The Yellow Brick Road to Brexit. An Occasional Paper. October Chris Smith Aviation Consultancy Limited

Transcription

1 Chris Smith Aviation Consultancy Limited The Yellow Brick Road to Brexit An Occasional Paper October 2016 Chris Smith Aviation Consultancy Limited is a company registered in England and Wales. Company Registration Number: VAT Number: GB

2 The Yellow Brick Road to Brexit Introduction The decision of the British people to leave the European Union came as a surprise to many, and an initial reaction may well have been that all would be well in the land of air transport and few difficulties would be encountered on the Yellow Brick Road to Brexit. In general, the air transport industry has coped well with the implementation of the Single Market, and has benefitted from good growth, far greater mobility and improved standards. So, let s retain this, right? Not necessarily, unfortunately, because of the Negotiator s first rule: Nothing is Agreed until Everything is Agreed, and the possibility that the UK might be able to exercise some leverage through the air transport sector: the industry has always been influenced by politics and why should that change now? This paper explores these thoughts in more detail. The starting point is a discussion of three distinct areas where EU membership has influenced the development of the air transport industry: Traffic rights with EU states; Traffic rights with non-eu states; and Legislation supporting market development and liberalisation. The paper then explores how the status quo might be best preserved, before discussing how the UK might exercise some leverage if negotiations either simply in the air transport sphere or more likely in a wider Brexit context do not go smoothly. Finally, it touches on some of the potential impacts of Brexit, and the airlines and airports that might be most affected. As this paper is aimed at an international audience (the outcome will have impacts far and wide), it starts with an observation on the Referendum. The Referendum The Referendum on 23 June asked a simple Remain or Leave question, as it probably had to do. However, this has created a problem as no single reason to Leave (or Remain) was given, and the certainty is that there were a number of reasons why people voted to leave. As Leave was not the policy of an individual organisation with a manifesto setting out the objectives of a Leave vote, the UK Government has to decide what it should seek to achieve in the Brexit negotiations; what elements are non-negotiable; and in which areas might there be compromises. Opinion Polls and Focus Groups have tended to suggest that the majority of Leave voters opted this way in order to be able to control immigration into the UK. Free movement of people is one of the core principles of the Single European Market, and while the UK may wish to retain the other elements of the Single Market (viz. free movement of goods and services), the other EU Member States have shown no willingness in the initial skirmishes to allow this compromise. 28 October

3 Traffic Rights with EU States Prior to the adoption of the 3 rd Package in 1992, air services within the EU were governed by traditional Air Service Agreements (ASAs) negotiated on a bilateral basis between sovereign states. These agreements had been liberalised in certain ways and under certain conditions by the 1 st and 2 nd packages, while a few EU member states, including the UK, Ireland and the Netherlands, negotiated some very liberal bilaterals. However, with the full implementation of the 3 rd Package in 1995 some aspects such as operation on routes internal to a single Member State were phased in any airline owned and effectively controlled by EU nationals had the right to operate between any two Member State airports and to base aircraft in any EU state, subject to obtaining any airport slots necessary. A number of new routes, operation on which had been previously thwarted by a lack of traffic rights between the airports concerned, were quickly introduced. Low Cost Carriers (LCCs) led by Ryanair and easyjet, expanded their operations reasonably rapidly, sometimes providing very low cost capacity on trunk routes (stimulating traffic in the process), sometimes identifying new opportunities and creating new needs to travel, and sometimes cannibalising charter traffic from the north of Europe to popular Mediterranean resorts. In the case of Ryanair, much of its growth from the late 1990s onwards for several years was from London Stansted, taking advantage of the EU ownership rules (it was and remains an Irish registered airline) of the 3 rd Package to launch extensive services out of the UK, as well as a few domestic operations within the UK. Since then, both it and easyjet have expanded materially in continental Europe with extensive (and largely non-overlapping) networks of focus cities and mini-bases. Wizz Air has joined them with a significant route network emanating from central and eastern Europe. Norwegian has also taken advantage of the European Common Aviation Area (ECAA), agreed in 2006, to expand its services, including the establishment of a base for both short and long haul services at Gatwick. These developments and many others have greatly increased social mobility within the EU, allowing EU nationals to move freely to find employment opportunities and visit cities and areas that many would not have dreamed of 20 years ago. Traffic Rights with non-eu States The European Union has the responsibility for negotiating air services agreements with non- EU Member States on behalf of the whole community. In practice, this competence is being exercised only gradually, and many air services between individual EU Member States and non-eu (and non-ecaa) states are still subject to bilateral ASAs between the two states concerned. For example, flights between China and the UK are still governed by a bilateral between the two countries. 28 October

4 The European Commission, as the agency responsible for executing this competence, has concentrated on reaching agreements with more important non-eu states, based on either size or proximity to the EU, with a key criterion being that they were prepared to negotiate. One of the first multinational ASAs was with the United States, which was signed in 2007, and the first phase became effective in It is interesting to note that one of the major objectives of the USA in the negotiations was to gain unrestricted legal access to Heathrow: the previous Bermuda 2 Agreement restricted Heathrow access to just two US airlines. An agreement was signed with the United Arab Emirates in 2007, and one with Canada in December 2009, at which time all existing bilateral agreements Canada had with individual Member States were suspended or superseded. The Commission has also negotiated with the Maghreb States of North Africa and states in the Middle East. Supporting Legislation In addition to legislation related to traffic rights, other EU Regulations and Directives 1 impact the air transport industry. Several of these are industry specific, although others have wider application. The first group includes on the commercial side 2 the Slot Allocation Regulation, the Ground Handling Directive, the Airport Charges Directive, and the more controversial Air Passenger Rights legislation covering, inter alia, compensation for delayed or cancelled flights. Legislation to prevent bias in Computer Reservation Systems seems to have become almost redundant with the advance of the Internet. Many of the earlier pieces of legislation were to ensure that a level playing field existed for fair competition throughout Europe. They also frequently included clauses granting fair treatment to airlines outside the EU provided that EU airlines received reciprocal treatment in the third country. Legislation covering a wider landscape than just air transport includes provisions on State Aid, and this has played a significant role in shaping the structure of the airline industry in the EU, and has also in more recent years impacted smaller airports. In general though, the UK has not provided State Aid to the air transport industry, so its primary historic interest has been to ensure competitors to its companies were not being unfairly supported. Another important area of legislation is Emissions Trading, which clearly is an important topic for the air transport industry. Other legislation includes employment law, although the EU Working Time Directive is probably less important to airlines than are industry flight time limitations. This should not be regarded as in any way an exhaustive list of the legislation affecting the air transport industry: that this is the case, is a clear illustration of the very significant effort that will be needed to support a post-brexit world. 1 A Regulation is binding in each EU Member State once enacted at an EU level, while a Directive needs to be adopted by each individual parliament before it gains legal force. 2 There is also a large number of technical regulations relating to safety and security. 28 October

5 Preserving the Status Quo There is no reason to believe that the UK voted to leave the EU because of dissatisfaction with the arrangements governing air transport: while there may have been occasional grumbles about specific issues, the levels of satisfaction of Government, of companies within the industry, and of the wider population utilising the services provided were high. Hence, in an ideal world this would be continued. Figure 1: Status Quo Possibly the easiest way of achieving this would be for the UK to become a member of the European Common Aviation Area. This would allow air services to continue both to operate and to evolve as they have done over the last 20 years. This would apply both within the ECAA and to third countries as and when Open Skies agreements are negotiated by the Commission (assuming that third countries abided by the terms of the agreement and did not seek to delay market entry). Having the UK as one of its negotiating cards might in fact be beneficial to the Commission, as it was in the accord with the USA. Figure 2: Membership of the ECAA The UK would continue to apply industry-specific EU Regulations and Directives as at present. The Slots regulation in essence is a codification of IATA guidelines so the UK would be most unlikely to wish to stray far from these, although given a free rein it might support more explicitly secondary slot sales and explore new monetised approaches to primary slot allocation. The ground handling market is largely open in the UK, so the UK can live with the existing Directive reasonably easily, and do without seeking to exempt London City Airport 28 October

6 from the requirement to appoint a second handler. Economic regulation of airport charges is probably significantly more advanced and longer standing in the UK than would be the case if it relied solely on the Airport Charges Directive. The major loss to the UK would be influence on drafting new air services agreements, supporting legislation and amendments to existing regulations. But that may simply be one of the less tangible costs of Brexit. It is possible of course that the remaining 27 EU Member States will not allow the UK to be a member of the ECAA if the UK prevents free movement of people to and from the future EU. As noted earlier, the ability to control immigration was probably the biggest single reason for the UK population voting to leave the EU, so that the UK Government may well feel that it could not agree to such a condition for membership of the ECAA, any more than it could to remain part of the Single Market (which would be far more valuable to the UK). And, of course, even if ECAA membership were not dependent on such a condition as free movement of people, the UK might find that negotiations on other non-aviation matters were not progressing to its satisfaction, and consequently decided to play hard ball in air transport: nothing is agreed until everything is agreed. The UK s Negotiating Strengths The UK does have a few important cards to play in the air transport area, namely: Imports of Sun and Snow by UK residents, holidaying in their millions in other EU states; Imports of EU houses and associated services by UK nationals choosing to live in other EU countries but supported by wealth created in the UK; and Imports of EU citizens to work in the UK, with some of their earnings being repatriated to their home nations. The UK operates a significant trade deficit in the non-business tourism sector with the EU as a whole, and with all but five individual Member States. The strongest of these cards is the holidays taken in the EU by UK residents, and it is the one which is most dependent on air travel to facilitate it. Grouping together holidays with miscellaneous reasons for travel (covering study, shopping, health, religious and attending sporting events), the UK recorded a deficit in 2015 of GBP 11.6 billion (or 16 billion at the average 2015 exchange rate), the amount by which its residents outspent EU residents visiting the UK for these same reasons. The five countries which benefitted the most were Spain, France, Greece, Portugal and Italy, which in total accounted for 94% of this benefit. 28 October

7 Table 1: Balance of Expenditure 3 on Holidays, Expenditure (GBP millions) Overseas UK Residents in Residents UK Overseas Difference Ratio of UK to Overseas Expenditure % by Air (UK residents) Top 10 Countries Spain 555m 6,020m 5,465m % France 818m 3,006m 2,187m % Greece 96m 1,305m 1,209m % Portugal 69m 1,140m 1,071m % Italy 585m 1,617m 1,032m % Cyprus 46m 378m 332m % Austria 101m 316m 216m % Malta 21m 198m 176m % Netherlands 384m 535m 151m % Hungary 26m 113m 87m % EU Total* 5,171m 16,796m 11,625m % - of which EU15 4,681m 15,330m 10,649m % - of which EU Other 490m 1,466m 976m % *The difference total includes both positive and negative differences Source: CSACL analysis of International Passenger Survey (IPS) data It may be seen that with the exception of France, the majority of UK visitors travel from the UK to each country by air. The UK also has a deficit in the Visiting Friends and Relatives segment, although this is a smaller market. The total UK deficit in 2015 was GBP 513 million (or some 700 million). The countries with the largest deficits are also different, and have a greater representation from the newer members of the EU in Central and Eastern Europe, led by Poland. It is also interesting to note that, typically, significant proportions of the UK residents making the expenditure are actually citizens of the country concerned (e.g. Polish citizens working and resident in the UK but returning for holidays to their home-land represented 86% of UK residents going to Poland). This has been a very tangible trend in most parts of the UK in recent years. 3 Expenditure includes all expenditure in the country being visited but excludes the cost of travel to or from the UK. 28 October

8 Table 2: Balance of Expenditure in VFR Segment, Expenditure (GBP millions) Overseas Residents in UK UK Residents Overseas % of Country Nationals in Visitors from UK % by Air (UK residents) Top 10 Countries Difference Poland 164m 468m 305m 86% 87.0% Romania 77m 178m 102m 89% 83.3% Republic of Ireland 282m 344m 62m 27% 60.4% Lithuania 33m 78m 46m 95% 91.8% Spain 240m 285m 45m 32% 98.6% Portugal 44m 86m 42m 52% 98.8% Hungary 21m 55m 34m 78% 93.3% Italy 129m 160m 31m 58% 92.3% Greece 35m 63m 28m 48% 99.5% Bulgaria 20m 46m 27m 78% 95.9% EU Total* 2,011m 2,524m 513m 52% 77.4% - of which EU15 1,594m 1,528m - 66m 37% 75.4% - of which EU Other 418m 996m 579m 82% 91.4% *The difference total includes both positive and negative differences Source: CSACL analysis of International Passenger Survey data The UK also recorded a deficit on business travel, some GBP 323 million ( 445 million) in In this case, the cause was UK resident business travellers spending about 40% more per night when overseas, than their European contemporaries did when visiting the UK! Overall, the other EU Member States in 2015 benefitted from the discretionary expenditure on holidays, miscellaneous travel reasons and VFR by UK residents of GBP 19.3 billion ( 26.6 billion) at a gross level, and GBP 12.1 billion ( 16.7 billion) net. The gross expenditures represent one component of the economic impact which UK residents made in other EU Member States 4. The difference between gross and net, of course, is the contribution which residents of other EU Member States made to the UK economy. Only five Member States do not have a net benefit from non-business travel with the UK. 4 Foreign citizens working in other countries do of course contribute to their local economies in other ways, but these contributions are not captured in these data. 28 October

9 Table 3: Countries with Positive Balances with UK (non-business Trips) 2015 Country Overseas Residents in UK 2015 Expenditure (GBP millions) UK Residents Overseas Difference Germany 1,041m 599m 422m Sweden 325m 92m 233m Denmark 265m 96m 169m Luxembourg 43m 6m 38m Finland 99m 89m 10m Source: CSACL analysis of International Passenger Survey data These trade balances were of course for 2015, when the average GBP:Euro exchange rate was 1.00 = 1.38, rather than the current rate of around 1.00 = Most economists expect the UK to be poorer than it would otherwise have been when it leaves the EU, so that the economic fundamentals would suggest that expenditure on foreign holidays may be lower in the future. However, the British public has historically attached less importance to economic fundamentals than to a sun-tan! A Different Negotiating Path If the UK does not join the ECAA, then a different arrangement would need to be put in place and in all likelihood a different negotiating path followed. The basic options for relations with EU Member States are either a single multilateral agreement or individual bilateral agreements with each state. For relations with non-eu states, setting in place a framework for the operation of international air services should be relatively straight-forward, as indeed would be appropriate given that the issue was not of the making of these states. The UK could either remove the suspension of a previous bilateral ASA if that were possible, or simply agree, through an Exchange of Notes, temporary permits to all operations to continue until such time as a new ASA could be negotiated. The Notes could acknowledge normal international standards and agree capacity and commercial clauses in line with those currently in use. The situation would though be different for air services to and from other EU and ECAA Member States. Although the EU claims competence in this field and EU Member States are obliged to comply with this competence, it cannot force a third party state, in this case the UK, to negotiate with it. Hence, the UK would have the choice of seeking a multilateral agreement with the ECAA States or pursuing bilateral approaches with each of the states. Multilateral A multilateral agreement with the EU and other members of the ECAA, would be akin to the US-EU Open Skies Agreement. It could be based on the wide range of access and freedoms currently enjoyed by all members of the ECAA. Some attention would need to be paid to airline ownership and control clauses. This would be most likely to affect easyjet which has 28 October

10 a UK Air Operator s Certificate (AOC), and which is the basis of most of its operations within continental Europe 5 : indeed, shortly after the Referendum, easyjet indicated that it was conscious of the potential need to obtain an AOC from one of the other EU Member States. This approach could easily see relatively limited change from the status quo. Figure 3: Multilateral Approach Bilateral The bilateral approach, however, provides the UK with at least a theoretical ability to leverage one of its negotiating cards, namely the imbalance on the non-business travel account. This leverage might be exercised by agreeing temporary permits to operate on those routes which are important to the UK (viz Table 3 above), but perhaps placing a lower priority on reaching any agreements (even temporary permits) on routes/to states which are not to the UK s economic advantage e.g. to holiday resorts (Table 1 countries). Figure 4: Bilateral Approach An obvious consequence of this is that it would be more difficult for UK residents to take foreign holidays and so would be politically unpopular in the UK. Equally though, it would be economically damaging and hence politically unpopular in main resort areas, thereby creating the negotiating leverage. This approach could easily have more material impacts on the air transport and travel industries, as well as on individual countries, with Spain having the most to lose. It would be tragic, however, if a potential negotiating position became the End Game. 5 It also has a Swiss AOC to cover operations from Switzerland which is not a member of the ECAA. 28 October

11 The Negotiations In all probability, negotiations will go to the final minute in March , whichever course is followed, but this would be most problematic if the UK refused to accept a multilateral agreement with the ECAA and opted for bilateral agreements with the 27 EU Member States (and Norway, Iceland and the several Balkan state members of the ECAA). Going down the bilateral route would be more likely to be a signal that overall negotiations were not going well, and hence prediction of the eventual outcome would be more difficult. Problems might not just arise on 1 April 2019, but might be foreseen the previous summer: Governments may warn their air carriers and tour operators that traffic rights should not be assumed after 31 March 2019, so impacting travel in Summer 2019 (even if a deal is done with or without stopping the clock as is quite common). High stakes indeed! Could it happen? is perhaps just as important a question as Would it happen? European history over the last 100 years provides some worrying examples of events that should not have happened but did. While this would not have as calamitous an outcome as some, the economic and social consequences would nonetheless be serious. Potential Consequences A bilateral approach would be more difficult for EU airlines operating into UK from several countries or basing aircraft in UK. The airlines that would be most affected would be Ryanair and Wizz Air, although Norwegian would also need to ensure that its operations were conducted by its recently established UK subsidiary operating with a UK AOC. Table 4: Non-UK Airlines with Substantial Activities from UK Bases, October 2016 Airlines Proportion of Total Network Seats that Depart from the UK Number of Countries Served from UK Ryanair 19% 30 + UK domestic Wizz Air 14% 15 Norwegian* 7% 15 * Data for October 2016 for Norwegian appeared unreliable, so data is for October 2015 Source: CSACL analysis of Flight Global Data The easiest approach would appear to be for both Ryanair and Wizz to also apply for a UK AOC. Qualification requires the UK to be the principal place of business of the airline (so a UK subsidiary would be required), and for services to be operated with UK registered aircraft. Establishment of a UK subsidiary would obviously have various taxation and employment issues, while an ability to exercise UK traffic rights would traditionally require the airline to demonstrate that it was majority owned and effectively controlled by UK nationals, although such requirements have become somewhat blurred in recent years. 6 The UK has indicated that it will trigger the start of the two year Brexit negotiation period no later than 31 March October

12 The majority of UK airlines tend to operate on a point-to-point basis from and to the UK, the exceptions being easyjet, and in some respects British Airways. As noted earlier, easyjet indicated very soon after the Referendum that it was exploring options to establish a legal presence within the EU27 to support its extensive operations there. British Airways is in a more interesting position, being part of IAG, whose other airlines include Iberia and Vueling of Spain, and Aer Lingus of Ireland. However, it should have sufficient flexibility to be able to manage its operations reasonably, provided that non-eu States are prepared to function for a limited period on the basis of Exchanges of Notes. Perhaps the most difficult challenge will be operations to and from Spain, where several significant problems could arise: the possibility of hard negotiation given the importance of UK residents to the Spanish tourism sector, and the perennial question of Gibraltar. Most UK regional airports would suffer if there were traffic right problems to the major holiday resorts in Spain, Greece and Portugal, as these three countries accounted for 37% of their international traffic in In contrast, for the six London area airports, the three countries represented only 16% of international passenger demand. The UK has also seen very significant growth in traffic from Eastern Europe since the major enlargement of the EU to the East in 2004 and Most States joining the EU since then have recorded growth above the average of the longer standing EU states (the EU15), with only two countries (Malta and the Czech Republic) being below the average. While some of this growth will have been associated with UK residents broadening the range of their holiday destinations, the majority of the growth will have been associated with the influx of citizens from the new Member States to live and work in the UK. Indeed, this rapid growth may well have tipped the balance in the Referendum to a Leave vote. Table 5: Passenger Growth Rates to/from UK for States Acceding to the EU in 2004/2005 Passengers at UK Year of Annual Growth since Country Airports, 2015 (x 1,000) Accession Accession Romania 1, % Lithuania % Poland 6, % Latvia % Slovak Republic % Hungary 1, % Estonia % Bulgaria 1, % Slovenia % Malta 1, % Cyprus 2, % Czech Republic 1, % EU15 (ex.uk) 117, % (2004 to 2015) Source: CSACL analysis of UK CAA Airport Statistics 28 October

13 The growth sustained over 10 years in several of these markets has been astonishing, particularly so for Poland given the size of the market: eye-catching growth rates are often associated with very low starting points, but this is not the case for Poland. Figure 5: Traffic Growth between UK and Major Recent Accession States, 2004 to 2015 Source: CSACL analysis of UK CAA Airport Statistics Irrespective of how traffic rights between the EU and the UK are agreed in the future, there must be a high chance of a reduction of air travel between the UK and Eastern Europe in the post-brexit world of the future, as the flow of workers reduces. Indeed, the fall in the Sterling exchange rate to the Euro makes the UK less attractive for migrant workers. The two most vulnerable airports are London Luton and London Stansted, which between them handled more than half of the passengers flying to and from the Eastern European EU Member States from UK airports in 2015 This is potentially more serious for Luton, as these passengers represented some 34% of its total 2015 throughput. 28 October

14 Table 6: UK Airports used by Passengers flying to/from EU States in Eastern Europe, 2015 Airport Passengers to/from Eastern Europe (x 1,000) Percentage of Total Eastern European Passengers Luton 4, % Stansted 3, % Heathrow 1, % Gatwick % Liverpool % Doncaster Sheffield % Total these airports 11, % Other UK airports 3, % Eastern Europe EU Total 14, % Source: CSACL analysis of UK CAA Airport Statistics The largest Eastern European market by far from the UK is that to and from Poland, with services offered from many airports throughout the UK, although again with a concentration on Stansted and Luton. Table 7: UK Airports used by Passengers flying to/from Poland, 2015 Airport Passengers to/from Poland, 2015 (x 1,000) Percentage of Total Polish Passengers Stansted 1, % Luton 1, % Heathrow % Liverpool % Doncaster/Sheffield % East Midlands % Glasgow % Bristol % Edinburgh % Gatwick % Total, these airports 5, % Other airports % Total 6, % Source: CSACL analysis of UK CAA Airport Statistics Conclusions The decision of the British people to leave the European Union has provided the leaders of Europe with a great many challenges. The air transport industry will be only one aspect of the myriad of details to be resolved. There will certainly be a need for some airlines to adjust their corporate structures, and a number of UK airports may well find their passenger numbers lower than they might have been. However, it is perfectly possible for business to continue more or less as normal, albeit on a slightly lower growth trajectory. 28 October

15 It is though equally possible to envisage a future which is subject to a material change and diminution of passenger traffic starting as early as Summer 2018, and in which there is a major dislocation of air services on 1 April 2019 to the very significant detriment of the citizens of the EU and the UK. This could happen if the Brexit negotiations become acrimonious and driven by ideology, dogma, stubbornness and personal advancement, rather than being based on an understanding of the other party s position and concerns, pragmatism and common-sense, and most importantly goodwill. The air transport industry has a vested interest in encouraging the latter framework for the negotiations. It may well be though that in a few years time, the British public will wish that like Dorothy on the Yellow Brick Road, they could wake up and find that the Referendum result had been a bad dream. 28 October