 167-178 Back
37  QQ 117-121 Back
38  QQ 179-184 Back
39  QQ 109-116, 188-194 Back
40  QQ 195-206 Back
41  See QQ 182, 185, 90 and 189, which deal respectively with points (a) to (d) of paragraph 3 Back
42  Published on 8 February 2001 Back
43  Q 195 et seq Back
44  Ninth Report, Session 1999-2000, op cit, paras 55, 56 Back
45  Supplementary paper SR2000/MoD, published with Spending Review 2000, Cm 4807 Back
46  Q 141 Back
47  QQ 141-151 Back
48  QQ 91,92 Back
49  QQ 91, 92 Back

 
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