How rules are changing for defense-weapons contractors

Arms manufacturers will soon face changes in how they do international business. What impact will these changes have?

Changes are coming to how arms manufacturers do business internationally, thanks to proposed changes in the International Traffic in Arms Regulations (ITAR). In fact, comments are due by the end of May. For details, the Federal Drive with Tom Temin talked with Stephanie Kostro, executive vice president for policy at the Professional Services Council.

Interview transcript:

Tom Temin Changes are coming for how arms manufacturers do business internationally. That’s thanks to proposed changes in the International Traffic and Arms Regulations, ITAR. In fact, comments are due by the end of May. We get details from the Executive Vice President for Policy at the Professional Services Council, Stephanie Kostro. And Stephanie, first of all, tell us how anything having to do with arms sales affects the services contractors that you represent.

Stephanie Kostro Tom, thanks so much for having me. And that is a question we often get at the Professional Services Council. So we, as you know, represent technology and professional services contractors who do business with the federal government. When you look at the International Traffic and Arms Regulations, or ITAR, a lot of this is about exporting, re-exporting, re-transferring internal to a country of defense articles. And so, a lot of these defense articles come with maintenance and sustainment tails. And oftentimes in a lifecycle of a system, it is that tail of sustainment and maintenance that actually overshadows the cost of the original defense articles. But I would also say ITAR focuses also on services. And so that is an area where we are very actively engaged.

Tom Temin All right. And what is going on with ITAR? It affects certain countries, in other words.

Stephanie Kostro A few years ago, you may recall that President Biden worked with his British and Australian counterparts to create something called AUKUS, which is the Australia, UK, U.S. Security partnership. It’s a trilateral partnership to really focus on two pillars. The first pillar has everything to do with submarines. And so, talking about getting allied capabilities improved in the Indo-Pacific area of responsibility. But pillar two brings to there a whole bunch of other areas. And I’ll list a couple of them for you, Tom: advanced cyber and AI, quantum technologies, electronic warfare, information sharing and a category called innovation, which, you know, you could probably drive a truck through. Australia and the Brits, as a result of this trilateral partnership, are considering legislation to address some of their licensing requirements. And so the U.S., as part of this partnership, has introduced two rules. One is a proposed rule you just mentioned, which is ITAR’s defense articles and services. The other one is an interim final rule that the Department of Commerce released. And these comments are due June 3. And this is the commerce counterpart to ITAR. It’s the export administration regulations, and that is more to do with dual use technologies. And so, both of these rules are something that, you know, PSC and our fellow associations are considering very carefully. We are also working with our Australian and British counterpart. We have trade associations with whom we have relationships over in other countries. And talking a little bit about how we as a group are approaching these.

Tom Temin In other words, these rule changes then would make it much easier to export and otherwise deal in U.S.-made arms with the UK and Australia.

Stephanie Kostro That’s exactly right. So, what we’re looking at here are two rules that would provide exemptions for Australia and the UK. Similar in the ITAR front, as we’ve had with Canada for a while. But introducing the UK and Australia to these exemptions would make it much easier to do defense business with both of these countries and vice versa, them with us.

Tom Temin I’m a little surprised we haven’t had that with the UK for decades, actually.

Stephanie Kostro You know, about 10, 15 years ago, we did have defense trade agreements come to Congress for ratification, one with the UK and one with Australia. You know, the devil is always in the details. The implementing legislation on those fronts were very difficult. And so, this is taking a crack at the regulatory side. And so, State Department and Commerce Department with these two rules are really moving quickly, as I mentioned earlier. One set of comments are due the 31st of May, the other June 3, and they hope to have comments adjudicated throughout the summer and go final. And of course, the Commerce Department one is an interim final rule. So, that’s already taken effect.

Tom Temin Right. So the main beneficiaries of this change should have happened would be the direct articles, manufacturers, missiles and so on. But the services contractors would come along with tail opportunities, you might say.

Stephanie Kostro 100%, and as I mentioned, the categories earlier, you know, quantum, AI, cyber, a lot of these are services heavy. So it’s not just the major defense platforms, it’s the other enablers as well.

Tom Temin Right. They get packaged often with these platforms.

Stephanie Kostro Exactly. And the biggest category that I’m looking at, I’m very curious about is this innovation category. Because again, you could drive a truck through it of what qualifies as innovation. And I think we can look forward to seeing a lot of pilot projects in that area.

Tom Temin We’re speaking with Stephanie Kostro, executive vice president for policy at the Professional Services Council. And at the same time, there’s some restrictions coming. They’ve actually been known to us for some time now, and that is the prohibition from a couple of years ago in the NDAA on buying semiconductors from Iran, if they make any there. China, Russia and North Korea, if they make any there. And you’re commenting on the fact that now some action is happening on some rulemaking to follow up on that NDAA provision.

Stephanie Kostro So, this is an advance notice of proposed rulemaking. There was, in the fiscal year 2023 National Defense Authorization Act, a ban on sourcing semiconductors from those nations that you mentioned. There is a report due from the Department of Commerce, but this ban takes effect in late 2027. There was a five-year grace period, so companies could start to think about their supply chains and figure out where they’re getting their semiconductors and get them from other sources. The question that we have at PSC is, why is there an advanced notice of proposed rulemaking coming out now, before we’ve seen that report, at least in the public? I don’t know if if the executive branch has shared it with the Hill behind closed doors, but we’re very curious about what assumptions they’re making about supply and demand. Semiconductors play a critical role not just in military technologies, but commercial technologies. If you think about your car, or certainly if you have an electric vehicle, in that domain, they suck up a lot of the semiconductors in the U.S. consumption. And so what are those assumptions being made about federal contractors and where they’re getting their semiconductors for federal missions?

Tom Temin Right. This gets into the whole question of supply chain, how far deep in the supply chain you have to worry about sourcing, and also the strategic reliance on places where maybe that’s the sole supplier of a particular type of circuit.

Stephanie Kostro That’s exactly right. If you think about supply chain, it’s not so much a pyramid, which is what I believe some people assume. It’s actually a diamond, right? Diamond shape. And as you get further and further down the supply chain, it narrows down to a few suppliers. China is a known supplier of semiconductors, of microelectronics. The Department of Defense has done a study of this. Congress did a study of this with their supply chain group a few years ago. And so semiconductors is an area which is very, very active. But we would love to see what assumptions underpin this proposed rule.

Tom Temin And it’s safe to say that given China’s designs on the world, they didn’t create the dependence accidentally that U.S. and everybody else pretty much has on their supplies.

Stephanie Kostro I think that’s a fair assumption, but I’d like to see something like that, you know, reflected in what the government is putting out to contractors.

Tom Temin So, what is your suggested comment? I mean, what are you going to say about it?

Stephanie Kostro We will talk about, from PSC perspective, how important it is to have ongoing dialogue with industry about where we’re actually getting our semiconductors. What do we do with legacy chips? How do we transition from legacy chips to to new sources of supply building in some redundancy? Because, as you know, 2027 is going to be here before we know it. We’re almost halfway through that grace period that Congress allotted in the FY23 NDAA. And as we move forward, we’re going to have to find, either in allied countries or in our own country, sources for the semiconductors. And we are going to hopefully work with the executive branch on how to do this in a way that makes sense.

Tom Temin Well, that’s what the CHIPS Act was supposed to be all about. But in many ways, you see money going to a lot of other things besides the strategic military and high-end circuitry that we sometimes don’t make here.

Stephanie Kostro You know, it’s not unusual to have a piece of legislation. And the CHIPS Act is a very large and long piece of legislation that has a bunch of other issues tucked away inside it. And so the CHIPS Act is not just about chips, but we are hopefully going to work with the executive branch on getting some common sense solutions in this regard, at least.

Tom Temin Stephanie Kostro is executive vice president for policy at the Professional Services Council. As always, thank you so much.

Stephanie Kostro Thanks, Tom.

Tom Temin We’ll post this interview at Subscribe to the Federal Drive wherever you get your podcasts.

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