Research Trends and Conclusions: Aviation 2013
With the benefit of over 14 years of research and tens of thousands of votes from clients and private practitioners, Who’s Who Legal takes a closer look at developing trends in the aviation legal marketplace worldwide. We explore changes in the marketplace affecting financing and regulation.
Finance lawyers identify one of the key trends over 2012 as a diversification of the types of financing used in the aviation industry. Whereas traditionally large banks have been the major source of funding for commercial airlines, the debt market for aviation finance has become increasingly tight since the economic crisis hit in 2008. This means that there are now “fewer banks than ever” operating as primary lenders. Several of the lawyers we spoke to during the course of our research were pessimistic about the big European banks returning to the aviation financing market in the foreseeable future; there is widespread concern that stringent regulations including the new leveraging and capital requirements under Basel III will make it too difficult for banks to enter into long-term airline financing projects.
However, practitioners are seemingly unaffected by a downturn in the amount of work. Instead, lawyers active in aviation finance are simply turning their expertise to different types of financing transactions, with export credit agencies (ECAs) and enhanced equipment trust certificate (EETC) transactions remaining popular (the latter being used for the first time outside the US earlier this year). The simple fact that airlines have to plan so far in advance for long-term development and expansion means lawyers are still working on transactions planned well before the financial crisis affected the banks. Therefore, creativity on the part of lawyers has been required to be able to advise airlines on the best way to keep their portfolio active. Restructuring remains a relatively busy area, as aircraft lessors would rather keep aircraft active by coming to an alternative payment arrangement than merely park planes and allow airlines to default.
This year, even the strength of ECA funding is dubious, as practitioners warn against becoming overly reliant on government-backed financing that “cannot last forever”. It seems that the next stage is to move further towards capital markets and new private equity products to fill a potential funding gap. In fact, many leasing and licensing agreements are now drafted with provision for future capital markets activity. Japanese banks are emerging as an important alternative source of debt, with a sound exchange rate, easy access to the dollar and an “adventurous” approach to internationalisation and outward investment. CAPA, the Centre for Aviation, has recently reported on Japan’s strong presence in Asia’s “burgeoning” aircraft market which looks likely to continue on a global scale – lawyers in numerous jurisdictions reported Japan as “one to watch” in terms of aircraft financing. Irish practitioners also reported an increase in the amount of financing work seen in their jurisdiction, due in no small part to the Irish Finance Act 2011 making it more profitable from a tax perspective to carry out aircraft leasing deals using an Irish special purpose vehicle.
The overwhelming use of operating leases as a means to fund the acquisition of commercial aircraft is also useful for airlines wanting to update their planes to keep up with the latest in technology and safety standards. In this way, leases are an excellent option for emerging aviation markets such as Brazil and particularly Russia, which has recently seen a surge of fleet renewal in response to poor safety standards.
Business and private jet finance remains busy, with cash-rich clients starting to bring valuations back to their pre-crisis heights. An interesting new development noticed by practitioners this year was an increase in helicopter purchase. Because the assets are smaller and less expensive, helicopters are still attracting some financing interest from banks. Combined with the ability to build up a large portfolio relatively easily without the long-term implications of running commercial aircraft, this has led to helicopter financing becoming a more active area.
A recent controversy surrounding the global aviation market is undoubtedly the heated debate around carbon emissions regulation. The EU Emissions Trading Scheme (ETS), applicable to the aviation industry since the start of 2012, imposes what is essentially a credits system for carbon emissions on all airlines operating into and out of EU airports. Lawyers within the EU seem unconcerned with the scheme, as compliance will merely require some additional contractual clauses to ensure that airlines meet requirements and declare their carbon emissions. However, the fact that the trading system would necessarily also apply when planes are flying in non-EU airspace has been met with fierce resistance in non-EU countries including the US, China, Russia and India. Despite a 2011 ECJ ruling stating that the ETS is not to be considered an unlawful tax in breach of either customary international law or the Chicago Convention, several other countries also object to the legitimacy of the measure. In the wake of such a negative international response – China cancelled large quantities of aircraft orders from Airbus and the US Senate passed a bill in September exempting US airlines from complying with the scheme – the EU recently announced its intention to freeze the ETS for planes flying in and out of the EU. The EU Commissioner for Climate Action, Connie Hedegaard, reiterated the need for a global solution to carbon emissions regulation, and agreed to suspend the operation of the ETS to create a “window of opportunity” for the International Civil Aviation Organization (ICAO) to devise an international framework at its General Assembly in September 2013. Practitioners are hoping that the ICAO will be pressured into making provisions that are more internationally acceptable, particularly since the EU has made clear that the ETS will apply once again if the ICAO fails to do so.
The aviation industry now operates in an environment of “de facto re-regulation”, according to one US lawyer. Increased passenger protection is a strong theme in both the EU and US, as regulations boost the compensation available to consumers in case of delay or cancellation. Regulatory practitioners within the EU commented on the increased amount of time they now spend advising on compliance with passenger rights regulations such as Regulation 261/2004. Delays or cancellations in a wide array of circumstances lead to heavy penalties for airlines, with passengers often entitled to several times the cost of the ticket. Compared to rail or ferry passengers in the same situation, who will normally only receive a proportion of the journey price by way of compensation, it may seem that airlines are getting a raw deal in terms of the penalties imposed upon them. This in turn affects an airline’s ability to maintain a competitive pricing policy.
One lawyer suggested that because demand for air travel is fairly constant – people will always need to fly – the aviation industry is an easy scapegoat for political manipulation. Obviously safety considerations are paramount, but several practitioners fear that what airlines might see as over-zealous passenger rights regulations are a reaction to high-profile negative aviation incidents such as the 2009 AirFrance crash and 9/11, from which “the aviation industry has never really recovered”. This is identified as an issue particularly in the US, with stringent measures being adopted in a manner akin to “regulation by headlines”.
On the whole, aviation lawyers have had a busy year; the main trend running through our research this year is that it is the type of work that is changing rather than its volume. Because of the relative inelasticity of demand for air travel and the need to make expansion decisions many years in advance, the aviation industry itself is less susceptible to market fluctuations, at least on the transactional side. Regulatory work also remains steady – as one lawyer said, “there will always be new regulations” on which airlines need advice. Finance lawyers have had to operate more flexibly and creatively to advise airlines on alternative financing rather than traditional bank lending, but the top practitioners have not found this to be a struggle. Liability and insurance work remains in something of a slump, mostly due to continuing improvements in aircraft safety resulting in fewer catastrophes.
In turbulent financial times, keeping costs down is obviously a key consideration, and this is something that has been highlighted by many lawyers; clients are less willing to pay upfront, are demanding more information about how fees are calculated, and are generally reticent about spending a huge amount on legal fees. This is the case particularly in the Asia-Pacific region, where airlines are pushing law firms to work at a reduced rate for high-volume transactions. Insurance clients have also reacted to a drop in profitability by putting pressure on counsel to reduce their costs. However, any worries that the aviation legal marketplace is to be overtaken by in-house practitioners are seemingly unfounded, as the majority of lawyers we interviewed remain confident that there will always be enough complex work for airlines to need the wider expertise offered by private practitioners. Some of the practitioners interviewed believe that full-service firms with a breadth of expertise are more attractive to aviation clients, who often require cross-disciplinary know-how. In this way, aviation lawyers can draw on the expertise of their banking, M&A and capital markets partners without clients having to look elsewhere. However, there is certainly room in the marketplace for boutiques formed of practitioners who can offer a range of experience within a specific aviation context, and our research identifies leading lawyers across a wide range of firms, as demonstrated by chart 1.
Aviation remains an alluring area for junior lawyers to qualify into, due to the interesting subject matter and diverse range of work involved. However, most lawyers admit that the market is dominated by the “same faces” who enjoy established professional relationships with key clients. Also making it difficult for newcomers is the fact that clients look for lawyers with immediate expertise, particularly on the regulatory side, where in-depth knowledge of regulations themselves and the aviation environment as a whole is crucial. Nonetheless, the number of outstanding practitioners featured in our research continues to grow year on year, illustrating that aviation is a thriving practice area.
Overall, it has been a fairly good year for aviation lawyers. Although there is a clear trend among finance practitioners that the type of work required is changing, and clients across the board are becoming more cost-conscious, this has not excessively affected the levels of work, demonstrated by the high number of lawyers featured this year. Aviation lawyers have clearly responded well to the challenges of adapting to difficult fiscal conditions, and can expect to remain busy for the foreseeable future, keeping clients up to date with key developments within the sector.