Major change lies in store for many travel businesses if the CAA pursues the reforms laid out in its consultation paper: ‘Atol Reform: Assessment of funding arrangements and the protection of customer money’. Ian Taylor reports
The CAA’s long-awaited consultation on Atol reform, launched last week, seeks industry views on proposals that would fundamentally change the way many Atol holders fund their operations.
The proposals are far reaching. The CAA not only intends to limit the use of customer money for advance payment of suppliers, which may require Atol holders “to re-evaluate their capital structure”, but also aims to introduce “risk pricing” through variable rates of Atol Protection Contribution (APC) on bookings.
Yet the consultation is also limited in scope. The proposals exclude wider reform and the CAA makes clear it’s “looking at changes which the CAA is able to make through its own regulatory powers.” So changes requiring legislation are ruled out.
The CAA insists no decisions have been made and there will be a follow-up consultation early next year on specific proposals in light of industry responses.
However, it does propose changes to agency agreements and to the way small Atol holders pay APC returns on which there will be no further consultation.
‘Two principal problems’
In making its key proposals, the CAA highlights “two principal problems”, arguing: “Many travel businesses are highly reliant on customer money as a source of working capital and not strongly capitalised enough in their own right; and the APC they incur may not [reflect] the risk individual Atol holders, or the value of bookings, pose.”
The CAA notes: “Issues arise when [customer] money is used to fund other business expenditure rather than the specific booking.”
It suggests: “Many Atol holders operate a business model which allows customer money to be commingled with operational cash . . . This can cause additional risk as it requires a constant inflow of new customer monies to meet the costs of providing the original services.”
The consultation document adds: “The Covid-19 pandemic has amplified the need for change, in that poor capitalisation and the use of customer monies as a primary source of working capital can lead to a rapid deterioration of available cash.
“Businesses that have clearly separated customer monies . . . have often been more financially resilient . . . and better able to pay refunds for cancelled holidays.”
The CAA insists: “This consultation is looking at how Atol holders finance their operations rather than restricting certain types of business models.”
Yet the purpose is clear: “The current framework has not done enough to restrict the use of customer monies as a source of low-cost financing.”
It argues the current system “has failed to sufficiently incentivise Atol holders to put in place more robust financing structures and protection . . . [and] a flat rate APC of £2.50 has failed to reflect the risk individual Atol holders pose to consumers. This view has been reinforced by the experience during Covid-19 [over refunds].”
Segregation of customer payments
All Atol holders as well as agents selling on their behalf would be required to segregate customer payments wholly or in part under the CAA’s proposals.
The segregated funds could not be used until customers completed their holiday. The CAA acknowledges this would mean “Atol holders would need to fund their operations from alternative sources”.
It suggests segregating payments “may provide comfort to merchant acquirers that they will be less exposed to insolvency risk and hence may make reduced or zero demand for security”. However, the extent to which merchant acquirers make allowance for existing trust arrangements is unclear and acquirers typically require security such as additional bonds from companies bonded with Abta.
‘Total’ segregation would mean no money could be paid from the account holding the money “prior to the customer’s return, including prepayments to suppliers such as airlines”.
Atol holders would still have to add an Atol Protection Contribution (APC) to bookings. The CAA notes that despite segregating the funds “there remains some exposure to the Air Travel Trust as a result of fraud or repatriation and administration costs of an Atol failure”.
‘Partial’ segregation would mean some money could be removed from the segregated account in advance of a holiday such as to pay for flights. But payments “would be limited”, says the CAA, suggesting as an example that it could insist only “up to 20% of the value of the . . . holiday could be removed”.
Payments could be held in a trust account, managed by professional trustees for a fee.
Or they could be held in an ‘escrow’, or third-party, account – the CAA suggests it would sanction this for “partial segregation only”.
A third alternative would be a ‘customer monies account’ – a separate, standard bank account used solely for customer payments. In this case, the Atol holder would need insurance or a bond as back up.
The CAA notes the new requirements “could reduce the choice of business models for Atol holders”.
Agents would also need to segregate payments taken on behalf of Atol holders. The consultation states: “Where monies are not paid directly to the principal Atol holder but are paid to an agent, this money would also need to be segregated upon receipt by the agent
“This could either be done in a segregated account held by the agent, or the monies immediately passed to the Atol holder to be held in their segregated account.”
Bonding could be retained to provide choice
The CAA’s proposed financial overhaul of Atol could see bonding requirements retained for companies in a “weak financial position” as well as bonds to supplement the partial segregation of customer money.
The Atol-reform consultation notes: “If the CAA chose to mandate bonds in the new framework, the value required would be set to meet a mandatory minimum of customers’ monies.
“Companies with a weak financial position could be required to provide a bond which has a higher value than the mandatory minimum.”
The new framework “could offer a choice between segregation of funds or bonds” allowing Atol holders a choice.
“Atol holders could have the option of utilising either or both methods of security to achieve the minimum level of protection required. For example, if the CAA required Atol holders to protect a minimum 80% of liabilities to consumers, an Atol holder may wish to provide a bond which protects 30% and an escrow account for the remaining 50%.”
The CAA notes: “This would likely be accompanied by a variable APC structure that led to Atol holders with a higher risk of failure . . . paying a higher contribution.”
Changes to the Atol Protection Contribution (APC)
Proposed changes to Atol holders’ financial arrangements are likely to be accompanied by changes to the Atol Protection Contribution (APC) rate, the CAA makes clear.
This could mean either an increase in the current ‘flat rate’ £2.50 APC or a switch to a variable rate.
The CAA proposes three variable-rate options based on the ‘risk’ posed by the Atol holder, the ‘value’ of the booking or a ‘hybrid’ of both elements.
The consultation notes the current flat rate APC “means companies [with] an increased chance of failure . . . pay the same as companies [which] pose a lower risk”.
The extent to which customer money is segregated by a business would be taken into account in the APC model the regulator chooses. The CAA notes: “Whichever was used, the rates [for less segregation] would be higher than for full segregation.”
If risk-based pricing comes in, the CAA suggests: “Those who operate trust accounts with maximum levels of protection in place would pay the lowest level of APC.
“A company . . . considered to be high risk [which] only had in place a bond, would pay more.”
It notes: “One of the intentions would be to give Atol holders the incentive to take steps to protect customers’ monies. The likelihood is that APC payments by Atol holders that took lesser steps would be materially higher.”
A ‘risk-based’ APC rate would involve the CAA assessing an Atol holder’s financial and business risk and capital structure as well as the extent to which it segregates payments.
A ‘value-based’ APC would reflect the value of a booking. The CAA notes this “would be best suited to mandatory segregation of funds where all monies are protected to the same standard. However, it does not reflect the increased risk some Atol holders pose.”
A ‘hybrid’ model “would take into account the value of the holiday and the risk profile of the Atol holder”. The CAA notes: “We would expect the formula . . . to be weighted more toward risk than value.”
It adds: “The APC rate paid by individual Atol holders would remain confidential.”
The proposal of a flat-rate rise in APC as an alternative implies the overall amount paid in APCs will increase whatever happens.
The CAA does propose moving to a wholly insurance-based financial-protection model as an alternative to reforming the current system.
But it makes clear this would require greater legislative change, something the consultation appears to rule out by stressing a focus on “changes the CAA is able to make through its own regulatory powers”.
A switch to an insurance model would also make the sector dependent on the insurance market rather than a mix of financing options.
It would mean “an Atol holder would be required to obtain full, Atol-equivalent consumer financial protection from third-party insurance providers”. These would set the financial criteria and conditions Atol holders would be required to meet.
The CAA notes: “This would remove the need for the Air Travel Trust [ATT] and any CAA involvement in handling failures. The CAA would remain responsible for issuing an Atol, [but] would refocus from financial testing on to requiring the Atol holder demonstrate [it] had sufficient protection for its licensable holidays.”
An Atol holder unable to obtain adequate protection through a third-party provider “would be refused a licence.”
The CAA adds: “This option would fully transfer the funding of the cost of failures to the financial markets [and] would be reliant on the capacity within the insurance markets.”
Moving to such a system would require a transition period “which would see the ATT and the financial protection it provides wound down”.
Small Business Atols
The CAA Atol-reform consultation proposes two changes which will not be consulted on further.
One involves a change to the way Small Business Atol holders (SBAs) and “certain franchise Atol holders” operate. SBAs are licensed for up to 500 Atol passengers a year and are mostly agents.
At the moment, both these group of small Atol holders pay Atol Protection Contributions (APCs) on their Atol bookings annually. The CAA proposes to make the payments quarterly to the Air travel Trust “within six weeks of each quarterly reporting period”, in line with the requirement for standard Atol holders.
The CAA also proposes a change to the terms applied to agency agreements – between Atol holders and agents selling their package holidays – to ensure these agreements are kept up to date with changes to the standard terms issued by the CAA.
Future changes would “take effect on the date of publication by the CAA and apply immediately”. The CAA notes this would “mitigate the risk of otherwise compliant agents holding non-compliant written agency agreements”.
However, for this to take effect, “Atol holders would be required initially to reissue all agency agreements”.
What happens next?
The CAA acknowledges the industry “may require time to adjust” to what could be substantial changes and promises “an appropriate implementation timetable”.
It also acknowledges that “whichever framework is chosen, there will be an impact on the funding needs of Atol holders”.
“The CAA will undertake a business impact assessment across the portfolio of Atol holders, as well as considering the effect any changes would have on competition, choice and pricing.”
It suggests: “In order to minimise disruption, there may be a transition period from when the current approach ends and the new framework is put in place.”
A framework resulting in “the most impactful changes to the system” would require a longer transition. This could be accompanied by “incentives for early compliance”, the CAA suggests, but gives no details.
Before finalising the regulatory changes, the CAA promises another consultation which “will set out in further detail the chosen framework, how the APC would be charged, and any other relevant changes such as updating the financial criteria”.
That consultation is expected in early 2022, meaning the full impact of the changes won’t be felt for two to three years.