FIA member firm Skytra is a young and innovative company developing indexes to underpin derivatives products that will allow airlines to hedge passenger ticket prices.
A London-based subsidiary of aerospace giant Airbus, the firm was created in 2019 with the goal of creating the data and infrastructure necessary for the aviation industry to help risk-manage revenue volatility. And since air travel generates roughly $1 trillion in annual revenue but 90% of that revenue is booked less than 90 days before the travel date, hedging ticket price risk is a tremendously important issue.
In fact, a whitepaper released on 15 February by an aviation financial analyst and Program Manager at Toulouse Business School calculated that reducing revenue volatility tied to ticket prices could materially improve airlines’ credit quality and financing costs — resulting in potential savings of up to $7.7 billion annually.
Particularly the wake of the COVID-19 pandemic, which saw tremendous ticket price volatility and tens of billions of dollars in government bailouts for airlines, Skytra's value proposition is quite clear.
While a lot of hard work has gone into building Skytra's data models in the hopes of supporting related derivatives markets, Skytra CEO Mark Howarth notes that the core idea of revenue hedging is not particularly new. In fact, the airline industry already uses derivatives to power a wide array of risk management strategies that cover fuel prices and foreign exchange rates.
"Markets to hedge commodity revenues have been around for 500 years in Amsterdam and Japan for a reason," Howarth said. "We want to support exactly the same kind of tools and facilities for revenue hedging across passenger airline tickets, and we want to do it in a straightforward and standardized way."
Howarth, a veteran of derivatives markets who previously worked at firms including Nomura, Merrill Lynch, UBS and Bloomberg, notes that the majority of Skytra's staff are financial services professionals. That means they understand the need to create regulated indices to power "vanilla structures and contracts" banks will actually use, he said.
In January, Skytra obtained approval from the UK’s Financial Conduct Authority (FCA) to be the regulated Benchmark Administrator for its air travel price indices. This regulatory approval now allows customers to use the benchmarks to price derivative contracts, which will initially be traded in OTC markets, facilitated by banks and inter-dealer brokers.
The benchmarks themselves are based on US dollars per revenue passenger kilometre in six jurisdictions:
- Air travel within Europe
- Air travel within Asia Pacific
- Air travel within North America
- Air travel from Europe to North America
- Air travel from Europe to Asia Pacific
- Air travel from North America to Asia Pacific
Elise Weber, co-founder and its chief sales and marketing officer, says Skytra's Price Indices are based on a comprehensive ticketing database and not simply upon a scaled-up data sample. Skytra’s database include both direct ticket sales commercialised by airlines as well as indirect transactions through third parties like internet booking portals. Thanks to a partnership with the International Air Transport Association the data set covers 83% of worldwide ticket sales by value on a daily basis — and is then in turn cross-referenced with independent data sources. Skytra's indexes reflect real-time current trends as they are calculated on a daily basis and offer retroactive pricing back to 2013 using historical data.
"We did a couple of iterations involving the index end-users and financial intermediaries to make sure they are fit for purpose before getting them approved by the FCA," Weber said. "Airbus knows how difficult it is to run an airline, and with the creation of Skytra want to support their customers in increasing their financial predicatbiliy. Our interests clearly are aligned in getting this right."
Matthew Tringham, the firm's chief strategy and product officer, said that the challenging environment caused by COVID-19 offered a true stress-test of Skytra's indexes, proving they can be resilient and offer insights even in times of unprecedented disruptions.
"We revised our rules and methodology to accept much, much smaller amounts of input data," Tringham said. "And we were still measuring realistically the price of air travel even with a market size that is 90% smaller than it was before."
He adds that while more radical scenarios caused by COVID-19 are likely behind us, including air traffic coming to a full halt in some regions for a short period of time, pricing volatility will remain a major issue for the industry going forward. Travel demand closely follows public health policies, and ticket pricing can change dramatically in a short period of time as airlines move to right-size operations and adapt pricing as various regions see swings in supply and demand trends.
Skytra CEO Mark Howarth said that he wished Skytra could have been in existence before COVID-19, and been able to offer the sort of mature markets he hopes to see for hedging ticket price risks in the future. But he stresses there is tremendous short, medium and long-term potential in the value proposition regardless of recent events. Air ticket prices have always been volatile and we don’t foresee this changing in the near future. On contrary, price volatility has increased up to 200% in certain markets as we could observe on our Skytra Price Indices. He believes that as for every new instrument, it will take some time for everybody to get familiar with it but he is very confident the aviation industry will get there as it’s a tailormade tool
"Alternative products aren't easy, and we're familiar with derivatives markets and the work that goes in to getting that first trade over the line. But it's worth it, because it's really compelling when you think about the business of airlines and ticket prices," Howarth said. "Whether we're educating people on the customer side or the market development side or just attracting staff to come and join the business, when we explain what Skytra does everyone just says 'Yes, obviously, of course! Why wouldn't you want to do that?"