Backbone of the Industry
Cash flow must remain positive in tough times, which makes efficient settlement systems crucial to industry wellbeing
Difficult economic conditions do not come with easy answers. But airlines can be forgiven for thinking the current environment is more challenging than most.
The latest IATA forecast warns of a turbulent future. A predicted $3 billion profit in 2012 is based on a steady US recovery and policy measures in China that help that country manage slowing economic growth.
It is Europe that really clouds the horizon, however. Although accepting that the Eurozone crisis could deepen, the IATA forecast warns that a large-scale banking crisis in Europe could easily wipe out profits.
“The deteriorating economic conditions in Europe have led to declining traffic, a decrease in load factors and falling yields,” says Brian Pearce, IATA Chief Economist. “Larger network airlines can mitigate the problem by managing capacity and deploying larger aircraft onto routes to stronger markets, but regional airlines in Europe are likely to face a tough time with many European economies looking increasingly weak.”
Strengthening the system
Financial systems have to be up to the challenge of the crisis. “Airlines are watching their cashflow very closely,” says Stephen Darnley, IATA Corporate Treasurer. “In an unstable environment, reliability and certainty of payment is very important.”
In 2011, IATA handled more than $282 billion through the settlement systems, with 99.97% accuracy in the Billing and Settlement Plan (BSP) and 99.99% accuracy in the Cargo Accounts Settlement System (CASS). The Association is committed to continuous improvement in quality of the settlement systems and at the same time will include a 23% reduction in the average BSP unit operating charge by 2017 compared with 2010.
Following the successful migration of the remittance and settlement functions to five regional hubs (Amman, Beijing, Madrid, Miami, and Singapore), work has now begun on moving the remaining back-office IATA Settlement System activities from IATA local offices to these same regional hubs. These migrations will take place on a country-by-country basis, beginning in the third quarter of 2012 until completion in mid-2014. Each regional hub will focus on delivering quality and consistent customer service. Following migration of the various office activities, IATA local offices will continue to perform an active role in managing risks to member funds as the eyes and ears in the marketplace, working closely with local airlines, travel agents, freight forwarders and other industry stakeholders.
“Regionalization brings greater control and reliability,” says Darnley. “Country-based settlement brings more challenges in terms of oversight, contingency and segregation of duties, all of which can be mitigated in regional hubs. Automation of the Remittance and Settlement process with a global system known as IRIS improves security and reliability while economies of scale control and reduce costs.”
The IATA Clearing House (ICH) is one of the critical IATA financial services. Established in 1947, the ICH allows airlines to bill each other for passengers and cargo traveling on interline journeys. Some 15% to 20% of all airline sales result in interline travel, and as consolidation takes hold as a response to the unstable global economy, this sector looks set to rise. In 2011, the value of interline passenger sales increased 5%.
A lot of work has been done to enhance performance. Greater speed and reliability ultimately leads to a cash-flow improvement, suggests Darnley, which in these times of crisis provides a crucial liquidity boost.
The Simplified Interline Settlement (SIS), for example, automatically processes and settles electronic billing files submitted by airlines through the ICH. SIS is expected to save the industry $500 million every year through paper removal and a more efficient process. In May 2012, the second and final stage of SIS was implemented, extending SIS to cover cargo and the Universal Air Travel Program.
The ICH has also moved to open period accounting. “We now run four settlement cycles per month—on the 7th, 14th, 21st and 28th day of each month, with claims being settled nine days after the relevant closing date,” says Nick Coote, IATA Director, Industry Clearing Services. “This is much quicker than the old monthly closed-period accounting, when it could take more than two months for a claim to be settled. This means that we have less cash tied up in the system, which in turn means that there is a major reduction in risk.”
There are multiple back-ups for the ICH but, as far as Coote is aware, there has never been any delay in making payments since he began his job in 2004. The ICH now processes a total of $50 billion worth of transactions per year. Approximately $35 billion of that effectively evaporates through the offsetting of billings by one airline against another, resulting in further cost savings.
The ultimate system
The ultimate solution for processing global financial transactions for airlines would be to integrate the BSP and currency clearing systems with the ICH.
“If these could be consolidated into a single system, many more payments could be offset against each other,” says Coote. “There are logistical and practical problems to be overcome, but it is something we are looking at under our Treasury Platform concept.”
For more information on cash management
The IATA Currency Clearing Service
Accounting for the variety of currencies used in sales is the work of the IATA Currency Clearing Service (ICCS). It converts sales into an airline’s home base accounting currency with a normal clearance cycle of four working days (although there is a two-day express service for some currencies). The ICCS is used by more than 270 airlines of varying sizes on all continents. Annual throughput for 2011 was $35 billion.