Brexit update: Evidence for Walsh and O'Leary views April 2018

Have you heard the one about the two Irishmen, each a Chief Executive of a major airline, but both apparently with very different views on the likely impact of Brexit on aviation? Michael O’Leary, CEO of Ryanair, predicts that we are all doomed. “I think Brexit is going to be one of the great economic suicide notes in history. I think it is a shambles — the UK will suffer hugely, Europe will suffer … and it will be bad for our industry.”

On the other hand, Willie Walsh, Chief Executive of IAG (which he is quick to point out, in the context of Brexit, is a European holding company and not actually an airline), takes a far more sanguine approach. “I’m a firm believer that this will get resolved,” he told the A4E Aviation Summit in March.

In reality, and in private, O’Leary and Walsh may well share similar views on the likely impact of Brexit on the industry and what needs to be done. Certainly, both Ryanair and IAG should have at least some concerns about their own ownership structures in the event of a failure to agree a liberal (soft) post-Brexit regulatory regime. Clearly, however, they have decided to adopt very different approaches to influencing the political debate.

A similar split can be seen in the political debate itself, to the limited extent that it has been made public. The UK Government appears to share Willie Walsh’s view that there is no need to panic; it will be all right on the night. Chris Grayling, UK Secretary of State for Transport, for example, told the Airlines UK Annual Dinner in January: “We want the best possible access to European aviation markets. We believe it is in the EU’s interests to seek a liberal arrangement for aviation … I am confident that we will get what we need.”

At the same time, Henrik Hololei, the European Commission’s Director General for Mobility and Transport, has painted a far more pessimistic picture. Attending the A4E Aviation Summit in Brussels along with O’Leary and Walsh, he was quoted as rejecting the possibility of an aviation sectoral negotiation (“everything must await the progress of the wider framework of the negotiations between the blocs”). He suggested that Grayling’s approach was far too optimistic (“wishful thinking”) and “not really substantiated by facts at this stage.”

Perhaps the most accurate comment came from Brian Pearce, Chief Economist at IATA, when he said shortly after the referendum: “Bluntly, we are in uncharted waters.” At the time IATA had followed most economic commentators in forecasting a substantial and early negative impact on UK GDP and therefore on air traffic to/from the country. This didn’t happen, at least in the way envisaged. But there was an economic impact, notably the significant fall in the value of sterling which affected air transport. Craig Kreeger, Chief Executive of Virgin Atlantic Airways, recently claimed that this was a factor in Virgin’s poor financial performance in 2017.

It is now evident that while there is likely to be a negative economic impact as a result of the Brexit vote, both on the economy in general and the aviation industry in particular, it will not be as great nor as immediate as was first envisaged. Inevitably much will depend on what type of Brexit is eventually negotiated, and in all probability, as is so often the case when dealing with the EU, that will not be totally clear until the last moment. We could yet experience again the infamous EU stopped clock. Nevertheless, in general expectations of a softer Brexit have certainly increased as the negotiators inch forward, and this is as true of aviation as it is of the wider negotiations.

The positives and negatives

There is a dearth of hard facts in the public domain about how much progress, if any, has been made in the various negotiating streams leading to a post-Brexit aviation world. But it is not true to say that we know nothing about what is taking place, and much of what we do know gives reason for some optimism. However, before considering what has been achieved, and always bearing in mind the negotiators’ tenet that nothing is agreed until everything is agreed, it might be helpful to list some of the more positive factors which have slowly emerged.

• The UK is the world’s third-largest origin/destination aviation market, and by some margin the largest in Europe. It is certainly not a market that the rest of Europe can ignore, nor would want to. In 2016, some 153 million passenger journeys were made between the UK and the EU/27. Of the more than 370 international destinations that had at least a weekly service from a UK airport, over half were in the EU.
• The creation of the internal aviation market (to which, ironically, the UK contributed so much) has been one of the EU’s greatest successes, an iconic popular achievement producing clear benefits for both consumers and industry. The exclusion of the UK from even a part of this market would have a significant negative effect, felt throughout Europe.
• Among the most difficult issues to be addressed in the Brexit aviation negotiations are the rules applicable to the ownership and control of airlines. But this is as much an EU/27 problem as it is a UK one. Airlines such as Ryanair and Wizz will, as things stand at present, struggle to maintain their status as Community carriers, while if IAG’s ownership structure is challenged, one might reasonably expect the UK to raise similar questions about the nationalities of various Lufthansa subsidiaries in Belgium, Austria and Switzerland. A common problem often results in a common solution.
• Many EU/27 countries and those situated outside the EU with whom the Community has signed liberal aviation agreements are highly dependent on UK tourist traffic. They are unlikely to want to see this market put at risk. In 2016, UK tourists spent over £25 billion in the EU as a result of 53 million visits. (EU citizens spent less than £10 billion in the UK during 25 million visits.) It may be relevant in this context that it was Spain which reportedly insisted on there being a specific mention of aviation in the recently signed Transition Agreement.
• Similarly, some EU Member States attract substantial numbers of UK transit passengers, notably the Netherlands where KLM serves more UK destinations than any other major airline.
• The Transition Period, not dissimilar to the ‘comity and reciprocity’ arrangements occasionally applied to aviation bilateral disputes, will extend the time available for negotiations by some 20 months. This provides airlines with more certainty and negotiators with more time to address the complicated issues remaining.
• There are tentative signs (see below) that the Gibraltar issue might not be such a serious problem after all.

These are all positive factors which should help to achieve a favourable outcome to the Brexit aviation negotiations. However, there are also negative elements which can’t be ignored. Commission officials are never slow, for example, to remind everyone that the UK cannot be seen to gain from leaving the EU, for fear that others might be tempted to follow. This highlights one of the more disappointing aspects of the way in which the UK has conducted the negotiations so far, namely its failure to argue persuasively that a liberal post-Brexit aviation agreement would be mutually beneficial to both sides.

Instead, such an outcome has repeatedly been presented as very much a British objective, a win for the UK rather than a draw for both sides. If left unchallenged, this will inevitably risk reducing the negotiating flexibility available to the EU, or require the UK to make politically difficult concessions in other sectors (fishing rights?) to get an acceptable aviation deal. It is noticeable that despite the widespread support among most stakeholders for maintaining the status quo in air transport, there has been no co-ordinated lobbying campaign of the kind we have seen in the industry in the past. Nor have the voices of consumer groups been heard seeking to protect what liberalisation has achieved. This is both surprising and disappointing.

There is also a minority of aviation stakeholders, with Air France/KLM and Lufthansa to the fore, who seem to see commercial advantage in a more restrictive European aviation regulatory regime in the future. For them, anything that limits the ability of UK airlines to compete in Europe can probably only be beneficial. At the A4E Aviation Summit in March the position of Air France/KLM seemed to be softening slightly, possibly a reflection not only of the importance of the UK market for KLM’s transit traffic, but also a recognition that the holding company’s investment in Virgin Atlantic could run into problems in the absence of liberal airline ownership and control rules. However, there was no sign that Lufthansa was changing its hardline approach, and even Air France’s position is by no means certain.

The Gibraltar problem

It is worth looking at the Gibraltar problem in more detail. While most attention has been devoted to the border between the Republic of Ireland and Northern Ireland, for aviation Gibraltar threatened to be more significant. Spain, like Ireland, has been given a veto on the final Brexit deal in order to put pressure on the UK to come up with a solution to a disagreement that stretches all the way back to 1713. For some years Spain has held up important EU aviation legislation on consumer rights and Single European Skies, insisting that such rules should not apply to Gibraltar.

The key aspect of the dispute with respect to aviation seems to revolve around access to the airport, which borders to the north on La Línea de La Concepción in Spain. An original deal providing for joint use was reached in 1987, but was blocked by Gibraltar. Another agreement in 2006 allowed for tripartite negotiations between the UK, Spain and Gibraltar. However, these do not seem to have made much progress. Now, in the light of the Brexit decision (which of course was strongly opposed by the vast majority of Gibraltarians), there are again reasons for some optimism. In particular, according to CAPA, the Gibraltar Government has indicated a willingness to accept the joint management of the airport, with access in both Gibraltar and Spain.

At the end of the day, the outcome of the Brexit negotiations will be determined by the self-interest of the States involved, and this is as true of the aviation talks as it is of the broader negotiations. Since self-interest tends to vary from country to country, predicting the final outcome is never easy, but on balance, and with all the usual caveats, it is beginning to look more rather than less likely that Willie Walsh’s public statements will prove to be more accurate than those of Michael O’Leary. This seems to be a reasonable conclusion from what has emerged so far from the government exchanges which have taken place and the public comments made.

EASA

First, let’s consider the critical issue of safety regulation. There is a widespread consensus among aviation stakeholders that the UK should continue to play as large a role as possible in the European Aviation Safety Agency (EASA). The problem is that EASA is an EU agency subject to the jurisdiction of the European Court of Justice, initially a solid red line for the UK. In addition, while it is possible to be an associate member of EASA, only full members, restricted to EU Member States, have a vote on key decisions. Again this was seen by many as a major barrier to the UK’s continued participation.

Both of these problems are more presentational than real with respect to EASA. (See, for example, Aviation Strategy, September 2016.) The European Court of Justice (ECJ) has never been involved in EASA affairs and there is no obvious reason why it should in the future. Similarly, formal votes are rare. EASA is a technical organisation which seeks to reach consensus decisions. It should also not be forgotten that in terms of finance and manpower, the UK is the largest current contributor to the organisation. Other members will be aware of the implications of the UK cutting all ties to EASA.

It looks as though common sense has prevailed, at least as far as the UK Government is concerned. In Theresa May’s Brexit speech on 2 March, she emphasised that the UK intended “to explore with the EU the terms on which [it] could remain part of agencies such as … the European Aviation Safety Agency” even if this would “mean abiding by the rules of those agencies and making an appropriate financial contribution.” In other words, the UK is looking for the type of associate membership which several other non-EU countries already enjoy. This is a major about-turn for the UK, and especially for arch-Brexiteer Chris Grayling, who previously had resisted any role for the ECJ once the UK had left the EU.

To say that most aviation stakeholders were delighted by this outcome is an understatement. There is still much to be done, of course, not least the acceptance of such a proposal by the EU/27 and the Commission. But realistically the likelihood of the UK remaining a key participant in EASA activities, and subject to its regulations, has increased substantially. It is difficult to see a UK application for associate membership, accompanied by a large cheque, being rejected when so many other non-EU countries have been welcomed.

Market access: the non-EU bilaterals

Market access is more complicated, involving a series of separate negotiations and numerous partners. Through its current EU membership, the UK has access to 44 countries, including the 27 other EU Member States. In passenger number terms, these agreements cover the bulk of international traffic to/from the UK. In other words, the UK has to re-negotiate 17 ASAs plus a new arrangement with the EU/27. The UK’s other 111 bilaterals are essentially unaffected by Brexit.

A key negotiation will be that between the UK and the US, covering the largest trans-Atlantic market. Before the EU/US agreement was signed, aviation relations between the UK and US were at times, to put it mildly, very strained. Coincidentally, a history of the Bermuda II saga has just been published — ‘The Life and Death of a Treaty’ by Handley Stevens. As Jeff Shane (the US Undersecretary of Transportation for Policy, US DOT,  from 2003 to 2008) aptly says in the Foreword: “Allies standing shoulder-to-shoulder in respect of just about everything else, they have more often been eyeball-to-eyeball when it comes to the commercial flights that connects their two territories.”

No doubt some may have dreamt of a return to ‘the good old days’, with access to Heathrow limited to just two US airlines, but that was never going to happen. Some early press reports suggested that the UK would have to accept a quite limited, and one-sided, agreement, little more than the model US Open Skies deal. Such reports, however, have proved to be wide of the mark. Instead it seems that good progress has been made.

Reports indicate that an agreement is very close, possibly with just one substantive issue left to be addressed, involving the ownership of Norwegian UK (probably not a surprise given that company’s past history, let alone its possible future ownership). By the time this article is published, even that problem may well have been settled. As Willie Walsh said in March: “There will be an agreement between the UK and the USA. That will be a comprehensive open skies agreement. Anybody who doesn’t believe that is living in cloud cuckoo land.”

The other trans-Atlantic bilateral agreement that the UK needs to negotiate post-Brexit is with Canada. However, that is very unlikely to be a problem. After all, the Canadian Prime Minister has recently stated publicly that he wants an early broad trade agreement with the UK going beyond the Canada/EU arrangement, and expects to get one. The UK had a liberal ASA with Canada, meeting both countries’ aviation needs, long before the EU became involved.

The other countries with which the UK needs to negotiate new ASAs are those around the periphery of Europe, such as the Balkan and North Africa States. It is not clear how much progress has been made here. The sheer number of countries involved certainly presents an administrative challenge. However, the Transition Agreement, if signed, will allow an extra two years for the work to be undertaken. Given the size of the UK market and the fact that many of these countries rely heavily on tourism from Britain, it seems unlikely that they will not readily agree to a continuation of the liberal regulatory environment they have been enjoying with the whole of the EU. There is every reason to be optimistic that mutually beneficial arrangements can be agreed.

Market access : the EU internal market

If serious negotiations on future access to the EU internal aviation market have started, they are being kept under wraps. The October 2017 issue of Aviation Strategy outlined various possible scenarios for a future EU/UK regulatory regime, based on an analysis carried out by Andrew Lobbenberg, an analyst at HSBC. Most of the options identified have serious shortcomings which would significantly reduce the benefits of the current internal market, or would be political non-starters.

It seems the most likely, and productive, way forward would be a new, fully liberal EU/UK agreement which went a long way towards maintaining the status quo in terms of market access. The fact that a model of such an agreement already exists, one moreover that has previously been supported by all EU Member States and most European aviation stakeholders, can surely only help. This is the negotiating mandate originally given to the Commission when it opened talks on a trans-Atlantic deal (not, of course, the more restricted deal eventually signed.)

It is difficult to judge at this stage the chances of achieving such an objective. As already explained, there is certainly opposition from some of the European legacy carriers, not helped by the failure on the part of other stakeholders to lobby effectively in favour of a liberal agreement. Similarly, it is unfortunate that the UK Government has been less than convincing in presenting a fully liberal aviation model as a win/win for both sides. But at the end of the day one has to hope that common sense will prevail and neither the EU nor the UK stands idly by as the much cherished baby is thrown out with the bathwater.

Thus, overall while much uncertainty still remains, there is also some reason for optimism. The Transition Period gives everyone more time to address the considerable problems associated with withdrawal from the internal aviation market; continued UK participation in EASA seems far more achievable than it did only a short time ago; and the new bilateral air services agreements which the UK has to sign to replace EU arrangements, notably that with the US, appear to be making progress. The major concern, if only because of the lack of transparency of what is happening, surrounds intra-EU market access, but even there at least there has been no obvious back-tracking, and some reason for hope. What might make a real difference is a strong public push from those keen to maintain the benefits of European liberalisation, including consumer groups.