In the previous EMD article, I stand on the “not-so-rational” point of view to reach a conclusion: we should accept EMD even we are experiencing loss. This time I will stand on the other side, using some economics concept and consider EMD as a special type of bond, to reach another conclusion.
Let’s review the scenario. Attributed to the pandemic, a high amount of cancellation generates a great number of cash refund, which sucks up airlines cash flow even more. To deal with that, airlines uses EMD for a buffer zone. EMD is a kind of valued voucher, check out the previous one for more detail: http://www.martinview.cn/?p=329
EMD is like a type of bonds issue by airlines, with some special elements. Bonds is a common tool in financial market, when a firm needs money and plans to repay more later. It is a great way to increase liquidity but with a strong influence on profitability. Compare to conventional bonds, airlines forces travellers to accept the token (EMD), without giving a clear date of repay. EMD have value, but with a unknown repay date.
The risk for EMD is higher than usual bonds. According to IATA, most airlines will face cash shortage within three months, with a possibility of bankruptcy. If bankruptcy does happen, EMD will not be the first to repay, and may not be repaid in the worst situation. More importantly, EMD is of no face value. Why should a customer consent with such an agreement: handling a higher risk with no extra payment? That’s not fair in the financial market.
This EMD contract is far from appropriate. Airlines kick the risk to consumer side. No wonder in Apr.3, FAA demands airline to “make the full payment in cash”, European Union rejects the EMD policy a few days earlier.
So, EMD is not viable at all? Not really. As EMD is used as a tool for “compel funding”, they should give interest rate out, just as bonds do. We assume EMD will be repaid 8 months after (As the Pandemic is forecasted to an end). Take Hainan Airline’s 2019.3 bond, it has a face value of 5.7%. At that time Hainan Airline has a higher credit rating than current airlines (Trash bonds). As EMD is forced and with a lower rating, the interest rate should be higher. Qualitative speaking, 10% should be the approximate amount.
In short, yet EMD shows airlines responsibility to use future revenue pay today’s debt, EMD basically is a type of bond that is force to buy, with more restriction and risks. Financially speaking, some bonus on interest rate should be implemented to compensate those risks.
Money is money, capital is capital.
Pearce, Brain. (2020.Mar.17th) Airlines’ Liquidity Crisis. IATA Economics.