Source Responsible Statecraft

WASHINGTON, U.S.-Sometimes the most secretive and risky parts of an arms deal are not the weapons.

This week U.S. government officials and defense industry personnel are walking the halls of the UAE’s International Defense Exhibition and Conference (IDEX) to promote some of the latest U.S. defense technology to the UAE and other Middle East buyers. 

The officials, however, will largely ignore one increasingly risky aspect of the deals defense companies will put on the table.

Typically referred to as “offsets,” these secretive “sweeteners” or investments mask corruption risks that could harm U.S. security interests and help keep millions in a constant state of poverty and conflict around the world. 
This U.S. approach also seriously undermines the Biden administration’s efforts to encourage U.S. companies and foreign governments to fight corruption and protect democracies.

Big Business

This year’s IDEX will be sure to result in many major arms sales agreements.. The EXPO comes at a time when defense spending is rising globally in response to growing threats and new conflicts. The UAE remains among the top arms buyers in the world. In 2019, the UAE Armed Forces signed 33 deals worth $2.8 billion with international companies at IDEX.

The United States continues to dominate arms sales to the UAE, but it faces competition from major players like China and European countries, as well as the growing defense production capabilities of countries like Turkey and Israel. 
Defense companies often rely on offsets to make their proposed arms sales more attractive to foreign buyers. Offset packages are essentially the selling company’s promises to invest in the buyer country’s defense industry (direct offsets) or broader economy (indirect offsets).

U.S. defense companies regularly agree to offset packages worth billions of dollars each year. In 2019, U.S. defense contractors reported entering into 31 new offset agreements with 12 countries valued at $8.2 billion, according to the U.S. Department of Commerce. 
The value of these agreements often equaled more than half the total value of the arms deal. Some of the common types of U.S. company indirect offsets include agreements to purchase items from the procuring country, subcontract with their businesses, transfer desirable technologies, or provide credit assistance.

At the 2019 IDEX, the UAE announced a new offset policy for their arms purchases, which requires defense companies to include offsets for contracts at $10 million or more. Unlike some previous policies, this one focuses more on offsets to areas outside the defense sector (indirect offsets), including infrastructure, food and water security, and other strategic sectors. 
The policy encourages defense companies to use cash payments to satisfy offset requirements. The UAE has made it a policy not to release any information publicly about its offsets agreements.

Facilitating Corruption

The use of offsets is controversial. In 2007, the European Commission directed European countries to put significant restrictions on companies using offsets as they viewed them as anti-competitive, and pushed member states to outlaw the use of indirect offsets. 
A common concern is that offsets transfer substantial resources, often to authoritarian governments, with very little transparency and even less accountability. Offsets, especially cash payments, can also serve as bribe money to help win a contract, avoid paying fees/penalties, or serve other corrupt purposes.

The Commerce Department has for years warned U.S. companies about investing in sovereign wealth funds in Persian Gulf countries and beyond out of concern that these funds could easily serve as vehicles for bribes. 
These funds can also be used to support foreign lobbying of the U.S. government. In 2016 and 2017, The Intercept reported that U.S. companies offset cash payments to the UAE’s sovereign wealth fund, Tawazun Holding, resulting in some $20 million reaching the DC-based Middle East Institute, which has promoted expanding sales of U.S. arms to Gulf countries.

The UAE’s refocus on indirect offsets, after a decade of focus on direct offsets, elevates the risks for U.S. companies indirectly supporting strategic sectors of the UAE economy that fuel conflict in Africa and facilitate money laundering. In 2009, an Italian defense company agreed to a joint production project to build a gold and silver refining plant in the UAE as part of its offset deal. 
Gold trade experts have raised concerns about the central role the UAE is playing in allowing gold acquired illicitly by African armed groups to be refined and resold to European and U.S. markets, masking and reinforcing conflict dynamics and death in Central and Eastern Africa.

U.S. and European defense companies have also invested in the UAE’s real estate markets through offsets. This strategic sector, however, has reportedly been a major source of money laundering for foreign public officials and U.S. sanctioned individuals. 
Think-tank reports on this sector have described how foreign public officials have invested millions in UAE’s luxury homes with money stolen from national budgets, leaving their own citizens in a perpetual state of poverty. International arms traffickers, such as AQ Kahn and Viktor Bout, have also used the UAE as a base of operations to ship weapons to U.S. adversaries.

There are also serious risks that politically connected individuals in the buying country may use offsets for their own political advantage such as funding campaigns for political office. Shareholders and key executives in the UAE’s indirect offset projects as well as its private sector defense initiatives are drawn from the wealthiest and most politically connected families. 
These influential families may seek out offset partnerships for their own political advantage over competitors, which opens U.S. companies to accusations of foreign influence in domestic political affairs.

Intentionally Ignored

Despite the serious risks of offsets, the U.S. government barely scrutinizes defense firms’ offset packages for corruption concerns when defense companies seek or obtain U.S. approval to sell arms abroad. 
U.S. government officials will likely tell foreign officials at IDEX that they should negotiate offset packages directly and only with U.S. defense companies largely out of concern that the U.S. government could be held liable if companies fail to deliver on their offset packages with the foreign government. This U.S. concern has undermined its ability to use the tools it has to address these known risks.

The United States has two regulatory avenues to review proposed offset packages before an arms deal is finalized, but these avenues are underutilized. U.S. defense companies are required to submit information on offsets when applying for a license with the State Department to sell arms abroad that require congressional notification. However, this requirement does not stipulate that companies describe who will be the beneficiaries of the offsets. 
The State Department also mandates that companies submit information on any political contributions, fees, or commissions they may have paid in connection with a proposed arms deal, but many U.S. defense companies do not regularly submit this information.

The Commerce Department does collect more detailed information on defense company offsets after the deal is made, which is compiled in a congressionally-mandated annual report. 
The department requires that defense companies submit information on the types of offsets offered and the intended beneficiaries. However, it appears that neither Commerce nor the State Department use this information to investigate corruption risks or acts of bribery. 
The focus of the Commerce Department is whether offsets risk harming U.S. defense industrial capacity. None of the State Department reports on post-export checks of U.S. arms sales from the last 10 years mention offsets.

It would be simple for the U.S. government to fix these issues. It could require more detailed and accurate information on offsets and political contributions for proposed U.S. arms sales that require congressional notification. 
The State and Commerce Departments could also start using annual offsets reports from defense companies to investigate possible cases of corruption or support for entities involved in smuggling or money laundering.

Without these enhancements, the U.S. government is at risk of undermining its own Strategy on Countering Corruption by failing to ensure that U.S. arms sales do not inadvertently support corrupt actors and facilitate bribery, foreign lobbying, and money laundering. 
There is a real possibility that the U.S. approach to offsets could discourage other countries from effectively tackling these corruption related issues. The Biden administration is right to push U.S. companies to strengthen their anti-corruption efforts. It should prioritize investigating offsets.