Airlines think nothing of hedging fuel prices and their FX risk. Now Airbus subsidiary Skytra hopes to offer airlines the ability to hedge ticket prices, their most important source of revenue.
Skytra, the wholly owned Airbus subsidiary, has won FCA approval to become a regulated benchmark administrator for the world’s first Air Travel Price Indices, Skytra Price Indices. The company has developed six new benchmarks which accurately represent an average ticket price in different regions around the world to allow airlines to hedge their ticket revenue by pricing derivative contracts for the first time.
Airlines already use a series of financial risk management strategies and tools to reduce volatility on risks such as fuel prices, exchange rates and interest rates, explains Elise Weber, Skytra co-founder and Chief Sales & Marketing Officer. However, there has never been a financial instrument to reduce volatility on revenue and the ensuing benefits on better navigating profit and loss. “In other industries like agriculture for example, farmers can lock in costs and revenues by hedging the price of fertiliser and the price they will sell their grain. Only when you can manage both sides of the equation, do you have a higher predictability of what’s in the middle which is profit, and what you want to protect,” she says.
Indeed, the ability for airlines to hedge their ticket revenue coincides with a new report that suggests airlines could save up to US$7.7bn a year in financing costs by hedging ticket prices. Regis Huc, Aviation Financial Analyst and Program Manager at Toulouse Business School, also calculates that hedging ticket sales could boost struggling airlines’ credit quality and financing costs.
Skytra says FCA approval is a key milestone on the way to building the new market. Its benchmarks will initially be offered OTC intermediated by banks, but the company will monitor how liquidity builds up to decide whether it makes sense to bring them on-exchange, explains Weber. “Pre-COVID, we were considering launching the benchmarks directly on our own market infrastructure,” she says. “Due to the pandemic, we expect airlines to hedge lower volumes until air traffic picks up again, so an OTC solution seemed more appropriate. Also, it will give companies time to get familiar with the new tools supported by their banks and get more bespoke products.”
Demand to hedge won’t just come from airlines selling tickets. Large corporates wanting to hedge their travel budget will also use the tools. And although travel volumes have collapsed, she believes intra-regional travel will come back first, and says that ticket volatility has also spiked sharply with the pandemic. “Nailing down a price for future travel is currently very difficult and getting visibility on this is attractive for a big corporate,” she says.
Between 15-20 corporate treasury teams are currently using the index under research licences, getting familiar with the tools that enable correlation analysis, ensuring the right price to hedge and exploring the right derivative instrument to use. Typically, this analysis will focus on how an airline’s data moves in line with the index – a low-cost carrier will be below the index and legacy carriers above. “While airlines are of course familiar with ticketing data, their treasury teams may not be,” says Matthew Tringham, Chief Strategy & Product Officer, Co-Founder of Skytra. “Furthermore, while the actual calculations are very straightforward (calculating average prices) the number of data points means that Excel may not be the best tool to use!”
Take up also involves complex internal sign off from risk management colleagues, says Weber. “The product will need to find its place in new risk management policy. Only then will companies be able to hedge two years out, and use their banks and existing ISDA agreements to place a hedge in the same way they hedge their FX and fuel risk,” she says. “Around six companies are very well progressed. Once you have innovators and early adopters then lots of followers will emulate.”
Success also depends on bank counterparties coming forward as intermediaries to facilitate the hedging process. Skytra has “support” from ten banks says Weber, who also flags that bank support will depend on factors like a company’s credit rating, how much they want to hedge, how far out and the volatility in the index. “All these elements will determine the cost of the hedge and if a financial intermediary wants to take hedge. It will be case by case,” she says, concluding that the focus for 2021 is education. “Companies won’t hedge everything in one day. They will get familiar with the process first, trust it, then gradually increase their position.”
