UK AEROSPACE INDUSTRY: SOURCES OF DIRECT UK GOVERNMENT
||Fund Title||Objective of Funding
||Level of Funding|
|MoD||PATHFINDER||Research and Technology Demonstration using:
||Usual max. 50% of project costs which are let on a yearly basis.
||(a)The Applied Research Programme (ARP)
||Budget subject to change after the SDR.|
||(b)The Corporate Research Programme (CRP)
||At the end of 1996, £24m worth of contracts let, with £20m in
||(c)Technology Demonstration Programmes (TDP)
| ||Future Systems, Air-FS (Air)
||Miscellaneousagreed on a case-by-case basis
||Variable-dependent on project|
| ||Private Finance Initiative (PFI)
||Industry financed initiatives, with agreed pay-back downstream. (PFI allows HMG to defer major financial commitments for large projects).
||Limit is dependent on project|
|DTI||CARAD||This is an initiative to promote R&T for civil and some dual use aerospace applications.
||£20m pa. (£2.6m available for "Avionics and Mechanical Systems")
| ||Technology Foresight
||Foresight Action-to promote the aerospace sector R&T relating to the Technology Foresight initiative (originally part of CARAD which has insufficient budget-the new budget has yet to be identified).
||No separate budget allocated-still part of CARAD. Industry requires more than is available if the proposed Foresight Action projects are to start.
| ||Launch Aid
||To invest in R&T of UK civil aerospace strategic importance which cannot be funded by industry. (There must always be a long term business case).
||Dependent on projectcan be>£200m eg Rolls-Royce for Trent development for A340-600 aircraft.
| ||Sector Challenge
||To improve competitiveness and long term profitability of business sectors eg Aerospace.
NOTE: This was a one-off programme.
|N/A-a one off programme.|
NB. The SBAC was awarded £1.5m for the Competitiveness Challenge which runs from June 1997 to May 2000.
| ||Local Challenge
||To enhance competitiveness by assisting local partnerships to design high quality business support services.
||Bids invited annually, usually for 3 years of funding. Typical award £TBD
|Engineering and Physical Sciences Research Council (EPSRC)
||Integrated Aerospace Manufacture Programme
||To support high quality strategic and applied university research in response to the need for more innovative manufacturing within UK industry.
||-50% max of total project. No funding for Industrial Partners.
| ||UK Lean and Agile Aerospace Programme (Lean Aerospace Initiative (LAI))
||To bring together the various strands of aerospace initiatives into a coherent umbrella framework based on emerging models of lean and agile (reduce time/cost) enterprises.
||DTI providing £50K to fund SBAC based programme manager.|
EPSRC and Industry co-funding (50:50) Academia with -£400K
| ||LINK||To manage the transition between the research base and industry for the benefit of the UK economy.
||Total of £0.5M available via CARAD
|DTI Local Offices||SMARTSmall Firms Merit Award for Research & Technology
||To promote and fund technical or commercial feasibility studies for innovative projects lasting 6 to 18 months. All technology fields eligible.
||max. £45K. per award = 75% of eligible costs
| ||SPURSupport for Products under Research
||To assist SMEs with the development of new products and processes which involve significant innovative technological advance.
||max. £150K per award = 30% of eligible costs
|Civil Aviation Authority (CAA)||
||To research areas relating to regulatory issues.
EXPORT CREDITS GUARANTEE DEPARTMENT (ECGD):
The UK aerospace and defence industries are amongst the primary
users of ECGD facilities. Civil aerospace and defence together
accounted for 62 per cent of ECGD's new business in 1999-2000.
More than $450 million of support was given to Rolls-Royce's aerospace
customers alone in 2000. Further support was extended to BAE SYSTEMS
both in its own right and as part of the UK's contribution to
the marketing and sale of Airbus products. The aerospace industry
uses a number of ECGD products, including cover under the OECD's
Large Aircraft Sector Understanding ("LASU") for commercial
aerospace transactions and cover under the OECD's Commercial Interest
Reference Rate ("CIRR") system for other exports.
Export credit is a vital element in overseas sales of large
commercial and military aerospace systems. ECGD represents the
only viable means by which many large medium- and long-term overseas
contracts receive support. All of the UK's major competitors and
collaborators deploy similar mechanisms and any loss or degradation
of the terms of UK support would have a serious affect on the
UK aerospace industry.
The UK Aerospace and defence industry is highly dependent
on exports. In 1999, 60 per cent of total aerospace turnover was
exported (nearly £12 billion), contributing £2.1 billion
to the UK balance of trade. Indeed, the UK is perhaps the most
export dependent of the major aerospace producing states. While
the direct users of ECGD are large companies such as BAE SYSTEMS,
Rolls-Royce and GKN-Westland, the business generated by their
overseas sales has a direct impact on UK companies (including
many SMEs) who constitute overall around two-thirds of their supply
chain business. The availability of competitive export credit
systems is also vital to maintaining the UK share of collaborative
programmes such as Airbus where the Airbus company may begin to
place work according to the support they receive in selling the
The full Mission and Status Review as finally published on
25 July 2000 but it left a number of significant areas open for
further consultation including Business Principles, the revised
Environmental Impact Assessments (now called Project Impact Questionnaires
or "PIQs") and Capitalisation. Despite assurances from
the TGovernment that reform to the ECGD system would not put UK
exporters at a disadvantage, this is clearly not the case as can
be seen from the examples below.
Changes to ECGD's products
ECGD unilaterally introduced a differential pricing policy
last year in relation to LASU funding. The agreed premium between
export credit agencies ("ECAs") for commercial aircraft
transactions is 50 basis points. ECGD withdrew from this agreement
and now either charges a higher premium for those deals where
it perceives the risks to warrant it or it lowers the supported
amount to achieve the same result. This immediately affected a
Rolls-Royce Airbus transaction that was in documentation with
Sri Lanka and caused considerable embarrassment for both Airbus
and Rolls-Royce with the other participating European ECAs as
well as the customer when ECGD reduced the advance rate shortly
before closing. In another Airbus transaction, involving an Irish
leasing company, ECGD unilaterally increased the premium.
A further unilateral change to LASU was announced in December
2000. As of 31 March 2001 ECGD will have withdrawn from the fixed
interest rate hold arrangements that had provided UK customers
with free interest rate options for up to three years prior to
an aircraft delivery. UK companies were warned that this was being
contemplated but had been reassured that it would not be implemented
until 31 March 2002 to allow for alternative arrangements to be
agreed. Neither of the other two European ECAs have followed suit.
ECGD have tried to justify the withdrawal by saying that the options
are expensive (yet at current market to market rates their book
breaks even and the German ECA has actually made a profit on their
hedging) and that the US EXIM does not offer them. The latter
point is true but the US EXIM product is already a cheaper one
and US exporters may also access tax-based export leases to support
their products which UK exporters cannot. Qantas have told Rolls-Royce,
for example, that they believed that the interest rate options
merely kept the European product on a level playing field with
the US one.
It has long been a contentious issue that the three European
ECAs will provide support for US engines in Airbus airframes in
their pro-rata proportions. The two unilateral changes to LASU
described above now mean that Airbus customers are better off
minimising the portion of the UK export credit by buying US engines
so that they can access a larger proportion of their cover on
the original attractive terms from the French and German ECAs.
This is a significant disadvantage for Rolls-Royce.
For new contracts Airbus now has no certainty of an ECA mechanism
to match the support offered by US EXIM. This is damaging Airbus's
competitive position. Feedback from existing customers of Airbus
is that they feel deceived by the planned changes to LASU announced
by ECGD when no new ECA product has been agreed to replace it.
The announced abolition of CIRR interest rate holds as of
31 March 2001 is another unilateral move by ECGD and will not
be followed by other OECD countries in the near term. Two banks
confirmed that they had already been refused fixed rates by ECGD
on transactions that would qualify for them but had been given
no official explanation as to why.
In the defence and aerospace sectors projects as a rule require
committed proposals to be submitted to customers many months before
contracts are entered into. In the past ECGD has provided firm
offers of support for such projects but have now indicated that
their capitalisation structure will prevent them from giving such
support in the future.
The capitalisation structure will, it is believed, lead to
pre-set capital limits being applied to particular territories,
irrespective of credit considerations. If this occurs it will
penalise large projects in particular, including those from the
defence and aerospace sectors.
The changes to ECGD's products appear to be primarily driven
by ECGD's pending capitalisation and a requirement not only to
break even (which is what international agreements require of
all ECAs) but to make sufficient profit to pay a return on that
capital. So far ECGD has refused to divulge at what level the
return on capital will be set. This is very important as it will
drive the premium levels that ECGD will charge. We understand
that the break even assessment is to be carried out on a three-year
rolling basis which is not appropriate for the long-term cyclical
nature of the exporting business and goes against the recommendations
of the Mission and Status Review.
There is also a concern that the imposition of ECGD's bureaucratic
"hurdles" on certain Customersincluding governmentswhere
administrative resources might not be readily availablemay
cause those Customers to shy away from even making an Application;
and yet on a prima facie basis the project would have been one
which ECGD and the UK Government would very likely have wished
to have been associated with. An example would be the planned
acquisition of two BAE SYSTEMS Regional Jets ("RJs")
by the National Airline of Bhutan, Druk Air. Air transport is
a vital communications/trade link for Bhutan to the outside world
and the Avro RJ is the only aircraft capable of operating in the
Following an explanation as to ECGD's requirements for supporting
documentation, the Bhutanese have not submitted an Application.
UK companies have also been advised that ECGD's dummy run
of the capitalisation will not run in parallel with the current
scheme, as they had previously told, but will replace it as of
31 March 2001 and that the consultation process that should have
been in hand prior to the implementation will not take place until
the middle of this year ie after the scheme has been implemented.
ECGD has tried to reassure exporters that this is a "trial"
and is therefore capable of being changed. Unfortunately ECGD's
record to date of immediate implementation of new or modified
requirements that then remain as originally instated, despite
repeated representations by exporters, leads us to believe that
once in place it will remain cast in stone.
Changes to ECGD's processes
ECGD unilaterally increased the number of countries on the
Highly Indebted Poorer Countries list in the middle of last year
adding 20 new ones including jurisdictions such as Sri Lanka and
Kenya. This means that UK exporters to those countries now have
to go through a longer approval process including input from DfID,
FCO and HMT and demonstrating for example that the ECGD support
is for "productive expenditure". These are not hurdles
that the UK's overseas competitors have to jump and no other country
has yet followed suit.
The aerospace industry is making every effort to reduce the
environmental impact of air travel. Technological developments
over the last two decades have already led to substantial improvements
in noise levels and fuel efficiency. The latter has also led to
reductions in CO2 emissions. The industry world-wide is seeking
to make further improvements, especially in emissions control
and noise. By its very nature, however, civil aviation is a global
issue and lessening its environmental impact involves many other
parties such as the airlines, airport operators and air traffic
control services, as well as the manufacturing sector.
The multi-sectoral, international nature of the problem has
led the SBAC to join the Royal Aeronautical Society, the British
Air Transport Association and the Air Operators Association to
investigate the environmental impact of aviation and to recommend
solutions. At an international level, the European aerospace trade
association, AECMA and its US counterpart, AIA, have also identified
the environment as a key area for joint action.
Unilateral action on the part the UK Government or any UK
agency would not only threaten the competitiveness of the UK civil
aviation industry, including the aerospace industry, but would
be largely nugatory. Internationally operating carriers could
circumvent increased fuel taxes and might damage their ability
to pay for new, greener equipment. The UK aerospace industry does
not seek to evade its responsibility for environmental improvement
merely to ensure that regulation and taxation is covered by an
enforceable and internationally agreed regime. In this respect,
the International Civil Aviation Organisation (ICAO) is the most
appropriate forum for international decisions on civil aviation
ECGD undertook a consultation process on their business plan
in November 2000 but UK companies received no feedback to their
input and the principles were published in very much their original
form. These do not place sufficient emphasis upon either UK exports
or UK jobs although they do clearly reflect the Government's ethical
foreign policy objectives which now form a large part of ECGD's
new Mission Statement.
The main comparable organisations to the ECGD are the US
EXIMBANK, Coface (France) and Hermes (Germany). BAE SYSTEMS Regional
Jet products also face very difficult competition from Brazilian
and Canadian companies who are aggressively supported by export
credit packages from their Government agencies. Generalised comparisons
of competitiveness are not possible, as terms and conditions vary
deal by deal. EXIMBANK are generally a cheaper alternative than
ECGD and the other European ECAs but they charge an up front premium
which is usually added into the financing cost. It is also possible
to securitise EXIM transactions and pass the financial benefit
on to the customer so they have that added benefit. This is not
possible on Airbus deals where three agencies are involved and
has only been done once where ECGD was there on their own. Additionally
US exporters have access to export lease products which UK exporters
do not so they have an attractive alternative to EXIM to fall
back on subsidised by the IRS rather than the Treasury.
It also appears that applying for EXIM is simpler and less
bureaucratic than the ECGD's procedures. Experience suggests that
ECGD is now by far the most time-consuming. Aerospace deals are
exempt from some requirements, eg Project Impact Questionnaires,
but ECGD's extended list of HIPCs does affect aerospace transaction
to those countries and necessitates a demonstration that the supported
equipment qualifies as "productive" expenditure. As
yet, none of the other OECD ECAs have yet to follow suit.
EXIM does not deal with defence goods, the support for those
is dealt with by another US government department, so they do
not suffer the adverse publicity that ECGD may attract in supporting
military sales. This also means that defence manufacturers in
the US seeking support do not have to jump through the same ethical
foreign policy/sustainable development hoops that UK exporters
of defence equipment seeking ECGD support must face.
FOR UK INDUSTRY
Postponing the abolition of LASU fixed rate options
for 12 months would enable workable alternatives to be discussed
and implemented. UK firms will lose business if this is not addressed
now. The Airbus/Rolls-Royce deal with Qantas is a prime example.
Representations need to be made to ECGD and the
DTI in relation to setting a realistic return on capital rate
for ECGD that will enable premium rates to remain competitive.
ECGD's ability to offer support for large projects,
and to provide firm offers of support prior to contact signature
should not be compromised by the proposed capitalisation structure.
No further unilateral changes should be imposed
by ECGD as UK exporters have already been significantly disadvantaged
by the number of stealth changes that have been implemented over
the past 12-18 months.
R&D TAX CREDITS: A LETTER TO THE CHANCELLOR OF THE
EXCHEQUER FROM THE DIRECTOR GENERAL OF THE SBAC
In your pre-Budget Statement last November, you announced
you were considering proposals to extend research and development
tax credits in the upcoming March Budget. Further to the discussion
that we had on that subject on 29 November last year, between
yourself and the Director General of the Engineers' Employers'
Federation, I am writing to expand on the benefits to UK Aerospace
of extending the current system to include medium and large companies,
and why we believe this would greatly help an importantand
growingpart of the UK's world-class aerospace industry.
I should first reiterate that we very much welcome the R&D
tax credit for SMEs which you introduced last April. While it
is too soon to see exactly how many companies will make use of
this facility in this its first financial year of operation, we
are sure that the credit will go some way to addressing the seriously
low levels of R&D spending among SMEs in aerospace.
We recognise that the trade association has a key role to
play in ensuring the success of this policy by promoting it within
the industry. On this point you will be pleased to note that in
addition to the regular seminars that we hold advising SMEs of
European R&D funding sources, we have now decided to establish
a R&D helpdesk which will enable SMEs to source and access
funds such as R&D tax credits.
Research and development is perhaps the most critical factor
in ensuring the continued success of UK Aerospace, as Ken Maciver,
Executive Vice-President of TRW and President of the SBAC, recently
highlighted before the Trade and Industry Select Committee:
"The absolutely fundamental issue in determining whether
this country has a continuing successful aerospace industry is
that the technology is based here."
Without the UK's heavy up-front commitment to the R&D
phase of many large-scale projects, such as the Eurofighter, the
A380 and the JSF, UK aerospace would not now be at the forefront
of the industry's major developments.
Despite the criticality of R&D, however, the UK's R&D
spend has fallen dramatically in the last 20 years, compared with
steep rises in the R&D budgets of our competitors. By 1997,
France's R&D spending in aerospace was double the UK's, and
Germany's almost 50 per cent more [see Annex]. As a consequence,
UK aerospace is living off the results of past investment in new
technology. There is an increasing risk that companies will focus
core research activities in countries with a more supportive regime.
It is within this context that the Society especially welcomed
the Government's R&D tax credits for SMEs last April. However,
the problem of under-investment in R&D in UK Aerospace, indeed
in the entire manufacturing base, is not restricted to SMEs. In
fact, SBAC figures clearly highlight a significant under-investment
in R&D for all companies with turnovers under £100 million
Companies above SMEs but with turnovers under £100 million,
namely those companies that would stand to benefit from an extension
of the R&D tax credit, spend only 4 per cent of turnover on
R&Ddown from 6 per cent three years ago. By contrast,
those companies with a turnover in excess of £100 million
increased their R&D spend from 10 per cent to 12 per cent
turnover. An extension of R&D tax credits to this specific
part of the industry would go a long way to improving the overall
climate for R&D investment in UK Aerospace.
This picture of under-investment in R&D is taking place
alongside two important associated trends: firstly, the drive
to stimulate competitiveness and consolidation throughout the
supply chain; and secondly the increasing disparities in R&D
spending and support between the UK and its key competitors.
Firstly, the drive to improve competitiveness throughout
the industry has fundamentally altered the relationship between
the primes and their suppliers. Primes are increasing pressures
on suppliers to provide more technologically sophisticated and
integrated products at a more competitive price, with concomitant
increases in risk and investment.
Richard Wood, Managing Director of Weston Aerospace, one
of the companies which would benefit from a tax extension, observes:
"Customers are coming to us expecting to have technology
on the shelf. If we do not have technology on the shelf we simply
do not get the opportunity to bid."
But despite these pressures to increase R&D spend, R&D
spend for these medium-sized companies has fallen by 44 per cent
in the last four years alone [see Annex].
The need to cut costs and provide complete solutions has
intensified the pressure to consolidate. Aerospace primes across
the world are reducing the number of suppliers they deal with.
BAE SYSTEMS, for instance, aims to reduce its supply chain for
the Eurofighter programme from 340 to 25 in three years.
This ongoing process of consolidation has a number of implications
for R&D investment. Firstly, rationalisation inevitably brings
pressure on profit margins, making R&D especially vulnerable
to cost-cutting exercises. R&D is a soft target, where short-term
cost savings will reap long-term damage.
In particular, the research and technology aspects of R&D,
which form the more abstract but still essential research base
on which future development programmes are based, are especially
susceptible to cost-cutting:
"Any areas of R&D that were being done "ex gratia"
as it were will no longer be done due to the harsh business environment.
Smaller companies are especially nervous about investing in an
area where the return is unclear and far off." Sean O'Connor,
Chief Executive, CJ Fox & Sons
Another effect of consolidation is that as SMEs merge and
grow, so many of them drop out of the technical SME bracket, rendering
them ineligible for R&D tax credits. A look at the SBAC's
membership clearly demonstrates that over the past two years alone
the number of companies moving out of the SME bracket has been
substantial. The consequence of this trend is that the technical
definition of an SME is applying to a smaller and smaller proportion
of the industry. In effect, the invaluable R&D tax support
is in danger of becoming redundant. We are therefore asking that
R&D tax credits develop in line with the industry.
Against this backdrop it is important to appreciate the impact
of the increased mobility of capital over the last five years.
International acquisitions and mergers are creating transnational
aerospace companies with a global reach and matching commercial
strategies. Aerospace companies now have a choice where to locate
investment. As in other key knowledge-driven industries, government
policies and choices will have a decisive impact on the future
of UK aerospace.
However, despite the importance of R&D to the industry
and the key role played by Government, the UK's R&D support
is widely accepted as amongst the lowest in the global aerospace
community. A recent study by the Conference Board of Canada concluded
that the US, Canada and France all had a more favourable treatment
of R&D support than the UK. [see EEF Budget submission].
With high capital mobility, the consequences are dramatic. Research
by the EEF and the FEI all point to the mobility of R&D activities
of international companies and to the role that tax incentives
play in their decisions.
The fall in R&D support explains in part the decline
in R&D spend in UK aerospace compared with our competitors.
Between 1980 and 1998, UK aerospace R&D fell in real terms
by 45 per cent. In France and the USA, R&D rose by 33 per
cent, and in Germany by 196 per cent. In 1980 the UK spent around
50 per cent more on R&D than France, and three times Germany.
But now both countries heavily outstrip the UK's spending [see
Annex]. R&D in aerospace has a characteristically long cycle
before the benefits are felt. The full consequences of these stark
disparities in national R&D spending will only be fully felt
over the coming years.
National R&D support is provided through a variety of
mechanisms. However, studies by the OECD, the Institute for Fiscal
Studies and the National Bureau of Economic Research all point
to the effectiveness of tax incentives in raising R&D expenditure.
The availability of secure, long-term fiscal support will provide
companies with a strong platform on which to build a sustained
high-value R&D strategy. R&D activities are characteristically
very labour-intensive. Reliable fiscal support will encourage
companies to invest in high-value long-term jobs, as one such
medium-sized company told us:
"Our specific need is to train graduates in product design
and application engineering. Tax credits would encourage us to
recruit and train more graduate engineers and other key laboratory
staff which would enable us to match the staffing levels in French
and US companies. The tax credit would have to be long-term to
support such a commitment to R&D overhead and product development."
Douglas Dunbar, Managing Director, Muirhead Aerospace
The labour intensity of R&D activities also plays a part
in minimising the impact on the Treasury of supporting R&D.
A 50 per cent incremental tax credit for R&D spending by large
firms would have very little cost for Exchequer, particularly
after allowing for the increased income tax and national insurance
revenues that would result from increased spending on R&D,
which is very labour intensive.
We believe that extending R&D tax credits to the growing
but crucial middle section of the supply chain will help plug
the gap in the industry's world-class R&D capabilityat
an affordable cost to the Treasury. Furthermore, raising R&D
levels in aerospace is entirely consistent with your Government's
key fiscal objective to promote sustainable investment in our
I hope you will find this information useful and relevant
in relation to the upcoming Budget. Of course, I welcome any comments
or further dialogue with the Treasury on how we can together build
on the success of UK's aerospace industry.
5 February 2001
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