Select Committee on European Union Seventeenth Report

CHAPTER 1:background

Origin of Air Service Agreements (ASAs)

11.  Civil aviation is currently supported by a multiplicity of bilateral air service agreements (ASAs), which in themselves derive from the 1944 Chicago Convention that re-affirmed the nation states' sovereignty over air space. EU Member States currently operate some 1,500 ASAs, of which the United Kingdom has 149.

12.  Bilateral air service agreements deal with the administrative provisions necessary to facilitate the operation of air services between the two states and with the economic provisions. These include the following elements:

·  points and/or routes served;

·  number of airlines which can be designated by each state to fly those routes;

·  whether there are any capacity and frequency restrictions;

·  whether "fifth freedom" rights have been granted, if any (see appendix 5 and glossary at Appendix 4); and

·  provisions for setting tariffs.

13.  The standard designation article (see box 1) requires, "that substantial ownership and effective control of that airline are vested in the Contracting Party designating the airline or in its nationals". This is commonly referred to as the nationality or ownership article. This practice—established in 1944—reflected the position of nation states at that time, the concern of such states about the security of their airspace, and the fact that most states operated a national airline.
Box 1

Original Standard Designation of the Ownership and Control—"nationality"—clause prior to the ECJ Judgments of 5 November 2002

Article 4

Designation and Authorisation of Airlines

(1) Each Contracting Party may designate in writing to the other Contracting Party one or more airlines for the purpose of operating the agreed services on the specified routes and to withdraw or alter such designations.

(2) On receipt of such a designation the other Contracting Party shall, subject to the provisions of paragraphs (3) and (4) of this Article, without delay grant to the airline or airlines designated the appropriate operating authorisations.

(3) The aeronautical authority of one Contracting Party may require an airline designated by the other Contracting Party to satisfy that authority that it is qualified to fulfil the conditions prescribed under the laws and regulations normally and reasonably applied to the operation of international air services by that authority in conformity with the provisions of the Chicago Convention.

(4) Each Contracting Party may refuse to grant the operating authorisations referred to in paragraph (2) of this Article, or impose such conditions as it may deem necessary on the exercise by a designated airline of the rights specified in Article 3(2) of this Agreement, in any case where the said Contracting Party is not satisfied that substantial ownership and effective control of that airline are vested in the Contracting Party designating the airline or in its nationals.

(5) When an airline has been so designated and authorised it may begin to operate the agreed services, provided that the airline complies with the applicable provisions of this Agreement.

Source: Department for Transport

Liberalisation of Aviation in the EU

14.  Within the European Community, the liberalisation process began in 1987 with the adoption of a first package of measures aimed at opening up the traditionally restrictive bilateral arrangements.[1] A second package agreed in June 1990 built on this foundation,[2] and a third package of measures was agreed in June 1992.[3] As a result, a single market in air transport in the European Community came into being on 1 January 1993. Box 2 summarises, using United Kingdom airlines as an example, the new freedoms available under the third aviation package.

Box 2

Third EU Aviation Package—Summary

New Freedoms from 1 January 1993

— United Kingdom airlines able to fly between other Member States without starting or ending at a British airport (so-called "seventh freedom" rights, e.g. Paris-Rome);

— Possible for United Kingdom airline to fly between destinations within another Member State, following or preceding a flight from the United Kingdom ("consecutive cabotage", e.g. London-Rome-Naples). A capacity limitation applies;

— Free setting of fares: new fares and changes in existing fares come in immediately, and all restrictions on low fares have been swept away;

— Any airline which meets uniform financial, safety and EC ownership and effective control requirements is entitled to an operating licence in any Member State where it is based;

— Charter services are included in the package for the first time. All remaining restrictions, e.g. on "seat only passengers"* have been removed;

— No special status for national flag carriers, in the form of discretionary route licensing or protection from competition on routes, is allowed.

New Freedoms from 1 April 1997

— Airlines able to fly purely internal routes within other Member States, e.g. United Kingdom airline flying Rome-Naples ("stand alone" cabotage), without restriction: any remaining regulation of national airlines for internal routes will go.

*Charter seats sold without accompanying accommodation or other services.

Source: Department for Transport

US Domestic De-regulation

15.  In the United States, the Airline Deregulation Act of 1978 ended some 40 years of rigid "public-utility" type regulation of the US domestic aviation market—the world's largest. Most economists believe that de-regulation has been a resounding success, triggering an explosion of air travel and bringing inexpensive travel within the reach of people of relatively modest means. By providing competition and incentives to innovate, de-regulation has also led to significant improvements in airline operating efficiency.

"Most important, it accelerated the shift from bureaucratically governed linear route structures to network structures based on hub-and-spoke operations. By funnelling traffic through large hub airports network carriers have reaped economies of scope and density and travellers have benefited from more frequent flights to many more destinations. Economists estimate that these and other operational efficiencies have allowed carriers to lower their costs in the United States by 25 per cent since de-regulation."[4]

Current Restrictions on Air Services Between the USA and the EU

16.  Bilateral "open skies" agreements, which govern competition between the United States (US) and 11 European Union (EU) Member States, stop short of complete liberalisation. Most important, they deny foreign entities the ability to own and control an existing (US) domestic air carrier, or to establish a new one within the US ("right of establishment")[5]; restrict important traffic rights such as a foreign (non US) carrier's right to provide domestic services ("cabotage") within the US; limit opportunities for EU airlines to wet-lease (see paragraphs 97 and 98) their aircraft into the US and impose restrictions on US government traffic and air traffic related contracts ("fly America") (see paragraph 73). Trans-Atlantic routes between the United States and the four remaining EU Member States (Greece, Ireland, Spain and the United Kingdom) are governed by bilateral agreements that are more restrictive. (See Box 3 for a summary for the differences between "open skies" and the US/UK Bermuda 2 agreement. See also paragraph 28(b), and Appendix 4 containing the glossary of terms.)

Box 3

Salient Features of an "open skies" agreement that distinguish such agreements from Bermuda 2

Under a US so-called "open skies" agreement, there is no restraint on access to the market and no capacity restrictions. There are also no restriction on 5th freedom services, i.e. airlines of both parties have the right to pick up traffic in the other state and carry it to a third country. However, "open skies" agreements do not give rights to the airlines of either party to exercise cabotage rights within the other state.

Under Bermuda 2, access to Heathrow is restricted to two airlines from each country. Routes from Gatwick, while open to all airlines of both countries, are limited in terms of the US gateways that can be served. Service frequencies are capped from both Heathrow and Gatwick and 5th freedom rights from both those two airports are limited to various named points on various named routes. There are no restrictions on services from United Kingdom airports other than Heathrow and Gatwick to anywhere in the US.

(For a summary of the key provisions of Bermuda 2, see Annex A (p97) of the Memorandum by the DETR to the ETRAC Report on Air Service Agreements between the United Kingdom and the US - July 2000.)

Source: Department for Transport

17.  In general, the following restrictions apply on air services between the USA and the EU:

·  EU carriers can fly directly to the United States only from their own country, whereas US airlines can fly generally from any "open skies" EU country to any US point; this distorts competition on trans-Atlantic routes in favour of US airlines and limits competition between European Union airlines;

·  EU carriers cannot merge without risking loss of the US traffic rights; this thwarts EU airline consolidation and further limits competition;

·  mergers of US and EU carriers have so far proved to be impossible because of US ownership and rights of establishment policies;[6] some EU airlines have settled for a looser relationship based on alliances or partnerships with US airlines; this still puts many of the potential benefits of cross-border consolidation out of reach;

·  limits on cross-border investment mean that failing EU and US carriers have restricted options for fresh capitalisation;

·  US domestic passengers are denied the benefits of foreign competition.[7]

18.  Under the US "open skies" agreements,[8] those EU Member States that have signed these agreements have ceded fifth freedom rights to American carriers, thus giving American airlines an ability to operate between EU points which is effectively a form of cabotage within the European Single Market.

EU Competition Policy and US Anti-Trust Legislation

19.  The European Commission would like to negotiate the removal of all commercial restrictions on EU-US aviation competition and investment creating a single open market encompassing the provision of air transport services not only between, but also within, Europe and the United States. This is referred to as an "open aviation area". However, according to the Brattle Report, and contrary to general belief, this open aviation area would not create new institutional or regulatory structures, and would not seek to harmonise EU and US competition policy or regulation of aviation safety,[9] security and environmental impact.[10] Nevertheless, recent press[11] reports suggest that the European Commission will be looking into the effect of anti-trust immunity currently enjoyed by certain alliances involving airlines of those EU Member States that have signed "open skies" agreements with the US. Anti-trust immunity by the US transport authorities may be granted when a non-US carrier enters into an alliance with a US carrier. The US Department of Transportation appears to grant this immunity only to alliances involving airlines of countries that sign "open skies" agreements with the US (see paragraph 32).

20.  In principle, therefore, the differences between the United States and the European Union stem largely from the fact that the United States aviation market is a single domestic market, whereas the European Union is a multi-state common market, but where the individual Member States have to date retained the privileges of independent nation states negotiating international bilateral agreements with nation states outside the European Union. Thus, whereas the granting of fifth freedom rights by European Member States on international routes within Europe effectively gives US airlines a form of cabotage within the common European market, the US domestic market can be protected by refusing to reach agreement on domestic cabotage (see box 3).

Other Aspects of Air Transport Already Covered by European Community

Legislation and Where the Community has Extensive External Competence

Slot Allocation at Community Airports

21.  On 7 December 1992, the Council agreed a Regulation[12] to standardise slot allocation procedures at Community airports. The Regulation is now due for revision in a two-stage process: the first stage, a limited "technical" revision, the second, a more radical revision. Proposals for the first stage were published in June 2001[13] and were part of a Commission strategy designed to:

·  clarify the legal nature of slots;

·  promote efficient slot allocation;

·  encourage the efficient use of slots;

·  enhance competition between incumbent carriers and new entrants; and

·  provide a stable environment for hub and spoke networks.

The first phase is limited to defining the existing situation pending the completion of a study from consultants who are due to report later this year (2003). Phase 2 will propose, as yet unidentified, changes to the existing structure. United Kingdom airlines, the United Kingdom Slots Regulator and the Government will be keen to preserve the United Kingdom's secondary market system for slot allocation. In oral evidence, the Minister expressed support for a transparent secondary market in slots e.g. at Heathrow.[14]

Ground Handling at Airports

22.  This covers a variety of airport activities including passenger check-ins, loading and unloading of luggage, operation of luggage carousels, positioning of ramps and steps, fuelling of aircraft and handling of freight and mail. The Council adopted a Directive in 1996 to liberalise ground handling services. [15]

Safety Issues

23.  Regulation EC No1593/2002 of 15 July 2002 sets out common rules in the field of civil aviation and establishes a European Aviation Safety Agency.[16]

Customs Duties, Taxes and (User) Charges

24.  Council Directive 92/12/EEC of 25 February 1992 deals with the general arrangements for products subject to excise duty and the holding, moving and monitoring of such products and the exemption of aviation fuel from excise duties covered by Council Directive 92/81/EEC of 19 October 1992.

Restrictions on Aircraft for Environmental Reasons

25.  There are several restrictions which limit the operation of aircraft including rules and procedures with regard to noise-related operating restrictions at Community airports.

The Application of Community Competition Law to Aviation

26.  The European Community's competition law is set out in:

·  Article 81, which outlaws agreements between firms which may affect trade between Member States, and which prevent, restrict or distort competition in the single market;

·  Article 82 which bans the abuse of a dominant position in the market; and

·  the Merger Control Regulation: Council Regulation 4064/89 which gives the Commission jurisdiction over mergers with a Community dimension. [17] This was subsequently modified in 1997 (Regulation 1310/97).[18]

27.  The application of Articles 81 and 82 to air transport services within the Unions is governed by Council Regulation 3975/87[19] and Regulation 3976/87.[20] This Regulation does not, however, apply to external aviation services, which remain subject to the rudimentary procedural regime set out in Articles 84 and 85 TEC.

28.  In June 1997, the Commission submitted a proposal[21] to extend Regulation 3975/87 to cover air services outside the Union. This proposal made no progress, but has most recently been revived.[22]

What this Report Addresses

29.  The Committee considered the Community's external aviation relations in 1991[23] and airline competition in 1998.[24] In this report we examine the effect of the judgments handed down by the European Court of Justice on 5 November 2002.

30.  The Court made judgments on eight cases brought by the European Commission against Austria, Belgium, Denmark, Finland, Germany, Luxembourg, Sweden and the United Kingdom.[25] There are two cases outstanding against France and the Netherlands. All Member States listed above, except the United Kingdom, have signed "open skies" bilateral air service agreements (ASAs) with the United States of America (see box 3).

31.  The Court found that:

(a)  the eight Member States had infringed Article 43 of the TEC through the ownership and control clause in their existing ASAs with the USA—the so called "nationality" clause; and

(b)  in addition, articles dealing with certain issues—such as intra-EU pricing and computer reservation systems—in the seven "open skies" ASAs were also in breach of Community law because these areas were within the exclusive competence of the Commission (see Appendix 6).

Wider Economic Background

32.  Aviation is not immune to the world downturn in economic activity, but is particularly susceptible to it. The attack on the twin towers in New York on 11 September 2001 brought about a sudden drop in passenger traffic, but this was against a background of increasing weakness in both the US airline industry and in the European airline industry. The current war in Iraq will not make it easier for the airlines to survive. IATA fears that passenger travel could drop some 15-20 per cent during this period. The past three years have been characterised as the worst crisis in the history of aviation.[26] The continued rapid rise of the low-cost carriers such as easyJet and Ryanair even in the aftermath of the terrorist attack on 11 September 2001, has only served to highlight the structural flaws in the aviation industry. There are too many airlines, particularly over the North Atlantic. A number of US airlines are in severe financial difficulty. There have been recent reports of cuts in capacity by BA, Air France and Lufthansa—the latter affected by losses made by BMI where Lufthansa has a substantial share-holding—reflecting a combination of short-term retrenchment against a longer-term weakening of the aviation market.

33.  Against this background, it could be argued that an attempt to use the ECJ judgments as a lever to bring about fuller liberalisation between the US and EU aviation markets demonstrates a poor sense of timing. However, a liberalised market is essential to bring about the restructuring of the airline industry on both sides of the Atlantic. Conversely, opting for a semi-liberalised aviation market based on the US "open skies" model will simply postpone the restructuring that the Committee believes will ultimately be necessary in order to ensure a financially stronger aviation industry in North America and in Europe. But the economic downturn, and in particular the parlous financial position of many of the airlines, will not make a negotiation between the EU and the US any easier.

34.  This report is divided into six chapters. In Chapter 2, we examine how to put right the specific breaches in Community law identified by the ECJ judgments. In Chapter 3, we consider whether or not Member States should give the European Commission a mandate to negotiate an "Open Aviation Area" with the United States. In Chapter 4, we look at the possible responses of the United States; in Chapter 5, at the problems faced by EU all-cargo operators. Finally, in Chapter 6, we give the Committee's conclusions.


35.  This report is based on an inquiry carried out by Sub-Committee B (Energy, Industry and Transport). The Membership of Sub-Committee B is given in Appendix 1 below. The witnesses are listed in Appendix 2; the Call for Evidence can be found in Appendix 3. We are grateful to all the witnesses for their evidence and particularly to those who travelled to the United Kingdom in order to give oral evidence.

36.  During the course of this inquiry the Committee made a short visit to Washington to hold informal discussions with the United States Department of Transportation, the United States Department of Justice, American Airlines, Northwest Airlines, Delta Airlines, the Air Transport Association of America and the Brattle Group. We also took evidence from Professor Button of George Mason University, Washington. We are grateful for the willingness of our American interlocutors to share their views with us. We are particularly grateful to the staff of the British Embassy, Washington, for arranging this visit and for their advice and hospitality.

  1. Finally, we should like to thank the Specialist Adviser, Professor Rigas Doganis, for his assistance during the inquiry and in the preparation of this report.

1   Council Directive 87/601 and Council Decision 87/602. Official Journal reference L374, 31 December 1987. Back

2   Council Regulations 2342/90, 2343/90, 2344/90 of 24 July 1990. Official Journal reference L217, 11 August 1990. Back

3   Council Regulations 2407/92, 2408/92, 2409/92. Back

4   The Economic Impact of an EU-US Open Aviation Area-a report by the US Consultancy, the Brattle Group, commissioned by the European Commission and published in December 2002-paragraph 1.2. Back

5   There are also restrictions in the EU-see paragraph 72 Back

6   There are also restrictions in the EU-see paragraph 72 Back

7   The Brattle Report, Executive Summary, paragraph I Back

8   The US uses a standard ASA which it calls an "open skies" agreement because it is more liberal than the older, restrictive bilateral agreements such as that between the US and the UK (see box 3). Back

9   While the US is content to accept countries that have similar levels of aviation safety, not all current EU Member States meet the US's "Level 1" rating. For example, Greece has a "Level 2" rating and the US might seek to put restrictions on Greek-registered airlines using the traffic routes to the US of "Level 1" EU Member States. Back

10   The Brattle Report, Section 1, 1.1. Back

11   European Voice, Vol XXX 27 February-5 March 2003. Back

12   Official Journal reference L14, 22 January 1993. Back

13   EM 10288/01 (now EM 14205/02) COM(2002) 623 final - amended proposal for a Regulation of the European Parliament and of the Council amending Council Regulation (EEC) No 95/93 of 18 January 1993 on common rules for the allocation of slots at Community airports. Back

14   Q 367  Back

15   Official Journal reference L272, 25 October 1996. Back

16   Official Journal reference L240/1 of 7 September 2002. Back

17   Official Journal reference L395, 30 December 1989. Back

18   Official Journal reference L180, 9 September 1997 and L40 13 February 1998.  Back

19   Official Journal reference L374, 31 December 1987. The Regulation will be replaced, as from 1 May 2004, by Regulation 1/2003. Back

20   Official Journal reference L374, 31 December 1987. Back

21   COM(1997) 218 final. Back

22   Proposal for a Council Regulation repealing Regulation (EEC) No 3975/87 and amending Regulation (EEC) No 3976/87 and Regulation (EC) No 1/2003, in connection with air transport between Community and third countries. COM(2003) 91 final.  Back

23   Conduct of the Community's External Aviation Relations, 9th Report Session 1990-91, HL Paper 39 Back

24   Airline Competition, 32nd Report, Session 1997-98, HL Paper 156. Back

25   As above (1) minus the United Kingdom. The US uses a standard ASA which it calls an "open skies" agreement because it is more liberal than the older, restrictive bilateral agreements such as that between the US and the UK (see box 3). Back

26   Comment and Analysis, Financial Times, Wednesday March 26 2003. Back

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