Stronghold offers a solution to enable advancing countries to effectively monetize offset obligations due to them from purchases of industrial & defense equipment & services
Definitions & Background
Offsets - Provisions to an import agreement, between an exporting foreign company or government acting as intermediary, and an importing sovereign state. The incentive for the exporter results from the conditioning of the core transaction to the acceptance of the offset obligation. Offset agreements frequently involve trade in defense equipment and services and can go by a variety of other names including: industrial compensations, industrial cooperation, industrial and regional benefits, balances, juste retour, and/or equilibrium.
Regulation & management - Ministries of defense or governments typically have responsibility to regulate and manage contracted offset obligations.
Direct offsets - Agreements directly related to products or services sold. Example:
Norway’s Kongsberg Defence Systems subcontracted work locally and transferred technology to the Polish Navy in support the sale of the Naval Strike Missile Coastal Defense System.
Indirect offsets - Agreements not directly related products or services sold. Example:
Russia’s Sukhoi, transferred technologies to the Malaysian National Space Agency to fulfill obligations related to the sale of 18 Su-30MKM aircraft.
Offset obligation fulfillment - a term of a purchase contract negotiated to award “credits,” an accounting metric specific to these programs. Sellers of equipment and services can receive credit toward fulfillment by negotiating - as part of a purchase contract or after a purchase - a “multiplier,” or an investment incentive that reflects the customer’s desire to direct funding or services toward particular sectors or economic initiatives.
Scale
While not typically reported in annual financial reporting, offset contracts have increasingly become C-suite agenda items.
US defense contractors enter into an average of 30 to 60 offset agreements each year, estimated at between $10 billion and $20 billion in obligations per year.
Recent data has identified an excess of $150 billion in offset obligations due to Saudi Arabia alone.
Avacent, the international strategy & consulting firm estimated that outstanding (unfulfilled) offset obligations would exceed $500 billion in the year 2016. The market associated with such transactions has an annual growth rate of some 9%. In 2021 Avacent project an increase in offset obligations of $371 billion between 2021 and 2025.
Risks
While offsets facilitate international sales, if the parties do not manage the process effectively, offsets can carry significant competitive, legal, and reputational risks.
Contractors that have acted improperly in fulfilling offset obligations or have proposed programs that failed to produce the intended results have faced penalties, including, congressional inquiries, reputational damage, inclusion on “black lists” of companies restricted from bidding on public procurements in specific countries, and investigations under the US Foreign Corrupt Practices Act and the UK Bribery Act.
Reforms to manage the above articulated risks, while welcome, have yet to fully address the issues.
Case Study
In support of a sovereign, Stronghold has offered:
US$ 7.5 billion for
Preferred shares in a Sovereign established development program
The offer constitutes a non-dilutive capital raise available in tranches to match investments in diversifying the Sovereign's economy. The parties can complete the first tranche of the proposal in as little as 90 days.
Stronghold’s innovations and proprietary financing solution enables the Sovereign to effectively monetize defense supplier offset obligations to make this offer possible. Stronghold developed its solution by forging unprecedented synergies across: insurance, finance, investment banking, economics, law, accounting, regulation, and knowledge of the specific advantages provided by global insurance jurisdiction - all mission-critical to the development of this solution and offer.
Transaction Overview
The program:
(1) Issues bond(s) — US$ 15 to $20 billion investment grade senior fully-secured (legally defeased) debt instrument(s) of an insurance company to defense suppliers with outstanding offset obligations to the Sovereign;
(2) Sets up Collateralized Insurance Reserves (in trust to guarantee contractual obligations of the bond) and Funds the issuing entity’s Investment Account (see Stronghold Overview below); and
(3) Purchases preferred shares in a Sovereign entity established to distribute financing (terms subject to agreement).
The Sovereign grants the defense suppliers fulfillment of their offset obligations.
The Sovereign entity established to distribute financing pays yearly dividends on the preferred. Dividend payments cover yearly operational costs and coupons to the bond purchasers.
Defense Suppliers & Offset Obligations
US$ 15 billion of outstanding offset obligations — We understand that defense suppliers have offset obligations (on past sales) due to the Sovereign in excess of US$ 15 billion;
Not carried as liabilities — With some variation, defense suppliers do not record offset obligations as liabilities on their balance sheets. Paying them directly (even if credited for a multiple of a payment) presents significant balance sheet and share price consequences;
Competitive constraints — Outstanding offset obligations place these companies at a competitive disadvantage on future contracts; and
Value proposition — Stronghold’s solution provides:
- Balance sheet stability — purchasers hold a real asset,
- Liquidity - purchasers can hypothecate the bond,
- Fulfills offset obligations, and
- Expected return — delivering a risk premium over U.S. Treasury yield.
No other alternative to delivering US $7.5 Billion to such a Sovereign so effectively benefits all parties to the transaction.
Macro Risk Discussion
Sovereign perspective
In the program proposed, the Sovereign:
Receives cash at closing;
Has no operational risk in the program; and
Will know prior to closing that the defense contractors will participate.
The Sovereign has a single risk in the transaction — the cost in time and money of due diligence on Stronghold and the program.
Defense contractor perspective
The defense contractors have a different position and different risks.
As proposed, defense contractors purchase a bond — a senior fully secured debt instrument of an insurance company. We anticipate four primary concerns:
Operational risk;
Credit risk;
Accounting/regulatory treatment of the bond vis-a-vis liquidity; and
Fulfillment of their offset obligations.
Operational risk
Solvency II Compliant — Stronghold has designed its programs to meet all solvency requirements under the global insurance industry’s Solvency II regulatory regime.
Regulatory oversight — As an embedded credit insurance program, the instruments receive regulatory oversight over every operational entity used in Stronghold designed programs. The operational entities include:
Insurance Company — Stronghold works with established insurance companies in Bermuda and Cayman.
Protected Cell established by Insurance Company — Protected Cell frameworks are widely used, in the insurance and reinsurance industry to ring-fence programs. They support trillions of dollars in insurance and asset holding programs.
Program Administrator — USA Risk.
Auditor —RSM.
Certifying Agent — RSM - fulfilling a technical roll whereby prior to closing and throughout the life of Stronghold designed instruments — certifies the size and assets of the solution’s Collateralized Insurance Reserves, ensuring that the Trust has the appropriate assets in the required amounts to cover the obligations to bond buyer(s).
Credit risk
Under NDA Stronghold can describe how our programs defease credit risk (the ability of the issuing Protected Cell to meet all contractual obligations of the bond).
Accounting and regulatory treatment
To support due diligence on our programs, Stronghold will supply a detailed accounting and regulatory analysis. Review of this information requires accountants and professionals with bank capital and insurance regulatory knowledge.
The importance of the accounting and regulatory treatment additionally goes to the instruments' liquidity in a secondary market sale or hypothecation to a bank for a loan.
Fulfillment of offset obligations
The Sovereign and defense contractors need to negotiate this. All parties have compelling interests to do so. They would resolve this before any of them spend any significant money or take any risk.