UNIDROIT Draft Space Assets Protocol
UNIDROIT is an international organisation comprising 63 Member States, based in Rome. Its remit is to “study needs and methods for modernising, harmonising and coordinating private and, in particular, commercial law as between States and groups of States and to formulate uniform law instruments, principles and rules to achieve those objectives”.
Member States of The International Institute for Private Law (UNIDROIT) will participate in a Diplomatic Conference in Berlin on 27 February to 9 March 2012, to finalise and to vote on the Space Assets Protocol to the Cape Town Convention on International Interests in Mobile Equipment. If the final version of the Protocol is adopted, it will become effective once five Member States have ratified it and thus become law in those Member States who do ratify it.
The Cape Town Convention on International Interests in Mobile Equipment, which opened to signature in Cape Town on 16 November 2001, provides a generic legal framework for registration of ownership and security interests and legal remedies for default. There are three specific sector Protocols:
- Aircraft equipment.
- Railway rolling stock.
- Space assets.
- How such experts would be selected.
- The cost of data assessment/scrutiny process and who pays.
- Problems of confidentiality with respect to disclosure of potentially commercially sensitive proprietary rights and the need to comply with externally imposed restrictions such as those of the US International Traffic in Arms Regulations (ITAR ).
- Potential delays to a project as a consequence of having to follow the registration process.
The Protocol on Aircraft Equipment came into effect in 2006 and has now been ratified by 44 States. The Luxembourg Protocol, relating to Railway stock has been adopted but has not yet come into effect.
Work on the proposed Space Assets Protocol started over ten years ago. UNIDROIT states that “the draft Space Assets Protocol... represents the coordinated efforts of both Governments and the commercial space sector to render asset based financing more accessible to an industry that is presently searching for innovative ways to obtain start-up capital for space-based services. Such ventures are full of risk and uncertainty and, consequently, their financing is currently still prohibitively expensive. By introducing a uniform regime to govern the creation, perfection and enforcement of international interests in space assets, notably satellites, it is envisaged that the cost of financing will be reduced as a result of the increased level of transparency and predictability for financiers, thereby making financing more widely available to a greater number of players in the commercial space sector. Such an instrument will, in particular, help bring much needed financial resources to the new space community, namely those small start-up companies that have emerged as a result of the booming commercial space sector.”
The Protocol will create an international registry to record and determine priority (according to when registered) among creditor rights in space assets. It would include transponder leases, conditional sales agreements and security interests.
The above are worthy objectives seemingly being jointly pursued by UNIDROIT and the space community, which one would suppose should greatly benefit as a result of this initiative. The reality is that, for the most part, the space community has had limited involvement in the drafting of the Space Protocol and has only really become active in voicing its opinions regarding the Protocol in the last three to four years. Furthermore, many parties in different disciplines in the space sector have become seriously alarmed about the implications of the Space Protocol, believing not only that it is unnecessary but also that rather than facilitating the process of obtaining satellite financing and reducing its cost, it will make the process more difficult and costly.
This briefing identifies some differences between the space sector and the aviation sector which are relevant to consideration of the benefits or otherwise of Protocols with regard to those sectors and it also identifies some of the key issues which have been identified by detractors as reasons not to adopt the draft Space Protocol.
Finally, there are references to some international initiatives to voice to UNIDROIT strong concerns regarding the Space Protocol and its possible impact and a brief summary about some events in the UK organised to provide a forum for review of the Space Protocol and some further separate written inputs to express concerns.
Differences between the space sector and the aviation sector
Whilst the relative success of the Aircraft Protocol is sometimes cited as a justification for the proposed Space Protocol, there are major differences between the two sectors which have a bearing on the relevance and benefits of the respective UNIDROIT Protocols. These include the following:
Aircraft are of a relatively uniform class whereas satellites are designed for specific applications/missions.
Aircraft are clearly very mobile, many of them frequently moving across international borders and legal jurisdictions and they are readily physically recoverable. Satellites are not mobile in the same way and the State where the satellite is registered retains jurisdiction and control over space assets. Furthermore, satellites in orbit are not physically recoverable.
Possession and control
Aircraft can have a very long operational lifetime lasting a number of decades, useful active life being extendable with replacement equipment and upgrades. They are often sold on and many will have a number of different owners and operators over time. Controls usually relate to safety aspects.
Satellites generally have a much shorter active lifetime and the satellite operator to which licences are granted and which registers the spacecraft with its national government authority, usually remains the sole owner throughout operations and disposal. The controls relate to regulatory aspects, particularly to operation in-orbit and rights and obligations arising from registration and orbit spectrum. These rights are not readily assignable. There is therefore effectively no secondary market for a satellite as such, also due to their design for specific applications and the specialised expertise required to operate them.
Aircraft financing is primarily asset- based whereas satellite financing is usually project-based relying on revenues flowing from use of the assets. Asset-based financing depends on there being a relatively long useful life-time for the asset, that the asset is properly maintained so that residual value is optimised and, last but not least, that it can be easily and swiftly repossessed should things go wrong. None of this is usually applicable to satellites.
The airline industry operates within a tightly regulated, customer- focused and low profit margin environment, which makes its collective financial performance over the years notoriously poor. There are numerous examples, most recently with American Airlines, of operators becoming insolvent. This increases the inherent credit risk in, and the cost of, aircraft financing transactions. By contrast, with a few exceptions, commercial satellite operators have tended to enjoy excellent financial results and a high level of profitability. This is clearly a factor for satellite operators in being able to obtain finance based on the financial potential of the project (which effectively determines the value of the asset) rather than the residual value of the asset in an active market, which is the situation for commercial aircraft.
Number of units
The number of registered commercial aircraft is of the order of 60,000 and at least twice as many engines. The number of commercial satellites can be reckoned in a few hundreds. This has implications with respect to the need for the Space Protocol and its practical implementation.
Space-faring Member States of UNIDROIT
It can be assumed that nearly all 63 Member States of UNIDROIT have an interest in aircraft assets. However, not all of them will have a direct involvement or interest in space assets. Those who do not will not have any impact in the implementation of a Space Protocol but would have an equal vote regarding adoption of the Protocol and in ratification of the Protocol.
Issues raised by those opposing the Space protocol
Most of the concerns expressed have remained fairly constant over the last three or four years and critics of the Protocol have claimed that UNIDROIT has failed properly to address these concerns.
The main issues raising objections, as stated by detractors, are the following:
The Protocol is not needed. The draft is inconsistent with current market practices of commercial satellite financing and incorporates features that will deter potential financial backing. The present system works well and no credible commercial programme with a sound business case, the required regulatory assets and adequate management capabilities has failed to secure financing. There are no new benefits for potential financiers to support financing of start-up or emergent satellite operators in developing countries or otherwise. Some parties have called for a benefit analysis objectively to consider the value of the proposed Protocol and to determine whether it would meet the objectives set for it by UNIDROIT itself.
Satellites in orbit cannot be considered to be mobile assets in the same way as aircraft or railway rolling stock, in that they do not move from one legal jurisdiction to another. Rather, as provided in Article 8 of the Outer Space Treaty, a State party to the Treaty and on whose registry a space object is registered retains jurisdiction and control over that object. There are adequate existing safeguards to protect creditors. The Protocol would set up a supra-national legal regime that would overlap with existing national laws and safeguards and could conflict with them. This is likely to create uncertainty and necessitate additional legal analysis.
As a consequence of the nature of satellite programmes, for the most part financing is project-based rather than asset-based and there tends to be a heavy reliance on the revenue stream from use of the assets as set out in the business plan, backed by loan guarantees and by taking insurance in respect of potential technical problems which might impact on revenues.
The Protocol would introduce unnecessary complexity and other features that would be an additional burden on industry, would deter prospective financiers and would generally increase costs rather than reduce them. The Protocol has been drafted by respected lawyers but they do not have experience of satellite financing and furthermore, they have not sufficiently taken stock of the views of stakeholders within the industry during the drafting process. It follows that there could in fact be a disincentive for new satellite operators to establish themselves in a State that has ratified the Space Protocol.
There is uncertainty about how the Space Protocol arrangements would apply in the (likely) circumstances of less than universal ratification of the instrument or, at least, limited ratification. Specific issues
The application of the Space Protocol and the definition of a “space asset” for registration purposes
In Article 1 of the Protocol the term “space asset” is defined as “any man-made uniquely identifiable asset in space or designed to be launched into space, and comprising:
A spacecraft such as a satellite, space station, space module, space capsule, space vehicle or reusable launch vehicle.
A payload (whether telecommunications, navigation, observation, scientific or otherwise).
- A part of a spacecraft or payload such as a transponder… together with all installed, incorporated or attached accessories, parts and equipment and all data, manuals and records relating thereto.”
The asset, to be recorded is therefore the physical asset but at what level and how do you address the question of hosted payloads and payloads with multiple users/clients from different countries whose rights are provided under contract?
Debtor’s rights and assignment of debtor’s rights
It seems that whilst the term “space asset” refers to the physical asset, the assignment of the foreseen revenue from use of the asset could be registered as a creditor’s right, but not other rights granted specifically to the operator by the ITU with respect to spectrum or licences granted by national authorities. These rights cannot be readily assigned and are therefore effectively not transferrable. This is significant as in practice, the right of use is the most important asset.
Public service exemption from default remedies
This is a new concept introduced by the Space Protocol in that it incorporates a “public service” restriction on the enforcement of creditor remedies to the detriment of lenders compared to the present situation, even when only a portion of a space asset may be considered to be providing a public service. There are a number of problems with this concept. One is the lack of a clear definition as to what can be deemed to be a qualifying “public service” and this uncertainty is compounded by the fact that satellite services can be provided on an international basis to different States and those States may have different interpretations of “public service” which could be in conflict. This uncertainty, together with the restriction of creditors exercising their default remedies for a period of six months from the registration of a creditor’s notice or otherwise, could discourage potential lenders.
Insurers salvage interest
Insurance is an important element of satellite financing and is often the third largest cost factor in commercial satellite programmes. Insurers have been seeking protection for their rights granted under launch and in-orbit insurance policies regarding possible salvage of satellites and initially requested that the Space Protocol should also permit registration of insurer’s salvage interests and make creditor’s remedies subject to insurer’s salvage interests. (As insurance policies are often agreed shortly before launch, if priority is determined solely on the basis of the time of registration of an interest, insurer’s salvage rights would automatically rank behind the interests of creditors who have registered their interest earlier).
Satellite operators are concerned that the inclusion of insurer’s salvage rights would create priority issues which would be prejudicial to creditors and would be inconsistent with market practice. It is now understood the final version of the Protocol may exclude provisions relating to salvage rights. If insurers feel that their salvage rights are prejudiced by implementation of the Protocol the likely outcome is that the threshold for a loss to amount to a CTL would be increased to a level of say, 90% and/or insurance premiums would be increased.
Practical aspects of the international registry and the identification of satellites and major elements of them
There are difficulties envisaged with regard to the registration of assets. In Article XXVIII it is stated that the Supervisory Authority “… may establish a commission of experts... and entrust it with the task of assisting the Supervisory Authority in the discharge of its function”. It may be supposed that such experts would be drawn from the space industry. Industry concerns with this approach are:
Initiatives to review the draft Protocol and to comment on it
It is not easy to identify space sector participants who actively support the Protocol in its present form, but a minority seem to have remained cautious and mainly silent about it. Furthermore, it is noted that little mention has been made of Export Credit Guarantee Agencies who often play an important role in satellite financing and whose view of the importance of the Space Protocol could be subject to government influence.
Certainly, critics and opponents of the Protocol have been active and vocal in stating their objections and this has resulted in initiatives demonstrating an unprecedented show of solidarity across the global space community.
A prime example of this is a petition dated 9 December 2011, signed by more than 90 leading players in commercial satellite programmes (including satellite operators (45), spacecraft manufacturers and launch services providers (17), insurance (11) and finance companies (11) that provide services to those in the satellite industry, and satellite and space related associations (8)), urging UNIDROIT and its Member States to reconsider the adoption of the draft Space Protocol.
Opposition to the draft Space Protocol has been led by the European Satellite Operator’s Association (ESOA) and The US Satellite Industry Association (SIA) who have both, during the last three years, repeatedly expressed their general and specific concerns about it in letters and petitions to UNIDROIT.
In the UK, the Finance and Procurement Working Group of the Space Innovation and Growth Strategy (IGS), which issued its final report in March 2010, addressed this subject and stated the concerns of the UK space sector. In September 2011, a letter was sent to the Minister of State for Universities and Science by Atrium Space Insurance Consortium representing 10 Lloyd’s Syndicates, stating its serious concerns regarding the Protocol and the negative implications for the space insurance community. It expressed regret that UNIDROIT did not undertake a sufficient stakeholder analysis during the earlier stages of the project and proposed that if the project is to continue there should first be an economic impact study carried out to establish whether the Space Assets Protocol would benefit or burden the space community. It is claimed that the positions expressed in the letter are also supported by approximately 80% of the London space insurance market, based on underwriting capacity. The response from the Minister acknowledged the concerns expressed and stated that a UK request in 2009 that UNIDROIT commission a report on the economic impact that the Protocol would have, before proceeding with its further development, was not supported by other Member States.
Also in the UK, there have been two Workshops on the draft Protocol hosted by The London Institute of Space Policy and Law (LISPL) on 25 February 2011, and 9 December 2011. At the February Workshop presentations were made by Professor Roy Goode, on behalf of UNIDROIT and by ESOA, the Satellite operator, Avanti Communications, ING Bank and Atrium Space Insurers Consortium. Also, the LISPL Director presented a legal analysis. The general consensus was that there are serious concerns about many issues addressed in the Protocol and even the need for the Protocol was called into question. At the second workshop on 9 December, chaired by Prof. Crowther of the UK Space
Agency, Prof. Goode again played an active role in explaining the UNIDROIT approach with regard to issues raised. HFW gave a presentation on the Aircraft Equipment Protocol which served to highlight some significant differences between the aviation and space industries as to the need or otherwise for an international regime for the registration of title and security interests.
There was a lively discussion of all issues led by the operators present. It was clear from those participants who spoke that the concerns with the Protocol remain and it is difficult to envisage that acceptable compromises can be reached. Nevertheless, Prof. Goode invited all to address identified problem areas by submitting proposed revised text for consideration.
With 44 States having ratified it, the UNIDROIT Protocol relating to Aircraft Equipment can be deemed to be a success, but the circumstances and issues relating to the financing of commercial space projects are fundamentally different to those of the aviation sector and the need for a Space Protocol is disputed by many.
With the drafting of the Space Protocol having started more than ten years ago and with the Diplomatic Conference to be held in Berlin in February/March 2012, one would have expected a much greater consensus regarding the need for the Protocol and on the detailed text. There will be an opportunity to review and modify the text during the Conference but unless significant changes are introduced radically to limit the scope of its application, it is difficult to imagine that the concerns of the space community, which the Protocol is said to be designed to support will be allayed. With that community, both lenders and borrowers, in accord in their opposition to the Protocol, it seems somewhat inappropriate to be pressing ahead with it at this juncture.
In these circumstances, the UK’s proposal that UNIDROIT should have an impact/benefits study carried out before proceeding further with the draft Protocol, which proposal was not supported by other Member States in 2009, would seem to be a logical step given the present lack of accord.
If the Protocol is not adopted it might seem to be a major set-back for UNIDROIT having put in so much time and effort on it. Equally, its adoption by Member States would seem to represent a hollow success when the space industry generally has strong concerns that, rather than achieve the stated objective of facilitating the obtaining of commercial satellite financing and reducing the cost of doing so, the Protocol would have the opposite effect of making the process more difficult and more costly.
If the Protocol is adopted and comes into force, assisted by a low threshold number of States who need to ratify it, there may be problems arising from the fact that creditors in States who have ratified the Protocol will be obliged to take actions with regard to registrations required under the Protocol in order to protect their interests in case other creditors register their interests. Creditors in Member States which have not ratified the Protocol will not be obliged to do so. This would raise questions about level playing fields which is also an important consideration in its own right. As always, if the application of a Protocol is not virtually universal its significance and value will be further diminished.
Usually Governments will seek to support their industry in those matters where they have some influence and where they consider it to be legitimate to do so. It is not known how different States will respond to this situation, in particular the non space-faring Member States, but it is clear that the UK Space Agency and Government are well informed on this subject and are sympathetic to the views of the UK space community. Will other governments be prepared to disregard the opposition of their industry and ratify the Protocol thus creating a potentially chaotic situation? Also, in practice, in spite of their reservations, will participants in the financing process in States which have not ratified the Protocol nevertheless feel obliged to register their interests to protect their position, and could there be some surprises such as new declarations by key players such as the ECGAs?
At this late stage in the process there are still many unknowns and no one can predict the outcome of the forthcoming Diplomatic Conference with any degree of certainty.
For more information, please contact Nick Hughes, Partner, on +44 (0)20 7264 8555 or firstname.lastname@example.org, or your usual HFW contact.