Japan, though, has begun to question its own liberality.

It seems that the cheap and popular financing option known as the ``Japanese operating lease,'' or JOL, while perhaps not doomed to extinction, is destined to lose much of its appeal.

China's fast-growing airlines have made scant use of JOLs to date, but this is definitely no time for them to be losing a financing alternative. In the next 20 years, China will require 90 to 115 new aircraft per year, according to the estimates of Boeing and Airbus.

At current prices, the total cost of these fleet additions could be anywhere from US$183 billion to US$230 billion.

China's state-owned banks once gave the airlines soft loans or guaranteed their cross-border loans, no questions asked, on national development grounds.

But for reasons of their own, the banks now chafe at this tradition.

Left to the mercy of foreign lenders not fully convinced of their creditworthiness, mainland carriers could soon find themselves having to pay much more to borrow.

Until now, the JOL has looked like the proverbial win-win solution for everyone except the tax collector.

"The JOL is one of the favorite financing tools of airlines, banks and Japanese equity investors,'' said Paul Ng, head of the China desk in the transportation and asset finance section of law firm Freshfields Bruckhaus Deringer. For airlines, it has typically meant the equivalent of a 3 to 5 percent reduction in financing costs over the life of the lease, normally 10 years. On an annual basis, the reduction is around 0.4 to 0.6 percent. Another benefit is 100 percent financing, as opposed to the 80-85 percent that banks are normally prepared to lend.

In a basic JOL, the aircraft is bought and leased to the airline by a company or partnership established by Japanese investors using a mix of debt and equity.

The investors usually kick in 20 to 30 percent of the purchase price in the form of equity, yet are able to claim a depreciation benefit based on the full purchase price to help offset their other tax liabilities.

At the end of the lease, they may also enjoy a profit on the resale of the plane.

Debt funding is provided by a bank or syndicate of banks, lending out of Tokyo branches in order to avoid Japanese withholding tax.

``These benefits are, to some extent, shared with the airline in the form of cheaper rentals,'' said Ng. But the JOL, one of the last of the major cross-border tax leasing loopholes, may be on its way out. New Japanese legislation that came into force on April 1 could radically reduce the tax benefits for Japanese investors. ``JOL economics are under threat,'' said Ng.

Most national tax administrations have tended to close down such structures if they feel their main attraction for investors is tax avoidance. Though a number of countries still support some form of domestic tax leasing, Japan, practically speaking, is the last to support cross-border tax leasing.

The new law says the depreciation that an investor can claim should be calculated on the basis of the equity investment, not on the full aircraft purchase price.

And it says the depreciation benefit should be denied when the lessor makes a profit on an aircraft resale where it runs no risk of loss - because, for example, it had obtained a residual value guarantee or purchased residual value insurance. However, the full impact of the law will remain unclear until a circular is issued by the tax authorities, possibly this month. JOLs will probably still be viable in some form, but their benefits will certainly be reduced, and business volume will be less.

``Airlines, arrangers and investors continue to hope for the best - that the implementation of the reforms won't be as draconian as they feared,'' said Ng.

  

Said Bob Grondine, a Tokyo-based partner at law firm White & Case: ``No one quite knows when [the circular] will come through. It may be as soon as next month, but it's more likely not to be until the end of the year - early next year even, according to some people.

``Many new issues of interpretation are still up in the air and the market is awaiting confirmation while the Japan Leasing Association discusses these issues with Japan's National Tax Administration Agency.''

In the meantime, the JOL market is on hold.

Southeast Asian airlines are the most likely to be affected. Those that have strongly tapped into the JOL market include Singapore International and Malaysian Airlines, which both used them to buy Boeing 777s last year.

Air Hong Kong arranged its first JOL recently, but Cathay Pacific has not done one as yet. An analyst said: ``In Hong Kong, reduced access would probably not have a major impact, though airlines such as Cathay Pacific would no doubt prefer that the product remain available.''

China Southern did a JOL earlier this year, the first for a mainland airline.

Carriers in the mainland have never been major users of international leases because they have long received favorable treatment from their home banks, but they will probably not be able to count on special favors much longer.

For years, Chinese banks were happy to lend to the airlines at rates far below those of the international commercial banks, or to provide guarantees to back international financing, most of it offered cheaply by US and European government export credit agencies to encourage sales of Boeing and Airbus aircraft.

Now, though, as Chinese banks take on foreign partners and aspire to stock market listings abroad, their managers are loath to lend for less than their rivals and tie up capital in guarantees that earn relatively small fees.

Without guarantees, the export credit agencies are reluctant to finance Chinese airlines, which, while they may enjoy triple-A credit ratings at home, are held in suspicion abroad.

As of last June, China Southern, China Eastern and Air China, the big three carriers, had net debt-to-equity ratios of 1.58, 3.2 and 3.96 respectively. Compare that with the 0.34 of Cathay Pacific, which is considered one of the world's best managed airlines.

Export credit agencies are also concerned about the legal problems of enforcing loan security on the mainland, where bankcruptcy law is feeble. ``Some Chinese airlines have considered using JOLs, but the recent change [in Japanese law] is a deterrent at this point,'' said Hallam Chow, a partner in White & Case's Hong Kong office.

China Southern is reported to be financing six new Airbuses, worth US$430 million, using European export credit finance via a French leasing structure.

Alvin Leong, a lawyer at Milbank Tweed Hadley & McCloy, said the demise of the JOL may have an impact on mainland airlines in the medium term as aircraft deliveries to China ramp up. ``My view is that it will drive the Chinese airlines to look toward more structured products, including the capital markets, for financing solutions,'' he said.

Even before Japan passed its new law, however, JOLs were not considered suited to all aircraft transactions.

The giant new Airbus A380, for example, which is counting on sales in China to be successful, would not be easy to finance this way - both because of the difficulty of calculating its resale value in the early stage of its life cycle, and because of the huge amount of equity that would have to be syndicated to buy even a single aircraft.

Said White & Case's Grondine: ``It's hard to imagine an A380 getting done with a JOL into the structure in large part because of the size and the absence of any established secondary market. There's no way that those A380s are going to get financed without some final substantial residual value support guarantees out of Airbus for both the debt and the equity. Those should come out probably in some kind of export credit agency financing into a finance lease structure.''

Several analysts said China should sign up to the Cape Town Convention, which is designed to make financing easier by protecting ownership and security interests of aircraft and engines under a global registry system, with worldwide mutual recognition of aircraft mortgages.

If China signed up, said Grondine, ``to seize a Chinese-registered aircraft and enforce a mortgage would become much easier on a broader basis outside China as well as within China, and therefore in theory, anyway, the lenders would be willing to take a little bit more risk ... having comfort that they could always seize the asset to enforce their mortgages.'' Having China's signature on the Cape Town Convention ``doesn't necessarily overcome the whole bank guarantee issue under discussion, but it would certainly be helpful,'' he said.

A spokeswoman for the Export-Import Bank of the United States, which funds many purchases of Boeing jets, said it wants international airlines to encourage their governments to accept the convention, which will be in force internationally once eight countries have ratified and implemented it.

``This treaty and the aircraft protocol will facilitate cross-border financings of large commercial aircraft, aircraft engines and helicopters,'' she said. ``Ex-Im Bank offers a one-third reduction of its exposure fee - the fee charged for the bank's transaction risk - for transactions with airlines in countries that have implemented the treaty.''

Four airlines in Ethiopia, Pakistan, Nigeria and Oman have benefited from Ex-Im Bank's fee-reduction offer to date. Grondine said that whatever the problems faced by China in financing aircraft purchases, there will always be ways to overcome them.

``China is still the country where they are buying the most aircraft in the world, and that's driven by the need for the aircraft, not the financing. When you need them and people are comfortable that they are going to be properly utilized, the financing will be there - it's just a question of price - and the airlines are going to buy them.

``Everybody has this amazing optimism about China these days. And when you look at China geographically, aircraft are probably the best alternative.

``It's a very resilient industry. On the finance side, tax leasing structures have come and gone and everybody still survives,'' he said.