The proposed BA/American alliance is forcing regulators to examine airline mergers more closely than ever, while Brussels is nearer to gaining a full mandate to negotiate with the US. Report by Mark Odell, Lois Jones and Mead Jennings.While UK and US regulators concentrate on the task of assessing the implications of the proposed British Airways-American Airlines alliance, an important sideshow is developing in Brussels. The European Commission is launching a bid to strengthen its hand to negotiate full traffic rights with the US on behalf of the European Union by seeking to establish its antitrust credentials.

The Commission is already on course to become the sole negotiating partner for the European Union in air talks with the US, although the prospect of negotiating market access is still some way down the line for Brussels (see box). Economic arguments about the impact of individual open skies deals between the US and EU member states may well have won transport commissioner Neil Kinnock some converts among Europe's transport ministers, but the one key advantage the US still holds is the bestowal of antitrust immunity.

Immunity fever has become a contagion over the past 12 months of transatlantic alliance building and with it the US is able to exert its extra-national powers in ensuring alliances comply with its political if not commercial objectives. No one European country could hope to project that sort of power internationally and the Commission recognises that its hand would be strengthened in the eyes of member states, reluctant to cede negotiating powers, if it could match the US by protecting Europe's carriers internationally.

To this end, Brussels sent shockwaves through the European aviation community when Kinnock, together with competition commissioner Karel van Miert, not only placed the proposed tie-up between BA and American under investigation in June, but announced it would simultaneously investigate the five existing transatlantic alliances, namely: Lufthansa-United; SAS-United: Swissair-Sabena-Austrian Airlines-Delta; KLM-Northwest; and BA-USAir.

As justification, the Commission points to concerns over the cumulative effects of these alliances on the European market. But the timing, only weeks after BA and American confirmed they were looking at a link which could involve 36,000 city-pairs globally, suggests Brussels needed to wait for the 'mother-of-all-alliances'. Based on 1995/96 passenger figures, BA and American jointly control 60 per cent of the UK-US transatlantic market, with a staggering 70 per cent market share on the London-New York route.

Suggestions that the Commission only included the other five alliances in its investigation in a bid to avoid accusations of discrimination fall flat for two reasons. Firstly, the Commission would not risk taking such a step because of concern over one alliance. Brussels is claiming a precedent under the little-used Article 89 of the Treaty of Rome to examine competition issues on EU routes to third countries.

Secondly, a Brussels source says the Commission initiated its investigation two months before the proposed deal surfaced, spurred on by concerns about the Lufthansa-United alliance. Kinnock held back for fear of disrupting unofficial talks with Washington over the timetable for talks on the external mandate.

The Commission still faces a number of hurdles. Its powers under Article 89 are limited. 'As Article 89 was seen as a transitional arrangement, the essential implementing rules that would allow the Commis- sion to impose fines and grant exemptions have never been put in place,' one European lawyer points out.

Article 89 also obliges Brussels to work in cooperation with the relevant member states. The member states are legally bound to cooperate with the Commission, but in practice their cooperation may not be forthcoming.

In this lawyer's opinion, a member state will challenge the Commission and the case will then be referred to the European Court of Justice. The Court would then have to decide whether the Commis- sion exceeded its mandate or was justified in launching its investigation. This would delay the Commission's attempt to arm itself with an external antitrust weapon and would leave a question mark hanging over the future security of the alliances, because should the Court rule in the Commis- sion's favour, any ruling would be binding.

While the positioning continues in Brussels, BA's and American's immediate concerns lie with their regulators at home. The Office of Fair Trading, the UK competition watchdog, is itself breaking new ground by classifying the BA-American linkup as a merger without any exchange of equity. The deal is considered a merger as it would gives the two parties more than 25 per cent of the UK-US market. The OFT's findings will be passed on to the government, where the secretary of state for trade and industry will decide whether the case should be referred on to the Merger and Monopolies Commission. The MMC could stop the deal, or ask BA/American to revise it.

Despite the outcry caused by its impending alliance with American, BA remains confident that the deal will go ahead before the US presidential elections in November. 'We were prepared for this regulatory intervention,' states one senior official. He also attempts to downplay UK rival Virgin Atlantic's vehement opposition to the deal. 'Virgin's protests are rooted in a misrepresentation of the market. The wilder assertions being made are unfounded and based on data that may be false.' Most of the data appears to come from the UK Civil Aviation Authority.

It would take major concessions on BA's behalf, however, for Virgin to give its blessing to the deal. 'If BA wanted to give up 25 or 50 per cent of its slots at Heathrow, then maybe we would be listening,' says Barry Humphreys, director of government and external affairs at Virgin. But BA is not interested in giving up any of its precious slots at Heathrow. 'If the regulators were to place conditions, then that would essentially kill the deal,' the BA official says.

But BA's hard-line position against handing out Heathrow slots is contradicted by the demands of most US carriers and the US Department of Transportation. For players other than American and United, slots will have to be made available at Heathrow 'in order to discipline a new alliance,' according to Patrick Murphy, the US DOT's deputy assistant secretary for aviation and international affairs. This is easier said than done.

But formal US-UK talks would not have taken place in July if the US' bottomline criteria - slots for new US carriers and clearance for those carriers to establish fifth freedom or codesharing services beyond Heathrow - had not been deemed at least within the realms of the possible.

Almost all players believe that the US-Heathrow market will have to be restructured to make room for BA-American, particularly if it obtains antitrust immunity. Immunity will require US DOT approval, as well as the signature of the US Department of Justice, which focused on gateway-to-gateway competition in its analyses of immunity applications by United-Lufthansa and Delta-Swissair-Austrian-Sabena earlier this year.

These DOJ studies concluded with the approval for immunity but subject to 'carve outs', such as one demanding that Delta and Swissair not collude on business fares between Cincinnati and Zürich. Most believe that DOJ will ask that similar requirements are applied to BA-American. For example, Continental, which now only serves Gatwick from its Newark hub, has applied for six daily Newark-Heathrow services to apply pressure to negotiations and firmly establish its needs. But from New York, BA-American together fly 13-18 daily flights, depending on time of year.

But sources say that DOJ is concerned not only with such gateway markets as Dallas-London, but also such beyond-gateway markets as Dallas-Johannesburg, or London-Buenos Aires. This would be the first time that a beyond gateway concentration study is applied to the approval process for immunity.

The question for aviation officials in Washington now is how seriously DOT will take DOJ's recommendations. In the Delta case DOT approved the alliance with only some of the carve-outs demanded by DOJ. There is speculation in Washington that the DOT is not in a strong political position to ignore the DOJ this time. 'The difference between "Delta" and "American" is ValuJet,' says one industry source, referring to the political heat DOT transportation secretary Federico Peña has taken since the ValuJet DC-9 crash in May.

November is the working deadline for US-UK liberalisation talks and approval of the alliance. From the US side, political and commercial reasons could ensure such a complex agreement is put in place in this relatively short space of time. Politically, Peña and the Clinton administration would win from reaching an open skies deal with the UK before November's presidential elections. Commercially, all US airlines hoping to benefit from a fully liberalised bilateral would want to meet the November proceedings of the twice yearly slot allocation process at Heathrow for the North Atlantic's summer season in 1997.

Source: Airline Business