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BRIEF ON

INDIAN DEFENCE OFFSET

J.L. Blanchart Thales Systèmes AéroportésInternational Cooperation & Offset Director

ECCO June 14th, 2011

2 /2 / Agenda©

Th

ales

14-0

6 -20

11

Indian Defence Market Scenario

Offset Regulations

Local Offset Authorities: DOFA

Return of Experience

3 /3 / Market Scenario

INDIAN DEFENCE MARKET SCENARIO

4 /4 / Indian Defence Market Scenario

�Third largest importer of Defence hardware

�Tenth largest Defence spender in the world

�National Defence Budget:

� US$ 29.46 billion in FY 2010-11

� 13.2% of the National Budget

�Roughly US$ 9-10 billion worth of imports every yea r

�Likely to spend nearly US$ 80 billion over the next five years (2010-15) onnew capital acquisitions

5 /5 / Offset Regulations

Offset Regulations

as per

Defence Procurement Procedures

(DPP 2005 to DPP 2011)

And their interpretation by Indian side

6 /6 /Evolution of Offsets Regulations

First introduced in 2005 (DPP-05)

Amended in 2006 (DPP-06)

� Offsets restricted to “Buy Global” and “Buy-and-Make with ToT”

� Offset partnerships permitted with private industries manufacturing under an industrial license from DIPP

� DOFA is set up as a specialized agency

IOP with Industrial License is requested for Direct Purchase of Products, not for Direct Purchases of Services

Amended in 2008 (DPP-08) Applicable from September 1, 2008

� Waiver of offsets under Fast Track Procurements

� DIPP industrial license condition removed

� Deletion of civil infrastructure from eligibility list

� Banking of offsets permitted

Offset is governed by DPP rules in force at time of issue of RFP

7 /7 /Evolution of Offsets Regulations

Amended in 2009 (DPP-08 + amendment in 2009)

� Introduction of new category for acquisition “Buy & Make Indian”

� No Offset requirement in “Option clause” cases

� After offset contract is signed, Offset plan modification not permitted (neither partner, project or value except in exceptional cases…)

Amended in 2011 (DPP-2011)

� Inclusion of defence internal security and civil aerospace products as eligible offset activities

Some further amendments / clarifications are expect ed to DPP-2011 concerning DFI, TOT, multiplier, and applicability of current offset

policy to projects under process

8 /8 / Defence Offset Policy – Key Features

� Applicable – On Capital Acquisitions ≥ INR 3 billion ~ 50 M€ ~ 60 M$ & categorized as ‘Buy (Global), or Buy and Make with ToT

� Offset Value – Minimum 30% of the Foreign Part Value of acquisition, 50% in some specific cases (like MMRCA or RSH H/C) Offset Requirements to be specified as part of RFP

� Foreign OEM free to choose Indian Offset Partner (I OP)

� Offset obligations to be fulfilled within period of main contract including warranty period (Annual Commitment Plan )

If you are under a “BUY & MAKE with TOT” RFP, you ha ve to transfer almost all your production to Indian Production Agency to reac h 60% min of your product in Indigenous Manufacturing phase of the Transfert of Production under Licence (TOT). Then you have to find other activiti es to cover your 30 or 50% offset obligation on the value of the Foreign part of the Contract.

9 /9 / Methods to discharge Offset obligations

Offsets can be discharged by any combinations of th e following methods:

� Direct purchase of, or executing export orders for, offset eligible productsand components manufactured or services provided by Indian defenceindustries and private defence industry.

� Direct Foreign Investment in Indian defence industri es for industrial infrastructure for services, co-development, joint ventures and co-production of defence products and components.

� Direct Foreign Investment in Indian organizations e ngaged in research in defence R&D as certified by DOFA.

� Banked offset credits valid from DPP2008

Until DPP-2011, the Direct Purchase of product or s ervices are eligible for offset credit only if in Military field. Dual Techn ologies are not accepted…Offset obligation must be discharged by the OEM. His subcontractors can be allowed only if they part icipate to the program and if there is a tripartite offset MOU between IOP, Subco ntractor and OEM. Other OEM’s Partners are not allowed.

10 /10 / Offset Banking

� Effective, 1 st Sept 2008, a vendor can bank offset credits and use them for RFPs which are issued within the 2 financial yea rs from date of approval of the banked offset credits.

� Offset Banking/discharge by investment in industry and R&D are valid throughout the duration of the MoD contract in relat ion to the RFP.

� Banked offset credits are non transferable except b etween main contractor and his sub-contractor within the same a cquisition program.

Still waiting for the official answer to a request for Banking submitted in October 2008…

11 /11 / Penalties

�Payment of a penalty amounting to 5% of the non-ful filled part of the yearly commitment

�Transfer of the non-fulfilled amount on the followi ng year (but pay 5% only once)

�At the end of the Offset Contract fulfillment perio d, risk of “Blacklisting” if offset amount is not fulfilled

Be careful to keep some margin when you plan your y early offset commitment as it will be the basis for penalty calc ulation

12 /12 / Indian Offset Partners (IOP)

�Indian Defence industries or organizations to be eli gible as “Indian Offset Partner” (IOP) shall, besides the 26/74% FDI rule and any other extent regulations in force, also comply with the guidelin es / licensingrequirements for the defence industry issued by the DIPP (specific requirements for DPP 2006 only).

As you are ready to be in for a few years before be ing awarded the Contract, make sure to have a few eligible IOPs per offset Work Package in your proposal when possible.

One IOP eligible in 2011 might not remain eligible a few years later…

13 /13 / Offset Proposal & Implementation

�An undertaking to comply with OFFSET requirements h as to be submitted along with main contract technical and commercial b id.

�Within 3 months of offer submission, a technical of fset offer and a commercial offset offer have to be submitted

� Contents of Technical Offset Proposal :

�Details of proposed Products, Services or FDI

� Identification of IOP + signed MoU with each

�% of offset commitment to be met per WP

� Contents of Commercial Offset Proposal ( opened at time of opening of commercial bid) :

�Value in monetary terms of the offer for each proposed WP

�Time frame for the yearly commitment on each offset WP

14 /14 / Offset Implementation

� Implementation:

�Quarterly Report on fulfilling Offset obligations

�Auditable invoices to be provided

15 /15 / Local offset authority: DOFA

Actor above OEM & IOP: Defence Offset Facilitation A gency

� Assist potential vendors in interfacing with the Indian defence industry

� Facilitate implementation of the offsets policy

� Assist in vetting offset proposals technically

� Assist in monitoring the offset provisions

� Suggest improvements in the policy and procedures

� Interact with Headquarters Integrated Defence Staff and Services Headquarters

� Advise in consultation with the HQ IDS services and DRDO areas in which offsets will be preferred

� Promote exports of defence products and services

Actually DOFA as of today:

� Is building its policy with difficulties (young institution, 4 revisions of DPP + 1 espected soon…)

� Does not affirm a clear position and decisions

� Tends to restrict the offset eligibility by imposing a “word for word”understanding of the DPP

16 /16 /

RETURN OF EXPERIENCE

17 /17 / Worldwide OEMs joined actions

Worldwide agreement by Foreign Defence Industries Associations that it is very difficult to perform successfully offset obligations following the actual DPP rules.

• Joint letter sent to Indian Defence Minister on August 25th, 2010 by AIA, ADS, AIAC, GIFAS, BDLI, USIBC recommending 5 points:

�Raising Foreign Direct Investment �Expanding the scope of what can count

as an offset�Offering multipliers in offset contracts,

especially in the case of ToT�Creation of one standing offset authority

with decision-making power�Capping of financial penalties

• Joint OEMs meeting on January 17th, 2011 at Indian MOD request, to present worldwide best practices in Offset

18 /18 / An example of a long process… 1/3

08/2008: Technical & Commercial Offset proposal

10/2008: Negotiation Technical Offset proposal with TOEC

�Some IOPs declared not eligible as IOP due to 26/74 rules

�Rejection of X workpackages for various reasons

�Request of replacement of those WP by an “equipment” wanted by Customer

11/2008: New Technical proposal including WP for “r equested equipment”

11/2008: TOEC visit to our main IOPs

12/2008: TOEC Report and request for Commercial Off set proposal

01/2009: New Commercial Offset proposal provided to MOD

03/2009: Openning of Commercial offers (Main Contra ct & Offset )

19 /19 / An example of a long process… 2/3

From 10/2009: Negotiation of Offset T&C

� Increase of amount of offset due to increase of main contract price

01/2010: Addition of a new WP to cover the increase of obligation

From 01 to 04/2010: Negotiation meetings

� On T&C

� On details of WP content

� On valorisation of WP “requested equipment”

06/2010: TSA provides an updated Draft Offset Contr act

� Valorisation of WP “requested equipment” to be solved during CNC

11/2010: Re-start of offset negotiation (end of Mai n Contract commercial negotiation) with new TOEC and back to the beginnin g with review of all items “as per DPP2006”… which means lost of the little flexibility we had previously obtained

20 /20 / An example of a long process… 3/3

11/2010: Negotiations on offset value of “requested equipment WP”

� No agreement on Offset value so we had to retrieved this WP

� And compensate by increasing one WP “Purchasing” to unblock the offset situation

12/2010: Various request for additional documentati on

� MOUs, Industrial Licence, Shareholding of IOP…

02/2011: Information that TOEC report is finalized

03/2011: Offset CNC

� During which clarification on WPs is provided to ensure that MOD agrees that what is proposed is realistic

� We tried again to obtain some improvement to Offset Contract: No, DPP2006 only!

Offset in India is compulsory, has to be as per DPP which doen’t give room for negotiation, and the process is entertwined within the various steps of the Main Contract negotiations so if you block on Offset, you can stall the whole process

21 /21 / Some Tips following to-day return of experience 1/2

When you make the technical offset proposal:

Amendment 2009 to DPP 2008 stipulate that when you have agreed on an Offset plan, you can’t change the content, value or Indian Offset Partners unless agreed by them so give

yourself some freedom at the proposal stage

�Stick to the rules of the DPP you are submitted to as per RFQ

�Separate your WP Direct Purchase of product from Direct Purchase of Services from FDI

�Have several Indian Offset Partner per WP and make sure they are eligible as IOP

�Obtain MOU with each potential IOP beforehand (compulsory)

� Include the warranty period in the offset fulfilment period

�Use only the words which are in the DPP and ban some words like Programme management, Training, ToT, Data Package, Repair, Civil infrastructure, Marketing assistance, NRC… which are not eligible as offset

�Only investment in cash is eligible as FDI (1 euro credited for 1 euro invested), investment in kind as tools, benches, ToT, IP, training are not eligible

�Total % of all your WPs in proposal should aim 110% at proposal stage

22 /22 / Some Tips following to-day return of experience 2/2

When you make the commercial offset proposal, the d ifferences with the technical offset proposal are:

� The value of each W.P. is in Euros instead of in % of the obligation

� You have to include the yearly timeframe break-up of each W.P. Because of the penalty risk, take some safety time margin

And remember that if you want to add new WP during commercial negotiation, it implies that you might have to go through the TOEC process again…

When you are at negotiation stage:

� No e-mails nor visio-conference with Customer so plan to go often even for very short meetings

� A front office in India managed by an Indian citizen to screen all the demands from Indian Industries is a must

� Keep in mind that the understanding of the rules might differ from an interlocutor to another one…