With the development of the global ship finance industry in recent years, leasing models from the Asia-Pacificregion, notably China and Japan, are increasingly competing with those traditionally offered by European and American bank financing. This provides new opportunities for shipowners and financiers who may not previously have dealt with such models.
THE DECLINE OF TRADITIONAL SHIP FINANCING
Ship financing has traditionally been provided by banks, with those in Europe and the US the most active in providing shipowners with credit facilities. After the financial crisis of 2008, they reduced their exposure to the shipping sector due to the strict regulations imposed by Basel III, increasing capital costs and low returns. US private equity firms then saw an opportunity to invest in the market but have since reduced their engagement. Although leasing structures have existed for decades, Asian lessors in particular have taken advantage of these market changes to fill the gap with leasing solutions tailored to the needs of modern shipping companies.
THE EMERGE AND RISE OF APAC LEASING MODELS
Leasing models provide an effective, efficient and convenient way of getting funding. Chinese and Japanese financial institutions are leveraging their strong capital bases and strategic initiatives to expand their influence globally by offering higher loan-to-value ratios and longer amortisation periods than traditional banks. Both Chinese leasing and Japanese operating leases with call option structures (“JOLCOs”) provide tax benefits that contribute to the reduction of the overall cost of financing. The IMO’s Green House Gas strategy, and decarbonisation efforts more generally, are also driving the leasing business. As leasing is often linked to newbuilding projects, environmentally friendly vessels are increasingly being financed through leasing structures.
“A typical Chinese sale and lease back is a financial arrangement where a shipping company sells a vessel to a financial institution and then leases it back for operational use.”
CHINESE LEASING
A typical Chinese sale and lease back is a financial arrangement where a shipping company sells a vessel to a financial institution and then leases it back for operational use.
Key components:
vessel ownership: the leasing company takes legal ownership of the vessel;
lease terms: relative flexible lease terms of 5-15 years depending on the type of ship and market trends; and
strategic alignment: some Chinese leasing companies are state-owned with financing plans are in line with China’s Belt and Road Initiative (“BRI”).
Advantages:
competitive pricing: Chinese leasing companies usually offer competitive pricing compared to traditional banks;
flexible terms: Chinese lessors may provide more flexible lease terms, including longer lease periods and tailored repayment schedules;
access to capital: Chinese leasing firms have significant capital resources, which can facilitate large financing deals;
support for new buildings: they also offer financing for ships under construction, which can be beneficial for shipyards and owners; and
government support: government support for the leasing industry ensures favourable financing conditions.
Disadvantages:
loss of ownership: sellers no longer own the asset, which may (formally) limit their control over it;
complex structure: structures can be complex and may require significant legal and financial expertise to navigate;
regulatory risks: China’s regulatory regime in China can be complex and unpredictable; and
limited experience: some Chinese leasing companies may be lacking shipping sector experience and expertise, though this should change over time.
“JOLCOs are based on the same fundamental concepts as conventional sale and leaseback but have additional provisions to meet Japanese tax law requirements.”
JAPANESE OPERATING LEASE WITH CALL OPTION
Japanese leasing companies have also continued to grow their market share through the tax effective JOLCO structure. JOLCOs are based on the same fundamental concepts as conventional sale and leaseback but have additional provisions to meet Japanese tax law requirements.
A JOLCO involves a “registered owner“, usually incorporated in a shipping-friendly jurisdiction such as the Marshall Islands. This entity purchases the vessel from the shipowner and sells beneficial ownership to one or more Japanese special purpose vehicles (“SPVs”). The Japanese SPV then charters the vessel back to the shipowner’s group, allowing the registered owner to remain the legal owner whilst the Japanese SPV claims the relevant tax benefits.
Differing from usual sale and lease back structures, JOLCOs provide up to 100% financing for the vessel, typically split into 70% debt and 30% equity. Funding is usually provided by loans from the Japanese SPV and investment from Japanese investors. Such investment is made through agreements into a limited partnership structure that is transparent for tax purposes, allowing those investors to share in the losses of the Japanese SPV. As usual, the vessel is bareboat chartered back to the shipowner, allowing existing chartering and management arrangements to continue. However, lease payments do not cover the capital costs of the asset leaving the residual value risk with the Japanese special purpose vehicle.
As with a Chinese leasing structure, the bareboat charter in a JOLCO includes a purchase option for the lessee to repurchase the vessel by paying off the debt and equity investment.
“Competition worldwide has increased due to the dominance of Chinese lessors and other regions are now adopting more flexible financing solutions.”
Recent regulatory changes in Japan have limited JOLCO eligibility to “advanced vessels” that meet specific environmental and technological criteria. This aligns JOLCOs with global decarbonisation efforts and encourages investment in green ship technology.
Key components:
type of investment:Japanese institutional investors take advantage of local tax incentives to fund the lease;
ownership arrangement: an SPV holds the vessel and the shipowner uses it under a lease agreement;
call option: the shipowner has the option to buy the vessel at the end of the lease term at a pre-agreed price, and
fixed term leases:a typical JOLCO lease has a term of seven to 12 years.
Advantages:
tax benefits: JOLCO structures often provide tax advantages as lease payments can be treated as operating expenses, potentially reducing taxable income;
off-balance sheet financing: JOLCOs allow shipowners to keep the leased asset off their balance sheets; and
established market: Japanese leasing companies have a long history and expertise in the shipping industry.
Disadvantages:
complex structure: the JOLCO structure can be complex and may require significant legal and financial expertise to navigate;
higher initial costs: the setup costs for a JOLCO can be higher than traditional financing options; and
limited availability: JOLCOs may not be as widely available as other financing options.
EFFECTS ON GLOBAL MARITIME FINANCE
The trends outlined above are accelerating the diversification of capital sources. Leasing models have assisted in shipowners’ efforts to modernise their fleets, whilst supporting the transition to the greener shipping technology. Competition worldwide has increased due to the dominance of Chinese lessors and other regions are now adopting more flexible financing solutions. Leasing has an impact on shipbuilding as it primarily supports the newbuilding market which is linked to domestic shipyards.
“The implementation of leasing structures requires significant legal expertise to be conducted correctly. For the German market, one of the major challenges for leasing models is regulatory constraint.”
REGISTRATION IN GERMANY AND TONNAGE TAX
It is worth to note that Chinese leasing structures usually allow for a vessel to be registered in Germany and, therefore, qualify for Germany’s tonnage tax regime. Chinese lessors regularly use single purpose companies incorporated in EU countries such as Ireland, Malta or Cyprus. A German flag law allows such entities to register their title in the German ship registry. On the basis of this registration, combined with the management of the vessel out of Germany, these structures generally comply with the requirements for German tonnage tax. The requirements for registration of such EU entities as legal owners differ from a standard registration so the registrars, as well as German Federal Authority that grants approval, will need to became familiar with the new structures.
REGULATORY CHALLENGES IN GERMANY
The implementation of leasing structures requires significant legal expertise to be conducted correctly. For the German market, one of the major challenges for leasing models is regulatory constraint.
Under the German Banking Act (Kreditwesengesetz)¹, finance leasing arrangements qualify as a provision of financial services (Finanzdienstleistungen). As a result, the lessor (unless it is already a credit institution) providing such financial services to the German market (or is targeting said market) commercially or on a scale requiring commercially organised business undertakings² is subject to licensing requirements from the German Federal Financial Supervisory Authority (Bundesantalt für Finanzdienstleistungsaufsicht or “BaFin”).³
BaFin does not view all forms of leasing as finance ones requiring a license.⁴ Arrangements are categorised as a finance leasing if they are economically equal to a financing of the leased object by the lessee. This can be the case if, for example, the leasing rates throughout the term of the lease achieve the full amortisation of the acquisition costs for the leased object or if, at the end of the term, the lessee must reimburse the lessor for any remaining residual value, should the leasing payment not achieve the full amortisation. In contrast, any other type of lease or rental arrangement is not a licensed activity in Germany.
“Chinese Leasing and JOLCOs are part of a changing face of maritime finance that offer new solutions to challenges both old and new. Models such as these are set to play an increasingly important role in determining the shape of global shipping finance in the future.”
It is important to note that the German Banking Act⁵ also outlines those entities (usually regulated already elsewhere) that are not considered to be financial services providers and therefore don’t require a license to provide finance leasing in Germany. The most notable exceptions concern domestic and EU-domiciled licensed insurance undertakings and licensed German AIFMs, EU-AIFMs and AIFMs domiciled in third states⁶ which conduct only collective asset management (kollektive Vermögensverwaltung)⁷ and/or certain listed activities as per the German Capital Investment Act (Kapitalanlagegesetzbuch).⁸
Market participants should be aware that in cases of so-called ‘reverse solicitation’ (i.e. where a lessee approaches a lessor for a finance lease), as per BaFin’s guidelines, the German market is not being targeted so a licensing requirement is not required.⁹
Leasing service providers should carefully examine any of their leasing arrangements that have any German elements to establish to what extent they fall within German regulatory requirements which, if breached, could lead up to criminal liability for the responsible decision makers at the lessor level.¹⁰
CONCLUSION
The APAC region is going to remain the dominant force in ship leasing for the near future. This trend provides a more versatile and competitive funding model that aligns with evolving industry needs. The market is and will keep growing due to the rising demand for cargo transportation. This is not only a reaction to the current economic environment but also a conscious effort to meet the larger objectives of innovation and sustainability in the maritime sector set by the IMO. Chinese Leasing and JOLCOs are part of a changing face of maritime finance that offer new solutions to challenges both old and new. Models such as these are set to play an increasingly important role in determining the shape of global shipping finance in the future.
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[1] See section 1, paragraph 1(a) Nr. 10 of the German Banking Act
[2] See section 32, paragraph 1 of the German Banking Act
[3] Please also refer to the BaFin’s memorandum (Merkblatt) dated 1 April 2005, as amended on 11 March 2019 on the licensing requirements in cross-border cases, when the German market is regarded as being targeted
[4] Please also refer to the BaFin’s memorandum (Merkblatt) of the meaning of “Finance leasing” dated 19 January 2009 as lastly amended on 18 December 2021
[5] See section 2 paragraph 6 of the German Banking Act
[6] Such entities have to meet the requirements for a manager of alternative investment funds as per EU Directive 2011/61/EU.
[7] E.g.: in the context of this article this should apply to such AIFMs which as part of the stated strategy of the managed AIF should be able to invest in vessels. As the result, managing such investment would entail leasing the vessels to third parties.
[8] See section 2, paragraph 6, Nr. 5a, 5b of the German Banking Act
[9] Please also refer to the BaFin’s memorandum (Merkblatt) dated 1 April 2005, as amended on 11 March 2019 on the licensing requirements in cross-border cases.
[10] The German Banking Act foresees in section 2 paragraph 4 the possibility of applying for an exemption from a license requirement, for example in cases where the applicant is already sufficiently supervised in his home jurisdiction and the respective authorities in such jurisdiction cooperate with BaFin in satisfactory manner.
Source: cyprusshippingnews.com
