BLG China Aerospace Briefing

WTO Update
In December, the Supreme People’s Court issued new rules allowing the court system to accept lawsuits challenging government decisions that impose trade barriers to protect domestic industry. The rules, which came into effect in January 2003, are intended to ensure that anti-dumping and anti-subsidy cases comply with regulations of the World Trade Organisation. In practice, the measures allow for judicial review of government actions. Vice-president Lu Guoguang of the Supreme People’s Court was reported as saying that he believes the rules will improve the confidence of foreign investors and enterprises in China, and better protect the interests of relevant parties involved in antidumping and anti-subsidy cases. China’s legal system already allows the government to impose retaliatory duties on specific imports if investigations show that the imports harm domestic industry by undercutting market prices, or if investigations reveal that a trading partner is subsidising exports.

Aviation Safety
On the 24th December, a TransAsia Airways ATR 72-200 freighter crashed into the Taiwan Straits killing the two pilots on board. The aircraft was operating a scheduled flight to Macau with small packages. Taiwan’s Aviation Safety Council ("ASC") has issued a safety recommendation urging that ’all airlines with turboprop airliners should review their training programmes’ to ensure they include comprehensive instructions on flight in icing conditions. According to the ASC cockpit voice recorder information reveals that the pilots had first mentioned icing nearly 20min before operating the deicing system, which they did just before the aircraft went out of control.

The official investigations into the cause of the crash of the China Northern Airlines MD-82 of 7th May 2002 have concluded that a saboteur deliberately started a fire in the passenger cabin as the aircraft approached its intended destination of Dalian on a flight from Beijing. 112 people were killed. Evidence of an incendiary device which reportedly probably caused the fire had been found in the wreckage. It was also discovered that the saboteur had purchased 10 insurance policies prior to the flight.

In January 2003, a man tried to commit suicide by lighting fire crackers in a Sichuan Airlines flight, shortly before it landed in Chengdu. The man and a fellow passenger suffered light injuries.

After mediation in the Japanese courts, 106 relatives of 38 of the 264 victims of a China Airlines crash near Nagoya in 1994 have accepted an undisclosed offer from the Taiwanese carrier.

Airports
The Civil Aviation Administration of China ("CAAC") has approved investments by Beijing Capital International Airport Group Co. (BCIAG), the parent of Hong Kong Beijing Airport Company Limited, in five domestic airports. These include Xi’an, Chengdu, Shenyang and Dalian. This investment is consistent with the CAAC’s policy of reform of the national airport system, which includes the CAAC transferring ownership and management for all airports (with the exception of airports in the Beijing Municipality and the Tibet Autonomous Region) to local governments and enterprises).

According to a report issued by the Airports Council International (ACI), Shanghai’s Pudong Airport was the fastest-growing airport last year.

The BCIAG has decided to raise airline user fees by up to 290% following a decision by the CAAC to change the formula by which fees at airports are structured. The airport earns most of its income from aeronautical charges.

Copenhagen Airport has agreed to take up 45% of Hainan Melian Airports’ shares following its successful listing.

Shenzhen Airport announced in November that it will invest a further US$3.62 billion in facilities including adding a second runway and a third passenger terminal. Shenzhen Airport is situated less than an hour’s drive by car from central Hong Kong.

The airports at Urumqu, Chengdu, Kunming, Wuhan, Xi’an and Shenyang have been designated by the CAAC as domestic and regional hubs. Under new rules, issued by the CAAC, airlines that have operating bases at Beijing, Shanghai and Guangzhou, will no longer be allowed to operate services to these six domestic hubs. Exempt airlines include Xinhua Airlines (recently acquired by Hainan Airlines) and Shanghai Airlines.

Hainan Airlines is to construct a new airport in the Xinjiang Autonomous Region in Northwest China.

Huahua military airport in the central province of Hunan is to be redeveloped as a civil airport.

BCIAG and Tianjin Airport established a new airport group in December – Capital Airport Group Corp (CCAGC). The new organisation incorporates a number of other organisations including the CAAC Airport Construction Corp and the CAAC Engineering Consulting Corp.

Airlines
In November, the State Council sanctioned the consolidation of the nine CAAC airlines into three groups led by Air China, China Southern and China Eastern. The CAAC now acts solely as a regulator.

China’s flagship carrier Air China has reported a pre-tax profit of 112 million yuan (US$13.6 million) for 2002, compared with a pre-tax profit of 34 million yuan in 2001. The results are the first since stateowned Air China was merged with two other major airlines China Southwest Airlines and China National Aviation Corp. in October 2002. Air China has 118 aircraft flying 307 routes. Its president, Li Jia Xing, has forecasted a profit of 360 million yuan ($43.6 million) for 2003. The airline incurred three years of losses in 1998-2000.

Meanwhile, China Eastern Airlines Group is set to adopt a unified "MU" flight code, dropping the "3Q" of Yunan Airlines and "WH" of China Northwest Airlines.

China Southern Airlines has signed revenue sharing agreements with China Northern and Xinjiang Airlines which became wholly owned subsidiaries of China Southern Air Holding Co. last year. The combined group has over 180 aircraft servicing 660 routes. China Northern Airlines and Xinjiang Airlines have already started to operate domestic services under China Southern’s "CZ" flight code.

The CAAC, has called a halt to the revenue pooling arrangement which was introduced in 2000 to try and control rampant ticket discounting on domestic routes within China. The revenue pooling arrangement helped control airfares on about 150 key routes that made up about 60% of mainland air traffic. The cash pool was controlled by the CAAC, which redistributed the money to the carriers via a complex formula.

The CAAC is currently studying a proposal to allow airlines to set their own fares within a 40% band as a prelude to completely deregulating fares within a year.

Hong Kong based Dragonair has been awarded route licences by the Air Transport Licensing Authority ("ATLA") of Hong Kong to begin passenger and freight services to Bangkok, Manila, Seoul, Sydney and Tokyo. However, the airline is still awaiting approval from the relevant authorities in those countries before operations can begin.

A landmark Public Inquiry by an ATLA Tribunal into Cathay Pacific Airways’ application to resume flights to key destinations in China, including Shanghai, Beijing and Xiamen has raised some interesting questions regarding the licensing of air services in Hong Kong, the legal status of the ATLA and procedures for public inquiries.

Air services between the Hong Kong Special Administrative Region (HKSAR) and foreign countries are governed by bilateral air services agreements (ASAs) which are international treaties and provide the framework for scheduled air services between two bilateral partners. Under the Basic Law of the HKSAR, acting under specific authorisations from the Central People’s Government, the Government of the HKSAR may negotiate and conclude new air services agreements providing routes for airlines incorporated and having their principal place of business in Hong Kong and providing rights for overflights and technical stops. Such agreements cover scheduled air services to, from or through Hong Kong, which do not operate to, from or through the mainland of China. Arrangements for air services between the HKSAR and other parts of the People’s Republic of China are to be made by the Central People’s Government in consultation with the Government of the HKSAR in accordance with the Basic Law.

A Hong Kong airline seeking to operate scheduled services must obtain a licence for the route from ATLA, secure designation by the Government of the HKSAR under the relevant ASA and be allocated traffic rights. The ATLA is an independent statutory body, comprising non-Government members and chaired by a Court of First Instance Judge. Its purpose is to ensure that the most effective service is provided to the public while avoiding uneconomical overlapping.

Once licensed, a Hong Kong airline is eligible for designation by the Government of the HKSAR under the relevant ASA. In general only one Hong Kong airline will be designated on a given route, and the airline first licensed by the ATLA for a route would normally be the one to be designated for that route. However, the policy also provides for flexibility to designate more than one Hong Kong airline on any route in circumstances such as where it is judged that more competition is needed in the public interest and the traffic is sufficient to sustain substantial operations by more than one Hong Kong airline in addition to the operations of foreign airlines; or where one airline has been designated for a route but chooses not to or has ceased to serve that route or does not operate services on it satisfactorily; or where the services provided by the airline which applies for designation are different from those provided by the existing designated airline on that route. Airlines seeking to operate non-scheduled services to and from Hong Kong have to apply for a permit from the Director-General of Civil Aviation.

In September last year, Dragonair filed a formal objection with the ATLA, arguing in a statement that the destinations sought by Cathay Pacific would be unable to "support the operation of more airlines" since there is more than sufficient capacity available on the route. The airline also commented that it relied upon revenue on routes from Hong Kong to Beijing and Shanghai as its ability to expand its operations to destinations outside China had been constrained in the past. During the hearing in January, ATLA Chairman Mr Justice Stone prevented the parties from seeking an adjournment of the proceedings pending the conclusion of commercial discussions that might have led to a solution to the dispute. The decision was made on the basis that it was not in the interest of the public to delay the hearing. Dragonair was also prevented from securing an adjournment of the hearing pending an application for judicial review proceedings against the ATLA on the basis that the ATLA does not have the power to determine the licensing of operations outside arrangements determined by Central Government. Dragonair argues that under the Basic Law, arrangements for flights to other parts of China are made by the Central Government, in consultation with Hong Kong.

The Inquiry has been adjourned until the middle of March after the five days originally allocated for the hearing proved insufficient for the parties to complete their submissions. We will report on the outcome of this hearing in the next edition of BLG Aviation News.

On 26 January 2003, Taiwanese aircraft entered mainland Chinese airspace for the first time since 1949. This followed a ground breaking decision by the Taiwanese authorities to allow Taiwanese aircraft to operate special Chinese New Year charter services to certain mainland cities via Hong Kong. The airlines included China Airlines, Mandarin Airlines, Far Eastern Air Transport, Eva Airways, Uni Airways and TransAsia Airways. It remains to be seen how much progress will be made on transport links after Chinese New Year. Direct cross-strait links remains the objective of Beijing policy makers.

China Airlines has rejoined IATA. It was a member carrier prior to 1974.

Taiwan plans to sell 20-30 per cent of statecontrolled China Airlines in March or April 2003, paving the way for the privatisation of the island’s largest carrier.

Eva Airways has returned to profitability, having incurred a net profit of NT$2.6 billion for the year 2002 from a net loss of NT$3.2 billion previously.

Aircraft Purchases
Hainan Air Group is purchasing three Boeing 737 freighters, to be used by Yangtze River Express, a joint venture domestic freighter operation owned by Hainan and the Shanghai Airport Group. This is the second dedicated Cargo carrier, the first being China Cargo Airlines, a subsidiary of China Eastern Airlines.

Shenzhen Airlines has taken delivery of two additional Boeing 737-700s leased from GE Capital Aviation Services.

Cathay Pacific Airways has taken delivery of the first two of three Airbus A340-600s from Airbus. Both are leased from International Lease Finance Corporation for operation between Hong Kong and the US West Coast, Australia and Europe.

Air Hong Kong, owned by Cathay Pacific and DHL, has ordered six new Airbus A300-800s scheduled for delivery between 2004-5. In addition, Air Hong Kong has applied to operate evening express services to India, Indonesia, Malaysia, Philippines, Singapore, Thailand and Vietnam.

Air China has agreed to increase its recent Airbus A319 order from eight to twelve aircraft. The airline’s only in-service Airbus aircraft are three long range A340-300s.

Taiwanese carrier China Airlines has confirmed new orders for up to 18 Airbus A330-300s and ten Boeing 747-400s.

Air Services Agreements (ASA):
Bilateral Agreements have been concluded between mainland China and Ethiopia, Singapore and Malaysia. Carriers from both China and Ethiopia can operate up to 14 weekly frequencies to Beijing. Passenger capacity between China and Singapore is to rise by 75% and cargo capacity is to triple by 2004. Finally, Malaysia has been granted up to ten new destinations in China.

Russia and Taiwan will operate direct air links between Taipei and Moscow from next April although the two countries do not have formal diplomatic relations. Initially China Airlines and Transaero Airlines will each offer two flights a week, once the formal agreement to operate the services is signed.

Hong Kong and The United States have finally reached a new Air Services Agreement. Representing a major turning point in bilateral relations, the new agreement includes provisions for greatly expanded fifth freedom rights for US freight operators; unlimited access to US cities for Hong Kong passenger and cargo carriers; Hong Kong carriers receiving the right to serve 25 cities in the US on a codeshare basis; and carriers from the US and Hong Kong having access to unlimited rights to codeshare on services on third country carriers between the US and Hong Kong. Dragonair and its shareholders, CNAC and CITIC, have objected publicly to the new agreement, in view of the additional competition from US carriers at a time when it is seeking to expand all of its operations, including freighter services to the US.

Aviation Services
In a US$29.8 million investment, Canada’s CAE Inc. has established a joint venture flight simulator training school with China Southern Airlines, Bombardier Aerospace and Shangdong Airlines. The school is called Zhuhai Xiang Yi Aviation Technology Co. and is based in Guangdong.

New aviation regulations in mainland China are expected to be introduced in May, paving the way for private and corporate operators of GA aircraft to obtain permission to fly through all civil air space in the country.

China Aviation Oil Holdings Co (CAOHC) has obtained the country’s fifth licence to import jet fuel. CAOHC dominates the market, supplying fuel to 90 airports. The licence is part of the State Council’s liberalisation of this strategic sector. Before the licence was granted by the Ministry of Foreign Trade and Economic Cooperation, China Aviation Oil purchased imported jet fuel from four designated trading companies (China National Chemicals Import and Export (CHINACHEM), China United Petroleum, Zhuhai Zhenjie and China United Petroleum Chemical). It has been estimated that the four companies will lose at least US$10 million in commissions. China is expected to lift all import quotas on jet fuel in 2004. This will have a significant impact on the fixed costs of airlines since imported fuel is 10-40% cheaper than jet fuel produced by domestic refineries. However, it may take several years before Beijing is prepared to fully liberalise this sector. A recent Directive published in the CAAC Journal has frozen the development of new jet fuel storage and refuelling facilities at mainland airports and ensured the maintenance of the present monopoly of CAOHC to "avoid chaos in the market".

Manufacturing
GE Aircraft Engines has signed a Letter of Intent with AVIC I aviation company to provide GE’s CF34-10A engine for China’s proposed regional jet, the ARJ21 and reportedly discussed the possibility of assembling the engine in China. The deal is said to be worth US$3 billion over 20 years. GE Aircraft Engines has long had a presence in China and currently buys engine parts from AVIC I valued at an average of US$20 million a year, a figure predicted to rise to US$400 million by 2005. China estimates it will require 300-500 regional jets over the next two decades.

Embraer has finally signed an agreement to build a production unit in China through a joint venture with Harbin Aircraft Industry (Group) Company and Haifei Aviation Industry Company, both of which are controlled by China Aviation Industry Group II (AVIC II). Harbin Embraer Aircraft Industry Company will be responsible for the manufacture, assembly, sales and after sales support for the ERJ 135/140/145 family of aircraft. The first aircraft is scheduled for delivery in December 2003. Embraer has 51% of the shares and the right to appoint a Managing Director. The Company has previously sold five ERJ145s to Sichuan Airlines in 2000 and has letters of intent with China Southern Airlines and Wuhan Airlines.

AVIC II is combining four of its companies (Haifei Aviation Industry, Harbin Dongan Auto Engines, Hongdu Aviation Industry and Jiangxi Chang-he Automobile) into a single entity with the intention of listing the new company on the Hong Kong Stock Exchange.

China Aviation Industry Corp I, China’s other main aviation group, has been given State Council approval to produce 72-79-seat regional jets, but the company is developing the aircraft on its own. AVIC I has said it aims to start production within three to five years. The CAAC has forecast that the country will order some 110 to 140 regional jets with 50 to 110 seats before the expiry of the 10th Five-Year Plan in 2005.

International Aero Engines (IAE) has won a US$100 million contract to supply its V2500 engines for eight of Air China’s new Airbus A319 aircraft. The Beijing carrier is a new customer for IAE’s consortium partners, Rolls-Royce Engines, Pratt & Whitney, Japanese Aero Engines Corporation and MTU Aero Engines.

Maintenance
MTU Aero Engines has unveiled a multi-million dollar aero engine maintenance facility in Zhuhai. Jointly owned with China Southern Airlines the facility is positioned to service the airlines of the Pearl River Delta. MTU Zhuhai will initially provide maintenance, repair and overhaul of up to 150 IAE V2500 and CFM56 series engines a year.

Lufthansa Technik Shenzhen (LTS) has secured a contract with Shenzhen Airlines to maintain the Airline’s CFM 56-3 thrust revenues.

Shangdong Airlines has purchased 12% of Shangdong TAECO Aircraft Engineering Co Ltd. from parent company Shangdong Airlines Group. Other major shareholders include Hong Kong aircraft Engineering Co Ltd.

Freight
In October, China Airlines was approved by the Taipei Economic Ministry Investment Review Board to invest US$47 million (or 25% of the shares) in China Cargo Airlines, which is owned by China Eastern Airlines and China Asia Shipping (Group) Company.

Yangtze River Express Airlines has reach an agreement with United Parcel Service to distribute UPS cargo to cities in Southern China from its hub at Shanghai Pudong International Airport. Chairman Liu Weining has been reported as stating that Yangze River Express intends to operate routes to the Western part of China in the second half of the year, after taking delivery of new freighters in addition to the three Boeing 737 aircraft that have been purchased.

Hong Kong-listed Citic Pacific plans to form an air cargo airline with Air China and BCIAG. The joint venture will have a registered share capital of 2.2 billion yuan.

China Sinotrans, a mainland freight forwarder, shipping and express services provider, was listed in Hong Kong on 13th February. Three strategic investors have agreed to take stakes: U.K.-based logistics company Exel PLC, New Yorklisted express delivery company United Parcel Service Inc, and Japanese transport concern Nissin Corp.

The State Postal Bureau ("SPB") has established a wholly owned logistics company, China Postal Logistics Co Ltd ("CPLC"). Meanwhile, the big four smallpackage courier service companies, DHL, Federal Express, TPG NV and United Parcel Service, have reached a compromise agreement in their dispute with China Post. The global courier service companies have agreed to a new licence system that technically allows China Post to restrict growth of their businesses. China Post used to have a virtual monopoly in the express market, but its business has grown by only 2% annually in the last five years. By contrast foreign express carriers have been experiencing growth rates above 20%.

The Ministry of Foreign Trade and Economic Cooperation (MOFTEC) has implemented new rules that allow foreign freight companies to hold controlling stakes in joint ventures in China. Effective 11 January 2003 the Provisions on the Administration of International Freight Forwarding Agency Enterprises with Foreign Investments allow foreign companies to own up to 75% of the shares of joint ventures, up from a previous limit of 49%. The regulations also allow overseas companies to purchase shares in other freight companies operating in China.

Following concerns raised by the European Commission regarding the detection of Asian Longhorn beetles in the packaging of shipments from China, new Wood Packaging Materials Regulations were implemented in China in October last year. These include compliance with the International Standard for Phytosanitary Measures (ISPM) 15 and a requirement for Phytosanitary certification. The requirements only apply to material comprising unprocessed wood. They do not apply to dunnage not landed and do not apply to shipments for which the final destination is Hong Kong. Failure to comply with the regulations may impede the final delivery of consignments, interrupt logistic supply chains and expose shippers and freight forwarders to penalties.

Space
Alcatel has signed a contract with the China Academy of Space Technology for the development and construction of a satellite for which it will provide the payload.

China’s fourth unmanned spacecraft, the Shenzhou IV, was launched on 30th December and returned to earth a few days later. The satisfactory performance of the capsule, which is based on the three person Russian soyuz capsule, and the Long March 2F Rocket has boosted Chinese confidence that a manned flight can be made later this year. Indeed, the China Aerospace Science and Technology Corporation, which builds and develops the rocket and capsule, has recently reported that the first manned spacecraft will be launched in October 2003.

Insurance
Passengers who purchase personal accident insurance at Chinese airports on the payment of a premium of 20 yuan will now be entitled to up to 400,000 yuan in cover, the CIRC having doubled the maximum compensation payable. Passengers will not be able to claim any compensation in cases of war or where the passenger commits suicide or where the passenger’s accident is caused by intoxication. If a passenger purchases multiple insurance policies the maximum amount payable will be 2 million yuan.

On 17th September 2002, the China Insurance Regulatory Commission (the CIRC) issued Provisions for the Establishment of Reinsurance Companies (the Reinsurance Provisions). These need to be read in conjunction with the Insurance Law, which was promulgated in June 1995, and amended by the National People’s Congress in October last year as well as the Administration of Foreignfunded Insurance Companies Regulations which took effect on the 1st February 2002 (the Foreign Insurance Regulations). The Reinsurance Provisions complete the legal framework for allowing foreign investment in the reinsurance sector which may take the form of a foreign-invested insurance company, an equity joint venture insurance company, a wholly foreign-owned insurance company, or a branch of a foreign insurance company. However, since the CIRC is currently drafting regulations governing the operation of reinsurance companies foreign reinsurers may still want to adopt a "wait and see" attitude towards opening companies, and doing business in the Chinese market until the operation regulations have been issued.

Unlike banking services and other insurance services, China has given major concessions to the reinsurance industry. Upon China’s accession to the WTO, geographic or quantitative restrictions on the number of reinsurance licences issued to foreign insurers were lifted because of the fact that the reinsurance market in China was relatively underdeveloped.

Premium income across all classes of business in China totalled 305.3 billion yuan (US$38 billion) in 2002, up 44.7% over the previous year.

The CIRC is to introduce more reforms in 2003 further to enhance the insurance sector including measures to encourage the public listing of several large state-owned companies, the diversification of capital structures and greater private and foreign investment, and the strengthening of regulations against illegal practices. Mr Wu Dingfu, the newly appointed chairman of the CIRC and the State Council have already given the green light to reform the People’s Insurance Company of China (PICC), China Life and China Re, China’s sole reinsurer.

According to the Taiwanese Department of Insurance (Ministry of Finance). Total premium income for non-life insurers reached NT$101.35 billion (US$2.9 billion) in 2002; an increase of 11.5% on 2001. The growth was largely attributed to increases in premium income in the aviation, engineering and fire insurance business. Aviation premiums rose by 63% to NT$3.9 billion.

Aon has been granted the first foreign insurance broker license in China. It is establishing a joint venture with stateowned trading firm China National Cereals, Oils & Foodstuffs Import & Export Corporation (COFCO), The joint venture, called Aon-COFCO, will be based in Shanghai.

GAB Robins has been granted the first international loss adjusting license in China.

Legal Developments
As is evident from our newsletters, aviation companies in China are engaged in an aggressive process of raising fresh capital through stock market listings on the mainland, in Hong Kong and elsewhere. While this process has presented new growth opportunities to companies, it has also caused the introduction of new obligations relating to corporate governance. Following a series of investigations by the China Securities Regulatory Commission ("CSRC") into companies accused of publishing false and misleading information, misappropriating funds and assets and manipulating share prices to create false markets in shares, the CSRC has imposed financial penalties on accountants, brokers, lawyers and directors of a number of listed companies. Also, a number of minority shareholders have issued proceedings to seek financial redress from companies.

On 9th January, the Supreme People’s Court issued a Judicial Interpretation concerning the Hearing of Civil Litigation arising in connection with false statements in the Securities Market. The principle features of this interpretation which establishes guidelines on the acceptance and hearing of cases includes the following: Victims may only issue proceedings after an administrative decision has been made or a criminal judgment has been issued regarding the false statement; potential defendants include sponsors, issuers, controlling shareholders, underwriters, accountants and lawyers, directors, supervisors and general managers; class actions are not permitted; false statements are defined as including false registration statements, misleading statements in the media and omissions; investors must prove that they purchased the securities after the false statement was made and that they have suffered a loss; and damages are limited to actual losses including investment losses, commissions losses and stamp taxes.

In a first for consumers in China, an electrical appliance company in Shanghai has voluntarily recalled all its food processors after a much published case where a saleswoman in a Nanjing department store suffered facial injuries from flying machine parts when she was demonstrating how to use the food processor. The company was obliged to take this action after the Shanghai Municipal Government enacted a regulation in October last year which requires manufacturers and suppliers to recall defective products and requires retailers to inform customers of defects. The Beijing and Shenzhen governments are drafting similar regulations.

© Barlow Lyde & Gilbert 2003