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RESTRUCTURING CANADA'S AIRLINE INDUSTRY: FOSTERING COMPETITION AND
PROTECTING THE PUBLIC INTEREST

INTRODUCTION

Canada's domestic airline industry has evolved from being an Air Canada monopoly to a virtually deregulated industry where the market is open to any carrier who can obtain an operating licence and pass a financial fitness test. This environment came about in response to pressure from carriers for less government regulation to allow them to better compete in the domestic marketplace. To this end, the government passed the National Transportation Act in 1987, which brought about the economic deregulation of Canada's domestic airline industry.

Since deregulation, through a series of mergers and acquisitions, there has been a consolidation of the airline industry. Canadian Airlines International Ltd. (CAIL) has evolved through the merging of CP Air with Eastern Provincial Airways, Nordair, Quebecair and Pacific Western Airlines in 1986, and the purchase of Wardair in 1989.

Air Canada consolidated its position by becoming a privatized corporation in 1988, thereby allowing it to compete without the constraints of being a Crown corporation, including the need for government approval of corporate and financial plans. It also acquired regional airlines, further strengthening its position.

What emerged from this process was a duopoly controlling 75-85% of domestic airline traffic. As well, both Air Canada and CAIL allied themselves with international alliances - Air Canada as part of Star and CAIL as part of Oneworld. Alliances between airlines are a major competitive force in global aviation, providing greater efficiencies and scope, and better service. Air carriers benefit from increased traffic, increased revenues and decreased costs. In particular, membership in global alliances improves the productivity of flight assets through code sharing, interlining and brand recognition, and enhances the return on non-flight assets through other sharing activities, usually involving co-locating to share gates, baggage handling, ground handling equipment, ticketing offices and corporate sales forces. Carriers retain their identity, national character and marketing presence while also receiving foreign market presence at relatively low cost.

While the airlines were free to compete, many have said that this duopoly led to destructive competition - competition that has proven to be unhealthy for both the carriers and consumers. Rather than the two carriers reaching a stable competitive equilibrium, they chose instead to compete head-to-head even when there was insufficient traffic for two carriers. The result has been that CAIL is in serious financial difficulty and Air Canada has not achieved the profitability or share value that might have been attained had they engaged in less destructive competitive behaviour.

This past summer, CAIL stated that it was in critical financial shape and would not have the necessary fiscal resources to "go it alone" for much longer. Recognizing its financial difficulties, early in 1999 CAIL approached Air Canada to discuss the possibility of a "friendly merger." While they agreed in principle on many of the proposed terms, discussions were not successful.

With CAIL continuing to face financial problems, on 13 August 1999 the Governor in Council issued an order pursuant to section 47 of the Canada Transportation Act, which altered the normal process in order to allow proposals for restructuring to come forward. This extraordinary action led many to re-examine Canada's airline industry in view of the job losses, increased fares, diminished shareholder value and bailouts that have characterized either or both of the national carriers since deregulation.

While the Committee is well aware of CAIL's financial situation and that many in the industry have said that the "status quo is not an option," there were some witnesses that stated that while one carrier is in trouble, the industry as a whole is relatively healthy. It is simply the case that, in a competitive marketplace, some companies succeed while others fail. Indeed, many witnesses told the Committee that, in general, the industry is doing fairly well given the size of Canada's market and the vast geography involved.

The Committee is of the opinion that, regardless of the general state of Canada's airline industry, we could be faced with a much different industry in the near future. Because of this, "time is our enemy." Tools and a policy framework have to be put in place quickly to deal with the possible emergence of a dominant carrier and the repercussions that this would have on the airline industry, airline employees, consumers and communities across Canada.

As a result, the House of Commons Standing Committee on Transport undertook a study to examine the policy framework for a restructured airline industry in Canada. As part of this process, the Minister of Transport asked the Committee to examine, in particular, the following issues:

• whether to increase the 10% limit on the individual holding of voting shares in Air Canada;
• the most effective means to foster competition;
• how to address pricing;
• maintaining service to small communities;
• air carrier commitments, including those related to the treatment of employees; and
• how to monitor the air market in which there could be a dominant carrier.

In large measure, these issues mirror the government's Policy Framework on Airline Restructuring in Canada,1 which focuses on ownership and control of Canada's airlines; fostering competition; price gouging; service to small and remote communities; and sensitivity to the rights and concerns of employees.

In this report, the Committee comments on these and other concerns with the expectation that our findings and recommendations will usefully guide future government actions. In particular, our focus is the twin goals of fostering competition and protecting the public interest, which includes consideration of the impact of airline industry restructuring on consumers, airline employees, and residents of small and remote communities.

While our discussion centres on a dominant carrier environment, the Committee believes that the possibility of CAIL restructuring, obtaining needed financial resources or otherwise revitalizing itself should not be discounted. In fact, some witnesses mentioned their desire that Canada continue to have an airline industry characterized by more than one national carrier operating in a competitive environment. We believe that, should CAIL cease to operate despite current efforts to avoid this situation, the recommendations made in this report would lead to the competitive environment needed for the emergence of other air carriers able to compete in the domestic and global marketplace.

FOSTERING COMPETITION

The Competition Bureau has stated its view that "very significant competition concerns will develop in most domestic airline passenger markets if a dominant carrier emerges from this process."2 This view assumes that "any restructuring will have to take place within the current framework respecting Canadian ownership and control of air carriers."3 It is expected that capacity will be reduced, which could lead to higher prices, a lessening of service, more difficult access to flights for consumers and detrimental effects for financially vulnerable airports. The Minister of Transport, in the government's Policy Framework for Airline Restructuring in Canada, identified fostering competition as a key element, feeling that action must be taken in a number of areas to ensure that the airline environment with a dominant carrier would be as pro-competitive as possible. An appropriate policy framework will ensure the environment needed for new and existing carriers to successfully start up and sustain a competitive service, which will benefit consumers, airline employees and communities across Canada.

Many witnesses suggested that there are two options: re-regulation, or the removal of barriers to full participation in the marketplace for new and existing carriers. Most witnesses appearing before the Committee argued against re-regulation. Others, however, pointed to what they viewed as the failure of deregulation in the industry, and urged the government to re-regulate. Rather than returning to a strict regulatory environment, the Committee believes that the most appropriate way to foster competition and protect the public interest is to remove, or to significantly lower, these barriers to participation in the marketplace. To this end, we make a number of recommendations designed to reduce them. In particular, we address predatory behaviour, ownership limits, slots, airport facilities and related issues, interlining and code sharing, regional affiliate divestiture, reciprocal cabotage, Canada-only carriers, a modified sixth freedom and charter carriers.

A. BARRIERS TO ENTRY

Barriers to entry4 can be created in a number of ways, including by governments and by firms within the industry. To create the best possible competitive environment, each of these areas should be explored.

The Competition Bureau, in its letter to the Minister of Transport, identified "the government's policies on foreign ownership and cabotage ... (as) the largest regulatory barriers to entry into the airline industry", and suggested that "the government may wish to reconsider them if a dominant carrier emerges." The Committee supports the Competition Bureau in this regard.

The Committee believes that barriers to entry must, to the extent possible, be removed. Otherwise, the emergence of new carriers might be inhibited, as might the expansion of existing carriers. We are convinced that, if re-regulation is to be avoided, a pro-competitive environment must exist. Removal of barriers to entry is critical in ensuring this environment. In our view, every opportunity must be taken to promote and create competition. This, in turn, will benefit consumers.

B. PREDATORY BEHAVIOUR

In the Policy Framework for Airline Restructuring presented to the Committee, the Minister of Transport identified predatory behaviour as a concern to be addressed within the context of fostering competition. In particular, the Policy Framework notes that "small and new entrant carriers are potentially vulnerable to excessively aggressive competitive attacks from a larger, established airline." To deal with this situation, "the government will ensure that there are effective measures put in place for dealing with predatory behaviour in the airline industry." The Policy Framework indicates that this may include the possibility of legislation to ensure that quick action can be taken to prevent this practice.

The Competition Bureau, in its letter to the Minister of Transport, noted that "predatory conduct is intended to eliminate or discipline a competitor or to deter future entry by new competitors and goes beyond a normal competitive response." Although predatory conduct is already addressed in two provisions of the Competition Act, the Competition Bureau recommended that the Act be amended to address airline-specific predatory behaviour, including the specification of acts or conduct that would constitute an anti-competitive act and the power to make temporary cease and desist orders under certain circumstances.

A number of the Committee's witnesses spoke of predatory behaviour. Some focused their comments on price, whereby a carrier might set low fares to harm competitors or match fares while adding capacity. Others noted that predatory behaviour can also take other forms, including excessive expansion of capacity, the matching of routes, selling below variable costs, modifying frequent flyer programs and restricting access to airport facilities. In the view of some witnesses, the definition of "predatory" must be sufficiently broad to encompass all types of predatory behaviour. Changes to the Competition Act to specifically address predatory and anti-competitive behaviour in the airline industry were also mentioned.

The Committee believes that predatory behaviour is a barrier to entry that must be explored, and urges the government to examine the manner in which such behaviour is defined and controlled in other countries. Allowing a dominant carrier to engage in predatory behaviour would greatly inhibit competition in the airline industry, with negative repercussions for the industry and for consumers, airline employees and communities across Canada.

From this perspective, the Committee recommends that:

1. The Competition Act be amended to define "predatory behaviour" within the airline industry and to give the Governor in Council the power to specify, by regulation, anti-competitive acts or conduct by air carriers.

2. The Competition Act be amended to give the Commissioner of Competition the power to issue temporary cease and desist orders in cases of predatory conduct in the airline industry. This action should only be taken following consultation with the Canadian Transportation Agency.

3. The government require, as a condition of approval, that a dominant carrier not engage in predatory behaviour. Any predatory action then taken by the dominant carrier should be subject to sanctions.

C. OWNERSHIP LIMITS

1. The 25% Limit

For many Canadians, ownership and control of the carriers within Canada's airline industry are critically important. The airline industry, because of our geography and population distribution, is a vital contributor to economic growth and prosperity, and the social fabric, of Canada. Thus, it is perhaps not surprising that one of the most contentious issues facing the Committee centred on ownership and control of our airlines.

Under the Canada Transportation Act (CTA), air carriers operating in Canada must be "controlled in fact by Canadians"; as well, the Act includes a 25% limit on foreign ownership of voting shares, although the Governor in Council may, by regulation, increase this percentage. In determining where control "in fact" lies, the Canadian Transportation Agency analyzes financial, managerial and operational relationships.

As well, the Investment Canada Act is relevant, and applies when a single foreign investor wishes to acquire more than 33 1/3% of a Canadian enterprise. This Act permits foreign shareholdings in a Canadian company up to 50% less a share, provided that these shares are widely held and that management control remains with Canadian shareholders.

The Policy Framework on Airline Restructuring presented to the Committee by the Minister of Transport states that "neither the 25% voting share limit nor the requirement for control "in fact" by Canadians will be changed. The Canadian Transportation Agency will maintain its role of ensuring that domestic air carriers remain Canadian-owned and controlled."

Foreign ownership restrictions are common to most countries. Those contained within Canadian legislation are intended to ensure that domestic routes are reserved for Canada's air carriers and that companies benefiting from designation as Canadian carriers for route rights under bilateral international air agreements are controlled by Canadians.

The Committee heard a great deal of testimony on these ownership limits and their effect on the restructuring of Canada's airline industry. With regard to the 25% foreign ownership limit under the CTA, many witnesses believed that this is a regulatory barrier to entry because the industry requires a great deal of funding and there are not sufficient pools of capital within Canada to allow new entrants to compete in the market, nor to allow existing carriers to expand their operations. They felt that the foreign ownership limit could be raised, or even eliminated, without losing Canadian control of our airline industry.

Other witnesses, however, argued for no change to the 25% foreign ownership limit. Some suggested that adequate access to capital exists, while others supported the status quo in order to limit foreign ownership of Canadian businesses.

Discussions of foreign ownership sometimes led to discussions of foreign control. In this regard, the Committee was also told that foreign control can be exercised through service and maintenance contracts, and through additional measures other than equity ownership. Examination of foreign ownership and control issues must go beyond equity considerations alone. These issues must be analyzed within a broader context.

The Committee also received testimony about the circumstances surrounding the current merger talks, with both Air Canada and CAIL receiving financial backing from their alliance partners. A number of witnesses noted that our two major airlines are heavily dependent on these partners. In fact, some felt that they were, to a large degree, controlled by the alliances.

The Committee is well aware of the controversy surrounding the foreign ownership issue. We are, however, also cognizant of the fact that Canada's air carriers are operating within a global context and as such require new tools to survive in this environment. As noted previously, the Competition Bureau cited the policy on foreign ownership as one of the largest regulatory barriers to entry, and suggested that the government may wish to reconsider this policy if a dominant carrier emerges. We believe that raising the foreign ownership limit to a higher level would remove a significant barrier to entry and enhance competition in the domestic air market, particularly given the capital-intensive nature of the airline industry and the need by new entrants and existing carriers for capital. In our view, increasing the foreign ownership limit may ensure that Canada has two competing national airlines, rather than one dominant carrier.

As a result, the Committee recommends that:

4. The government raise the foreign ownership limit in Canada's airlines to 49%.

2. The 10% Limit

The 10% limit on the holding of voting shares by any one entity that exists in the Air Canada Public Participation Act has also been at the centre of the Committee's deliberations. When Air Canada was privatized in 1988, this limit was put in place to ensure that control could not be acquired by a single entity and to ensure that shares were widely held.

According to the Policy Framework on Airline Restructuring, "the government is prepared to consider increasing the limit to a new level, .... if such a measure contributes to achieving a healthy, Canadian-controlled airline industry."

Some witnesses told the Committee that a governance structure with strict shareholder ownership limits reduces shareholder influence in the management of a company, while others argued that limits are needed to ensure that no single shareholder is able to exercise undue influence on a company's management. It was also pointed out that while major airlines in other countries have controls over foreign ownership, they usually do not have limitations on individual holdings affecting their own citizens. The Committee was also told that changes to ownership rules could have implications for our obligations under the North America Free Trade Agreement (NAFTA).

The Committee is of the opinion that the 10% limit on share holdings of Air Canada by a single entity has outlived its intended purpose. Air Canada has been a private company for more than 10 years, and has been operating and competing successfully in domestic and international markets during that time. Raising this limit would in all likelihood contribute to a better managed company by enabling shareholders to hold management more accountable for performance. Moreover, a review process would allow an examination of any effects, adverse or otherwise, that an increase in the limit would have on the operation of the company. It should be noted that the Committee is confident that a change to ownership limits in the airline industry would in no way violate our NAFTA obligations.

Therefore, the Committee recommends that:

5. The Air Canada Public Participation Act be amended to raise the limit of voting shares that any one entity can hold in Air Canada from 10% to 20%, with a review after two years to determine the impact of this change on the operation of the company.

D. SLOTS, AIRPORT FACILITIES AND RELATED ISSUES

1. Slots

A slot is a scheduled time of arrival or departure available or allocated to a particular airline on a specific date at an airport. Toronto's Lester B. Pearson International Airport is the only Canadian airport that is currently at slot capacity. Slots there, as well as at other slot-controlled airports throughout the world, are allocated through a process involving two international meetings per year, where airlines submit their requests for access to airport slots. To the extent possible, slot coordinators attempt to accommodate these requests. At present, there exists only a general International Air Transport Association (IATA) protocol, which is used as a guide for slot allocation.

The Competition Bureau addressed the issue of slots within the context of a dominant carrier environment and recognizing that, while the focus of their discussion was Pearson, similar constraints could occur in future at other airports. In particular, the Competition Bureau recommended to the Minister of Transport that "the dominant carrier give up, on demand from other Canadian carriers, a sufficient number of slots at Pearson, and at any other Canadian airport should slot constraints emerge, at times reasonably close to the requested times, so that effective competition can be mounted in domestic markets. ... . Slots should then be allocated according to regulations to be developed by Transport Canada." It was also indicated that "slots currently attributed to a regional affiliate that might seek to establish itself as an airline independent from the dominant carrier should continue to be held by that affiliate, rather than by Air Canada or CAIL. The affiliate would also likely require additional slots."

Certainly, slot access is a key concern for many. In fact, witnesses cited access to slots as the most significant barrier to entry should a dominant carrier emerge from the restructuring process; as well, slot access was identified as a problem at some airports even now. Independent carriers, charter operators and regional affiliates told the Committee that if a dominant carrier emerges from the restructuring of Canada's airline industry, that carrier could control the majority of slots at our major airports, resulting in a barrier to entry for existing carriers and potential new entrants, and significantly lessening competition. Pearson is a good example of this. As well, the dominant carrier could hoard slots at peak times by moving flights from off-peak periods, or by offering increased frequency at peak times.

Some witnesses suggested that no airline, group of airlines, or commercial airline alliance should be permitted access to, or control over, more than 65% of the available runway slots at any airport in Canada during any 15-minute period. While the Committee is not in a position to state categorically what the percentage should be, we believe that the government must ensure that existing carriers and new entrants have reasonable5 access to slots at Canadian airports, in terms of both number and timing. As well, a number of witnesses advocated a "use it or lose it" policy, whereby any airline that has been granted slots must use them within a reasonable period of time or forfeit them for re-allocation.

The Committee agrees that Transport Canada should develop rules governing the allocation of slots at Pearson and, if necessary, at other Canadian airports; we recognize that this is currently a problem which would be exacerbated in a dominant carrier environment. These rules must ensure that carriers, other than a dominant carrier, have access to slots so that effective competition can occur in the domestic market. We feel that while the IATA protocol provides guidance, it may not adequately address competition concerns should a dominant carrier emerge from the restructuring process. Moreover, we believe that the Local Airport Authorities (LAAs) should be consulted as the slot allocation rules are being developed. Clearly, access to slots on a reasonable basis would be a significant factor in fostering competition in the airline industry.

From this perspective, the Committee recommends that:

6. Transport Canada, following consultation with Local Airport Authorities, develop regulations regarding slot allocation in such a manner that new entrants and existing carriers have reasonable access to slots at Pearson, and at other Canadian airports should the need arise. These regulations should incorporate a "use it or lose it" principle.

2. Airport Facilities

The Policy Framework on Airline Restructuring indicates that, within a dominant carrier scenario, "the government will ensure that access to airport facilities will be allocated to permit competitive domestic services to be introduced." This may require a dominant carrier to "give up some access to airport terminal facilities to ensure that airport access is not a barrier to entry for current or potential competitors."

From its perspective, the Competition Bureau, in its letter to the Minister of Transport, called for "the dominant carrier (to) surrender to airport authorities, on reasonable terms and conditions, its rights, under subleases or licences, to those facilities that could be converted to common use, such as gates, loading bridges, ticket counters, baggage systems and flight information display systems." It also suggested that "the federal government could provide incentives (for example, reduced rent) to encourage airport authorities to adopt this recommendation ... ."

The Committee believes that access to slots would, by itself, be insufficient to bring about the desired level of competition. What is required is access to the broad range of airport facilities needed by new and existing carriers to compete effectively with a dominant carrier.

Thus, the Committee recommends that:

7. Transport Canada, as landlord, use its powers under ground leases and through such incentives as reduced rent to encourage airport authorities to adopt policies that provide reasonable access to airport facilities to new entrants and existing carriers.

3. Computer Reservation Systems

The two major Computer Reservation Systems (CRSs) in the airline industry are Gemini and Sabre - the former used by Air Canada, the latter by CAIL. These systems are a key component of airline ticket selling and distribution. When these systems were created, airline owners structured displays in such a way that their own flights were favoured over those of their competitors. To alleviate this problem, some countries, including Canada, have instituted rules that remove or reduce the potential for most anti-competitive uses of the systems.

Nevertheless, in conducting its analysis in the context of a dominant carrier environment, the Competition Bureau has indicated that improvements can still be made in a number of areas. For example, it cites a case where the display for a new entrant, which would have only small networks or point-to-point service, will show interline connections which will not receive as high a priority as on-line connections of the dominant carrier. This will occur even if the interline connection has a shorter elapsed travel time.

Another case identified by the Competition Bureau dealt with multiple displays of the same flight due to code sharing by alliance partners which results in a practice known as "screen padding". For example, a flight from Charlottetown, Prince Edward Island to Rome, Italy could be displayed as two on-line connections as well as one or more interline connections. These multiple displays will often push competing travel options onto secondary screens.

Mention was also made by the Competition Bureau that the CRSs give all carriers very detailed data about each other's sales. This would allow a dominant carrier access to marketing information on new and existing carriers and could increase its ability to injure competitors. This level of access to information concerning one's competitors is rather unique.

Recommendations made by the Competition Bureau dealt with mandatory code sharing, a requirement that the same flight not be displayed more than twice and restrictions on the sale or acquisition of booking information in certain circumstances.

The Committee believes that a dominant carrier must not have access to detailed marketing information on new or existing carriers. Access to information that might be considered confidential, proprietary or prejudicial must not be permitted, since such disclosure could be used by a dominant carrier in a manner that could inhibit competition.

As a result, the Committee recommends that:

8. The government review the Computer Reservation System (CRS) regulations to remove anti-competitive practices and to ensure that CRS competitive marketing information is not disclosed.

4. Frequent Flyer Programs

Many witnesses mentioned frequent flyer programs, both generally and as a barrier to entry. This issue was addressed by the Competition Bureau in its letter to the Minister of Transport, which recommended that "new entrants be able to purchase points in the dominant carrier's (frequent flyer) plan at a cost equal to either the parent's cost or the internal transfer cost to an affiliate, whichever is lower." Moreover, according to its recommendation, "points would be awarded by the new entrants on all their domestic flights," as well as "on transborder and international routes if a competitive analysis conducted at the time of restructuring reveals that there is insufficient competition on these routes." As well, the Competition Bureau recommended that "points awarded by new entrants (would) have the same rights and privileges as those awarded by the dominant carrier."

The Committee believes that frequent flyer programs are an important marketing device for air carriers. These programs have had a beneficial effect since their introduction, particularly for business travellers. We feel that regional affiliates and other carriers which currently have an arrangement with a national carrier regarding its frequent flyer program must have it safeguarded in the event of a dominant carrier environment.

Moreover, the Committee is of the opinion that a frequent flyer program could be used by a dominant carrier as a barrier to entry. It is for this reason that we believe that new and existing carriers should also be permitted to participate in a dominant carrier's program, at a cost. Allowing access to the frequent flyer program offered by a dominant carrier would serve the dual purpose of fostering competition and protecting the public interest.

From this perspective, the Committee recommends that:

9. The government require, as a condition of approval, that a dominant carrier honour all frequent flyer points awarded by its affiliates, carriers with which it has an arrangement in this regard, and any airline that it acquires or with which it merges. As well, as a condition of approval, a dominant carrier should be required to allow continued participation by these carriers in its frequent flyer program.

10. The government require, as a condition of approval, that a dominant carrier allow new entrants and existing carriers to purchase points in its frequent flyer program.

5. Surplus Aircraft

Brief mention was made by witnesses of the sale of surplus aircraft that would be likely to occur should the restructuring of the airline industry result in a dominant carrier. The Competition Bureau recommended to the Minister of Transport that "the dominant carrier offer to transfer, within a reasonable period following restructuring and on reasonable terms and conditions, all surplus aircraft, either owned or leased, to any interested parties in the domestic market before selling them abroad or parking them."

The Committee believes that, in the absence of any condition requiring that it do otherwise, a dominant carrier could hold on to its surplus aircraft or sell them outside of Canada, thereby creating a barrier to entry for new entrants and existing carriers.

For this reason, the Committee recommends that:

11. The government require, as a condition of approval, that a dominant carrier offer to transfer its owned or leased surplus aircraft to interested parties in the domestic market. This offer should be made on reasonable terms and conditions, within a reasonable time period following restructuring and before selling them abroad or parking them. In the event that a dominant carrier and an interested party cannot agree, the Canadian Transportation Agency should assess what is reasonable.

E. INTERLINING AND CODE SHARING

1. Interlining

Interlining is an agreement between two carriers to facilitate connecting traffic, and involves them charging less for a combined ticket than for two tickets purchased separately. The carriers also facilitate baggage handling and ticketing for connecting service. The Competition Bureau identified interlining as a concern, and recommended that "the dominant carrier be required to negotiate interline agreements on commercially reasonable terms and conditions with all new entrants in the domestic market wanting such agreements." It should be noted that, in its letter to the Minister of Transport, the Competition Bureau used the term "new entrant" to refer to both new and existing Canadian air carriers, other than Air Canada and CAIL.

Regional, charter and independent carriers told the Committee that they must have access to interlining agreements in a dominant carrier scenario to allow them to compete. Without this, while they could carry traffic from Thompson to Winnipeg and then on to Hong Kong on a dominant carrier, the price could be prohibitive and would involve two separate tickets.

The Committee believes that interlining agreements between a dominant carrier and new or existing carriers would facilitate the competitive environment needed to ensure protection of the public interest and "seamless" air travel.

Therefore, the Committee recommends that:

12. The government require, as a condition of approval, that a dominant carrier negotiate interline agreements under commercially reasonable terms and conditions with all new entrants and existing carriers in the domestic market wanting such agreements.

2. Code Sharing

Code sharing is the use of one carrier's designator code by another airline in computer reservation systems, timetables and tickets. It is an extension of interlining and allows carriers to better market their services because code-shared flights are considered to be on-line flights.

Like interlining, this issue was addressed by the Competition Bureau in its letter to the Minister of Transport. In particular, it was recommended that "new entrants be able to place their codes on those flights for which they have an interlining agreement with the dominant carrier."

Witnesses told the Committee that they consider it essential that new entrants and existing carriers have access to code sharing arrangements with a dominant carrier. In general, they spoke of code sharing and interlining arrangements as being parallel requirements.

The Committee holds the same view. Without code sharing arrangements, new entrants and existing carriers will not be able to compete effectively. Code sharing is critical to the development of a competitive airline industry in this country, and conditions in this area should be imposed on a dominant carrier prior to approval.

From this perspective, the Committee recommends that:

13. The government require, as a condition of approval, that a dominant carrier code share with new entrants and existing carriers with which it has interline agreements.

F. REGIONAL AFFILIATE DIVESTITURE

In the opinion of the Competition Bureau, "divestiture of some or all of the dominant carrier's regional affiliates may go some way toward introducing competition into domestic markets," although it was not recommended as a solution since "a full merger review (would have to be carried out) before recommending it as a remedy." Nevertheless, assuming that divestiture is feasible and would result in viable competitors, the Competition Bureau noted that the government would have to address four issues:

• regional carriers do not compete with the parent carrier, instead serving local and regional markets;
• since the success of the regional carriers depends on feed traffic received from and sent to the mainline carrier, mandatory interlining and code sharing arrangements between the dominant carrier and the divested regional airline would be needed;
• regional carriers are financially and operationally dependent on parent carriers; and
• regional carriers benefit from the parent carrier's volume purchases of certain items and share the loyalty benefits of the parent carrier's frequent flyer program.

The Competition Bureau recommended that, in the event that regional carrier divestiture is required, several conditions be met:

• a divested regional carrier be relieved by the dominant carrier of any restrictions on its ability to compete;
• the dominant carrier be required to enter into interlining and code sharing agreements on reasonable terms and conditions with any divested regional airline;
• the dominant carrier be required to transfer, to the divested regional airline, slots and, on reasonable terms and conditions, gates, counters and other facilities comparable to those currently enjoyed; and
• the dominant carrier give any divested regional airline the same level of financial and operational services now provided for a reasonable transition period at prices no less favourable than those currently offered to regional airlines or to any continuing affiliated carriers, whichever is lower.

Witnesses addressing divestiture of regional affiliates stressed that a dominant carrier must have a strong, efficient feeder network, whether through ownership or through commercial agreements. Their opinions differed, however, about whether a dominant carrier should be required to divest itself of its regional affiliates. In the view of some, regional affiliates are critical from two perspectives - providing feed traffic and "growing" new routes. Others, however, believed that allowing a dominant carrier to continue its current relationship with its regional affiliates would inhibit competition. A number of witnesses pointed out that regional affiliates and mainline carriers need each other.

The Committee believes that divestiture of regional affiliates could result in enhanced competition. Recognizing the symbiotic relationship between a national carrier and its regional affiliates, however, it is not clear to us that divestiture should necessarily be a condition of approval. In this area, caution is needed. It is not clear how a dominant carrier might be affected if it were required to divest itself of its regional affiliates and instead negotiate what would amount to a partnership with divested, or other, regional carriers to coordinate schedules and facilities. The potential effect of divestiture on regional affiliates is also unclear. More study is needed, and should occur within the context of a full merger review.

For this reason, the Committee recommends that:

14. The government ask the Competition Bureau to study, within a full merger review, the extent to which divestiture of regional affiliates would enhance competition in the airline industry in a dominant carrier scenario. If this study reveals that competition would be enhanced, the government should require a dominant carrier to take such action as a condition of approval.

G. RECIPROCAL CABOTAGE

The Competition Bureau's terms of reference from the Minister of Transport excluded an examination of cabotage. Along with the government's policy on foreign ownership, however, its policy on cabotage was identified by the Competition Bureau as the largest regulatory barrier to entry into the airline industry; government reconsideration of this policy was suggested if a dominant carrier were to emerge.

Among the witnesses who addressed cabotage, some stressed that it must be reciprocal, while others had no difficulty with it being extended unilaterally; others rejected it outright. Those supporting reciprocal cabotage argued that if foreign carriers are to have access to Canada's markets in this way, our air carriers must have similar rights in foreign countries. Witnesses supporting unilateral cabotage made the point that at least some of Canada's air travellers would benefit by increased competition on domestic routes, and that they should not have to wait the potentially lengthy period of time that might be taken in negotiating reciprocal rights.

Those witnesses who expressed no support for cabotage did so on the basis that allowing foreign carriers, especially U.S. carriers, access to Canada's domestic air market could financially harm some of our airlines. The point was made that cabotage would likely lead to increased competition by foreign carriers on profitable routes where we already have competition in the absence of cabotage.

The Committee understands the problems associated with cabotage. In spite of this, we think reciprocal cabotage would open up the market to more domestic competition, while at the same time allow Canada's air carriers to expand their markets in the United States. Along with the other barriers to entry discussed previously, cabotage must be viewed as a viable means by which competition can be fostered within Canada's airline industry.

From this perspective, the Committee recommends that:

15. The government initiate negotiations with the United States on reciprocal cabotage. However, no agreement should be concluded without a comprehensive review of the outcome of the negotiations by the Canadian Transportation Agency, the Competition Bureau and the appropriate committees of Parliament.

H. CANADA-ONLY CARRIERS

The Competition Bureau has suggested that the creation of Canada-only carriers would provide a significant amount of competition in the dominant carrier scenario. In fact, in its view, "the creation of such Canada-only carriers could potentially be more effective in contributing to domestic competition than all the other recommendations" made to the Minister of Transport.

By "Canada-only carriers," the Competition Bureau is referring to an airline that would be established under an Australia-like model for foreign ownership. Under this model, which would require a change to government policy regarding ownership and control, a carrier would be created that would be licensed to serve only domestic routes and could be up to 100% foreign owned. This model would use Canadian crews, be required to comply with all Canadian laws and regulations, and be subject to the same competitive conditions as any other Canadian carrier operating in the domestic market.

The Competition Bureau believes that this would allow for greater access to foreign capital to finance Canadian airline operations and could align new entrants with knowledgeable foreign operators who have the expertise to operate as effective competitors to the dominant carrier.

While the Committee did not hear a great deal of testimony on this proposal, we believe that it has merit as a means of enhancing competition and perhaps avoiding a dominant carrier scenario. The Australian model bears study in order to determine whether or not it is applicable to the Canadian situation and what regulatory/policy framework would be required. Such a review is particularly important in light of the prominence given to this proposal by the Competition Bureau.

As a result, the Committee recommends that:

16. The government examine the viability of licensing Canada-only carriers to operate solely on Canadian domestic routes.

I. A MODIFIED SIXTH FREEDOM

The Competition Bureau, in its report to the Minister of Transport, suggested using a modified sixth freedom approach as one way of enhancing domestic competition should a dominant carrier emerge from the restructuring process. A sixth freedom is the right to carry traffic from one foreign country to another foreign country via the carrier's home country. For example, a Canadian carrier could pick up passengers in Frankfurt and fly them to Detroit via Toronto. Under the Competition Bureau's proposal for a modified sixth freedom, a passenger could be taken from a foreign country via the home country back to the foreign country. For example, a U.S. carrier could pick up passengers in Montreal and fly them to Vancouver via Chicago. While it is now possible to do this, this service cannot be sold, marketed or displayed, on a travel agent's computer reservation system, on a single-ticket basis.

The Competition Bureau suggested that allowing this form of modified sixth freedom rights will instill price discipline on the dominant carrier to the benefit of travellers, particularly transcontinental business travellers. It recommended that, as a result of restructuring, the Minister of Transport should immediately attempt to implement modified sixth freedom rights with the United States; if immediate implementation is not possible, the Minister should allow modified sixth freedom unilaterally within two years, assuming there is no compelling evidence that new entrants and existing carriers are providing effective competition and price discipline to the dominant carrier.

While the Committee believes that a modified sixth freedom could provide a degree of competition for a dominant carrier, we caution that the price would have to be significantly lower than that offered by a dominant carrier to attract sufficient traffic to bring about "real" competition on these routes. We feel that the inconvenience and delays associated with going through a U.S. hub would require markedly lower fares to attract large volumes of traffic away from a dominant carrier. Having said this, we think that this option is worth exploring. Carriers may be willing to provide sufficiently low fares to give consumers a choice, and at the same time instill price discipline on a dominant carrier. Given the significant changes that may occur in Canada's airline industry in the future, the government should take every opportunity to implement proposals that would ultimately lead to a stronger, more viable airline industry and more choices for consumers.

From this perspective, the Committee recommends that:

17. The government begin negotiations with the United States for the implementation of modified sixth freedom rights between the two countries to allow the sale, marketing or display of sixth freedom traffic on a single-ticket basis.

J. CHARTER CARRIERS

Regulations developed in 1978 govern international air charter services. Although a new policy has not yet been announced, the government has recently re-examined these regulations. At the present time, Canada has signed more than 60 bilateral air services agreements, which define what cities carriers may serve, the number of carriers that can fly these routes, the frequency of service or capacity on these routes and the approval of prices. Some of these agreements are highly restrictive, while others are relatively liberal.

In addressing international charter regulations, the Competition Bureau indicated that the current distinction between charter and scheduled air service should be eliminated for the international market, as has been done for the domestic market. As well, it suggested that Canada should "remove the current regulatory restrictions relating to advance booking requirements, minimum stay, purchase of return transportation, points of departure and return, minimum prices and entity charters."

Several witnesses told the Committee that charter carriers will provide some competition in the domestic market in a dominant carrier environment, provided that certain barriers to their full participation in the marketplace are eliminated. Their ability to provide effective domestic competition is tied to their success in the international marketplace. From this perspective, they argued that changes must be made to international charter regulations. Particular mention was made of recommendations submitted by charter carriers to the Minister of Transport in September 1998.

In the Committee's view, liberalized rules for international charter carriers are needed. Their international success is critical to their ability to compete domestically. All possible mechanisms for contributing to this success must be explored to advance their role as a competitor in the domestic marketplace. To this end, we believe that the distinction between international charter service and international scheduled service should be reduced, to the extent possible. The elimination of this differentiation would enhance the ability of Canada's international charter carriers to compete domestically for their benefit and the benefit of Canada's air travellers.

From this perspective, the Committee recommends that:

18. The government examine its international charter policy with a view to reducing the distinction between scheduled and charter services.

19. The government, recognizing restrictions that may exist within international bilateral air services agreements, remove current regulatory restrictions in such areas as advance booking requirements, minimum stay, purchase of return transportation, points of departure and return, minimum prices and entity charters.

PROTECTING THE PUBLIC INTEREST

Throughout the debate on the restructuring of Canada's airline industry, witnesses consistently mentioned how Canada's air travellers, airline employees, and residents of small and remote communities would be affected by any restructuring. The negative effects were frequently identified as including higher fares, fewer discount seats, less generous discounts, reduced frequency, service that is of a lower quality, and reduced benefits from frequent flyer programs. While the Committee is convinced that increased competition in the airline industry will benefit consumers, airline employees, and residents of small and remote communities, we also believe that protective measures must be put in place.

The regulatory framework that currently exists has certain features designed to protect consumers. For example, new entrants to the airline industry must meet a financial fitness test. This requirement ensures that they have sufficient funds to sustain operations in an initial three-month start-up period without revenues from ticket sales. Related to this is a prohibition on ticket sales prior to licensing, which ensures that advance ticket sales cannot be used to finance the start-up of operations.

The Committee received testimony about airline alliances and the manner in which they benefit air carriers but also, importantly, consumers and the residents of small and remote communities. In particular, they benefit from access to larger international networks and lower fares. More communities can be reached more frequently and in a relatively "seamless" manner, with consumers using the same air transportation system without having to transfer between unconnected airlines. Benefits can also result from reciprocal frequent flyer programs, alliance member lounges, coordinated ticketing and baggage handling, conveniently situated connecting gates and improved coordination of schedules. We believe that alliances must be preserved, since their loss would reduce benefits received by air carriers, air travellers and the residents of small and remote communities.

Protecting the public interest is of paramount importance to the Committee. While we believe that fostering a competitive environment has a role to play in the restructuring of Canada's airline industry, there are also public interest concerns that must be addressed. For this reason, we make specific recommendations concerning safety, air fares, service to small and remote communities, financially vulnerable airports, airline employees, travel agents, the merger/acquisition review process, commitments by a dominant carrier, and a monitoring and review process.

A. SAFETY

Everyone is concerned about airline safety - air travellers, air carriers, airline employees and the government. In fact, a critical consideration identified by the government in the Policy Framework for Airline Restructuring is no compromise of our existing high safety standards. This framework indicates that "the government will ensure that Canada's safety standards remain among the highest in the world."

Safety considerations include the presentation of flight safety and other relevant information in a language easily understood by the air traveller. In this regard, linguistic considerations exist. Recognizing that linguistic duality is fundamental to the identity of Canada, the Policy Framework indicates that "the government will ensure that the Official Languages Act continues to apply in the case of Air Canada or any future dominant carrier, and that the Act is effectively implemented."

Many of the Committee's witnesses mentioned safety issues, including firefighting, emergency services, the number of, and training given to, airline personnel, and the need to ensure that safety information is properly communicated to air travellers. Particular mention of linguistic duality was made by several witnesses, some of whom recommended that the government ensure that the Official Languages Act continue to apply in its entirety to Air Canada or to a future dominant carrier, and that regional affiliates and other subsidiaries be subject to certain parts of the Act.

The Committee is aware that the matter of the application of the Official Languages Act to Air Canada affiliates has been referred to the Federal Court. We believe that linguistic considerations are important for many reasons, not the least of which is safety. The Committee, too, feels that safety must not be compromised, and thus supports the comments made by witnesses regarding adequate staffing on flights and training for airline personnel. While we are confident that safety is, in fact, the first priority for everyone - the government, air carriers, airline personnel, and air travellers - in our view there is no harm - and indeed great benefit - in communicating this regularly.

Moreover, the Committee hopes that all air carriers, regardless of whether or not they are specifically subject to the Official Languages Act, will recognize the linguistic profile of the clients they serve, and will offer all safety instruction and other services in the appropriate languages.

Therefore, the Committee recommends that:

20. In implementing its commitment to the very highest levels of safety in airline travel, the government use every available opportunity, throughout and following the restructuring of the airline industry, to communicate that safety is the first priority.

21. The government encourage all Canadian air carriers not specifically subject to the Official Languages Act to respect the spirit and intent of the Act where there is significant demand for services in either of Canada's official languages.

B. AIR FARES

The Policy Framework for Airline Restructuring presented by the Minister of Transport to the Committee notes that Canadians, and the government, are concerned about the future price of air travel. The Minister of Transport told the Committee that "although the best way to address pricing is to have an air services market that remains competitive as a means of disciplining pricing, it is recognized that competition may not exert sufficient control on prices in all circumstances." The Policy Framework indicates that the government will review section 66 of the Canada Transportation Act, and "will require commitments on pricing from the dominant carrier during the restructuring process and will consider adding conditions to its restructuring approval."

Section 66 of the Canada Transportation Act enables the Canadian Transportation Agency, on a complaint basis, to review basic fares or fare increases on monopoly routes in Canada, and to order roll-backs and refunds where practicable. An important issue is whether this section of the Act should be broadened to address other types of fares, and fares on non-monopoly routes.

The issue of air fares was also addressed by the Competition Bureau in its letter to the Minister of Transport. It suggested that "there is no effective regulatory protection against excessive pricing in the dominant carrier environment."

Witnesses commented on the rate at which air fares have risen over time, noting that their rate of increase has exceeded the inflation rate. They also often mentioned the high cost of flying to Canada's small and remote communities. In fact, 90% of passengers use discount fares, with the result that section 66 of the Canada Transportation Act provides them with no protection. Witnesses repeatedly shared their fear that, in a dominant carrier environment, air fares could become prohibitively expensive for some Canadians, especially in the absence of new entrants.

The Committee, too, is concerned about prohibitive air fares, and the effect on air carriers in terms of traffic volume, on the Canadian economy in terms of reduced business travel, on air travellers in terms of reduced travel opportunities to visit family, friends and other parts of Canada, and on small and remote communities in terms of reduced economic development and links to the rest of Canada.

While the Committee does not wish to jeopardize the financial viability of a dominant carrier, we believe that consumers, and residents of small and remote communities, must have some assurance that air fares will not rise to prohibitive levels, and that this assurance should take the form of a condition of approval for a dominant carrier.

For this reason, the Committee recommends that:

22. The government require, as a condition of approval, that a dominant carrier freeze air fares and ensure the availability of a reasonable number of discount seats. These conditions should exist for a two-year period.

23. The Canada Transportation Act be amended to allow the Canadian Transportation Agency to approve or disapprove any fare increases requested by a dominant carrier.

24. For the two-year period during which air fares would be frozen, a dominant carrier be required to justify any requests for air fare increases to the Canadian Transportation Agency. Requests would only be considered in extraordinary circumstances.

25. Upon approval of a fare increase by the Canadian Transportation Agency, a 60-day notice period be required before any fare increase takes effect. The amount of the increase must be communicated to consumers.

C. SERVICE TO SMALL AND REMOTE COMMUNITIES

Despite its confidence that an appropriate competitive environment will induce existing carriers or new entrants to the industry to serve routes vacated by a major carrier or its affiliates, the impact of a dominant carrier on small and remote communities is a concern for the government.

Sections 64 and 65 of the Canada Transportation Act require that notice be given by the second last and last carrier out of a domestic point. These requirements exist to alert the community and other carriers of an emerging competitive opportunity. As part of its Policy Framework, the government has indicated that it will review these requirements to give notice when exiting a market; as well, it will "require commitments on service to small communities from the dominant carrier during the restructuring process and will consider adding conditions to its restructuring approval."

A number of the Committee's witnesses shared their views about regional, charter and independent air carriers, and the role they should or will play in a restructured airline industry. Many indicated that any restructuring will create new opportunities for the realignment, adjustment and expansion of existing carriers, as well as the potential emergence of new carriers, provided a level playing field is created. A level playing field requires that attention be paid to many of the issues discussed previously in the context of fostering competition, particularly slots, airport facilities and predatory behaviour.

Witnesses also highlighted the importance of regional, charter and independent carriers in the economic development of small and remote communities, as well as their role as an important link for residents of these communities to the rest of Canada. Mention was made by some witnesses about the potential impact of airline restructuring on economic development initiatives by our Aboriginal peoples. Another concern raised was add-on fares, with some witnesses suggesting that air carriers holding a monopoly position on any route in Canada be required to offer add-on air fares to all other carriers on a pro rata basis, as it would if constructing add-on fares for connections to its own air services.

While we are concerned that service to small and remote communities be retained at the current level, if not enhanced, the Committee does not believe that service to these communities should be subsidized by Canadian taxpayers. As well, we do not believe that a dominant carrier should be "forced" in the long term to continue serving communities where the routes are not commercially viable; that is, a dominant carrier should not be forced to cross-subsidize, and pay for unprofitable routes with the revenues earned on profitable routes. In our view, the proper solution is the creation of a competitive environment that would allow new entrants to emerge and existing regional, charter and independent carriers to thrive.

As well, the Committee is concerned about the sections in the Canada Transportation Act requiring the second last and last carrier out of a domestic market to give notice. In our view, a requirement to give notice, without a companion requirement to continue service during this time, makes little sense. Nevertheless, we think that it would be inappropriate for government to force a private sector company other than a dominant carrier or its affiliates, particularly one suffering financial difficulties, to continue or begin serving a market. We believe that air travellers need greater protection than is given by the notice requirement in the Canada Transportation Act, and feel that they are entitled to receive advance notice of a service disruption. In addition, we think that service to small and remote communities must be provided for a period of time should an independent carrier cease to operate or to serve particular routes; in our view, a dominant carrier or its affiliates should have the responsibility to serve these communities for a period of time. It is hoped that, during this time, a new entrant will emerge or an existing carrier will provide the service.

From this perspective, the Committee recommends that:

26. The government require, as a condition of approval, that a dominant carrier and any wholly-owned affiliates continue existing service to small and remote communities for a three-year period, notwithstanding sections 64 and 65 of the Canada Transportation Act. This condition should apply for the three-year period unless a new or existing carrier provides service of a similar quality at a reasonable price to these communities.

27. In a dominant carrier scenario, if an independent carrier ceases to provide scheduled air services, the government request the dominant carrier to operate these routes for a one-year period.

28. The Canada Transportation Act be amended to require all air carriers to give 48 hours notice to the Canadian Transportation Agency prior to initiating a service disruption. The Agency should then inform the public and affected airports.

D. FINANCIALLY VULNERABLE AIRPORTS

The Committee received testimony from a number of witnesses about the devolution of government control over aviation infrastructure and navigation, user fees and the financial problems of some airports. While many characterized devolution of aviation infrastructure as a positive initiative, witnesses identified the increased costs that this has meant for airlines and ultimately for consumers. Also highlighted was the financial vulnerability that has resulted for some of our airports and for some Local Airport Authorities (LAAs). Mention was also made of the funding of the Airport Capital Assistance Program (ACAP), particularly given the capital investments needed at some airports following devolution. They asserted, as well, that government policy changes following devolution have had an impact on the financing of such services as firefighting and emergency response.

In relation to financially vulnerable airports, the question of providing "essential air services" was also raised. In the view of some, adoption of an essential air services policy would require a financial commitment by the government to ensure that these services were provided where the cost of operation would be prohibitive in the absence of government support. Without this, consumers could be negatively affected, as could an entire community if an airport were to close.

The Committee believes that these concerns are serious. Increased costs associated with changes to airport user fees and navigation fees, among others, are potentially passed on to consumers in the form of higher fares and/or reduced service. As well, we believe that promoting a competitive environment to ensure service to small and remote communities can only be successful if airports in these communities continue to exist.

For this reason, the Committee recommends that:

29. The government review funding of, and eligibility for, the Airport Capital Assistance Program for financially vulnerable airports and assess whether the Program could be expanded to include airport operational costs to support essential air services to these airports. As well, the government should examine the impact of the devolution of airports and means by which emergency response services at airports should be financed.

E. AIRLINE EMPLOYEES

As indicated in the Policy Framework for Airline Restructuring, the government, being aware of airline employees' concerns about job loss, relocation and layoff resulting from the restructuring, will "encourage labour-management discussions with a view to reaching an agreement satisfactory to both that will alleviate employee concerns." As well, during any major restructuring of the industry, the government will insist that "employees are treated fairly, and will require commitments from the dominant carrier to this effect."

It is assumed that the emergence of a dominant carrier will reduce much of the duplication that currently exists, with both of our national airlines flying many of the same routes at about the same time in planes with empty seats. That being the case, employment consequences are to be expected; in fact, if no employment effects were felt, a dominant carrier would likely have too much capacity.

Within this context, a number of the Committee's witnesses voiced their concerns about such issues as layoffs, terminations, relocation and the manner in which collective agreements and seniority lists would be merged. They argued for no involuntary layoffs or relocation, preferring instead attrition, early retirement incentives, voluntary severance options, leave of absence programs, and voluntary transfers. Some witnesses suggested that public support should be given to employees affected by the restructuring. In particular, income support, training, job search, relocation assistance and priority access to jobs in the industry for displaced workers were identified. In their view, the costs of adjustment for these employees should be borne by all taxpayers, rather than by air travellers. Concerns were also raised about the protection of benefits, including retirement benefits.

Although the Committee sympathizes with employees and their families who are likely to be affected by airline restructuring and the potential emergence of a dominant carrier, we are not convinced that public support should be provided to airline employees affected by restructuring. Many employees, in many industries, experience job loss and relocation through mergers, acquisitions and closures; in these cases, assistance is often provided by the company in question, particularly if a union exists, rather than by Canadian taxpayers in the form of "special assistance."

From this perspective, the Committee recommends that:

30. The government require, as a condition of approval, that a dominant carrier agree to no job losses and no involuntary relocation. Instead, a dominant carrier should be required to achieve employment reductions only through attrition and voluntary separations associated with early retirement and other incentives.

31. The government require, as a condition of approval, that a dominant carrier negotiate early retirement and other incentives with representatives of employees.

32. The government require, as a condition of approval, that a dominant carrier negotiate the protection of retirement and other benefits with representatives of employees.

Another issue addressed by witnesses appearing before the Committee was the "merging" of collective agreements, particularly seniority lists, that might be required as a result of the restructuring process and "common employer" designation. The Committee also heard testimony from witnesses about the "scope clause" included in the collective agreement between Air Canada and the bargaining agent representing its pilots. Witnesses noted that this scope clause is the most restrictive in the industry, and limits regional affiliates to flying turbo-props of 70 or fewer seats except for very limited services. They have identified a number of routes where they believe the introduction of jet aircraft would enhance service to small communities at reasonable cost.

The Committee is aware of the efforts that have been taken by air carriers and unions representing airline employees when mergers have occurred in the past. As well, we are cognizant of the Canada Industrial Relations Board's powers as they relate to the merging of seniority lists. Moreover, we recognize the desire of regional affiliates for the flexibility to operate jet aircraft. In our view, this would provide communities with alternatives that are not presently available. We believe that elimination of the scope clause would yield opportunities for regional affiliates, their pilots and communities throughout Canada. In our view, scope clauses are anti-competitive and have the impact of limiting quality service to certain communities in Canada.

As a result, the Committee recommends that:

33. Parties to collective agreements containing a scope clause remove the clause in their next round of collective bargaining, recognizing that these clauses are anti-competitive and a barrier to quality service to certain communities in Canada.

34. The government instruct the Canada Industrial Relations Board to decide all outstanding cases regarding common employer designation in the airline industry in a timely manner but no later than 31 January 2000.

F. TRAVEL AGENTS

Travel agents account for more than 75% of ticket sales by scheduled airlines in Canada, and are the most important distribution mechanism for air travel. Airlines pay agents base commissions on a fixed percentage of the ticket price, up to a capped value, and make additional payments, called override commissions, when agents meet certain sales targets. Override commissions provide travel agents with an incentive to target business to particular carriers.

In its letter to the Minister of Transport, the Competition Bureau noted that "market share targets could be set so high that these override commissions would have a powerful exclusionary effect," should a dominant carrier emerge. To address the situation, the Competition Bureau recommended that, for the domestic market, "the dominant carrier link its travel agent remuneration system to sales volume alone, on a straight-line basis, and not tie it directly or indirectly to travel agent loyalty."

Witnesses raised concerns that airlines have access to travel agent information, such as the precise number of bookings each travel agent makes for each carrier on each route. As a result, travel agents contend that airlines use this information to target commission overrides and other incentives, which places them in a difficult position when discussing remuneration with the airlines.

The Committee was struck by the inability of travel agents to join together and "negotiate" commissions with air carriers. We believe that fairness dictates that travel agents be permitted to "negotiate" collectively in this manner, despite the fact that they are not "employees" as defined by the Canada Labour Code.

For this reason, the Committee recommends that:

35. The government require, as a condition of approval, that a dominant carrier link travel agent remuneration only to sales volume and on a straight-line basis.

36. The government consider an amendment to the Competition Act that would enable licensed travel agents to "negotiate" collectively with air carriers regarding commissions.

G. THE MERGER/ACQUISITION REVIEW PROCESS

At the present time, the Competition Bureau conducts a comprehensive review of potential mergers to ensure that they do not lead to a substantial lessening of competition. If this is the case, conditions are imposed to mitigate the lessening of competition, and the merging companies must satisfy these terms in order to proceed without the Competition Bureau's objection. In general, the aim of these conditions is to facilitate the entry of new competitors into the market or to allow existing companies to expand and provide real competition.

The Policy Framework for Airline Restructuring identifies the government's intention to introduce legislation "designed to authorize the government to review and approve any restructuring proposal and to apply conditions and issue regulations relevant to all policy issues arising from a possible restructuring of the airline industry." The government's proposal, as indicated in the Policy Framework, would involve three elements of government oversight designed to capture fully the public interest:

• "the Bureau of Competition will review any specific proposed merger or acquisition with regard to competition issues;
• the Canadian Transportation Agency will review any specific proposal to determine if it meets the legislated ownership and control requirements; its mandate is to examine all aspects that relate to control, including all financial transactions, management and service agreements, contracts, shareholder agreements and other related documents;
• the Minister of Transport will review all aspects of any proposal from a transportation and public policy perspective and, taking account of the results of the Bureau and Agency reviews, will take responsibility for the final comprehensive recommendation to the Governor in Council."

Under the government's plan, a restructuring proposal would go simultaneously to the Minister of Transport, the Competition Bureau and the Canadian Transportation Agency, with all three proceeding as quickly as possible recognizing the financial health of the companies. Failure to comply with ownership and control requirements would mean rejection of the proposal, while Canadian Transportation Agency determination that these requirements would be met would allow the process to continue and be completed by the Minister and the Competition Bureau.

In this process, the final decision to approve a merger or acquisition would rest with the Governor in Council on the recommendation of the Minister of Transport. In particular, should a merger or acquisition be found by the Canadian Transportation Agency to comply with the requirements to be owned and controlled by Canadians, the Minister of Transport would recommend approval. This recommendation would consider the extent to which the carrier has made undertakings to address the remedies negotiated with the Competition Bureau and the conditions needed to meet public policy objectives.

The Committee supports the Minister of Transport's initiative with respect to the three-element merger/acquisition review process, recognizing that a number of agencies and individuals have a role to play. In drafting the legislation, we urge the government to consider a type of "fast track", albeit comprehensive, process to be used in extraordinary circumstances, in order to ensure that situations like the one which currently exists are resolved in as expeditious a manner as possible. This would alleviate hardship for all concerned - the air carriers themselves, their employees, consumers, and residents of small and remote communities. In our view, quick decisions must be made in order to reduce losses and disruptions that might otherwise be experienced.

Therefore, the Committee recommends that:

37. The government, in drafting its legislative proposal for a three-element merger/acquisition review process for the airline industry, develop mechanisms for expeditious decision making in extraordinary situations.

H. COMMITMENTS BY A DOMINANT CARRIER

In an industry as vital to Canadians and the economy as air transportation, it is perhaps not surprising that the government would take actions to protect the public interest. In fact, the Committee was told repeatedly during its hearings that if we were to be faced with a dominant carrier following the restructuring of the airline industry, commitments would have to be sought from such a carrier to ensure that some degree of competition is maintained and that the public interest is safeguarded.

Witnesses stressed that these commitments must be made "up front" by a dominant carrier, prior to the government giving its approval. Anything less would result in a lack of competition in the Canadian airline industry, and would not allow consumers to enjoy the benefits of a competitive marketplace - low prices, product choice, and quality service.

As a result, the Committee believes that a dominant carrier must agree to respect the guidelines we have proposed for reducing the barriers to entry over which it has control - slots, airport facilities, computer reservation systems, frequent flyer programs, interlining, code sharing, surplus aircraft, travel agent commission overrides and, generally, any type of predatory behaviour. It is equally important that a dominant carrier agree to, and implement, our recommendations designed to protect the public interest, including those related to air fares, service to small and remote communities, and airline employees.

The appropriate balance must be struck, however, between protecting the public interest and not impairing the competitiveness of a dominant carrier in both the domestic and international markets. While the Committee supports the concept of imposing conditions on, or seeking commitments by, a dominant carrier, we believe that these conditions, and their attendant costs, should be carefully considered by the government. In particular, to the extent that they are additive or interrelated, they must not inhibit the competitiveness of a dominant carrier in the global marketplace. In our view, the conditions, if onerous, could mean reduced benefits for air travellers, airline employees, and residents of small and remote communities.

From this perspective, the Committee recommends that:

38. The government require that a dominant carrier abide by conditions designed to lower and/or eliminate the barriers to entry for new and existing carriers, as well as conditions to protect consumers, airline employees, and residents of small and remote communities. Dominant carrier agreement to abide by these, and all other, conditions must be assured prior to approval being granted, and must be monitored on an ongoing basis.

I. MONITORING THROUGH AN OMBUDSPERSON AND PARLIAMENTARY REVIEW

The Committee recognizes that we are moving into "uncharted" territory with the restructuring of the Canadian airline industry and it is unclear what the outcome of the restructuring will be. Decisions made in the near future will have far-reaching and long-term effects. Whether competition will be sufficient and whether the public interest will be adequately protected are questions that only time can answer. We believe, however, that the government has the obligation to ensure that the goals of adequate competition and protection of the public interest are realized. To achieve this end, we believe that the government must take action in two areas.

The first involves amending the Canada Transportation Act to include a review process, while the second involves the appointment of an independent ombudsperson. The review process within the Canada Transportation Act would require an examination of the operation of the restructured airline industry to determine whether or not the commitments of a dominant carrier were being met, and whether or not the public interest was being adversely affected by a dominant carrier. The independent ombudsperson would have a variety of functions related to dominant carrier compliance with conditions and commitments, public complaints and reports to Parliament. This person might consider an Airline Passengers Bill of Rights, mentioned by several of the Committee's witnesses, as a model.

In its June 1993 report, the Standing Committee on Transport noted that competition may not always work, and that the public interest may require public intervention. In the case at hand, the Committee believes that intervention in the public interest should take the form of review, with the possibility of extending the conditions imposed on a dominant carrier, and the appointment of an ombudsperson.

Thus, the Committee recommends that:

39. The Canada Transportation Act be amended to require the Minister of Transport to appoint one or more persons to carry out a comprehensive review of the operation of a restructured airline industry no later than two years after a dominant carrier has been in operation.

40. The government instruct the Competition Bureau to conduct a review of competition issues related to a restructured airline industry no later than two years after a dominant carrier has been in operation.

41. If, on the basis of the reviews conducted under the Canada Transportation Act and by the Competition Bureau of a restructured airline industry, it is determined that conditions of approval applied to a dominant carrier should be extended, the government take such action.

42. The government appoint an independent ombudsperson to monitor the commitments of a dominant carrier, to oversee a public complaints process and to report annually to Parliament and to the appropriate committees of Parliament on the state of the airline industry. This person must be selected in accordance with a public and transparent selection process, and must possess expertise in such areas as airline policy, public interest advocacy, and regulatory and legislative processes.

CONCLUSION

Two key questions in this debate about the restructuring of Canada's airline industry are how healthy competition should be fostered and how the public interest should be protected.

The Committee is firmly of the opinion that eliminating barriers to entry will result in a healthy, competitive airline industry with benefits for everyone - air carriers, airline employees, air travellers, and residents of small and remote communities. We also believe that actions taken in accordance with the recommendations we have made throughout this report must occur to protect the public interest.

Many of the recommendations contained in this report focus on the conditions of approval for a dominant carrier, which presupposes a dominant carrier emerging as a result of a merger or acquisition. However, the Committee believes that should a dominant carrier emerge through other means, the government should ensure that the dominant carrier comply with the conditions contained in our recommendations in order to foster competition and protect the public interest.

The current examination of Canada's airline industry will result in changes - changes that will lead, in the longer term, to a strong, competitive Canadian airline industry able to compete in the global marketplace for the benefit of Canada's air carriers and consumers alike through safe, efficient, affordable and adequate air service. The Committee is confident that the adoption of our recommendations will lead to a revitalized airline industry able to thrive and serve Canadians well into the next century.

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1 Transport Canada, A Policy Framework for Airline Restructuring in Canada, October 1999.

2 Letter from the Commissioner of Competition to the Minister of Transport, 22 October 1999.

3 Letter from the Minister of Transport to the Commissioner of Competition, 30 August 1999.

4 Within the context of the airline industry, barriers to entry are impediments that protect a carrier from competition from potential new entrants and existing carriers.

5 The term "reasonable" has a generally understood meaning within the Canada Transportation Act.