International University of Applied Sciences Bad Honnef Bonn School of Business and Management Bachelor Aviation Management Post-Brexit Scenarios of EU- UK Relationship in Air Traffic Markets Student Number: 3150079 Adolf-Kolping-Straße 10 63303 Dreieich Germany Prof. Dr. Brützel 26.05.2017 1
Table of Content 1. Introduction 2. Table of Content 3. Legal Framework 3.1 Ownership & Traffic Rights 4. Scenarios after the Brexit and their Legal Implications 4.1 ECAA 4.2 Bilateral Agreements 4.3 No Agreement arranged by March 2019 4.4 Effected Stakeholders 4.5 Implications for the European Aviation Industry 5. Economic Implications 5.1 Correlation between Economic Indicators and the Aviation Industry 5.2 Economic Impact for the EU27 6. Conclusion on the Impact on the European Aviation Industry List of Abbreviations European Union = EU United Kingdom = UK Air Service Agreement = ASA European Common Aviation Area = ECAA 2
1. Introduction On June 23 rd, 2016, the UK voted by majority for leaving the EU. The surprising result of the referendum directly hit the UK, the EU as well as the rest of the World with great uncertainty. With Theresa May trigger Article 50 of the Treaty of Lisbon on March 29 th, 2016, a lessening of the uncertainty regarding the future impact of the Brexit is not foreseen at least for the next two years. There are several possible economic scenarios into which the Brexit could develop. To the complete disintegration of the UK from the EU I will refer to as the pessimistic scenario. The UK mostly being integrated into European laws, policies and regulation at the end of the two-year negotiations I will be referred to as an optimistic scenario. Optimistic and pessimistic here refers to the value a scenario brings to major European and British stakeholders of the Industries. The British Government argued that there will rather be a pessimistic Brexit compared to an optimistic Brexit when it comes to the integration of UK laws and regulations into EU laws and regulations. This leaves experts around the world questioning whether these two years of negotiations between the UK and the EU will be sufficient. It is clear however that the Brexit will have short as well as long term consequences for Industries of the UK as well as of the EU. 1 The Aviation Industry is predicted not to be an exception to this case. However, the evaluation of the impact on the Aviation Industry is not an easy task since there are several outcomes and possible scenarios in place. Scenarios of different economic integration of the UK into the EU are necessary to evaluate the short-term impact on the European Economy and how this translates into consequences for the European Aviation Industry. More importantly however is what the European Aviation Industry will face two years down the road. The result of the negotiations between the UK and the EU will unveil whether the European Aviation Industry of today will remain in its structure as if Brexit never happened, or whether effected air carriers will have to completely restructure their identity in order to fit into a future with a full deck of mixed cards. This paper will focus on the implications that can be derived from Brexit on the European Aviation Industry and its stakeholders. However, for argumentation purposes other viewpoints and implications are considered. In order to include all relevant aspects without going beyond the scope of this paper, only key considerations might be described. 1 http://www.ainonline.com/aviation-news/business-aviation/2017-03-04/legal-experts-fear-major-brexitdisruption-aviation 3
2. Table of Content After giving a short introduction into the topic of this paper in chapter one, an outline of contents is provided. This is followed in chapter three with a short display on legal implications. Depending on the level of integration of the British into the European Aviation Industry, different scenarios can occur. The implications of these scenarios differ from optimistic, when taking opinions of major stakeholders of the Aviation Industry, to pessimistic. Several these scenarios are taken into account in chapter four. Which stakeholders of the Aviation Industry are effected and implications on the European Aviation Industry are also discussed in this chapter. Chapter five will give economic impacts of the Brexit and how economic indicators can be used to predict an impact in the Aviation Industry. Findings regarding the economic impact are then combined with the findings of a correlation between economic indicators and the performance of the aviation industry. This is then reflected on the European Aviation Industry. Chapter six will combine the results of chapter three, four and five in order to draw a realistic conclusion to the short as well as long term implications of Brexit on the European Aviation Industry. 3. Legal Framework Until March 2019 the UK will remain being a member of the ECAA. It is important to emphasize that until the leaving process triggered by Article 50 of the treaty of Lisbon is complete, no changes of the legal structure are in place. This allows British air carriers to continue to enjoy the benefits of the ECAA and therefore operate from and to any point in the European Union. The British Aviation Industry enjoys a very liberalized Single European Aviation Market with almost no operational restrictions. This wildly contributed to the rise of the Low-Cost Carriers in Europe many of which have their home base in the UK. 2 One of the most severe legal consequences of the Brexit can be the invalidity of EU Regulation 1008/2008 to British air carriers. This means that air carriers holding an Airline Operating Certificate under the Civil Aviation Authority of the UK will no longer be considered as Community Carriers in legal terms. The determination of this regulation will have an impact on the traffic rights granted to British air carriers. In order to avoid 2 CLYDE&CO, 2016 4
such drastic consequences, the government of the UK is trying to find a suitable compromise between an Integration and Disintegration of the UK in their relations to the European Union. However, major players of the British Aviation Industry are now concerned that there will not be sufficient guidance by the government concerning aviation matters. Without having a clear picture of the legal outcome, air carriers like EasyJet and many more now have to make decisions effecting their future strategy. 3 3.1 Ownership & Traffic Rights In Regulation 1008/2008, it is stated that in order to characterize an air carrier as a Community Carrier, it has to be owned as well as effectively controlled by a EU Member State and/or nationals of EU Member States. 4 The implications of the origin of the Airline Operating Certificate and the Ownership are essential to understand in order to evaluate which air carriers are directly affected by the Brexit. 5 Traffic Rights and Freedoms of the Air are permissions to operate within an aviation market. The higher the grade of freedom granted to an air carrier, the more liberal operations are possible. The Single European Aviation Market is characterized by its liberal and non-discriminatory nature. Every European air carrier is granted to operate up to the 9 th Freedom of the Air. This greatly contributed to the development of the market as well to increased competition and lower ticket prices. Regulation 1008/2008 gives a hint which air carriers might find themselves in a need for a new corporate structure in order to continue to enjoy the traffic rights stated above. 4. Scenarios after the Brexit Within roughly the next two years the British and European Government have to decide how to integrate the British into the European Aviation Market. Possible scenarios vary from nearly unchanged conditions to a full disintegration of the British Aviation Industry in case there will be no agreement created by March 2019. There are numerous implications that come with each scenario. 3 InterVISTAS 4 http://eur-lex.europa.eu/lexuriserv/lexuriserv.do?uri=oj:l:2008:293:0003:0020:en:pdf, 2008 5 KPMG, 2016 5
A main goal of European Aviation Policy has been including neighboring countries into the Single European Aviation Market in order to support liberalization. This already has often been implemented by including non-eu countries like Norway into the ECAA. This is not even the only agreement a non-eu member can arrange in order to enjoy the benefits of the Single European Aviation Market. Several legal options are possible. An integration however never comes without cost. Besides monetary payments into the European budget, basic rules and regulations have to comply with European standards. 6 The scope of the impact on the European Aviation Industry depends on which scenario will become reality in March 2019. 4.1 ECAA Currently the UK is a member of the European Union and of the ECAA. Having the main goal of European Aviation Policies in mind and given the fact that the Aviation Industry of the UK is one of the major players of the European Aviation Industry, a re-entry into the ECAA seems obvious to most stakeholder of the British as well as European Aviation Industry. Due to the benefits to the stakeholders, this scenario is considered the optimistic scenario. From a legal perspective, this scenario would not bring much changes. By continuing the membership with the ECAA, all legal policies remain unchanged to the state they are today and until March 2019. That also implicates that all traffic rights up the 9 th Freedom of the Air are restored. However, as already mentioned this access into the Single European Aviation Market does not come without cost. Besides the monetary payments into the European Budget, all British Aviation laws and regulations would have to comply with EU standards. Competition law, safety, security and employment law are just some of the European Legislation that will have to be prolonged in case of a continued membership to the ECAA. This by first glance does not seem to be of any disadvantage. Never the less, there are some EU legislations that are not intended by the government of the UK to be prolonged. A good example for this is the Freedom of movement of labor. A compliance with this law is of necessity in order to continue the membership to the ECAA. However, this legislation is at least to some degree contrary to the aims of the Brexit. 6 CLYDE&CO, 2016 6
4.2 Bilateral Agreements Besides a continuation of the membership to the ECAA there is the possibility to negotiate a bilateral agreement. At this point the UK could either negotiate a bilateral agreement with the EU as a whole, having the EU representing its 27 Member States, or negotiate bilateral agreements with individual Member States. In this scenario, there is the possibility that all Freedoms of the Air will be granted to British air carriers. Also, there would not be the need for any restructuring of the corporate structure of effected air carriers. The scenario of an umbrella bilateral agreement has been negotiated before. Switzerland is a non-eu country and has negotiated a bilateral agreement with all EU Member States at once. This however was just one part of a much bigger trade agreement. More important is to state that Switzerland had to agree to four fundamental freedoms of goods, service, capital and labor. By this the EU again ensured a uniform policy structure between all countries enjoying the benefits of the Single European Aviation Market. Additionally, a successful negotiation of a EU wide bilateral agreement needs the acceptance of all 27 EU Member States. Some of the EU27 Member states might use the current position of the British Aviation Industry and disagree with a umbrella bilateral agreement to protect their own carriers. While for example many EU Member States benefit from touristic inbound traffic flows originating in the UK, others feel pressured by the Low-Cost Carriers like EasyJet. Currently, due to EU legislation and the liberal characteristic of the Single European Aviation Market, there is not much room for these countries to protect their national carriers. Anyway, due to multiple solutions for air carriers effected (AOC replacement/ restructure Ownership) in their operational flexibility by possible scenarios of the Brexit, a protective approach for not accepting a umbrella bilateral agreement will most probably not be of use. I will reflect to this in more detail in following chapters. 7 7 KPMG, 2016 7
4.3 No Agreement arranged my March 2019 Scenarios described in the previous chapters are made under the presumption that the UK and the EU will have agreed on terms and conditions regarding the integration of the British into the European Aviation Industry by March 2019. However, there is also the scenario which has to be taken into account that the two years time will not be sufficient. Given the relatively short time frame and the fact that aviation policy is not the first point on the agenda of the British Parliament, it is not to be neglected that this scenario isn t hypothetic. In addition, this scenario brings the biggest amount of consequences for stakeholders of the European Aviation Industry. In this pessimistic scenario, all rights would fall back to those agreed on before EU agreements were established. What does that mean? The British Aviation Industry would find its aviation policy thrown back to a time when liberalization was low and therefore competition a secondary problem to stakeholders of that times. 8 The legal framework in this scenario would be formed by old ASAs. It goes without saying that these old agreements were tailor made for an aviation environment that could not be much more different to its modern counterpart. These agreements permit specific air carriers of one nation to operate into selected airports of the other nation. Many other variables are restricted in order to protect the home carrier. Restrictions on frequencies, capacity and even tariffs were common. These old ASAs do not permit to operate within the domestic aviation market of another country which is today granted by 7 th to 9 th Freedoms of the Air. 9 Moreover, these ASAs only permit operations between two countries to air carriers registered in those countries. According to Europa.eu, 1000 Air Service Agreements with 122 different countries would form the regulatory base for the British Aviation in case no suitable solution is found within the next two years. This does not only include bilateral agreements between two EU Member States but also horizontal bilateral agreements with over 50 non-eu Member States. Since these agreements are governed by European legislation, the UK would have to individually renegotiate these agreements. 8 Frontier Economics, 2016 9 Watson Farley & Williams, 2017 8
4.4 Effected Stakeholders The Single European Aviation Market is known for its liberal character. However, in order to enjoy the benefits of this markets some legal criteria have to be fulfilled by the air carriers. An air carrier to be included in the Single European Aviation Market needs to have an operating license issued by a EU Member country. Having in AOC issued by an EU Member State comes with two necessities: - the principle place of business is located within the European Union - the air carrier must be owned and controlled with at least 50% by EU Nationals 10 These regulations give a background on which air carriers of the Industry are effected and should be taken into consideration in this chapter. Whether the effect of a pessimistic scenario on an air carrier bring an impact on the European Aviation Industry depends on the corporate structure of the effected air carrier as well as on the business model this air carrier employs. For example, British Airways employs the Full-Service Network Business Model. The main aim of British Airways is to feed European traffic into London. Therefore, the main traffic British Airways is subject to mainly flows from one country into the UK and vis a vis. The traffic rights needed for these operations will at least to some extend still be in place even if we take the pessimistic scenario into consideration. However, the invalidity of the EU-US Open Sky Agreement in case of a pessimistic scenario draw another picture that at least to some extend effects British Airways in their operation. These implications are discussed more in detail following chapters. In contrast to British Airways there are air carriers that are highly dependent on intra- European Air Traffic. This comes with the difference in the Business Model. The UK is known for being the home of many Low-Cost Carriers. Several Low-Cost Carriers are British or at least operate out of the UK. Ryanair and EasyJet are just the most famous examples. Following a KPMG Statistic made in November 2016, Ryanair and EasyJet are the biggest and third biggest European air carrier when being measured by passenger volume. However, due to difference in ownership and the nationality of the Civil Aviation Authority that issued the AOC for the respective air carrier, both air carriers are effected to a complete different extend by the Brexit. 10 KPMG, 2016 9
Ryanair is an Irish air carrier and therefore will continue to enjoy EU privileges, even in case of a pessimistic Brexit. 11 On the other hand, there is EasyJet. EasyJet is a British air carrier holding an AOC issued by the UK. As a Low-Cost Carrier EasyJet very much depends on intra-eu Routes. Roughly 43% of services provided by EasyJet are between non-uk airports. 12 In order to continue to operate these routes, EasyJet as a British air carrier needs traffic rights, which are no longer provided in case of the pessimistic scenario. Another Stakeholder I want to mention is IAG. IAG is an airline holding consisting out of air carriers belonging to various nationalities. Given that IAG is a holding company of British Airways and Iberia (and some others), it is questionable whether this structure will be feasible with a possibility of a pessimistic scenario. However, the corporate structure of IAG is arranged in a way that, neglecting the involvement of IAG, British Airways as well as Iberia have an AOC of their respective country and are majority owned by nationals of their respective country. 13 This draws the conclusion that even a pessimistic scenario, would not substantially effect the European subset of IAG (Iberia, Vueling, ect.) in their operational structure. Summing this chapter up, even with a pessimistic scenario, not all air carriers operating out of the UK are effected. However, examples like EasyJet make it clear that in case of a throwback of the British Aviation Industry to old ASAs, there is demand that overnight will not be served anymore. How this might affect the European Aviation Industry, I will evaluate in the next chapter. 4.5 Implications to the European Aviation Industry A re-entry of the UK into the ECAA as well as a umbrella bilateral agreement between the UK and the EU don t come with a lot of structural changes to the European Aviation Industry and its stakeholders. However, as mentioned in previous chapters, due to lack of time as well as political reasons ( Freedom of Movement of Labor ), it is reality that the most pessimistic scenario for the British Aviation Industry has to be taken into account. This Scenario also brings the biggest impact for the European Aviation Industry. 11 InterVISTAS, 12 Frontier Economics, 2016 13 CLYDE&CO, 2016 10
As mentioned in the previous chapter, a pessimistic scenario would affect many British air carriers due to a lack of traffic rights. Several traffic rights implications have to be taken into account in order to draw a picture of free demand structures. Following traffic right implications are taken into consideration: - Intra EU27 operations by British Air Carriers - UK-EU operations by third Country EU Air Carriers - UK-US operations by British and EU Air Carriers - EU-US operations by British Air Carriers All examples mentioned above are subject to renegotiations in case of a pessimistic scenario. Intra EU27 operations by British air carriers would affect stakeholders like EasyJet. EasyJet operates 43% of its services on routes not including UK airports. Given the passenger volumes EasyJet is subject to, it is clear that a big amount of free demand is at stake for the competition. European Carriers like Eurowings face the opportunity to gain market shares overnight, in case of a pessimistic scenario. Ryanair operating a lot of its services on UK-EU27 routes is subject to the second example given above. Ryanair is an EU27 air carrier but due to its location of its home base (e.g. Stansted), and the lack of traffic rights for this kind of operations in case old ASAs will become effective, also here free demand is at stake. These conclusions can also be drawn to UK-US operations by British and EU27 Air Carriers. A pessimistic scenario would cause the invalidity of the Open Sky Agreement for the UK. All carriers operating UK-US Routes would find themselves back at the regulation called Bermuda 2. This regulation highly restricts operations between the UK and the US, making it for EU27 Air Carriers impossible to operate. Even for British Airlines a great restriction in the operations would be in place. This will reflect into higher ticket prices due to less competition. Given the higher price elasticity of today compared to times of Bermuda 2 (1977), this will lead to a shift of demand. Finally, British air carriers would no longer enjoy traffic rights to operate between EU27 and US Destinations, leading to another source of free demand. Summing up it is possible to say that a big amount of traffic flows is free to access for mostly European air carriers not effected by a pessimistic scenario. A final conclusion of these implications is drawn in chapter 7. 11
5. Economic Implications All effects on the European Aviation Industry discussed in the previous chapters were based on the change in the regulatory framework for British air carriers. These implications become very real in case of a pessimistic scenario. However, besides regulatory implications and their effect on the European Aviation Industry, a possible economic downturn and its effect also has to be taken into account in order to estimate the impact on the European Aviation Industry. The magnitude of the impact on the European Economy very much depends, similar to the situation within the Aviation Industry, on the degree of disintegration of the British into the European Economy. In addition to the possible disintegration of the British Economy political uncertainty intensifies the economic effects of the Brexit. How and if at all these economic impacts have a relationship to the effects on the European Aviation Industry will be evaluated in the following chapters. 14 5.1 Correlation between Economic Indicators and the Aviation Industry The Aviation Industry is subject to periodic up- as well as downturns, also referred to as cycles. These cycles can also be recognized in the economy. When visualizing this phenomenon, it becomes clear that there is a relationship between demand growth in the Aviation Industry and the evolution of economic activities. In fact, it has been proven that there is a strong correlation between economic growth/recession and demand for air travel. Due to this correlation, major organizations like ICAO and IATA rely on this relationship in order to predict future air traffic demand. y y)=0.73 The formula above shows the result of a study taken from 1971 until 1996. This study took into account world GDP as well as world traffic in order to find the correlation between the respective variable. The result suggests that economic growth/recession and traffic growth are highly correlative. It is nowadays accepted that even though economic evolution is not the only variable for fluctuations in air traffic demand, it remains the most significant. 15 14 Hartwell C. and Horvath R., 2016 15 Lenoir, N. 12
5.2 Economic Impact for the EU27 The current studies being done on the impact of Brexit on the European Economy mostly take trade disintegration as the major economic variable. Trade between the EU27 and the UK are comparable in order of magnitude to trade between Europe and the US. It is argued that trade disintegration might account for longer term consequences of the Brexit, while the level of uncertainty accounts for short term consequences. An example for this was the drop of share prices in various Industries (EasyJet Share price are down by 34%) 16 following the result of the referendum. Both trade integration as well as uncertainty have an impact on the European Economy and therefore can be related to impacts in air traffic demand. However, the level of uncertainty is predicted to influence the economy until a result of the negotiations between the EU and the UK is known, earliest March 2019. The long-term consequences are subject to the level of trade disintegration. The balance between trade integration and trade disintegration are dependent on various scenarios. These scenarios also can be referred to as optimistic and pessimistic. The UK agreeing to membership in the European Economic Area (EEA), like Norway currently is subject to, brings a high level of trade integration and therefore is referred to as the optimistic scenario. The UK having no trade relationship with the EU and therefore only participate in trade through their membership of the World Trade Organization (WTO) brings major trade disintegration. This pessimistic scenario brings the biggest economic impacts. However, between these two extreme scenarios there are various other solutions but in order not to go beyond the scope of this paper, only the pessimistic scenario is taken into account. Trade of goods and services between EU27 and the UK is significant. Only exports by the EU27 to the UK account for 2.5% of the GDP, whereas UKs exports to the EU27 account for 7.5% of the GDP. This directly reflects the imbalance of dependency on trade between the EU27 and the UK, making the UK more vulnerable to negative economic effects. However, as the figures of GDP account for an average of all 27 EU27 Member states, it is necessary to state that some EU member states are heavily effected while others are no subject to economic consequences. EU27 Member states like Germany, Ireland and Netherlands are due to their close trade relationship as well as their geographical location also vulnerable for economic effects. This picture can also be drawn when taking the total 16 http://www.bbc.com/news/business-37485412, 2016 13
economic effect on the EU27 Member States. While the EU27 on average loses only 0,52% in GDP, results for some EU27 Member countries appear much more significant. 17 6. Conclusion on the Impact on the European Aviation Industry In order to come to a conclusion about the magnitude of the impact on the European Industry it is necessary to sum up all factors contributing to an impact, stated in chapters 5 and 6. Chapter 5 gave all necessary regulatory implications that can affect European air carriers. Summing this chapter up it leads to the conclusion that due to free demand that might be accessible in case of a pessimistic scenario, European air carriers can gain market share. However, these implications neglect the fact that British Air Carriers like EasyJet have the possibility to restructure their corporate structure. That means that by moving the principle place of business to an EU27 Member State and shifting more than 50% of their shares to EU Nationals, British Carrier can get a European Member State s AOC and therefore operate freely within EU territory. Besides regulatory implications, an economic downturn to the European Economy will also hit the Aviation Industry. These economic effects are not evenly distributed and therefore hit the individual Industries with a different extend. Having all these impacts, as well as the flexibility of British Air Carriers in the back of our mind, it is possible to say that even in case of a pessimistic scenario, no clear picture on the Impact to the European Aviation Industry can be drawn. While an economic downturn might decrease demand for air travel and therefore challenge European air carriers, the shift of demand and the possible access to free demand might be a positive effect to the European Aviation Industry and its stakeholders. 17 CEPS, Emerson M., Busse M., Di Salvo M., Gros D. and Pelkmans J., 2017 14
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