Mexico - The Strategic View - Aviation 2017

Carlos Sierra and Miguel Ruelas discuss Mexico’s thriving aviation sector, its evolving legislation and the ambitious development of the nation’s largest airport

Contributing firm

1. Currently, what are the main issues (strategic and political) affecting those in the aviation sector in your jurisdiction?

The most relevant political issue that might affect the aviation sector in Mexico is the prompt implementation of the new, more modern, aviation policy.  The Mexican government is currently consulting with ICAO and other entities in order to implement a more modern policy based on the needs and problems that have been evidenced in daily practice by 2017 – a hard deadline to meet.

Another issue that affects our industry is the transition from the General Directorate of Civil Aviation to the Federal Civil Aviation.  This transition is still undergoing administrative, financial and legal processes, which does not provide, at least at this moment, any assurance or certainty of it occurring in the short term.  An important issue in the agenda of the Mexican aviation industry is the correct implementation of the Cape Town Convention and its Aviation Protocol, as Mexico is currently not eligible for the economic benefits under the OECD Aircraft Sector Understanding.  Efforts are currently being conducted to correct the declarations lodged by Mexico in 2007.

2. Where has your jurisdiction seen the most growth in the aviation sector over the past 12–18 months? And, if any, where do you anticipate growth coming from during the next 12 months?

Mexico’s aviation sector has thrived in recent years and anticipated growth projections for the coming years are just as positive.  Mexico’s aviation industry focuses principally on aircraft, engine and auxiliary equipment manufacturing, making it one of the biggest players on the market.  From the late 2000s to 2014, the Gross Domestic Product (GDP) of the aerospace industry grew by more than 20% each year and reached over 1 billion USD in 2014.  From 2010 to 2014, the average Gross Domestic Product growth rate of the industry was around 21%, far higher than the GDP growth of the country.  Today, the percentage of sustained increase in these numbers has decreased from 20% to just above 10%.

The investment activities of the Aerospace industry in Mexico have diversified as it finds its way into new branches.  It has gone beyond the collocation and maintenance of foreign-owned assets in Mexico under leasing and financing structures, to developing billion-dollar manufacturing plants and technology-developing research centres.  The aerospace sector in Mexico is becoming broader and broader, as international players become aware of the benefits that Mexico can provide to them.

Today, Mexico is one of the top ten players in the aviation industry globally, which was an objective set in 2012 by the Federal Government [The Pro Aereo 2012–2020 plan].  Following the key strategies set forth therein has resulted in an increase of asset collocation in the country by developing manufacturing centres under private investment and by important economic incentives provided by Federal and some local governments.  Today, nearly every component of a plane can be manufactured in Mexico, including turbines, fuselages and sensors for jet engines, and out of the country's 31 states, 16 are home to factories that produce aeroplane parts and components.  Over 300 aerospace manufacturers have functioning working plants in Mexico as of today, and without a doubt Mexico has attracted the biggest and most relevant aerospace players in all its branches; exporting directly to the world’s leading original equipment manufacturers including Bombardier, Boeing and Honeywell.  Mexico’s aerospace industry was the fourth largest in the Americas, after the US, Canada and Brazil.  The civil aerospace segment was the most lucrative segment in Mexico, accounting for 65.1% of the total market value.

The growth of the market is expected to decelerate to a compound annual growth rate of 6.1% between 2016 and 2018.  However, these numbers are still evidencing sustained growth; the total market value is forecast to reach 9.6 billion USD in 2018, an increase of 35.2% compared to 2013 (ProMexico).  This outstanding performance is indicative of the quality and vibrancy of the industry in Mexico.  The aerospace industry is a strategic sector for Mexico’s development, as we become a country with significant competitive advantages for the establishment of new enterprises and infinite possibilities for future growth over the next years.

3. Does the GDS distribution model continue unchallenged as the most popular model for flight distribution?

We consider the GDS distribution model to be a central component of the aviation industry, though it is starting to face challenges as GDS leads to higher prices for consumers, which could be significatively lowered through the adoption of new and more innovative technology, among other factors.  Nevertheless, the Passenger Name Record (PNR) system, which is central and pivotal to the GDS distribution model, has become a standard in the industry.  However, this system does not remain unchallenged, as several problems have been raised in the past years with regulatory overlaps that occur when rules on privacy and intellectual property of certain jurisdictions prohibit the direct exchange of “confidential information” required by PNR-based systems.  Clearly, the GDS model must be revisited in order to confront the regulatory challenges set forth in an ever globalised industry. 

4. In your jurisdiction, does airport capacity require boosting and, if so (and even if not), what plans and/or processes are in place to address this (or increase or re-organise airport capacity, as the case may be)?

According to data provided by Mexico’s airport system, there are over 86 airports throughout the country.  Out of the total number of airports, 59 are equipped with the infrastructure to host international travel.  Currently, Mexico’s busiest airport, and Latin America’s second-busiest, is Mexico City’s International Airport (AICM by its acronym in Spanish).

The AICM is the nation’s most important airport in terms of number of passengers, flights and capacity.  The AICM has an average of over 32 million passengers per year and connects the Mexican capital with over 100 international destinations.  AICM numbers estimate that over 270,000 people attend the airport daily, with over 100,000 daily passengers.  With over 1,000 daily flights, the AICM can no longer sustain the average annual passenger flow growth of over 16%.  Therefore, the Federal Government, aware of the need to boost and reorganise the airport, has decided to develop and construct the New International Airport for Mexico City (NAICM by its acronym in Spanish).

The NAICM project is Mexico’s most ambitious infrastructure project of the last decade and it is predicted that the new airport will be the third-largest airport worldwide – after Heathrow and its upcoming expansion and Istanbul’s International Airport.  What has been called the world’s most modern airport plans to be the most eco-friendly and sustainable airport in the world, increasing over 100% the capacity of the current AICM.  The NAICM plans to have at its initial phase three runways which may be operated simultaneously.  The initial phase of the airport envisages a capacity of 50 million passengers per year with an average of over 130,000 passengers daily and over 1,500 daily operations.  The second phase of the project anticipates these amounts to increase to 125 million passenger capacity and 1 million operations per year.  The modern and state-of-the-art airport plans to have 90 gates with direct access to a sole terminal and 30 remote gates.  Construction of the airport has begun and plans for its inauguration are expected by 2020.

5. Does the national "flag" carrier carry the most passengers into and out of the national airports and: (a) if so, what competition exists and how significant is it?; and (b) if not, what are your thoughts on the reasons for this, and why do competing airlines have higher load factors?

The national flag carrier is Mexico’s predominant agent in the airline market.  According to statistics provided by the Secretary of Communications and Transport (“SCT” by its acronym in Spanish), Grupo Aeromexico accounts for 30% of domestic travel and 56% in the international market.  Despite their dominant position in both the international and domestic market, significant competition exists with other air carriers.  For the domestic market, Volaris, an ultra-low cost carrier accounts for 26% of the market participation, followed by Interjet – a low cost carrier – with 20%.  However, in order to understand the competition of the airline market in Mexico, it is imperative to look at the growth rate of new market participants.  The nation’s flag carrier has had a sustained growth of 8.1% in the market over the last year, but Volaris, VivaAeobus (both ultra-low cost carriers in the market which are strongly consolidating themselves in the industry) and TAR (Mexico’s newest player in the field) have had a yearly growth of 13.5%, 41.2% and 150.7%, respectively, in 2016.  These numbers evidence the ever-growing competitive market in Mexico. 

6. What trends, in terms of regulatory intervention and involvement, has your jurisdiction observed over the past 12–18 months in relation to airline acquisitions and alliances?  Do you anticipate a change in the regulatory environment of your jurisdiction during the coming 12 months, and if so, how?

Mexico has provided and enacted several laws and incentives for the aerospace industry as a whole, including airline acquisition and alliances and benefits for the manufacturing market.  Some of the most relevant are:

  1. Mexico signed the Bilateral Aviation Safety Agreement (BASA) – a component of the international Open Skies policy initiative – with over 40 countries.  This development essentially eliminates a step in the supply chain since aeronautical products no longer have to be inspected internationally before being shipped off to assembly companies.
  2. Mexico recently signed the Bilateral Air Service Agreement with the United States of America.  This new, modernised air service agreement expands opportunities for passenger and cargo carriers of both countries.  The new agreement includes unlimited market access for U.S. and Mexican air carriers, improved intermodal rights, pricing flexibility, and other important commercial rights.  The agreement removes numerical limitations on the number of airlines that could provide a passenger service in all U.S.-Mexico City pairs.  This possibility allows Cargo airlines to expand their market and opportunities by providing services to new destinations and providing services even beyond both jurisdictions.
  3. The Mexican Authority responsible for the regulation of Economic Competition and Fair Commercial practices recently authorised the economic and shareholding participation of an American airline in Mexico’s flag carrier.
  4. Mexico developed the IMMEX programme, where manufacturing in Mexico as a maquiladora under the IMMEX programme can offer tremendous benefits for virtually any foreign manufacturer.  The IMMEX programme offers foreign companies easy access to inexpensive labour, favourable tax benefits and special import/export terms under 44 free trade treaties and agreements with countries around the world.
  5. Mexico also reformed its Foreign Investment Law, permitting a higher participation of foreign invested capital in Mexican companies. 

7. What trends are being observed in relation to new technologies – such as UAVs/drones – and what impact are these technologies having on the aviation regulatory environment?

The evolution of drones seen in the last decade has been exponential, and the regulation has exhaustively tried to keep up.  This novel technology, which has soared in leisure, commercial and military practices, has deeply impacted the aviation regulatory environment.  As the aviation authority realised the lack of regulation, authorities throughout the world, including Mexico, realised the need to issue guidelines on the matter.  Mexico issued its first circular obligatoria (a binding memorandum issued by the corresponding Authority) in 2013 relevant to unmanned aerial vehicle (UAV) regulation, operation and authorisation – later revised in 2015.

Common to EU and U.S. regulations, the Mexican regulation has adopted UAV norms on five specific matters: i) the certification of the ground pilot; ii) the need for an Airworthiness certificate; iii) the corresponding registry; iv) the programme of operations; and v) the restrictions of UAV usage in certain areas, thus assuring the responsibility in tort or criminal law for their misuse.

8. Legal issues in the “lease-to-part out” market.  A major market development is the interest of investors purchasing mid–end life aircraft on lease for the purposes of making returns on a lease tail and component margin model.  What challenges are inherent in this segment of the aviation finance market, and what techniques and disciplines are required to manage the risks involved?

When dealing with the lease-to-part out market, one must understand the specific challenges of this sector within aviation finance.  Some of them are: i) being particularly careful with the in rem rights bestowed on different parts of the aircraft – as parts are separated from the fuselage and the aircraft is totally dismantled; ii) the possibility of taxes being generated; and iii) awareness over the importation regime of the aircraft prior and after to its dismantling.  Mexico established the Decree for the Promotion of the Manufacturing, Maquiladora and Export Services Industries with the objective of promoting the exportation business in Mexico.  The Decree allows the temporary importation of the necessary goods avoiding VAT used in particular industrial processes or services whose purpose is to develop, transform (dismantle) or repair foreign merchandise.

9. Manufacturer support in the new cycle of new OEM products, e.g. MRJ, E2, C-series, etc.  In an increasingly sophisticated and competitive environment, in what way is the type of OEM financial and product support for this new era of aircraft more complex and far-reaching than in previous cycles?

The ability to support OEM products, where a company produces a specific part or subsystem used in someone else’s end product, has diversified the aviation industry as a whole.  It is in fact one of the Mexican aeronautical industry’s biggest strengths.  This new feature has resulted in manufacturers having the opportunity to lower their production costs in an adverse economy.  This leads to even more financial possibilities for the industry, for two reasons: i) as production costs decrease in this modality, the affordability and accessibility of aircraft and spare parts increases; and ii) it allows aircraft to have a strong supply of parts and engines, amongst other elements, permitting aircraft to be better maintained and granting new players access to the airline business.

10. The advent of cheaper oil and the knock-on effects.  What are the consequences that arise as a result of the unexpected purchasing power of a number of third/fourth-tier airlines? What will challenge lessors and suppliers in particular as they are faced with speculative judgments on an airline's longer-term financial viability?

The current sustained decrease in oil prices compared to the elevated prices in other decades has positively reflected on the financial viability of airline companies.  As oil has always represented one of the airlines’ biggest expenses, operational costs have substantially decreased.  This has resulted in a positive and healthy ambiance for the airline market, permitting new players and airlines to start playing in a market characterised by high barriers and high investment costs.  This domino effect has produced a greater demand for aircraft for lessors and suppliers.  It is important to mention that apart from oil prices, many other factors are taken into account when assessing the financial stability of an airline.  Eligibility for optimal financial and leasing structures in the long run is often decided by analysing many other factors like the creditor’s risk in an airline’s jurisdiction and the overall financial planning of airlines, making lessors prepared for any speculations on one of the variables that compose the entire equation of risk calculation.

11. Iran and the market return.  What remain as barriers, including sanctions-related issues to navigate, where Iran and aerospace and aircraft transactions are concerned?  What sort of jurisdiction is Iran from a risk perspective, and what techniques from a supply perspective are likely to be needed so that Iran's potential and promise for OEMs, lessors, suppliers and service providers is realised and does not become the latest example of a disappointing gold rush?

Iran’s return to the world market represents infinite possibilities for investment both in Iran and abroad.  Regarding Iran’s aerospace market and aircraft transactions, several issues remain that must be dealt with before speaking of a total sanction relief.  First, Iran must comply with and sign the corresponding bilateral air agreements with multiple nations, including, and most importantly, with the European Union, which as of the date of this publication has not placed Iran’s flag carrier on its Air Safety List.  Second, regarding aircraft transactions, clear financial schemes that comply with Shari’ah law – while they clearly exist – must be introduced to the financiers and lessors in order for them to understand the specificities of such a particular jurisdiction.  Finally, as Iran opens and the market opens up to Iran, risk assessments are to be made and effectuated in order to provide assurance to lessors and suppliers alongside such a promising scenario.  Subscription to the Cape Town Convention by the Republic of Iran would definitely pave the road to the goldmine that this country is to the aircraft industry due to its large population and favourable geographical characteristics.

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