Brexit: Is a bespoke deal for aviation on the cards?

The June referendum on British membership of the European Union sent airline shares tumbling while profit warnings from BA, Ryanair and others seemed to portend a few years of volatility and uncertainty. EasyJet has even mooted moving its headquarters to the continent. Much will depend on whether Britain retains access to the European Common Aviation Area (ECAA) – the basis of so much of the industry’s success over the last 20 years.  But with the political situation deteriorating, is a bespoke deal for aviation a real possibility?

The Ishka view is that yes, it is. The aim for the majority in the UK aviation industry is for a deal that is as close as possible to the status quo and minimises disruption. Such optimism is not entirely misplaced because aviation is a unique sector, that doesn’t have WTO rules to fall back on and both parties have a mutual interest in resolving.  Continued access to the EU internal market in aviation can be achieved by remaining a member of the ECAA, as Iceland and Norway are.  Reaching an agreement in this space is likely to be the least difficult of all the upcoming trade negotiation, if and when, Article 50 is triggered.

 

Aviation is a unique industry

 

“Aviation has always been treated differently from other industries in global trade,” says Barry Humphreys a consultant BKH Aviation. “It has its own set of regulations and was never a part of WTO agreements.”  In fact, a bespoke deal is the only option because there are no WTO standards to fall back on.

“Aviation is unlike other industries because it is a key enabler for other businesses and an infrastructure asset it its own right,” Brian Pearce, IATA’s chief economist told a UK House of Lords subcommittee.  Globalised supply chains mean than manufacturers rely on air freight for just-in-time delivery of high value components.  In 2010, carmakers Nissan and BMW were forced to temporarily halt production when ash from a volcanic eruption in Iceland grounded thousands of flights across Europe and cut their supply lines. The implication is that the effect of Britain leaving the EU internal aviation market would hurt more than just the tourism industry.

EasyJet is betting on a favourable deal because its management believe that all parties have a mutual interest in accessing each other’s markets. Airlines 4 Europe, which includes EasyJet, Air France KLM, Lufthansa and others, has been actively campaigning for access to British and European airspace.

 

Priorities: what does a satisfactory deal require?

 

The industry wide aim is for “a deal that is as close as possible to the status quo,” says Pearce. What is almost certain, is that this will require access to the internal market via the European Common Aviation Area (ECAA). The free internal market was finalised in 1996 and has since been extended to non-EU members including Switzerland, Norway, Morocco, Israel and the Western Balkan countries and now covers 36 countries and 500 million people. The ECAA is the basis for the explosive growth of LCCS in the last two decades. Average fares are down by 40% in real terms since 1996 and the number of routes have increased by 180%, both inter and intra-European. Exclusion threatens the core business model of LCCs and others.

The second priority is to safeguard or renegotiate third-country agreements such as the 2007 EU-US Open Skies Agreement.  The agreement allows any US and EU airline to fly between any point in the European Union and the United States. It also grants US airlines to the right to operate within Europe. One consequence of this was to open London Heathrow to full competition.

In 2015, passengers travelling to and from Europe accounted for 52% of total UK traffic, rising to 56% is the ECAA is included. However, if passenger traffic from the US and Canada is also included, it accounts for a full two-thirds of passengers passing through the UK. Exclusion is therefore a threat to Heathrow’s hub status. The UK must renegotiate an informal agreement or, more likely, reach a new arrangement via continued membership of the ECAA – like Iceland and Norway – or via a separate bilateral deal with the US.

 

Hurdles on the Horizon

 

Access to ECAA is not guaranteed although non-European counties such as Iceland are members. Like those members, the UK would have to agree to abide by all future EU regulations on issues such as passenger safety and consumer protection, without having any direct input into how those regulations are formed.  While this may be politically unpalatable to those who voted for Brexit, it does not appear to be an insurmountable hurdle and could easily be incorporated into UK law.

However, each non-EU country has used a slightly different legal route to membership of the ECAA.  In Norway’s case, it is membership of the European Economic Area (EEA). And in the case of Switzerland, a series of seven cooperation agreement of which aviation is one.  But crucially, both entail the free movement of labour which the UK government has indicated it is not willing to accept.

Ownership and Control. At present, Community carriers must be majority owned and controlled by European Union nationals under EU regulation 1008. Post-Brexit, a UK carrier would have the freedom to restrict this further or liberalise these rules.  However, some UK registered airlines, such as Thomas Cook, are majority owned by European citizens.  Likewise, IAG, is the majority owner of British Airways and Iberia, two flag carriers.

It would be in the UK’s interest to preserve the current arrangement although there is some uncertainty over how this would be done. If ownership and control regulations were to come into effect, it could result in significant company restructurings and in some instances the ceding of routes to competitors.  EasyJet may sidestep this issue by moving its headquarters to Europe.  But long-haul carriers on the continent, would lose out if, for instance, the UK-US market was closed to them.  Operators may have to hive off national minority owned subsidiaries just to retain market access.

However, the law firm, Clyde&Co believes that in the case of IAG – the company most likely to be affected – the way the firm is structured protects it against changes in ownership and control rules. BA would continue to be majority owned and effectively controlled by UK nationals and Iberia similarly by Spanish nationals.

Protectionism may benefit European carriers more than UK ones.  Reciprocity in trade deals is what makes them mutually beneficial, however not all trade partners are equal.  For instance, UK traffic accounts for 50% of traffic out of Cyprus and Ireland.  But in the case of France and Germany it is less than 10% each. Given that UK-based low cost carriers have wreaked havoc on the profits of European legacy carriers in last 20 years, some EU airlines may find that it is not in their competitive interest to allow the UK into the ECAA.

Spain could veto deal over Gibraltar. Since a Brexit deal will require the consent of all 28 member states, Spain has the potential to hold up negotiations over the territorial status of Gibraltar. An ongoing dispute from April this year over whether the territory's airport should be included in EU legislation on aviation is already blocking progress on matters from passenger rights to ground-handling liberalisation.  However, once article 50 has been invoked the stakes will be much higher than they were before the vote.  Spain is particularly reliant on inbound UK tourism which accounts for 20% of all Spanish passenger traffic.

 

The Ishka View

 

If the UK leaves the European Union without reaching a satisfactory agreement, or even an interim agreement, there will be severe disruption and uncertainly across the industry. Even temporary loss of traffic rights for UK airlines could prove ruinous. But of all the forthcoming trade negotiations, aviation is probably the easiest to resolve. In relative terms, it is a “low-hanging fruit,” according to Pearce. The earlier an agreement can be reached, the smoother the transition will be. Airlines plan their business up to 18 months in advance, so early warning of upcoming risks will be well received.  Two priorities for the UK aviation sector will be to keep access to the EU’s internal market in aviation and reaching a satisfactory agreement with the Unites States to secure Heathrow’s hub status.  The greatest sticking point is likely to be over the free movement of labour.  It is not yet clear whether the EU will demand this a concession from the UK in aviation negotiations.  By contrast it is almost guaranteed to be a core debating point over access to the common market for the UK’s manufacturing and financial services sectors.

 

Photo Source: flickr.com/photos/garryknight

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