Frustrating questions of ownership and control April 2014

Dublin early in April saw an influx of aviation professionals to CAPA’s Airlines in Transition 2014 conference to debate a key element of the industry’s development: that of national ownership and control. On the dais were Willie Walsh, CEO of IAG; Bjørn Kjos, CEO of Norwegian Air Shuttle; Conor McCarthy, co-founder of Air Asia and Chairman of Dublin Aerospace; Matthew Baldwin, the EC’s Director of Aviation and International Transport Policy; and Eamonn Brenan, CEO of the Irish Aviation Authority. The session was chaired by John Byerly, the former Deputy Assistant Secretary the US DoT (and a key negotiator in the EU-US Open Skies agreement).

John Byerly set the scene for the discussion. He outlined the arcane restrictions on foreign ownership and control that date back to the 1945 Chicago Conference, and are inherent in most bilateral and multilateral air service agreements (and especially in all the “Open Skies” agreements negotiated by the US): a scheduled airline must be “substantially owned and operated” by nationals of the home country. He pointed out that in a global industry, corporations benefited from economies of scale, market access, purchasing power and diversification of risk. In most industries they could merge and create subsidiaries with relatively little impediment while the airline industry is “tied in legal knots”.

With a very few exceptions countries round the world have laws in place limiting foreign ownership and control, and these statutes remain in place for reasons of national pride, defence, labour protectionism, and (probably above all) inertia. As a result they act as an impediment to cross-border mergers and acquisitions in the industry — or at least add a significant element of risk. Meanwhile, although questions of ownership are relatively easy to determine (despite, we may add, arguments of how to treat convertible loan stock in calculations of equity) the question of control by a foreign entity is more complex — many bilateral air service agreements will preclude “effective control” by a foreign national even if their equity position is below the proscribed maximum.

Byerly did not think that there would be any legal changes to the system. The EU-US Open Skies treaty missed the opportunity to remove ownership restrictions. Initially it was an a priori requirement from the EU in 2008, but with protectionist attitudes from Washington it then was pushed into the second round of negotiations in 2010 and conveniently side-lined (after all the US had overturned Bermuda II and gained access to Heathrow, which was all it really wanted). The EU is still hopeful that it can include the question in the forthcoming Transatlantic Free Trade negotiations: but Byerly bluntly stated, “I am not putting any money on success”.

On top of this he noted that the existing rules are being strongly enforced — especially in the more protectionist nations. For example, Virgin America encountered significant opposition to its application for an AoC in the US, where the DoT not only refused to accept that Branson only had a minority stake , but that also decided that the CEO, Fred Reid, despite being a US National, was too closely involved in the UK’s Virgin Group. The EC has started investigations into Delta’s 49% stake in Virgin Atlantic, Etihad’s involvement in Air Berlin, Air Serbia, Darwin (and possibly Alitalia), and Korean’s investment in CSA. This is a further example of regulators taking the question of control beyond a simple view of equity involvement. Meanwhile, Delta seems to have persuaded the Italian courts to dismantle Emirates’ fifth freedom route rights between Milan and New York.

The solutions that exist involve “threading the legal needle”. These include the mergers (such as between Air France and KLM, BA and Iberia, or Lan and TAM) with a special purpose vehicle that skirts the legal niceties of equity control to allow the holding company to retain all the economic benefits of the merger but “national” companies to officially hold a majority of the equity. In addition there are the models used in SE Asia, such as by Air Asia, with local majority owned subsidiaries providing the legal ownership requirement to allow brand expansion. Of course only Lufthansa would have had the chutzpah to persuade the governments of Switzerland and Austria to renegotiate their bilaterals to allow German ownership of the national carrier.

Why merge? Byerly pointed out that global branded alliances were all very well for developing market access, but membership of an alliance came at a cost. Willie Walsh re-emphasised this comment saying that only through a merger or acquisition could cost synergies really be achieved; and that alliance membership would add costs.

Among the panellists there was broad agreement that the whole system is “stupid”. Walsh said that he’s argued consistently for years that foreign ownership laws need loosening and until recently felt confident that this would happen. However, now he was more pessimistic as there were increasing moves towards protectionism. He praised Bjørn Kjos and norwegian for what they were doing with the establishment of the Irish long haul subsidiary, pointing out that this was one of the very things that the liberalisation inherent in the US-EU open skies agreement was meant to allow. In fact, British Airways had been the only other carrier to set up an airline — Open Skies — outside its home country to operate on the Atlantic (although it was not performing particularly well and now only operating between New York and Paris). What particularly seemed to annoy him was that the objectors to norwegian’s plans were using Article 17bis of the 2010 EU-US protocol as a prime reason to deny access. This states that “The Parties recognise the importance of the social dimension of the Agreement and the benefits that arise when open markets are accompanied by high labour standards. The opportunities created by the Agreement are not intended to undermine labour standards or the labour-related rights and principles contained in the Parties’ respective laws.”

Meanwhile on the question of labour issues driving corporate activity Willie Walsh pointed out that the obvious labour-management conflict is that labour unions are there to protect employment while the airlines are there to create employment. Ultimately an airline is interested in being increasingly efficient and growing profitably.

In a recent speech at the Washington Aviation Club ALPA’s president Lee Moak hit out at state-owned foreign carriers, provision of customs pre-clearance at foreign airports and at norwegian’s Irish subsidiary as “unfair” competitive positioning saying “ultimately this is about saving the US airlines... if the US Government does not allow the US airlines and their workers to compete fairly, the US airline industry as we know it today will disappear”. He is now calling for “fair skies, not open skies” and using terms like “flags of convenience” and a “race to the bottom”.

Norwegian’s Bjørn Kjos denied that his plans to base his subsidiary airline in Ireland (with some staff recruited from Asia) went against any regulations. He pointed out that Oslo only has a direct catchment population of 0.7m, and emphasised that he had a choice of going to another European base area and creating employment or giving everything away to “to the Asians or others”. Expanding competition creates a huge number of jobs — not only in the aviation industry but also in related tourism and support industries, particularly hotels and restaurants.

The question of minority cross-border airline investment appeared in a later session in the conference. Here was particular interest in Etihad’s model of investing in those airlines no-one else would touch — with CAPA’s Peter Harbison applying the soubriquet of an Egocentric Equity Alliance. It was a model described as providing a composite designed to create near global reach for the central stakeholder, with some benefits for the other participants. For Maurizio Merlo, CEO of Darwin Airlines (now Etihad Regional), the presence of a strong partner as a shareholder provided significant benefits: a major improvement in buying power and relationships with suppliers; and, perhaps surprisingly, the ability to offer staff more of a career path through the “family” of related airlines. In that session the conclusion seemed to be that the minority investment route will be the principal driver of industry transformation over the next few years. However, the EC’s investigation into whether Etihad actually exercises control (and its recently-announced €300m emergency investment in convertible loans in Air Berlin won’t help) may provide a brake on activity.

The airline industry is one of the few industries that is restrained from becoming truly global. Over a decade ago ICAO proposed a new model airline designation clause for bilateral air service agreements separating the question of ownership from that of effective control, whereby nationality would be determined by where an airline “has its principal place of business and permanent residence in the territory of the designating country”; with the footnote that criteria for determining the principal place of business would include local incorporation, base of operation and capital investment in facilities, payment of tax, aircraft registration and employment of nationals.

This definition has not been widely used — a notable exception being Chile. All the attempts at developing code shares, global branded alliances, linking frequent flyer programmes are part of the process for airlines to try to overcome the regulatory hurdles and join the trend towards globalisation; but they are a poor substitute for the real thing.