COMMERCE AMENDMENT BILL 2018

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1 COMMERCE AMENDMENT BILL 2018 SUBMISSION TO THE TRANSPORT & INFRASTRUCTURE COMMITTEE OVERVIEW OF SUBMISSION Airlines, airports and the aviation sector more broadly provide vital services to the New Zealand community and are key drivers of New Zealand s economy. Airlines for Australia & New Zealand (A4ANZ) believes that in order to ensure that this vital sector is efficient, sustainable, and continues to foster innovation, there needs to be appropriate airport behaviour and operations, and efficient access to domestic airport infrastructure. There is a growing body of evidence clearly showing that under the current light-handed regulatory system, the major airports in New Zealand have been able to exercise their market power to extract excessive profits from airport users, without demonstrable improvements in quality or efficiency. These excessive profits have come at a cost to the New Zealand community, both financially and through lost opportunities for improving the quality and efficiency of airport services. Clearly, more effective regulatory pressure is required to prevent excessive profits by airports and return more value to consumers and the economy. A4ANZ supports the Government s Commerce Amendment Bill 2018 and welcomes the opportunity to make a submission to the Transport & Infrastructure Committee. A4ANZ s submission on the Bill pertains only to Airport Services; we have not made commentary regarding sections of the Bill which deal with market studies, or enforceable undertakings. A4ANZ would welcome the opportunity to appear before the Transport and Infrastructure Committee the provide further commentary and evidence in support of this submission. ABOUT AIRLINES FOR AUSTRALIA & NEW ZEALAND A4ANZ is an industry group, established in 2017 to represent airlines based in Australia and New Zealand, including: Air New Zealand, QANTAS, Virgin Australia, Regional Express (REX), Jetstar and Tigerair. Member-funded and representing international, domestic, regional, full service and lowcost carriers, A4ANZ advocates on key public policy issues relevant to airline operations, including efficient access to domestic airport infrastructure. The A4ANZ Board identified at the time of the organisation s formation that one of its highest priority issues was ensuring that the regulatory and pricing environment for monopoly airports: Encourages competition and innovation; More accurately reflects cost inputs; Accurately reflects a reasonable and fair return on assets; Keeps growth at reasonable not exponential rates; Supports investment and maintenance of infrastructure that is fit for purpose, efficient and timely; and Maintains accessible airfares for consumers across all areas of Australia and New Zealand. These principles are the framework for our submission to the Transport & Infrastructure Committee.

2 CURRENT SYSTEM OFFERS NO PROTECTION FOR AIRPORT USERS There is compelling evidence to show that the major airports in New Zealand have historically set prices that are designed to target large profits but are not in the long-term interest of consumers. Auckland Airport provides a clear case study of how this practice has continued over time. Promised capital investment projects, planned since 2011, are yet to commence, and the Commerce Commission s review of the airport s current approach to price setting highlights concerns that the airport operators are targeting excessive profits. 1 A4ANZ shares this concern. Independent analysis by Frontier Economics found that the total value of excess returns to Auckland and Wellington airports (across all airport operations) since privatisation is more than $3.6 billion and $400 million, respectively (in 2017 dollars). 2 Margin data from Frontier s analysis of New Zealand Airports supports these central findings and demonstrates that New Zealand airports are earning far higher margins than comparable airports, as can be seen in the graph below. EBITDA * measures the cash-generating performance of business. High EBITDA margins are indicative of market power being exercised these comparisons demonstrate the extraordinarily high profits of Auckland and Wellington airports, compared to airports of a similar magnitude that may have less market power, face increased competition or are subject to regulation. In fact, Auckland Airport has the second highest margin of all the international airports in the cohort second only to Sydney Airport, which also operates under a light-handed monitoring regime. 3 While Christchurch Airport was not included in this comparison, it similarly occupies a monopoly position in the New Zealand domestic airport market. 100% 73% 72% 70% 68% 67% 64% 60% 60% 56% 54% 53% 52% 51% 50% 90% 82% 79% 80% 75% 50% 44% 40% 40% 35% 30% 30% 27% 20% 10% 0% Sydney Auckland Melbourne Brisbane Wellington Hong Kong Average EBITDA margins, international Perth Vancouver Washington Dulles Source: Frontier Economics Results represent data from financial years. Oslo Copenhagen ADP (Group) Average non NZ/Australian Singapore Zurich London-Gatwick Amsterdam Vienna Dublin (DAA Group) Seoul Frontier also calculated EBIT margins for the same airports to further assess whether differences in EBITDA margins could be due to different stages of the investment cycle (i.e. high investment * Earnings before interest, tax, depreciation and amortisation (EBITDA) margins provide an indication of the cash-earning potential of a business. Christchurch Airport was not included in this comparison as it has not been wholly privatised, unlike all the other airports in the cohort. 2

3 leading to high capital charges). It was apparent from those data that the EBIT margins at Auckland and Wellington airports of 63% and 57% respectively, are extraordinarily high by international standards (an average 28 per cent). 4 These data provide a clear depiction of not only the ability of New Zealand airports to use their monopoly position to earn excessive profits, but the demonstrable proof that they have been doing so in the absence of a regulatory threat. A growth trend that began over a decade ago and which not only shows no sign of stopping, but is increasing. By contrast, in the competitive airline market, airfares have been kept low - and declining - over the same period. A4ANZ is not a lone voice in suggesting that the New Zealand community and economy more broadly could benefit from a change in the regulatory settings for airports, to mimic the effects of a competitive market. A4ANZ members are committed to building, maintaining and improving positive, constructive commercial relationships with airports; with a view to seeing airports, and the whole aviation sector prosper. Clearly, however, more must be done to protect airport users from the market power exerted by monopoly airport operators. It is not only in the airlines interests, but also in their passengers interests, as well as the Government s and New Zealand economy s interests for this to occur. THE COMMERCE AMENDMENT BILL COULD BE STRENGTHENED A4ANZ congratulates the Government on the introduction of the Commerce Amendment Bill 2018, and believes that it is a necessary and timely piece of legislation. While A4ANZ supports the intent of this Bill, we believe that the proposed changes do not go far enough to address the problems outlined in this submission. Under the current light-handed regulatory system, the major airports in New Zealand have clearly been able to exercise their market power to extract excessive profits from airport users. These excessive profits have come at a cost to the New Zealand community, both financially and through lost opportunities for improving the quality and efficiency of airport services. It is a fact that an airport or indeed any business with market power has the ability to sustain prices for its services above efficient costs or deliver a poor quality of service. To comprehensively address the issue of airport monopolies and market power driving excessive charges, a multi-faceted approach involving industry engagement and consultation is required. While A4ANZ appreciates the consultation that has been undertaken thus far, including the opportunity provided by this submission, consideration must be given to how this consultative approach carries through once the Act is amended. In the section that follows, we highlight the specific parts of the Bill that could be strengthened. We have done this with an objective of ensuring that all airport users not just airlines - can play an integral part in the proposed process for assessing the effectiveness of the information disclosure requirements. Given that market power manifests in a range of ways beyond profitability, A4ANZ believes that there must also be clear pathways available for airport users to provide input into determining the most appropriate regulatory solution if when the current regulatory model is found to be ineffective. 3

4 INFORMATION DISCLOSURE HAS NOT BEEN EFFECTIVE Comments on PART 2, Specified Airport Services In the proposed new Section 53B, Effect of being subject to information disclosure regulation, the amendment to be inserted includes the following: To avoid doubt, the Commission may, as part of a summary and analysis, include an analysis of how effective the information disclosure requirements imposed on the goods or services are in achieving the purpose of this Part. A4ANZ believes that to ensure that the Bill is effective as possible, the Commission must be required to assess whether the current regulation is working. A4ANZ suggests that the Commission assess the effectiveness of the regulatory regime after each airport price-setting event. We contend, however, that there is ample evidence to allow an assessment to be undertaken immediately. Perhaps most importantly, a key consideration is the parameters by which the Commission might assess the effectiveness of the regulatory regime (for example terms and conditions of access for users, quality, and efficiency), and the abilities they have if any to address any failings. These parameters need to be determined through consultation with the users of the airport infrastructure. New Zealand s approach to regulation of its major airports is a factor in the overall costs borne by travellers and airlines overall. The current method of regulating airports in New Zealand by information disclosure, is light-handed and intended to be a deterrent regime. However, to act as an adequate deterrent, such a regime relies on the following: 1. An ability to identify, demonstrate and measure misconduct i.e. An ability to adequately monitor outcomes / behaviour Clarity around what outcomes represent evidence of misconduct 2. A credible threat of effective punishment / penalties: Penalties that are suitably high and certain to act as a discouragement Penalties are not perceived as avoidable i.e. firms must not be judgement proof for example, too big to fail; OR 3. Regulatory constraint on the exercise of market power A4ANZ believes that the Commission would find that the current information disclosure regime has been ineffective in constraining the major New Zealand airports from exercising their monopoly power to target excessive profits. As outlined earlier in this submission, independent analysis from Frontier Economics confirms that earnings at New Zealand airports are excessive, with profit margins significantly higher in some cases more than double those of other airports around the world operating in competitive markets or with greater regulation. CREATING A CREDIBLE REGULATORY THREAT Comments on Subpart 11, Airport Services A4ANZ welcomes the proposed measures in this Bill and believes that the amendments detailed in the new Subpart 11, Airport Services, are an important first step to create a credible regulatory threat to encourage airports to act in the best interest of their consumers. As noted within the explanatory notes to the Bill, the current Act does not provide a specified process for imposing additional regulation if information disclosure is found to be ineffective. While 4

5 the amendments proposed allow for a truncated inquiry process to investigate the need for further regulation, A4ANZ contends that there exists already a very strong case for greater regulation, with the excessive profitability of the airports a clear demonstration of market power. While A4ANZ broadly supports the intent of the new proposed Subpart 11 Airport Services as drafted, we wish to draw the Committee s attention to Section 56G, Commission inquiry. As noted in this section, there are several potential approaches to addressing the problems created by the current regulatory environment. International evidence suggests that the most effective regulatory solution and the one that is most likely to result in genuine commercial negotiations between airlines and airports to effect fair outcomes for airport users, is a negotiate-arbitrate model. A4ANZ therefore supports this type of regulation being imposed ahead of the other options. Greater oversight by the regulator to encourage and, where required, force constructive, commercial engagement is needed to minimise the negative impact of the airports monopoly powers. The threat of regulation by the Commission acting as an arbitrator would result in a genuine commercial negotiation, greater investment by airlines and improved efficiency in the allocation of resources. Importantly, international experience suggests that concerns about invoking a system of independent dispute resolution including regarding the costs - are unfounded, and in fact would take the current light-handed regulatory model forward. 5 MAKING BEST USE OF A NEGOTIATE-ARBITRATE PROVISION While negotiate-arbitrate regulation would see the Commerce Commission acting as an arbitrator if the parties could not reach agreement, the form this arbitration takes is an important consideration. Traditional arbitration leads the arbitrator to generally award its own determination which may or may not be a compromise between the parties' final positions. However, this process has the potential to incentivise gaming of the negotiate/arbitrate process with little incentive for either party to negotiate a reasonable outcome. It can, as has been noted previously, also become costly. Hence, A4ANZ is proposing the Government give formal consideration to "final offer arbitration", a method commonly used in various sectors in Canada and the United States. Using this method, a dispute between two parties is resolved by an arbitrator choosing between final offers of settlement made by each party to the dispute. With the arbitrator selecting one party s final position (or parts of each party s final position) without the possibility of compromise or variation, the risk of arbitration is raised and therefore, increases the incentives for the parties to bargain and negotiate on reasonable terms prior to the regulator's involvement. In other words, creating a highly credible threat of intervention. The use of final offer arbitration in Canada is acknowledged to have been effective in fostering a more competitive negotiating environment. 6 Furthermore, international evidence has shown that the existence of final offer arbitration as a method used by a regulator has the effect of obviating the arbitration process altogether. 7 In Australia, the Australian Competition and Consumer Commission (ACCC) have previously noted, Practical experience including in the airport industry itself when Sydney Airport domestic services were declared has shown that parties greatly prefer to reach commercial agreements rather than fall back on ACCC or any other arbitration. 8 5

6 In New Zealand, the adoption of final offer arbitration would be unlikely to require legislative direction if this Bill passes, and could be recommended by the Commerce Commission in the undertaking of its Section 56H 2(a)(b)(c) requirements. The obvious other benefit of the final offer arbitration model proposed, is that the benefits of imposing this type of regulation would invariably outweigh the cost of imposing this type of regulation given that, as highlighted above, this particular method generally has the effect of parties effectively negotiating to reach agreement, thereby not requiring involvement of the arbitrator. This approach would not only bring New Zealand into line with what is regarded as a best-practice approach, it would give effect to the provision for negotiate-arbitrate that already exists in the legislation, but without requiring a potentially complex process of investigation and exploration of alternative regulatory models. 9 CONCLUDING COMMENTS A4ANZ supports the Government s Commerce Amendment Bill 2018 and thanks the Transport & Infrastructure Committee for the opportunity to make a submission on this important piece of legislation. Here, we summarise the key points outlined in the submission. A4ANZ members are committed to building, maintaining and improving positive, constructive commercial relationships with airports; with a view to seeing airports, and the whole aviation sector prosper. It is not only in the airlines interests, but also in their passengers interests, as well as the Government s and New Zealand economy s interests for this to occur. A4ANZ believes that major airports in New Zealand have set prices that are not in the long-term interest of consumers, and more must be done to protect airport users from the market power exerted by these monopoly airports. New Zealand s approach to regulation of its major airports is a factor in the overall costs borne by travelers and airlines overall. The current method of regulating airports in New Zealand by information disclosure, is light-handed and intended to be a deterrent regime. However, it has clearly not been effective at deterring airports from exercising their market power. A4ANZ believes that in order to ensure that the Bill is effective as possible, the Commission must be required to assess whether the current regulation is working. A4ANZ suggests that the Commission assess the effectiveness of the regulatory regime after each airport price-setting event, but contends that there is ample evidence for this assessment to be undertaken immediately. A4ANZ believes that the most effective regulatory solution and the one that is most likely to result in genuine commercial negotiations between airlines and airports to effect fair outcomes for airport users, is a negotiate-arbitrate model, using final offer arbitration. A4ANZ supports this type of regulation being imposed. A4ANZ would welcome the opportunity to further discuss in person the issues addressed in this submission, with the Transport and Infrastructure Committee. 6

7 A4ANZ CONTACT Dr Alison Roberts Chief Executive Officer E: W: 1 Commerce Commission Review of Auckland International Airport s Pricing Decisions & Expected Performance (July 2017 June 2022), 2 Frontier Economics The performance of airports in New Zealand. Report prepared for A4ANZ. 3 Airlines for Australia and New Zealand The performance and impact of Australia s airports since privatisation. 4 Ibid. 5 Stephen C Littlechild Australian airport regulation: exploring the frontier. 6 InterVISTAS Consulting Inc. 2014, Issues Regarding Regulation of New Zealand s Gateway Airports. 7 Ibid. 8 Murray Clemens Final Offer Arbitration: Baseball, Boxcars and Beyond. 9 Stephen Gifford, 2014, Best Practice in Economic Regulation: Lessons from the UK ICAO Global Aviation Cooperation Symposium 7