Participants in the aviation industry put their seat belts on ready for a bumpy ride in 2021. While 2021 remained a mixed year in the aviation industry, with major restructurings of various leasing and financing arrangements, it has been remarkable how resilient the industry has been in the circumstances in the face of closed markets and dramatically reduced passenger numbers.

The typical airlines and aircraft lessors that utilize the Islamic banks and financial markets responded quickly to the COVID-19 crisis to ensure liquidity facilities were put in place to fund ongoing activities in particular with commodity Murabahah facilities, and sale/leaseback Ijarah facilities.

It has been interesting to see that, unlike in other financial crises, there has remained strong liquidity in the aviation finance sector, and even with some players retreating, there has been a real growth in private equity and non-bank alternative funding vehicles investing in the aviation funding and leasing space.

Review of 2021
The number of new deliveries of aircraft was much reduced in 2021 with the large original equipment manufacturers, such as Airbus and Boeing, cutting production numbers, although we have started to see deliveries of the Boeing 737-Max aircraft starting to be delivered into the Middle East following the lifting of restrictions.

This production cut, coupled with deferrals, has resulted in a lower number of new deliveries in 2021 in general, but Shariah compliant banks have continued to play their part with the new delivery market with a number of new portfolio facilities.

It must be recognized that there have been a number of large airlines, and even a small number of aircraft lessors, that have sought bankruptcy protection over the last 12 months, although perhaps fewer than expected at the start of the year.

While every airline restructuring and bankruptcy is different, the trend has been for airlines not to simply utilize their domestic bankruptcy processes but to combine this with a UK or US formal restructuring process such as the US Chapter 11 procedure (eg Philippine Airlines, and LATAM) or a UK Restructuring Plan or Scheme of Arrangement (eg Malaysian Airlines).

The concerns of Islamic banks and investors have been similar to those with conventional banks, although there clearly are some additional structuring points for them in implementing typical restructuring transactions.

In some cases, the distress has led to airline defaults, most notably, in the Islamic context, with defaults of Garuda, the Indonesian flag carrier, on its unsecured Sukuk.

There have certainly been some positive movements in the context of the London Inter-Bank Offered Rate (LIBOR) reform in 2021. For something where the big picture direction of travel has been so certain, the indecision of how and when to get there has certainly been bugging those trying to plan for the future.

It has been clear for several years that key financial regulators around the world have wanted to get rid of LIBOR as a benchmark rate. The key questions have been how and when this would happen.

While regulators have been increasing the pressure on their financial institutions and setting dates, and we have seen some transactions (outside of the aviation sector) adopt the backward-looking daily compounded Secured Overnight Financing Rate (SOFR), this has not led to a mass exodus from US LIBOR to SOFR.

In part, this has been because the backward-looking rates are more difficult to administer and are far more complicated — the mechanics may be fine in a set of bond documents but do not fit well into Islamic finance deals.

The announcement by the New York Federal Reserve Bank and the Alternative Reference Rates Committee supporting the adoption of Term SOFR (as a forward-looking rate) has certainly been welcomed, albeit that there has not yet been a stampede toward its wholesale adoption.

Preview of 2022
As the aviation industry largely operates in a US dollar world, some of the immediate pressure for change has been lifted as we see how Term SOFR is adopted in Islamic transactions, but we would expect the momentum to pick up in 2022.

The last major development in aviation has been the pivot to start addressing the topic of environmental, social and governance (ESG) policies. Even though aviation makes up roughly 2.5% of total CO2 emissions (with roughly 4% of global GDP), it has still ended up with a high profile compared with some other much larger emitters. What we are seeing is an increase in the use of sustainability-linked transactions (ie with specific sustainability performance targets that can adjust the profit rates) such as for British Airways and Etihad Airways.

In the context of looking at potential ‘green’ or transition transactions, it will be interesting to see what developments occur with the EU’s Taxonomy which is currently looking at permitting the following five options to be marketed as green financing transactions for aviation:

(1) Zero-emission aircraft — green hydrogen or electric
(2) (Until 2030) best-in-class new aircraft where coupled with decommissioning another non-compliant aircraft within six months
(3) (From 2030) as with (2) above but also needing to use 10% sustainable aviation fuel (SAF) (increasing by 2% annually thereafter)
(4) Aircraft that uses a minimum of 5% SAF in 2022 (increasing by 2% annually thereafter), or
(5) (Until 2024–26), a corporate financing where a proportion of the fleet meets the aforementioned aircraft requirements by reference to aircraft delivered/decommissioned over the last 10 years.

Conclusion
As we look toward 2022 and beyond, we would expect to see increased opportunities for Shariah compliant banks and funds as the aviation industry looks to grow out of its current position back toward pre-pandemic levels, though this will likely be without the use of LIBOR structures and a much greater move toward ESG-led transactions.

Antony Single is a partner at Pillsbury Winthrop Shaw Pittman. He can be contacted at [email protected]