REVIEW OF THE CAA S STATEMENT OF POLICIES ON ROUTE AND AIR TRANSPORT LICENSING

Transcription

1 REVIEW OF THE CAA S STATEMENT OF POLICIES ON ROUTE AND AIR TRANSPORT LICENSING SUMMARY 1. The CAA proposes to revise its Statement of Policies on Route and Air Transport Licensing. A draft revised Statement is at Attachment A. This Statement applies only to routes outside the European Economic Area (EEA). The CAA s starting point is that aviation on these routes should be placed on the same footing as other industries, as is now the case within the European single aviation market. This should be achieved through the liberalisation of international aviation markets and the application of normal competition law. It is against these objectives that the CAA believes the future licensing regime should be designed. 2. The 1993 Statement signalled strongly that the CAA would expect to intervene only where bilateral constraints impeded competition or in order to deal with anti-competitive behaviour. But to the extent that competition problems arise, the competition authorities are now better placed to deal with such cases using the Competition Act Thus the use of the CAA s route licensing powers for such purposes should be seen as redundant. There are otherwise no good grounds for constraining competition, and this points to a fully liberal approach to the grant of licences to serve points outside the EEA, just as now applies to routes within the EEA. Indeed, whereas prior to 1993 the majority of licensing cases which came to public hearing involved applications for Route Licences, this has changed dramatically. The licensing system is now used almost exclusively for the purpose of allocating scarce bilateral capacity at the request of the Secretary of State, and this issue therefore constitutes a substantial element in this policy review. 3. The main proposals in this review are as follows: To liberalise further the licensing regime by: a) granting global Route Licences in place of individual Route Licences; and b) reducing to two the number of classes of Route Licence - one for passenger services and one for cargo and mail only services. To establish a clear economic framework for the allocation of scarce bilateral capacity. This would comprise a two-stage approach: a) a competition test to establish whether awarding the capacity to an airline would enable it to gain or strengthen a position of dominance such as might allow it to exploit its position by raising prices or reducing quality without being disciplined by the market; b) the allocation of capacity so as to maximise economic efficiency. That allegations of anti-competitive behaviour are best addressed under normal competition law rather than through the licensing system. INTRODUCTION 4. The CAA s Statement of Policies was last revised in It was reviewed at a time when the third stage of liberalisation in Europe had only just come into effect. This involved the abolition of the CAA s route licensing powers in respect of intra-eu routes. We have now had eight years experience of the liberalised market in Europe. Aviation within the single European market has operated on essentially the same basis as other industries, with bilateral restrictions eliminated and normal competition policy engaged. Aviation outside the EEA, on the other hand, still operates under the constraints of the bilateral system, with

2 competition in many markets limited by government-imposed restrictions on numbers of airlines, route frequency and capacity and fares. LICENSING POLICY 5. Under the present system of route licensing, any carrier wishing to operate to a point outside the EEA must hold, in addition to an EU Operating Licence, a Route Licence. Under existing Regulations, all applications for Route Licences are published in the CAA s Official Record and 21 days are allowed for objections by competitors or other interested parties. If a valid objection is made, an application may be taken to a public hearing. Although the CAA s policy is to license competing services liberally, the system itself provides an opportunity for incumbent airlines at least to delay competitive entry by objecting to Route Licence applications by competitors. Given the CAA s basic stance towards airline competition, and from the perspective of seeking to place international aviation on the same footing as other industries, the system of route licensing looks increasingly anachronistic. 6. A fully liberal approach to the grant of licences would be given effect by granting global licences in place of the present individual Route Licences. The CAA has already been prepared to grant world-wide licences to charter carriers, which generally operate outside the terms of bilateral air services agreements. This was originally in response to an application by Britannia in In its decision the CAA stated that granting the application was entirely consistent with its policy of licensing charter services liberally and would further the CAA s aim of reducing the regulatory burden on the industry by eliminating unnecessary restrictions. It would also bring the licensing arrangements for charter services to points outside the EEA more closely into line with those for intra EEA services. Holders of worldwide charter licences are therefore free to serve any route in the world without further approval from the CAA. They do however have to secure permission from the receiving country. 7. If this approach were extended to scheduled services, any carrier in possession of a world-wide scheduled licence and seeking to operate a new international scheduled route would, of course, need authorisation, usually in the form of a permit, from the receiving country. Normally this would require formal designation by the DETR under the relevant bilateral air services agreement. 8. At one level, a change to such a global licensing system would merely recognise the reality that the right to object to new licence applications is now very rarely exercised. At the same time, such a system would anyway still allow the CAA to propose, or other airlines to apply, to vary the licence of another carrier. In particular, this would remain the mechanism for the CAA to implement scarce capacity decisions at the route level. But the introduction of world-wide licences would also send a clear signal that the CAA would pursue as liberal a licensing policy as possible. In doing so it should help to discourage airlines from seeking through the licensing process to restrict either competitive entry to a route or the expansion of existing competition. ALLOCATION OF SCARCE BILATERAL CAPACITY 9. With such a liberal approach to route licensing in place, it seems to the CAA that the only circumstances in which it might be called upon to intervene through the route licensing system would be where UK airlines were prevented by bilateral constraints from operating all of the capacity they planned to provide. Capacity of course may extend beyond frequencies and could encompass seat numbers, overflight rights, or even scarce code share rights. Designation rights may also be scarce, although this seems likely to be the subject only of either pure substitution or allocation of unused capacity. 2

3 10. The CAA has made clear in successive scarce capacity decisions its regret that continuing bilateral restrictions still require it on occasion to allocate capacity between UK airlines. However, where this is unavoidable, the basic issue facing the CAA is which of two proposals is likely to produce the greater benefits for users of air services. In deciding between competing proposals, therefore, the CAA is often presented with arguments on two levels. Each airline will usually argue that there are particular aspects of its proposal that will provide greater benefits to users. Examples might be greater aircraft capacity, superior quality of in-flight service, more convenient schedule, or innovative fares. Alongside these arguments, which are essentially about short-run user benefits, the airlines will also often deploy arguments about industry and market structure. In cases between BA and Virgin, for example, BA will tend to argue that airline competition is increasingly between global networks, and that strengthening BA s position in the global aviation market will be to the benefit of UK users. Virgin, on the other hand, which at the route level will often be either a new entrant or at a frequency disadvantage relative to BA, will tend to argue the need to promote competition on the particular route, or at the level of the total UK market for air transport services. 11. Experience over recent years suggests that the current Statement of Policies does not offer clear enough guidance on how the various elements should be weighed. In particular, a better economic framework is needed so as to enable the airlines to address their evidence to best meet the CAA s approach. This would make it easier to adopt a more analytical approach that might enable respective benefits to be quantified. In practice, other than rare cases where short run user benefits point overwhelmingly in favour of one proposal, decisions under the existing framework have often concluded that the two carriers offer good quality products and that, on balance, there is little to choose between them. In such circumstances the decision then often turns largely or wholly on issues of competition and industry structure. 12. In dealing with cases of scarce capacity, therefore, the CAA proposes to establish a clear economic framework within which allocation decisions will be taken. The CAA believes that its overarching objective in such cases should be to maximise economic efficiency, i.e. to maximise the size of the national pie or GNP. It sees this as the best means of ensuring that the long term interests of users are met. However, this objective might be threatened if the allocation of scarce rights were to result in the creation or strengthening of a dominant position. The CAA therefore proposes to adopt an approach which would separate issues of industry structure and competition from those of user benefits. This would be achieved by employing a two-stage approach. First, a competition test would be used to assess the impact on competition arising from the award of scarce capacity. Second an analysis of consumer benefits and, where possible, economic costs would be used to determine how the scarce capacity should be allocated so as to maximise economic efficiency. This approach is explained in more detail below, and the CAA s proposed methodology as regards the assessment of user benefits is set out in Attachment B. (Not attached - available upon request.) Competition test 13. Unlike most other firms wishing to acquire valuable rights or assets in a market where dominance may be in issue for example The Airline Group s bid for NATS airlines are not subject to any formal competition clearance prior to being awarded scarce bilateral capacity by the CAA. However, the effects of an award of capacity on competition are particularly important given the near absolute barriers to entry that (by definition) exist where issues of scarce bilateral capacity arise. 3

4 14. The CAA therefore proposes to incorporate into its procedure for allocating scarce capacity a competition test in order to identify airlines that have, or would thereby acquire or strengthen, a position of dominance in the relevant market and where it is not demonstrated that there would be countervailing benefits to offset the detriment to competition. As a first stage in any allocation decision, the CAA will wish to establish whether awarding the capacity to an airline would enable it to gain or strengthen a position of dominance that would allow it to exploit its position by raising prices or reducing quality without being disciplined by the market. 15. The steps of such a test would be consistent with those generally adopted by competition authorities in assessing mergers. In practice it would involve the following stages. Step 1: Market Definition The starting point in any type of competition analysis is the definition of the relevant market. The purpose of defining a market is to provide a framework within which the structural implications of the capacity allocation can be analysed. The relevant markets are those in which competition may be affected by the allocation being considered and encompass both a geographical and product dimension. Consistent with the approach widely adopted by competition authorities, the boundaries of the product and geographical markets will be identified by considering the extent to which consumers are able to substitute other products, or across geographical regions, when they are given the incentive to do so by a change in the relative price of the product concerned. The CAA also recognises that at times it may be necessary to expand the market definition process to include a time element so as to take into account likely future developments in the market such as the prospects for further liberalisation. Step 2: Structure of the Market The existing market structure and level of competition already in the market are also important in analysing the implications of particular allocation decisions. A thorough understanding of the present participants, market structure and the level of competition is essential for gauging the structural and competitive impact of the granting of further rights to a particular carrier. In particular, the CAA will take full account of the market share and strength of competition arising from foreign third/fourth, fifth and sixth freedom carriers operating in the market. So, for instance, an allocation of capacity to an incumbent UK airline may not raise significant competition concerns if in fact the relevant market is wider than simply the individual route and/or the airline would face effective competition from foreign carriers. Step 3: Is a position of dominance created or strengthened? Economic analysis would then provide a coherent framework for an assessment of the market power able to be exercised by an applicant airline both with and without the additional capacity. In general, the higher the share of the relevant market possessed by an airline seeking scarce capacity, the greater the likelihood that a position of dominance would be created or strengthened. However, the CAA recognises that market shares are insufficient in themselves to establish that market power exists. Other factors, such as the extent of other barriers to market entry and whether there is joint or collective dominance will also be relevant. 4

5 Step 4: Assessing any Benefits Finally, the CAA recognises the importance of any such competition test being flexible enough to cater for cases where, notwithstanding the creation or strengthening of a dominant position, it is right to weigh any offsetting benefits to consumers against any detriment arising from changes to market concentration. Such factors are frequently considered by competition authorities in assessing proposed mergers. Potential efficiency gains include the rationalisation of resources, the exploitation of economies of scale and scope, network benefits and other synergies. It is easy to envisage, for example, that an airline seeking to increase frequency on a route where it currently operates a less than daily service may be able to offer users an improved schedule. It may also enable the airline to reduce its costs through improved utilisation of aircraft and other assets, although where such improvements are claimed, the extent to which consumers would share in the benefits within a reasonable period would be considered. 16. In the event that it was concluded that an award of capacity to a particular carrier would create or strengthen a dominant position to the detriment of competition in the market, it might be possible also for the CAA to take into account any undertakings that the airline might be prepared to offer in order to address this concern. Economic efficiency 17. Second, the scarce capacity would be allocated so as to maximise economic efficiency. In theory, such an outcome might be best secured by auctioning the rights, but such an approach would require legislation and would raise a variety of issues requiring careful consideration, particularly the problem that dominant incumbents would have strong incentives to out-bid entrants to protect their position. The most complete administrative procedure would be to conduct a full economic analysis of the likely costs and benefits of each application. In essence this would be an attempt, on an administrative basis, to elicit the same revenue and cost information that airlines would use in preparing their bids for an auction and to allocate capacity accordingly. The capacity would be awarded to the airline that provided the highest level of consumer surplus at the lowest resource cost. 18. This approach has some practical difficulties. A cost/benefit analysis of this type would need to draw on detailed economic cost data which airlines may not always be in a position to supply. Such data differs from the accounting data which most airlines produce. The asymmetry of information problem remains as airlines have relatively weak incentives to provide the CAA with the complete picture of their cost structures, and the incumbency bias remains. Finally there is the additional issue of administrative costs for the CAA. This technique requires significant resources in part because there would only be limited time available to carry out the analysis. Nevertheless the CAA will aim, wherever possible, to obtain and analyse airlines economic costs, but in practice the extent to which it will be able to place reliance upon these will depend on the quality of the data available. 19. The airline with the lower costs will have greater scope for offering lower prices and thereby producing greater consumer surplus so any significant difference in costs should be captured in the assessment of consumer benefits where the information and resource problems of comparison may be smaller. In theory consumer benefits (or welfare) are measured by the consumer surplus metric defined as the excess of the consumer s valuation of a product over the actual price paid. In this context, the consumer surplus of a particular airline s proposal would be determined by: the quantity of seats the airline expects to sell in each class; the (weighted) average price in each class; 5

6 the value which users in each sub-market are likely to place on the airline's product. 20. In scarce capacity hearings to date significant time and evidence has been devoted to discussion of the relative quality of each airline s product. This has embraced numerous aspects of service, ranging from relatively objective factors such as capacity, frequency, timings, and price, through to more subjective factors such as quality of in-flight service. The consumer surplus approach described above should capture all of the relevant objective criteria. These factors should all contribute ultimately towards determining the shape of the demand function facing each airline in each relevant sub-market. Airlines have a strong private incentive (profit) to respond most appropriately to consumer preferences both now and in the future, and this would be best reflected in their passenger and yield forecasts. The CAA would not therefore expect to place weight on subjective evidence about quality of service, such as market research or travel industry awards. 21. By awarding the capacity to the airline that offered the largest increase in consumer surplus, taking other criteria into account where appropriate, it should be possible to obtain an outcome as close to a competitive equilibrium as possible within the capacity restraint. 22. In summary, the aim would always be to conduct a full cost/benefit analysis wherever possible, although the extent to which this can be achieved would depend on the quality of the economic cost data. In practice, it is likely that an analysis of consumer benefits only would often be a more practicable, yet sufficiently sophisticated, alternative means of attempting to quantify the benefits of an airline s proposal to use the scarce capacity. Attachment B sets out the methodology the CAA proposes to adopt in assessing consumer benefits. ABUSE OF A DOMINANT POSITION Anti-Competitive Behaviour 23. Prior to liberalisation in Europe in 1993, the CAA, using its powers under the Civil Aviation Act 1982, was seen by the Government as providing the principal bulwark against anti-competitive behaviour in the UK air transport industry 1. It is notable however that, despite there being a section in the current Statement of Policies dealing specifically with the CAA s policy in this respect, the licensing system has not been used since 1993 to deal with a single case of alleged anti-competitive behaviour. There may be a number of reasons for this, but the fact that the licensing system does not provide any strong deterrent nor offer appropriate remedies to complainants is likely to be one of them. The CAA s powers are limited to adding a condition to a UK airline s licence designed to prevent it from engaging in a specified form of conduct, for example operating more than a certain level of frequency on a particular route, or perhaps offering fares below a certain level. 24. The CAA has long advocated that international aviation should be exposed to normal competition law. The practical mechanisms for applying EC competition law in aviation which were introduced in applied only to the intra-european international air transport market. And moreover, air services were only partially subject to UK competition legislation. Domestic air services and, since 1985, international charter services were covered by the Competition Act 1980, under which the Director General of Fair Trading (DGFT) was able to investigate conduct which might amount to anti-competitive behaviour. However, international scheduled air services were excluded from the scope of the 1980 Act. Since 1997 aviation within the UK s domestic market has come within the practical application of 1 White Paper on Airline Competition Policy, Cmnd 9366, October Council Regulation (EEC) 3975/87 of 14 December 1987 laying down the procedure for the application of the rules of competition to undertakings in the air transport sector. 6

7 the EU s competition rules. And since the Competition Act 1998 entered into force on 1 March 2000, UK competition law has applied to international aviation, including on routes outside the EU. 25. Under the Competition Act 1998, there are no exclusions for any part of the air transport sector and responsibility for applying and enforcing the provisions of the Act rests with the DGFT. The following prohibitions therefore now apply to the airline sector: i) agreements between undertakings which prevent, restrict or distort competition and which may affect trade within the United Kingdom (the Chapter I prohibition); and ii) conduct by undertakings which amounts to the abuse of a dominant position in a market and which may affect trade within the United Kingdom (the Chapter II prohibition). 26. The Competition Act provides the Office of Fair Trading with strong powers, e.g. the power to impose financial penalties of up to 10% of the turnover of an undertaking in the UK; and third parties who consider they have suffered loss as a result of any unlawful agreement or conduct have a claim for damages in the courts. Indeed in view of the stronger remedies available under the Competition Act, and the deficiencies in the 1982 Act as a means of dealing with anti-competitive behaviour as described above, it seems even less likely that a UK airline would bring an allegation of anti-competitive behaviour against another UK airline to the CAA under the licensing system. 27. The Draft Statement therefore makes clear that the CAA now regards competition authorities as best placed to deal with allegations of anti-competitive behaviour. However, in the unlikely event that an airline were to make an application to vary the licence of another airline as a means of remedying alleged anti-competitive behaviour, the CAA would be obliged to hear the case. In those circumstances the CAA would adopt, so far as possible consistent with its duties, the principles and analytical methods of normal competition policy. Air Fares 28. The CAA believes that where competition is attainable it is preferable to and thus eliminates any need for regulation. Thus as aviation markets outside the EEA are liberalised in the way they have been within the EEA, with government-imposed restrictions being eliminated, any remaining fares regulation should be removed. However, where competition in such aviation markets remains subject to significant bilateral constraints, it may sometimes be necessary to safeguard users against any resulting exploitation of market power. 29. Where the CAA has intervened in fares on bilaterally constrained routes outside the EEA, it has generally done so only with respect to the lowest fully-flexible fare offered by UK airlines and not on the thinner international routes. It does not propose any change in this approach. LICENSING MECHANISMS 30. The CAA has evolved over a long period a liberal approach to route licensing, and the proposals set out in this consultation paper represent a further step in that direction. It intends to take this opportunity to do a complete reappraisal of the licensing framework, which still incorporates many elements that were designed as adjuncts to a more interventionist system. The restrictions on licences set out in Series 1 are long, complex and inappropriate to a more permissive approach. 7

8 31. Many of the restrictive elements have been retained to secure the acceptability by foreign governments of services by UK airlines for example, charter services are defined in a particular way so as to differentiate the services that will normally fall outside bilateral agreements. The CAA believes that this is not the best approach for the future, and that licences granted by the CAA should incorporate only those restrictions which the CAA itself considers necessary to secure its policy objectives or to serve practical needs. It will follow that an airline may hold a licence that in theory permits a wide range of services, but that in reality it will not be able to operate all those services even if it wished to do so: in order to operate particular routes it will additionally have to secure the appropriate designation by DETR or the appropriate authorisation from the receiving country. Exempt Services 32. Currently, airlines that hold Operating Licences do not require any further authorisation for services within the United Kingdom (excluding the Channel Islands and the Isle of Man) or within the EEA; these services are permitted by the EC Market Access Regulation (EEC 2408/92), whatever the nature of the services. The CAA has also exempted all sole use flights under current instruments and this means that a Route Licence is not required for air taxi work to or from the Channel Islands or the Isle of Man, or for UK Operating Licence holders to do helicopter flights to offshore oil and gas installations. However, a Route Licence is still required for flights other than sole use flights to or from the Channel Islands and the Isle of Man. 33. The CAA can see no reason of policy that any authorisation beyond an Operating Licence should be required for services to the Channel Islands and the Isle of Man; even if these points were included in a global Route Licence, there might still be an entry barrier for small operators who may not normally need to hold Route Licences but who might wish to start services at short notice. It proposes therefore to grant an exemption to all UK Operating Licence holders which will have the effect of granting them access to the Channel Islands, the Isle of Man and the UK North Sea equivalent to their access to the EEA. This will greatly simplify the general exemption, since many of the fairly complex exempt categories, and exclusions from them, will fall. Licences 34. Route Licences granted by the CAA currently fall into eight categories. The licences themselves are not necessarily complex, but they incorporate by reference lengthy schedules defining categories of passengers that may be carried and a range of conditions, some of which reflect circumstances that no longer apply. The CAA believes that this structure can be greatly simplified. 35. Its proposal is that it will grant two classes of licence in future, one for passenger flights and one for cargo and mail only. In outline: A passenger licence would permit the carriage of passengers, cargo and/or mail anywhere in the world (except in the area permitted by Regulation EEC 2408/92 and the area exempted by the CAA). It is envisaged that it would permit seats to be sold either direct to the public or through a charterer, and that it would not contain any requirement for a minimum proportion of capacity to be made available directly to the public rather than through an intermediary, nor would it contain any definitions of categories of passenger that might be carried. 8

9 It would contain the following conditions: A tariff condition, which would apply only to particular categories of fares sold direct to the public. This would require fares in the specified categories to be filed with the CAA and not to be sold if the CAA had disapproved them. A condition requiring the licence holder to make clear to each passenger who was intended to be the operator of the flight. The CAA believes that this is relevant consumer information and that the existing condition should be retained. A cargo licence would permit the carriage of cargo and/or mail, plus cargo attendants who are carried in that capacity, anywhere in the world (except in the area permitted by Regulation EEC 2408/92 and the area exempted by the CAA) with space made available either direct to the public or through a charterer. It would not contain any further conditions. Air Transport Licences 36. Air Transport Licences are held by airlines that fall within the CAA s licensing remit but are based outside the EEA; in practice, this means airlines based in the Channel Islands and the Isle of Man. These airlines are not eligible to hold Operating Licences and the licences (Air Transport Licences) they hold have to incorporate mechanisms that are dealt with through either Operating Licences or the Licensing of Air Carriers Regulations 1992 for UK-based airlines. This means that they will necessarily be subject to rather more conditions than Route Licences, covering for example matters like insurance and liability. 37. Nevertheless, the licensing structure for Air Transport Licence holders is capable of some simplification. A basic Air Transport Licence could replicate many of the features of the Operating Licence system by permitting access to the whole of the EEA plus the Channel Islands, the Isle of Man and offshore oil and gas installations, irrespective of the type of service operated; it would facilitate entry for small carriers if there were separate Type A and Type B categories as there are for Operating Licences. For any Air Transport Licence holders who wanted access to the wider range of services that would be reflected in Route Licences for Operating Licence holders, the basic licence could be varied by the addition of a passenger or cargo schedule on the lines of those in Route Licences. As with Route Licences, the possession of an Air Transport Licence would not necessarily allow the holder access to all the services theoretically permitted, and with Air Transport Licences that would be true of many services within the basic area as well as those in the Route Licence schedule: designations or permits will remain necessary for services within the EEA but outside the UK, the Channel Islands and the Isle of Man. 38. Air Transport Licences would contain the following conditions: conditions reflecting the requirements imposed on Operating Licence holders by Regulation 11 of the Licensing of Air Carriers Regulations 1992, relating respectively to not making available seats to an intermediary unless the intermediary complies with the Civil Aviation (Air Travel Organisers Licensing) Regulations 1995 and to ensuring that passengers carried on football flights hold match tickets; a condition replicating the requirement on Operating Licence holders to comply in relation to passenger liability with the Carriage by Air Act and Carriage by Air (Application of Provisions) Order as amended by the Air Carrier Liability Order 1998; a condition similar to that in Route Licences requiring the licence holder to make clear to each passenger who would be the operator of the flight etc; and a tariff condition, similar to that in Route Licences. 9

10 Processes of Change 39. The CAA will propose to revoke all existing Route Licences and Air Transport Licences, and to refuse all outstanding applications for these. At the same time, it will invite applications for new forms of licences which will at that point be fully defined, together with the conditions attached to them. 40. It is accepted that some airlines with limited networks may not wish to have a fully global licence. It will be possible to apply for a more limited version in cases where that is more appropriate. PROCEDURES 41. A key part of ensuring the effectiveness of the scarce capacity process is the procedure adopted. The CAA is open to comments or suggestions from consultees about how the current procedure might be improved, particularly in view of the policy approach now being proposed. At present, airlines supply their submissions shortly before the hearing, the parties make oral submissions at the hearing, before the CAA publishes a written decision. Inevitably, due to the relatively low costs associated with appeal, the losing party often appeals to the Secretary of State. We set out below some suggestions as to how the procedures may be improved and would welcome comments. Draft decision followed by a hearing 42. One mechanism able to improve the hearing process (used by several competition authorities in the context of merger applications) would be for the CAA to publish a paper prior to the hearing indicating to the parties how it viewed the case. Such a paper, which would include the CAA s competition and cost/benefit analyses, would be based upon the parties full written submissions supplied to the CAA including the possibility of signed witness statements. There is a range of possibilities here. As a minimum, the CAA could publish a Statement of Key Issues, which would be designed to focus the parties attention at the hearing to what the CAA believed to be the relevant issues. At the other extreme, the CAA could publish a full draft decision, with reasons. An approach falling between these two might involve publication of preliminary conclusions, but also identifying key questions or areas of uncertainty. The intention behind each of these approaches would be to assist the hearing itself. 43. At the hearing, the parties would be invited to provide further submissions. Such submissions would be likely to focus primarily on those issues identified in advance by the CAA, and, in the case of preliminary conclusions or a draft decision, on the areas which were most disputed. But they may also cover any issue which the CAA had identified as important but which the airline may have not adequately addressed in its original submissions. Witnesses who had submitted written evidence to the CAA would also have to make themselves available for cross-examination at the hearing. 44. The CAA would then make its final assessment of the case, taking into account issues raised at the hearing and any submissions made since its pre-hearing paper was issued, and issue a final decision. Benefits 45. The main benefit of a pre-hearing paper of some description is that the CAA would identify the issues it considered to be important in a particular case and would thereby allow airlines to focus their oral submissions at the hearing. One consequence of such an approach is that the total time taken to reach a decision may be lengthened because of the 10

11 need to prepare the pre-hearing paper. However, offsetting this, hearing times would be likely to be shortened as a result of submissions and cross-examination being more targeted. Legislation 46. Any amendments to the procedural aspects of a hearing are likely to require amendments to the Civil Aviation Authority Regulations

12 DRAFT STATEMENT OF POLICIES ATTACHMENT A Part 1 GENERAL PRINCIPLES, OBJECTIVES AND APPROACH 1. The Authority s general objectives are set out in Section 4(1) of the Civil Aviation Act 1982, as amended by the Licensing of Air Carriers Regulations 1992, ( the Act ) and its general duties in relation to air transport and route licensing functions are set out in Section 68 of the Act. 2. The Authority believes that the interests of users will be best served if airlines are free to operate air services in competition with one another according to their commercial judgement, subject only to the application of normal competition policy. To this end, it believes that the long term interests of users would be best served by a full liberalisation of international aviation markets, involving the removal of all bilateral restrictions so that the airline industry can compete on the same footing as other industries. The Authority will aim to make the UK s international aviation markets as contestable as possible by eliminating all unnecessary restrictions within its licensing and other regulatory processes. Licensing Policy 3. Consistent with its aim of making the UK s international aviation markets as contestable as possible, the Authority sees no good grounds for constraining competition through the licensing process other than where government-imposed bilateral restrictions prevent British airlines from operating all of the services they plan to provide. This points towards a fully liberal approach to the grant of licences to serve points outside the EU, just as now applies to routes within the EU. The Authority will therefore be prepared to grant global Route Licences which permit the combination of any points world-wide. 4. Many international routes are subject to bilateral restrictions on designation, frequency or capacity which would prevent a British airline from exercising its licence freely. However, subject to advice on the bilateral position from the Department of the Environment, Transport and the Regions on individual applications, the Authority would not regard the absence of the necessary bilateral rights as good grounds for refusing to grant a licence application. If a problem of scarce bilateral capacity should arise as a consequence of the Authority granting an application, then this would be most appropriately addressed through specific procedures established to allocate such scarce rights. Allocation of Scarce Capacity 5. Where bilateral restrictions prevent British airlines from operating all of the services they plan to provide, the Authority will allocate scarce capacity between competing British airlines. In such cases, the Authority s overarching objective will be to maximise economic efficiency. However, the Authority will aim to ensure that this objective is not threatened by the creation or strengthening of a dominant position. It will therefore adopt a two-stage approach in order to deal separately with issues of industry structure and competition on the one hand and of economic efficiency on the other. The Authority will employ a standard competition test in order to establish whether an award of scarce capacity would, or would be likely to, create or strengthen a dominant position. In the event of such a finding, the Authority will consider whether or not any resulting detriments to competition would be offset by other benefits. 12

13 6. The second stage will be for the Authority to consider how the scarce rights should be allocated so as to maximise economic efficiency. The most comprehensive approach would be to conduct a full economic analysis of the costs and benefits that would accrue to airlines and users, with capacity being awarded to the airline that provided the highest level of consumer benefit at the lowest resource cost. In practice, given the difficulties which might arise in identifying airlines true economic costs, decisions may need to be based primarily on analysis of the consumer benefits each would deliver. 7. In a limited number of cases competition may be precluded, or unattainable on acceptable terms, because of bilateral constraints. In these circumstances, the Authority will be ready to consider substituting one carrier for another, in whole or in part, so as to safeguard or further the interests of users. It will expect to do so sparingly, and only when to do so would manifestly enhance the achievement of the objectives of the Act. It will take into account the length of time the incumbent has had to establish itself on the route and the degree of commitment it has shown in serving it. It will pay particular attention to the quality of service (capacity, seat availability, frequency, timings and price) offered by the newcomer relative to the incumbent s established standard. Abuse of a Dominant Position Anti-competitive behaviour 8. The Authority believes that allegations of anti-competitive behaviour are best addressed through the application of normal competition law. With the entry into force of the Competition Act 1998, UK competition law now applies to the UK aviation market, including routes to and from points outside the European Union. 9. However, in the event that the Authority is called upon to apply its regulatory powers to a case involving allegations of anti-competitive behaviour, it will adopt the principles of normal competition policy for the purposes of discharging its statutory duties. It will therefore seek first to establish whether the airline whose behaviour is the subject of the complaint is dominant in a relevant market. If so, it will then seek to establish whether its behaviour constitutes an abuse of that dominant position. Air Fares 10. The Authority s preference is for airlines to be free to set their own fares with a minimum of regulatory intervention. In markets where competition between airlines is unconstrained by government-imposed barriers to entry, the Authority will therefore not expect to intervene in airlines fares proposals. 11. However, the presence of government-imposed bilateral constraints can confer market power on airlines. Therefore, the Authority will be prepared to consider intervening where, after taking into account the relevant market, the degree of bilateral constraints, the availability of different fare products and other factors including route profitability, it concludes that airlines possess and exploit market power to the disadvantage of users. In such circumstances, it will be concerned to ensure that all those who require it on international scheduled services have available basic on-demand travel. This will provide at least a commensurate level of seat access, freedom to change reservations and appropriate in-flight facilities, at a price reasonably related to the cost of its provision, including a return on capital. Where this exists the Authority will not expect to intervene in the prices or conditions of other products solely to protect users from being overcharged. 13

14 Part 2 OTHER POLICIES Leasing of foreign-registered aircraft 12. The Authority believes that airlines should be free to choose the aircraft they employ and, subject to Article 8.3 of Council Regulation (EEC) 2407/92, will advocate a liberal policy when advising the Department of the Environment, Transport and the Regions on applications for the use of aircraft not registered in the United Kingdom. If, however, the applicant fails to demonstrate a genuine commercial requirement for the aircraft within its own operations the Authority will advise that the application would be more appropriately dealt with under the Department s policies on fifth freedom flights. Part 3 APPLICATION OF POLICY 13. The Authority will reach its decisions on the basis of the facts and circumstances of each particular case. It may need occasionally to depart from its policies in unforeseen circumstances or where the Act requires. Part 4 COMING INTO EFFECT 14. This Statement of Policies will take effect on x xxx 200x and the Statement of Policies established by the Authority on 25 May 1993 (CAP 620) will cease to have effect on the same day. 14

15 ATTACHMENT B THE BENEFITS TO PASSENGERS OF COMPETING AIR SERVICE PROPOSALS Introduction 1 As indicated in the consultation paper, this attachment describes the general approach which the CAA will adopt in estimating the benefits to users of competing airline proposals for the use of scarce bilateral capacity. It builds on the same budgetary information that airlines would use in preparing their applications. The intention is that the resultant estimates qualified as necessary will aid decision-making by providing a systematic way of identifying consumer benefits, estimating their possible order of magnitude and, hence, isolating the most important elements in each applicant s proposal. Although the paper attempts to set out the methodology as fully as possible, it may be that unforeseen circumstances will arise in the course of a specific case and it may therefore be necessary to make adjustments or additions to the methodology to meet those new circumstances. In addition, it will be open to the parties to a case to propose adjustments or additions. 2 An air route will serve a number of different markets. The proposals may have different effects on these markets depending on the state of competition within those markets. The less competitive a market currently is, the greater the impact of a new service on consumer benefits is likely to be. There is thus a link between the first stage of the framework set out in the consultation paper, the competition filter, and the second stage, the evaluation of the proposals. The markets that are identified in the first stage as being relevant to competition considerations are those which will tend to figure most prominently in the evaluation of user benefits. Types of Hearing 3 Scarce capacity hearings can fall into a number of different categories. First, two or more airlines may apply to operate the scarce capacity on the same route on which there are already direct services 3. This category can be subdivided depending on whether any of the applicants already operates on the route or not. Second, the applicants may wish to use the scarce capacity on the same route but on one which will receive direct service for the first time. Third, the scarce capacity is to be used on different routes. This case too may be subdivided since, for example, one airline may wish to use the scarce capacity to supplement a existing service whereas another wishes to start a new route. 4 Each of the airline proposals which form the basis for the hearing falls therefore into four possible cases: A. An airline wishes to add frequency to a route it alone already serves B. An airline wishes to add frequency to a route it already serves in competition with another carrier(s) C. An airline wishes to enter a route which other airlines currently serve D. An airline wishes to start a route which no airline serves 3 Bilateral capacity limits are often set on the basis of the overall frequency which each country s airline may operate on all the routes linking the country-pair but often there is only one route of commercial interest to UK airlines. 15

16 Passenger Types 5 The passengers affected by a new air service between cities X and Y can be classified as follows 4 : 1) Passengers in the XY OD market 2) Passengers in OD markets WY where the routeing W-X-Y is a feasible choice 3) Passengers in OD markets XV where the routeing X-Y-V is a feasible choice 4) Passengers in OD markets WV where the routeing W-X-Y-V is a feasible choice 6 The classes above may be sub-divided by journey purpose (business, VFR, leisure) and by residence (UK-originating or foreign-originating). User Benefits Existing Passengers 7 Air travel is a derived demand and the passenger does not normally attach a value to the air service itself but to carrying out business or leisure activities at his or her destination. The basic need of a passenger could be defined as the wish to arrive at his or her chosen destination at a particular time and user benefits from air travel are essentially reductions in cost, either in terms of lower prices or less inconvenience. There are circumstances in which the value of the trip could be increased but these are probably rare 5 and here the concentration is on cost reduction. 8 The non-fare costs to a passenger in a given OD market might reduce because A greater flight frequency provides a more convenient departure time and thus reduces schedule waiting time costs A quicker flight reduces travel time costs A more direct flight will reduce the inconvenience of changing aircraft and possibly airlines The new service leaves from or arrives at a more accessible departure and/or arrival airport There is greater in-flight comfort There is an increased airline choice There is a greater chance of getting a seat on the flight of his or her choice 9 In principle these factors will be captured in the demand curve for a particular service. If that demand curve were known, then the benefits of a service could be deduced using the fare levels on offer and the shape of the demand curve in the relevant area as encapsulated in the demand elasticity. In the absence of this information a more pragmatic approach will be adopted, as outlined below. 4 The four categories are sometimes referred to as GG (gateway-to-gateway), BG (behind point-togateway), GB (gateway-to-beyond point) and BB (behind point-to-beyond point) respectively. 5 A new service might allow a holiday to the passenger s most desired destination which would not have been possible before because of leave restrictions etc. More commonly, the ability to gain loyalty rewards could be regarded as enhancing the trip value. 16