South African Defence Industry challenges; Defence Sector Charter & Fund

Meeting report

South African Defence Industry (SADI) presentation
Mr Sandile Ndlovu, Executive Director of the Aerospace, Maritime and Defence Industries Association (AMD), stated that AMD represented the South African Defence Industries (SADI) as an industry funded association, serving the common interests of its members; recognised as such by government and the broader aerospace and defence industry. It is governed by an elected Board of Directors comprising CEOs of SADI companies.

SADI Statistics 2019/20 vs 2016/17
• Revenue declined by R7 billion from R19.5 billion to R12.5 billion
• Exports declined by almost half to R6.5 billion from R12 billion
• There was a reduction in R&D spend from R1.7 billion to R500 million
• Due to retrenchments, employees declined from 15 000 to 12 500

SADI Policy Framework is guided by the Constitution; Companies Act; PFMA (DOD/Armscor, Denel and CSIR); Defence Act; SADI B-BBEE Charter; National Conventional Arms Control Act (plus Small Arms and WMD control regulations); NDP; Industrial Policy Action Plan; Public-Private Growth Initiative / Master plan.
 
State of SADI
The medium-term budget allocation for defence and state security is R52.20-billion in 2020/21, R50.50-billion in 2021/22 and R52.70-billion in 2022/23. The funding shortfall means that the army, air force, navy and military health services cannot modernise or acquire new equipment and systems, while maintenance, repair and overhauls are falling behind. To have a "technologically advanced military force, capable of executing its functions" as per the Constitution s226(4) a strong local industry is key. National Treasury has calculated that the recommendations flowing from the Defence Review, if implemented in full, would add R53.03-billion to defence expenditure over the next six years.

Government has expressed its wish to support the defence industry to become export driven on the back of international investment by having a policy stance favouring international joint ventures (JVs) with local industry. South Africa has unique factors that international partners find appealing. Owing to its history, there is a large and independent defence industry, which has created a culture of innovation and decades’ worth of intellectual property (IP), but only some has been converted into products - a number of highly marketable products have not been optimally commercialised or industrialised. Government wants foreign direct investment in defence to double from R12-billion to R24-billion in five years.

SADI is recognised as an integral part of the SANDF’s capabilities for national security. There is significant untapped value in SADI for the economy and the people through:
• Employment – quality, hi-tech jobs at 12,500 whilst supporting 50,000 indirect jobs;
• Import replacement – prevention of outward flows of R6bn in defence, safety, security spend;
• Export revenues – forex income at R6.5bn in favour of the RSA;
• Fiscal input – at least R2 to 3bn per annum towards a constrained tax base;
• Skills development and diffusion – scarce and critical skills; and
• Technology development and diffusion – innovative and IP generating towards a true knowledge based economy and active/lead participant in the 4IR.

Challenges
SADI would thrive if the following were facilitated:
• Direct, deliberate, focused and highest political support;
• Government wide/ all of government approach to SADI support;
• Stable and predictable local defence spending including R&D;
• Stable and sustainable Denel;
• Effective arms control regime to facilitate arms export
• Financing and related instruments

Risk factors of losing existing exports markets
• SADI depends on exports and accounts for more than 50% of total revenue;
• Threat to the current jobs with a potential reduction of more than 40% in the workforce;
• Further loss of supply chain and more than 25 000 jobs will be lost;
• Potential decline in technology investments;
• Reputational damage to the South African brand;
• Reduction in tax revenues;
• Halt in training of students in the engineering field impacting the STEM programme.

Middle East Impact
• R20.5bn estimated value of lost opportunities
• Denel stands to lose $160m (R2.7bn) worth of opportunities over five years.
• Middle East (KSA, UAE, Oman, Kuwait and Jordan) presents a special challenge to SADI as the current impasse has resulted in the cancellation or stalling on negotiations for future contracts.
• This has jeopardised our standing as an industry and country in these countries.

Way Forward – with JSCD Assistance
• International defence industry relations are highly political and need to be driven by political leaders;
• Relations underpin or undermine international relations between countries;
• Brand reputation management with the crisis specifically in Middle East region and a number of African countries
• Engagement with the Presidency on the implications and image of the country;
• Instruments used by the state should support defence industry exports (NCACC);
• National Conventional Arms Control Committee (NCACC) approval process needs to be fast tracked and benchmarked with other countries to ensure competitiveness;
• Interim measure to allow the industry to operate during emergency periods and election cycles;
• Digitisation of the system.

National Defence Industry Council (NDIC) presentation
Ms Sonto Kudjoe, Secretary for Defence gave an update on the National Defence Industry Council and its implementation of the Defence Industry Strategy.

Aim of Strategy: It is the sustainment and further development of a capable defence industry that will:
• Provide sovereign defence technology capability;
• Provide a real degree of strategic independence;
• Provide the Defence Force with optimised equipment;
• Provide a valuable diplomatic tool providing friendly states with equipment and technical support;
• Provide equipment to other security services and agencies;
• Maximise the positive impact of defence spending by means of:
- Local manufacture, keeping funds and jobs in South Africa;
- Local design and development, generating export earnings;
- Establishing new technologies and processes spinning them off to wider industry.  

NDIC Initiatives in implementing the Defence Industry Strategy:

Defence Sector Code:
The Charter was published for comments from all walks of life and therefore well informed.This was approved by the Department of Trade and Industry in April 2019. It makes provision for recognition of companies that do business with the military veterans. Defence companies are required to contribute 1% of their net profit after tax. Armscor procurement and acquisition is already in line with Code requirements. The objectives of the Charter are:
- Ensure effective participation of Black people in the South African Defence Industry (SADI)
- Encourage participation and growth of SMMEs in SADI
- Promote the growth of technical innovation with SADI
- Promote SADI as a profitable, sustainable industry
- Promote local manufacturing capability for local and export purposes
- Advance the acquisition, retention and transfer of critical technical and scarce skills in SADI
- Protect South Africa’s sovereign capabilities in SADI
- Promote entrepreneurship and new enterprises in SADI.

Defence Industry Fund – DIF
• One of the barriers of entry into the defence industry is access to affordable funding
• Therefore Armscor and AMD are establishing a fund run by an independent Fund Manager
• DIF was launched in 2018 to provide contract financing to SMEs for defence industry transformation.
• DIF provides contract/project finance to SMEs and defence and security companies in South Africa     
• The Fund Manager is licenced by Financial Sector Conduct Authority (FSCA)
• DIF Advisory Council Board has DOD, Armscor, AMD representatives and the Fund Manager.
• The DIF Advisory Council Board meets quarterly
• A process is being developed to fund companies awarded contracts by Armscor and DoD.

Sovereign Capabilities
Capabilities giving Defence Force an advantageous edge over the enemy: Communication, Small Arms Calibre Weapon (Denel PMP), Armoured Vehicle (Denel land systems) and Missiles (Denel Dynamics).

Task Team on Denel (TTD):
• TTD was established by NDIC to support Denel Executives find solutions to its liquidity crisis
• A report made recommendations on funding, project delivery and governance.
• TTD supported Denel in motivating for added funding at National Treasury which resulted in R1.8bn. Another R1bn is possible subject to Denel implementing specific cost-reduction measures.
• Denel CEO left Denel in August 2020. This is work in progress.
• More than 200 companies are negatively affected by Denel’s inability to function normally.

Resource-based Alternative Funding Model:
• This entails finding a mechanism to enable local defence companies to sell military equipment to clients in Africa by using their natural resources
• Internally, this model has been benchmarked and confirmed with a major bank in South Africa for feasibility and viability. The local bank was eager to support NDIC in this initiative

Challenges
• Denel situation has made it difficult for many SMMEs in the defence sector to survive
• DOD budget decrease has led to decline of demand making it difficult for defence companies to survive
• End-User Certificates, which was resolved, caused many companies to lose business in key markets
• COVID-19 has slowed getting small-calibre weapons / ammunition designation presented at JCPS cluster
• The Defence Sector Charter is not yet fully operationalised by the interim Charter Council to ensure compliance and establishment of Enterprise and Supplier Development Fund by DIF.
• It is suggested that RSA develop a ‘favoured nation’ system that allows exports to identified countries with general pre-approval without going through the NCACC.
• Enabling non-contentious export permits to be approved by just one member of the NCACC.

Discussion
Mr S Marais (DA) stated that whilst, the Committee represented the interests of the Defence Force and the Department of Defence, there were clearly many more stakeholders who needed to be involved to deal with the challenges presented. The industry was one which was not confined to just the current Committee, as such discussions with other Portfolio Committees needed to take place. Mr Marais emphasized that the delegation needed to be more direct with the Committee on the challenges they had experienced so that the Committee could at the very least try and address those.

With the Committee generally receiving reports by NCACC on challenges in exporting of products, he asked if more information could be supplied to the Committee on that. On NCACC permit applications, he asked if the Committee could get the statistics on permits approved, pending or denied.

With the presentation indicating a probable 40% cut in employment if challenges were not soon resolved, Mr Marais sought an impact analysis on the potential contributions to GDP as the Minister of Finance would be concerned about loss to GDP.

Part of the frustration by the industry seemed to be it liaised with other Departments and Committees who did not necessarily have the empathy and understanding for the defence industry like that of the JSCD. He asked for more information on where Denel’s requirement of R683 million had stemmed from. He asked why everyone in the industry had been dependent on Denel for survival or held the view that if Denel failed, the industry would fail, adding why there were no mechanisms in place to deal with the possible failure of Denel. On strategic weapons, he asked how they could ensure those units remained available with stable capacity, irrespective of what happened to Denel itself in the future. Mr Marais politely asked what the industry required from the Committee to help the industry prosper.

With National Treasury reluctant to provide funding, he asked if they had come up with a redesigned model of what they could offer the South African National Defence Force – which could allow it and the industry to become more sustainable while complying with the Constitution in terms of integrity of the country.

Mr Ndlovu, AMD Executive Director, responded that they were in an industry where information was shared on a need to know basis and as such would leave certain things to be answered by Adv Jele. Before companies could enter into contractual agreements with potential customers, they signed a non-disclosure agreement so that information would only be disclosed with the relevant government authorities. The fact that Denel was going through challenges did not mean they needed to negate their existence, as such they were engaging as an industry internally on what mechanisms they could put in place to ensure that at the very least capabilities within the DoD were maintained until Denel recuperated. While discussions had occurred internally with the industry as part of the master plan process, they had not yet taken their possible model ideas to the SANDF.

SADI believed strongly in the Arms Control Regime which South Africa headed as it allowed them to say without any fear or contradiction that whenever and whatever they exported, they exported with the express approval of the government. Whatever happened post export, was an entirely different matter, however, they played a role in providing government with all the relevant information to allow it to take a decision on whether or not to export.

Summing up, Mr Ndlovu stated that it was all about accountability and consequence management. South Africa was a country with laws which needed to be followed. He emphasized that it was the Portfolio Committee's duty to hold the delegation, including himself, accountable in ensuring that processes functioned as required. He ended off that it would be premature for him to speak on recommendations outside a consultative process.

Adv Ezra Jele, Head of NCACC Secretariat, responded that statistics were compiled quarterly and annually – where the number of applications which were denied was provided. However, for the 2019 calendar year, including Q1 and Q2 of 2020 there had been no denials. There was a system where these reports were tabled in Parliament and became an open source for whoever needed that information.

He reminded the Committee that the NCACC could only take three decisions on the applications presented to it as recommended by the Scrutiny Committee – deny, approve or place under consideration. When an application had been placed under consideration, it meant that certain aspects had not been clarified or questions which could not be answered during the sitting of that meeting needed to be dealt with for the pending application to be served subsequently in the next meeting. NCACC was of the opinion that it needed to protect and live up to the standard set by South Africa as good ambassadors for the material exported in terms of quality and efficiency.

Mr Talib Sadik, Denel Interim Chief Executive Officer, referred the Committee to the 2015 Defence Review and its triple mandate to be the custodians of the sovereign and strategic capabilities in servicing the SANDF, whilst commercialising those capabilities to contribute towards the socio-economic status of South Africa. Recently the Department of Defence reported it was no longer in a position to sustain those sovereign and strategic capabilities. In response to that, all Denel Group divisions were asked how much they had been spending on strategic and sovereign capabilities, including research funding and technology driven projects; which was how they got to R683 million for the current year. He emphasized that they were experiencing a declining Defence budget which had an impact on those capabilities and the ability to sustain and develop them further.

Denel was currently engaging with the Air Force on additional funding and the challenges presented by a limited budget. They were looking for strategic equity partners as Denel was a conglomerate with different specialised businesses. They were looking for sustainable market access in the export markets and believed that with the help of strategic equity partners, they would still be able to provide the SANDF with world class products.

Mr William Hlakaone, Denel Chief Operating Officer, replied that there were two aspects to intellectual property. One was the tangible IP and the other was the intangible IP. The intangible IP referred to the knowledge which was sitting in people’s heads – that was where the difficulty lay. In terms of management, they had basically lost that particular intangible IP as a result of not being able to pay salaries on time.

Adv Solomzi Mbada, ARMSCOR Chief Executive Officer, replied that that insofar as IP utilisation was concerned, ARMSCOR had a very favorable policy framework.

Mr J Maake (ANC) stated that it was beyond disappointing to see that the industry was not being supported. Things such as Ministers being on recess proved to be an impediment to the industry and showed the lack of understanding of the industry in itself. He emphasized that something needed to be done about businesses having to wait for Ministers to meet or get back from recess before they could give an outcome or decision to something which was of high priority.

Mr Trevor Mketi, Director: Industry Support at the Department of Defence, replied that the problems and challenges raised by the industry were the same challenges raised in Parliament the previous year.

Secretary for Defence, Ms Kudjoe, replied that Denel needed a concerted effort by everyone to try and resolve the problem. The Department of Defence, National Treasury and Department of Public Enterprises came together and took a more piecemeal approach in how they dealt with things – salaries and UIF needed to be paid. However, eventually the approach taken was deemed not helpful. She emphasized that even the President stated that the Minister needed to come up with proposals on how to resolve the Denel matter as it was something which could not wait. On the point about convergence, she stated that all of them felt that the South African Defence Industry was in serious danger and required all their effort. The number of jobs and families whose lives would be affected if Denel was not resolved was far too much to even count.

She stated that anyone in the defence industry ought to be able to sit comfortably in their office, put in their application for a permit and do everything required of them until the point of them receiving their permits without actually being asked to a meeting. It would make it not only convenient but also far more efficient. She appreciated the meeting which allowed the Committee and key role players proper insights into the industry paving the way for things to only get better.

The Committee thanked the delegation for the vigorous discussion.

The meeting was adjourned.