Introduction
Evolution of global controversy
Patchwork of administration and enforcement
EU governments begin cracking whip
Comment


Introduction

Carbon emissions from the aviation sector have a highly emotive and clearly visible profile compared to those in many other industries. During 2015 the aviation sector emitted approximately 757 million tons of carbon dioxide (CO2),(1) representing between 2% and 3% of the world's anthropogenic carbon emissions(2) – just slightly less than the entire carbon footprint of major industrialised countries such as Canada, South Korea and Germany. Many climate change scientists believe that the effects of aviation CO2 and other greenhouse gas emissions could be of a magnitude three or four times greater than calculated, by virtue of being deposited at high altitude and taking much longer to be absorbed by the earth's ecosystems than they would if deposited at sea level.(3)

The White House has estimated the social cost of carbon emissions to be $36 per metric ton.(4) Based on this calculation, the annual cost to society resulting from current aviation CO2 emissions is approximately $27 billion; little of this societal cost is paid for by the air transport industry. To date, only the European Union has enforced stringent aviation compliance measures under its Emissions Trading Scheme (ETS),(5) whereby aircraft operators must account for their intra-European CO2 emissions. Even under the EU ETS, up to 85% of compliance costs are currently subsidised by the European Union by way of free carbon allowances. Most other carbon-intensive industries regulated under the EU ETS receive no such financial support or social impact relief. As a result, aviation emissions have become a highly charged global issue, which will approach a critical crossroads by the end of 2016.

Evolution of global controversy

In 2008, in order to meet its commitments under the Kyoto Protocol to the UN Framework Convention on Climate Change,(6) the European Union expanded its flagship ETS to include aviation activities.(7) This triggered a considerable international backlash against the European Union for the unilateral regulation of emissions occurring within other sovereign territories and within international air space. In response, the United States:

  • enacted the EU Emissions Trading Scheme Prohibition Act of 2011 (similar to prohibitions by India and China against their airlines participating in the EU ETS);
  • led the formation of a "coalition of the unwilling" comprised of over 20 countries that initially refused to comply with the EU ETS and considered several potential countermeasures, ranging from airspace overflight restrictions to Airbus order cancellations and boycotts.

EU bureaucrats failed to see the signs of this backlash brewing and by November 2012 were forced to back down by enacting a temporary 12-month measure to 'stop the clock' on international emissions until after the International Civil Aviation Organisation (ICAO) Assembly held in Autumn 2013. The stop-the-clock derogation reduced aviation emissions for flights commencing or terminating in Europe from a 100% compliance target to a 40% compliance figure overnight. However, the EU ETS remained in full force and effect for all intra-European flights, even for operators based outside the European Union. Many European airlines, particularly low-cost carriers, saw this measure as penalising European airlines by increasing their compliance costs relative to those of their international competitors.

The European Union's intent was to give the ICAO time to devise a global aviation emissions reduction scheme that was equivalent to the EU ETS measures and ready for implementation by 2020. If the ICAO failed to devise such a scheme by the Autumn 2013 ICAO Assembly, the European Union planned to revert to the full-scope EU ETS as originally enacted prior to the 2012 stop-the-clock decision. However, rather than coming up with an alternative scheme to the EU ETS, ICAO members used the 2013 assembly to admonish the EU ETS and give themselves another three years to decide what a global aviation-emissions reduction scheme might look like – a process that at that stage had already taken 16 years.(8) The European Union once again was forced to concede and in April 2014 the European Parliament voted to extend the stop-the-clock derogation to the next ICAO triennial assembly in Autumn 2016. The European Union also enacted amendments to the EU ETS to increase compliance thresholds and exclude many small aircraft operator emitters where the cost of enforcement vastly outweighed any potential non-compliance penalty recoveries.

Patchwork of administration and enforcement

The EU ETS framework was based on a bureaucratic European scheme designed for stationary installations such as power plants and steel mills. As such, many contend that it was not the best starting place for an aviation emissions scheme. The EU ETS is politically complicated and technically cumbersome, being fully understood in most parts only by civil servants and a few accredited verifiers and specialist commodity traders. Unlike Eurocontrol, which is centrally administered and regulated, EU ETS compliance is delegated among the 28 EU member states plus Iceland, Norway and Lichtenstein (collectively, the 'EEA states'). Each EEA state has transcribed the EU ETS directives into its local laws differently, effectively creating 31 different variations of the EU ETS. Administration under the scheme mostly has been delegated to non-aviation entities such as environmental agencies and even ministries for agriculture, fishing and forestry. Each EEA state has different administration requirements and local laws concerning enforcement. Many international airlines face confusion as to which regulatory authority is assigned to regulate them, with some authorities being far more helpful, organised and pragmatic than others. Non-EU aircraft operators are generally assigned to the regulator in the EU country to which they historically have had the greatest number of scheduled flights.

The three basic common denominators of compliance and enforcement under the EU ETS are as follows:

  • Covered operators must report their annual CO2 emissions by March 31 of the following year;
  • Sufficient allowances commensurate with each year's emissions must be surrendered by April 30 of the following year; and
  • A statutory penalty of €100 per ton (or the local currency equivalent) is enforced for non-compliance.

Each EEA state also has the right to enforce local civil penalties for non-compliance in addition to EU ETS statutory penalties. Local penalties, if applicable, vary from state to state. For example, local penalties in the United Kingdom are capped at around £63,000, while in Spain each potential offence carries a maximum penalty of €2 million which could have crippling financial implications for a single aircraft operator. As indicated above, there are also different levels of enforcement codified under the various EEA states' domestic laws. For example, under the UK Greenhouse Gas Emissions Trading Regulations, the Civil Aviation Authority has the right of seizure, detention and sale of aircraft in the event of persistent EU ETS aviation non-compliance; whereas the authorities in most other EEA states do not.

Covered aircraft operators were effectively given a two-year compliance holiday after 2012, but had to submit 2013 and 2014 emissions reports by March 31 2015 and surrender sufficient emissions allowances by April 30 2015. Aircraft operators failing to meet these deadlines are being sent enforcement notices and penalty calculations (based on Eurocontrol flight data) by the relevant regulatory authority. Each EEA state has its own appeal procedures and in some countries it can take years to determine and adjudicate non-compliance.

EU governments begin cracking whip

The United Kingdom, Germany, Belgium and the Netherlands have proactively issued penalty notices against European and international aircraft operators since 2014 and are currently pursuing enforcement measures. Civil penalty appeals brought by Jet Airways against the UK regulator, which could be considered a potential test case of EU ETS enforcement against international carriers, were dismissed in March and October 2015. In the latter appeal, Jet Airways unsuccessfully argued that force majeure had compelled it to follow the Indian government's mandate against EU ETS participation. It was found that Jet Airways was not bound under Indian law not to comply with the EU ETS, political motivations notwithstanding, and that there was no external force compelling it to make intra-EU flights. Jet Airways has since paid the statutory penalty. While all Chinese international airlines now appear to be compliant under the EU ETS according to the EU Transaction Log, it remains unclear whether the EEA states have been instructed not to enforce statutory penalties against Chinese carriers in order to encourage compliance. Belgium recently levied a fine of €1.4 million against Saudia(9) for non-compliance in 2012 and, while the penalty may have been paid, the airline appears to be absent from the EU Transaction Log, thus potentially calling its compliance into question. The United Kingdom, Belgium and the Netherlands have published lists of non-compliant operators. However, it is understood that these lists are incomplete in that the names of a number of offenders have yet to be published due to ongoing investigations and appeals. In April 2014 the German authorities ordered 61 operators from Russia, the United States and other countries to pay fines totalling €2.7 million for breaching EU ETS regulations.(10) However, the authorities declined to name the non-compliant operators.

Aircraft lessors and financiers should be concerned if their airline customers do not comply with the EU ETS, and could feel compelled to repossess aircraft rather than risk being dragged into EU ETS enforcement proceedings (which could significantly jeopardise lessor and lender rights) and face exposure to fleet-wide liens that could give rise to aircraft detention and sale, much in the same way that Eurocontrol liens may be enforced. While it is possible that EEA states may continue to administer a light touch so as not to antagonise the ICAO process towards a potential global ETS, it is also unlikely that the increasingly strident political forces at work within the European Union will allow this situation to continue indefinitely. In fact, aircraft operators constitute the only delinquent participants in the EU ETS. The European Commission's director general for climate action has intimated that once diplomatic avenues to bring delinquent flag carriers into compliance are exhausted, legal proceedings will commence.

To call the proposals being discussed by the ICAO a global scheme is somewhat misleading, as the scheme will – if implemented – cover emissions only from international flights, not domestic flights. For example, 60% of all flights departing and arriving in the United States are domestic flights and therefore will not be covered under the proposed ICAO scheme. The recent proposed endangerment finding by the US Environmental Protection Agency (EPA) concerning aviation emissions has triggered a rulemaking process that ultimately could fill this gap, although it is too early to tell who will be bound by the EPA's final regulations (ie, only US domestic or also international operators), which aircraft models will be covered and whether the EPA rules will be promulgated in time to dovetail with the ICAO process, or will stand on their own as yet another layer of complexity for operators forced to comply with differing standards around the globe.

Many industry insiders believe it is unlikely that a workable global emissions reduction scheme can be devised by the next ICAO assembly in Autumn 2016. The biggest hurdle is conflict between developed and developing nations over who should bear the greater proportion of compliance cost. It will be difficult to resolve the tension between the UN principle of 'combined but differentiating responsibilities and respective capabilities' and the Chicago Convention guiding principle of creating a level playing field regardless of state of domicile. Any proposals to operate a phased-in route-based system may antagonise the United States while potentially benefiting other countries – particularly those in the Middle East and Asia – which are rapidly making significant economic inroads into markets historically governed by bilateral aviation agreements.

The 21st Convention of the Parties of the UN Framework Committee on Climate Change (COP 21) was held in Paris during November and December 2015. While COP 21 resulted in what many consider a historic agreement to cap average global temperature increases at no more than 1.5 degrees Celsius above pre-industrial levels, many stakeholders were surprised by the removal of aviation (and shipping) from the final text of the Paris agreement. This means that there is no binding requirement on countries to include aviation emissions within their respective self-determined emissions reduction commitments (known as 'nationally determined contributions' (NDCs)). A recent study undertaken by the European Union concluded that the combined emissions from aviation and shipping could reach 39% of all anthropogenic emissions by 2050.(11) Many climate change experts therefore believe that the 1.5 degrees Celsius cap will be impossible to achieve unless emissions from international aviation are capped by the ICAO, as the Paris agreement does not require them to be included in NDCs. This has led to growing concern within the aviation industry that time is rapidly running out, and that the ICAO needs to redouble its efforts to find unity and an agreement that will lead to aviation carbon neutrality from 2020 onwards. Many aviation industry insiders are concerned that an ICAO global emissions reduction scheme will not be ambitious enough to contribute to limiting global temperature increases to within two degrees Celsius,(12) particularly considering the meteoric increase in aviation activities and the current low price of oil.

Comment

Lessors and financiers of aircraft operated by customers covered under the EU ETS should be taking a proactive interest in EU ETS monitoring and reporting and ensuring contractual covenant compliance. If no agreement on a global emissions reduction scheme is reached at the ICAO's next assembly in Autumn 2016, the European Union may feel emboldened and legally obligated to reintroduce the full-scope EU ETS covering all flights within, to and from the European Union, regardless of origin, end point, operator domicile or aircraft registry. This could have wide-ranging consequences for aircraft operators and owners, including heightened risks of lease and loan defaults, imposition of significant monetary penalties, crippling operating bans (in extreme cases) and – of even graver concern – threats to possession and ownership. Absent clear and practical EU ETS compliance covenants in lease and loan agreements, aircraft lessors and financiers may find themselves in a difficult recovery position should the European Union reintroduce the full-scope EU ETS, as threatened. Aircraft lessors and financiers therefore should be closely following developments over the next 12 months, as a reversion to the full-scope EU ETS likely will result in further airline defaults. Proactive risk management is therefore advisable.

For further information on this topic please contact Jordan R Labkon at Vedder Price's Chicago office by telephone (+1 312 609 7758) or email (jlabkon@vedderprice.com). The Vedder Price website can be accessed at www.vedderprice.com.

Endnotes

(1) International Air Transport Association, June 2015.

(2) DS Lee, LL Lim and B Owen, "Mitigating Future Aviation CO2 Emissions – Timing is Everything", available at www.cate.mmu.ac.uk/docs/mitigating-future-aviation-co2-emissions.pdf.

(3) EU Directive 2008/101/EC, November 19 2008.

(4) For more information see www.whitehouse.gov/sites/default/files/omb/inforeg/social_cost_of_carbon_for_ria_2013_update.pdf.

(5) For more information see www.ec.europa.eu/clima/policies/ets/index_en.htm.

(6) For more information see www.unfccc.int/kyoto_protocol/items/2830.php.

(7) By enacting EU Directive 2008/101/EC, which amended EU Directive 2003/87/EC.

(8) Euractiv, July 17 2014, www.euractiv.com/sections/aviation/icao-under-pressure-forge-deal-aviation-emissions-303563.

(9) Euractiv, May 19 2015, www.euractiv.com/sections/transport/first-major-airline-fined-breaking-aviation-ets-law-314673.

(10) Transport & Environment, May 30 2014, www.transportenvironment.org/news/netherlands-and-germany-fine-foreign-airlines-over-ets.

(11) See European Parliament report "Emission Reduction Targets for International Aviation and Shipping", available at www.europarl.europa.eu/RegData/etudes/STUD/2015/569964/IPOL_STU(2015)569964_EN.pdf.

(12) From pre-industrial times, this being the UN Framework Convention on Climate Change consensus target. "We must limit global temperature rise to 2 degrees." UN Secretary-General Ban Ki-moon, Council on Foreign Relations, February 2013. For more information see www.un.org/en/globalissues/climatechange/.

Barry Moss and Andrew Pozniak contributed to the preparation of this update.

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