Insights / June 17th, 2024

AUKUS Pillar 2 – We Are Not There Yet

Many will be aware that the Australia – United States – United Kingdom partnership known as AUKUS comprises two pillars:

Pillar 1 – Submarines – Nuclear powered, conventionally armed

Pillar 2 – Advanced Capabilities.  This pillar is broken into a number of workstreams but may be summarized as the development and provision of joint advanced military capabilities to promote security and stability in the Indo-Pacific region.[i]

Pillar 2 refers to the three partner countries cooperatively developing defence technology. Australian companies have to develop their own capabilities. But achieving this collaborative development of advanced capabilities will require actions on three levels.

a) Government to government harmonizing of policies and regulatory frameworks.

b) Defence working with industry to develop and build systems that facilitate competitive advantages for Australian companies.

c) Cooperation between industry participants across supply chains. Participants will need to cooperate to expedite the building of information and innovation sharing, advanced capabilities and increased interoperability, thereby promoting operational efficiencies.

There has been some limited progress at the level of government regulation.  But it appears to us that there is a long way to go in the three partners harmonizing their policy approaches and regulatory frameworks. Of the three partners, the United States has by far the largest (in terms of cost and capability) defence-related networks. Effective achievement of the Pillar 2 aims will in respect of stream (a), require harmonization as between the US International Traffic and Arms Regulation and Export Administration Regulations and the Australian Defence Export Controls regime.

Many Australian SMEs will say that there have been long standing difficulties in navigating Defence’s labyrinthine processes and regulatory requirements and that in negotiating contract terms, Defence appears to lack understanding of the commercial realities that SMEs face.  Much will need to be done by Defence to improve and streamline processes in order to enhance the ability for Australian industry to leverage opportunities for cooperative innovation and capability development.

Progress has to be made on both these levels in order to achieve any success in realizing the aims of AUKUS Pillar 2.

The large contractors in the defence industry (“primes”) typically have deep experience in working with departments of defence and complying with regulatory requirements pertaining to the export of military or dual use material. They typically have the resources to establish and maintain areas of regulatory compliance, including cyber and other systems security.  They have the expertise and resources to navigate the sometimes conflicting regulatory requirements of the three partner countries.

Some SMEs (“subprimes”) have been able to invest over years to build up this expertise.  But that is not so for many subprimes involved in or seeking to become involved in the defence industry, in particular by becoming involved in the global supply chains established by the primes. The following are some practical observations that may be of assistance.

1 - Primes and subprimes alike have to carefully manage their own manufacturing and supply chains and concomitantly, their financing of those activities. Anticipating delays in obtaining export approvals or complying with export control regimes or the requirements of primes and resultant costs can be critical for subprimes to successfully conduct business. Subprimes will be assisted in this regard by building expertise in the export and import regulatory environments so that they understand and can anticipate processes likely to apply to them and with which they must comply.

2 - Allied to paragraph 1, subprimes should develop relationships with people expert in the above areas. That expertise may be developed inhouse or may be outsourced.

3 - Subprimes will gain an advantage by building collaborative relationships with international colleagues – suppliers, customers and advisors. The intelligence sharing and assistance that may arise from such collaborative relationships may sometimes be a lifesaver.

4 - Subprimes building collaborative relationships with regulators in Australia and overseas is likely to be beneficial.  Fractious relationships won’t be helpful.

5 - Subprimes should build expertise in manufacturing processes and time and supply line management particularly in the context of the regulatory environment and the contractual delivery demands that exist in the industry.

6 - Subprimes should plan for scale up. This will involve both financial capability and development of other resources and capacities. Whereas supply to Australian customers may involve a few units, the US market size is such that a supply order may involve many, many units, often in a short space of time. An inability to scale up supply capacity may be the difference between being successful and unsuccessful in securing orders.

7 - It will be important for subprimes to decide whether they are prepared and have the capacity to persevere (money and other resources) in an environment that has such complex regulatory hurdles and competitive pressures.

All of these steps involve very significant commitments of financial, personnel and other resources, often at an early stage when there may be no certain prospect of substantial success and financial returns.  These can be big bets.

Defence industry participants will look to governments for developments or improvements in several areas.

1 - The US Government invests substantially in providing financial support for defence industry participants, especially in the provision for funding R&D. It will be of great assistance to Australian participants if the Australian Government significantly increases its investment in R&D funding and capability building for the Australian industry.

2 - It will be essential that the Australian Government in conjunction with its US and UK partners, builds better, more streamlined regulatory processes, including with respect to export approvals, personnel permitted to be involved in regulated activities and technology transfer.  The US takes somewhat different regulatory approaches with respect to military or defence articles (ITAR) and dual use articles (EAR). Australian regulates both under the one DEC regime.

3 - Defence must streamline systems to assist participants and especially subprimes to navigate its systems. In particular, it would be of real assistance for Defence to engage personnel with commercial experience whose focus is to assist companies to quickly navigate systems and negotiate contractual terms to achieve commercial outcomes. This would substantially enhance the ability particularly of subprimes to compete for places in global supply chains.

It would be interesting to know whether the Commonwealth sees the value and importance of the above steps and whether senior personnel are prepared to commit to doing these things. Private sector defence industry participants invariably work with hard deadlines and measure performance by clearly stated KPIs. It would be useful if Defence had the same rules and was prepared to be transparent about the steps taken and the progress made.

Australian suppliers are competing for places in global supply chains against extraordinarily capable competition, not least if they wish to supply into US markets. While the three partner governments have committed to AUKUS Pillar 2, it is an open question whether the major contractors in the US and UK will follow through on the same commitment.  We wait to see what will be the opportunities for Australian subprimes to participate in their supply chains and what the subprimes have to do to achieve success.  The Commonwealth taking concrete action to assist Australian companies to build competitive capability will be a key component to the achievement by those companies of the aims of AUKUS Pillar 2.

We recommend the paper produced by the Australian Strategic Policy Institute (George Henneke and Roland Stephens) entitled “AUKUS Pillar 2 Critical Pathways”, May 2024.

[i] Prime Minister and Cabinet AUKUS - Factsheet

For further information please contact Brett Cowell in our Defence team.

This publication has been prepared for general guidance on matters of interest only and does not constitute professional legal advice.  You should not act upon the information contained in this publication without obtaining specific professional legal advice.  No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication and to the extent permitted by law, Cowell Clarke does not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting or refraining to act in relation on the information contained in this publication or for any decision based on it.

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