29-Jun-2015 11:42 AM

Jetstar Hong Kong licence application rejected: Hong Kong becomes an island of protectionism in Asia

Analysis

"Never imagine yourself not to be otherwise than what it might appear to others that what you were or might have been was not otherwise than what you had been would have appeared to them to be otherwise." (Alice in Wonderland; Lewis Carroll).

The battle of semantics over the issue of Jetstar Hong Kong's compliance with an esoteric and highly subjective definition of the words "principal place of business" appears to be over. As Hong Kong's licensing authority rejected Jetstar Hong Kong's licence application on 25-Jun-2015, Cathay Pacific had successfully defended its market dominance with arguments more befitting of a scene from Alice in Wonderland. It is a precious victory over longstanding foe Qantas, which recently attacked Hong Kong's bilateral access to the Australian market as making no "concession to the legitimate interests of Australian airlines in establishing reciprocal hub opportunities in Hong Kong."

Ironically, the principal place of business test was established to circumvent the fact that Cathay was actually a foreign owned airline operating under a local AOC; consequently it could not be accommodated under typical bilateral air services agreements which required "substantial ownership and effective control" to reside in Hong Kong. For decades, the world made a special exception for Cathay. Today, even though it is based in Hong Kong, nearly two thirds of Cathay's voting rights reside in London with the Swire Group. And 30% of the airline is owned by Air China. It is also a common assertion that Hong Kong Airlines, another opponent to Jetstar's entry, is controlled by mainland-based HNA.

But, in the arcane world of international aviation regulation, logic and good sense is frequently a scarce commodity. The result here, as Alice in Wonderland's delightfully illogical Queen of Hearts would have said, is "Off with their heads!".

Summary

Jetstar Hong Kong's license application has been rejected by Hong Kong's licensing authority, a decision that has been seen as a victory for Cathay Pacific and a blow to Qantas.
The rejection of Jetstar Hong Kong's application is seen as a setback for Hong Kong's aviation policy and a sign of increasing protectionism in the region.
The decision was largely based on the interpretation of the term "principal place of business" and whether Jetstar Hong Kong's functions performed in Australia would undermine its status as a Hong Kong airline.
The ruling has raised concerns about the future of liberalization in Asia and the potential for other incumbents to challenge proposed start-ups.
The rejection of Jetstar Hong Kong's application is not expected to have a significant impact on China Eastern and Qantas, but it does affect the Jetstar Group's plans for expansion in the region.
The decision will likely have implications for future bilateral air services talks between Australia and Hong Kong, with Hong Kong expected to ask for more capacity and Australia not needing more at this time.

The Authority's decision came at an important time for Hong Kong - and the world

With the advent of local LCCs and Jetstar's potential arrival, Hong Kong was at an inflection point. The city at large and aviation in particular has thrived due to its liberal access regime. With Jetstar's application (which would have been approved without blinking in every other jurisdiction in Asia), there was opportunity for continued liberalisation that has occurred across the rest of the region.

It is inconceivable that a pro-competition Hong Kong could credibly reject Jetstar's application. No other Asian market has had an ostensibly impartial regulator wind back the clock on liberalisation. Hong Kong becomes part of a troubling global story: that of pressures for increasing protectionism. This examination of airline control is the latest in the world stretching from Washington to Cape Town to Brussels. It is the first significant challenge in Asia.

Cathay Pacific, leading the opposition, advocated an old world definition of control in which almost all airline functions are performed locally. Jetstar, as part of the new world that uses the efficient franchise concept, planned to outsource some tasks to Australia. Cathay meanwhile owes its success to market liberalisation. 60% of the airline's traffic is sixth freedom, flows which many governments prohibited for years. Such double standards are on the rise: Southwest, once the fighting LCC in America, has watched as its pilots' union opposes Norwegian Air International. Lufthansa, another connecting carrier heavyweight, opposes Gulf carriers. From Cathay to Lufthansa to the Southwest pilots, these groups are betraying their entrepreneurial past to secure their own future.

This was not an opportune moment for regulators to diverge from the path of liberalisation. If nothing else, they owed it to their constituents. Yet the 150 page ruling makes zero references to whether the entry of Jetstar Hong Kong was in the interest of the public or consumers. At best this is a sad day for Hong Kong's aviation policy; at worst it sends a hopeful message to those who would seek to protect the status quo.

Consumer interests have been ignored. But Cathay says rejecting Jetstar was "the right decision for Hong Kong"

Hong Kong's Air Transport Licensing Authority, by rejecting Jetstar Hong Kong's application, determined the airline did not meet the principal place of business requirement. Jetstar can have a judicial review, but as this mostly covers the process and not facts, there is slim chance for a reversal.

For a process where time was of the essence, in a fast moving competitive airline market, ATLA's process has been ponderous and unpredictable. There were numerous delays prior to the hearing that commenced on 23-Jan-2015 and concluded on 14-Feb-2015, but a decision was not rendered for another four months. Leading up to the decision, Cathay Pacific said it shortly expected a result, even though there was no communication from ATLA to the public. Transparency, a key part of democratic administrative procedures, was not a theme of the hearings and decision making: the Jan-2015 hearing had been tentatively scheduled on 07-Nov-2014 and confirmed on 09-Jan-2015, but the public was informed of the hearing only one day prior and none of the documents - stretching into the thousands of pages - were made public.

Cathay issued a statement describing the rejection as "the right decision for Hong Kong" - a big call, to argue protectionism is beneficial to the wider public. Cathay in 2013 said Jetstar Hong Kong "would undermine the Hong Kong economy". But by the time the decision was finally delivered, incumbent airlines had occupied so many of the scarce airport slots that Jetstar's market impact would have been minimal at best. It was the principle that Cathay was at such pains to contest.

Cathay's narrow views were influential: potential benefits to the public and consumers from Jetstar Hong Kong are not given a single mention in the 150 page ruling. This is despite ATLA previously stating consumer interest would be considered. The only mention of benefit to the Hong Kong aviation hub is a statement paraphrasing Jetstar Hong Kong's view that it will bring gains to the hub.

GDP and LCC penetration of Asia-Pacific markets: 2015

The ruling was largely based on evidence Jetstar Hong Kong submitted in late-2014 and 2015. Yet incumbent airlines opposed Jetstar Hong Kong long before with assorted claims, often of dubious merit (CAPA examined these in 2013, see link below). This raises the question if Jetstar Hong Kong was given a show hearing under Cathay's strong lobbying and fear mongering, and excuses to block Jetstar Hong Kong were found along the way.

The short term impacts from the decision are limited

The downside of this decision will become apparent over the long term. More immediately, there is limited impact to airline investors China Eastern and Qantas. Given the slot constraints Jetstar Hong Kong would have brought only limited strategic opportunities. There is a wider impact to the Jetstar Group, where Jetstar Hong Kong would have introduced an appealing new hub and would have also bridged gaps between its Southeast Asian and Japanese operations. There is some compensation however as Jetstar Pacific (Vietnam) and Jetstar Japan launch Hong Kong services. The Cathay-Qantas relationship has been torrid for a long time, and whatever goodwill remained is likely to dissolve.

The determination will be an interesting backdrop to forthcoming bilateral air services talks between Australia and Hong Kong - if they proceed. Hong Kong is expected to ask for more capacity; Australia, under-utilising its existing allocation, does not need more. A negative outcome from the talks, however, is actually likely only to benefit Cathay Pacific. Cathay has little interest in an expansion of rights under the Australia bilateral since at least some of the new capacity would likely have to be allocated to Hong Kong Airlines, adding unwelcome competition.

Incumbents clearly perceived Jetstar Hong Kong a threat given the ferocity with which the application was opposed. Although Jetstar Hong Kong would have had an initially small impact overall, on overlapping routes Cathay would have felt pressure, just as it has on other routes. Following Scoot's entry on Singapore-Hong Kong, for example, Cathay steeply discounted fares and has kept them low.

There was also the matter of a slippery slope precedent: if Jetstar Hong Kong were approved, that could theoretically have opened the gates to an Emirates Hong Kong or a Singapore Airlines Hong Kong. "Granting a licence to a foreign-controlled airline would set a very negative precedent," Dragonair said in a 2013 statement. A number of airlines had considered a Hong Kong joint venture but watched Jetstar Hong Kong's application to see what the process would entail. None expected an easy ride so waited to see if there would even be a chance. That answer is clearly no. Even a positive outcome for Jetstar Hong Kong may not have seen further license applications.

Other cross-border joint-venture LCCs, announced and unannounced, have failed to launch due to regulators. Often applications were knocked back through unofficial channels or the application was not moved on. In none of those cases was there such an official and ostensibly open administrative hearing as Jetstar Hong Kong was given. Most markets continue to see the benefit of competition, in particular from LCCs, which generate new types of traffic and avail of under-utilised slots.

As CAPA previously wrote, a Jetstar Hong Kong rejection is unlikely to change the pace of liberalisation in Asia:

There is a risk - albeit fairly small - now that Cathay's unabashedly protectionist plea move could embolden incumbents in other markets to challenge proposed start-ups. The argument in other markets would be the same: boxes may be ticked - including majority local ownership - but the foreign carrier might ultimately call the shots. But other governments have taken the course of favouring the economic benefits additional airlines bring, even if it meant looking past the technicality of local control. (The restrictive ownership and control provision in bilaterals was established 68 years ago when aviation was in its infancy. Its origins were in ensuring there was adequate safety regulatory oversight by a recognised authority. But it has since been perverted to become the cornerstone of protectionism.)

Jetstar Hong Kong hearing was critical but other hurdles remained

Jetstar Hong Kong was announced in Mar-2012 with expectations to launch in 2013 and amass a fleet of 18 A320s in 2015. Cathay Pacific, assisted by Hong Kong's smaller carriers, mounted an effective campaign to drag out the process. Fault is also with a Hong Kong government that does not move as fast as it used to. This is seen in other city matters, including the dragged out process for the third runway for Hong Kong International Airport.

The hearing on 23/24-Jan-2015 was in regards to Jetstar Hong Kong's principal place of business, the major criteria to be a designated Hong Kong airline. A finding that Hong Kong was the principal place of business would not have automatically granted Jetstar Hong Kong a license. Instead Jetstar Hong Kong would have been able to move on to other regulatory matters and further hearings. Objectors would have been expected to continue to oppose Jetstar Hong Kong.

The initial hearing sought to determine the meaning of 'principal place of business'

Most but not all countries require airlines to have majority local ownership and control. Hong Kong however is one of a small number of exceptions. Under Article 134 of the Basic Law, local airlines are required to have "their principal place of business in Hong Kong", but no definition of principal place of business is provided. Any ownership requirement was intentionally left out as it would have conflicted with Cathay Pacific's foreign ownership.

Hong Kong's Transport and Housing Bureau licenses airlines and in Apr-2014 completed a 10-month review of its designation criteria, which followed Jetstar's application. The bureau told the South China Morning Post that "Factors such as ultimate management and control of the business, the relationship between the applicant and other foreign airlines, the place where the major operations of the airline's business is conducted would be relevant. It has also been stipulated clearly in the revised guidelines that public interests will be taken into account when considering whether an airline should be designated." However, exact terms were not disclosed and even then would be subject to interpretation.

Global definitions of principal place of business also leave room for interpretation. ICAO in 2002 said this of principal place of business:

"Evidence of principal place of business includes: the airline is established and incorporated in the territory of the designating Party in accordance with relevant national laws and regulations, has substantial amount of its operations and capital investment in physical facilities in the designating Party, pays income tax and registers its aircraft there, and employs a significant number of nationals in managerial, technical and operational positions."

The vague elements are found in words like "substantial", allowing objectors to question what is and is not substantial. The obscurity of control (principal place of business) has prompted European authorities to investigate the matter.

Objecting to Jetstar Hong Kong's licence were the city's main airlines: Cathay Pacific and Dragonair (acting as one in the hearing), Hong Kong Airlines and HK Express. Their full objections were not disclosed but their public statements regarding the objections mentioned matters besides principal place of business, although this was the major concern.

Cathay publicly offered carefully circumscribed endorsement of competition: "Cathay Pacific Airways is not against competition. We successfully compete with other airlines every day in Hong Kong and around the world. This includes the 107 other Hong Kong and foreign airlines serving Hong Kong, 17 of which call themselves low-cost carriers (LCCs). Cathay Pacific Airways supports increased choice for consumers in Hong Kong, including the set up of LCCs with their principal place of business in Hong Kong."

Cathay Pacific's own principal place of business was challenged, but Cathay did not want itself examined

During the hearing, counsel for Jetstar Hong Kong noted discrepancies in Cathay's own qualification of principal place of business. Cathay's 1H2014 report stated 48.10% of its capital and 60.63% of the voting rights are with London-based John Swire & Sons Limited or its wholly-owned subsidiary John Swire & Sons (H.K.). This gives foreign majority control.

An evaluation of Jetstar Hong Kong's principal place of business "has to be reconciled with that fact", Jetstar Hong Kong counsel said of Cathay's principal place of business.

Jetstar Hong Kong has three shareholders: Australia-based Qantas Group, Shanghai-based China Eastern and Hong Kong-based Shun Tak Holdings. The three have equal equity shares, meaning two-thirds of the airline's equity is foreign. (This by itself is not an issue as Hong Kong has no ownership criteria.) However, the voting rights structure is different, with Shun Tak having a majority 51% and China Eastern and Qantas each holding 24.5%.

Jetstar Hong Kong sought to convey it was actually "more Hong Kong" than Cathay since the majority of Cathay's voting rights are not in Hong Kong. The ownership structure of Hong Kong Airlines and HK Express is convoluted but would likely raise questions about where those two are controlled.

Further, some senior management at Cathay are employed by Swire and seconded to Cathay with Cathay reimbursing Swire; Jetstar Hong Kong staff are employed and remunerated by the airline. Jetstar counsel noted the full details of the Swire-Cathay management agreement are not public. The implication appeared to be that disclosure would reinforce arguments for Cathay's UK - not Hong Kong - principal place of business.

Jetstar Hong Kong counsel said Cathay sought to "put blinkers on" that would have Jetstar Hong Kong's principal place of business evaluated but not Cathay's. The implication was that if Jetstar Hong Kong received the same treatment as Cathay, its principal place of business would be found to be in Hong Kong.

Cathay counsel rebutted, saying that Jetstar Hong Kong is "introducing irrelevant facts" to create "fussy thinking" and "divert attention away". Cathay counsel continued it was "unhelpful and a distraction to look into Cathay Pacific." These statements are curious. CAPA wrote a Sep-2013 report on the objections to Jetstar Hong Kong. Cathay interpreted the report as CAPA saying laws should be disregarded. Cathay director of corporate development James Barrington wrote that: "Your suggestion that the authorities should ignore the law in this case is quite astonishing." Yet in the circumstances it would be reasonable to suggest that a similarly detailed analysis should be made of Cathay's own principal place of business.

The report and Cathay's response can be found here: Hong Kong's Jetstar Hong Kong decision could be a milestone in liberalisation. Or a compromise

Cathay questioned Jetstar Hong Kong's intent. Jetstar's timing was not solid

It is likely that Jetstar would have handled its proposed entry very differently with the benefit of hindsight. While Jetstar Hong Kong has a local shareholder, which holds the majority of votes, this was not always the case. Jetstar Hong Kong was incorporated in Sep-2012 with its initial investors: Australia's Qantas and mainland China's China Eastern.

It was only in Jun-2013 Shun Tak was introduced as Jetstar Hong Kong's first local investor. Later that month Jetstar Hong Kong submitted its Air Transport Licence application. In Aug-2013, Shun Tak managing director Pansy Ho was named chairman (chairwoman) of Jetstar Hong Kong. In Feb-2014, Jetstar Hong Kong changed its voting structure so that Shun Tak held the majority of votes. (Over 70% of Jetstar Hong Kong's board are Hong Kong permanent residents.)

Cathay called Jetstar on this, claiming the revisions were "clearly crafted by [a] lawyer" for "one purpose and one purpose only: for purpose of this tribunal". As CAPA wrote in Sep-2013, one view is that Jetstar Hong Kong always intended to introduce a local shareholder but doing so at launch time did not present the best timing. The long intervening period created the impression that local representation was an afterthought and gradually added only as Jetstar Hong Kong's application was stalled.

Jetstar and Qantas knew Hong Kong was sensitive about principal place of business. Private intent and public interpretation are different, and Jetstar Hong Kong bore the consequences. It certainly did not help that even prior to Jetstar Hong Kong, Cathay and Qantas had almost no relations despite both being in the oneworld alliance. This amplified Cathay's opposition.

Cathay management previously commented on the appointment of Shun Tak and Ms Ho, saying: "The Hong Kong residence of a particular shareholder of Jetstar Hong Kong and the number of shares held by that shareholder do not determine management control or principal place of business under the Basic Law. Nor does the fact that particular officers of Jetstar Hong Kong are residents in Hong Kong."

Cathay counsel questioned where executive final control rests. Cathay cited a document (unavailable for public review) that certain Jetstar Hong Kong votes require a majority as well as a vote from either China Eastern or Jetstar in Australia, which Cathay contended protects China Eastern and Jetstar in Australia. Cathay also said that a dispute within Jetstar Hong Kong would be referred to Jetstar Group's CEO in Australia. Cathay acknowledged however that Jetstar Hong Kong's disagreement with the group CEO would send the matter to international arbitration.

Cathay questioned the fundamental legality of an airline franchise

More fundamentally - and cutting across the underpinnings of recent Asian liberalisation, Cathay questioned whetherJetstar Hong Kong, by mere virtue of being a franchise, could be independent. It is worthwhile to recall the (short) history of Asia's franchise airlines, more commonly known as cross-border joint-ventures. As CAPA previously wrote:

Cathay is mounting the largest challenge yet to what has generally been a relatively relaxed process to establishing cross-border subsidiaries.

As Southeast Asian LCCs entered domestic markets, then sought to expand internationally, it was near impossible in the short term to amend the host of bilateral agreements necessary to allow the liberalisation needed to allow efficient services. These air services agreements, based on reciprocity, were described by the last CEO of IATA as "archaic" in their restrictiveness, and born of a very different age.

They prevent the cross-border establishment that has been such an important part of freeing up Europe's previously closed skies. By allowing Asia's LCCs to establish on a minority shareholding joint venture basis ("cross border joint ventures"), all governments involved were prepared to allow de facto liberalisation, without having to go through a process of re-negotiating the dozens of bilateral combinations otherwise needed.

Cathay pointed out that Jetstar acknowledged cross-border joint-ventures are born out of regulatory restrictions. Cathay cited a Jetstar application to Australian regulators to coordinate activities amongst the various Jetstar units. The application said: "One of the reasons for pursuing the Jetstar business model in Asian jurisdictions is the strict regulatory environment in which airlines are required to operate."

Cathay asked if Jetstar Hong Kong is trying to "effectively pay lip service" to local laws by having the appearance of local control. Cathay's challenge was not that Jetstar Hong Kong is a franchise but that Jetstar Hong Kong is a foreign-controlled franchise. Cathay's arguments however suggested franchise and foreign control are linked.

Acknowledging there are regulatory restrictions in cross-border establishment did not automatically mean Jetstar Australia was undermining foreign laws. Jetstar Hong Kong argued that filing the application to Australia showed its intent to comply with laws. Further, counsel argued, requesting approval to coordinate the foreign units showed Jetstar Australia does not control them: if Jetstar Australia did control them, there would be no need to apply for the right to coordinate them. (Ironically, much of Cathay's arguments were based on this submission that is public due to Australia's transparency - in strict contrast to the Hong Kong hearings.)

Cathay's argument has potential ramifications for all of the planned and future cross-border airline subsidiaries being established in Asia. Cross-border joint venture airlines are widespread in Asia. For example, Malaysia has an affiliate of Indonesia's Lion Air (Malindo) while Thailand and Japan see numerous units, from Vietnam's VietJet in Thailand to China's Spring Airlines in Japan.

As CAPA previously wrote: "Foreign laws for airlines generally require local ownership and control, the latter often winked at. Cross-border subsidiaries have so far had little trouble persuading authorities that local ownership equates to local control, even if foreign subsidiaries are not entirely autonomous, depend heavily on the foreign airline and the local owner is a silent shareholder."

Jetstar Hong Kong was to be different. There is a clear distinction between the requirement for local ownership and local control. Further, Jetstar Hong Kong chairman Ms Ho is hardly a silent individual. She takes an active role in Pearl River Delta tourism, including to Macau, where the Ho family operates casinos. Jetstar Hong Kong CEO Edward Lau said Ms Ho's Shun Tak had given ancillary revenue suggestions to Jetstar Hong Kong based on Shun Tak's transportation experience with ferries to Macau. While Mr Lau's point may have been over-emphasised, the wider message is that Shun Tak does have interest beyond financials in making Jetstar Hong Kong successful. Jetstar Hong Kong can become part of Shun Tak's wider transportation and tourism portfolio.

The heart of the argument: Jetstar Hong Kong would outsource functions to Australia. Cathay alleged Jetstar would not have control

Hong Kong has not previously dealt with a licence application such as Jetstar Hong Kong's. What was different and being contested by incumbent airlines is that a number of Jetstar Hong Kong's functions were to be performed in Australia. The incumbents sought to argue this meant Jetstar Hong Kong's principal place of business cannot be in Hong Kong. Jetstar Hong Kong said the functions may be performed out of Hong Kong but are under its direction and final control.

Where tasks are outsourced, Jetstar Hong Kong counsel said, it is "performed as benefit for the company".

Jetstar Hong Kong made available to the parties (but not publicly) its business service agreement with Jetstar in Australia. Cathay counsel noted Jetstar in Australia would establish pricing, make decisions on pricing levels and manage allocation in addition to making route network suggestions. Jetstar in Australia "basically controls everything", Cathay counsel alleged. Jetstar's Mr Lau clarified that Jetstar Hong Kong can decide pricing and revenue management; it is Australia that carries out those decisions.

On a smaller scale, partnerships and alliances provide reflection. Airlines allowed to coordinate may have staff in the other airlines' (foreign) office or allow the home market to coordinate pricing for all local sales; for example, British Airways maintained and sold Qantas' ex-Europe capacity when the two had their joint service agreement, while Qantas sold BA's ex-Australia capacity. In these instances, the business is not being carried out in the airline's home market but is being done under the direction of the airline. Such coordination was created to be efficient, and LCCs would seek to similarly streamline operations and remove redundancies.

Mr Lau said Jetstar Hong Kong had not rejected any network recommendations from Australia since Jetstar is unlicensed and has not sold tickets. But Mr Lau said he was aware of other Jetstar units that had rejected network recommendations from Australia. Network planning and general reservation sales and management require expensive IT that are an obvious target to get scale on. Mr Lau said using Australia's IT would expedite implementation, lower costs and provider greater support.

This perhaps compares to HK Express' gradual transition and build-up on its new Navitaire IT system. In comparison, Jetstar Hong Kong would have been able to launch from day one with a comprehensive offering. It might be questioned how much control Hong Kong Airlines has with its TravelSky platform; it (and other functions) could be managed as part of the mainland-based HNA Group. Further, Hong Kong Airlines has large IT off-shoring - meaning those staff may be under the control of the Hong Kong company but not physically in Hong Kong, not dissimilar from Jetstar Hong Kong.

Mr Lau defended that Jetstar Hong Kong would (with a few exceptions) use an aircraft configuration specified by Jetstar in Australia. He said the configuration was proven, with a 180-seat A320 configuration common, while using a standard aircraft type allowed scale for maintenance and spare pare procurement, quality assurance and a common customer experience.

HK Express is again perhaps a point of comparison: it has more than one A320 configuration and various interiors that do not create a common customer experience. Hong Kong Airlines' IPO application showed its fleet is moved around HNA Group airlines. It was not stated if those movements are done at the direction of Hong Kong or Beijing. The arrangement between Jetstar Pacific in Vietnam and Jetstar in Australia was unknown, but Jetstar Pacific has sourced second-hand aircraft.

In short, Jetstar Hong Kong counsel said, Cathay was trying to "tell the tribunal how to operate an airline". Cathay sought to admit evidence from international affairs manager Arnold Cheng about the running of Cathay. Jetstar Hong Kong opposed this, noting Mr Cheng was only an expert on Cathay and not all airlines and thus could not speak on how to operate an airline. The tribunal in this event declined to admit Mr Cheng's evidence.

Jetstar Hong Kong noted Cathay ignored functions including hiring, crew rostering and compliance that would be performed in Hong Kong. Further, all international operations require some degree of outsourcing. Cathay sought to argue most functions, in size or importance, would not be under Jetstar Hong Kong's control. Cathay raised the communication Mr Lau has with Jetstar Group CEO Jayne Hrdlicka in Australia, but ignored the communication Mr Lau has with the other shareholders as well as locally-based board members and directors.

"It cannot possibly be said day-to-day control should lie in Australia, as urged by Cathay Pacific," Jetstar Hong Kong counsel said.

Hong Kong Airlines and HK Express left most of the arguments to Cathay

Cathay, also representing wholly-owned subsidiary Dragonair, did almost all of the speaking at the hearing. Hong Kong Airlines noted Jetstar Hong Kong's business service agreement with Jetstar in Australia allows the Australian entity to remove Jetstar Hong Kong management.

Hong Kong Airlines did not cross-examine Mr Lau while HK Express did. In response to HK Express questioning, Mr Lau confirmed six of Jetstar Hong Kong's nine A320s were sold. The aircraft were originally on Jetstar Hong Kong's books and the sale proceeds also went to Jetstar Hong Kong. Separate to the tribunal, a regulatory filing states Jetstar Hong Kong lost HKD19 million (USD2.45 million) from the aircraft's value minus sale price and transaction costs.

Mr Lau confirmed Jetstar Hong Kong pays for the parking cost of the three A320s at Airbus' factory in Toulouse but was unable to provide the exact parking cost. Mr Lau said "those aircraft are ready" to be transferred to Hong Kong and commence the certification process in the lead-up to the launch of operations, if permitted.

HK Express may have sought to show one of Jetstar Hong Kong's shareholders was footing the bill, but Mr Lau made clear the costs "sit in my book". Much of this information was in fact already public.

Cathay opposes liberalisation. Its arguments recall IATA's days of regulating sandwiches

Cathay's conservative view and wish for a narrow interpretation on principal place of business is unsurprising. Mr Barrington in his Sep-2013 letter to CAPA wrote: "In discussing air traffic rights, you quote former IATA Director General, Giovanni Bisignani, as saying they are 'archaic' in their restrictiveness and born of a very different age. We disagree with that position."

Mr Barrington explained his view that the bilateral system has "driven the huge increase in travel over the last few decades". More accurately, that increase has occurred with the rules in place, not been driven by them; it is patently clear that the massive surge in low cost travel in Asia over the past decade has been driven by liberalisation, not by adhering to the letter of the arcane bilateral principles.

At the tribunal, Cathay sought to define what airlines do, and where. This recalls IATA's 1958 decision that detailed what a sandwich could be. This followed the "sandwich wars" on the North Atlantic, where cartelised pricing existed and some airlines were breaking ranks and offering more than the stipulated "sandwich".

"...(a) [They] may be of the 'open' or 'closed' variety; (b) each to be a separate unit, the whole meal not to give the appearance of a cold plate; (c) a substantial and visible part of each unit to consist of bread, roll, or similar bread-like material; (d) each unit to be cold; (e) each unit to be simple (i.e., not complicated) and unadorned-this calls for a minimum of garnishing; (f) each unit to be inexpensive: this calls for avoidance of materials normally regarded as expensive or luxurious (such as-for example, but without limiting-smoked salmon, oysters, caviare, lobster, game, asparagus, pate de foie gras), and also for avoidance of over-generous or lavish helpings of permissible commodities, such as meats, which affect the money value of the unit and destroy the necessary conditions of low cost and simplicity."

A narrow view of where, for example, revenue management should be performed benefits Cathay the same way the IATA sandwich definition benefitted Pan American and TWA, who brought the case against European airlines that wanted to offer more generous sandwiches as a way to compete. Jetstar saw an opportunity to compete by centralising certain functions and passing the savings to consumers.

Cathay here sought to handicap rather than permit innovation. IATA was the same: TWA showed films in-flight to set it apart from peers, but IATA required TWA to offset the cost (and the competitive advantage) with a compulsory headset fee amounting to USD2.50 - or USD20 in 2015 inflation-adjusted terms.

Singapore Airlines at that time deemed IATA too limiting and did not join the association. It offered free headsets and other perks. SIA achieved gains and made economic contributions disproportionately larger than its tiny home size might otherwise have allowed. This was due to innovation rather than adhering to the constraints IATA used to stipulate - and Cathay advocated. SIA's cavalier attitude provoked an undisclosed European airline executive to tell SIA, as quoted in Christopher Clarke's Sustaining Corporate Growth, "You are a small airline from a small country. Start behaving accordingly!" A former IATA Director General notoriously described SIA as a "parasite" on the industry.

Cathay wanted Jetstar to "start behaving" (or better, go away). Instead, Jetstar Hong Kong believed it - like SIA before it - found new ways to bring additional passengers an economic and social benefit. That was more obviously a pro-Hong Kong position than Cathay asking for protection. To define an airline in this Alice-like way is like defining a sandwich; the intent - protectionism, with all the anti-consumer detriments that brings - delivers the same outcome.

Creeping economic regulation is unfortunately an infectious disease, particularly where conspicuous vested interests are at stake. Indonesia, for example, requires its airlines to adhere to one of three types of service. But Indonesia has permitted cross-border joint ventures (Indonesia AirAsia and the former Tigerair Mandala), perhaps recognising that to be low cost some functions need to be centralised. This flows in the other direction: home-grown Lion Air has established affiliates in Malaysia and Thailand, which no doubt rely on Jakarta for certain functions.

Cathay is a formidable airline with enormous professional and financial resources. It would have no difficulty in establishing a seriously powerful LCC, and at a time when the previously closed shop of North Asian aviation is opening up. Cathay stands out in the region for not having a LCC; even previous laggards like China Eastern now have one flying (China United) and several Asian carriers even have more than one.

Indonesia airline categories

Former Cathay CEO Tony Tyler supports liberalisation

After hearing about ICAO's views on principal place of business, the tribunal asked if IATA (now far departed from its cartel, sandwich-regulating days) had any views on the topic, looking at IATA as a respected, and perhaps neutral, body.

IATA has squashed the premise of restrictions and control. There is an informative remark from IATA's director-general, and this perhaps carries extra weight since the director-general is Tony Tyler, who until 2011 was CEO of Cathay Pacific.

Mr Tyler said in Dec-2014, as reported by Reuters: "At every aviation conference, everyone agrees market access controls and ownership restrictions are a bad idea and should be done away with and 'let's go to global open skies'...But it doesn't happen, and I can only think that is because...governments stifle it. That for all their high intentions, governments quite like it the way it is or at least can't think of a system they'd prefer to have."

In 2005, then-Cathay COO Mr Tyler was not pursuing aggressive liberalisation of traffic rights. He did not support the suggestion of Hong Kong-US open skies, remarking: "There are different paths toward liberalisation; Hong Kong has chosen progressive liberalisation."

Curiously, part of the Cathay argument was that the US open skies proposition was not being replicated elsewhere. As Mr Tyler said back then: "If the US model is such a success, why have countries such as China, Japan, Australia, the UK, Russia and Canada failed to adopt it?" Since then, however, most of those countries have signed significant open skies agreements.

Notably, once-protectionist Japan has gone on a liberalisation binge: in five years it has agreed to approximately 30 open skies agreements and has permitted three cross-border LCC joint-ventures (Jetstar Japan, AirAsia Japan Mk I and Spring Airlines Japan) and will likely approve a fourth (AirAsia Japan Mk II) over the next year. Mainland China may be a reluctant bilateral partner for many, but it has open skies with Japan and partial open skies with Korea. China has not approved a local cross-border JV, but its home-grown Spring Airlines has launched a cross-border JV in Japan.

If Mr Tyler's comments are indicative, departing a vested interest for a top-level overview of the industry provides a reformed view. That view identifies governments missing the opportunity to liberalise, often because they are persuaded not to. Mr Tyler's former colleagues at Cathay persuaded government to achieve the protectionism Mr Tyler now rallies against.

Singapore's liberal and adaptive policies provide reflection for Hong Kong

The question Hong Kong faced regarding Jetstar Hong Kong was whether to continue with an old, narrow (and arguably flawed) view of principal place of business or one that allows functions to be performed offshore but with control. One government that promotes agility in aviation regulation is Singapore. This is significant as Hong Kong compares itself to Singapore across a number of topics, including aviation. Most recently Hong Kong looked to provide tax incentives to lure the aircraft leasing sector, in which Singapore excels.

Hong Kong could have followed advice from Singapore. "To fully capture the benefits that LCC[s] can bring, governments would need to embrace the LCC sector and facilitate its growth," Singapore Minister for Transport Lui Tuck Yew said in 2014. Embracing the LCC sector would have to include acknowledging the cost-saving measures that make LCCs low-cost. Such measures may include functions performed offshore (but not necessarily without loss of control).

Hong Kong appears to have fallen to the over-regulation Cathay favoured by stipulating what an airline should do and where. As Mr Lui said: "Aviation needs to remain safe and secure. Governments clearly need to play a firm regulatory role in this. However, governments need to guard against over-regulation in other areas. It should instead strive to create space for their airlines and airports to respond to market changes and opportunities." The demand for local LCCs (in the plural: most markets have more than one) is a change while Jetstar Hong Kong is an opportunity to fulfil that.

Finally was the advice from Singapore to "remain nimble and far sighted to ensure that our countries can continue to reap the benefits of aviation." Gains are brought by having multiple parties and opportunities for innovation. It simply beggars belief that an additional airline - Jetstar - would be detrimental to Hong Kong's wider interests.

Former prime minister Goh Chok Tong oversaw the establishment of three LCCs in Singapore, including one - Jetstar Asia - that was a cross-border JV. Singapore Airlines has been hurt by those local LCCs (and many other factors) but Singapore as a country and hub has benefitted. To take that holistic approach, the nation was put ahead of the national carrier. Mr Goh in a 2014 speech advocated that "In formulating aviation policies, governments should look beyond the narrow interests of their national carriers. The latter approach will limit the potential that growth in the aviation sector can bring."

The obvious difference of course is that Cathay Pacific is not government-owned and so the government exposes itself to falling victim to business lobbying. Another difference is in the way that Singapore Airlines has adapted aggressively to this new environment, establishing itself across a range of competitive markets, with a group of short and long haul subsidiaries, in doing so creating a pathway for the future.

Hong Kong will face more dilemmas about growth and liberalisation. Protective delaying tactics are not an end, but they do hurt competitors

While Hong Kong debated the validity of a single airline, AirAsia co-founder Tony Fernandes was pushing regulators further by advocating the lifting of foreign ownership controls from 49%. Mr Fernandes said in a 22-Jan-2015 interview with Bloomberg: "For me, the next step is to try and get consolidation on the line, to try and push ownership up beyond our 49%. As the ASEAN economic region becomes an economic union...you know banks can own 100% of ASEAN telecommunications companies...Airlines are the next stage." This would surely be too much for North Asian regulators right now.

Southeast Asia will likely continue for some time to be the more vibrant market - and reap the rewards. Thailand for example has had an unpleasant 2014. Political instability and Chinese worries caused international visitors numbers to drop 7% in 2014. Yet Thailand's numerous LCCs - including foreign cross-border JV ones - created a growth story. As CAPA previously wrote:

Across the six AOT airports total LCC traffic increased by 23.4% to 35 million passengers. Domestic LCC traffic was up a staggering 31.8% to 23.8 million passengers while LCC international traffic was up 8.8% to 11.2 million. The international growth, while relatively modest compared to prior years, shows LCCs were able to buck the overall trend as total visitor numbers declined.

Halfway around the world, the trans-Atlantic market is experiencing low single-digit growth despite the absence of negative events. LCC Norwegian Air Shuttle is being obliged to stagnate as three global alliances account for the vast majority of trans-Atlantic capacity. Norwegian already serves the US on its Norwegian licence but wants licensing for an Irish unit. The Ireland-based airline(Norwegian Air International) will have more favourable traffic rights to markets other than the US, and Norwegian would ideally like to consolidate licenses. The big three major US airlines (which between them will account for half of the world industry's 2015 profits) have mounted a challenge similar to Jetstar Hong Kong in finding excuses to protect their vested interests - while the European Commission has argued loudly that the US Department of Transportation is in breach by delaying the approval.

In South Africa, incumbent Comair objected to the launch of LCC FlySafair. While FlySafair was ultimately successful and launched, it was significantly delayed, as was SkyWise. African LCC group fastjet has been able to launch cross-border JVs but not in the key markets of Kenya and South Africa.

See related reports:

See video of panel discussion from CAPA's world aviation summit in Antwerp: The Essential Question: Where is Liberalisation Heading?

Cherry-picking liberalisation can be a useful strategy for a company; but not for the marketplace

The greatest irony is that Cathay owes its success to liberalisation but seeks to restrain it where it might erode its market position. 60% of the airline's traffic is sixth freedom, itself a form of liberalisation not contemplated by the bilateral system so admired by Cathay. For decades sixth freedom traffic was a shady practice and only became mainstream in the late 1980s. Until then it was considered an "abuse" of third and fourth freedom rights which formed the basis of the bilateral structure. KLM was so reliant on this traffic it listed on the New York Stock Exchange in a bid to placate American regulators, as recounted in Marc Dierikx's Clipping the Clouds. US regulators wanted to curtail KLM's size to reflect the true number of origin and destination passengers, but KLM refused to disclose where its passengers originated.

Cathay sought to promote the argument that Jetstar Hong Kong was in prima facie contravention of the Basic Law. But in reality the interpretation is inevitably a highly subjective one just as Cathay's was when it pushed for the sixth freedom interpretation that has allowed its remarkable success. Cathay's accomplishments have elevated Hong Kong, just as Singapore Airlines' have in that island nation. The time was ripe for further evolution that would have generated gains for Hong Kong and reinforced its aviation hub.

Hong Kong here had the opportunity to show the way for foreign regulators grappling with similar issues. If regulators took the wider view of supporting the public interest and not narrow, arcane interpretations (which happened to support vested interests, the decision would have clearly and quickly been in Jetstar Hong Kong's favour.

Hong Kong is struggling to position itself in a wider and changing world. In aviation it is falling behind, as seen with the lengthy third runway approval. Given the length of the construction period, it is probably time to start planning for what is after a third runway. There is no shortage of hubs around Asia that are emerging or seeking to claim a wider market. Hong Kong is already missing out on a lot of that growth. Jetstar Hong Kong would have been one tool to continue the hub's evolution and to perpetuate the appearance of an open and forward looking marketplace.

It is inevitable Hong Kong in coming years will feel the repercussions of underwhelming planning and policy. Survival, Charles Darwin said, is granted not to the strongest or smartest but those who can adapt to change. It appears here that Hong Kong is content with its old ways. This is no recipe for the future, especially when on the doorstep of innovative hubs itching for growth, having realised the economic gains resulting from a sophisticated and liberal aviation policy.