Economic Participation Program Required for Saudi Government Procurement
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Economic Participation Program Required for Saudi Government Procurement

Abstract

To promote economic localization, the Saudi government has introduced several guidelines and policies, including the Nitaqat system for labor, the Regional Headquarters Program for investment, and the Industrial Participation Policy for procurement overseen by the General Authority for Military Industries (GAMI) since 2019. The Economic Participation Program, introduced on 14 December 2023 under the Local Content and Government Procurement Authority (LCGPA), aims to enhance benefits from government procurement in the non-military sector, while the Industrial Participation Policy focuses on military procurement. This commentary mainly analyzes the Economic Participation Program in government procurement, and provides a brief about its application, the calculation of economic participation, related incentives and penalties.

Offset in WTO Agreement on Government Procurement

The WTO Agreement on Government Procurement (GPA) is a plurilateral agreement designed to reduce barriers to participation and strengthen governance in public procurement markets among the contracting parties, to achieve international liberalization of government procurement. The GPA restricts or prohibits the use of offsets to encourage local development or improve the balance-of-payments accounts by means of domestic content, licensing of technology, investment requirements, or counter-trade and similar requirements.

For developing countries, taking their development needs into account, the GPA allows them to negotiate the use of offsets upon accession, such as the inclusion of local content requirements. However, such offsets can only be used to qualify for participation in the procurement process and not as criteria for awarding contracts.

Since GPA is a plurilateral rather than a multilateral agreement, WTO members are free to access or not. Although Saudi Arabia is a WTO member, it has not joined the GPA and is therefore not subject to the GPA’s restrictions or prohibitions regarding offsets. Consequently, Saudi Arabia has been introducing and updating its regulations on economic offsets since 1980s, with the Economic Participation Program being one such initiative. Saudi Arabia has been an observer to the plurilateral GPA since December 2007; however, recent policies and the Government Tenders and Procurement Law indicate that the Saudi government tends to favor the protection of local economic development, making the application of the Economic Participation Program indisputable in the near future.

Saudi Economic Participation Program

  1. What Is Economic Participation Program : What Is Economic Participation Program The Economic Participation Program originates from the pre-existing Economic Offset Program, which was initiated in 1984 by Economic Offset Committee, making Saudi Arabia the first Gulf state to establish an offset program, followed by the United Arab Emirates in 1991 and Kuwait in 1994, with the aim of promoting local economic development, achieving self-sufficiency in key industries, and diversifying the economy. The Economic Offset Program specialized in both military and non-military sectors.In 2019, the Local Content and Government Procurement Authority (LCGPA) was established in Saudi Arabia. In the same year, the General Authority for Military Industries (GAMI) introduced the Industrial Participation Policy to regulate offsets in government procurement related to military sectors. In 2023, LCGPA introduced the Economic Participation Program to regulate government procurement in non-military sectors. Thus, the Economic Offset Program is now divided into the Industrial Participation Policy supervised by GAMI and the Economic Participation Program overseen by LCGPA. The Economic Participation Program stipulates that foreign investor bidding for government procurements worth SAR 100 million or more shall commit to promoting local economic development when signing the procurement contract. The amount of the economic participation commitment is 35% or more of the contract value.It is important to note that the Economic Participation Program involves two contracts: the Government Procurement Contract between the foreign investor and the relevant government entities, and the Economic Participation Commitment Contract, which details the investor’s commitment to promote local economic development. In the p Government Procurement Contract, the government pays the agreed price to the investor, while in the Economic Participation Commitment Contract, the investor shall make a commitment to promote local economic development, which shall deliver added value and new contributions that go beyond the specified tender requirements and not result in any additional costs for the tender.
  2. The Scope of Application : The Economic Participation Program is applied to (1) government procurements on the imported services, and (2) the procurements equals or exceeds SAR 100 million, and (3) the party to the Government Procurement Contract is a foreign investor, or a local entity with the products or services ultimately provided by a foreign investor. Should the government procurements meet the minimum level specified in the Economic Participation Program, the foreign investor shall fulfill an economic participation obligation equivalent to 35% of the value of the imported goods and services. Although the documents issued by the LCGPA do not specify that the Economic Participation Program applies to quasi-government entities or state-owned enterprises, the applicability is not ruled out, especially in light of Cabinet Resolution No. 658/1443, which provides that entities wholly owned by the government or more than 50% owned shall prioritize local content and small and medium-sized enterprises in procurement to promote local economic development.
  3. Qualified Activities : The economic participation commitments made by foreign investors shall meet the following conditions: The value of the economic participation commitment contract shall equal or exceed 35% of the Government Procurement Contract (referred to as the Economic Participation Amount). This amount is negotiated between the foreign investor and the government, but shall not be less than 35% in general.The calculation method: Economic Participation Amount = Value of qualified activities * valuation factor. Qualified activities refer to:
    • Technology Transfer :Valuation factor 0.5-3. Transfer of technology from an obligor (namely the foreign investor) to the local beneficiary. The transfer of technology includes the transfer of technical tools and techniques as well as training and technical assistance related to the technology to the local beneficiary by the obligor. The technology transfer can also include the implementation of the technology to make it accessible by the local beneficiary.
    • Knowledge transfer :Valuation factor 0.5-2. Knowledge transfer refers to the transfer of technical know-how from an obligor to the local beneficiary. Knowledge transfer is a dynamic process that refers to all activities and mechanisms of interaction that promote the dissemination, adoption, and implementation of the new skill by the local beneficiary. It includes the transfer of drawings or documents associated with specific knowledge and providing training either within or outside Saudi Arabia.
    • Export promotion :Valuation factor 0.5-3. Purchasing local goods and services by foreign companies for export and launching new markets for national products to enter global supply chains.
    • Investment :Valuation factor 1-3. Through capital injection dedicated to establishing, expanding, or upgrading a manufacturing or service facility, Joint venture or an entity in Saudi Arabia. It includes two aspects: either fulfilling investment commitments under the Government Procurement Contract or making investments outside of that contract, or promoting the export of products related to that investment.
    • Research and Development :Valuation factor 3. Conducting applied research according to a structured framework to find a solution to a specific problem or to develop a new product, which is carried out within the Saudi Arabia to meet the needs of national strategic sectors.
    • Localization : Valuation factor 0.5-2. Supporting local beneficiaries to establish new services or manufacturing capabilities within their service portfolio. This can be achieved through transfer of manuals, tools and document, training or establishment of dedicated programs which focus on performance improvement and optimization of operations of local services or manufacturing capabilities.
    • Subcontracting : Valuation factor 1. Purchasing local products and services from a local company as part of a commercial agreement between the local beneficiary and the obligor.
It should be noted that the valuation factors of the qualified activities fluctuate, as there are several sub-projects under each qualified activity, and their importance or contribution to local economic development varies. LCGPA may add to the above valuation factors between +0.5 and +1, but not more than +4 in total.

Key Considerations for Investors

When carrying out qualified activities under the Economic Participation Policy, investor shall comply with the following rules:
  1. Causality : All qualified activities shall be directly linked to the Government Procurement Contract. should be related to the primary contract. For instance, in the 2011 Haramain High Speed Rail project, the winning bidder, a Spanish company with the support of King Abdullah University of Science and Technology, committed to establishing a specialized training center to train Saudi graduates in the railway industry.
  2. Sustainability : Each qualified activity shall be economically and operationally sustainable even after the completion of Economic Participation Commitment Contract.
  3. Subcontracting and Responsibility : Foreign investors that are obligated to fulfill economic participation commitment shall be solely responsible for their fulfillment, and the subcontracting does not constitute an exemption from responsibility.
  4. The Valuation Factor of Qualified Activities : Due to the differing valuation factors of the qualified activities and their sub-projects, qualified activities affect the investment amount. For example, if the Government Procurement Contract is valued at SAR 1 billion and the investor makes a 37.5% (above 35%) economic participation commitment to win the bid, the Economic Participation Commitment Contract shall be valued at SAR 375 million. If the investor opts to an eligible research and development activity with a valuation factor of 3, the concrete monetary investment required in such a case is SAR 125 million instead of SAR 375 million.
  5. Timeline : Investors shall fulfill their economic participation commitments within five years and may submit the required documentation in the sixth year. Although the compliance period is five years, specific annual milestones shall be met from the date of the economic participation commitment.
    • Annual Performance (percentage) for the first year: 10%
    • Annual Performance (percentage) for the second year: 20%
    • Annual Performance (percentage) for the third year: 40%
    • Annual Performance (percentage) for the fourth year: 70%
    • Annual Performance (percentage) for the fifth year: 100%

Incentives and Penalties

The incentives and penalties related to the Economic Participation Program are somewhat vague as LCGPA has not specified them.
  1. Incentives : If an investor successfully fulfills his economic participation commitment, LCGPA will provide additional Economic Participation Amounts that can be used for future government procurements. However, this additional amount is non-transferable and shall be used within five years. If the investor uses the additional Economic Participation Amount to wholly fulfill their economic participation commitment for future projects, he shall obtain approval from LCGPA.
  2. Penalties : In practice, penalties for failing to meet the Economic Participation Program requirements include, but are not limited to:
    • Prohibition from Government Procurement :Investors may be banned from participating in future government procurements. This disqualifies them from bidding.
    • Fines for Non-Compliance : Generally, government tender and procurement documents specify economic participation requirements. Failure to meet these requirements may result in fines, which may vary depending on the employer.

Contracting and Compliance Process

  1. Submission of Economic Participation Commitment and Proposal: Investors shall submit their commitment and proposal during the bidding process.
  2. LCGPA Assessment
  3. Concluding the Contract: The Economic Participation Commitment Contract should be concluded prior to or simultaneously with the Government Procurement Contract.
  4. Performance Guarantee: Investors shall submit the performance guarantee of 15% of the value of the Economic Participation Commitment Contract within 30 days of concluding the contract.
  5. Compliance: Investors shall fulfill their commitments within five years. During this period, they are obligated to report their performance, including but not limited to:

    • Semi-annual reports.
    • Annual meeting with LCGPA.
    • Requesting LCGPA’s approval for any delays with justification and explanation.
  6. Verification : After verifying and assessing the investor’s performance and compliance, LCGPA will return the performance guarantee.

Conclusion

Although the Saudi government has introduced the Economic Participation Program, several ambiguities remain. For instance, it is unclear whether the Economic Participation Program applies to quasi-government entities or state-owned enterprises. It is also unclear whether investors shall submit audited reports when submitting required documentation. Further clarification is needed on the penalties.

Overall, the Economic Participation Program may be unfamiliar to investors. The Abdulaziz Bin Ali Law Firm, as a local Saudi firm with extensive project experience in the engineering sector, can provide guidance to investors.

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