01-Nov-2017 7:40 PM

The great Brexit aviation debate. A transition deal is needed to avoid disaster for UK airlines

Analysis

Sixteen months after the Jun-2016 Brexit referendum, nobody in the UK government or EU can say anything at all about the details of what will happen to aviation after the UK leaves the EU in Mar-2019.

A debate moderated by leading aviation consultant John Byerley at the ACTE-CAPA Global Aviation Summit in Oct-2017 considered whether "Brexit will be a disaster for UK airlines". A range of outcomes is possible, but it will be a disaster if no replacement for the existing traffic rights regime is negotiated before the UK leaves the EU in Mar-2019. It could also be a disaster if the UK's participation in EASA does not continue.

The best possible outcome on market access would be keeping the status quo - an outcome favoured by the large majority of industry stakeholders (although some European legacy airlines expect an opportunity to limit competition from UK airlines).

However, that would appear only to be the best likely outcome, with a lesser result much more likely. It is still impossible to say how a positive outcome can be achieved, given the UK's rejection of the jurisdiction of the European Court of Justice and freedom of movement.

Meanwhile, airline planning horizons demand clarity around a year in advance, leaving very little time to negotiate an agreement - with uncertainty the almost inevitable result. A transition deal is the only practical way forward.

Summary

The details of what will happen to aviation after Brexit are still unknown, causing uncertainty for the industry.
The best outcome for market access would be maintaining the status quo, but this is unlikely due to the UK's rejection of the European Court of Justice and freedom of movement.
European legacy airlines may use Brexit as an opportunity to limit competition from UK airlines.
The UK may need to find a new and bespoke solution for market access, as existing models like Norway and Switzerland may not be suitable.
An open skies style agreement with the EU may be the best option for the UK, but it may not allow for full cabotage and removal of foreign ownership limits.
A deal on aviation safety needs to be reached before market access issues can be resolved, as safety should be the priority.

Not everyone wants the status quo on market access…

Many, if not all, of the arguments that are optimistic about the prospects for aviation post Brexit can be summed up as a kind of blind faith that it will all work out because it is in everyone's interests that it should.

However, the situation is more nuanced than that.

It may actually not be in everyone's interests to allow the same unfettered access to the EU internal aviation market to all UK airlines as they currently enjoy. Europe's big legacy airlines, such as Lufthansa and Air France-KLM, may be quite happy to use Brexit as a way to keep easyJet, for example, out of their domestic markets.

In May-2017 a group of mainly heavyweight European airlines comprising those in the Lufthansa Group, Air France-KLM, SAS, Croatia Airlines and TAP Portugal issued a position paper on Brexit. It called for regulatory convergence between the EU and the UK as a precondition for UK airlines' access to the internal aviation market.

The paper opposed cabotage rights (i.e. domestic flights) in EU countries for UK airlines, even in a transitional phase, and called for limits to their fifth freedom rights. It also argued that ownership and control rules should be strictly enforced, with UK nationals treated in the same was as any other third country nationals post Brexit (i.e. forbidden from controlling an EU airline).

… and the status quo may not be achievable, due to UK rejection of ECJ and freedom of movement

Moreover, even if everyone were to agree that it is in everyone's interest to maintain the existing traffic rights/market access scenario for all UK and EU airlines, that still has to be enabled through legally robust agreements and structures.

The UK's position on a couple of critical principles will make this hard to achieve in practice.

One of the key preconditions for full access to the EU single market, whether in aviation or any other sector, is the acceptance of the jurisdiction of the European Court of Justice. UK Prime Minister Theresa May has recently suggested that UK Courts might be able to take account of ECJ decisions, but rejection of the ECJ's supremacy is considered fundamental to the UK's referendum decision to leave the EU.

Another key precondition for single market access is the principle of free movement of people, something that UK politicians also regard as unacceptable.

Without explicit reference to aviation, the UK's government has said that it does not intend for the UK to remain in the single market after Brexit, precisely because it wants to end the ECJ's jurisdiction and freedom of movement.

The EU's single aviation market has brought significant consumer benefits

The creation and development of the EU's single market in aviation took a long time to achieve. In many ways led by the UK, the extent of liberalisation of the European aviation market is unprecedented, and still unmatched.

It led to increased competition, the emergence of low cost carriers in Europe and the subsequent evolution of legacy airline business models in response to the LCC threat.

Lower fares and a greater number of routes have been the tangible benefits to consumers of the EU's single aviation market.

The UK's exit will rip a hole that might not be plugged easily and quickly. That provides a compelling reason to ensure that the EU and the UK find a way to avoid the schism, but it still does not provide the mechanism for doing so.

Other non-EU countries have single aviation market access, but these models may not be suitable for the UK

There are European countries with important aviation activities that are not EU members, but have access to the single aviation market, notably Norway and Iceland (both members of the European Common Aviation Area) and Switzerland. Switzerland has access to the single aviation market, but without cabotage, through its own bilateral air services agreement with the EU, linked to a series of bilaterals covering other sectors.

One of these could arguably provide some sort of template for UK airlines' access to the single market post Brexit.

However, none of these were EU members before negotiating market access, and all have had to accept freedom of movement and adopt EU aviation law (without having a vote on the development of EU regulations). In addition, Norway and Iceland have had to recognise the competence of the ECJ.

There is no precedent for a former EU member state's ongoing access to the single market.

EasyJet is the UK airline with the greatest exposure to flying within and between the non-UK EU countries. It has established easyJet Europe, a subsidiary with an AOC in Austria, in order to mitigate the regulatory risk.

Nevertheless, until fully tested post Brexit, the robustness of such corporate structures cannot be 100% guaranteed. The easyJet structure seems to rely on the 33% stake in easyJet plc held by Sir Stelios Haji-Ioannou, simultaneously having both UK and EU nationality.

Meanwhile, IAG is confident that its corporate structure will ensure that British Airways remains UK-owned and its three EU subsidiaries remain EU-owned, but this confidence must be subject to at least some uncertainty.

EasyJet's action in establishing its Austrian subsidiary highlights the industry's lack of confidence in the UK's ability to negotiate a new bilateral with the EU in time to maintain existing traffic rights.

Rather than adoption of the Norway or Switzerland models, a new and bespoke solution to the market access challenges may need to be found.

An open skies style agreement with the EU may be the best that the UK can hope for

The EU and the UK will likely need to negotiate a liberal bilateral that gives mutual access to each side's airlines, perhaps along the lines of the EU-US bilateral.

However, the EU-US agreement does not allow cabotage, and keeps strict limits on the foreign ownership of airlines. Full cabotage and the removal of foreign ownership limits are effectively what distinguish the EU internal aviation market from just another open skies agreement.

Professor Rigas Doganis, aviation consultant and Chairman of the European Aviation Club, rightly identified cabotage and intra-EU flying as "the big issue" in the UK-EU negotiations.

Without accepting freedom of movement and the ECJ's jurisdiction, the UK may find that an open skies style agreement is the best that it can hope for. Even that type of agreement can take a long time to negotiate, as evidenced by the many years needed to agree the EU-US accord.

The UK will lose access to EU level bilaterals with other countries (e.g. EU-US)

At this point it is also important to remember that the UK will no longer be able to guarantee access to EU air services agreements negotiated on behalf of all member states with other countries outside the EU.

The EU-US agreement is the most important of these to the UK, which will have to negotiate a new bilateral with the US. This will need to be an open skies type of agreement in order to preserve the antitrust immunity granted by US authorities to trans-Atlantic joint ventures involving UK airlines.

However, the US may not be willing to replicate the existing EU-US agreement in full for UK airlines flying across the Atlantic. For example, will UK airlines be allowed to fly to the US from other EU countries, as they are now? Will UK subsidiaries of EU/Norway/Iceland airlines be allowed to fly to the US from the UK?

A deal on safety will be needed before market access

There has been very little public debate about the impact of Brexit on aviation, but where there has been any discussion, it has focused mainly on market access issues.

However, another area of vital importance is that of aviation safety. According to Barry Humphreys, Chairman of BKH Aviation and a veteran of the UK airline sector, the safety consequences of Brexit are the biggest threat facing European aviation.

A deal on safety must be reached before market access issues are resolved, since safety must always be the priority.

The UK is a very significant contributor to the European Aviation Safety Agency (EASA), both financially (through the EU budget and through industry participants) and in terms of its leadership on ideas and policies. EASA is an EU agency, but its membership also includes Norway, Iceland, Liechtenstein and Switzerland.

There is virtual unanimity in the industry on the need for the UK to remain in EASA, whose function would be almost impossible for the UK's Civil Aviation Authority to replicate (particularly in a manner that ensures future compatibility with European regulations as they evolve).

Again, however, the UK will need to overcome the hurdle presented by its unwillingness to accept the jurisdiction of the ECJ.

Politicians will not want to accept any risk of a reduction in safety standards, and so, there is a very powerful incentive to find a way to reconcile the need to remain in EASA with the UK's desire to leave the EU and reject the ECJ's supremacy. Again, however, it is far from clear how this can be achieved.

Other areas also need to be negotiated

In addition to market access and safety, there are many other areas that affect aviation and need a significant amount of regulatory negotiation prior to Brexit.

These include rules covering wet leasing between airlines, immigration and customs procedures and data transfer.

UK airline costs have been hit

Even before Brexit has taken effect, the cost of running a UK airline has already been hit by what has been called by Pat Byrne, Chairman of CityJet, an "uncontrolled and unwanted" devaluation of GBP as a result of the Brexit vote in Jun-2016.

This was certainly a contributory factor in the demise of the UK low cost airline Monarch Airlines (although by no means the only cause).

Time is slipping away

It may well be that everything will work out. However, matters of such complexity do not work themselves out; they need a lot of work and attention to detail.

Meanwhile, time is ebbing away.

For planning purposes, airlines need to publish their schedules a year in advance. The first IATA scheduling season post Brexit will be summer 2019, and airlines will want to have a good idea of their schedules for that season by the start of summer 2018.

That is, at the end of Mar-2018, less than five months away. And if UK airlines cannot guarantee they will be allowed to operate services 12 months later, the risk heightens that consumers will find other options; they in turn will be unwilling to risk losing forward hotel and travel bookings if they become unable to fly on a British airline. This has further repercussions along the travel chain; those international hotels are likely to demand steeper cancellation penalties when there is uncertainty about whether travellers will actually arrive.

Aviation has no WTO fallback option

It may well be in everyone's interests to come to an agreement that maintains the status quo, but the timescales have become impossible, for all practical purposes. Unlike other industries, which can continue to trade under WTO rules if no deal is reached, aviation has no fallback option.

For aviation, no deal means no flights or, at best, a return to the outdated and protectionist bilateral agreements of previous eras (if in fact they remain legally valid, itself an unknown).

A transition deal is the only practical - but temporary - solution

The only practical way to ensure that flights between the UK and the EU do not come to an abrupt halt when Brexit takes effect will be for the UK to leave through a transition period that preserves existing arrangements, giving more time to negotiate the future relationship.

A transition period for the whole UK economy has emerged as a preference for the British government, but even that needs to be negotiated.

The aviation industry is only one of a myriad of sectors in which the UK and EU need to negotiate their future relationship. As Emma Giddings, Partner at law firm Norton Rose Fullbright, said at the ACTE-CAPA Global Aviation Summit, these are not easily resolvable administrative matters.

The task ahead is enormous.