Canada backs businesses to join in the next chapter of lunar exploration

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  July 23, 2019 | Local, Aerospace

  Next-gen aircrew training

  Rarely in the life of a large, complex military program do you get the opportunity to reshape it from the ground up. But with two pilot training contracts coming to an end in the mid-2020s, the Royal Canadian Air Force (RCAF) is taking advantage of the moment to “reimagine how we are doing training,” said Col Pete Saunders, director of Air Simulation and Training. RCAF pilots obtain their wings through two contracted training services, Contracted Flying Training and Support (CFTS) and NATO Flying Training in Canada (NFTC), delivered from two schools in Manitoba and Saskatchewan: 3 Canadian Forces Flying Training School (3 CFFTS) at the Southport Aerospace Centre in Portage la Prairie and 2 Canadian Forces Flying Training School (2 CFFTS) at 15 Wing Moose Jaw. CFTS, delivered by Allied Wings and led by KF Aerospace, ends in 2027 while NFTC, provided by CAE Military Aviation Training, runs until December 2023, with the option for a one-year extension–the program was recently extended from 2021. At same time, the RCAF would like to transition in-house training of its air combat systems officers (ACSO) and airborne electronic sensor operators (AESOp) to the same program as pilot training, a move partially driven by the end of service life of their primary training platform, the Dash-8 “Gonzo” in 2028. “There are things we have done really well, things we probably wouldn't do that way again, so this is an opportunity to re-baseline everything,” said Saunders. By concentrating all aircrew training under one program, the RCAF is requesting one of the more comprehensive and ambitious industry-managed programs worldwide, from courseware and training devices to aircraft and maintenance, instructors and facilities management. The Future Aircrew Training (FAcT) program hasn't yet released an official price tag, but with NFTC worth about $3.8 billion over 25 years and CFTS valued at $1.8 billion over 22 years, the eventual contract could exceed $10 billion over 20 plus years. More than 80 companies initially expressed interest in the program and five have been down-selected to offer bids when a request for proposals is released in early 2020: Airbus Defence and Space, Babcock Canada, Leonardo Canada, Lockheed Martin Canada, and SkyAlyne Canada, a joint venture between the two incumbents, CAE and KF Aerospace. A sixth qualified bidder, BAE Systems, withdrew in April. What they will be asked to bid on boils down to a single word: Output. In presentations to industry over the past two years, Saunders has stressed, “it is not an aircraft acquisition program, it is a training service, [and] what we are contracting for is output. How a successful supplier gets there, I am not that fussed. What I care about is the output.” And that is a straightforward demand: 120 pilots, 40 ACSOs and 36 AESOps, plus or minus 15 per cent, to a defined standard every year. The flexibility to ramp up or down is intended to deal with shortages–the RCAF is at about 82.6 per cent of manning or around 275 pilots short at the moment–the introduction of new fleets like remotely-piloted aircraft systems (RPAS), and the transition from legacy to new airframes when throughput may not be as high. The numbers are based on demographic shifts and forecasted attrition rates, a “sweet spot” that acknowledges the fact the newer generations may be less likely to enroll for a 25-year career, he said. The Air Force also wants a program adaptable to technological change as both training systems and teaching methodologies evolve. “Our existing programs are delivering exactly what we are asking for, but they don't have that flexibility baked into them, which then handcuffs the contractor who would love to do things slightly differently, but it comes at a certain cost,” said Saunders. FASTER WINGS The current training system produces around 100 to 115 pilots each year for the RCAF's fleets of multi-engine, rotary wing and fighter aircraft. Though the schools delivered a record 116 pilots in 2016, the number has been scaled back to 107 for 2018 to manage a bottleneck developing at many of the operational training units (OTU). The Air Force revised its selection process about five years ago, from a series of aptitude tests and hand-eye coordination simulators to a computer-based assessment purchased from the Royal Air Force, and has seen a significant drop in its overall attrition rate from about 15 per cent to six to eight per cent. On average, 155 students from a pool of almost 1,200 are selected for the four-phase program that begins with primary flight training on the Grob 120-A in Portage la Prairie. About 130 advance to Phase II in Moose Jaw for basic flight training on the CT-156 Harvard II turboprop–an additional 10 often remain on the Grob if there is a capacity issue with the Harvard or they suffer from air sickness on the faster aircraft and are likely going to become helicopter pilots. At the end of Phase II, students are streamed into multi-engine, rotary wing and fast jet. Approximately 35 multi-engine and 60 helicopter candidates will return to Portage for Phase III advanced flight training on the Raytheon King Air C-90B or the Bell CH-139 Jet Ranger and Bell 412 while around 30 remain in Moose Jaw for advanced fighter training on the CT-155 Hawk, learning advanced aerobatics, instrument flying, and tactical formation flying. With Wings proudly pinned to their uniforms, multi-engine and rotary-wing pilots are assigned to operational training units while fighter pilots move on to Phase IV, also known as Fighter Lead-In Training (FLIT), still on the Hawk but at 419 Tactical Fighter Training Squadron at 4 Wing Cold Lake, Alta. The Air Force is also in the process of analyzing the options for a future FLIT program, but has opted to separate FAcT from the more specialized FLIT requirements. One of the many objectives of FAcT will be to stream pilots earlier in the process, rather than waiting until the end of basic flight training after Phase II. In preparation for a new program, the RCAF has revised the qualification standards for all its aircrew trades, but especially for pilots to reflect the mission management component of flying more data-generating aircraft. “There will be a basic flying training phase for all pilots. And then as early as possible, we want to stream them between rotary and fixed-wing,” said Saunders. “Then rotary folks will go off and do their basic rotary training and advanced training, be that on one aircraft or two aircraft. On the fixed wing stream, there will be [additional training] and then they will split again between fast jet and multi-engine.” Whether that is delivered as four distinct phases has yet to be defined, he said, but the Air Force has been working with potential bidders through workshops to develop the training plan. “As long as they meet the standard we have laid out, how we get there will be unique to each one of these qualified suppliers.” The Air Force recently adjusted its training plan to a block approach where student performance is measured by passing certain gates rather than following a linear progression. “The result has been very positive in that we've reduced our extra do-overs, our extra training by half,” said Col Denis O'Reilly, commander of 15 Wing Moose Jaw. By allowing students to focus on areas where they know they need the work and giving them more input into their flights, “it has decreased attrition rates and increased student confidence,” he said. “That has allowed us to use these hours more wisely... [I]nstructors are more successful on every trip they take a student on.” ACSOs and AESOps will remain in Winnipeg, but bringing them under the same training program is intended to capitalize on the fact that much of the basic courseware is common to both pilots and systems operators. Specialized training for future RPAS pilots and weapon systems operators will be done at an OTU, but the initial skills will be to the same standard as other aircrew, said Saunders. “If we determine that the nature of the work is so different that it requires a change in the qualification standard or that we need to make a different stream, then we will have the ability to do that.” The CFTS and NFTC programs are delivered with a mix of 12 Grobs, seven King Airs, 10 Jet Rangers, nine 412s, 22 Harvards and 17 Hawks, and all have an availability rate of over 90 per cent. And at 17,600 hours per year, no one flies Harvards more than Canadian pilot candidates. However, Saunders has told industry not to assume access to any of the current training fleets. “The [18-year-old] Hawks and the Harvards have done a great job and we're pretty confident they will be fine to the end of the contracts,” he said. “But we put a lot of abuse on them. Let's just say pilot training is not kind to aircraft. So those aren't going to be available. Similar with the rotary wing aircraft. We are seeing a clean slate. I'm not telling [qualified bidders] which airplane ... as long as it achieves my training objectives.” TRAINING INNOVATION In 2015, the RCAF released a long-term simulation strategy intended to “transform [the] training system from one that relies on aircraft to one that exploits new technologies to train aviators in a simulation-focused system that creates, in effect, a ‘virtual battlespace'.” Leveraging the latest in technology is still an Air Force goal, but the RFP for FAcT will not prescribe percentages for live flying versus simulation training. “We haven't given them a specific ratio,” said Saunders. “We spoke with allies who have introduced programs over the last couple years, and looked at our own experience on the CH-148 Cyclone and the CH-147 Chinook, where we have more modern simulators, and said, ‘Is there a sweet spot?' I can't say there is a consensus out there.” Rather, the Air Force has looked at its performance objectives and tried to determine how many can be completed in a simulator. “Our initial cut is probably more flying hours than we are currently getting,” he admitted. Because the Air Force also wants to push more training down from the OTUs to the pre-Wings phase of a pilot's development–skills like VFR navigation, night vision systems, and formation flying operating with night vision goggles–Saunders also expects the number of simulator hours to increase. “I want to teach the whys and hows and get them comfortable trusting these things on a much less expensive aircraft,” he said. At present, the majority of simulation flying is done during Phase III of rotary wing (42%) and multi-engine (59%) training. Peter Fedak, a former commanding officer of 3 CFFTS and the site manager for Allied Wings in Portage, said the “pendulum has swung back a bit” when it comes to simulation. The school recently acquired an advanced simulator for the Bell 206, but instead of replacing hours one-for-one, “we are trying to use the sim to the best of its ability and seeing how many things we can take out of the aircraft.” In fact, the changes added five days to the training curriculum. However, the Air Force will be looking to industry for ideas and technologies to improve how students learn. O'Reilly noted training is expensive and industry is well ahead of the military on new methodologies. “I don't think we can be closed minded about it,” he said. Added Saunders: “That is where I think we are going to see the largest differentiator between bidders, is in how they want to get somebody from point A to point B using some of these more advanced technologies. But it has to be cost-effective. I've been very clear that this is not a developmental program. Canada can't be the guinea pig in terms of new and unproven technology.” CONTRACTING EXPERIENCE All the improvements to the training system won't matter much if the operational training units are unable to absorb Winged pilots more quickly. At present, the Air Force has a bottleneck at most OTUs due to challenges retaining experienced pilots and an operational tempo that has pulled veteran instructors from most fleets for deployments. That has resulted at times in lengthy delays for some young pilots, observed Fedak. “The gap is longer than we would like and we are seeing some fade and a lot of returns. Because of that wait, we have had to do refresher training for a lot of people who we would love to never see again, unless they come back as instructors.” Saunders said the ideal wait is no more than six months to finish advanced training and then move, get settled, complete some ground school and begin flying at an OTU. “That is motivating and it's also efficient.” As part of FAcT, the Air Force is open to more contracted flight instructors. While industry under both the CFTS and NFTC provides simulator-based instruction, live flying has remained the purview of the military, a commitment that requires around 130 instructors in both locations, said O'Reilly. “The intent is to allow the OTUs to be better staffed from a uniform perspective, which is where I really need those instructor pilots,” said Saunders. As the former commander of 406 Maritime Operational Training Squadron in Shearwater, N.S., when the Cyclone was introduced, he relied on a dozen serving and contracted instructors to manage the conversion from the CH-124 Sea King to the Cyclone. “Half of those are probably contracted flight instructors on any given day, and you would not be able to tell who is who,” he explained. “My focus at the time was to create that one team, one standard, one mission approach. There were things the contracted folks don't teach–tactics that are a classification level beyond what they hold–but they definitely teach everything up to that point, interspersed with our uniform flight instructors.” Transitioning from a program managed by two companies to a single provider of what are now three distinct programs won't be straightforward, even if the winner is the joint venture of CAE and KF Aerospace. Though the two companies have been “very responsive” managing an inter-related program, ensuring the right number of aircraft are on the line each day, students transfer back and forth and “an issue with one creates a ripple effect with the other,” noted Saunders. “These are different companies under different contracts with different metrics, so just by the very nature of it, it creates a challenge.” The RCAF, however, has experienced enough fleet transitions in recent years to “have learned what things work well,” he said. Through a series of workshops with industry on everything from training plans, to aircraft, to infrastructure that will extend into the fall, the Air Force hopes to present an RFP in early 2020 that is well understood and not subject to unexpected delays. “I've said, ‘I know it isn't going to be a cheap program, but tell me if there is something we are asking for that is going to create a significant cost driver',” he said. To date he has been getting that type of feedback. Potential bidders, for example, have raised questions about his contention flying hours may increase. “We have provided our rationale based on what we've learned from our allies, but we are not being prescriptive, we are saying this is what we see as a benchmark. And if you are telling me something different, tell me why.” The Air Force created two documents, Concept of Training and Concept of Training Support, to guide prospective vendors through the current process, from weather and number of flying days in both locations to meals and accommodation. “I would argue by the time the RFP comes out, most people would have their bids in a 95 per cent completion state because we have been working with them all the way through,” he said. Among other measures, the Air Force will stand up a Training Implementation Working Group led by 2 Canadian Air Division to monitor the process and assess the implications of various decisions once a contract is awarded in 2021. “It will be very complicated,” but when you have that rare opportunity to makes changes, you need to seize it, he said. https://www.skiesmag.com/features/future-aircrew-training-program-next-gen-aircrew-training/?utm_source=skies-daily-news-top-story&utm_campaign=skies-daily-news&utm_medium=email&utm_term=top-story&utm_content=V1

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  February 28, 2020 | Local, Aerospace, Naval, Land, C4ISR, Security

  Financing Capital Assets: The Missing Link in Defence Procurement

  by Vern Kakoschke February 2020 Introduction Defence procurement in Canada has had some well-known challenges in recent years. Many commentators have suggested possible strategies for fixing the defence procurement system. The identified problems include overspending on defence programs, unnecessary and undue delays in re-equipping Canada's fleet of aircraft, ships and ground transport, and defence budgets that remain unspent. The problems also include procuring authorities experiencing a shortfall in manpower and expertise, the inability to execute on defence procurements, unjustified sole-sourcing without a proper competition, political interference in selection issues, and the list goes on. The proposed solutions often address process-related matters: establish a single agency responsible for defence procurement or perhaps a cabinet secretariat to manage the involvement of three of four government departments who are often not on the same page. To date, not much has been written or discussed in public policy forums on a critical question: How should the necessary capital assets be financed? At one extreme, Canada could simply write a cheque and pay for them up front, thereby placing the assets on Canada's balance sheet. At the other extreme, Canada could drop the financing obligation into the laps of private-sector bidders and let them worry about the most efficient way of raising the necessary capital. A middle-ground solution could involve a public-private partnership (P3) structure, a model which seeks to balance the interests of the public and private sectors in a manner that leads to a better solution for all parties. Any public policy discussion often begins with first principles. What is the government's policy objective? It is to procure the best available equipment, with the most benefit to the Canadian economy or local interest groups and at the lowest possible cost. All three goals must be balanced in a manner that is politically acceptable, meets budget constraints and withstands public scrutiny. In major procurements, capital can be the largest single cost of a defence procurement. Conventional wisdom is that Crown debt is by far the cheapest financing alternative for any new program that requires the acquisition of capital assets. The Crown issues Government of Canada (GoC) bonds for a term that matches the expected useful life of the capital assets and the interest rate does not include a risk premium or credit spread (often called “Canada's flat”). Canada purchases the capital assets and then, if necessary, makes them available for use by a private-sector operator under a lease or loan arrangement as government-furnished equipment (GFE). The fixed-wing search and rescue (FWSAR) program is an example of a procurement in which Canada simply paid for the aircraft up front with the related maintenance services (in-service support) for the assets being funded over a long period of time. The government ownership model is simple, straightforward and enjoys the lowest capital cost. But it has two serious drawbacks. First, the GoC bonds are consolidated on the Crown's balance sheet with other Crown debt. This brings them to the attention of the major rating agencies. If the total Crown debt increases beyond acceptable rating norms, rating agencies will typically downgrade Canada's credit rating with the result that the interest rate on future GoC bond issuances will rise. Increased Crown debt may also lead to a politically unpalatable higher budget deficit. Second, the Crown typically selects the appropriate capital assets, a decision that is fraught with risk and intense public scrutiny. Politicians likely dread having to make such decisions. In a scenario where the capital assets can be bundled with required services, the Crown may prefer to procure only the services and leave the related asset selection up to the successful proponent. If the service provider bears the debt service costs and they are simply embedded into the price for services, then the program's cost can be booked in the Crown's operating budget and not its capital budget. Capital budgeting decisions tend to receive a much higher level of public scrutiny than changes to the annual operating budget. Milestone payments made to the successful proponent that are tied to the delivery of a portion of the capital assets can be buried in operating budgets. Relatively low milestone payments may not attract public scrutiny whereas higher payments in a material amount likely would. Historical Perspective The financing for the NATO Flight Training in Canada program (NFTC) can offer some historical perspective. In 1994, Bombardier made an unsolicited proposal to provide contractor-supported jet pilot training in Canada.1 The proposal contemplated certain novel economies of scale for the high fixed cost of establishing a training program. The acquisition costs and non-recurring charges would be amortized over trainees from the Canadian air force and from the air forces of participating NATO nations, thereby resulting in a lower cost per student. Less well-known was the proposal's financing package: the program's entire capital cost would be financed in a manner that was “off-balance sheet” to Canada and to Bombardier. It became known as the Milit-Air financing as it involved the establishment of a special purpose entity (SPE) called Milit-Air Inc., a not-for-profit corporation. In 1997, the Canadian government awarded Bombardier a 20-year service contract for the NFTC program, valued at $2.85 billion. Under the service contract, Bombardier was responsible for providing fully serviced aircraft, flight simulators, training content, and airfield and site-support services to the Department of National Defence (DND). Milit-Air financed all the capital assets pursuant to a bond issue to institutional investors and then leased them to Bombardier. The Milit-Air financing was completed in two tranches: the first tranche in the amount of $720 million of amortizing secured bonds was issued in 1998 and the second tranche in the amount of $106 million was issued in 2002.2 The financings coincided with the obligations to pay equipment suppliers such as Raytheon for the T-6A aircraft and British Aerospace for the Hawk 115 aircraft that were required for the training program. The SPE purchased the capital assets and leased them to Bombardier who in turn provided services to Canada in exchange for firm fixed fees and variable fees. The fixed portion of the service contract payments were “hell-or-high-water” obligations of Canada and were assigned by way of security to the SPE so that it could service the debt on the outstanding bonds. The complex financing structure is described in detail in a 2002 decision of the Ontario Securities Commission.3 The OSC concluded that the distribution of the bonds was exempt from provincial prospectus requirements even though the financing did not fall within an exemption for government debt: “the arrangements do not constitute a direct obligation of Canada to make payments on the bonds or a collateral obligation of Canada in the nature of a guarantee.” In other words, Canada did not guarantee the payments to bondholders and hence under then-applicable accounting principles, the total debt of $826 million was not consolidated with Crown debt.4 The Milit-Air financing was widely considered in financing circles to be an innovative and cutting-edge transaction well ahead of its time. Why was it admired? Standard & Poor's (S&P) rated the Milit-Air bonds. S&P rated most financing transactions involving a service contract structure and an SPE as an accommodation party at one or more notches below the then-current rating of the sponsoring government.5 Milit-Air was a rare exception. S&P awarded the Milit-Air bonds a AAA rating, the same rating as GoC bonds.6 In other words, Canada and the procuring authority for the NFTC capital assets could have its cake and eat it too: the Milit-Air bonds were not shown in the consolidated accounts of Canada as Crown debt and yet the interest rate on the bonds was the same as what Canada would have paid if it had issued GoC bonds. This was an impressive result that likely resulted in interest cost savings over the full term measured in the millions of dollars. Unfortunately, the auditor general of Canada did not see it that way. In his 1999 annual report, the AG found that the decision to award a sole-sourced contract to Bombardier (which contract was assumed by CAE Inc. in 2015) “was not adequately justified”. The AG reviewed the financing arrangement and found it to be lacking, primarily due to the fact that Canada was on the hook for the debt servicing charges even if no services were being provided. The risks were not justified in the AG's view: “The main risk is that if Milit-Air Inc were ever to become insolvent, National Defence would face the drastic consequence of losing its access to the planes while continuing to pay the firm fixed fees.”7 Perhaps the AG did not appreciate that the SPE was designed to be bankruptcy-remote and that an insolvency of Milit-Air was highly remote. The AG would have much preferred if Canada had simply purchased the capital assets outright and supplied them to the contractor as GFE. The AG also failed to acknowledge that if Canada had used the GFE approach, it would have been responsible for the debt servicing charges on the GoC bonds in any event. On an incremental risk basis, it may be that the benefits of the financing in terms of lower interest costs outweighed the incremental risks. In subsequent years, the AG continued to criticize the NFTC program and its financing. In 2002, the AG concluded that the profit margin built into the NFTC contract was excessive and could not be justified. In 2006, the AG calculated that the Crown paid about $39 million for training that it could not use. In his 2006 annual report, the AG stated that the Crown was “less than successful in obtaining foreign student commitments”. The mandarins at Public Services and Procurement Canada (PSPC) likely got the message: they would probably never again attempt a highly structured financing such as Milit-Air in a defence procurement and risk incurring the AG's wrath. A chill fell on the procuring authority. In 2003, the pendulum in respect of defence procurement contracts swung in the opposite direction. Canada released a Request for Proposals (RFP) for a contract to provide long-term primary helicopter and multi-engine fixed-wing pilot training at Southport, Manitoba. The RFP incorporated the AG's recommendations that the next training contract should have payments tied to performance and value received. The AG reviewed the draft RFP for the primary training project and found that payments would be based on milestones: “If the contractor fails to achieve the milestones, this could result in payment holdbacks and forfeiture. Incentives are also in place for good performance.”8 In 2005, Canada announced that a relatively unknown Western Canada-based aerospace company was the winner and awarded the contracted flying training support (CFTS) contract, subject to confirmation that the winner (a relatively small private company) could raise the financing.9 Details of the CFTS financing are not publicly available, apart from the fact that a $137.5-million transaction was concluded at the time of contract award.10 The Enron Debacle The Enron scandal in 2001 changed the landscape for Milit-Air style financings.11 Enron filed for bankruptcy and its accounting firm, Arthur Andersen, was dissolved. The CFO of Enron went to jail. One of the causes of their downfall was Enron's use and abuse of SPEs that enabled the company to hide hundreds of millions in liabilities from its shareholders and lenders. Largely as a result of the Enron debacle, the U.S. accounting regulator (the Financial Accounting Standards Board) changed the accounting rules to make it more difficult, if not impossible, to use off balance-sheet financing structures.12 Most large Canadian corporations that had taken advantage of such financing structures promptly reversed course and consolidated their SPEs' debt. It is not clear from the public record whether the AG also responded to the change in accounting standards by adding the outstanding Milit-Air bonds to Crown debt in the Crown's audited accounts. Future Air Crew Training (FAcT) Program The competition for the next-generation training contract started in 2013. The Crown announced that it would combine the pilot training currently being provided under the NFTC program and the CFTS program together with air crew training for combat system officers and airborne electronic sensor operators into one massive procurement.13 A RFP is expected to be released in 2020 with a contract award expected in 2021. The Crown has made no mention in its public releases how the required capital assets are expected to be financed under the FAcT program. The four qualified bidders in the FAcT competition may be faced with uncertainty in bid preparation in that they may or may not be expected to provide the financing as part of the bidding process. The amount required to refresh or fund the FAcT program's capital assets will likely be significant: if the total capital cost of the two existing programs approached $1 billion over 20 years ago, the capital cost of a refresh could be well in excess of that amount. Such an onerous financing obligation could put smaller bidders at a disadvantage to larger multinational defence contractors. Public Private Partnerships (P3s) The P3 procurement model is an investor-friendly method of transferring risk for public infrastructure projects to the private sector and enabling a private-sector financing at an acceptable risk premium over GoC bonds.14 It is all about delivering value for money. Cash-strapped provinces have enthusiastically embraced the P3 model for the design, build, operation and maintenance (DBOM) of various projects in the health-care sector, social infrastructure such as hospitals, libraries and prisons, and transportation such as roads and bridges. Relatively few P3 projects have been completed at the federal level: the RCMP headquarters in Surrey, the Gordie Howe Bridge and the Communications Security Establishment Centre (CSEC) in Ottawa. It was unfortunate that the Liberal government in 2017 disbanded PPP Canada, a Conservative-created Crown corporation that encouraged P3s at the federal level. There is no reason why the P3 model could not be applied to defence projects, particularly if they involve a mix of capital assets and service delivery, as most P3s do. Security concerns can be overcome, as was evidenced in the CSEC project. There is no loss of government control over strategic assets in any P3 deal. Contracting practices for P3 deals have been well developed over the years and the investment community has accepted the risk allocation set out in commonly used P3 documentation. No need to reinvent the wheel with new and complex documentation when preparing a RFP. Other countries, such as the U.K. and Australia, have fully embraced the P3 model (known locally as PFIs or private finance initiatives) for defence procurement and yet Canada has not followed their lead, notwithstanding the demonstrable benefits that could be derived from such an approach.15 P3s are typically built on time and on budget as the risk of delays, cost overruns and non-performance are transferred to the successful proponent in the private sector. Lessons Learned When it is released, the RFP for the FAcT procurement will provide an interesting case study for whether Canada has learned any valuable lessons from the predecessor financings undertaken in the NFTC and the CFTS programs. Some shaping principles that could be helpful when designing a defence procurement involving significant capital assets (such as FAcT) include the following: Contemplate an investor-friendly financing for the capital assets. Unless Canada prefers to increase its budget deficit by a material amount, the RFP's terms should not scare off potential investors. By adopting best practices in the P3 industry, Canada could level the playing field when it comes to financing. Each bidder should have the same opportunity to raise the capital on the strength of the underlying service contract and not simply on the strength of its balance sheet. Unwind the Milit-Air financing. The Milit-Air bonds are nearing maturity but are still outstanding. The original purpose of the financing structure – off balance-sheet accounting treatment – has disappeared. The annual cost of maintaining a not-for-profit corporation cannot be insignificant. This cost could be avoided by unwinding the financing in a manner that involves Canada stepping up to assume the obligations under the bonds as a direct obligation of the Crown. This could well facilitate transition issues between the existing NFTC assets and the refreshed assets. Involve the auditor general in the RFP design process. The AG made numerous helpful recommendations in his reports regarding the NFTC program, many of which remain valid concerns today. Has the AG ever followed up and determined the current status of his recommendations? Better transparency would assist the bidders and their investors in risk assessment. Moreover, the expected accounting treatment for all parties concerned could usefully be reviewed by the AG and anticipated in the RFP. Reconsider the use of milestone payments. If Canada intends to partially contribute toward funding the capital cost in whole or in part, the contributions could take the form of progress payments rather than milestone payments. The former payments are considered to be earned when paid, whereas the latter are considered unliquidated advance payments (meaning the Crown could claw them back in certain circumstances). No investor will wish to invest in a project where the Crown has a prior claim on the same assets funded by an investor. The AG may also consider the accounting treatment of such milestone payments, as they may in some cases be treated as being on capital account rather than on income account and buried in a government department's operating budget. Provide certainty for bidders in the RFP process. Uncertainty is the enemy of a cost-effective program. If bidders are given advance notice of the essential terms of a procurement, they can plan accordingly, including preparing for a financing that will likely require substantial amounts of debt and equity from the investment community. Any necessary governmental approvals, including from Treasury Board, would be best sought at the start of a procurement process. Leaving the funding approvals to the end as an after-thought would not be helpful. Defence procurements are large and complex. Financing considerations should be taken into account as early in the procurement process as possible. The failure to consider the appropriate financing approach for major capital assets could well add millions to an already costly program. Conversely, a properly structured procurement and related financing could save the Crown many millions in terms of the cost of capital. End Notes 1 National Defence and the Canadian Armed Forces, “NATO Flying Training in Canada: An Innovative Solution for NATO Flying Training Requirements,” Sept. 7, 1998. Available at http://www.forces.gc.ca/en/news/article.page?doc=nato-flying-training-in-canada-an-innovative-solution-for-nato-flying-training-requirements/hnlhlxhd 2 Offering Memoranda dated May 5, 1998 and June 25, 2002 issued by Milit-Air Inc. and its financial advisor and underwriter, Scotia Capital Markets. 3 In the Matter of Scotia Capital Inc. and Milit-Air Inc. Available at https://www.osc.gov.on.ca/en/SecuritiesLaw_ord_200220628_2113_scotiacapital.htm 4 The auditor general concluded in his 1999 annual report that Milit-Air was an independent organization and not subject to the control of Canada or Bombardier. In the result, the debt appeared on the balance sheet of Milit-Air Inc., but not on any other party's balance sheet. 5 The reason for the lower rating is that the payment stream under the service contract could be caught up in a service provider's bankruptcy and hence the payment flows to the bondholders could theoretically be interrupted. 6 Standard & Poors Rating Direct Report (Oct. 11, 2007). 7 1999 September and November Report of the Auditor General of Canada – Case Study 27.1-NATO Flying Training in Canada. 8 May 2006 Report of the Auditor General of Canada. 9 National Defence and the Canadian Armed Forces, “Backgrounder on CFTS,” March 30, 2005. Available at www.forces.gc.ca/en/news/article.page?doc=contracted-flying-training-and-support-cfts/hnocfoke 10 McCarthy Tétrault LLP. Available at https://www.mccarthy.ca/ 11 Many corporations in capital-intensive industries were taking advantage of off balance-sheet financing structures at that time. In such financings, the debt was typically issued by a special purpose entity that was not controlled (de jure control) by the sponsoring corporation. Hence the debt that the SPE issued was not consolidated with the sponsoring corporation's debt even though the latter was indirectly responsible for the debt servicing, typically through lease payments to the SPE. As a result, the sponsoring corporation did not put any stress on its financial covenants with its lenders and it also avoided the payment of capital tax which was based on the corporation's stated liabilities. 12 In 2009, FASB issued Interpretation FIN 46(R) entitled “Consolidation of Variable Interest Entities”. If an SPE qualified as a VIE under a new substantive test (rather than control test), the VIE's debt would have to be consolidated with the debt of the primary beneficiary (i.e., the sponsoring corporation). The Canadian accounting regulator soon followed suit with the publication of Accounting Guideline AcG-15 (Consolidation of VIEs). 13 FAcT website: www.tpsgc-pwgsc.gc.ca/app-acq/amd-dp/air/snac-nfps/ffpn-fact-eng.html 14 Many P3 projects have been financed at interest rates based on the then-prevailing applicable GoC bond rate plus a credit spread of 150 -200 bps. 15 The benefits have been well documented by the Canadian Council for PPPs in numerous published studies. About the Author Vern Kakoschke is Managing Director of Gothic Strategic Solutions Inc. (www.gothicsolutions.ca). He provides consulting services in the aerospace and defence sector and advises on complex structured financings, including tax-advantaged financings. Vern has 30+ years experience practising law in Toronto and in the investment banking industry where he completed several novel financing transactions for major capital assets involving aircraft, rail, power and infrastructure assets. He retired last year from a senior management role at KF Capital (owner of KF Aerospace), including as a director of SkyAlyne Canada LP (one of the bidders for FAcT) and was formerly the finance lead on the SkyAlyne bidding team. https://www.cgai.ca/financing_capital_assets_the_missing_link_in_defence_procurement

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  April 20, 2021 | Local, Naval

  MBDA to supply Sea Ceptor weapon system for Canadian CSC frigates

  MBDA announced on 19 April it has been awarded a contract from Lockheed Martin to equip the Royal Canadian Navy's (RCN's) new single class of 15 Canadian Surface Combatant (CSC) multimission frigates with the Sea Ceptor air-defence weapon sy...