On 29 March 2017, the UK Government served formal notice under Article 50 of The Treaty on European Union to terminate the UK's membership of the EU (following the June 2016 UK referendum on EU membership). Based on Article 50, the EU Treaties shall cease to apply to the UK and the UK exit will take effect in March 2019 (subject to the unlikely possibility of the withdrawal agreement being concluded sooner and unless all Member States agree to extend the period). Negotiation of a new trade agreement with the EU could take several years beyond 2019 although the Prime Minister has declared the objective of achieving such an agreement within the two-year period. This bulletin intends to briefly describe the implications of the decision from an aviation regulatory perspective.
Amidst the media excitement following the UK's decision to leave the European Union, there are few certainties about the effect on the UK and broader European aviation sector. Equally uncertain is the extent to which the air transport sector, which is international in everything that it does, is subject to considerable EU influence, and has a number of non-EU Member States participating in the current European structure, will actually change as a consequence of the decision to leave the EU. However, a few early predictions and reflections may be in order.
Among the bigger issues where the EU has affected UK aviation are the role of the EU in traffic rights and access to routes for commercial air transport services (whether within or to and from the EU) and its role in managing aviation safety. The EU also plays a significant role in many other matters, such as consumer protection. How will these issues be affected by the Brexit decision?
- We believe the European Aviation Safety Agency (EASA) is here to stay. The standards it sets are recognised worldwide on a par with the requirements of the US Federal Aviation Administration (FAA). Financiers will advance money on aircraft which hold an EASA type certificate and certificate of airworthiness. EASA's role is crucial in relation to most aspects of safety regulation including design and production of aircraft, their operation, flight crew licensing, and also oversight in relation to air traffic services.
- UK aircraft operators must comply with the EU safety rules but do at the same time benefit from recognition of licences and rights to operate throughout the EU.
- As an EU Member State, the UK participates in EASA and plays a full part in its management. So too do Norway, Iceland, Liechtenstein and Switzerland; none of them being a Member State of the EU. Countries that are not Member States of the EU are allowed to participate in the EASA processes where they have entered into agreements with the EU under which they adopt and apply EU law in the fields covered by the Basic Regulation. Such participation is not a right, but a possibility, subject to negotiation. It would therefore be open to the UK, as a non-Member State, to negotiate participation on similar terms to those other European countries and thereby to receive many of the benefits. If it does so, the existing regulatory environment could proceed.
- The disadvantage will be that, as a non-EU Member State, the UK would lose influence over the full development of the EASA legal framework. Historically these rules have been adopted through a variety of legislative processes. EASA's role is often limited to making recommendations to the Commission as to the content of regulation and advising the Commission and other European institutions on associated policy issues. Countries that are not full Member States of the EU lose power to influence the final form of regulations as they go through the remainder of the legislative process. If the UK were to seek membership of the European Economic Area (EEA), it would have some influence on future EU legislation but not to the same extent as a full Member State.
- Many readers will know that in late 2015 the Commission announced a new aviation strategy coupled with a substantial revision to the Basic Regulation. One of the important elements of the revision is to try to give EASA greater power to define regulation, by means of delegated acts, without the same level of political debate. Over time, we would expect that process to increase the role of EASA and, therefore, increase the influence of states participating in EASA.
- How the delegated acts process will function in practice must await the entry into force of the revised Basic Regulation, and views differ on just how long that will take. In the more immediate future there is real uncertainty about the degree of influence which the UK has, both as a member of EASA and as a Member State of the EU, in the legislative process that will shape the final revision to the Basic Regulation, which entails a number of major changes to the aviation regulatory structure.
- While some commentators have suggested that the UK's decision may have greater ramifications for the EU as a whole, any wider impact caused by Brexit is unlikely to have a significant effect on EASA or the current European aviation safety regime. Our prediction is that, even in the unlikely event of fundamental change to other EU institutions, the agency, which is now well established following considerable investment by the EU and its Member States, and performs an essential function, will continue to play its current role in the technical regulation process.
- Since 1993, airlines from Member States of the EU have had free access to operate commercial services throughout the EU (although the right to operate routes within another Member State was not fully implemented until 1997). This market liberalisation is without doubt one of the main factors behind the successful growth of low cost carriers such as easyJet, Ryanair and Norwegian; all having pan-European networks that extend beyond their home countries.
- Access to the single EU aviation market has also been extended to airlines based in Norway, Iceland and Liechtenstein under the EEA agreement, and subsequently to Albania, Bosnia and Herzegovina, Croatia, Kosovo, the former Yugoslav Republic of Macedonia, Montenegro and Serbia under the European Common Aviation Area (ECAA) agreement (to which also Norway and Iceland are parties). Switzerland, while not a party to the ECAA agreement, also has access to the single EU aviation market through a bilateral agreement with the EU.
- By leaving the EU, UK airlines will no longer enjoy automatic access to the single EU aviation market meaning that their rights to operate to, from and especially within the EU would need to be provided through new agreements. The importance of that access was illustrated by the disclosure, on the day of the announcement of the result of the referendum, that easyJet had written to the UK Government and the European Commission requesting that they prioritise the UK remaining part of the single aviation market, and by a number of subsequent reports about the possibility that easyJet may move its headquarters to a state remaining in the EU.
- Should the UK wish to maintain such access for its airlines, it would have to either accede to the ECAA agreement or enter into a separate agreement with the EU (similar to Switzerland). Entering into bilateral agreements with specific Member States or blocs of states of the EU could also be an option, although unlikely, and not a process which we anticipate would be favoured by the EU. Irrespective of which avenue is chosen, it could potentially become a lengthy process: by comparison it took some seven years for the Swiss agreement to be negotiated and enter into force (although it should be remembered that the Swiss bilateral agreement forms part of a package of other agreements between the EU and Switzerland). From a UK standpoint, access to the single EU aviation market may be weighed against the freedom to adopt its own regulations and policies, and the possibility of negotiating new bilateral agreements.
- With that being said, it is equally important to remember that a departure by the UK from the EU would also deprive European airlines of automatic access to the UK aviation market, a market which undoubtedly is one of Europe's most important. This should give the UK leverage in negotiating access to the EU aviation market but at what price? Most obviously, of course, would be the UK granting EU airlines reciprocal access to the UK aviation market. Other issues that may come into play could include consumer protection, security, emissions trading and commitment to the Single European Sky.
- If the EU and UK find a solution that ensures continued access for its respective airlines to the internal EU and UK aviation markets, most airlines would probably be able to continue operating as if Brexit never happened. A UK airline would likely be able to continue operations from its EU bases under its UK air operator certificate and operating licence (without having to establish local airlines), in just the same way as an EU airline can presently operate, and could continue to operate, from and within the UK.
- What will happen to the horizontal agreements that the EU has negotiated with third countries (i.e. countries not forming part of the single EU aviation market) is more difficult to predict. As an example, the UK will potentially cease to be a party to the EU-US Open Skies Agreement once it leaves the EU. Given the importance of the EU-US market generally, and the UK-US market specifically, an early solution is critical. Whether the UK would permit other EU airlines access to the UK-US market is, however, far from clear and could potentially be used by the UK to increase its own leverage in the negotiations with the EU. For that matter we cannot exclude the possibility that the US may also have reservations, especially in view of the extent to which members of the US Congress, labour organisations, airlines and even presidential candidates have questioned whether Norwegian Air International's application for a foreign air carrier permit is consistent with terms and conditions of the EU-US Open Skies Agreement.
- The above essentially boils down to two main issues. Firstly, to what extent would EU and UK airlines be allowed to operate flights to, from or within the UK and EU respectively, and whether agreements on such access also encompass controls over traffic rights to points outside the EU? Secondly, would the EU's ownership and control regulations (which provide for majority ownership and control to be vested in EU nationals) apply to UK nationals, and will the UK in such case impose similar ownership and control regulations requiring UK airlines to be majority owned and/or controlled by UK nationals?
Ownership and control limitations
- Many countries around the world have ownership and control regulations in place that, to a varying extent, restrict foreign ownership and control of their airlines. As mentioned above, the EU is no exception, in that EU nationals are required to have majority ownership and control of EU airlines.
- It seems far-fetched to expect the UK to take a more liberal stance and allow EU nationals to own or control UK airlines if the EU does not do likewise. If ownership and control limitations were to come into effect, it could significantly affect certain airlines, prompting them to restructure both on a corporate and operational level, and in some instances perhaps forcing them to give up certain routes and markets.
- If the UK-US market became reserved to UK and US operators (and other airlines that are able to negotiate fifth freedom rights), this would prevent EU airlines not only from operating flights between the UK and the US on its own, but also through a majority owned or controlled subsidiary. Such airlines would thus have to maintain a split operation (with a minority owned UK airline operating between the UK and US) should they wish to operate to the US from the UK. The same issues would probably also face UK airlines wanting to operate between the EU and the US.
- We assume that the UK wants to avoid such an outcome since it would, of course, also affect UK airlines' abilities to operate throughout the EU, as well as owning or controlling airlines in the EU. Some UK airlines have stated that they might seek to set up an airline elsewhere in the EU should Brexit become a reality; this could become complicated should the EU and UK impose ownership and control regulations against each other. As mentioned above, however, one of few things that are certain at this stage is that nothing is certain.
- Brexit could also affect consumer protection; especially passengers' right to compensation and care in connection with delayed and cancelled flights pursuant to Regulation 261/2004. As a member of the EU, UK airlines are always bound by the regulation, while third country airlines, in principle, would only be bound by the regulation on flights from an EU country.
- Although the UK historically has advocated high consumer protection standards, it is no secret that the airline industry generally believes that the burden placed on the airlines is too big; especially with regards to delays and cancellations caused by extraordinary circumstances.
- Should the UK wish to remain in the single EU aviation market, we believe it is safe to assume that the EU would require compliance with Regulation 261/2004 whether the UK becomes a member of the ECAA agreement or enters into a bilateral agreement with the EU. However, it might also be an opportunity for the UK to ease some of the requirements placed on UK airlines.
Implications for airlines from outside the EU and UK
- As a starting point third country airlines – i.e. those from outside the EU - do not have automatic access to the internal EU aviation market and the access they might have would probably not change as a matter of the UK leaving the EU. What could change though is the right to operate into the UK, at least if such right follows from a horizontal agreement between the EU and the relevant third country. Should this be the case, the UK's departure from the EU could potentially require the UK and the relevant third country to negotiate a new bilateral agreement to ensure continued market access.
- Should the UK adopt its own ownership and control regulations in a form that is similar to the EU rules, the potential implications for non-EU airlines would probably be small, since these airlines would already be subject to the EU's ownership and control regulations. That said, we note that under the new EU aviation strategy, the Commission will under certain circumstances pursue a policy of relaxation of ownership and control rules with respect to European airlines. A departure by the UK from the EU would mean that such the benefit of such relaxation would not automatically extend to UK carriers.
Banking and finance
- Brexit might have a significant impact on London as a financial centre. Brexit, and the potential loss of the UK's "passporting" into the EU, could affect the choice of London by foreign financial services firms. "Passporting", by way of EU directives, permits financial services firms authorised in one member state to conduct business in any other member state without additional authorisation. It also permits companies in one member state to offer bonds and shares to the public throughout the EEA or list them on an EEA regulated market with prospectuses complying with the home state's authority and common EEA rules. Brexit's ultimate effect on London as a financial centre will depend on the eventual form, and extent, of the UK's exit from the EU.
- The effect on the loan market will be different at each stage of the Brexit process - the initial "leave" vote, the notice given by the UK government to leave the EU, any eventual Brexit and, at each stage, any economic consequences of such actions. The notice to leave the EU itself, except as may result from the knock-on effect to the economy, is unlikely to have any immediate impact on most existing loan facilities. However, the notice will affect (and is already affecting) the market for new loan deals – in particular, lenders may wish to reassess the business case for UK borrowers that rely on EU membership or, as a result of credit committee requirements, impose currency hedging obligations, stricter financial covenants, increased pricing or a reduced term.
- It is very unlikely that the "leave" vote would trigger any material adverse change (MAC) event but it is possible that economic consequences of the vote may, depending on the facts and the specific MAC event wording, provide for a valid trigger. If, at actual Brexit, there is no longer unrestricted access to the EU market and free movement of people, this may trigger forward looking MAC events (e.g. prospects) in respect of UK-based borrowers. However, a lender would need to be extremely confident of its position before invoking any drawstop or acceleration of a facility on account of a MAC event.
- The economic consequences at each stage of the Brexit process could have an impact on a borrower's business which may, in turn, cause breaches to applicable financial covenants or, where the lender or the interbank market is severely affected, trigger market disruption clauses. If Brexit does occur then this could also have an impact on tax and increased costs provisions depending upon the eventual form of the UK's post-Brexit legal regime and its legal relationship with the EU.
- It is clearly open for the UK to seek to negotiate a position in a post-EU world which would enable aviation business to continue as it has in the years leading up to the referendum.
- As many observers have noted, this will in all probability require subscribing to the same regulatory regime and legislative requirements that pertain at present. Arguably, for the industry, that would represent limited change, but the UK's influence to determine the overall European policy direction and the detail of much of the legislation will be diminished (although its own policy freedom potentially could increase in certain areas). The outcome in terms of future access to routes, and the extent to which the UK may be able to negotiate favourable terms, will depend on many factors, not least the approach adopted by a future UK administration and the view taken by continuing Member States or European institutions about the effect of offering concessions, or of taking a hard line, on any other Member States whose electorates might be thought likely to follow the UK's example.
The range of areas within aviation affected by European regulation is broad: we have not addressed the Emissions Trading System, commitment to the Single European Sky project, or directives and regulations on such matters as groundhandling, airport charges, slot allocation or security regimes. We will be publishing further updates as the situation develops in order to assist you in assessing the wider impact of Brexit on the aviation industry.
Assistance from Sam Triggs, Nicholas Puschman, Niki Leys and Yasmin Bhatti
This article is part of our Brexit series