Andreas Fankhausercovers recent growth within Switzerland’s aviation sector, including Pilatus’ development of the business jet PC-24 and advances in UAV technology, as well as increased competition from Gulf carriers faced by Swiss airlines
1. Currently, what are the main issues (strategic and political) affecting those in the aviation sector in your jurisdiction?
Following extensive stakeholder involvement, the Federal Council published a new aviation policy report on 24 February 2016. According to the report, the main aim of Swiss aviation policy is to ensure that Switzerland has optimal connections to all major European and global centres.
The three national airports in Zurich, Geneva and Basel-Mulhouse are the backbones of the international connections of Swiss air traffic. Zurich is the largest airport and the hub of Swiss International Air Lines Ltd (SWISS). During the last 10 years, passenger numbers at the three national airports increased by more than 60 per cent and reached 47 million in 2014. In the same year, air traffic accounted for more than 400,000 tons of cargo and mail. Forecasts predict an increase in the demand for air traffic services of approximately 3.2 per cent per year.
The challenges are numerous. Foreseeable capacity bottlenecks at Zurich and Geneva airports, increased competition from the Gulf carriers like Emirates, Qatar and Etihad, an unclear future of Switzerland's relations with the European Union, and environmental restrictions are the main issues that the aviation sector in Switzerland faces.
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?
Substantial growth has been generated by the manufacturing companies, including Pilatus, which are progressing in their niche markets, in spite of the strong Swiss franc and high wage costs. Over the past year, Pilatus and other manufacturers generated more than CHF 1 billion. Most manufacturing companies are likely to grow further in the year ahead.
Particularly noteworthy is the PC-24 twin-engine business jet, which is under development by Pilatus. This is the first ever Swiss-built business jet. The aircraft made its maiden flight on 11 May 2015. Certification and first deliveries are expected for mid-2017.
Growth is also anticipated in the sector of unmanned aerial vehicles or drones, where some highly innovative Swiss firms have entered the market (see question 7).
3. Does the GDS distribution model continue unchallenged as the most popular model for flight distribution?
While all major Global Distribution Systems (GDS) continue to operate in Switzerland (eg. Travelport, Amadeus, Sabre, etc.), the GDS model does not remain unchallenged. With effect from 1 September 2015, the Lufthansa Group airlines, including SWISS, introduced a globally uniform charge of CHF 16 for all bookings made through GDS. The Lufthansa Group's airlines are working on an alternative distribution channel for direct connection based on the International Air Transport Association's New Distribution Capability (IATA NDC) data-transmission standard.
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)?
As recognised by the Federal Council in its aviation policy report, Switzerland requires a clear strategy to overcome the foreseeable capacity bottlenecks at the two airports in Zurich and Geneva, but the prospect of building new runways look bleak. Dübendorf air base near Zurich has been proposed as a future relief airport, particularly for business aviation.
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 flag carrier SWISS does not have a monopoly, but still remains the most important airline in Switzerland. Of a total of 24 million passengers in 2014, SWISS carried 16 million passengers, mostly to and from Zurich airport.
The second most important airline after SWISS is the low-cost carrier EasyJet, which has a significant base at Geneva airport.
Like other airlines in Europe, SWISS faces increased competition from the Gulf carriers like Emirates, Qatar and Etihad. The Gulf states have access to large cash reserves from oil assets. This enables these states to finance high rates of airline capacity growth and offers indirect support through airport development and infrastructure. Accordingly, the Gulf carriers have gained market shares on long-haul routes to Asia, Africa and Australia, and it is to be expected that this trend continues. As announced in the aviation policy report, the Swiss government nevertheless continues its liberal policy in respect of third and fourth freedom flights to and from the Gulf region, but the Swiss government will be reluctant to grant fifth freedom flights beyond Switzerland.
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?
Already in 2005, the European Commission cleared the acquisition of SWISS by Lufthansa under the EU Merger Regulation. The Commission's clearance was conditional upon the parties surrendering slots at Zurich and Frankfurt airports and other concessions. In light of these commitments, the Commission concluded that the transaction would not significantly impede effective competition within the European Union and Switzerland.
Because of Lufthansa's acquisition of SWISS, Switzerland has been renegotiating its bilateral air service agreements with non-EU countries. Most traditional bilateral air service agreements require that the designated airlines must be substantially owned and effectively controlled by the respective states or their nationals. While the interpretation of these nationality clauses is liable to many variations, the concept does not cover a fully or majority foreign-owned airline. The nationality clause is thus a major deterrent to the international consolidation of airlines through mergers and acquisitions. To continue flying, a foreign-owned and/or controlled airline must either benefit from a unilateral waiver of the substantial ownership and effective control requirements, or obtain from the two governments concerned the renegotiation of the nationality clause and the adoption of a more liberal regime. It is against that background that more than 90 of Switzerland's bilateral agreements now contain a clause, which merely requires the designated carrier to be incorporated and to have its principal place of business in the country of designation. The current regime allows SWISS to operate air services from its Zurich hub to numerous destinations all over the world. Switzerland is likely to support liberalisation by further promoting the 'principal place of business' clauses.
In the European context, the 1999 EU-Switzerland Agreement on Air Transport, which gives Switzerland's airlines access to the EU's single market, has been put at risk. On 9 February 2014, Swiss voters narrowly approved a referendum to reintroduce quotas on the number of foreigners allowed to live and work in Switzerland. The move is difficult to reconcile with the 1999 EU-Switzerland Agreement on the Free Movement of Persons, providing for the right of EU and Swiss citizens to freely choose their place of work and place of domicile in the territories of the contracting parties. The two EU-Switzerland Agreements on the Free Movement of Persons and on Air Transport form part of seven sectoral agreements, which were negotiated and concluded as a package deal. The agreements are linked by a guillotine clause, stipulating that they can only remain effective together. If the Agreement on the Free Movement of Persons were to be terminated, the other six agreements, including the Agreement on Air Transport, would also cease to have effect half a year after receipt of the termination notice. Following the referendum, the Federal Council must draft implementing legislation within three years, but it is currently unclear how this will be done. It is also unclear whether the Federal Council will find a new arrangement with the EU. The aviation sector as a whole, including in relation to airline acquisitions and alliances, would be hampered if European market access based on the Agreement on Air Transport were no longer possible. While this scenario does not appear likely at this point, it remains to be seen whether a politically and economically acceptable solution will be found.
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?
Young and innovative Swiss companies, such as senseFly, Skybotix, Pix4D, Flyability, Fotokite or Gamaya, are at the forefront of the development of Unmanned Aerial Vehicles (UAVs or drones). In a report dated 7 February 2016, the Federal Office of Civil Aviation (FOCA) highlights that Swiss companies specialise in sophisticated civilian drones and high performance, complex systems. The two Swiss federal institutes of technology (ETH in Zurich and EPFL in Lausanne) have special expertise in robotics and microsystems, and have indeed produced most of the start-ups.
As is typical with any kind of new technology, regulations follow technical developments. So far, Switzerland has seen only a light-touch regulation in relation to small and micro UAVs: vehicles lighter than 30 kilograms are exempted from a special licence requirement and are only subject to few operational restrictions, including that they must be flown within line of sight of the remote pilot. No additional authorisation is required from FOCA if UAVs are used commercially.
However, it is likely that Switzerland will adopt any future EU regime on UAVs. The scope of the basic regulation of the European Aviation Safety Agency (EASA) is currently limited to aircraft with a maximum take-off mass of 150 kilograms or more, but the EU is looking to develop a more comprehensive regime for UAVs. On 18 December 2015, EASA published a technical opinion on the introduction of a regulatory framework for the operation of unmanned aircraft, in conjunction with the publication by the EU Commission of its aviation strategy. The EU's approach is to be commended, because the new regulation will harmonise the fragmented frameworks of the European countries. It will reduce the transactional costs for UAV manufacturers and operators in their certification and licensing efforts.
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 leasetail 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?
The residual value plays a vital role when choosing an asset to invest in, but few financing providers can confidently assess accurate residual estimates of mid-life to older aircraft. The residual risks of such aircraft undoubtedly affect the financing providers' willingness and the commercial terms to conclude leases, but there could also be lending opportunities. Lenders can protect themselves better with deal terms and conditions, for example by requiring additional collateral, shorter terms or loan-to-value pre-payments.
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?
As a new generation of commercial aircraft enter service, airframe, component and engine original equipment manufacturers (OEMs) seize greater revenue-generating opportunities in the aftermarket support. OEMs, such as Embraer (the manufacturer of the E2 Regional Jet) and Bombardier (the manufacturer of the CSeries aircraft, which SWISS has selected as the successor to its existing Avro RJ100 fleet), now offer comprehensive engineering and maintenance support on the aircraft they manufacture. These companies have moved away from their traditional focus on products to transform themselves into service-centric organisations. Independent maintenance, repair and overhaul providers (MROs) without OEM relationships may find the market an increasingly difficult place going forward.
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 historically low oil prices ought to be good news for the airline industry. However, whether an airline benefits from the fall in fuel prices depends on how much it is actually paying for it. Many airlines opt to offset potential fuel price rises through hedging contracts. If the price then goes up, the carrier benefits, but if it goes down, it ends up paying more than if it had bought it on the spot market. The trend for the first half of 2016 is that airlines are hedging now less than a quarter of their fuel needs. Some airlines, particularly in Southeast Asia, are not hedged at all – they bet that oil prices are likely to stay at similar or even lower levels. Southeast Asia is also a region that will see aggressive network and fleet expansion of new entrant airlines. However, the current low oil prices are by no means guaranteed to continue. A sudden price swing will affect financially weaker and unhedged airlines most. Lessors and suppliers might then have to deal with default and enforcement issues.
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?
Following the recent easing of sanctions, a major renewal of Iran's old fleet should now start, but because the sanctions regime is not yet fully lifted many issues remain that require a careful approach when dealing with Iranian entities. Restrictions connected with ballistic missile and human rights violations remain in place. There are a number of designations, including the Islamic Revolutionary Guard Corps, which have significant interests in Iran's economy. The US Office of Foreign Assets Control (OFAC) takes the view that Iran's second largest airline, Mahan Air, is connected to the Islamic Revolutionary Guard Corps. Any international investor must verify that its Iranian counterpart is not designated, and that the latter is not owned or controlled by entities that are designated. In addition, there is not yet any relief for US clearing banks or financial institutions who deal in USD. Although the aviation industry is largely USD-dominated, deals should be structured in a way to avoid any payments in USD. Further, any sale or lease agreement concerning US-origin commercial passenger aircraft and commercial passenger aircraft that contain at least 10 per cent US-origin content (i.e. where US-origin goods comprise more than 10 per cent of the value of the goods) require OFAC approval. This is very relevant, as most aircraft will have at least 10 per cent US-origin equipment on them. Accordingly, OFAC still has to approve major deals between Airbus and ATR on one side and Iran Air on the other side, which were announced in January and February 2016. Lessors should also be aware that repossession rights may be difficult to enforce in Iran. For now, selling is more prudent than leasing. That said, and all risks notwithstanding, there are good opportunities for aviation OEMs, lessors, suppliers and service providers who wish to do business with Iran.