Thailand - The Strategic View - Aviation 2017

Alan Polivnick considers the legal, regulatory and commercial issues which have arisen following Thailand’s ICAO red flag and FAA downgrade, while exploring slot and route access issues

Contributing firm

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

Thai carriers are currently dealing with the decision by the International Civil Aviation Organization (ICAO) to give Thailand a red flag and the decision by the United States Federal Aviation Administration (FAA) to downgrade Thailand to Category 2.

The replacement of the Department of Civil Aviation (DCA) with the Civil Aviation Authority of Thailand (CAAT) and its new powers and authority was a significant and necessary change.  The concerns of ICAO and the FAA and the grounds for their actions were highlighted by the difficulties in recruiting experts to retrain the examiners and inspectors and to restructure the regulation of civil aviation in Thailand.

Much of what has been done by the CAAT has been positive and has assisted in stabilising the industry’s position following the ICAO red flag and FAA downgrade.  However, the red flag and downgrade remain in force.  Efforts are being made to expedite a review by ICAO and the FAA, although the recent experience of Indonesia and the Philippines suggests this may take longer than is currently anticipated.

The downgrade and red flag have affected expansion and growth plans for full-service and low-cost carriers (LCCs), as a number of countries have curtailed access by Thai carriers.  Established carriers with routes and slots have been proportionally less affected than those seeking to expand to new destinations and increase services on recently awarded routes.  This is particularly in relation to routes between Thailand and North East Asia.  Plans for new routes to the US remain suspended until Thailand is returned to Category 1 by the FAA.  Whilst traffic between Thailand and North America is a comparatively small sector of the market, the broader impact of the FAA downgrade cannot be underestimated.

Global aviation is being reshaped by the rise of LCCs, their expansion from short to medium and long haul flights, and the dramatic and rapid rise of the ‘ME3’ Gulf carriers and their hubs.  Thailand is no exception to these influences and Thai carriers have had no alternative but to adjust their fleets, routes and focus to accommodate the changes.  Traditional connecting traffic between Australia and South East Asia and Europe has steadily moved to the ME3, and Thai Airways has had to look to other markets for growth; notably China, India and Iran.

The growth of LCCs and the competition they offer in the short and medium haul markets has also had a significant impact on the operations and profitability of full-service airlines.  This is best demonstrated by the dramatic increase in inbound Chinese passengers, many of whom fly on Thai or Chinese LCCs or charter operations.

The Association of South East Asian Nations (ASEAN) Open Skies initiative has been in force since April 2016, with ratification by Indonesia and Laos.  The significance of the movement of people and goods by air across ASEAN cannot be underestimated.  Although air traffic has grown dramatically in recent years, this has largely been in new markets, particularly the rising middle classes for whom air travel is now affordable.  The newer entrants – notably LCCs – have used franchise and other structures to circumvent restrictions on foreign ownership and control of airlines, albeit with varying degrees of success.  This business structure may limit the benefits of deregulation.

The other key issue in liberalisation is access to routes and airports.  With very few exceptions, airports across ASEAN are operating at or above capacity.  The reopening of Don Mueang Airport as Bangkok’s second airport resulted in the movement of a number of LCC operators from Suvarnabhumi; notably Air Asia.  However, the additional capacity this created at Suvarnabhumi Airport was short-lived and an accelerated expansion of the terminal and runways has recently been approved by the government.

If slot and capacity constraints continue and airlines are unable to expand to take advantage of the ASEAN Open Skies policy, liberalisation will have produced limited benefits.  The lack of a binding commitment on the part of each ASEAN member and the absence of a pan-ASEAN body to enforce such commitments are likely to ensure that for access to slots and routes, airlines remain dependent on the goodwill of governments and their desire or need to protect local flag carriers.

For Thai operators, access to slots and routes is likely to become a more significant issue in the future as route and airport capacity fails to meet demand.  The current regime allows Thai Airways a critical role in slot allocation.  It is unclear how such issues will be resolved, particularly where carriers are forced to compete for slots.  This may be more critical in the near term for domestic operators, who compete for slots at popular times, particularly morning and evening flights between Bangkok and Chiang Mai and Bangkok and Phuket. 

The issue of foreign ownership, management and control of Thai carriers remains a key issue for foreign investors.  The replacement of the DCA with the CAAT has resulted in more rigorous scrutiny of applications, and the CAAT is continuing to audit the financial statements of Thai carriers.  Although this should not have had any impact on applications, it has deterred applicants and ensured that some Thai carriers, who could have benefitted from the expertise and capital of foreign partners, have been unable to do so. 

Assuming that the current CAAT review and audit regime remains in force, the key issues for foreign investors will be to comply with the requirements for Thai domicile, ownership, management and control, whilst ensuring that the operations, standards, branding and reputation of their Thai affiliate do not diverge from those of the foreign investor’s other airline(s).  Given the FAA downgrade and ICAO red flag, this has become an even more significant issue for foreign investors.

A new Carriage by Air Act came into force in May 2016, giving effect to much of the Montreal Convention (MC99), which deals with liability for passengers and cargo.  However, the law does not give effect to the entire text of the Convention and its status relative to other laws governing carrier liability remains unclear.  This is particularly in the context of provisions in the Civil and Commercial Code restricting a carrier’s ability to limit or exclude liability, which directly contradict the provisions of MC99.

Increasing acts of ‘air rage’ and increasing numbers of abusive and violent passengers prompted a new law dealing with ‘air rage’ in 2015.  The act implements much of the Tokyo Convention but diverges in a number of key areas.  Since it came into force, enforcement has been sporadic and inconsistent.  A better understanding of the offences and the scope and jurisdiction of the new act should result in more consistent enforcement.  The publicity resulting from such enforcement may serve to moderate the growth of ‘air rage’.  Many carriers are reluctant to risk the publicity from enforcement, particularly in circumstances where their crew continued to serve alcohol to intoxicated passengers.  However, this should be balanced by the willingness of other passengers to share their views, photos and videos on social media, together with criticism of the performance of the cabin crew and pilots.

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?

The key markets are inbound flights from China and India, with the former continuing to show robust growth and demand.  This is likely to continue for the foreseeable future.  The start of services to Iran by Thai carriers later this year may increase traffic on routes between Thailand and Iran.

The ability of carriers to obtain slots at Suvarnabhumi and Phuket will also affect the growth of the sector.  The very limited availability of slots at Phuket has a direct impact on the further growth of inbound tourism, particularly given the interest from the ME3 and European, Russian, Chinese and Korean tour and charter operators.

Private jet and business aviation is likely to continue to expand, taking advantage of Thailand’s location and the increasing demand for private jets, driven by increasing wealth and the demands of corporations.

The government has designated maintenance, repair and overhaul (MRO) facilities as a focus and is seeking to create an MRO hub in Thailand.  This would be in competition with established MRO hubs in Hong Kong and Singapore.  A proposed joint venture between AF KLM Industries and Thai Airways may serve as a model for future growth.  However, the ICAO red flag and FAA downgrade may have a negative impact on these plans, particularly by comparison with established regional rivals.

The cost base in Thailand for labour-intensive MRO and component manufacturing is a key attraction and selling point.  However, recent increases to the minimum wage are likely to continue in the face of labour shortages.  This will require efforts to ensure that Thai-based MRO and aviation-related manufacturing focuses on higher-value Elaborately Transformed Manufacturing (ETM), where increasing labour costs are less critical.

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

Yes.  However, the growth in popularity of LCCs and their booking engines cannot be ignored.  As internet penetration and bandwidth increase, the use of mobile devices may affect the continued position of the GDS distribution model.

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)?

Yes.  The government has fast-tracked plans to expand Bangkok’s primary airport, Suvarnabhumi, as it is operating well beyond capacity.  Bangkok’s second airport, Don Mueang, is also undergoing expansion to meet the demand.  It is one of the busiest LCC airports in the world.

The Royal Thai Navy is expanding Utapao Airport and it is being developed as the third airport for the Bangkok area, despite its distance from Bangkok.  The airport has attracted flights from China and Russia, as well as domestic LCC services.  Its proximity to Pattaya and the manufacturing sector on the Eastern Seaboard should enable it to expand, although the existing facilities will require expansion and upgrading.

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?

No.  Thai Airways has, approximately, a 25% share and this has been declining for several years, despite ever-increasing passenger numbers at Thai airports.  Recent route suspensions and terminations, together with the inability of Thai Airways to introduce new routes as a result of the FAA downgrade and ICAO red flag, may act to continue this trend.

As noted above, the flag carrier is competing with LCCs in short and medium haul markets and with the ME3 in key connecting markets.  In the Chinese market, it is the LCCs which are driving growth and which have the greater share of traffic; full-service carriers often have little alternative but to compete on price, despite higher costs and overheads.

The ME3 are able to offer a substantially broader range of destinations in Europe, Africa and the US East Coast, taking advantage of their hub location and the opportunities from their expanding networks.  They have also begun to offer direct services to other airports in Thailand, notably Phuket, where the flag carrier offers no service.  This gives them a competitive advantage, particularly in the inbound European market.

This has reduced the connectivity offered by Thailand and Thai carriers, notably on routes connecting Australasia and South East Asia to Europe.  This had been a key sector with competitive yields and steady demand for premium products.

Perceptions of service, quality and the age of aircraft have also affected the flag carrier, particularly on routes where it competes with fellow alliance airlines and the ME3.

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?

As noted above, the key regulatory issues relate to the ICAO red flag and FAA downgrade.

The CAAT is likely to continue to take a more proactive stance than its predecessor, particularly in relation to the granting of air operator licences and to suspending or cancelling these licences for operators who fail to meet its requirements.  The CAAT has shown that it is prepared to do so and provided it continues to be as vigilant and proactive, this should ensure that Thai operators strictly comply with all regulations and requirements.

The restrictions on foreign investment are unlikely to be moderated in the near to medium term.  This has not deterred investment by foreign airlines and parties but has complicated their ability to invest.  A less restrictive approach may improve the standards of Thai operators but appears unlikely to be permitted by the government.

Thai operators, other than Thai Airways, have shown little interest in joining alliances.  NokScoot has joined the Value Alliance, an affiliation of LCCs in the region.  At this stage, it appears premature to draw any conclusions as to its effectiveness or benefits to passengers.

Current competition laws exempt State-Owned Enterprises (SOEs), including Thai Airways, from their operation.  Proposed changes to Thai competition laws removing this exemption are under consideration as part of a strengthening of the anti-competitive regime.  It is unclear whether the Cabinet would then grant Thai Airways an exemption, as appears contemplated by the current draft before the Cabinet, or exempting existing arrangements, which would include the current exemption for Thai Airways.

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 use of drones/UAVs in Thailand is comparatively low and, at this stage, not subject to specific legislation.  If their use increases, there are likely to be calls for it to be regulated.  The restrictions on the use of helicopters, which curtail their operations in Thailand, may serve as a model for regulation, although this would limit their commercial use.

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?

This is not applicable in Thailand.  There are restrictions on the age of commercial aircraft and ‘part out’ is typically done in other jurisdictions.

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 products and services offered in Thailand tend to be offered on the same terms as in other jurisdictions.

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 fall in oil prices has allowed a number of Thai carriers with marginal operations to remain in business and to become more commercially viable.  For those carriers that have taken advantage of this to upgrade their fleets, increases in oil prices can be accommodated to varying degrees.  For those carriers that have not done so and continue to operate older and less fuel-efficient aircraft, they remain vulnerable to increases in oil prices and to competitors with more fuel-efficient aircraft.

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 is a key tourist market for Thailand and the easing of sanctions has made it an attractive market for Thai carriers, who previously did not offer services to Iran, leaving Iranian carriers with a monopoly on direct flights.  The limited Thai lessor, supplier and OEM market is unlikely to be significantly affected by the easing of sanctions.  Thai companies are likely to look to their competitors to assess how best to engage with Iran.  The proposed development of an MRO hub may allow Thai service providers to offer MRO services to Iranian carriers, although this may depend on the speed and extent to which Iranian carriers modernise their fleets.

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