Rule Britannia?
Dis-United Kingdom. June 2016

Divorces are painful, stressful and rarely easy. The UK’s decision to leave the European Union (by a 52/48 margin) has come as a shock to the political elite, the EU, and the fragile world economy, not least because this is the first referendum (the fourth in the country's history) where the voters have opted for change.

In the UK there will be a change of government. Prime Minister Cameron, having made as one commentator put it the worst political decision since the 1956 Suez crisis in holding the referendum, signalled his intention to hand over the reins by the autumn; and the leadership of the ruling Conservative Party is likely to take it a lurch further to the right of the political spectrum. Although it has a narrow majority in Parliament (and despite the new five year parliament rule) there could well be pressure for a general election in 2017. In anticipation of this perhaps the opposition Labour party elected members are in the process of forcing their leader Jeremy Corbyn to fall on his sword.

The process for a member state to leave the EU seems to have been included in the Lisbon Treaty almost as an afterthought. The UK will have to invoke “Article 50” formally indicating its desire to leave and at that point will be given two years to negotiate the terms of the divorce settlement.

Cameron has stated that he will leave it to the next Prime Minister to start the formal process. This might give the UK a bit of time to decide what it actually wants: balancing the economic need of retaining access to the single market with the political expediency of trying to “keep foreigners out”. It could join the EEA (which encompasses the EU members along with Norway, Iceland and Liechtenstein), but this would mean accepting all the principles of EU membership except for fishing and agriculture — and without any involvement in decision making. It could just join the EFTA and like Switzerland negotiate a plethora of bilateral agreements with its former partners. It might find its own solution.

The EU itself is likely to take a tough line in the negotiations. Apart from anything else the main member states will be terrified of other nationalist movements being encouraged to push for separation, in the fear that this could lead to the break-up of the EU itself.

Perhaps the best hope of limiting the economic damage from the Brexit vote would be to delay enacting Article 50 for as long as possible — the earliest a new British PM could make the formal move would be October or even November. This delay would help clarify the economic fall-out from Brexit and allow a focus on the real issues facing both the UK and the rest of the EU (by their own astounding admission the Leave campaign does not have a post-Brexit plan in place).

This period, hopefully, would, allow the pragmatists to take control, and it is just possible that the UK might end up trading access to the single market for free movement of EU citizens — probably the best outcome for the European economies and European aviation. Politically though such an outcome is highly problematic or ironic — the UK would be in the same economic position as it is today, the perceived issue of immigration would be unchanged, it would still be paying into the EU budget and it will have lost all it legislative powers in Europe.

The impact on the UK economy will be relatively high in the short run. HM Treasury's own assessment was that the economy would be some 3.6%-6% lower by 2018 than it would otherwise have been: the main reasons for this coming from the very uncertainty of the exit procedure, the lower value of the pound, and higher imported inflation. The markets certainly seem to have believed this by marking Sterling down by 12% immediately, and with forecasts suggesting it will force an overall 20-25% devaluation.

The impact on aviation could also be severe. The UK is one of the strongest markets for originating air traffic — and London has some of the strongest pure O&D air travel markets in the world. The lower value of Sterling combined with a lower GDP growth rate will have a negative impact on demand growth. Conversely the weakness of the currency could have a positive effect on in-bound air travel demand, but as this runs at about half the level of outbound traffic is unlikely to make up for the shortfall from what would otherwise have been.

More important perhaps is the uncertainty of the regulatory regime. There is a possibility, however unlikely, that the UK is excluded from the European Single Aviation Area. This could mean that UK majority-owned and operated airlines be excluded from internal EEA routes and routes from the EEA to non-EAA countries, while non-UK owned and operated airlines would equally be prohibited from routes with the UK or from the UK to countries other than their home.

The pragmatic expectation would be that the UK would look to negotiate membership of the European Common Aviation Area (ECAA), although this will probably be well down on the list of priorities for the next Government. ECAA membership obliges the UK to conform to the “air transport acquis communitaire”, ie all the continuously evolving EU aviation laws and regulation. But now the UK will have very limited influence on these regulations.

There could be significant risks to the operating rights of easyJet, Ryanair, Wizz, norwegian and to a lesser extent IAG.

easyJet has grown strongly throughout Europe. Some 40% of the seats it operates this year will be on flights that do not touch the UK. It may be able to find a solution of creating an “EU owned” subsidiary AOC (it currently has a Swiss AOC for easyJet Switzerland, but this could also come in question), but this would add an unwanted element of complexity. (This structure is reminiscent of the LCC pioneer, Air Europe, which in the 1980s had to set up subsidiaries in several other countries in order to create a European network: one of the many factors that led to that airline’s failure.)

Ryanair is an EU airline but has its largest European base outside its home country at London Stansted and operates a significant level of outbound as well as domestic operations, accounting for some 30% of its seat capacity this year, (though it now plans to shift all future expansion to outside the UK), while its original core Irish-UK flights (some of the most profitable in its network) would not be affected.

If Ryanair wanted to, it might try to establish a UK AOC under “UK ownership”. Michael O’Leary lobbied furiously for a remain vote, one of his deepest concerns being a domino effect with other counties following the UK out of the EU.

norwegian has been building presence at London Gatwick, and specifically has been targeting long haul routes to the US. It has a UK AOC, and although it might try to move it to “UK ownership” its operating license on the Atlantic (already having been under severe pressure) will be in doubt and could severely dent its long haul plans.

Wizz, Europe's second largest ULCC, is based in Hungary but has built up a significant business from Central and Eastern Europe. According to the schedules some 28% of its seat capacity this year is on routes that touch the UK (but less than 4% on routes between Hungary and the UK). It is likely to be harder hit by the UK's apparent xenophobia.

IAG ironically should have less at risk on the European scene. While IAG is registered in Madrid, BA remains officially UK majority owned under the structure of the 2011 merger with Iberia. It may have to replace some UK based routes currently operated by Aer Lingus and Vueling, but could move its minor OpenSkies airline operations out of Paris to another of its subsidiaries. However, in the unlikely event that the UK is booted out of the European-US open skies agreement, its North Atlantic JV with American would have to be dismantled.