ESG and Global Aviation

Global Airlines and Aviation are beginning to use Environmental, Social, and Corporate Governance (ESG) efforts as a key differentiator for both investors and sustainability conscious travellers who are paying more and more attention to a company’s ESG track record when making travel decisions. Our current assessment of the ESG landscape is that it is currently a mixed bag as far as where the global airlines stand within the various components that make up ESG. While the E.U. and Latin America have focused earlier on the environment (and are thus ahead of the U.S. with changes being made), there is a past track record of labour discord and business disruption that is much more prevalent in these areas than in the U.S., all of which impact an airline’s ESG score. While the European and Asian airlines have focused first on ESG and in particular the environment and sustainability as it relates to emissions, Covid-19 has titled financial help to the U.S. airlines who have been helped more by their government. We expect this to enable them to focus on ESG and improve their overall ESG footprint relative to their international counterparts.

Environmental:

Much attention has been placed on the aviation sector as it accounts for 2.4% of global carbon emissions. Looking ahead, the airline industry is facing even more stringent regulations in this area as the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) will become mandatory globally in 2027. There are now 82 countries which will take part in the first, voluntary, phase of CORSIA and it is anticipated that about 80% of the growth in international aviation CO2 will be covered by the scheme from the end of this year. This is a mid-term solution as the world’s airlines focus on reducing its overall emissions footprint.

In Europe, the idea of emissions reduction has really caught on, helped by public “flight shaming” by environmentally conscious flight travellers (Greta Thunberg is the most notable), especially when there is a rail or car alternative. In all fairness, Europe is unique with its well-established train system versus the rest of the world that does not have this strong alternative. Europe as a result has led the world with its more vocal focus on reducing carbon emissions and putting in place strong Sustainability programs. It really is a mixed bag worldwide, however, as there are key airline leaders in each geographic area that are focused on pushing this forward. Covid-19 and the devastating impact to airline financials have made this less of a priority to many airlines that are struggling for survival. Our expectation is that the US airlines, who have been helped more financially by strong government support, will be able to focus more on this than their international counterparts.

Social:

The airline industry is judged on many social factors and risks that include service quality, safety and labour relations issues. In an intensely competitive industry that has also been focusing on cost-cutting initiatives, on-time performance in particular has been a challenge. Safety and quality incidents have impacted an airline’s performance in this area. On the labour front, the airline industry is heavily unionized and there have been back and forth power struggles between managements and union leaders. Labour strikes and disruptions aren’t unheard of particularly in Europe. Managements that put a lot of time in overall labour relations are not only rewarded with higher Social scores, but are also rewarded with higher customer satisfaction results as well.

Governance:

Corporate governance will continue to be a key area of focus for airlines around the world, as the COVID-19 pandemic brough financial uncertainty to the whole industry. While the sector’s focus is shifting towards more sustainable aircraft and overall travel models, airlines need to continuing weighing these interests against their financial stakeholders, to create strategies and structures that benefit the company as a whole.

This can be particularly difficult for the airline industry, where stakeholders range from lawmakers and regulators, to employees, lessors, shareholders, boards of directors, and more. This becomes slightly easier for some airlines that are considered state-owned, mostly concentrated in Asia and Europe. Some countries have gone as far as creating guidelines to ensure domestic ownership, such as in the U.S. where foreign investors can only own up to 25% of the existing shares for an airline, or in Europe where foreign investors can only own up to 49% of existing shares. While these sorts of domestic protectionist policies may seem intuitively positive, they also prevent the influx of additional capital, at a time when the global airline industry is in need of cash.

As more of an emphasis shifts towards sustainability, we expect corporate governance structures to change to align with renewed sustainability priorities. Additionally, while protectionist policies will most likely stay in place, we would not be surprised to see more airlines pursue forms of foreign investment and also try to relax foreign ownership restrictions to fill financial gaps caused by the pandemic. This may be particularly true for non-government owned airlines outside of the U.S. who received little to no financial support from COVID relief legislation.

FTI’s Point of View

ESG is becoming more of a focus for investors around the globe and we believe airlines who have not invested in ESG yet should pivot towards improving their overall ESG score and reducing their carbon footprint. This pivot is important for three key reasons: 1) airlines can capitalize on the massive transfer of wealth from baby-boomers to millennials who are caring more and more about a Company’s ESG policies when making travel decisions, 2) large asset managers such as Blackrock and State Street are becoming more vocal and active on investing in companies that have strong ESG programs. In many cases these are the airlines’ top active holders, and 3) Focusing now on ESG improvements will help reduce the risk of what we are seeing as increasingly frequent ESG-themed shareholder proposals.