2020 has been a pivotal year for the aviation industry. The COVID-19 pandemic has had a transformative impact on commercial air travel, which will take time to recover to 2019 levels. In conjunction with the financial stresses associated with the COVID-19 pandemic, the industry has also been hit by the grounding of Boeing’s workhorse B737-Max aircraft. Despite these challenges, the industry has proven resilient and adaptable to new challenges and, as with past major downturns, many are now looking how best to time the bottom of the market for maximum investment opportunities.
Review of 2020
There may have been some tailwinds going into 2020 with the grounding of Boeing’s B737-Max aircraft and the prospect of LIBOR and Basel III reforms, but the year started with enthusiasm after a buoyant 2019.
The demand for urgent financial responses to the pandemic has resulted in airlines and aircraft lessors trying to access as many funding sources as possible. Islamic corporate facilities, and Ijarah and Istisnah asset aircraft and engine transactions, initially saw greater traction in 2020 than the Sukuk market, often as these deals have been quicker to execute.
Capital markets have been very active generally, though more in the conventional unsecured space for the aviation industry, but we have seen a noticeable increase in interest in the aviation Sukuk space; at the time of writing led by Etihad Airways’s recent US$3 billion environmental, social and governance (ESG) Sukuk. We are likely to see both airlines and aircraft lessors access the capital markets further for the remainder of 2020 and into 2021.
However, the financial challenges presented by the COVID-19 pandemic have impacted the existing Sukuk market, with a number of issuers having to defer their existing payments or extend the maturity of an existing Sukuk. Two examples are Malaysia Airlines and Garuda Airlines — Malaysia Airlines needed to agree to the deferral of profit payments while Garuda Airlines extended the maturity of its existing Sukuk repayment date.
It has not been all bad news in 2020. Despite the disruptions to the industry caused by COVID-19, airlines have remained committed to their sustainability goals. In August this year, Etihad and Boeing launched a sustainable test flight trialling innovative environmentally friendly technologies to ensure that commercial aviation can progress sustainably into the future, and we would see ESG-linked funding transactions as ones well suited to Shariah principles. In September this year, Airbus also unveiled its plans for zero-emissions hydrogen-powered aircraft.
Preview of 2021
The aviation industry has experienced major downturns in the past and some of today’s major players have benefited from managing their risks in past down cycles. We would expect to see private equity take opportunities in partnership with operating lessors (such as the recently announced US$3 billion transaction between GECAS and PIMCO), and would also expect to see equity raised in the Shariah compliant fund space.
The replacement of LIBOR is likely to have a large impact for Shariah compliant transactions during 2021 as part of the phasing out of LIBOR. This is of course something that is impacting the global financial community, but given that a lot of Shariah compliant hedging transactions are not documented through the International Swaps and Derivatives Association (ISDA) format, such hedging transactions will not have the benefit of ISDA amendment protocols and will require more bilateral negotiation.
While we might expect that changes to the Basel accord are probably less likely to have an immediate impact on a lot of Shariah compliant financial institutions directly, we are seeing a number of banks around the world start to prepare for the impact of changes to the Basel accord which may create more opportunities for banks that are not subject to the removal of asset finance slotting rules.
Although airlines have been seeking to delay deliveries of new aircraft, we are seeing an increased demand for export credit financing which we would expect to accelerate in 2021. The groundbreaking UK Export Finance-backed Sukuk in respect of Emirates aircraft perhaps came at the end of the last peak of export credit agency finance, and it will be interesting to see whether we will see this product revisited in a Shariah compliant manner.
The long-term sustainability of the aviation industry will continue to dominate the agenda for the industry into the future. Aviation leaders have committed to ensuring that sustainability goals and the long-term ‘greening’ of the industry will be prioritized as it recovers from the economic fallout from the pandemic. Continual technological advancements will ensure that air travel continues to improve efficiency and accessibility, as well as safeguard its status as the desirable method of global transportation into the future.
Commentators are using an alphabet soup of suggestions on what the global recovery coming out of 2020 might look like but at this stage accurate predictions are difficult. We have seen the bottom of the cycles before and they are never pretty at the time, but what is clear is that the Islamic finance industry will have a key part to play in any recovery.
Antony Single is a partner in Clifford Chance’s global transportation team and Ahmed Choudhry is a counsel in Clifford Chance’s Islamic finance team. They can be contacted at [email protected] and [email protected] respectively.