Heathrow rages at not getting its way on raising landing charges Heathrow airport and its shareholders are licking their wounds after failing to persuade the aviation regulator to permit an inflation-busting rise in the fees paid by airlines for using Europe's busiest hub. Heathrow is warning that the consequence of the Civil Aviation Authority's "final proposals" for a real-terms freeze in airlines" landing charges could be that its shareholders are no longer willing to invest in a multibillion pound third runway - should the company get the go-ahead to build it. But have Heathrow and its shareholders - who include Chinese, Qatari and Singaporean sovereign wealth funds - really been short-changed by the CAA? The CAA infuriated Heathrow Airport Holdings by this month proposing the charges paid by airlines for using the hub's facilities should rise only in line with inflation over the next five years - in stark contrast to the substantial real-terms rises approved by the regulator during the past decade. Since 2003 Heathrow has invested £11bn in improving its once dilapidated facilities - notably by building two terminals - and the airport complains it did not secure the profit it was supposed to under the regulatory regime over the past five years because of a shortfall in passengers during the downturn. "There is no trust left with the regulator," says one Heathrow shareholder, who declines to be named. We think the regulatory system is broken and it's not going to be good for attracting capital to doing new things at Heathrow - third runway or not. Heathrow strongly objects to the CAA proposal that the company's weighted average cost of capital - a proxy for its return on invested capital and a significant element of the regulatory formula for setting the landing charges - should be cut from the existing 6.2 per cent to 5.6 per cent over the next five years because of record low interest rates and reductions in corporation tax. "The shareholders of Heathrow regard this as an expropriation of our investment capital," says the Heathrow shareholder. It is not hard to see why emotions are running high. The consortium led by Spain's Ferrovial that in 2006 bought Heathrow, then called BAA, paid a large premium - only for the UK competition authorities to subsequently order the airport group's break-up. Colin Matthews, the airport's normally diplomatic chief executive, who used to run Severn Trent, the water company, says the rate of return is "no longer an incentive to investment." He fears this could affect sovereign wealth funds" appetite to invest in UK infrastructure: "That's . . . the big issue here. We have among our shareholders the Qataris and the Chinese; there are other global investors who'll be watching this. Mr Matthews says Heathrow will consider the case for mounting an appeal once the CAA reaches a final decision on its proposals in January. The CAA also angered the airlines, led by British Airways, that use Heathrow, because they had been seeking a deep real-terms cut in the charges they pay for landing at the airport. Willie Walsh, chief executive of International Airlines Group, BA's parent, says the airline's customers have been "let down by the CAA." Heathrow, which announces third-quarter results on Monday, has some of the highest landing charges in the world, and this levy is passed on to passengers in the form of higher ticket prices. The CAA stresses it is consulting on its proposals, but describes them as "good news" for passengers because they "create a positive climate for further capital investment where it is in the passenger interest." Iain Osborne, CAA director of regulatory policy, insists the regulator is allowing Heathrow a "fair market return for an asset of the risk profile of Heathrow." Heathrow is a relatively low-risk asset - it secures a steady stream of cash from the airlines that are keen to fly there because of the large numbers of lucrative business passengers who use it. But Heathrow says the CAA has underestimated the risk it is contending with. For example, while the airport loses travellers in a downturn, it cannot significantly increase the number of passengers coming through Heathrow in a boom because of its capacity constraints. Heathrow took particular exception to the regulator comparing its business profile to that of the National Grid, the monopoly provider of electricity transmission in England and Wales. The CAA has given a little ground to Heathrow by, in its final proposals, increasing its weighted average cost of capital from 5.35 per cent to 5.6 per cent for the next five years. But it has also highlighted how Heathrow's cost of capital has been set at a level higher than National Grid and some other regulated companies. Dieter Helm, an economist specialising in infrastructure, says the CAA's cost of capital calculation for Heathrow is "broadly correct." Heathrow's claim that the regulatory settlement could hurt broader efforts by the government to secure foreign investment in British infrastructure may sound like hyperbole. After all, ministers were able this month to welcome Beijing Construction Engineering Group's participation in an £800m industrial park development next to Manchester airport. But some experts are warning that efforts by regulators to keep a tight rein on the utility bills paid by consumers - in sectors such as telecoms and water - could hurt the government's drive to persuade overseas investors to finance improvements to UK infrastructure. Richard Threlfall, an infrastructure specialist at KPMG, says: "The UK's regulatory regimes currently have a strong focus on keeping down utility bills to customers - or, in this case, landing charges to airlines - and this approach could put at risk much-needed investment in UK infrastructure, including a third runway at Heathrow or another solution to the UK's southeast airport capacity need." Shareholders seek greater certainty over investment Heathrow and its shareholders are pushing for new funding arrangements to pay for a third runway. Heathrow Airport Holdings is furious that the Civil Aviation Authority's last three regulatory reviews have cut the airport's weighted average cost of capital, because this figure is a proxy for the company's return on invested capital. From 7.75 per cent in 2003, the figure was cut to 6.2 per cent in 2008, and the CAA is proposing a further cut to 5.6 per cent in 2014. In the event of the west London hub obtaining permission for a third runway, and to ensure it secures an acceptable return on this infrastructure, the company wants to explore the case for its cost of capital to be fixed for a much longer period than five years. This would offer Heathrow's shareholders greater certainty over any investment in a third runway. While Heathrow may be aggrieved at the CAA's proposed cost of capital cuts, it does have opportunities to boost its profit by exceeding targets set by the regulator - for example on cutting operating costs. The CAA notes that staff remuneration is higher than elsewhere in the aviation industry. Heathrow accepts it must become more efficient, but - after showing at last year's London Olympics that it can cope with a big logistical challenge, in contrast to the botched opening of Terminal 5 in 2008 - the airport is alive to the threat this could pose to its improved customer service.