New Export Rules Coming Soon: Will They Open Trade Floodgates?

By Sandra I. Erwin

The Obama administration is just weeks away from kicking into high gearlong-awaited export control reforms. New regulations that are scheduled to take effect Oct. 15 would allow U.S. manufacturers to export dual-use goods — which serve military and commercial purposes — under the less restrictive Department of Commerce licensing process.

Up until now, any component of a military system or a communications satellite required a State Department arms-exporting license, even if they were commercial goods. Thousands of dual-use items will transition from the International Traffic in Arms Regulations (ITAR) to the Export Administration Regulations.

The first categories of items to transition to the new regime are aircraft and jet engines. Next in line are ground vehicles, naval vessels, submarines and oceanographic equipment, which will transition in January 2014. Other categories will follow over time.

For aerospace and defense firms, these reforms have been a long time coming. “The export controls regime is the number-one concern of many companies,” said David Fitzpatrick, leader of

AlixPartners’ aerospace and defense practice in North America. “They feel they have usable technology that can't be sold even though they are not critical to national security,” he said. “Reforms are not moving fast enough,” said Fitzpatrick. “Many categories of technology are still too restrictive, out of date. The process of reviewing them isn't adequate in the view of many companies.”

Items covered by ITAR make up what is known as the U.S. munitions list. The Export Administration Regulations oversee the Commerce Control List. The new rules transfer many items from the munitions list to the CCL.

U.S. manufacturers would prefer “concurrent rather than consecutive reforms,” said Remy Nathan, vice president of international affairs at the Aerospace Industries Association.

Under the current plan, product categories will be removed from the U.S. munitions list in a sequential order, which means some companies will have to wait years for their products to be transferred to Department of Commerce jurisdiction.

"Reform of this system is challenging,” Nathan said, but he noted that it is “headed in the right direction.”

Of roughly 5,000 companies that are registered with the State department’s Directorate of Defense Trade Controls, 1,000 could see their entire product lines no longer will be licensed by the State Department.

“That’s quite significant,” said Brandt Pasco, an attorney at Kaye Scholer, in Washington, D.C. Before joining the firm, Pasco was a member of the National Security Council task force that spearheaded the Obama administration’s export control reforms.

“Are these reforms going to do everything that industry would like? The answer is ‘no,’” he said. But they will help U.S. exporters, especially parts and components makers, Pasco said in an interview. The upshot could be tens of billions of dollars worth of potential exports that would not have to go through the restrictive State Department licensing process. State last year issued about 85,000 licenses.

It was obvious to the White House task force that led the current export reform efforts that too many commercial items had been jammed into the munitions list, said Pasco. Military ground vehicles, for instance, are mostly made of commercial components that are so similar to commercial products that they do not justify control on the U.S. munitions list. Diesel engines are a case in point.

Although historically on the munitions list, the difference between a military diesel engine and a commercial one was determined to be negligible. Under the new rules, 74 percent of the items now licensed under military vehicles are moving to the Commerce list.

Pasco cautioned that the reforms are not intended to boost weapons sales. Arms exports will still be tightly controlled. The goal is to update the system so that commercially available goods and services do not have to undergo the same licensing process as sensitive military technology.

“Major weapons integrators won’t necessarily see the biggest benefits of export reforms,” he said. But subcontractors that supply components will. “We are not trying to de-control weapon systems,” said Pasco.

Under the existing regime, companies have to wait months to get an export license for a product that is sold in the open market. “That makes it harder to do business, and it makes the United States a less reliable partner” to friendly countries that buy U.S. technology.

Although Congress has put up roadblocks to reforms in years past, this time, there is no sign of “organized opposition” on Capitol Hill, Pasco said. Lawmakers have recognized that these changes were long overdue.

Among the staunchest advocates of reform is Rep. Ed Royce, R-Calif., chairman of the House Foreign Affairs Committee. His home state’s aerospace sector was among the hardest hit by the 1998 law that reclassified commercial satellites as munitions. Lawmakers at the time were reacting to a breach of security that occurred when a Chinese space vehicle supplier was provided with classified information after a failed launch of a Hughes Co.-built satellite.

The draconian export controls imposed in 1998 resulted in a substantial loss of market share for American exporters, industry groups said. Congress repealed the satellite provision in the 2013 National Defense Authorization Act, and the administration is expected to request that commercial spacecraft be removed from the munitions list in early 2014.

Under the Export Control Act, the president has to notify Congress when an item is being removed from that list. The process is supposed to take 30 days but usually extends to several months.
Pasco credits the Obama administration for accelerating reforms that had started under President Bush.

The indispensable player was former defense secretary Robert Gates, Pasco said. “This could not have happened had Gates not wanted it. This was a Defense Department led initiative.”

Before taking over the Pentagon in late 2006, Gates was the initial co-chair of a National Academy of Sciences study, titled, “Beyond 'Fortress America': National Security Controls on Science and Technology in a Globalized World.”

The study, which was completed in 2009, argued that the U.S. export control system was broken, stifled American engagement in the global economy, and hindered innovation in science and technology.

During a cabinet meeting in the summer of 2009, Gates handed President Obama a copy of the study and told him this was something important that “needed to get done,” Pasco recalled. “Obama deserves credit for driving this. But the momentum started under Bush with Gates.”

Exporters have been gearing up for the new rules since they were published in April. How they will affect corporate bottom lines remains to be seen. The transition could take months, and it could be years before companies begin to see an uptick in international sales as a result of export-control reforms. Satellite makers are unsure of what to expect in terms of economic impact, mostly because over the past decade, foreign competitors have stepped in to fill the gap left by slowed or denied American exports.

Analysts like Fitzpatrick do not expect a near-term windfall for U.S. defense firms that are pursuing new markets overseas. Spending cuts by the U.S. and most Western governments are putting pressure on companies to tap emerging markets in Asia, Fitzpatrick said. One problem for American exporters is that one of the fastest growing defense budgets in the world, the People’s Republic of China, is off limits. The United States and Europe stopped exporting arms to China after the Chinese Communist Party’s 1989 crackdown on protests in Tiananmen Square. Alleged cyber-espionage by Chinese hackers and U.S. worries about China’s military buildup also have ratcheted up tensions between both nations.

Aerospace firms understand these restrictions but recognize that they are costing them billions of dollars in sales, said Fitzpatrick. “There are areas like avionics, space systems and communications technology where they really wonder if the restrictions in place are outdated or overly restrictive.”

The latest wave of paranoia over cyber attacks could result in even greater restrictions for U.S. exporters, according to Clif Burns, an attorney at Bryan Cave LLP, in Washington, D.C.

He noted that the Senate Armed Services Committee’s version of the 2014 National Defense Authorization Act includes a proposal for new export controls on software that could be characterized as “cyber weapons.” The legislation would require the president to convene an “interagency process to control the proliferation of cyber weapons through unilateral and cooperative export controls,” Burns wrote in a recent blog post.

This language should stir fears in the high-tech industry, said Burns, as it could crimp exports of dual-use software. Distinguishing between nefarious “cyber weapons” and lawful technologies is virtually impossible, Burns suggested. “The only people who are going to be bothered by [the] proposed export controls will be legitimate manufacturers of network intercept, analysis and testing software.”

Topics: Business Trends, Business Development, Doing Business with the Government, Government Policy, International

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