eu slot trading Slot trading in the EU

John Pheasant, partner at Hogan & Hartson in Brussels and London, and Matthew Giles, associate at Hogan & Hartson in London, ask what role competition law has in promoting the most efficient allocation of airline slots at international airports

lots are a bundle of rights that allow transatlantic flights to American cities solely access and slot illiquidity at Heathrow and airlines to take off, land and use other from their home country as was required other airports will continue to constitute sig- Sinfrastructure at a given airport. They under previous bilateral arrangements. nificant barriers to entry for the provision of are a key input into the downstream provi- In terms of Heathrow, Open Skies will transatlantic services on the most profitable sion of air travel services. Many major car- supersede the 1977 ‘Bermuda II’ bilateral routes. This is the result of both the histori- riers therefore view slots as a particularly agreement between the US and UK which cal manner in which slots have been allo- valuable ‘asset’, especially at congested air- permits only British Airways, Virgin Atlan- cated and the privileges of use (and reuse) ports such as London Heathrow. For exam- tic, American Airlines and United Airlines to that have been bestowed upon incumbent ple, British Airways has 3,800 slots a week fly between the US and Heathrow. It should carriers under the existing allocation rules. at Heathrow (roughly 40 per cent of those be noted that the Bermuda II agreement only Currently, the allocation of slots in the available), which are estimated to have a covered Heathrow. Other airports in the UK EU is an administrative procedure gov- value in excess of €3 billion. were open to any US carrier. erned by EC Council Regulation 95/93 (as However, the demand for slots at some amended). The regulation defines slot capac- European airports vastly exceeds supply, ity available for allocation (a definition that, with the scarcity of slots seen as a major since the coming into force of Regulation obstacle to full liberalisation of the trans- Some anticipate 793/2004, also includes the use of airport atlantic air transport market. The issue is infrastructure), the process of such alloca- particularly apparent at Heathrow, where that Open Skies tion, and the supervision and monitoring of there is a severe shortage of airport slots how allocated slots are then used. available for potential new entrants – that The rights to use airport infrastructure is, carriers who, in light of the Open Skies will increase overall to operate services out of congested airports agreement signed between the United States are allocated by ‘slot coordinators’, who and the European Union, might otherwise transatlantic air have a duty to act in a transparent, neu- challenge incumbent carriers by offering tral and non-discriminatory manner. The their own transatlantic services to and from travel by as much coordinator allocates slots to applicants as Heathrow. Open Skies may have granted permissions to use the airport infrastruc- carriers the legal right to fly in and out of as 50 per cent by ture for landing and taking off during the Heathrow, but it has not facilitated actual requested period. Once this period of use access for potential new entrants. 2013 has elapsed, the carrier has a right of first In response to the problems caused by refusal to continue using the slots subject to congestion and the illiquidity in slots, the a ‘use-it-or-lose-it’ rule requiring the carrier European Commission, stakeholders and to demonstrate that it has used the slots for other regulatory bodies have been discuss- In theory, the privileged position of this at least 80 per cent of this period. ing formalising a market approach to slots small group of carriers will be terminated Only when the carrier cannot demon- to ensure that scarce airport capacity is allo- by Open Skies: any US or EU carrier will strate such required intensity of use (or cated efficiently. In light of this, it is impor- be entitled to fly directly between Heath- elects voluntarily to give up the slots) are tant to ask what role competition law has row and US destinations. As a result, some slots returned to the pool. Otherwise, the in promoting the most efficient allocation anticipate that Open Skies will liberalise the incumbent may continue to retain already of this scarce resource and whether com- lucrative transatlantic passenger market, held and employed slots. These rights are petition law can deal with anti-competitive reducing UK-to-US ticket prices by approx- known as ‘grandfather rights’ and they behaviour arising out of the use of market imately 10 per cent and increasing overall potentially enable incumbent carriers to mechanisms, however configured, for slot transatlantic air travel by as much as 50 per hold allocated slots in perpetuity. allocation and trading. cent by 2013. It is also important to note that the use- it-or-lose-it requirement is purely a quantita- Open Skies Slot allocation and illiquidity tive concept and has no qualitative aspect in The Open Skies agreement will allow any Despite the optimism, the benefits of terms of evaluating how the allocated slots EU-based airline to fly directly to any US unrestricted transatlantic competition are have been employed. Given the value of destination and vice versa (as of 31 March unlikely to be fully realised given existing slots and the access they will provide in the 2008). In particular, European airlines will congestion, access and infrastructure issues future at congested airports, there is argu- no longer be restricted from scheduling at Europe’s busiest airports. Limited slot ably a strong incentive to use allocated slots

30 global competition review eu slot trading at less than optimal efficiency (eg, by oper- ensuring that slots (whether they be new that deals only with available or new slots ating half-empty flights) rather than risking ones or those already subject to grandfather is unlikely to change the current dynamic reallocation from the pool to a competitor. provisions) were allocated to airlines that and provide credible possibilities for new This raises the question of whether other valued them most highly. Secondary trad- entrants. In particular, the retention of the carriers might make more effective use of ing, in turn, would be used once an initial grandfather rights principle will continue the slots and, if so, how to construct a sys- allocation of slots had been made, allowing to favour incumbents that have entrenched tem that deters inefficient use and ensures airlines to sell (or possibly lease) slots that positions at hub airports and that would allocation or transfer to those carriers likely they had been allocated. Such secondary have very little reason or incentive to return to employ the slots most efficiently. trading would, therefore, further increase slots to the pool for reallocation. In addi- Incumbent carriers have historically efficiency by allowing changes or correc- tion, any benefits from secondary slot trad- benefited from more-or-less free use of slots: tions to be made via the market once the ing would be reduced by a system that valuable rights to which their competitors primary allocation had been established. retains the grandfather rights approach and have had only limited access. This position restricts overall liquidity since only a small is a legacy of the days of state-run, flagship number of slots (and often those of lesser carriers that has not been addressed by pri- commercial value) would likely be subject vatisation or deregulation of the European to secondary trading. airline industry. As it stands, the principle of British Airways In short, many argue that any form of grandfather rights insulates and reinforces primary allocation that does not address the incumbent positions at hub airports and has 3,800 slots a potential distortion produced by the histori- means that there is very little slot liquidity. cal allocation (and continued possession) of Thus, at Heathrow 97 per cent of the slot week at Heathrow, slots will make very little meaningful dif- capacity is allocated (and unlikely to become ference (and might make matters worse). available), while the remaining unallocated estimated to have They suggest that only the reclamation of slots are largely unsuitable or unattrac- grandfathered slots and primary allocation tive for transatlantic operations. Although a value in excess of of time-limited rights through, for example, new entrants do receive priority when slots an auction, would result in the most efficient become available, they are very limited in €3 billion use of slots, increased competition and, in number: the loss rate for grandfathered slots turn, the greatest overall benefit to consum- is less than 0.5 per cent annually, whereas ers. increases in runway capacity and the recov- Against this, others argue that slot ery and reallocation of slots during peak and There appears to be strong support mobility should not be a goal in itself and prime periods have been very limited in the for secondary trading of slots as it would that a formalised secondary market might be past decade. formalise a practice that has been in exist- beneficial, even without the introduction of Open Skies will not address the lack of ence for several years now, at least in the a primary market mechanism. There would slots or slot illiquidity that has resulted from UK. Heathrow slots have been traded and still be benefits in establishing a secondary capacity constraints and an allocation sys- exchanged along with (often) undisclosed market as long as there are rules in place to tem that assigns slots primarily on the basis sums of money. This practice was scrutinised deal with instances of market power (as dis- of historic use. Therefore, for new entrants, in the 1999 English High Court’s judgment cussed below). However, whatever new pri- the process of building a meaningful number in R v Airport Coordination, in which the mary allocation mechanism might be chosen, of slots at congested airports will be diffi- court held that airlines have the authority it would need to be fair and defensible. This cult. Furthermore, those European airlines under Regulation 95/93 to exchange slots includes avoiding an arbitrary reallocation which currently have Heathrow slots (but and for such exchanges to be accompanied of slots: one that creates liquidity simply for were unable to serve the transatlantic routes by financial compensation. Although differ- liquidity’s sake without considering who in out of Heathrow) will have to sacrifice other ent EU member states may take alternative fact is best positioned to make the most effi- services into Heathrow if they decide to views (ie, as to whether Regulation 95/93 cient use of these valuable rights. employ (or transfer to alliance members) actually permits trading in exchange for any of their current slots for transatlantic compensation), to see slots as tradable com- Slot ownership services. modities is neither a novel idea nor a radical It has not been definitively established who leap forward. Existing rights and obligations owns slots but commentators seem to agree Slots as a tradable commodity attached to the airport slot would simply that the airlines do not have ownership Both the European Commission and expert transfer to the purchasing carrier, includ- rights. Airlines might claim that slots belong commentators have concluded that slots ing grandfather rights and use-it-or-lose-it to them because slots are an integral part could be better allocated through market obligations. of the infrastructure enabling them to offer mechanisms, including alternative primary Less clear is how primary allocation downstream services to customers. But this trading (eg, auctions) and secondary trad- would (or should) work. As noted above, argument is not recognised in law. Slots are ing mechanisms rather than through purely slots are currently allocated by reference to allocated to airlines with a ‘permission’ to administrative criteria. administrative criteria. This applies only to make use of them (potentially for an indefi- Primary trading mechanisms would be ‘new’ slots (ie, the small number of unal- nite period) but such rights are not synony- used to determine an initial allocation of located slots and those returned to the pool mous with ownership. slots with governments, airport coordina- under the use-it-or-lose-it principle); there is The better view is that airlines have tors or authorities in charge of selling (or no process of allocation (or reallocation) for rights to use defined infrastructure that is granting) the rights (or ‘permissions’ to use). slots currently held by incumbents. owned or operated under licence by airport The objective of primary trading would be Many critics of the system argue that the operators whose own rights might derive to improve the efficiency of allocation by introduction of a primary market mechanism from national property case law and legisla- www.GlobalCompetitionReview.com 31 eu slot trading

tion. The position appears to be the same in underlying rights (be they member states or its national equivalents) might be limited the US where the aviation regulator (Federal airport operators) should not undermine in its applicability (ie, transactions involv- Aviation Administration) notes that “slots the concept of a tradable right in slots or, ing one or a relatively small number of slots represent an operating privilege subject to therefore, a secondary market in which are unlikely to be viewed as appreciable and absolute FAA control”. Finally, it should slots move to those carriers who value them would, therefore, be outside the scope of the be noted that incumbent airlines have not, most. prohibition). until relatively recently, listed slots as assets Overall, there is the concern that slot in their annual accounts (and, where they The role of competition law trading may well fall between the main have, only in relation to purchased slots and Recent European Commission policy has planks of competition rules, in particu- not the vast majority, which were allocated been to remove, or reduce sector-specific lar unilateral exclusionary behaviour that to them free of charge in the past). protection from competition law that has exploits or protects an airline’s market Nevertheless, even without a support- been enjoyed by a number of industries. power. Indeed, dealing with slots strictly able claim to legal ownership, incumbents This has been the case, for example, in the as a tradable commodity raises concerns clearly have certain property rights, which, motor industry (ie, the revised motor vehicle as to whether a primary trading process or in addition to the right to use for the purpose block exemption) and in the maritime sector secondary trading might enable airlines to of operating commercial flights, includes cer- (ie, the repeal of the block exemption for reinforce dominant positions, for example, tain rights of transfer and exchange (subject liner conferences). Equally, in the air trans- at hub airports or on specific sets of com- to limitations laid down in Regulation 95/93 port sector, the commission has repealed a mercial routes to and from particular air- and in the absence of any applicable juris- number of sector-specific block exemptions ports. Some believe that a market-based prudence). Those rights can be extended (or including the one relating to IATA passenger system might lead to a consolidation rather limited) either by further European Com- tariff conferences for routes between the EU than a reduction of incumbents’ slot hold- munity legislation or national case law and and non-EU countries, which it has decided ings and that incumbents will, in turn, have the interpretation of community law by the not to renew. Overall, it indicates a general the opportunity and incentive to abuse their European courts. Such extension (or limita- level of confidence on the Commission’s part market power. tion) of an airline’s right to use would not that substantive and procedural competi- interfere with the underlying property rights, tion law is sufficient to address issues that Unilateral firm conduct which derive from, for example, the owner- might arise out of sector-specific behaviour Article 82 EC – or its national equivalents ship under national property law of, or stat- – governs unilateral behaviour by companies utorily granted rights to operate, a runway (or groups of unrelated companies) occupy- or terminal building. As airlines have certain ing a dominant (or collectively dominant) property rights in slots, they may attribute market position. Its provisions do not pro- value to those rights and, subject to limita- hibit dominance itself or the manner in which tions and conditions laid down by EU and such dominance is achieved: it prohibits the national law, transfer their rights for value. Overall, there is a abuse of dominance as manifested in cer- The proposals that envisage various forms tain exclusionary or exploitative behaviour. of primary and secondary trading reflect concern that slot Thus, a dominant company might abuse this legal position: the transfer of property its position when it conducts business in a rights for valuable consideration does not trading may well manner that restricts or distorts competition depend on the transferor being the owner that remains in the market, whether that be of the underlying property right. “fall between the through exploitation of its commercial part- In practice, the main challenge with ners or customers (exploitative abuse) or by respect to future efficient allocation – and, in main planks of excluding actual or potential competitors turn, the ultimate efficacy of any follow-on from the market (exclusionary abuse). trading – consists in finding the right balance competition rules” However, the distinction between per- between the legitimate interests and expecta- missible and abusive competitive behaviour tions of incumbent air carriers (which have by a dominant company is not always clear. invested significantly at hub airports) and Dominant players are allowed (and indeed ensuring the possibility of meaningful new expected) to compete actively on a given entry and competition at congested airports. market, albeit that such behaviour should The costs involved in disrupting the current and that any insulation from competition reflect competition ‘on the merits’ (ie, com- distribution of slots, even if it is rooted in a law’s normal reach is unjustified. Save in petition reflecting the competitive advan- historically inefficient system of allocation, exceptional cases, the application of com- tages enjoyed by the dominant company might outweigh the benefits (if any) that petition law through public enforcement rather than restrictive practices). In terms may be gained by enhancing the position of or private actions, as opposed to ex-ante of dealing with slots as a tradable commod- current competitors or facilitating new entry regulation, appears capable of addressing ity, the incentive for an already strong or by reallocating all or some slots. Incumbents competition problems as and when they dominant carrier to increase slot holdings might be best placed to reap economies of may occur. However, some suggest that at a congested airport may reflect a strategy scale, the benefits of which are passed on to competition law cannot adequately address to restrict competition by limiting access to consumers in a manner that could not be anti-competitive behaviour that would a scarce resource. Equally, however, it may offered by alternative users of the slots. result from a pure market approach to pri- reflect a pro-competitive strategy to increase As such, determining ownership of the mary slot allocation and secondary trading. efficiency through the extension of existing underlying property rights for the purposes For example, merger control is unlikely to complementary services at a hub airport. of the primary allocation of slots and pro- apply to transactions involving the sale or Such concentration of slots in the hands viding compensation to the owners of those leasing of slots, whereas article 81 EC (or of one carrier naturally gives rise to concerns

32 global competition review eu slot trading that it will (or has the incentive to) engage Abuse It should be noted that the courts have in anti-competitive conduct amounting to Even if a carrier were dominant in a relevant never ruled on the issue of essential facilities abuse of a dominant position contrary to market as a result of the right to use a high in the air transport sector. However, based article 82. Abuse would, in this context, be percentage of available slots, the acquisition on other cases, a refusal to supply slots characterised as exclusionary insofar as ‘slot of further slots does not imply abuse. Thus, would not be viewed as an abuse where the hoarding’, refusal to supply, overbidding or where dominance exists in an upstream slots in question were not indispensable to what might be called ‘predatory purchas- ‘slots market’ (something potentially dif- relevant downstream service (ie, other slots ing’ denies other competitors (or potential ficult to prove), the claimant or competi- were available from other airlines at the air- competitors) access to an essential input that tion authority still faces hurdles. Existing port or are available at other airports from would otherwise allow them to compete and case law has established that exclusionary which competing services might be offered) contest the incumbent’s market position. behaviour does not necessarily infringe or where the refusal is objectively justified In terms of exploitative abuse, this article 82 when the dominant company can (ie, that the incumbent is better placed than occurs, for example, where the dominant demonstrate an objective justification for its others to use the slots most effectively by, company indulges in ‘excessive’ pricing. actions. Moreover, in line with the European for example, taking advantage of the hub The possibility of exploitative abuse might Commission’s initiative to introduce a more network that it already has in place). materialise in a market for slots at a par- economics-based approach to the applica- It should also be noted that, where an ticular airport (where the conduct might tion of article 82, it would be necessary to abuse has been proven in previous exclu- also be regarded as exclusionary against demonstrate that the acquisition of more sionary cases, the time involved has been a rival seeking to purchase slots) or into a slots gives rise to a restriction of competi- substantial, so much so that potential com- downstream market for the provision of air plainants may be deterred from bringing transport services (where the victim would similar claims. be the passenger, the consumer of such serv- ices). The first type of abuse might best be It is unclear Market investigations addressed through the rules applicable to a Finally, there has been discussion of the secondary trading system; the second type whether potential use that might be made (ex-ante might be more appropriately addressed and ex-post) of market investigations or through an ex-post application of the rules competition sector inquiries to examine the conditions under article 82. in which slots may be allocated and sub- law can deal sequently traded. The Air Traffic Work- Market definition ing Group of the European Competition Article 82 would only regulate the use or satisfactorily with Authorities acknowledges that, with the misuse of slots where it is established that a exception of the UK, the main difficulty for carrier holds a dominant position. The mere all of these issues most authorities would be the lack of reme- holding of a high number of airport slots dial powers. In its recommendations, the may not confer a position of dominance. group notes the possibility of such investi- The relevant market is likely to be defined gations as both an ex-ante and an ex-post by reference to certain air transport services tion: this may depend on the number of slots competition control, while highlighting rather than a market for slots. acquired as well as the specific circumstances both pros and cons. The question, however, Slots, it might be argued, are an in which the carrier operates. If a restriction is not so much whether such investigations upstream input into the downstream serv- were established, the carrier would have the could be used as procedural tools to review ice market in which airlines compete. If so, opportunity to demonstrate that the acqui- and address competition issues arising from it is dominance on this latter market that sition and use of the additional slots would a market-based approach. Rather, it is to must be established to found a claim. Mar- produce efficiencies that would be passed on determine whether the use made of slots and ket definition has the potential to handicap to consumers. As such, a dominant incum- the circumstances in which they are traded any potential claim based on an airline’s bent might justify its behaviour on the basis (or not traded, eg, slot hoarding) constitutes holding of slots at a particular airport since that its already established position makes a competition law infringement or evidences any relevant downstream transport market it best-placed to make the most efficient other market failures. might be contested by carriers operating out use of the acquired slots and that it is sim- of different airports or by operators of other ply extending the benefits of the system it * * * forms of transport. That congested airports has in place. Where an airline controls all It is unclear whether competition law, rather have stimulated competitors and, in par- or the vast majority of slots at an airport than tailored slot allocation or trading pro- ticular, budget airlines to look elsewhere for and refuses to sell slots to actual or poten- visions, can deal satisfactorily with all of slot capacity suggests that different airports tial competitors, one might construe this as the competition issues peculiar to the sector (and therefore the slots available) may be an abuse of a dominant position. Aggrieved and, in particular, those which arise out of regarded as falling within the same relevant third parties might argue that the airline the acute illiquidity detailed above. Indeed, geographic market. The finding that two or owns and controls a facility to which com- in such circumstances, a system of allocation more airports fall within the same relevant petitors require access to provide services. In based purely on market mechanisms (and market implies that operators at these differ- short, slots at congested airports might be without any additional supply-side meas- ent airports will exert competitive pressure regarded as an ‘essential facility’ (ie, where ures) may produce unintended outcomes. In on each other and that the right to use, for reasonable access to a sufficient number of this light, some commentators have noted example, over 40 per cent of the slots at one slots is indispensable, there are no suitable that the American experience is instructive airport does not necessarily confer a posi- alternatives and it is not economically feasi- insofar as the introduction of a pure pricing tion of dominance on that carrier. ble – nor technically possible – for competi- mechanism appears to have strengthened tors to reproduce the facility). the position of a small number of carriers. www.GlobalCompetitionReview.com 33