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Jetstar Hong Kong, and some flag carrier issues

Andrew Pyne’s career and experience makes his observations about Jetstar Hong Kong of considerable relevance to Qantas shareholders and those of other airlines that might now reconsider their options for expanded Hong Kong operations

Hong Kong-A flag of convenience?

By Andrew Pyne

So having been knocked back on his plan for a premium carrier based outside Australia, somewhere in South East Asia, Alan Joyce has grabbed the headlines back this week with his plan to partner with China Eastern and set up Jetstar Hong Kong.  In the rush to excite the markets and placate Qantas shareholders has anyone bothered to read the fine print?  Those words, ‘subject to regulatory approval’ were included in the press releases – and this may turn out to be far more than a formality.

My guess is that Qantas and China Eastern are trying to railroad the government of the Hong Kong Special Administrative Region (SAR) into coming out in early support of the plan: it all sounds good – Hong Kong has a huge, relatively new, airport to fill; it lacks a true low cost airline in its otherwise broad and impressive aviation portfolio.  Just one snag: allowing Jetstar Hong Kong to set up in the territory doesn’t  just require a tweak in policy direction.  It actually requires a change in Hong Kong’s constitution – the Basic Law.

When Hong Kong moved from British to Chinese sovereignty in 1997 it developed a then unique formula to protect its autonomy in aviation matters.  When Australia negotiates a bilateral air services agreement with another country it typically agrees that only airlines owned and controlled by Australian nationals will be allowed to exercise the Australian set of traffic rights that exist under it, ie who flies where and when.  Hong Kong has no nationals as such so it uses the formula of Incorporation and Principal Place of Business (IPPB)  to determine which airlines should qualify to use those rights – and there is no way in which an airline carrying an Australian branding and controlled in effect from Sydney and from Shanghai can be said to have its principal place of business in Hong Kong.   Many have tried to circumvent the IPPB rules; none have succeeded.  If this project were to be allowed,  there would be a long queue of other airlines waiting to operate from Hong Kong – maybe Lufthansa Hong Kong or KLM Hong Kong or Virgin Atlantic Hong Kong. (Even Qantas Hong Kong?)  Hong Kong would quickly become something it has never wanted to be:  the aviation equivalent of a Liberia, that is a flag of convenience.  And Cathay Pacific, the territory’s highly successful, de facto, flag carrier would probably be looking for a new home.

But let us suspend disbelief and consider that Hong Kong, under pressure from its Beijing masters, decides to ignore Cathay Pacific’s concerns and then moves to  rewrite or reinterpret its own constitution,  what then of its 60 or so aviation partners?  They signed up to formal and solemn treaties granting air traffic access to their markets based upon a very precise understanding of what being a Hong Kong carrier constituted. They re unlikely to roll over and accept an Australian airline traveling in disguise as the real thing.

A good idea in concept – the devil is indeed lurking in the details. Back to the drawing board Mr Joyce.

Andrew Pyne worked in the Hong Kong Economic Services Bureau as the desk officer for aviation policy between 1994 and 1996; prior to that he worked in the British Embassy Peking on aviation policy and then advised Governor Chris Patten on Hong Kong aviation designation issues.  Post 1997 he worked in senior positions at Cathay Pacific , at Viva Macau (as CEO) and at Avianova (Russia s first LCC) (again as founding CEO). Andrew Pyne is now senior Partner at specialist aviation consultancy, Concuros Partners, based in Moscow.

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  • 1
    Farmer
    Posted March 27, 2012 at 1:44 pm | Permalink

    Hi Andrew,
    A very interesting post. Surely if Joyce has got this wrong to he has to go. If he bungles two proposed joint ventrues, Red Q and then Jetsar Hong Kong while Qantas shrinks then he will achieved nothing except the demise of the main line Qantas operations without any successful offshore intiatives with Jetstar.

    Your piece suggests it is another project that is not even half baked.

    Farmer

  • 2
    ltfisher
    Posted March 27, 2012 at 2:29 pm | Permalink

    Well written Andrew. I did not know the ‘law’ involved but do know that as a general rule the Chinese government is highly protective of its own businesses in the domestic market. To somehow believe that, for the purposes of this deal, Hong Kong is not part of the PRC would show incredibly poor research by Qantas/Jetstar and China Eastern. I just hope that in making their announcement Qantas/Jetstar is not relying assurances from China Eastern that they can get the approval of Beijing. Shanghai often acts as the bell wether for testing business and social initiatives on the central government. However, they are not always successful.

  • 3
    Rufus
    Posted March 27, 2012 at 5:50 pm | Permalink

    So how does that work with Hainan Airlines-controlled Hong Kong Airlines?

  • 4
    W J
    Posted March 27, 2012 at 6:18 pm | Permalink

    Hainan Group has a 45% stake in HKA, the rest is held locally by Mung King Keung

  • 5
    TT
    Posted March 27, 2012 at 6:36 pm | Permalink

    I would agree with Andrew’s analysis that Cathay Pacific would fight left, right and centre to defend their market share in Hong Kong market. However, Jetstar HK can only occur with a change of Basic Law? I think that’s a bit over the top.

    If you read carefully on Article 134, subparagraph (2) of the Basic Law, it states

    The Central People’s Government shall give the Government of the Hong Kong Special Administrative Region the authority to :

    ( 2 ) issue licences to airlines incorporated in the Hong Kong Special Administrative Region and having their principal place of business in Hong Kong;

    I would say as long as Jetstar HK can demonstrate the majority of its board member is HK resident, board meetings are mostly held in HK, and most of the office function are carried in HK (I can’t see any real obstacles here), then there shouldn’t be any problem.

    The reality is HK Government actually administer their own aviation, with virtually no interference from Beijing Government. They are so separate that in practice, it is causing grief to Hong Kong airport: when aeroplanes take-off or lands at HKG, it has to enter mainland China aerospace which is controlled by the PLA, and PLA have placed a FL limit for HKG bound aircraft such that it is causing capacity constrain at HKG! If Beijing has such an influence on HK aviation policy, then it wouldn’t ended up such a practical issues at HKG right now!

    For those who are interested to read the relevant section of Basic Law on aviation, you can read it here:
    http://www.basiclaw.gov.hk/en/basiclawtext/chapter_5.html#section_4

  • 6
    Aidan Stanger
    Posted March 27, 2012 at 6:58 pm | Permalink

    Hong Kong has no nationals as such so it uses the formula of Incorporation and Principal Place of Business (IPPB)  to determine which airlines should qualify to use those rights – and there is no way in which an airline carrying an Australian branding and controlled in effect from Sydney and from Shanghai can be said to have its principal place of business in Hong Kong.

    Of course there’s a way. ‘Tis the same way Tiger Australia’s IPPB is Australia.

    If this project were to be allowed,  there would be a long queue of other airlines waiting to operate from Hong Kong – maybe Lufthansa Hong Kong or KLM Hong Kong or Virgin Atlantic Hong Kong. (Even Qantas Hong Kong?)  Hong Kong would quickly become something it has never wanted to be:  the aviation equivalent of a Liberia, that is a flag of convenience.  And Cathay Pacific, the territory’s highly successful, de facto, flag carrier would probably be looking for a new home.

    I don’t see why. Surely Cathay Pacific is competitive enough? Any other airline based in HK would have to conform to the same regulations, so there’s no obvious way of undercutting them. Hong Kong would benefit substantially from increased landing fee revenue as well as more business there – what do they have to lose?

  • 7
    michael r james
    Posted March 27, 2012 at 10:49 pm | Permalink

    Here is an extract from the NYT report on JetstarHK: (note the speculation about competition with HSR).

    (nytimes.com/2012/03/27/business/global/qantas-china-eastern-partner-in-new-low-cost-airline-venture.html?)
    Qantas in China Venture for Budget Airline
    By BETTINA WASSENER
    Published: March 25, 2012

    For China Eastern, which carried nearly 70 million passengers last year, the venture represents a first foray into the low-cost segment. The move is likely to be watched closely by rival mainland Chinese carriers like China Southern and Air China, analysts at the Center for Asia Pacific Aviation, a consulting firm in Sydney, wrote in a report on its Web site.

    Further expansion in the low-cost sector, however, might be handicapped by Beijing’s tight control of routes, as well as new competition from the country’s burgeoning high-speed rail network.

    Beijing “will be cautious in allowing further new entry — especially low-fare carriers — that would threaten a delicately balanced market in which billions of state assets and investment are engaged,” the consulting firm noted.
    …………..

  • 8
    wildsky
    Posted March 28, 2012 at 2:38 pm | Permalink

    WJ,

    What is your source for “Hainan Group has a 45% stake in HKA, the rest is held locally by Mung King Keung”?

    Ben,

    Although I understand that Andrew has been doing some recent work in his old HK stamping ground, I wonder whether the policy direction has changed over the years. I must admit, I don’t quite understand how “Jetstar Hong Kong” is an Australian brand. But he also raised the issue of control, something that has vexed me in regard to the other Jetstar spawn, Jetconnect and the recent Virgin corporate machinations.

    I do not quite understand(both in the HK case and here in Australian determinations) how far the analysis of control delves into the typically labrinthine arrangements of interposed entities. Let me see if I can illustrate my dilemma using Rufus’ question about HNA’s relationship with HKA.

    Unlike WJ, my understanding is that HKA has 4 significant shareholders of interest, namely, HKA Consultation Services at around 15%, HKA Holdings at around 48%, HNA Group (HK) Investments at around 34% and Grand China Air with about 3%. The first two are HK domiciled and the last two are based in the PRC, so at first glance local ownership runs at about 63%.

    But, going one step further, who owns HKA Holdings?

    There appear to be 3 significant shareholders: HKA Consultation Services at around 43%, HKA Group at around 22% and, surprise surprise, HNA Group (HK) Investments with 34%. Again, at first glance, this is still good as the first two represent a local HK interest of 65% with the PRC-based Hainan holding as a minority interest.

    The last step is fairly straightforward: who owns HKA Consultation Services and who owns HKA Group? I believe that both are wholly-owned by HK domiciled individuals, namely Guosong Zhong and Mung King Keung.

    To my simple aviator’s brain, this raises a major question about control versus economic interest.

    If we suppose that there are no hidden deals or voting agreements, etc., in the background, then voting control of HKA appears to be firmly in the hands of HK domiciled interests.

    But that does not appear to be the case when it comes to economic interest. My simple arithmetic may be flawed, but my understanding is that the Hainan Group directly controls a little over 50% plus some more via Grand China Air and that Guosong Zhong controls about 36% and Mung King Keung only about 10%.

    So for those who know how these things work, is the distribution of economic interest relevant to the assessment of IPPB in HK? Similarly, is it relevant to the assessment of foreign shareholdings in Australia for the purposes of the Air Navigation Act/Qantas Sale Act?

  • 9
    DB2820 Postman
    Posted March 28, 2012 at 2:43 pm | Permalink

    This is some of the best reasoned and rational comment I have seen on this blog in a long time. Most commentary is biassed rubbish.

    It could be that Jetstar HK does get up and running. However getting rights from PRC to fly to various destination within China is a very different matter indeed.

    Cathay Pacific could certainly contribute chapter and verse on how they have over the years been hindered from flying extensively within China. Even when approval was technically granted there were also a myriad of “technica reasons” why it could not be executed which went on and on and on.

    So, will be very interesting to see how it pans out.

    Also if Jetstar HK does work, it will be interesting to see how long it will be before Qantas’ interest in Jetstar HK is through a “technicality” seized by mainland China interests. It has happened before with foreign equity interests in China business entities and it will most likely happen again before corporate governance in China finally reaches western standards (or should we say for example, Singapore standards and/or (what were before 1997) HK standards).

  • 10
    Pyne Andrew
    Posted March 28, 2012 at 6:42 pm | Permalink

    Thanks: a very interesting and well-informed set of comments. Of course my original piece was a very compressed view of the regulatory and constitutional position – but I stand by its analysis. The relevant Basic Law articles have to be set in the appropriate context, with reference to precedents, the policy position, the assurances given to foreign aviation partners over time etc etc. So some quick points in response here-

    - Hong Kong ownership is neither here nor there (see Cathay Pacific): as Wildsky rightly observes this would open a real can of worms and be extremely difficult to police. The IPPB criteria – as interpreted over the past 25 years or so – have revolved instead around whether or not the airline concerned has a distinct Hong Kong identity, ie whether through branding, presentation, operations, management etc it can be seen to truly take Hong Kong as its principal place of business (or whether it s simply a subsidiary of an overseas airline seeking to cash in on Hong Kong s hard won traffic rights!) Under this test Hong Kong Airlines for example – despite its links to Hainan – does meet the PPB test; Jetstar ‘Hong Kong’ clearly would not,

    - Tiger Australia is also cited here, but really raises a different set of issues: I should say that I m far less familiar with Australia s application of IPPB to its domestic aviation regime than with Hong Kong s but the circumstances seem to me to be different – we re talking here (primarily) about domestic operations rather than international operations. (And Australia may in any case be far more relaxed about how it applies PPB than Hong Kong – that s its prerogative.) But in Jetstar Hong Kong s case every flight will be ‘international’: even Hong Kong to Shanghai is not a domestic operation but is governed by an inter government understanding between Beijing and Hong Kong; rights are tightly restricted and no Hong Kong airline has yet been allowed to fly ‘internally’, that is connecting two Mainland points without touching Hong Kong,

    - if IPPB is to be appplied in the fairly relaxed way that others have suggested here it would indeed represent a fundamental shift in Hong Kong s aviation policy and would rightly cause concern amongst its aviation partners who accepted Hong Kong s unique status in aviation on a set of very clear assurances about who could and would be designated as a ‘Hong Kong airline’. Certainly the overall aviation policy position does appear to have shifted in the last few years, ie to be less protective of CX interests, but as recently as January of this year my contacts within Hong Kong government circles confirmed that the basic position on IPPB at least remains unchanged. To move away from it would imply as I said setting up shop as an aviation flag of convenience – that s not on the cards.

    - finally, I m aware of at least one precedent case where an airline attempted to set up a subsidiary in Hong Kong without dealing adequately with the issues that I ve described at the first bullet above: they were knocked back. Surely the exceptionally long lead time that MU and Jetstar have announced for the project – Summer 2013 – more than a year away, indicates that they understand the complexities of the regulatory process and the time it will take to work through them? But in doing this they have also opened the door to CX – or HX – preempting them with a home based LCC of their own that could move more quickly to market.

    Andrew Pyne

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