• Economic Regulation of UK Airports - An Overview
  • May 8, 2012
  • Law Firm: Norton Rose Canada LLP - Montreal Office
  • Introduction

    This overview discusses the regulatory regime applicable to UK airports, in particular economic regulation.

    The UK Government is currently proposing a significant overhaul and modernisation of key elements of the regulatory framework for civil aviation in the UK, which is expected to become law in the Summer of 2012.

    Our Airport Group brings together lawyers from a range of specialisations from regulatory to M&A and financing each of whom have particular experience and expertise in the airports sector. If you would like to know more about any of the information provided in this overview, or about our experience in this area generally, please contact us.


    The regulatory framework

    The regulatory framework for airports in the UK is set out primarily in the Airports Act 1986.

    The Civil Aviation Authority (CAA) is the independent aviation regulator in the UK, with responsibility for economic regulation, airspace policy, safety regulation and consumer protection. The CAA has a number of statutory duties - in particular:

    • to further the reasonable interests of users of airports within the UK

    • to promote the efficient, economic and profitable operation of such airports

    • to encourage investment in new facilities at airports in time to satisfy anticipated demands by the users of such airports

    • to impose the minimum restrictions that are consistent with the performance by the CAA of its functions

    • to take account of the UK’s international obligations as notified to it by the Secretary of State for Transport (eg, in Article 15 of the Chicago Convention and bilateral air services agreements).

    The primary instrument of economic regulation of airports is the so-called permission to levy airport charges. In general, a UK airport with an annual turnover of £1 million or more requires a permission to levy airport charges from the CAA - that is, charges on aircraft operators in connection with the landing, parking or taking off of aircraft, and charges on passengers in connection with their arrival at or departure from an airport by air. Airport charges therefore include landing charges, passenger load supplements and aircraft parking charges.

    A permission to levy charges may be revoked in certain circumstances where the airport fails to comply with a condition which the CAA has imposed on it. The permission is issued for the airport itself; it is not specific to a particular airport operator, so a new owner or operator of an airport can inherit the permission. Airports with a permission to levy charges have to pay monthly fees to the CAA; for the year from 1 May 2012 these are up to 5.40 pence per arriving passenger.


    Price control regulation for designated airports

    The UK Government is also able to designate airports for detailed price control. Broadly, an airport will be so designated where:

    • the airport has, or is likely to acquire, substantial market power

    • competition/antitrust laws may not be sufficient to address the risk that, absent regulation, the airport would increase and sustain prices profitably above the competitive level or restrict output or quality below the competitive level

    • designation would deliver additional benefits (ie, over and above competition law) which exceed the costs and potential adverse effects of such designation.

    Currently, it is only the three main London airports which are designated as subject to price caps - Heathrow, Gatwick and Stansted. For such designated airports, the CAA is required to:

    • set a price cap to limit the amount that these airports can levy by way of airport charges over a five-year period

    • impose a condition that obliges the airport to publish certain accounting information

    • impose any conditions to remedy certain types of conduct identified as operating against the public interest.

    Further information regarding the setting of price caps and conditions is set out on the next page.

    Price caps

    In essence, the price cap limits the ability of designated airports to pass on costs to their customers by way of airport charges. The cap operates as a maximum price (typically expressed as maximum average revenue yield per passenger), and it is not a guarantee that the airport will be able to charge at that level. So a designated airport could price below its cap where it wishes to or is forced to do so by commercial pressures. For instance, if the airport has excess capacity, it could reduce prices as a strategy to stimulate demand or as a necessary response to airlines threatening to switch their flights to another airport because they consider pricing at the level of the cap to be too high.

    The five-yearly regulatory process for determining price controls is a significant exercise. The CAA is required to make a reference to the UK Competition Commission for this body to consider what the maximum amounts of airport charges should be and whether the airport operator has pursued any course of conduct operating against the public interest, either in relation to its charges or operational activities. The Competition Commission’s investigation generally lasts six months; in practice, the reference needs to be made about a year before the CAA makes its final determination. The costs of any Competition Commission investigation are generally met by the airport(s) concerned.

    The CAA will then consider the Competition Commission’s recommendations (the CAA must have regard to the Competition Commission’s conclusions but is not bound by them), together with any other evidence and the need to fulfil its statutory duties as set out in paragraph 1.2 above, before issuing its final determination.

    Although not subject to regulation, in recent years expected income from unregulated activities has been taken into account in setting the level of airport charges, such that the airport operations as a whole, including services to airlines and commercial activities (eg, retail and car parking), would make no more than a reasonable rate of return. Under this “singletill” approach (as opposed to the “dual-till” approach where income from unregulated activities would not be taken into account), the profits from such activities, in particular some of the highly profitable commercial activities have in effect been used to reduce the level of airport charges to airlines.

    As with other UK regulated utility sectors, price caps for designated airports have to date generally been set on an RPI+/-X basis, based on an allowed return on the Regulatory Asset Base (RAB) - although there was a move away from this in the case of Stansted in the most recent price control determination. The price cap is thus set so as to allow a reasonable return on the RAB, comprising new and existing assets - in particular, to allow new investment to earn the cost of capital necessary for such investment to be made - after allowing for depreciation, an appropriate level of operating costs and income other than airport charges.

    The price cap has been typically expressed as a maximum allowable yield per passenger, adjusting for RPI year-on-year within the five-year period. Changes in costs and revenues and in assumed traffic volumes are addressed going forward when price controls are re-set for the following five-year period. Generally, there is no retrospective adjustment for shortfalls in income or for additional costs (except in relation to the cost of certain specified additional security requirements).

    Airport operators typically recover their allowable revenues through three types of airport fees and traffic charges: passenger fees, based on the number of passengers on board departing aircraft; landing charges, calculated in accordance with the take off weight of the aircraft and adjusted, where applicable, in accordance with each aircraft’s noise-rating and emissions, and the time of day; and aircraft parking charges, based on the duration of the ground stay and aircraft weight.

    Conditions

    The CAA can add conditions to any airport’s permission to levy charges - and in the case of the designated airports is required to impose certain mandatory conditions.

    For designated airports, the mandatory conditions cover the airport’s price controls as outlined above, and also a requirement to disclose certain information in their statutory accounts in addition to what is required by normal company law, and any need to address airport conduct found by the Competition Commission to operate against the public interest.

    The CAA can also impose discretionary conditions on any regulated airport (ie, not just designated airports). One such condition may be to extend an accounting disclosure condition as referred to in the previous paragraph to airports which are not designated.

    It is also possible for the CAA to impose a condition to address unreasonable discrimination or other forms of anti-competitive behaviour found, following investigation by it (eg, in response to a complaint by an airline), to have been undertaken by the airport. After investigating, the CAA will publish a report setting out its decision and reasons. The CAA will generally make its decision in accordance with the application of competition/antitrust rules, meaning that an airport would normally have to be found to have a dominant position within a relevant market before the CAA would consider imposing such a condition.


    Other forms of airport regulation

    There are a variety of other regulatory rules to which airports are subject, over and above the core requirements of economic regulation by the CAA which are imposed through the permission to levy charges:

    • Airports are also subject to an aerodrome licensing regime, to ensure that the operator is competent to run the airport safely from an operational point of view. There are different types of aerodrome licence, eg, public use, ordinary, permanent, seasonal and temporary licences. A public use licence will require that at all times when the aerodrome is available for the take off or landing of aircraft it is available to all persons on equal terms and conditions.

    • An EU Directive on airport charges aims to establish a common European framework and timetable for regulating the essential features of airport charges. In the UK this is implemented through the Airport Charges Regulations 2011. These rules apply to airports with more than five million passengers per year and impose certain requirements for transparency, user consultation, and non-discrimination in the setting of airport charges.

    • Another EU Directive on liberalisation of groundhandling services, implemented in the UK by the Airports (Groundhandling) Regulations 1997, imposes requirements on airports to allow third party suppliers of groundhandling services to operate on their sites and also selfhandling by airlines. The extent of the airport’s obligations under these rules increases with its size, based on categories referencing annual traffic volumes.

    • There are also rules for the allocation of take-off and landing slots, again based on EU regulation applying to congested airports, with the need for an independent coordinator to allocate the slots. At airports subject to this regime slots are typically allocated twice yearly, although grandfather rights entitle an airline to continue using the same slot in the next scheduling period provided that it has used that slot for at least 80 per cent of the previous period. Remaining slots are pooled and allocated on a priority basis to new entrants. It is also possible for slots to be traded. Slots rights at major airports, particularly Heathrow, are obviously a valuable asset for airlines.

    In December 2011 the European Commission published an “Airport Package” of legislative proposals on groundhandling and slots (as well as noise), putting forward measures to liberalise groundhandling further in order to improve the quality and efficiency of these services at airports and, as regards slots, to introduce more market-based mechanisms for the transparent trading of slots between airlines and reduce grandfather rights by raising the “use it or lose it” threshold from 80 per cent to 85 per cent.

    It is also worth noting that the UK airports sector is subject to other general forms of regulation, including competition/antitrust rules. With regard to the latter, the airport operations of BAA, the largest UK airports operator since privatisation of the industry in the 1980s, have been subject to unprecedented regulatory scrutiny and intervention in recent years. In 2007 they were referred to the Competition Commission for an in-depth market investigation, particularly in view of concerns about the effects of the absence of competition in the South East of England, as a result of the common ownership of the three major London airports by BAA. The Competition Commission ruled in 2009 that BAA should sell Gatwick, Stansted, and also one of Edinburgh or Glasgow as a result of similar concerns in relation to lowland Scotland (and also that BAA should take on certain obligations at Heathrow and at Aberdeen in Scotland for improved reporting, consultation and service quality). The full implementation of these requirements has been delayed following a series of appeals by BAA against the ruling. However, Gatwick has been sold into independent ownership (in December 2009), Edinburgh is currently in the process of being sold, and (subject to the final exhaustion of BAA’s appeal rights) the process for the sale of Stansted may commence towards the end of this year.


    Reform of the UK regulatory regime

    In January 2012 a new Civil Aviation Bill was introduced to Parliament, setting out the UK Government’s plans for modernising key elements of the regulatory framework for civil aviation in the UK.

    The main reforms proposed under the Bill are as follows:

    • The CAA’s current multiple statutory priorities would be replaced by a general duty to perform its functions in a manner which it considers will further the interests of users of air transport services regarding the range, availability, continuity, cost and quality of airport operation services. Where appropriate, the CAA would also do so in a manner which it considers will promote competition in the provision of airport operation services.

    • The current “one size fits all” approach to economic regulation based on the permission to levy charges would be replaced by a more modern flexible licensing regime where licence conditions can be tailored to the specific circumstances facing individual airports Operators of “dominant areas” located at “dominant airports” will require a licence to levy charges for “airport operation services”. A licence may include such conditions as the CAA considers necessary or expedient having regard to the risk that the airport may engage in conduct that amounts to an abuse of substantial market power in a market for airport operation services and also to its statutory duties. Such conditions may include price control provisions. A significant issue under the new regime will be whether and how price control regulation will be applied to the main London airports which are currently subject to a price cap regime as explained in section “Price control regulation for designated airports” above.

      The CAA has published a draft indicative licence for consultation, using the template of Heathrow for the purposes of providing examples of proposed licence conditions relating to current price control and public interest conditions. At the request of the Secretary of State for Transport, this includes indicative “financial resilience” conditions, being a nonexhaustive list of typical ring-fencing conditions found in other regulated sectors - for instance, a requirement to maintain a minimum credit rating (although it is acknowledged that derogations would be required initially to accommodate the existing financing arrangements of airport operators).

    • Responsibility for deciding which airports should be subject to economic regulation would be transferred from the Secretary of State to the CAA. Decisions would be taken by the CAA against specified criteria to ensure that airports are only subject to economic regulation where the benefits outweigh the costs (these criteria being essentially the same as those used under the current regime - see paragraph 2.1 above). The CAA may make a market power determination whenever it considers it appropriate to do so but, also, must do so upon request by the airport or a person with material affected interests (eg, an airline) unless the CAA has previously done so and considers that there has not been a material change of circumstances since that previous determination.

    • Stronger new civil enforcement powers would be introduced, including financial penalties (of up to 10 per cent of airport turnover) to enable the CAA to tackle poor performance more effectively.

    • A new system of appeals of CAA decisions would be established in order to improve accountability and bringing the sector more into line with other regulated utility sectors. This would include removing the current requirement for the (non-binding) Competition Commission review of charges prior to the CAA setting price controls, and instead using the Competition Commission as an appeal body with regard to contested CAA price determination decisions. The Competition Commission would also hear appeals against CAA licence modification decisions on other matters.

    • To bring it into line with other utility sector regulators, the CAA would be given full competition/antitrust powers in relation to airports, concurrently with the general UK competition authorities, in order to enable it to investigate and remedy anti-competitive behaviour by them (currently, these concurrent competition powers are limited to air traffic services).

    • Various aviation security functions would be transferred to the CAA.

    It is expected that the Civil Aviation Bill will become law in July 2012 - with implementation of the new regime to follow by early 2014.