The impact of COVID-19 (“Coronavirus”) on aviation is becoming more pronounced by the day, with the International Air Transport Association (“IATA”) yesterday asking that airport slot allocation rules be suspended to prevent airlines from losing their take-off and landing slots on the basis of failure to meet the required 80% usage rates, as flights continue to be cancelled globally. About 54 countries, including the US, have now introduced travel restrictions to China and the wider Asia/Pacific (“APAC”) region.
Leasing has been a staple of the aviation industry for more than 40 years, and has become increasingly attractive to the shipping industry over the last five years, particularly given the scarcity of traditional bank finance.
Until 2017, Chinese money was the dominant force – particularly in aviation finance. However, the Chinese government has since put pressure on domestic corporations to sell assets and deleverage. With Chinese money no longer so readily available, a product that was better known in aviation (and container box leasing) has become increasingly common in shipping over the last few years: the Japanese Operating Lease (more commonly known as the “JOL”).
The JOL has been a feature of aviation financing for nearly 20 years. Common in the wider maritime sector, there has also been a noticeable increase in the desirability of this product in the vessel-financing market over the last five years.
Traditionally, JOLs were more popular in aircraft finance because investors were comfortable with the residual value risk. Shipping, by contrast, is a much more diverse asset class, with value being a direct consequence of the country in which a ship is built and the specification of each particular vessel. Continue Reading
Aviation was exceptionally – and often uncomfortably – visible to the public eye over the course of 2019. The powerful combination of the grounding of the 737 MAX fleet as a result of tragedies and the advancing ‘flygskam’ (‘flight shame’) movement had influenced the global conversation to a significant extent by the middle of the year, which was then compounded by various airline insolvencies and an announcement from a British political party as part of an election campaign that it would investigate a complete ban on private jets from 2025.
As an asset class and as an industry, aviation has been attractive to investors for some time now, as its relative youth as a market compared to its peers and the reliability of its returns have drawn funds from all over the world. Recently, however, it has seemed that some of the features of the market we have come to take for granted have been evolving. For example, the words ‘long haul’ now bring to mind an image of the two-engined 787 Dreamliner, rather than its four-engined predecessors. The famed “double digit” returns for investors may be easing (with IATA reporting a 5.7 per cent ROI for the end of 2019), investments once considered “platinum” are now being sent for part-out, reports of ‘trade wars’ are developing on a weekly basis and we appear to be coming to the end of the era of low interest rates and oil prices.
However, we are also seeing increasing attention from new investors and ever-growing passenger demand figures which, together with the evolutions noted above, indicate a maturing market with a new set of trends being observed by aviation financiers. Continue Reading
I went to the Bath Children’s Literature Festival a couple of weekends ago, and at one of the events a very well-known illustrator mentioned that the main focus of the climate strike movement was aviation, before going on to suggest that in her opinion another industry was more particularly culpable. A hall full of primary school children (and their parents) nodded soberly – this was not news to them. They know what ‘flygskam’ means.
It is a commonplace in the press at the moment that the aviation industry is a major contributor to humanity’s carbon emissions, especially with the renewed efforts of Extinction Rebellion also hitting headlines. Private aviation is an especially soft target, with high-profile (and even royal) individuals and occasions attracting criticism for their use of corporate and personal aircraft.
The thing is, I have been trying to write this blog post for months now, hoping to be able to do some research and identify some positives to try to respond to this, but there is a dizzying amount of press coverage of the issue every week, and a bewildering number of industry reports from the last twelve months alone, and it is exceptionally difficult to find a unifying message or distil an accurate sense of the progress we are making – even if, like me, you work in the sector and are actively looking for some digestible takeaways. Continue Reading
A party should not assume that the failure of its counterpart to provide or satisfy conditions precedent gives rise to an automatic right to terminate or not perform a contingent obligation, where it could have obtained or satisfied those conditions precedent itself.
The recent Odyssey Aviation Ltd v GFG 737 Limited in the English High Court saw both the buyer and seller under an aircraft purchase agreement (the ‘APA’) claiming the deposit, as both parties attempted to terminate the APA on the basis of various alleged breaches of warranty, failure to satisfy conditions precedent and non-payment of purchase price and fees.
The case is significant for aviation sale and leasing practitioners, especially in relation the satisfaction of conditions precedent which is noteworthy for transactional lawyers more generally. It was held that a term should be implied in the APA where a party was to ‘have received’ certain documents, evidence or confirmations, or that the sale would take place ‘subject to the fulfilment’ of conditions precedent, the recipient should take ‘reasonable steps’ to obtain them themselves. This was held to be the case even where there is no express obligation to this effect. Failure to take these steps will mean that the intended recipient would not be able to rely on the other party’s failure to satisfy the condition precedent as a ground for termination. Continue Reading
The Extinction Rebellion protests in London have finally died down, after several weeks of aggravation and disruption to City commuters making their way to work, protestors gluing themselves to overground trains and grinding traffic on Waterloo Bridge and at Oxford Circus to a halt. Their execution was annoying, but they had a point. Serious remedial action needs to be taken within the next 12 years, or humans will have taken our fragile environmental state one step too far away from recovery. The automotive, rail and shipping industries have already put electrification and environmentally conscious fuel-saving on the menu. Why then has the aviation industry, known to be a development trailblazer, not yet been able to make hybridisation more readily available in the commercial aviation space?
It may well be a question of scale. Batteries used for electric cars are fairly small and therefore easier to manufacture. Overall, battery packs are heavier than their combustion engine counterparts. Aircraft-grade batteries are weighing in between 2 and 3 metric tons (that’s Range Rover heavy). This means that aircraft manufacturers will need smarter materials to reduce some weight to compensate for those heavy batteries and their cooling systems.
In recent weeks, the French airport industry has seen two major and unexpected setbacks, with the cancellation of the privatisation of Toulouse airport and the postponement of the sale of the Paris airports company.
For months, the infrastructure world has been scrutinising the French market, with all major players in the airport sector eagerly lining up for the sale of 49.99% of the shares in the Toulouse airport company, announced by its current Chinese owners, and the sale of 51% of the shares in the Paris airport company (Aéroports de Paris, ADP) announced by the French government. The size of ADP, which not only runs three of the four Paris airports (CDG, Orly and Le Bourget), but also runs eight other major airports around the world, makes this an extremely lucrative prospect for private sector investors.
However, the last two weeks have seen major and quite astonishing setbacks in both these transactions, leaving the industry in turmoil with many unanswered questions about the future of these projects. The resulting uncertainty has both political and legal implications.
On the one hand, Toulouse airport finds itself owned by a consortium that is no longer authorised to own it, leaving it in a legal quagmire that will take months to unpick. On the other hand, the sale of ADP may find itself being put out to a national referendum following a constitutional challenge using a procedure that has never been used before.
Well, sort of.
There are parallels to be drawn – I know, but indulge me for a moment. With Avengers: Endgame released this week, it’s the end of an era.
Much like the Avengers, we in aviation have lost a few of our heroes recently, and there are likely to be more losses to come. As the cover of the latest issue of Airline Economics (pictured) demonstrates, we are seeing very high airline casualty rates at the moment, with forecasts of further collapses in the short and medium term. While it has been sad to see some greats fall (although the disappearances are attributed variously to flawed business models, rising fuel prices, Brexit uncertainty and lack of funding rather than a super-villain snapping his gauntleted fingers…), and we are undeniably looking at challenges as the industry cycle begins to turn, we are also seeing this provoke some self-reflection and perhaps re-direction in the industry.
Some of this reflection relates to Earth Day, which also happened in the last week, and while the commentary on the environmental impact of aviation is more or less constant, there are moments of hope peeping through the fog. We have written before about the need to develop some sort of Tony Stark-style arc reactor to innovate out a lot of the fuel-related environmental side effects, but (if we could turn for a moment from Iron Man to Thor and his lightning bolts…) there are also increasingly viable options emerging in electric technology, which are particularly suited for countries like Australia where there are high volumes of short-haul travel, and few cost-effective options for accessing remote areas. It is predicted that we could see electric 150-seat aircraft with a 500 km range in operation before 2030, which could significantly reduce both the environmental costs of air travel and the operating costs incurred by airlines running these routes, who would gradually become less reliant on expensive and polluting aviation fuel. Innovation in this vein would be a meaningful step forward for our industry. Continue Reading
We are observing a distinct uptick in press coverage of aviation in the context of climate change discussions of various kinds at the moment. The headline item is, of course, the conversation about the proposed place of aviation within the Green New Deal plans in the United States, and what that might look like in the context of a 100 per cent carbon-neutral society, alongside clean fuels, high-speed electric rail, etc. At the industry level the conversation is centred on the new Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA), as the mandatory emissions reporting requirement kicked in on 1 January this year.
Closer to home, we are also seeing incoming lessees, lessors and financiers asking these questions when re-leasing aircraft emerging from the various recent airline insolvencies, as people query the ongoing place of the familiar EU ETS letter and seek to understand where the new CORSIA reporting requirements will need to be accommodated in lease and finance documentation, and how this monitoring will be carried out and reported in practice. The freshly updated Green Loan Principles are also raising questions in asset finance generally, as the latest advice in relation to how these principles can be applied to revolving credit facilities clarifies the options available to operators and financiers in terms of green tranches within working capital revolvers.
What seems clear from all of these discussions is that the finance aspect of the industry will be equal in importance to technological advancement if aviation is to meet the targets and regulatory regimes to which it has signed up, within the necessary time frame.
CORSIA takes a two-pronged approach to ensuring that airlines are able to cap their emissions at 2020 levels, by imposing the reporting requirements mentioned above to encourage emissions reductions in the first instance by way of transparency, but also by establishing an offsetting scheme requiring carriers to buy carbon credits from other industries that have made more progress in their reductions, thereby financing advances in other fields while aviation technology catches up. As a result, it may be the case that we see airlines seeking to use green loans or green revolver tranches to finance the purchasing of these credits, which will encourage the development and meaningful implementation of emissions reductions technologies in various industries as well as in aviation, while simultaneously making investment in aviation more attractive to financiers keen to show participation (and tangible results) in green financing.
Intriguingly, it has been suggested that CORSIA might be a source of hope to industry generally, as an example of the ways in which the ‘profit incentive’ can be mobilised for environmental good. “In short,” it has been observed, “CORSIA could catalyse a global carbon market that drives investment in low-carbon fuels and technologies” (Less Than Zero). Aviation has a real opportunity to show leadership on this issue, despite the distance yet to be covered in terms of more efficient equipment and less harmful fuel sources. And with the next generation of aviation CEOs (now as young as 10 years old and already proving to be both observant and organised: Qantas boss Alan Joyce responds to letter from 10yo CEO of Oceania Express) watching us closely, the example we set and the changes we make now will be beyond price.
It turned out to be an unhappy Valentine’s Day for the Airbus A380 and her admirers, as Airbus announced the scrapping of the A380 programme, with the last deliveries scheduled for 2021.
It’s hardly a shock, however, after the fleet’s first retirement last year and with two of them already being parted out. The economics of operating these fantastic beasts just never really made sense, however game-changing the concept (or indeed the passenger experience).
The answer to this question is just one of the many fascinating things the Reed Smith aviation finance team discussed around St Stephen’s Green this January, as members of our London, Paris and Miami teams attended aviation’s largest annual industry gathering in Dublin.
The presiding concern in discussions this year was where the industry is in its cycle. More and more money is being made available, by banks and private equity, to the point where we are now hearing that there is more money than there are aircraft to back it. We have heard, for example, of nascent leasing platforms that are fully funded but are struggling to obtain the necessary aircraft, and of end-of-life lessors/operators and cargo carriers having to take retired aircraft back out of the desert and refit them, due to the disruption caused by the necessity of keeping mid-life aircraft in service to meet capacity demands, to cover manufacturer delays affecting new aircraft and to provide assets capable of delivering the yields required by this influx of funding.
While the abundance of cash is causing certain stresses on the aircraft life cycle and pressure on margins, conference week also made it clear that this cash and those responsible for deploying it are increasingly asset-agnostic, drawn by the prospect of high single- to double-digit returns and long asset life rather than by the assets themselves. These investors tend to be already active in shipping, rail, real estate and even aerospace as they look for new opportunities in aviation. We spoke to people mandated to invest anything from US$2 to 8 billion in the industry over the next 24 months, so it seems there is quite the investment pipeline developing, with all of the attendant challenges and opportunities (and warning signs). However, it is not just about investing in ‘aviation’ across the board, but rather about finding the right airline, aircraft and region at the right time.
This combination of ready funds and potentially scarce metal, when considered in light of more macro factors relating to jurisdiction (for example, the as-yet-untested new economic substance rules in the Cayman Islands, ‘trade war’ issues, and general Brexit uncertainty), would seem to suggest that we will increasingly be seeing more asset trades rather than M&A activity, as it becomes more efficient and less risky to buy and sell the assets themselves rather than the entities or platforms that own them. (This tends to be the preferred approach in aviation, as size is not necessary for survival and M&A tends to be seller-driven – for example, in distressed situations.) This would, in some cases, include the financing arrangements attached to the asset, so that secondary debt trading may in tandem become more of a focus. The sale and leaseback market is also likely to continue apace as competition to finance and own the aircraft intensifies, with lease extensions and novations similarly continuing to tick over as operators try to hold onto or redistribute the capacity they already have.
It therefore seems that we are in for an interesting year, as new players come to prominence, financier attention shifts and grows, and we collectively deal with regional economic and political turbulence. Overall, we would say the atmosphere at the conference was wary but optimistic, and there was a general enthusiasm to tackle these emerging headwinds, as well as real enthusiasm from the financiers to get stuck in.
The answer, in case you are still wondering, is 67.
We have published our semi-annual update on developments in state and local tax affecting the aviation industry. In this update, we will focus on some noteworthy sales and use tax law changes, cases, rulings, and guidance from the second half of 2018.
Click here for a copy of the client alert.
At the end of last year I wrote a published piece entitled “The Allure of Investing in Aviation”. A client asked me this week whether, a year later, I stood by what I’d written.
To answer that, you have to decide whether or not you think 2018 was a good year for the airline industry as a whole. There were many highs, but some telling lows as well. There can be no doubt that we are still in a ‘supercycle’ of sorts, but this has to be balanced against both macro and sectoral environmental conditions.
The expectations as we headed into 2018 were that profitability would improve over the year, with 56 per cent of airline CEOs in a positive mood. However, this positivity has to be tempered by IATA’s adjustment of its own profit forecast from US$38.4 billion in December 2017 down to US$33.8 billion by June last year.
So what should investors be looking at? Is aviation still an attractive investment?
Our aviation finance team has made it to the end of its first complete year since its relaunch in summer 2017 – and it has been a big one! We have worked on transactions involving over 100 aircraft and 19 different jurisdictions, we have met with clients and friends in Dublin, New York, Hong Kong and London, and we have seen our renewed team go from strength to strength as we welcomed new members in Paris and the United States.
In a very significant, closely watched aviation product liability preemption case in the U.S. Court of Appeals for the Third Circuit, Sikkelee v. Precision Airmotive Corp., et al., No. 17-3006, 2018 WL 5289702 (3d Cir. Oct. 25, 2018), the court recently held that state law claims against type certificate holders can go forward unless the defendant can show that the FAA would not have approved a plaintiff’s proposed change to the FAA type certificate. The court held that the plaintiff’s design defect claims against Lycoming, the type certificate holder for the engine on the accident aircraft, were not conflict preempted because Lycoming was in a position to make changes to its type certificate and was unable to show that the FAA would not have approved the alternative engine design the plaintiff proposed. The court emphasized that allowing state law claims to proceed against type certificate holders complemented the federal scheme and furthers its purpose of ensuring the safety of aircraft. Accordingly, under this ruling, it appears that the only time a type certificate holder can potentially succeed with a conflict preemption defense under these circumstances is if there is clear evidence establishing that the FAA would not have approved an alternative design proposed by the plaintiff.
The dissent held that the claims were preempted and pointed out significant issues with the majority’s decision. The majority relied primarily on a U.S. Supreme Court case which held that state law claims against brand name pharmaceutical manufacturers are not preempted because the manufacturer was able to implement changes prior to receiving FDA approval. The dissent pointed out the critical distinction between that case and Lycoming – unlike a brand name pharmaceutical manufacturer, an FAA type certificate holder cannot implement design changes without prior FAA approval. Thus, the dissent held that the majority’s analysis was flawed because it would be impossible for Lycoming to independently implement the changes that the plaintiff alleged state law required. Continue Reading
A 2017 survey showed that just 3% of airline chief executives are female, against the FTSE 100’s 7% at the same time. As of the middle of 2018, only 12 of the 286 IATA member airlines were led by women – a mere 4%. And with the future of Flybe under question at the time of writing, this number may yet be reduced.
The Hong Kong conferences are over for another year, and our Aviation Finance team had another very productive week at the various sessions. It was great to see so many familiar faces and connect with new people, and doing so in what is fast becoming one of the world’s new aviation finance powerhouse jurisdictions gave the meetings a real buzz.
Aviation seems to be facing a fuel-related existential crisis at the moment, as pressures mount on the industry from various angles.
Within asset finance generally the major discussion is the looming bite of the IMO 2020 regulations, which will reduce the amount of sulphur permitted in ship fuel oil to a limit of 0.50 per cent mass by mass from 1 January 2020. Aside from the huge impact this will have on the world’s vessel owners and operators, it is also anticipated that there will be knock-on effects for aviation.
In this blog post we take a brief look at export credit agency (“ECA”) supported finance in the asset finance industry, and the development of a new template loan agreement by the UK’s Loan Market Association.
The role of the ECAs
ECA finance describes transactions where states (whether by direct sovereign bodies or by separately mandated organisations) provide (financial) support to would-be purchasers of certain goods or equipment constructed in that ECA’s home jurisdiction.
ECA support can make deals both more bankable and more affordable, and has long been a useful feature of asset and project finance. Over the last two decades, a significant amount of export credit support in the form of both guarantees and insurance has been provided to capital-intensive global projects.
With the increased capital adequacy requirements of the Basel III and Basel IV accords, the importance of the sector has continued to grow. ECAs were once seen as insurers of “last resort” and were largely confined to support high risk financings in emerging markets, with much export credit agency insurance having been counter-cyclical. Whilst the perception remains that ECA support increases in importance as traditional financiers become more reluctant to lend (and so provides a bridge where the required debt finance exceeds the available bank liquidity) they just as often will now be found providing specialised products not available elsewhere, for example political risk insurance.
The heatwave may be over but the wave of August out-of-office responses is still building, so rather than post about controversial redelivery conditions or the fascinating behaviour of interest rates, and prompted by the striking intersection of aviation and literature recently, we thought it seemed high time to offer Legal Flight Deck: The Summer Reading Edition. You’re welcome.