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1993 Report of the Auditor General of Canada

Assistant Auditor General: Shahid Minto
Responsible Auditor: Douglas Timmins

Main Points

22.1 The Aeronautics Act gives the Minister of Transport broad powers with respect to airports, but it does not require the Minister to own or operate airports. The Department of Transport does not operate most of the licensed airports in Canada, although it used to operate all the major airports. In 1992, the international airports in Vancouver, Calgary, Edmonton and Montreal (Dorval and Mirabel) were leased to Local Airport Authorities. Departmentally operated airports in other cities may be leased or sold in the near future. The Department continues to be responsible for aviation matters, such as air navigation and air traffic control, for all airports, including those leased to Local Airport Authorities.

22.2 The transfer of the airports shifts responsibility for airport operations and maintenance from the Department of Transport to Local Airport Authorities, relies on local involvement and accountability and fixes minimum capital expenditure amounts to be spent on these airports for the next 18 years.

22.3 We noted in our 1990 and 1992 Reports that there was a shortfall between capital needs and funding from traditional sources. The lease agreements increase capital expenditure commitments over historical levels for the next 15 years by $326 million. The expectation is that over the long term these capital commitments would be funded from increased revenues. However, revenues are significantly lower than the original forecasts that were used as a basis for negotiating the leases. Future revenue increases will have to be significant to achieve the optimistic forecasts and avoid a permanent shortfall between revenue and net cash that would have been generated under departmental operations. This shortfall results from the increase in capital expenditures for the transferred airports. There is also a risk of a permanent shortfall in lease revenue for future transfers if capital expenditure commitments exceed historical departmental budget levels.

22.4 The capital projects that are undertaken at the transferred airports are no longer subject to approval by the Department or Treasury Board or to scrutiny by Parliament. The Department also no longer has the flexibility to defer capital expenditures at these airports as it has done in the past.

Introduction

22.5 In October 1985, the Minister of Transport established a Task Force on Airports to examine alternatives to the existing federal airport system. The following September, the task force recommended the establishment of Local Airport Authorities (LAAs) that would have the support of their provincial and municipal governments. The broad objectives of the airport transfer initiative are to permit airports to better serve local community interests, to enhance regional economic development and to allow airports to operate in a more cost-efficient and commercial manner.

22.6 In 1992, international airports owned and operated by the Department of Transport in Vancouver, Calgary, Edmonton and Montreal (Dorval and Mirabel) were leased to Local Airport Authorities. Each Authority is a not-for-profit corporation headed by a board of directors, whose members are nominated by local municipalities and other representative local groups and cannot be elected politicians or civil servants. The LAAs are responsible for the management, operation and maintenance, as well as the capital projects, for the airports they lease, including runways, terminal buildings, industrial properties, parking, ground transportation, emergency response services, and financial, personnel and administrative functions.

22.7 The Department is now preparing to transfer airport operations in some other cities through long-term leases and is also in the process of selling a number of small airports. In our 1990 Report chapter on airports, we observed that the Department owned 135 of the country's 466 licensed/certified airports. The Department operated only 76 of those it owned and had various arrangements with other parties to operate the others on its behalf. While it is not unusual that other parties operate smaller airports, the airports transferred handle a substantial number of interprovincial and international travellers each year. Previously, major airports were operated only by the Department.

Background

22.8 The Aeronautics Act gives the Minister of Transport broad powers with respect to airports, but it does not include a statutory obligation requiring the Minister to continue to own, operate, maintain or finance airports. Based on a Cabinet decision, the Minister announced a new policy in 1987 that encouraged discussions on airport ownership or operation by other interested parties. Under the policy, the federal government would remain responsible for safety and security, including air navigation services, air traffic control, and airport certification. The policy contained eight guiding principles to be used as the basis for any transfer of airports to local groups. These principles included such items as no increase in federal long-term funding requirements, an equitable package for transferred employees, and federal retention of all taxes, such as the Air Transportation Tax.

22.9 In developing this new policy, several options were considered. These options included airports being:

  • owned or operated by private sector enterprises;
  • operated within a departmental structure with an enhanced commercial mandate and operating authority;
  • owned and operated by a parent Crown corporation with several wholly owned subsidiaries; and
  • owned, operated and financed by an autonomous local entity, a Local Airport Authority.
22.10 In 1988, the Minister established the Airport Transfer Advisory Board, headed by the Deputy Minister and composed of eight members from the private sector from across the country, to advise the Minister on airport transfer proposals. The Department also formed a task force that would support the Board and manage the daily analyses, negotiations and policy development related to airport transfers. Treasury Board approval was obtained in late 1989 to engage a consulting firm to provide financial advice on the initial four transfers.

22.11 In 1989, Cabinet approved 36 supplementary principles for airport transfers to provide more specific guidance than the original guiding principles. These supplementary principles included such items as the initiation of the transfers on the basis of a long-term lease with consideration of other options, the valuation of each airport at ``fair market value" with appropriate consideration of the airport's future earning potential, and the financing of operating and capital requirements by Local Airport Authorities without recourse to the federal government.

22.12 The four parties that were interested in the transfers, and that were supported by the affected municipalities and provincial governments, submitted proposals for the airports. Attached to the proposals were feasibility studies undertaken by the local groups with financial assistance from the Department and, in some cases, from other levels of government as well as other federal organizations. The Department analyzed the proposals, and when the local groups incorporated, negotiations commenced. In November 1990, Cabinet approved a financial formula for the lease of the Vancouver International Airport, which was also intended to serve as the basis for similar financial arrangements with the other LAAs, subject to adjustment for local conditions.

22.13 In March 1992, the Airport Transfer (Miscellaneous Matters) Act received royal assent. The Act required the Official Languages Act and the Canada Labour Code to apply to transferred airports and employees. The Act was later amended to exempt Local Airport Authorities from income tax on airport-related businesses and give them powers to seize aircraft for unpaid airport charges. It also deemed the rights and interests acquired by the Authorities under the transfer agreements as assets and therefore as qualified investments for banks, insurance companies and pension funds for debt instrument purposes.

22.14 Each Local Airport Authority has signed a transfer agreement and a lease. The transfer agreements outline the general transfer provisions and the leases specify the detailed operational and financial requirements. The agreements were approved by Governor in Council in 1992. Treasury Board instructed the Department to manage the transfers within its existing budget levels and to prepare a plan on how to reduce administrative overhead to reflect the transfers. The LAAs have been operating the airports since July 1992 at Vancouver and Calgary and since August 1992 at Montreal and Edmonton.

22.15 The Department of Transport has retained control over aviation matters such as air navigation and air traffic control. Local Airport Authorities are subject to inspections by the Department for the purpose of retaining their aerodrome certificates. For each of these airports, there are, along with the transfer agreement, ancillary agreements for air traffic control and air navigation services and facilities, Canadian Inspection Services and police and security. The Department pays for the cost of utilities and services provided by the LAAs for air navigation. The Royal Canadian Mounted Police continue to provide policing services to the airports at no cost to the LAAs. A Memorandum of Agreement on Employment outlines the responsibilities of the Authorities for employees transferred from the federal government. Although the leases do not require the Department, as the landlord, to pay for any direct operating costs, in some cases a negative lease payment (a payment to the LAA) can arise. The term of the leases is 60 years with a 20-year renewal option.

22.16 The Department has agreed to consider proposals from Local Airport Authorities regarding the purchase of the transferred airports after five years. The transfer agreements also require the LAAs to assume the operation of specific satellite airports within five years.

22.17 The Department has yet to agree with three Local Airport Authorities on how progress payments on the lease rent will be adjusted based on actual revenues and capital expenditures at the end of the year.

Audit Scope

22.18 This audit focussed on the financial aspects of the transfer process in relation to the transfer principles approved by Cabinet. Although the majority of our work was directed toward analysis of matters for the airports already transferred, we also looked at whether the Department had defined its role with regard to transferred airports and the effect of these transfers and possible future transfers on the operations of the Department. We did not review the transfer agreements, leases and associated legal documents for completeness or from a technical point of view. We also did not attempt to determine whether the documents were being complied with; nor did we, in any way, audit the Local Airport Authorities.

22.19 Financial information available for our analysis was for the first five or six months of operation under the LAAs. This information may not be indicative of financial results over the long term.

Observations and Recommendations

Results of Transfers to Date

22.20 We reported in our 1990 and 1992 Reports that the Department had not defined its role in regard to airports. We stated that it needed to develop criteria for providing federal funding to airports and to formulate a plan to rationalize federal asset holdings and financial involvement in airports. While this role has still not been formalized, the transfer initiative is clearly a step toward reducing the Department's operational control of airports. There are several areas where the impact of the transfer of airports is positive and others where the impact is not yet clear.

Financial arrangements provided for in the lease agreements
22.21 The guiding and supplementary principles endorsed by Cabinet and issued publicly provide only general indications of what the government envisioned in terms of rent from Local Airport Authorities. The Department took the approach that each Authority should provide the government with at least the same cash flow, on a net present-value basis, as the Department would have generated if it had continued to operate the airports. The Department engaged consultants to prepare financial forecasts for each of the airports that showed net cash flows to the Department under three possible traffic scenarios for continued departmental operations.

22.22 We found many similarities among the lease arrangements, such as insurance requirements, terms of the leases, costs to be paid by LAAs, default clauses and environmental provisions. While the financial format was generally the same, the specific rental clauses differ in several respects from those contained in the Vancouver lease, which was approved by Cabinet as the model for the other leases.

22.23 Vancouver International Airport was expected to be able to generate sufficient revenue on airside and general terminal operations (fees to airlines for use of runways, terminals, etc.) to recover its costs, and as a result, an annual minimum rent payment of $10 million is required in the lease. For the other Authorities, the net airside and general terminal rent revenue was not expected to be sufficient to cover airside and general terminal operating and capital costs for the early years of LAA operation of the airports. The resulting shortfall is deducted from the other rent revenues of the airport (concessions and property rentals). For one airport, this has resulted in negative rent payments, or payments from the Department to the Local Airport Authorities, at least in the short term. Another airport has produced a negative rent payment for at least the first year of the lease. The Department has indicated that these modifications to the rent formula were not considered to be significant and therefore did not warrant specific Cabinet approval of the subsequent leases.

22.24 For three of the leases, as requested by the LAAs concerned, deferred rent is permitted. Deferred rent allows the Authority to retain a portion of rent from any of the first five years of the lease to be payable, with compound interest, from the eleventh to the fifteenth years of the lease. Two LAAs have opted for deferred rent and the third has indicated that it intends to do so. The Department advised us that the deferred rent option, as approved by Cabinet, was provided to finance early operations of LAAs because financial institutions were unfamiliar with them. The Department also stated that it does not see a need to offer deferred rent in future transfers.

Leases were designed to protect the Crown's interests
22.25 While the Local Airport Authorities are responsible for the operation, maintenance and administration of the airport, the airports remain assets of the Crown. The leases protect this interest by prohibiting Authorities from pledging capital assets as collateral. Although the rights and interests in the lease can be pledged, the rent payable to the Department cannot be subordinated to other LAA debts. As a result, financing obtained by an Authority must stand on its own merits, and the government assumes no legal liability. LAA by-laws or provincial legislation require that upon dissolution of an Authority, after payment of all liabilities, its assets and property shall be distributed to the Government of Canada. Distribution of any assets or property of the LAA among the members is not permitted. With regard to land use, the LAA is to consult with local municipalities, and any changes to the approved land use plan for each airport must be approved by the Minister of Transport.

Local involvement and accountability are increased
22.26 In the past, many important decisions on an airport were made by politicians or bureaucrats often situated far from the airport and, as a result, somewhat insulated from local concerns. The members of each Local Airport Authority are, on the other hand, nominated by municipalities and other representative local groups and are intended to represent the interests of the regional community. The process for nominating members to the board of directors of a Local Airport Authority was approved by the Minister and the local governments, and changes to this process would require approval by the Minister. Each Authority must hold an annual public meeting to present its audited financial statements. The Department has the right to examine any and all LAA records and to cause an audit to be done, with the result being binding on both parties. Every five years, each LAA is obliged to have an independent review of its management, operational and financial performance conducted, which shall be made public upon request. The Department does not have a say in determining the scope and nature of this review.

22.27 Not only can a Local Airport Authority promote the use of its airport as a key part of the local economy, but virtually all decisions concerning a transferred airport are made locally. For example, the Authorities decide on service levels to be provided, on which capital projects should proceed and in what order, on rates for user fees, rents and concessions, and on marketing of the airports. They are also accountable for environmental matters relating to the operations for which they are responsible at transferred airports. In addition, because of their commitment to the community and their legal liability, they have the potential to be more proactive and responsive to environmental matters than the Department.

22.28 The Department stated that the Minister of Transport has responsibilities as the landlord and is still accountable to Parliament for air navigation services at these airports. However, the Minister is no longer responsible for airport operations. The Department must rely on the aerodrome certification procedures, the default provisions in the lease and its position as landlord to hold Local Airport Authorities accountable for airport operations. Nevertheless, under the terms of the lease, the Department does not hold the Authorities accountable for many aspects of airport operations. For example, there is no requirement for them to report information on levels of service provided, rates for user fees, environmental matters or, as discussed earlier, capital expenditures.

Most departmental employees were retained
22.29 There were 1,025 permanent positions at the transferred airports on 31 March 1991. A total of 881 employees were transferred from the Department to the Local Airport Authorities. Only 110 employees had to be placed in other jobs within the federal government. As a result, potential service disruptions resulting from large-scale staff changes at transferred airports were avoided. The agreements stipulate that for the first two years of operation of each Authority, all transferred positions must be kept. Subsequent to the transfer date, the LAAs and their employees are to bargain collectively for new agreements that will cover all aspects of wages and benefits, including pensions. We have been advised that reciprocal transfer agreements relating to pensions are expected to be completed in 1993.

User fees increased by Local Airport Authorities
22.30 In previous annual Reports, we reported that the Department was making little progress on cost recovery through fee increases. Generally, it takes six months for the Department to make any changes to its rate structure, and its user fees to airlines have not increased since 1989. We have been told that the Local Airport Authorities have all made some increase in their user fees during their first year of operation, and the Department gets a share of this increase. Vancouver International Airport has instituted an airport improvement fee that no departmentally operated airport charges. The Department will receive a portion of the revenues from this airport improvement fee. Consequently, transferred airports are now generating more revenues than they would if the Department were still operating them because the fees charged at airports that the Department operates have not been increased.

22.31 Local Airport Authorities also have the flexibility to change their rates to respond to market conditions without going through the government regulatory approval process. In this regard, there is no independent third party that reviews the rates charged by the LAAs. A share of revenue for the Department is assured in two of the leases, since they contain minimum airside and general terminal revenue amounts to protect the Crown from traffic declines and reductions in fees charged by the LAAs. However, users have put pressure on the Authorities to explain why they have raised fees while departmentally operated airports have not.

Some funding reductions have resulted
22.32 By transferring airports, some funding requirements have been reduced for the government. For example, no working capital - or at least a reduced amount - is required from the government at the transferred airports, since it is provided by the Local Airport Authorities. Also, the Authorities are required to secure appropriate insurance, whereas the government did not insure; the costs of any losses are no longer borne by the government. The government also sold chattels and inventories such as fuel supplies and mobile and office equipment to the LAAs at net book value, which will result in payments to the Department of about $22 million, although the amounts have not been finalized.

Future viability of Edmonton International Airport is at risk
22.33 Even before the transfer in August 1992, Edmonton International Airport was in competition with the Edmonton Municipal Airport, which is owned and operated by the City of Edmonton. In December 1991, the Edmonton Regional Airports Authority issued a discussion paper that identified options for airline service in Edmonton. Closure of either airport was not considered a feasible option and was not pursued. In March 1992, the Authority published a report concluding that consolidation of scheduled service must occur at the International Airport. In response to the report, it was proposed that the Municipal Airport be transferred to the Authority, with the eventual consolidation of scheduled service at the International Airport. In October 1992, this proposal was overturned in a plebiscite forced by a petition initiated by a local group. The result of the plebiscite led to the decision to continue scheduled service at the Municipal Airport for the next five years. We noted that in 1993, scheduled flights to Vancouver started from the Edmonton Municipal Airport, while scheduled flights at Edmonton International Airport were reduced. The Authority has stated that the future viability of the International Airport is at risk if the current trend continues.

Clarifications Needed for Future Transfers

Capital funding needs to be addressed
22.34 In our 1990 and 1992 Reports, we reported that the Department had determined that a large ``backlog" existed between capital expenditures that were required at airports and capital expenditures that were being made. What this meant was that previous capital funding levels at airports were inadequate to meet the demands of the airport infrastructure. The Department's capital budget and the portion allocated to airports have declined over the past few years. In 1988-89, $246 million was spent on capital expenditures for airports, while only $119 million was forecast for 1992-93.

22.35 The transfer of airports to Local Airport Authorities provides a new way of addressing the capital requirements. Each Authority has the ability to borrow from external sources for capital projects. This permits them to undertake capital projects that would not likely be carried out by the Department, particularly given current budget constraints.

22.36 The Vancouver International Airport Authority is building a third runway while maintaining its rent payment to the federal government. Had the airport not been transferred, the Department would have had to obtain additional funds either from the government or from external sources in order to carry out this capital project. The Authority is also planning to construct a new terminal building at an estimated cost of $250 million, which will be funded by external financing and the recently introduced airport improvement fee charged to travellers departing from the airport.

22.37 The leases specify a minimum amount that must be spent on capital expenditures by the LAAs. If the minimum amount in the lease is not spent over a specific period, the difference is payable to the Department as additional rent. The lease for the Vancouver Airport Authority in effect requires it to generate additional revenues to fund the increase in capital expenditures over amounts previously spent by the Department. For the other airports, the government is effectively funding the increase in capital expenditures up to the minimum specified in the lease through the offset of such expenditures against rent revenues. The Department states that the amounts specified for capital expenditures were based upon its assessment of what should be spent to maintain and rehabilitate the present infrastructure at the airports. This has resulted in a significant increase in commitments for future capital expenditures at some of the transferred airports. It could also result in the situation where an Authority is unable to generate sufficient revenues over the long term to offset the increased level of capital expenditures. If this were to occur, then lease revenues paid to the Department would not equal the net cash that would have been generated had the Department continued to operate the airport. The Department would then have to absorb the impact of any shortfall in lease revenue in its own budget or request additional funds from the government.

22.38 The capital projects to be undertaken at the airports are no longer subject to approval by the Department or Treasury Board or to scrutiny by Parliament, even though they will result in new assets or enhanced assets owned by the Crown. Decisions on the extent, nature and timing of specific capital expenditures are solely within the mandate of the Local Airport Authority. Further, the provision of minimum amounts for capital expenditures in the leases means that the Department no longer has the flexibility to defer capital expenditures at the transferred airports. It had this ability prior to transfer. The Department has stated that the commitment of minimum amounts for capital expenditures ensures an adequate level of capital for maintenance of the existing infrastructure. It has also stated that safety and security projects are not subject to a rate-of-return requirement. While not all capital expenditures can be deferred indefinitely, the Department may wish to have the ability to defer some if traffic does not meet expected levels or if funds are needed to meet departmental or other government priorities. The Department needs to explore other options, including whether some portion of the capital funding for future airport transfers could be linked to revenues to deal with cases where traffic is not increasing, and whether it could be linked to other capital funding criteria, such as a specific rate of return.

22.39 The Treasury Board submission approved in March 1992 for the four transfers estimated that the Crown would be better off by $4 million as a result of the transfers over the first 15 years of the leases. This included forecast shortfalls of $2 million in 1993-94 and surpluses of $5 million and $39 million for the next two years. The estimate was based on the assumption that the increase in capital expenditures over historical departmental levels would also be spent by the Department if it had continued to operate the airports and that overhead costs would be reduced. Later that year, the Department advised Treasury Board that the Department's budget had been adversely affected by the transfer to the extent of $44 million for 1993-94, and that $49 million and $52 million were forecast for the following two years. Much of the difference in the two sets of estimates results from the effect on the Department's budget of capital expenditures being increased and overhead costs not being reduced.

22.40 The Department indicated to Treasury Board in March 1992 that, under the transfer agreements, $326 million of capital in excess of currently approved and projected levels would be spent by the Local Airport Authorities over the next 15 years. In the short term, the Department would subsidize this shortfall from its parliamentary appropriations by changing priorities and delaying other departmental capital programs. In the long term, increased revenues to be generated by the Authorities would be expected to fund the increased capital commitments. We note that the originally forecasted revenues, used as the basis for the negotiation of the transfer, are not currently being achieved at three of the airports (see Exhibit 22.1 ). The Department has stated that forecasted traffic increases were not met due to unforeseen events, including the recession, the Gulf War and airline flight rationalization. In addition, the Department did not increase its fees as forecasted. However, the revenue forecasts were not revised as negotiations proceeded with the LAAs or when approval from Treasury Board was obtained.

22.41 Over the long term, future revenues will have to increase significantly to reach the original optimistic forecasts and avoid a permanent shortfall in lease revenue due to the increased commitment in capital expenditures at the airports. Further, the risk of such shortfalls in lease revenue will increase as the Department continues to transfer airports, if it commits to minimum capital expenditures in excess of current departmental budget levels.

22.42 To illustrate what has happened since the transfers occurred, we compared LAA 1992 rent payments (projected on a yearly basis) to the net cash from the airports under departmental operations for the 1990-91 fiscal year (see Exhibit 22.2 ). The combined effect of the first four transfers shows that net cash provided to the Department from airport operations has gone down by approximately $15 million. The increase in capital expenditures committed in the lease for Montreal International Airport of $13 million per year accounts for a substantial portion of the reduction in the net cash provided to the Department. The capital funding at this airport had averaged $14 million for the four years ending 31 March 1991. The lease, however, provides for funding of $27 million annually for the next 15 years. This increased capital funding was to be offset by increased revenues. Original departmental forecasts predicted total airport revenues of $142 million for Montreal International Airport in 1993-94, while current predictions are for total airport revenues of only $108 million.

22.43 The Exhibit also shows that capital expenditures for the four airports have increased by about $35 million. Of this amount, $22 million is the increase in capital expenditures that Vancouver International Airport will have to offset by generating additional revenues.

22.44 The principles endorsed by Cabinet and the financial formula used to arrive at the lease payments for Vancouver International Airport were approved with large airports in mind. The Department is now in the process of negotiating the transfer of a number of other airports of various sizes. These transfers may include both sales of airports to municipalities and transfers of operations with continued departmental funding. The Department has methodology approved by the Minister for the transfers of both small and medium-sized airports. Some of the small airports will have a more limited revenue potential than the large airports already transferred. As a result, capital requirements are less likely to be offset by increases in future revenues.

22.45 The Department should ensure that revenue forecasts used for future transfers are kept current throughout negotiations. The Department should consider whether funding of minimum capital expenditure amounts in future leases is appropriate, or whether capital funding should be linked to revenues and/or to other capital funding criteria.

Department's response: The Department plans to use the most current forecasts during negotiations. Linking capital funding to revenues and to other capital funding criteria was considered and rejected for a number of reasons not the least of which was that it would involve the Department in Local Airport Authority decision making and this is counter to the objectives of the transfer policy.

The Department must leave the Authority enough working capital to maintain its asset base. The amounts of capital expenditures in the leases are for basic maintenance and replacement and do not include a provision for expansion.

The Department will remain vigilant in determining the most appropriate method of funding, and will alter its approach if warranted.

Cost savings are not being realized
22.46 Prior to the transfer of the four airports, the Department recorded overhead costs, based on a percentage of direct operating and maintenance expenses, that amounted to $17.2 million for the year ended 31 March 1991 for these four airports. Subsequently, the Department indicated to Treasury Board that it would be able to avoid only about one third of these costs in 1992-93. The Department also stated that these costs could be further reduced by 10 percent annually to a maximum reduction of 70 percent. In its approval of the transfers, Treasury Board requested that the Department bring forward a plan as to how it would reduce its administrative overhead to reflect the transfers. In response, the Department reported that it could now identify only $2 million of overhead costs as avoidable. However, the Department has stated that Department-wide budget cuts have been made to offset, among other things, revenue shortfalls resulting from airport transfers.

22.47 We noted that during the transition period provided for each airport for the transfer of control to the Local Airport Authority, the Department encountered a number of problems, such as a loss of control over receivables, improper cutoff and breakdown of controls. An additional problem was that staff transferred to the LAAs had to now also respond to departmental concerns. The Department has commenced audits of the transition periods at three of the airports. Once the audits are completed, the recommendations may influence plans for future transfers.

Changes may be needed to facilitate land development
22.48 Because airports are key to the transportation infrastructure and economy of a community, one of the objectives of the transfer initiative is to enhance regional economic development. Local Airport Authorities claim that the attainment of this objective is impeded by the lease provisions relating to land development at airports. Departmentally operated airports are subject to many of the same restrictions on property development.

22.49 Three leases require that 85 percent of the fair market value of the land, valued at the transfer date, will go to the Department as land rent for developed land. Land rents paid by the LAAs to the Department are to be based on market values and updated every five years to ensure that the Crown receives current rental rates. This leaves the LAAs uncertain as to what their future costs will be. Furthermore, any structure built by a tenant on the leased property will vest to, or become property of, the Crown at the end of the lease term.

22.50 The Department indicates that common commercial leasing practices provide for regular rent increases and that the LAAs do not have to pass on these increases to their tenants based on the updates every five years. The Department needs to determine the extent to which it wants to increase land development at airports and whether changes to the present lease conditions would be required to facilitate such development.

22.51 The Department should review the lease provisions to determine whether changes are required to facilitate the development of airport lands.

Department's response: The Department has invited Local Airport Authorities to submit any proposed changes that would facilitate land development but that do not leave the government worse off.

Future leases could be simplified
22.52 The Department has described its role in transferred airports as a ``hands-off" or ``arm's-length" relationship. The Department has attempted to establish a balance between giving the Local Airport Authorities freedom to operate the airports and maintaining control of the airports as both landlord and regulator. Yet the leases and other legal documents are lengthy and complex. The rent articles in the leases are extensive and broken down into different categories and also have participation factors for increased revenues. A simpler approach would have been, for example, to use a percentage of gross revenue on a reduced number of rent categories.

22.53 The lease provisions should be reviewed to see if the leases for future transfers could be simplified.

Department's response: The lease provisions have already been reviewed in detail and a significant number of simplifications have already been identified for incorporation in the next group of leases. The priorities are the protection of the Crown's interests and the provision of flexibility to Local Airport Authorities so they can manage. While we endorse any means to make the leases simpler, we must ensure that the objectives of these complex leases are met.

A different approach is being taken for Pearson International Airport
22.54 We observed in our 1990 Report that Pearson International Airport not only was the nation's busiest airport, but also had many problems that the Department needed to address. The Department contracted with a private sector developer to construct and operate Terminal 3. It has reached an agreement with another company to renovate and operate the other two terminals at the airport in partnership with the operator of Terminal 3. In addition, it has issued a request for proposals for the construction of additional runways at the airport. As a final ingredient in this mix of external players, a Local Airport Authority has been established, but it has not yet been endorsed by the Minister of Transport.

22.55 We support the Department's initiative in seeking Local Airport Authority involvement in the management of airports, but it is not clear what the advantage is in proceeding with external financing for these large capital commitments before transferring the airport to a Local Airport Authority instead of proceeding with an approach similar to that taken for the Vancouver International Airport. If a significant portion of airport revenues is committed to these projects before the LAA is operating the airport, it may limit the ability of the Authority to generate revenue and funding for other capital projects.

22.56 In addition, the Department will have to resolve the issue of what level of capital expenditure is to be provided for in any lease with a Local Airport Authority and how any private sector involvement will be co-ordinated and factored into the lease. Once these issues are clarified, it will be possible to determine the rent payments that the Department could receive or the funding that it could be required to provide.

Department's response: Given passenger forecasts, proceeding with the runways and terminals maintains a good level of service to the public and avoids lengthy delays and serious congestion while the terms and conditions are negotiated over the coming years and an LAA is eventually put in place. The funding of these projects will not limit the LAA's ability to fund other capital projects.