Foreign rights

The question of overseas ownership and control of carriers is a contentious one and can arouse strong nationalistic concerns

Virgin America and Qantas have put the issue of foreign ownership and control back on the agenda. Whenever this happens, the question is always whether the same well-worn arguments will produce yet another impasse, or if something new can point to a breakthrough.

Transatlantic Open Skies between Europe and the US are in urgent need of such a breakthrough, but hopes are receding again. The US Democrats made it clear before they recently took control of Congress that they would reject the Department of Transportation’s (DoT) proposed distinction between local control of an airline on strategic issues, such as military airlift, and foreign control of the same airline on commercial issues, such as routes and fares. The idea was designed to break the logjam over ownership and move Open Skies forward.

However, conceding a need for more consensus, Transportation Secretary Mary Peters shelved the DoT’s proposed interpretation. That effectively leaves talks between the European Union (EU) and the US in limbo, because Europe had linked Open Skies to a relaxation of US airline ownership and control rules so that Europeans could invest more in or launch their own US carriers. The entire issue is ripe for a fresh look.

Nearly every country limits foreign ownership or control of its airlines. Bilaterals also commonly require airlines to be owned and controlled by citizens of the nation that designates them.

Little is usually said about the policy differences between ownership of a foreign airline versus ownership of a local one. Yet, nearly all nations draw this distinction in practice, even though they may not concede it. A country simply has less interest in who owns a foreign airline that flies into it than it does in who owns its own carriers.
Aviation officials often turn a blind eye to the ownership of foreign airlines. The US, for instance, does not question the nationality of Aerolineas Argentinas, even though it uses Argentinean rights while it is effectively controlled by Spanish owners. Ownership of a foreign carrier becomes an issue mainly when local rivals complain, as when US airline objections prompted the DoT to force changes in LanEcuador’s ownership as a precondition for US flights.

Transport Canada proposes to extend this “blind eye” policy even further. It is reviewing comments on several long-term policy proposals. One of them would allow airlines designated by a foreign country under a bilateral with Canada to fly into Canada without regard to that airline’s ownership or control, so long as it has its principal place of business in that other country. In other words, Canada does not care and would never ask who owns Aerolineas Argentinas so long as it is based in Argentina. This would formalise the de facto “blind-eye” policy that is already widely practised.

In contrast, the question of who owns domestic airlines invokes quite different policies and stirs strong nationalistic concerns. Witness the recent uproar in Australia over the bid to acquire Qantas, which is perceived by many to be a foreign takeover of a national icon. A few nations apply the “blind eye” rule even in this case. As noted, Argentina allows Spanish owners to control Aerolineas merely because they own shares in a holding company that is incorporated in Argentina. By this pretext, Buenos Aires can pretend that Aerolineas is an Argentinian airline.

In a similar vein, a court in Chile recently dismissed a complaint by Sky Airlines against local rival Aerolineas del Sur, which Sky accused of being foreign-owned.

Aerolineas del Sur is indeed foreign-owned. But as the court observed, so is Sky, which is 55% German-owned. But the court did not rest its decision on that. By allowing Aerolineas del Sur the right to fly within the country, the judge reasoned, Chile creates “a good relationship with both the airlines and their respective countries. If we allow them to fly here then Chilean airlines will encounter [fewer] problems flying in other countries.”

Chile has the most open-minded aeropolitics of any Latin nation. It could not act otherwise and still be the leading voice for Latin liberalisation. Yet, the policy in most countries remains one of enforcing foreign ownership and control caps on domestic carriers.

In the case of the proposed Qantas takeover, the architects of that bid hope to create special non-voting warrants that distinguish between a bidder’s economic interest and voting rights. As proposed, foreigners would hold a 49% economic stake in Qantas, but control only 39% of the votes. The largest foreign investor, Texas Pacific Group, would have an economic stake of 25%, but hold less than 15% of the votes. Whether this will pass muster remains to be seen, because Australia defines voting power as either direct or indirect, including “arrangements or practices” that may affect actual control. Yet buyouts in other Australian companies have successfully used this approach to avoid scrutiny by the country’s foreign investment review board.

Non-voting shares, of course, have been around for ages, but their use as a way to draw critical distinctions between ownership and control in the context of airlines is relatively new.

For publicly traded airlines, Canada has taken this a step further. It has pioneered an ownership structure that can satisfy foreign caps and still attract foreign capital. Canada places a 25% cap on foreign ownership of a domestic airline, but measures that in voting rights. This effectively merges ownership and control into one test. So long as foreigners do not own more than 25% of the voting rights, they can buy as many airline shares as they like.

This led Air Canada to devise the concept of variable voting rights, which WestJet and Transat have since copied with the government’s blessing. Air Canada’s holding company created two classes of publicly listed securities: class A variable voting shares, held by foreign investors, and class B voting shares, owned by Canadian residents.
Class B shares have one vote per share. The class A shares, in aggregate, are limited to only 25% of all shareholder votes. If the number of class A shares exceeds 25% of all shares outstanding, the vote attached to each class A share drops proportionately, but the combined voting power of all class A shares stays at 25%. Thus the voting rights attached to each class A share fluctuate, giving rise to the term “variable voting rights”.

If a foreigner buys a class B share from a Canadian it instantly converts into a class A share, and vice versa when a foreign investor sells a class A share to a Canadian resident. The two classes of shares trade at the same price. As Clive Beddoe, WestJet’s chief executive, notes: “It doesn’t make any difference to the value of the stock. It’s very rare that shareholders need to vote on any contentious issue.”

A new kind of share

Under this system, it is impossible for foreigners to ever control more than 25% of the voting rights in a Canadian airline. US law imposes several caps on foreign ownership of a US airline. First, foreigners may own no more than 25% of the voting stock. Second, the airline’s president and at least two-thirds of its directors and managing officers must be US citizens. Finally, as the dispute over Virgin America underscores, the airline must be under the “actual control” of US citizens.

The DoT has developed several tests to determine “actual control”. For instance, foreigners may not own more than 49% of an airline’s equity. Other factors the DoT considers are restrictive licensing agreements; supermajority or disproportionate voting rights; veto rights; family ties between foreigners and an airline’s US officers; buyout clauses, and so on. Subject to the 49% cap on foreign equity ownership, none of these would restrict a US airline from adopting a variable voting rights scheme similar to Canada’s.

If the Europeans want US equity more than control, such an approach might help revive the stalled EU-US talks. At least it could enliven a debate that is overdue for some new ideas. ■

Source: Airline Business