PACC Committee Report
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Transport Canada – Airport Transfers:
National Airports System
The Standing Committee on Public Accounts convened on November 20, 2001, to review the recommendations of Chapter 10 of the October 2000 Report of the Auditor General of Canada (Transport Canada – Airport Transfers: National Airports System). In accordance with Standing Order 108(3) (e), the Standing Committee on Public Accounts presented its Twenty-First Report focusing on the implications of the Auditor General’s recommendations as they pertained to future lease renegotiations and requested a response from the Government pursuant to Standing Order 109. This report is the Government’s response to the Standing Committee’s recommendations.
The Government recognizes the importance the Committee attached to its examination of the issue of National Airports System (NAS) airport transfers with respect to the federal government’s ongoing responsibilities and the interests of Canadian taxpayers and the travelling public. The Government has taken note of the concerns raised by the Committee and has prepared responses detailing existing and proposed measures designed to address the issues and recommendations in the Committee’s report. The overall context for the individual responses is outlined in the following background discussion and chronology of events that culminated in the current airport transfer environment.
Prior to setting out the Government’s response to the Committee’s ten recommendations, it must be emphasized that there will be no renegotiation of the financial terms of existing leases until such time as recommendations on the most appropriate rent policy for leased NAS airports, resulting from the National Airports Rent Policy Review, are completed and approved by the Government.
The Airport Transfer Process
The First Airport Transfers: the LAAs
The commercialization of federally owned and operated airports had its genesis in the mid-1980s during the period of deregulation, fiscal restraint, and serious pressures on the Government’s capital resources. By transferring responsibility for the operation, management, development and financing of airports to non-public sector entities, the role of the Government would evolve from owner and operator to that of landlord, policy maker and regulator.
The airport transfer policy framework developed between 1987 and 1992 resulted in a unique, made-in-Canada transfer model which defined the Government’s broad transfer objectives and guided the conduct of transfer negotiations. Under principles approved by Cabinet, the Government would retain ownership of airport lands while transferring responsibilities for airport management, operation, development and financing to community-based, not-for-profit, corporate entities. Airports were to be transferred by way of a long-term lease rather than by placing airports on the open market for bids.
While the commercialization [by both lease and sale] of federal airports was not without precedent in the international arena, an initiative of this scale in Canada was revolutionary in terms of both public policy and the magnitude of the asset that was being transferred. A number of communities (political, financial, legal, transportation industry) were uncertain of the possible outcome of the undertaking, and extensive consultation and creativity was required on the part of federal officials to reconcile the interests and views of those parties in the airport transfer framework to ensure its success.
Initial candidates for transfer were several international airports in which the local communities had expressed an interest. Negotiations with four Local Airport Authorities (LAAs) for operation of the airports serving Vancouver, Calgary, Edmonton and Montreal (Dorval/Mirabel), commenced in 1988 and were conducted in parallel until successfully concluded in 1992. The new Airport Authorities were expected to be financially independent of Government. At the same time, it was the Government’s position that taxpayers were entitled to some return on their substantial investment in these airports, and in recognition of the business opportunity being handed over to the airport authorities. It was concluded that rent payments would be the appropriate vehicle for such compensation, since the Government had elected to not sell the airports outright. Using both internal analyses and the advice of independent experts, rent negotiations were based on the projected future cash flows of the airport, assuming a continued Transport Canada operation.
The Transfer Process Evolves: the CAAs
While the duration of the LAA negotiations might seem protracted, they in fact served to expose a variety of new technical, financial, legal and human resource challenges in transferring airport operations to non-government entities. The lessons learned from that process were invaluable in identifying the critical issues and success factors that needed to be addressed in subsequent transfers. At the same time, there was a realization that some revision of the transfer framework was required in order to accommodate the range of fiscal and operating realities of the remaining Transport Canada operated NAS airports.
In 1994, the role of the federal government in airports across Canada was redefined through the National Airports Policy (NAP). Under the NAP, 26 airports (including the LAAs) were identified as being critical to the national air transportation network; these were to be transferred to airport authorities through long-term leases. Other regional and smaller airports were to be transferred outright to local communities or other entities. Another distinction was that whereas the previous (1987) policy had been reactive to expressions of interest from communities, the NAP was proactive, i.e., the Government would pursue transfers and encouraged communities to participate.
The introduction of the NAP also served as an opportunity to undertake some modifications to the LAA transfer framework in the interest of improving the overall process. Through the NAP, Transport Canada responded to the concerns of stakeholders by simplifying the rent formula and strengthening public accountability principles for the creation of subsequent airport authorities. The Canadian Airport Authority (CAA) model began with the divestiture of several large, international airports (Toronto, Winnipeg and Ottawa) in 1996-1997. The process has continued with the transfer of the remaining NAS airports to CAAs (by lease) and the three territories (outright transfer). At the time of writing, only one NAS airport (Prince George) remains to be transferred, and it is anticipated that this transfer will be completed by the end of the current fiscal year.
Throughout the transfer process, Transport Canada was required to respond to a wide range of issues that arose when dealing with airports of differing levels of maturity and development in terms of financial viability, infrastructure requirements, passenger mix and volume, environmental considerations, etc. This required the Department to develop “variations on a theme” which would recognize these differences but still remain consistent with the overall transfer framework. Thus every airport authority in the NAS operates on the basis of a lease that has some unique elements in recognition of that airport’s particular circumstances or characteristics, but at the same time was based on the same set of principles and methodologies. For example, several airports received a negotiated adjustment reflecting unusual environmental problems.
It is widely recognized both in Canada and abroad that the Canadian airport transfer initiative has been a positive development in terms of public transportation policy and one that has proved beneficial for the communities served by NAS airports. Many countries and financial institutions continue to view the Canadian transfer model as a unique and successful example of public sector commercialization.
Ongoing Transport Canada Initiatives
Since 1992, all NAS airport transfers have been subject to a broad range of comprehensive internal and external reviews designed to evaluate the success of the transfer process and the achievement of federal policy objectives. These reviews were largely Transport Canada initiatives that provided valuable guidance for the airports remaining to be transferred. Frequent consultations have taken place with a variety of stakeholders, including individual airport authorities and the Canadian Airports Council, airlines and airline industry groups, various levels of governments, chambers of commerce, and other federal departments and agencies. Overall, the broad range of interests and stakeholder opinions on the success and effectiveness of NAS airport transfers is reflected in the evolution of the LAA and CAA model, as well as recent initiatives such as the National Airports Rent Policy Review and the drafting of the proposed Canada Airports Act.
In 1997, Transport Canada initiated a comprehensive five-year review of the original four 1992 transfers. Called the LAA Lease Review, it was undertaken over a two-year period with the assistance of independent advisors, and examined in detail a number of lease management, operational, financial and governance issues. The Review found the initial transfers to be successful, with the airports exhibiting full financial viability, timely expansion and improved levels of service. At the same time, it called for some improvements in the management practices and policies, the governance model, and the enforcement provisions of the airport transfer framework.
Shortly before the results of the LAA Lease Review were presented to Cabinet for consideration (May 2000), the Auditor General of Canada (OAG) undertook a review of the airport transfer initiative to date. The audit was not limited to financial issues but also examined the extent to which Transport Canada adhered to government directions and key financial principles established for airport transfers. The report expressed concern that Transport Canada had yet to clearly define its role as landlord and overseer of NAS airports and pointed to Airport Improvement Fees, subsidiaries and sole source contracting as areas requiring
further policy clarifications. It noted that while the Government approved a policy of receiving fair value in consideration for the transfer of a going concern to airport authorities, Transport Canada could not demonstrate that fair market value was determined before negotiating airport transfers. Nor could Transport Canada demonstrate how individual transfer deals were equitable, uniform and consistent. The report also held that there was no comprehensive and consistently applied lease management regime for leased airports. The actual recommendations of the Audit were published in Chapter 10 the Auditor Generals Report of October 2000, along with the Department’s response to specific observations.
Transport Canada recognized the benefits of an on-going program of self-evaluation in the interest of improving the delivery of the program early in the airport transfer initiative process. With the observations of the Auditor General coming on the heels of the recommendations of the LAA Lease review, Transport Canada determined that measures were required to respond to the recommendations of these two reports as well as other views and concerns expressed by various stakeholder groups.
In response to the recommendations of recent internal and external reports and reviews, and with the benefit of ten years experience in airport transfers, Transport Canada is undertaking the following three major initiatives related to airport transfers. The first two involve major policy initiatives; the third responds to the Department’s oversight and landlord roles.
The Government’s airport transfer initiative was undertaken without the benefit of having airport legislation in place that clearly articulated the post-transfer roles and responsibilities of the Government and the airport authorities. Instead, broad policy issues were packaged with contractual issues in airport lease documentation. This provided few enforcement levers short of terminating the lease, and meant that any changes required renegotiation (or changes in law).
Transport Canada took the initiative to undertake the drafting of legislation that would address these issues. In June 2001, the Minister of Transport announced the intention of the federal government to develop a Canada Airports Act, which would clarify the roles and responsibilities of both the Government of Canada and the airport authorities. Specifically, it will
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strengthen the governance regime for airport authorities, including requirements for increased transparency, consultation and disclosure of information;
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establish principles for charges imposed by airport authorities;
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address competition issues, most notably equitable access for airlines to airport facilities;
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ensure NAS airport activities are consistent with Canada’s international obligations;
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establish parameters for non-core activities undertaken by airport authorities, and
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establish appropriate enforcement mechanisms.
Following Ministerial approval of the completed draft text, it will be released for public consultation. It is anticipated that a first draft of the legislation will be available for stakeholder comment and consultation in the fall of 2002.
National Airports Rent Policy Review
From the inception of the airport transfer program, stakeholders have expressed views and concerns over a number of airport rent issues. These issues include: the policy basis for collection of rent, the quantum of rents being paid to the federal government (both in total and by individual airport authorities), the impact of airport rent on the viability of the overall domestic air industry and the relative amounts of rent paid by similar classes of NAS airports.. However, there was seldom a consensus of views among stakeholders on any given issue. In the case of rent payments, some stakeholders questioned the legitimacy of paying any rent. However, the opposite view has also been expressed that not only should rents be charged, given the potential revenue generating capacity of certain airports that are using taxpayer funded infrastructure, but that they should be higher.
Airport authorities criticize the government for seeking to participate in their future earning potential when such earnings are attributable to entrepreneurial activities, capitalization, and risks undertaken by the Authorities. The Canadian Airports Council (CAC) has taken the position that the rent formula should be cost based, which would reflect the government’s historical investments in the airport infrastructure. Finally, airlines allege that the level of rents is jeopardizing the overall health of the air transport industry and have called for the abolition of rent in order to enhance competitiveness and lower costs.
Taking into consideration the recommendations of recent reviews, along with accumulated financial performance information, the Government determined that it was prudent to undertake a comprehensive rent policy review to address these issues. Consequently, the Minister announced the intent to undertake a comprehensive rent policy review on June 12, 2001.
The National Airports Rent Policy Review (Review) will assess current and future rents in the context of the knowledge and experience gained over the course of the past several years and the realities of the aviation industry. The Review is designed to address the issue of fair value by examining various methodologies for determining value and assessing the appropriateness of various forms of rent (including participation rent). Consideration will also be given to the issues of fairness and equity from a variety of stakeholder perspectives. The Review will require the examination of a number of issues related to airport economics, financing, and business valuation that require external expertise. Consequently, the Review will rely heavily on the advice and recommendations of independent advisors. Five national firms have been retained by Transport Canada to provide expert advice, either individually or collectively, on rent policy options to be presented for Ministerial consideration in the fall of 2002. Furthermore, the use of independent advisors will support the transparency, objectivity and integrity of the Review, which are overarching objectives of the department.
The Review has to find a balance among a number of fundamental policy foundations. For example, an objective of the Canada Transportation Act is that “a safe, economical, efficient, and adequate network of viable and effective transportation services …at the lowest cost is essential to serve the transportation needs of shippers and travellers”. The provisions of the Treasury Board Real Property Revenue Policy require that “all disposals of federal real property by
lease be supported by an estimate of the rental market value of the real property”. The NAP reflects the cabinet approved objectives and principles regarding the NAS airport transfer initiatives.
The Review will examine the most appropriate methods of “valuing” components of leased NAS airports and associated airport business activities. This process of determining what constitutes “fair value” is critical to establishing “fair rent”. Although the specific valuation methodology that will be applied to all leased NAS airports is currently under development, long-term (20 year) airport authority cash-flow projections will be compiled to support studies relating to the impact of rent on the financial viability of leased NAS airports. The Review will include an examination of the link between airport rent and how it is passed on as a cost by airport operators to airport users and ultimately the traveling public, and whether this impacts on the overall profitability and competitiveness of the Canadian commercial air industry on a North American and broader international basis. Stakeholders are being consulted as part of the process.
In considering the issue of value, it is useful to review the terminology in play over the years. For example, in the 1987 policy, A Future Framework for the Management of Airports in Canada, the Government said it “… would expect to obtain reasonable compensation for any facility transferred …” and such compensation “should consider historical investments as well as future earning potential”. The 1989 Supplementary Principles for the Creation and Operation of Local Airport Authorities indicated that the transferred airports would be valued at “fair market value” and this would include consideration of “the airport’s future earning potential”. The 1994 National Airport Policy (NAP)’s Fundamental Principles for the Creation and Operation of Canadian Airport Authorities specifically stated that the airport transfer “will result in fair value for the federal government with appropriate consideration to the airport’s future earning potential”.
Thus the terminology may have changed over the years, but the objectives and principles for achieving fair value have remained consistent. In the case of airport transfers, however, a determination of market value was complicated by the decision to negotiate terms of the airport lease with a specific, unique, local not-for-profit entity, rather than to solicit proposals or bids on the open market (as is the more common practice internationally). Accordingly, Transport Canada sought the advice of independent experts in the field of business valuations, and was informed that, in the absence of a true “market”, projected future cash flow was the best method to utilize in determining fair value. This approach was consistently applied throughout the transfer process.
With all but one NAS airport transferred, the focus has moved from negotiating leases to refining the lessor-lessee relationship. The Department has for some time been actively engaged in its role as overseer of the NAS and landlord of the LAA and CAA airports. For example, Transport Canada established a Lease Monitoring Program designed to assess the extent to which both the Authorities and the Crown are fulfilling their obligations and exercising their rights under the provisions of the principal documents (primarily the Ground Lease) that govern their relationship. This was implemented in response to the October 2000 Report of the Auditor General of Canada and building on the Department’s evolving experience with Airport Authorities.
The monitoring process involves a variety of activities such as pre-arranged site visits, attendance at formal public and informal ad hoc meetings, review of documents, discussions with other regulatory agencies, use of checklists and regular contact with the Authorities on any number of day-to-day Ground Lease administrative matters (e.g. overall compliance, safety and security, public accountability, asset protection, environmental diligence and rent).
Transport Canada’s regional offices completed 17 individual reports on Airport Authorities in 2001;all 21 NAS airports are scheduled for monitoring in 2002. Only a few non-contentious issues were identified, and the Department has clarified the requirements and sought compliance. The Department will continue to work on improving and refining its methodologies and checklists, especially those relating to asset protection and life safety systems, and training regional staff.
Another example is the Department’s financial audit framework. A first round of rent audits was conducted on the LAAs in 1995. Subsequently, an audit framework and strategy for LAA/CAAs was promulgated in January 2001, dealing with audits of airport rents and capital subsidies. Rent audits have been conducted under the new framework at Vancouver (2001), Edmonton (2002) and Montreal (2002).
No further site rent audits have been scheduled over the next few years because many airports do not pay rent as yet, or are paying the maximum base rent included in their lease. Audits of capital subsidies are being carried out at
St. John’s and Toronto airports. Current plans include Charlottetown, Halifax, Moncton, Regina, Winnipeg and Saint John. The main focus of these audits will be on capital subsidies provided by Transport Canada since the transfer of the airports.
With respect to the Committee’s concerns about the financial viability of the NAS airports, Transport Canada is well aware of its role in this regard. This was not a major concern in the first few years after transfer, because even the smallest NAS airports were successful in taking over operations, and the larger airports were achieving results beyond our expectations. However, the ability of the NAS airports to generate operating surpluses and attract over $5 billion in investment capital are important measures of the overall financial stability of the System.
Nonetheless, Transport Canada was already developing the databases, communication channels and human resources required to provide the appropriate level of oversight and monitoring not only of the NAS, but also of the airport system as a whole. As an example, the Department reviews quarterly financial statements from the 21 Airport Authorities; this serves as an “early warning system” for any airport specific problems. More recently, the Department launched a study into the viability of small and regional airports with a view to understanding the impact of airport divestitures on the communities served by those airports.
The events of September 11, 2001, put a new and unexpected perspective on both the strengths and the weaknesses of the aviation system. Most impressive was the rapid reaction by many airports to the sudden need to get hundreds of planes on the ground as quickly as possible and make major adjustments to their operations. The results reflected the professionalism of the management of those airports, and were a source of pride for all Canadians.
On the other hand, we also saw some examples of how the aviation industry can be vulnerable to sudden changes in consumer confidence. Thankfully, as events have unfolded, the trend is turning back. A comparison of passenger traffic data for the first six months of 2002 with the same period in 2001 indicates a gradual improvement from the past September 11 lows.
Some other September 11 related developments have served to demonstrate that the Department can, and does, act quickly and rigorously as the system’s overseer. The best example is the Government’s handling of the war risk insurance crisis. Insurance underwriters issued a seven-day notice of cancellation of aviation war risk liability coverage to all stakeholders. Within seventy-two hours of identifying the problem, Transport Canada officials designed and obtained the necessary Governor in Council authority for a bridging risk indemnity program which provided coverage not only to airports, but to the entire aviation system including airlines, Nav Canada and airport service providers. In the absence of this Government response, the domestic air transport system would have been shut down in a matter of days.
The Department also put in place interim airport Security & Policing and Pre-board Screening programs, pending the establishment of the Canadian Air Transport Security Authority (CATSA). The Department accelerated the airport Explosive Detection System program, again pending the establishment of CATSA. These interim programs were commissioned and completed under the tight time frames dictated by exceptional circumstances.
Government Response to Standing Committee Recommendations
The above represents a review of the airport divestiture process and major commentaries surrounding it to provide context to the Government’s response to the Standing Committee’s recommendations below.