response by zhy88234

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									bmi response - NATS (En Route) PLC price control
review for CP3: CAA Consultation Feb 2010

Index

Section        Description                     Page
4              SCOPE OF PRICE                     2
               CONTROL
5              STRUCTURE OF PRICE                   5
               CONTROL
6                                                   -
7                                                   -
8              SERVICE QUALITY AND                  8
               ENVIRONMENTAL
               PERFORMANCE
9              CAA SCRUTINY OF                     12
               OPERATING COSTS
10             CAA SCRUTINY OF                     15
               PENSION COSTS
11             CAA SCRUTINY OF                     18
               CAPITAL
               EXPENDITURE
12             REGULATORY ASSET                    25
               BASE AND
               DEPRECIATION
13             COST OF CAPITAL                     25

ANNEX B:       SERVICE QUALITY AND                 27
               ENVIRONMENTAL
               PERFORMANCE
4. SCOPE OF PRICE CONTROL
4.40 Do consultees agree that the scope of the London Approach
service within NERL’s licence should be expanded to include Luton and
London City airports?
For the reasons elicited by the CAA in the consultation document, we agree
that the approach costs for LTN & LCY should be brought within the remit of
NERL’s licence.

4.41 Do consultees have views on how the London Approach service
should be regulated and charged for in CP3?
Of the options the CAA has proposed, option 2 proposes to make London
Approach charging cost reflective based on Single European Skies legislation.
bmi’s position is that we can only support this if this was implemented
simultaneously across Europe.

Currently this is not the case, and indeed certain countries and ANSP
providers are heading in the other direction, in contravention of the Airport
Directive. In 2008 all Dutch LVNL approach costs were transferred into en-
route charges from terminal navigation costs. This is the case with other
European hubs.

Moreover, by NATS unilaterally applying approach charge increases with no
reciprocal contra benefit for those London carriers flying over other countries’
airspace, it actually works against one of the aims of the European Airports
Directive - namely to achieve a level playing field. We consider unilateral
implementation is not justifiable.

To implement this proposal unilaterally (which NERL would be moving
towards with no commitment to reduction in future years when traffic
increases) would disadvantage London based carriers against their European
counterparts. Consequently we cannot accept this as reasonable in a
competitive environment and consider it to be commercially unfair.

We note the CAA’s point that London Approach is a hybrid of en-route and
terminal navigation costs, and that this does not sit neatly within the European
Charging Directive’s remit.

For these reasons maintaining the current position (option 3) would maintain
the level planning field and allow for the hybrid nature of the costs.

4.63. Do consultees agree that the Eurocontrol price control for CP3
should be set on the basis of all the costs that NERL reasonably incurs
in providing the range of services that it is obliged to provide under its
air traffic services licence?

Farnborough LARS and ATSOCAS
We have no objection to capital spend, that contributes towards the protection
of Commercial & General Aviation (GA) aircraft, being included in the CP3
Baseline Business Plan (examples of this in CP2 were the Farnborough LARS
and ATSOCAS) so long as those parties such as GA that are in receipt of
increased utility from this capital spend (through increased safety of its
members), paying their fair share towards such capital.

In the absence of this, GA free rides, obtaining benefits without paying costs,
which leads to both parties enjoying the benefits, but only one party paying
the costs.

We would consequently recommend that any income from GA should be
made available to reduce the capital spend, and to reduce the capex plan in
CP3 (see response to question 4.64).

4.64. Do consultees agree that the CAA has identified the relevant policy
and practical issues bearing on the issue of charging? Are there any
other factors the CAA should take into account?

General Aviation (GA)
GA benefits from positive externalities
The CAA states in the consultation document that:

‘the design and extent of controlled airspace are driven by the requirements of
commercial operators, it is reasonable they should meet the associated costs,
even when others may need to use these services’

What stems from this though is that GA enjoys an immense positive
externality from controlled airspace in terms of improved safety which
commercial aviation pays for.

Economics dictates that the consequence of one party in receipt of utility and
receiving a positive externality that it has not paid for, is that it will over-
consume that service, or in this case, do nothing to reduce its infringements,
which bear cost to another party. GA has no incentive to change its
behaviour.

Duty of Care
There is a duty of care on both sides to avoid potential for collision. Currently
Commercial Aviation is meeting its duty of care – NERL has spent £0.4m on
Farnborough LARS in 2007 and £4.7m on ATSOCAS management in 2009
(funded through airline charges).

This cost has been incurred to address increasing incidents of potential GA
collisions which are a function of GA’s sporadic use of transponders. Those
transponders that are turned on are often non-mode S transponders which do
not provide altitude position.

As a result GA is compounding the externality (requirement for controlled
airspace), and not meeting its duty of care obligation - GA must pay for its
share of the externality it is creating.

Potential Benefits of providing incentives to GA
   •   Improved safety for both GA & commercial aviation by reducing the
       probability of a collision
   •   Reduction of re-routing required when infringements occur. This brings
       the following benefits:
               Environmental (through reduced fuel emissions)
               Financial (through reduced fuel consumption)
               Passenger experience (through reduced delay)
       All of these stem from more direct routings as airspace does not have
       to be cleared when infringers are spotted.

       This brings a reduced cost burden on the operator which then
       represents a smaller cost that has to be passed through to the
       passenger.

European Law
EU legislation supports the case for GA to pay its fair share. It mandates the
charging to GA through EU regulation 550/2004 Article 15 3(b):

"Exemption of certain users, especially light aircraft and State aircraft, may be
permitted, provided that the cost of such exemption is not passed on to other
users"

This is unequivocal – consequently GA should incur its fair share of costs in
accordance with the EU’s regulations on the provision of air navigation
services.

Potential Solutions
The options available to change GA’s behaviour include:
   • A monetary payment contributing a fair share towards the capital cost
       of safety systems
   • Make compulsory the carrying and turning on of transponders in UK
       airspace/parts of UK airspace (Transponder Mandatory Zones)

The optimal solution would be to implement both.

Conclusion
bmi recommends that CAA considers charging GA in order to provide the
benefits outlined above. In the absence of this, we would support the creation
of more Transponder Mandatory Zones.
5. STRUCTURE OF PRICE CONTROL

5.16 Do consultees agree that, should the IR set the first review period
for SES II to run to the end of 2014, the price control for both
Eurocontrol and Oceanic services for CP3 should be four, rather than
five years?
We agree that CP3 should run for four, rather than five, years for the reasons
outlined in your consultation documentation.

5.22 The CAA invites comments on whether the volume risk sharing
allocation for CP2 should be continued in CP3
Volume Risk Sharing
The volume risk sharing mechanism allows NERL to transfer risk to the
airlines, in the absence of which, it would itself bear. If the mechanism didn’t
exist, the regulatory return demanded by shareholders would increase.
However, this issue should be taken into account when calculating the cost of
capital and there is no evidence that this has been done. Reduced risk should
result in a reduced cost of capital.

The crux of the matter is to ensure that the traffic forecasts are as accurate as
possible, and that the capex & opex cost required for this level of traffic is
appropriate. Provided this is the case, and provided that some appropriate
adjustment is made to the cost of capital, we would support the retention of
the Volume Risk Sharing Mechanism for CP3.

Asymmetrical nature of the mechanism
Regarding the asymmetrical nature of the mechanism, its justification on the
basis that additional revenues would not be sufficient to cover the additional
costs incurred is fallacious for the following reason. NERL’s capacity is geared
towards the two daily traffic peaks, and this capacity has not declined even at
the height of the current economic turbulence. Airlines have only reduced
middle of the day and late night activity in the face of the downturn in
economic activity. And the airports do not have the capacity to extend peak
activity.

It follows that if any extraordinary increase in traffic does occur, it would
primarily occur during the parts of the day currently not served. NERL’s cost
base is two-thirds fixed and so any extraordinary increase in traffic would not
increase NERL’s costs to anywhere near the increase in revenues.

A symmetrical volume sharing mechanism in which the benefits of any upside
are shared with the airlines would reduce the potential benefit to NERL but
would not impact the overall risk and therefore the cost of capital. We believe
that this a more equitable approach.

For these reasons we would recommend a move to a symmetrical volume
sharing structure.

5.38 The CAA invites comments on the treatment of Government
charging schemes (G factor) For CP3
We would agree with the CAA’s proposal to remove UK government revenue
from the price control as this would encourage NERL to generate revenues
from this source in regard to state aircraft. Given that the revenue involved is
relatively immaterial in the total settlement, this represents an opportunity for
NERL to take advantage of economic charging for this sector, and any extra
revenues generated would flow back into the single till in CP4.

Note, however, that given bmi’s response to question 4.64 that General
Aviation should, under European law, bear some of the costs for providing its
own safety, this revenue would also be classed as ancillary revenue, and
would form part of the Single Till in reducing the net revenue requirement and
the amount levied to airlines.

It is desirable to remove the G factor from the price control to incentivise
NERL to generate income from it in CP3, which would fall into the single till in
CP4. However, given that the general aviation point is predicated upon the
same bit of EC legislation, we make the point that we would not want GA
income to follow the same principle on the grounds that income from GA is
material, unlike that from the Government.

5.54 Has the CAA correctly identified the issues and options for the
treatment of bad debts?
Treatment of bad debt allowance in CP2
The treatment of the CP2 bad debt allowance, as currently proposed by the
CAA, permits NERL to write off CP2 bad debts of £3.6m against the CP2
settlement allowance of £6m but to chase payment and hence retain any
difference between the two. In the event of retrieving the debt, which appears
possible , NERL can retain the cash recouped, which would act as an
incentive to maintain the current process..

We do not agree with this approach for the following reasons:

   •   NERL has very little control over its debt management due to this
       function lying with Eurocontrol. So providing NERL with an incentive
       has little, if no impact, at all.

       Effectively £2.4m of airline money has been handed over with nothing
       in return.

   •   We would propose returning to airlines whatever remains from the CP2
       allowance for bad debts. This would allow NERL to continue to have
       risk-free bad debt provision, hence permitting an advantageous
       downwards effect on the WACC as shareholders would not require as
       much in return.

The CP3 pass-through proposal has been designed with this in mind.

Treatment of bad debt allowance in CP3
We concur with the proposed treatment of the bad debt provision in CP3, to
pass through the exact cost of the bad debt provision to users, for the same
reasons we are recommending this treatment, ex-post, for CP2.

Level of bad debt allowance in CP3
Regarding the level of bad debt allowance in CP3, we would concur that the
level of bad debts have been far lower in CP2 than forecast, and as the CAA
proposes to do, that this should be reflected in CP3. However, it is also worthy
of note that we are at the nadir of the economic cycle, and although airline
balance sheets are weak, that the weakest and most marginal airlines have
collapsed with those that remain much stronger. Airline overcapacity has also
been addressed by this, and reduces the likelihood of a bad debt level to the
extent seen in CP2. We would ask the CAA to consider making a reduction in
the bad debt provision. To the extent that this is not done, it is another factor
reducing risk which should be reflected in the cost of capital..

5.60 The CAA invites comments on whether there should be a pass-
through of any unanticipated additional spectrum costs in the course of
CP3.
bmi will be responding under separate cover to OffCom re the introduction of
Spectrum costs. The airline industry has spent significant sums in investing in
8.33 khz spacing, and sees the introduction of this proposal as just an
additional tax measure. Due to the nature and manner of spectrum usage we
are fully equipped to take advantage of such spectrum, however, we neither
control the allocation, or are able to drive forward further efficiencies, unlike
the GA community, and as such do not believe that here should be any pass-
through of any anticipated or unanticipated spectrum costs. We believe that
the CAA can play its part in the effective allocation of Spectrum in the U.K.
without the need for incentivised pricing.

5.66 Are consultees content with the broad scope and extent of NERL’s
involvement in the SESAR Joint Undertaking?
We are content with the broad scope and extent of NERL’s involvement in the
SESAR Joint Undertaking as long as such involvement is transparent to the
Operators, and is subject to rigorous cost/benefit analysis. See also our
comments in 5.67, and 5.68

5.67 Do consultees consider that there should not be a cost plus
mechanism for over-runs on cost in the SESAR packages for CP3?
We concur with the CAA’s approach in permitting the RPI– X mechanism to
provide the regulatory rigour to keep these costs under control. Any excess
costs of the SJU should be borne by NERL given that the remit of the SJU is
reasonably well known and as the control period will only be 4 years.

5.68 Do consultees consider that there should be a mechanism to
reduce the RAB (and future changes) by 90% of the proceeds from any
IPR that is then transferred by NERL to the SESAR Joint Undertaking?
We concur with the approach that the RAB should be written down by 90% of
the value of the IPR rights, and that it is correct not to permit a 100% write
down to provide an incentive for NERL to engage in selling the products they
have designed.
8. SERVICE QUALITY AND ENVIRONMENTAL
PERFORMANCE

8.28 The CAA invites views on how, depending on the freedom the CAA
has, it should deal with any requirement within SESII for incentivisation
of delay. Should any SES II metric be in addition to, or substitute for,
part of the scheme proposed following CCWG.
bmi has taken a leading role in discussions on metrics for CP3, and further
comments will follow under this section in response to individual questions,
and as such these responses should be viewed holistically.

We believe that any SES II metric should be in addition to the scheme
proposed following CCWG. We believe that current NATS proposals (not
withstanding further comments below) are mature, and as such are more
specific in meeting the needs of the customer, and we would not want to see
these diluted, rather they can be complemented.

Therefore, we support the CAA’s comments from the February 2009 Policy
Update that “it was not its intention to dilute the prospective array of
incentives on NERL in order to achieve ‘lowest common denominator’
alignment with what might be required under the SES II Performance
Framework.”

8.31 The CAA invites views on the measurement of ATFM delay in
general and on the appropriate source of data for the metrics for CP3.
bmi understand the case for using CFMU data, as in effect there should be no
difference between the figures produced, and are therefore in alignment with
SES II. We believe that there are a number of issues with ATFM delay
reporting, and there may be more benefit in remaining with NATS reporting to
maintain consistency, and the range of more detailed reports available
through NATS. Further, the current plan for SES II does not appear to make
any allowance for tactical measures used in the management of delays.

The CCWG working group put intense pressure on NATS regarding the use
and reporting of Tactical measures, which will not be captured by the CFMU.

The NATS proposed metrics terms T1 T2 T3 are designed to incentivise the
application and performance of regulated delay.

Throughout the CP3 consultation Operators have expressed concerns with
regards to the current application of non-regulated tactical tools (such as
MDIs, ADIs, ARDS, miles in trail and scenarios).

At present these tools are utilized according to a set of criteria contained
within the MATS part 2. Despite these tools having been in use for several
years, they have only just begun to be recorded in a robust manner that will
enable data analysis of the application by reason and duration. Because the
delay they cause is localized to the airfield in the form of start up delay or
extended taxi time, this delay data is not captured for official reporting. It
therefore does not contribute to the total NATS attributable delay figure
reported by NATS, and we are concerned that no process may exist to
capture their application with respect to highlighting weaknesses in the
network.

The airline operators recognize that tactical tools can be useful and
depending on the circumstances an appropriate option instead of regulation.
Importantly the airline operators seek to distinguish between the use of these
tools to manage late notice short term issues specific to a stand alone airfield
and issues relating to airspace capacity (NATS and Non-NATS attributable).

However, the use of tactical tools can, and does lead to a lower level of delay
reported as NATS Attributable through the current regime, and we believe that
further action need to be taken to ensure that wrong behaviours are not being
incentivised as a result i.e. an increased use of tactical measures to alleviate
the allocation of regulated delays. Therefore, we would seek the
implementation of a metric measuring the impact of such tactical delays. To
suggest that NERL have not had the time or means to develop measurement
tools is a fallacy, as this subject has been under discussion for some
considerable time.

8.33 Do consultees consider that it is reasonable to retain the same
amount of money at risk in CP3 as in CP2 to encourage appropriate
performance?
We believe that it is reasonable to retain the same amount of money;
however, this is dependent on the target regimes being set at a challenging
level, unlike the basic measure through CP2. This was set a level which
effectively guaranteed NERL bonuses on an annual basis – the target being
set at 45 seconds per flight, whereas the reported outturn was 20-23 seconds
in the first part of CP2 to 5.5 seconds in 2009. The CAA has stated that to a
considerable degree the latter is explained by the reduction in traffic. It is
interesting to note that at recent meetings including the OPA NERL have
stated that it is not just traffic reductions which have helped to improve the
outturn. We believe that the introduction of new technology such as the long
awaited iFACTS should show further improvements particularly set against
current traffic levels, which are not expected to recover to 2007 levels until
2013, and we would seek reassurance that such improvements are factored
into any targets set for CP3.

8.37 Do consultees consider that the amount at risk should be equal for
each of the three delay metrics T1, T2, T3 and potentially any SESII
metric if it is additional to these?
Firstly, this question automatically assumes that there will only be 3 delay
metrics, we will argue this under our response to B38. However, assuming
four delay metrics we would expect to see a sliding scale of bonuses, and
penalties along the following lines:-

Achievement of 1 Term       = 20% Bonus, and possible 80% penalty
Achievement of 2 Terms      = 45% Bonus, and possible 55% penalty
Achievement of 3 Terms      = 70% Bonus, and possible 30% penalty
Achievement of 4 Terms      = 100% Bonus and 0 penalty
This method provides a clear direction to manage all areas of the
incentivisation program.

8.46 Do consultees consider the illustrative par values put forward
during CCWG to be a reasonable basis for the service quality scheme in
CP3?
bmi’s responses in previous SIPs have highlighted the unrealistic nature of
the delay target under CP2, and the non-incentivisation or measurement of
the impact of Tactical Measures which may lead to driving the wrong
behaviours causes serious concern about the setting of delay target values for
CP3.

In line with the earlier comments and NERL's statement that “formal proposals
for Par values will be set out during 2010 as part of the CAA consultation in
conjunction with the latest traffic forecasts and CAPEX and operating
efficiency assumptions”, we would need to see the detailed assumptions and
workings associated with any par value proposals prior to final responses in
order to full assess the realistic nature of such proposals, and fully understand
the methodology used in reaching the proposed targets, including the impact
of capacity enhancers such as iFACTS during the CP3 period.

Par Value Modulation
bmi accept the principle of par value modulation; however, believe that there
are flaws in the current proposed level of modulation.

   1. The par value range quoted during the CCWG process, for example
      T1, and contained in NATS documentation as an illustrative table,
      gives a par value range (or dead zone) of between plus or minus 12.5
      to 16.67%. This automatically gives a contingent allowance for certain
      levels of traffic variation over a significant range – up to 33% in the
      example quoted, and is seen as far too loose a measure, particularly if
      the regulator were to adopt a lenient target regime.

   2. The modulation itself allows for further leeway in the scope of target
      measurement. In the NERL Delay Elasticity – Further Information
      requested by Customers at CCWG3 Sub-group meeting Reference:
      Action MSG98 Dated: 15 September 2009 document NERL have
      attempted to show the non-linear relationship in demand analysis with
      the highest r2 factor being exhibited by the Polynomial curve, and thus
      confirming that the shapes of the curves indicate that a steeper slope
      for the Par value modulation above base traffic growth is appropriate.
      We would not argue with this statement. However, the Par Value
      figures of +6.6 and -3.1 have been changed by NERL to figures of +8
      and -4, due to, in their words, “a cautious approach”.

       This is a theme that is consistent throughout the CP3 process with
       NERL's cautious approach applying layer upon layer of safeguards to
       ensure that in probability terms NERL are highly unlikely to pay a
      penalty, and highly likely to receive a bonus. In this case with a
      combination of loose par value ranges and cautious par modulation.

      Further it should be noted that the figures are based on a 2007 Daily
      Traffic versus delays benchmark. At CCWG6 the NERL September
      Traffic Forecasts showed that flights peaked in 2007, and are not
      expected to return to this level until the end of 2012 into 2013. Coupled
      with a backdrop of increasing capacity for which the customers are
      being asked to pay significant amounts – for example – iFACTS is
      quoted as delivering an estimated 12% increase in overall LACC
      capacity during the period 2011-2016. EFD provides a 5% increase in
      capacity in TC Capacity from winter 2010/11.

      While we are aware that the level of delay increases as the capacity
      ceiling is reached we believe that the low levels of traffic forecast
      coupled with the capacity enhancements planned, mean that the
      benchmark used for CP3 is incorrect. Once again we would reiterate
      that any bonus/penalty mechanism must be based on realistic
      assumptions and these must be transparent to the operators.


Par Value Range
The customers would reiterate the statements made throughout this
document, and captured in the CCWG process that while we agree with the
principle of Par Value Ranges, the par value and the range must be set at
realistic levels, unlike the average delay per flight target set for CP2. NATS
has stated that “Firm proposals for Par Values cannot be set out before the
terms of the price control (particularly related to Capex & Operating
Efficiencies) and the final traffic forecast are known.” Therefore we must
ensure that there is sufficient time within the process to analyse, understand,
and agree the final Par Value Ranges proposed. Further, the mechanism
must allow for challenges in this area supported by clear reasoning.

8.53 The CAA invites views on the proposal that some performance
incentive (equivalent to two months of the 2012 allocation should be
retained for the period of the Olympics.
bmi agree with the CAA proposal as outline in paragraph 8.52

8.55 The CAA invites views on the relative benefits and risks of adverse
consequences of introducing horizontal flight efficiency metric alone.
bmi believe that an incentivised Environment/CO2 metric must be in place for
CP3.

This requirement is based on a number of factors, namely:-

          1) The imposition of the Emissions Trading Scheme on the airline
             community ,which will have a major impact on airline costs, and
          2) The impact NATS can have on Environmental efficiency through
             the effective use of the airspace, and by definition, the
             measurement of efficiency.
As such we have had to invest significantly to provide data for ETS within a
relatively small timescale, and it is simply unacceptable for NATS to argue
that they will not be in a position to provide a meaningful measure in the
timescale for CP3.

However, we agree that the metric should not be based on horizontal flight
efficiency alone, although this may for part of the SESII KPI process, as it
does not reflect on the significant issues associated with Vertical Efficiency,
and would therefore support the introduction of a combined, or combination of
metrics.

8.59 The CAA invites comments on the scope for introducing a robust
incentive mechanism for flight efficiency either from the beginning or
during the course of CP3.
We re-iterate our comments that an incentivised Environment/CO2 metric
must be in place for CP3 as per our comments in 8.55.

However, we recognise that such metrics must be robust and drive the right
behaviour, and as such would be prepared to delay implementation during the
course of CP3, as long as there were sufficient guarantees of a workable
metric and associated roadmap timescales.
9. CAA SCRUTINY OF OPERATING COSTS

9.57 The CAA invites views on the preliminary assessment that available
efficiencies relating to operating costs may already be captured in
NERL’s plan
See reply to 9.58.

9.58 Do consultees have suggestions for additional evidence on
operating cost efficiency that should be considered?

Employment & Back-Office Costs
The concerns arising from the benchmarking studies highlight areas for
review, and a business operating in a commercial environment would seek to
address these areas to derive maximum benefit for customers and
shareholders.

We consider that the best forecasts of these planned efficiencies should be
incorporated into the business plan:

   •   Weekend ATCO manning
       Reductions in ATCO manning at the weekend at both Prestwick and
       Swanwick control centres (as has occurred at Manchester)

       We would note that this is also the case with night manning in which
       reductions have been made, but we believe there are further
       opportunities to reduce cost in this area without impacting service
       delivery. This appears not to have been highlighted in the consultant’s
       report.

   •   Sickness Pay
       Adjustment of sickness pay to something more akin to that expected in
       the private sector. As levels of sickness are well below the average,
       this measure would not be expected to yield much, but is more about
       ensuring that potential liabilities are controlled.

   •   Annual Entitlement
       We understand that it is unlikely that existing contracts can be
       amended , but for new entrants annual leave entitlement should be
       realigned to the market level. Savings in this area will be minimal given
       NERL’s downsizing, but nevertheless productivity of future staff can be
       increased by this measure.

   •   IS costs
       LECG identified potential IS savings that could be introduced in CP3.
       We look forward to their inclusion in the CAA’s May 2010 report.

   •   Facilities Management savings
       Savings of £2m are potentially available although LECG stated that
       realisation of these is not under NERL management control. We would
       like NERL to investigate how to unlock these savings and bring them to
       fruition, and for this to be incorporated in the CAA’s price proposal in
       May 2010.

2% Efficiency target not sufficient
Private companies are currently engaged in superhuman efforts to reduce
their costs. This involves hard decisions, including by way of example,
restructurings, headcount reductions and restructuring of pension provisions.
This is a direct response to the recession and unprecedented and challenging
economic times.

NERL’s proposed 2% reduction in operating costs is not of a magnitude
comparable with what is happening elsewhere in the economy and is yet
another example of their very risk averse approach.

NERL has reacted differently to that of an archetypal private sector
company
We would contest the conclusion being drawn from the work by Helios and
IDS of that there is little or no scope for amendments to salary levels. The
evidence examined by the consultants naturally looked at historical evidence
against the market average.

The key salient point to make here is that the UK economy has seen marked
salary adjustments (ranging from pay cuts, wage freezes or hourly reductions
with less pay) since 2008. This has been a major contributory factor in
keeping UK unemployment at 2.5m, rather than its projected 3m.

Hence the market average used by IDS as a comparator has fallen in 2008
and 2009, yet we do not see equivalent evidence of pay reductions/freezes
within NERL’s business plan.

We would question whether NERL has reduced its salaries in real terms in
line with non-air traffic related firms in the private sector. If the benchmarking
was rerun for 2008 and 2009, it may show NERL in a worse light.

bmi proposal
NERL have proposed a 2% efficiency measure. It would be more beneficial to
split the operating cost targeted efficiency reductions into two:
    • An efficiency target aimed at those opex costs over which NERL has a
        greater degree of control, of say 10%.
    • An efficiency target aimed at those opex costs where NERL has less
        control, or where there is less scope for reduction, for example ATCO
        controller pay, of say 2%.

In this way, NERL is differentially targeted into removing cost from parts of the
business, allowing more cost to be removed from those parts of the business
where that opportunity exists.

Pension problem
bmi recognises NERL have downsized their operation, and propose to
continue to do so throughout CP3, and we welcome the cost efficiencies
emanating from this. However this good work is being outweighed by the
pension cost increases which form part of the top level operating costs, and
underlines the critical imperative of reducing pension liability (see our
comments on this later).

9.66 The CAA invites views on the relationship between operating costs
and traffic growth
We would make the point that when NERL discuss reducing operating costs,
they state that although overall traffic has fallen, the traffic at the daily peaks
has not fallen, and as NERL have to cater for activity at the peaks, they would
be unable to reduce operating costs.

However, when it is proposed to reduce the capital spend programme, an
alternative rationale is put forward that the any reduction is very risky as the
ability to respond to any increased demand would be limited. Given that the
majority of traffic increase would not be in the peaks (as airlines have not
reduced peak traffic activity), a substantial part of any traffic increase would
come from existing capacity, and this rationale should be questioned.

As can be seen these two arguments stand in contradiction to one another.
Either opex can be reduced in line with traffic, or the capital plan can be
reduced to reflect that any traffic increase will not occur at the peaks – hence
the risk that NERL attribute to traffic growth and the ability to respond to it is
not there.

This contradiction lies at the heart of the NERL concept of headroom – with
opex, NERL state no headroom exists as the capacity is restrained by the
daily peaks, but with capex the daily peaks are not mentioned, and NERL
state they cannot risk decreasing the LTIP further without damaging capability
to provide for any above-baseline increase in traffic (the daily peaks means
increases in traffic above the baseline would be provided out of non-daily
peak capacity).

We would ask the CAA in their deliberations with NERL to ascertain the
veracity of the peak daily rationale and to reflect the outcome in either a
reduced capex plan or reduced opex costs in the pricing proposals in May
2010.

9.76 The CAA invites views on the appropriate treatment of additional
opex items, including contingency
Redundancy and relocation
It is entirely reasonable that having engaged in cost cutting, that any one off
associated costs are included within the price control.

Opex contingency
We are concerned that we should not allow NERL a risk free approach to cost
cutting. Affording a level of contingency in the plan for the non achievement of
efficiencies sends the wrong message to NERL, at best acting as a buffer for
non-performance, at worst acting as a disincentive to push ahead with the
efficiencies should they prove more difficult to achieve.
We recognise the need for a type of fund to deal with costs that are non-
controllable by NERL such as insurance and business rates as quoted, but
would suggest the following:

   •   Reduction of the contingency to remove the disincentive effect
   •   Automatic reconciliation within the SIP process so that airlines are
       made aware of drawdown of the remaining fund, and to provide airlines
       with justifications
   •   CAA to engage in post-ante checks on whether the use of contingency
       has been ‘fit for purpose’

We would encourage the CAA to ascertain the exact nature of why the
contingency has increased from CP2’s £21m to CP3’s £70m. We see no
reason for an increase of this magnitude.

9.81 The CAA invites views in principle on whether it would be
appropriate to include a RIM in CP3
We are in principle in agreement with the RIM, however it is not clear to bmi
what is included in the RIM in CP2 (as we are still a reasonable way from its
completion). This is something which could be highlighted in the SIP process.

As NERL is already incentivised to reduce opex to the level stipulated in the
settlement, if NERL did not manage to generate these savings in the last 2-3
years of a control period, then it would bear the cost in that control period, but
the airlines would then have a higher base opex cost at the start of the
following control period.

We would not want a case whereby NERL receive a RIM reward through
engaging in cost saving initiatives they would have engaged in anyway.
However we would support further efforts to examine whether this has worked
in CP2 and look forward to the outcome of the CAA’s review in May 2010.

10. CAA SCRUTINY OF PENSION COSTS

10.36 Has the CAA correctly identified the issues on the design of the
end-of-period true up mechanism?
See response to question 10.37.

10.37 The CAA invites views on the extent to which NERL’s response to
rising pension costs has been appropriate given the constraints

Have NERL have done as much as they can?
NERL has implemented a limited number of measures to contain the pension
liability including the cap on future pensionable pay increases, the introduction
of SMART pensions and the closure of the Defined Benefit scheme to new
entrants. bmi welcomes these actions.
We would however assert that in spite of these measures, NERL has not
done enough to limit the risks and costs of its pension liabilities. We make the
following points regarding NERL’s inactivity on this point:

   •   PPP Obligations
       Maintaining the DB pension scheme in its current format is putting an
       unsustainable burden on airlines as illustrated by the increase in the
       unit rate by £6.13 over CP3. On the other hand, the rush of private
       sector companies closing their DB schemes is indicative of enterprises
       reducing risks & liabilities to manageable levels.

       NERL cites the obligations outlined in the ‘Trust Deed & Rules’ which
       commit the Airline Group to DB salary provision. In order to ensure that
       the cost and quality of air traffic services is optimised, we ask the CAA
       to review, with a view to changing the obligations imposed under the
       PPP scheme. Such structural change, whilst immensely difficult, must
       be addressed if the industry is not to be competitively disadvantaged.

       We note the UK Treasury has sought advice on whether it is under a
       legal obligation to fund in its entirety its own public sector pension
       commitments. As the government is looking at the ability of being able
       to fund its own liabilities, the same is required here. We are not
       recommending that prior funding is questioned, simply that future
       funding of the pension scheme for existing members be reconsidered.

       NERL has already made small changes to the terms and conditions of
       the PPP, and so the precedent has already been set.

   •   Final Salary Scheme produces sub-optimal market outcome
       The cost of the final salary scheme adds £6.13 to the unit rate in CP3.
       Airlines will find it more costly to operate in UK airspace and price
       elasticity of demand dictates demand will reduce.

       If improved safety or quality of service was received in return for this
       price increase, then demand would not be curtailed as the airlines
       would be receiving a different, improved product for the increased
       price. However, the final salary scheme does not do this, simply adding
       cost to the same service. Ceteris paribus, demand for its services will
       fall.

       In fact, the refusal to consider other pension options undermines, to a
       greater or lesser extent, NERL achieving all 8 of its key strategic
       targets outlined in its business plan. This is not in the interests of the
       vast majority of NERL’s stakeholders, namely the airlines, the
       passengers, and the shareholders.

   •   Impact on Investment Grade Issuer Credit Rating
       A key condition of NERL’s licence relates to NERL’s obligation as
       licensee to use ‘all reasonable endeavours to maintain at all times an
       investment grade issuer credit rating’. Allowing any element of risk or
    cost to have an uncontrollable impact on demand, such as is
    happening with pension costs puts NERL at odds with the terms of its
    licence.

    Current investors/prospective investors will see NERL’s cost base as
    having a detrimental impact on returns, and would either demand a
    higher return, which would itself have an adverse impact on demand,
    or simply avail of higher returns elsewhere.

•   Standard commercial organisation reaction to risk
    As pension costs are a material part of the operating costs of NERL,
    the question the CAA asks of operating costs should be addressed in
    this context.

    ‘Whether NERL’s planned operating cost reductions are consistent with
    those which an efficient and economic company would propose’

    When this question is targeted at pension costs we would point to the
    various measures taken by commercial enterprises to reduce their
    pension liabilities:

              Closure of DB schemes to new entrants
              SMART pensions
              Increased employee contributions
              Reduced rate of accrual
              Closure of final salary schemes to existing members

    We would expect NERL to react in a similar commercial manner. NERL
    has implemented the top two measures, but not the others, and here it
    differs from the reactions of the archetypal private sector company. To
    ensure convergence, regulation should seek to replicate competitive
    market conditions.

•   Potential Options
    Option 1: RPI less X mechanism
    We would concur that shareholders are likely to demand a higher
    return and that the extra cost will be borne by users either through
    increased user charges, or a higher cost of capital.

    Option 2: 90/10 Pass-through mechanism
    We concur that shareholders are highly likely to request a higher rate
    of return in view of increased cost/lower profits from this mechanism.

    Options 3 & 4
    Option 4 provides a little more incentive for NERL to drive down on
    actuarial assumptions as it will have to meet any adverse cash flow
    implication vis-à-vis option 3. However any potential adverse cash flow
    situation would again be met by shareholders demanding a higher cost
    of capital, negating any value for money benefit for users.
       All 4 options support bmi’s request to limit the source of the risk rather
       than discussing how the burden should be allocated to customers.

       In the absence of a willingness to re-examine the uncontrollable nature
       of the pension problem, we would expect a fundamental review of how
       the £6.13 increase in the unit rate attributable to the final salary
       pension scheme in CP3 can be removed elsewhere from NERL’s
       proposals.

10.49 Do consultees agree with the CAA’s preliminary assessment that
NERL’s pension costs have been reasonably incurred?

Efficient Management of Pension Scheme Assets
The proposed ‘stewardship test’ to initiate a process whereby the regulator is
assured of NERL’s pension scheme assets being efficiently managed, whilst
better than nothing, does not address the main problem of risk of the liability
growing uncontrollably in size.

bmi believes that airlines should not pay more for pensions in CP3 than we
did/are doing in CP2. If pension liabilities increase in the future (for example in
the forthcoming December pensions review), then it is NERL’s responsibility
to manage those increases and take corrective action.

We would point to the number of commercial pension schemes that have
closed and in comparison NERL was very slow to close its own scheme to
new entrants. bmi closed its DB scheme to new entrants in 2001, Barclays
Bank in 1997, Lloyds TSB in 2003. Looking at other regulated entities, BAA
closed its scheme in 2007, so NATS were even late in comparison to its peers
in the regulated sector.

10.55 The CAA invites views at a general level on the most appropriate
profiling of deficit repair programmes

bmi would propose a 15 year deficit recovery plan for its existing deficit on the
basis that NERL is a monopoly and enjoys, to a level, guaranteed income,
which ensures that it will recover this money at a certain point in time.
11. CAA SCRUTINY OF CAPITAL EXPENDITURE
11.48 The CAA invites views on whether NERL’s capex performance in
CP2 has been undertaken in an efficient & economic manner.

Additional £33m capital spend over and above that awarded in CP2
Regulatory policy allows for an ex post adjustment mechanism which permits
the full un-depreciated cost of investment to be recovered if it’s greater than
projected spend.

We would make the following points:

   •   Clear requirement for a governance process / improved SIP process
       The additional £33m investment is not something that we were aware
       of, and to us highlights a weakness in the SIP process concerning
       governance that we will expand on in section 11.58.

       bmi has never consented to additional spend over and above that in
       CP2. On learning of this in the consultation material, we have asked
       the question of NERL, and have learnt that this was communicated in
       SIP2010, slides 40-45 inclusive.

       However, for such an important issue, this is surely not enough. To
       emphasise this point, the additional capex over and above that
       awarded in the regulatory settlement is outlined as:

                    •   RPI
                        This is allowed for in the regulatory structure

                    •   £3.4m SESAR early enablers
                        On this subject bmi’s position to NERL was made
                        clear at the time:
                        ‘We must stress that the current economic climate has
                        placed a tremendous burden on the airline industry,
                        and that we would not expect to see any cost
                        increases as a result of the implementation of the
                        early deliverables as these are due for implementation
                        within the current CP2 regime i.e. prior to 2010.’

                        We assume that approval of this must have been
                        made on a majority basis, although we were not
                        made aware of the result or the process through
                        which the outcome was reached! This is a clear failure
                        of governance and consultation and needs to be
                        addressed

                    •   Additional capex required to deliver the LTIP
                        This refers to slide 83 in SIP2007, however our
                        SIP2007 documentation only goes up to slide 73.
       Logica themselves highlight the difficulty in tracking changes in the SIP
       process. This is something that could be factored into Logica’s
       proposals in 11.58 for improving the SIP process during CP3 (see
       below).

       We question whether this investment should be allowed into the RAB,
       on the basis that it was not made clear to bmi that this required
       additional funds, and a proper consultation process was not followed.

       A much improved and transparent SIP process is urgently required.

   •   iFACTS spending
       The IFACTS programme is clearly out of control and we would have
       expected a new cost/benefit study to have been undertaken before we
       agreed to proceed.

   •   Risk & Contingency/ Savings made in other areas
       NERL’s justification of the capex increase over and above that
       permitted in the CP2 settlement, is that it is due to changes in the
       operating environment, service priorities and procurement strategy. But
       we would have reasonably expected that these factors would have
       been covered by the project specific risk and contingency provision, or
       certainly in the general company wide risk & contingency fund.

We respectfully suggest that NERL should be expected to fund the overspend
from their own resources.

11.58 The CAA invites views on whether Logica’s proposal for enhanced
capex reporting is likely to be beneficial in practice including whether
any modifications to the proposal would further improve this approach

We welcome the approach as set out by Logica as it clearly represents an
improvement on the current SIP process.

However the proposals would be considerably improved if Logica’s proposals
were augmented by the following:

   •   Business Cases
       Alongside the capex plan, airlines would like to see sight of the
       business cases for each project. NERL already have a few project
       business cases on its website, however these are restricted to a select
       few and have not included subsequent amendments.

       The detail provided on the website for these business cases is at an
       appropriate level of granularity which, at around 2 pages, allows ample
       opportunity to present project justification, i.e.
                        • Financial benefits - NPV
                        • Safety benefits
                        • Operational/Service benefits
                        • Asset replacement benefits
                         •   Capacity benefits

   •   Change Control Process required
       Any changes to capex plans would have a change in business case
       presented to NERL’s board. We would concur with Logica’s finding that
       changes in capex plans are difficult to track, and provision of
       amendments to business cases would ameliorate this.

       Compulsory provision of business cases of projects above a certain
       value would improve transparency and consultation.

   •   Governance Process required
       A much needed improvement is for airline approval for changes in
       capex to cover both operational and finance issues. Currently NERL
       communication is for these approvals to be operationally approved –
       NERL ask whether operationally airlines want a certain capability, and
       airlines’ operational departments usually concur with this. However this
       does not imply an overall business approval by the airlines.

       The absence of business cases is indicative of the lack of robustness
       in this part of the process, alongside the issue outlined in the first bullet
       point of our response to section 11.48 relating to whether additional
       investments were covered by existing regulatory awarded funds.

   •   SIP committee
       Referring to our comments in reply to section 11.48 there is a clear
       urgent need for the SIP Committee to put forward the business cases
       (as outlined above) and to justify these to the finance and operational
       departments of airlines.

   •   Transparency of how NERL brings together differing opinions
       The process through which NERL decide on how to proceed when
       confronted with a difference of airline opinion is currently not
       transparent. We note that other regulated entities in similar positions
       seek to attain consensus and that this process is transparent.

   •   Justification for drawdown from risk and contingency provision
       See comments to question 11.59 pertaining to ‘further comments on
       risk and contingency’ below.

11.59 Do consultees consider that NERL’s November 2009 Business
Plan sets out an appropriate capital investment plan and cost for CP3?

Our comments on NERL’s capex plan are as follows:

Risk averse capex plan due to reduced traffic
NERL asserts its revised CP3 Business Plan has a higher degree of risk
attached to it due to airline requests during CCWG for a reduction in the
capex plan.
However, due to the generous headroom in traffic capacity afforded by the
collapse in traffic in 2008 and 2009 (and a forecast which only sees 2007
levels being reached by c. 2013), there is a considerable degree of freedom
for NERL to react to increased demand without increased investment.

This can be illustrated by a contradiction in NERL’s response (paragraph
9.44) in that NERL assert they cannot reduce their operating or capex costs
anymore than they have done as this is constrained by the limit of the twice
daily peaks which have remained largely unchanged since the advent of the
downturn.

The converse then is also true, that an increase in traffic would happen
outside of the peaks, and this would consequently not provide capacity
problems for NERL as the their existing capability is geared towards capacity
at the two daily peaks.

However NERL state that the capex plan is risky because of the inability to
react to a sudden increase in traffic. By NERL’s own logic there is sufficient
existing capacity to render the capex plan relatively risk averse,.

SESAR linkage to NERL capex plan – capex plan is risk averse
There is a realistic chance of slippage to the SESAR timetable. This is partly
driven by other European ANSPs having fallen behind in their own schedule
for SESAR compliance. As a consequence NERL has a reducing need to
adhere to the existing SESAR timetable.

In terms of the investment programme this would imply a delay. By its own
admission, NERL states this is a risk to the delivery of its capex programme.
A relaxation in the SESAR deadline will help in reducing the resource
required, and hence for the amount required in the capex plan – this would
shift to CP4.

Level of Risk & Contingency provision (1)
Risk & contingency is at a level which affords a degree of comfort we do not
have in the airline industry. Some sustainment projects (for example
Information Solutions) have risk & contingency percentages in excess of 10%
which is very generous and very risk averse.

As a result we would question Logica’s conclusion that NERL’s revised
business case has too low a risk and contingency provision. We suspect their
conclusion stems from their analysis of the iFACTS programme which Logica
had concluded was under-budgeted due an under-estimation of project
complexities. Consequently it is recommending a much higher risk &
contingency provision for similar software projects for CP3. However, in
coming to this conclusion, several points have been missed:

   1) Complexity only part of the reason for iFACTS overrunning
      Complexity was only part of the reason for the overrunning and late
      delivery of iFACTS.
   There were other substantive reasons including:

          Early user acceptance testing led to various
          improvements/changes in the scope of the project – we were
          not explicitly made aware of the cost impact of these specific
          changes.
          Scope creep – examples include processor upgrades and
          changes to failure modes.
          A lack of proper budget planning – for example ATSA
          redundancy costs & ATCO training costs were not included in
          the original scope.

   We would not expect that these would be repeated.

2) Much improved NERL project delivery management process
   NERL’s project delivery management process is now much improved in
   comparison to CP2. It cites 33 out of its 34 CP2 projects are now on
   track.

   In addition the supplier management process NERL has put in place
   will also contribute to de-risking projects, something not at their
   disposal in CP2.

   To the extent that iFACTS was badly budgeted, NERL have now
   safeguarded through its much improved project management capability
   against the probability of an error of the same magnitude happening in
   future.

3) Capex plan represents ‘a significant challenge’
   Logica asserts the capex plan will present a very significant challenge
   for NERL, and infers that their risk and contingency needs to rise as a
   result.

   bmi would counter that a significant challenge represents exactly what
   airline customers want – value for money from capital investment. A
   very significant challenge itself is a sign of planned efficient capital
   investment.

   If it didn’t represent a challenge to NERL, this would raise concerns
   around NERL’s capital efficiency.

4) Practice in peer regulated industries
   We would point to other regulated industries having cost efficiency
   targets built in to their capital investment programmes as a way of
   locking in efficiency.

   These locked in targets are challenging but ensure the customer
   receives efficient capital investment. It is an idea that could be
   considered in the CAA’s capex considerations.
   5) Reduced control period removes later relatively unknown costs
      The control period has been reduced from five years to four, and
      consequently the fifth year of more undefined costs has been removed.
      It would be reasonable to expect a consequent substantial reduction in
      the amount for risk & contingency.

Level of Risk & Contingency provision (2)
We would like to highlight the extent of some of the provisions being
presented in the business case.

Project complexity is being cited as the reason for the high level of risk and
contingency within most projects within CP3 of which NATS Common
Workstation is one such example. Project complexity is tackled by appropriate
resourcing of development time, usually through contractors. The table below
demonstrates how the size of the provision translates into contractor man
days.

Impact of risk and contingency
on consultancy man-hours
                                                 £ Comments
Total project cost                     130,000,000 Per original draft
                                                   business plan

Project Risk                            19,000,000 Per original draft
                                                   business plan

Project cost less risk                 111,000,000

Risk provision                               17.1%

CP3 risk per annum                        9,500,000

CP3 risk per day                             38,000 Assumes 250 working
                                                    days in the year, and
                                                    that contractors do not
                                                    work weekends
People working full time on NATS                 38 Assumes a contractor
Common Workstation per day                          daily rate of £1,000 per
                                                    day

This assumes that should NERL require to drawdown from the contingency
fund, the contingency would allow for 38 contractors to work every working
day for two years at a rate of £1,000 per day. If they worked every day (i.e.
including weekends), this would be reduced to 26 contractors per day working
flat out.

This also assumes that the risk & contingency would need to be used from
day one, which is also highly unlikely, and so would increase the number yet
more.
We conclude that the risk and contingency provisions are very risk averse.
They are either too high or the cost of capital should be reduced to account
for the risk averse nature of the business.

Risk and contingency ring-fencing
We propose the risk and contingency be ring-fenced, and that as and when
NERL draw down from it, that the rationale for this be justified & demonstrated
to the airlines as part of the improved SIP capex process outlined by Logica
(see response to section 11.58 above).

As part of this we would expect staged milestones, so that as projects
progress further to completion, the risk & contingency provision would reduce
as project variables would decline in uncertainty. At these staged milestones
we would expect any re-planning, de-scoping or scope creep to be brought to
the fore and highlighted as being reasons for drawdown from the risk
provision.

Essentially we are asking for a very transparent risk and contingency
provision to be effectively communicated, and for airlines to approve
drawdown.

IS Provision
During the CCWG process it was elicited that a large swathe of the capital
programme is integrated, and a change to one part of the programme would
necessitate by default changes to other parts of the programme.

However, one programme stood in relative isolation – the IS Solutions
programme. In the investment sub-group an action requested from NERL was
to look at potential savings from this project. Certainly the £1.5m annual
efficiency from a £30m capital investment would not yield a positive NPV as it
would take 20 years for this to occur – yet the average life of IT assets is
something in the region of 3-4 years.

The project IS solutions was provision of state of the art, server in the sky IT
provision. Airlines contended that either by using existing IT infrastructure that
would continue to do the job, or by moving the timescale to the right, could
yield savings. Its standalone nature would facilitate this.

The reduction of the capex plan from £650m to £637m is due to pension
accounting adjustments, so there has been no adjustment to the IS solutions
project.

We would like this project to be justified, and any savings returned to the plan.
12. REGULATORY ASSET BASE AND DEPRECIATION

12.13 The CAA invites views on the depreciation lives used by NERL in
its depreciation calculation and the CAA’s initial assessment, if the
depreciation charge is appropriate, that NERL’s method is reasonable.
bmi considers the depreciation lives appropriate, and therefore the method
reasonable.




13. COST OF CAPITAL

13.10 Do consultees agree that the CAA should continue to use a pre-
tax, real cost of capital where the uplift for tax is based on an effective
rate?
Yes

13.15 Do consultees consider that it is appropriate for the CAA to
continue with its approach of using CAPM as the primary tool to
estimate the cost of equity with high level cross checks to other
methods as appropriate?
Yes

13.19 Has the CAA identified reasons for, and issues around, testing
financeability?
As long as the CAA ensures that cost of capital assumptions link in with the
metrics required for maintaining an investment grade credit rating, all issues
have been covered.

Given that NERL has a guarantee of cost recovery for a majority of its costs,
we do not see the maintenance of the investment grade credit rating being a
problem.

13.29 Has Europe Economics identified all material considerations for
the cost of capital?
See response to question 13.29.

13.44 The CAA invites views on the cost of capital and the CAA’s initial
reflections of the cost of capital

Reduced cost of equity
We would expect, for a number of reasons, that the equity beta element be
significantly lower, reflecting in a lower cost of capital, due the following:

   •   Demand risk reduced
       Volume sharing arrangement provides additional security to NERL.

   •   Capex risk reduced
       Any capex overspends are paid for by the airlines. Yes we have
       recommended that the capex overspend in CP2 not be added to the
       RAB, but improved communication in the SIP process would preclude
       this from happening in CP3, and hence there would be no impact on
       the cost of capital in CP3.

   •   Risk averse business plan
       The completely risk averse nature of the NERL business plan transfers
       risk to the airlines from NERL.

   •   Opex risk reduced due pass-through mechanisms
       This is reduced due two pass-through mechanisms:

       1) The proposed CP3 pension pass-through mechanism hands the
          risk in its entirety to airlines of the single most uncontrollable
          element of opex (or that NERL refuses to control). The remaining
          part of opex is declining and represents

       2) The bad debt allowance pass through reduces the operating cost
          risk to NERL yet further.

          All these pass-through arrangements ensure that airlines take the
          risk, and we would expect to see a reduced beta feeding into a
          reduced WACC to reflect these factors.

   •   Opex cost a reducing element of total revenue
       Taking the pension element out of opex cost, as a percentage of NERL
       revenue, it is predicted to fall from c.64% in CP2 to c.49% in CP3.

The pricing proposals moves a substantive degree of risk away from NERL in
all areas of its business – on the demand side, and in its cost base, ensuring
risk is parked with the airlines. Consequently we would expect the cost of
equity element of the WACC to be low.

Effective rate of taxation
We would ask the CAA to examine the marked increase in the effective rate of
taxation from 11% to 35%. This has been explained through capital
allowances being higher than depreciation in CP2 and vice versa in CP3.

We believe this needs validation as PWC’s derivation of the CP2 11.1%
shows a wildly fluctuating tax charge with a 27% tax rate in 06/07, followed by
2 years of a negative tax charges with a large 44% tax charge at the very end
of CP2. These fluctuations do not, at a first glance anyway, appear to agree
with depreciation being greater than capital allowances. We would ask the
CAA to validate the explanation and the numbers.

13.45 Should the CAA estimate the value of the tax uplift in pre-tax
WACC approach in a way that makes the monetary tax allowance the
same as if the CAA took a post-tax WACC approach and explicitly
included a tax allowance?
They should both reach the same value and so we are indifferent.
ANNEX B: SERVICE QUALITY AND ENVIRONMENTAL
PERFORMANCE

B24 Do consultees consider it is appropriate not to exclude NERL
equipment failures, which cause the T3 thresholds to be reached from
the T2 measure?
bmi believe it is appropriate not to exclude NERL equipment failures, which
cause the T3 thresholds to be reached from the T2 measure.

B38 Do consultees agree that there may not be further merit in having a
T4 delay measure in addition to the T1, T2, and T3 metrics?
At CCWG 3 NERL set out its proposals for three delay terms to be
incentivised from the start of CP3, and the development of Environment
Metrics for future incentivisation. These were discussed at CCWG3 and
CCWG5, and at two sub-groups, and as a result NERL reviewed and updated
its position.

This response sets out bmi’s view of the appropriateness of the delay metrics
suggested, and any requirements for inclusion in the term as part of CP3.

There is some concern that unrealistic targets as set out in CP2 are treated by
NATS as a method of extracting further bonus payments from the operators,
and do not necessarily reflect the impact NERL have had on their customers.

Delay Metrics
NERL set out proposals for three delay terms as follows:-

T1 – Average Delay – expressed as the “Average Delay per Flight”.
NERL state that T1 retains a high-level single measure of overall NERL
performance (needed for a strategic view and for future consistency with SES
II performance regime), and bmi have no issue with accepting this as a
measure subject to certain conditions as discussed below.

bmi feel that on its own this term is too simplistic, and does not adequately
reflect the level of delays experienced by those flights that are subject to
NERL attributable delay. In other words it is diluted by out of area traffic which
is not, and cannot be, subjected to NERL attributable delay. For example, in a
static traffic, capacity, and delay situation, a change in the balance between
out of area traffic and in area traffic will lead to an overall reduction of
“Average Delay per Flight”.

In order to rectify this situation the airline community proposed the T4 term,
defined as the Average Delay per Delayable Flight. We believe that this term
eliminates the dilution of overall delay by out of area traffic and possible
distortions to give a more realistic view of the impact of NERL attributable
ATFM delay on those carriers that are impacted.

In its own paper – CP3 Service Quality Performance Metrics – Delay
Performance – Summary of NERL Position – NERL has shown how out of
area traffic grew year on year between 2006 and 2008. NERL has also stated
in the same paper that “it would be neutral to its use alongside the other 3
metrics, although NERL does not consider it adds any value beyond T1 and
T2.”

In view of its neutrality, and the strong requirement from airlines for the
inclusion of T4, and the apparent parallels between the two measures bmi
would like to see both measures included in the T1 Term i.e. the new T1 Term
would become

1a – Average Delay per Flight, and
1b – Average Delay per Delayable Flight.

The payment of any bonus or penalty has been outlined in earlier responses.

T2 – Impact Score
NERL set out this impact score as “the sum of weighted NERL NATS
Attributable planned pre-departure ATFM Delays divided by the count of all
NERL chargeable flights”

Further, the Impact Term also sets out exclusions – delays caused by NERL
equipment causes (cause code TE82 which reach the T3 thresholds.)

In principle bmi support the inclusion of the Impact term, but not the
exclusions, but with one modification, and certain conditions.

The Impact term is an attempt to drive appropriate behaviours, and give
NERL a clear focus on what is important to the customer i.e. a higher
weighting applied to early morning, or long delay flights – that is those that
have maximum impact on the customer. However, the impact of such NERL
attributable delays is felt exclusively by the ‘in-area traffic’, and has no impact
on ‘out of area traffic’, and as such the definition of the term should be
modified to show the level of impact on those it affects. Therefore, the term
should be defined as:-

Impact Score
= Sum of Weighted NERL NATS Attributable planned pre-departure ATFM
delays
                       The count of all NERL Delayable Flights


This provides a true impact score. Therefore, this definition of the T2 impact
score would be accepted by bmi.

T3 Variability Score
bmi accepts the principle of T3, although our comments in previous sections
on the need for a realistic target still stand.

However, there are some concerns with the Exclusions, as follows:-
NERL states that “Delays associated with temporary capacity reductions
during the bedding down period following implementation of service
enhancing investments and operational changes. These would be expected to
be limited and relate to a relatively small number of events, e.g. 1-2 per year.
The specific durations and impact would be set in the implementation plan
following consultation with customers. The exemption does not include any
service impacts prior to implementation.”

The concerns here are that NERL may be conservative in its implementation
plan impact analysis and that as the final arbiter of delay attribution, may be
able to offset normal delay measures. Secondly, what mechanism is in place
to ensure that a) the consultation on impact is effective, and b) in the event of
a non-agreement between the stakeholders on the impact what is the
reconciliation method?

Further NERL states “it is proposed that the Variability term also exclude
recovery periods from abnormal situations that are not attributable to NERL,
e.g. 9/11, other ANSP technical problems or strikes, due to their potential to
cause temporary imbalances in capacity and demand leading to excess
delays.”

While we understand the mitigation for ‘force majeure’ circumstances such as
9/11, the exclusion of other ANSP technical problems or strikes is
problematical in that the definition is subjective. NATS would effectively be the
arbiter of whether such a problem is material or not. Therefore, there would be
no transparency to the customer, and no method of determining when such
measures had been excluded, and as such this is not acceptable.

								
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