13 Feb 2017
High Value-added Maritime Services: Ship Financing Opportunities
Lending Shrinkage from Traditional European Banks
The shipping industry is considered highly capital-intensive given the huge underlying requirements for the construction and maintenance of vessels, not to mention other strands of maritime services that may prove costly. At present, bank loans are the primary source of financing in the shipping industry. Since the global financial crisis of 2008-09 and the ensuing recession, the shipping industry has suffered heavily from a contraction of loan credit, as banks tightened their lending standards in observance of regulatory changes demanding sufficient capital reserves.
Meanwhile, the structural overcapacity faced by the industry also created substantial downward pressure on both vessel value and charter rate. For example, the Baltic Dry Index (BDI), the most common measure of freight costs, touched a historical low in early 2016 since its launch in 1985, losing more than 90% from its peak level in May 2008.
In the wake of the heightened regulatory pressure and market volatility, many European lenders, who traditionally dominated the ship finance industry, have downscaled their shipping finance operations. For instance, Germany’s HSH Nordbank AG and Commerzbank AG have reduced lending to shipping companies as they are burdened by non-performing loans for the sector. The Royal Bank of Scotland (RBS) has begun winding down its global shipping finance business, following Lloyds Bank, another British financial institution that exited in 2014.
It is worth noting that the European Central Bank also stepped in to launch a review of banks’ lending to the shipping industry in June 2016, reportedly asking banks – including several from Germany – for details of their shipping portfolios. Germany was a global shipping finance centre before the 2008 global financial crisis. Despite marked write-downs and provisions, it is estimated that German banks with close links to the shipping industry still have a shipping loan overhang in the magnitude of multiple billions of euros. In this context it is expected that there will be a further decline in ship finance activity among European banks.
On the other hand, despite the emergence of some alternative shipping financing options other than bank financing as the global economy emerged from recession, most have not proved sufficiently attractive and thus have had limited uptake by shipping companies (for example, private equity and bonds, as seen in the figure below). While capital requirements for banks in the wake of the global financial crisis have increased, in particular for shipping loans, repeated quantitative easing attempts adopted by developed countries’ monetary authorities have also put downward pressures on loan rates, thus rendering alternative financial options less often deployed than would otherwise be the case.
Chinese Financial Institutions Stepping Up
While ship-scrapping activities have gone up somewhat in recent years, it has far from turning the tide. Major shipping companies are still keen to finance their new ships, as the building of larger vessels is their pre-dominant business strategy to minimise costs and wrest market share, despite the continued challenges of the credit crunch, overcapacity and diminished returns.
Evidently, there has not been any substantial decline in the size of the global order book over the past few years, particularly containerised ships, resulting in no sustainable projected decline in the overall vessel numbers or tonnages over the medium term.
To fill the funding gap against the backdrop of the withdrawal of European banks, the focus of global ship finance has therefore gradually shifted towards Asia, a region of growing importance on two counts – first in terms of the demand for new ships and shipping finance, and second, in terms of the presence of Asian lenders that are subject to less restrictive banking regulations and marked with a relative abundance of capital.
At present, Asian banks are still behind their Western competitors in terms of technical know-how, yet there are initial signs that Asian banks are stepping up their activities in the global shipping finance sector. China, in particular, has been eager to build its presence. In 2014, three out of 15 of the world’s largest shipping lenders were Chinese banks, namely, the Bank of China, the Export-Import Bank of China (China Exim Bank) and China Development Bank. Back in 2007, before the global financial crisis and the consequential shipping market downturn, none of them made the Lloyd’s list of top shipping finance institutions.
These three Chinese banks, with a combined shipping portfolio of more than US$45 billion in 2014, have a huge domestic market to serve. For example, the China Exim Bank has recently signed a RMB120 billion (US$18 billion) financing deal with China COSCO Shipping Corporation Limited (China COSCO), a new shipping conglomerate formed by the merger of COSCO Group and China Shipping Group in early 2016. Under this agreement, the China Exim Bank will finance the construction of more than 50 vessels, on top of supporting the group’s merger and acquisition costs and overseas investment.
Opportunities for Hong Kong’s Ship Finance Industry
Hong Kong, as an international finance centre in Asia, is benefiting from the growing presence of Chinese mainland lenders in the city, including many already engaged in the ship finance market. According to statistics from the Hong Kong Monetary Authority (HKMA), shipping loans in Hong Kong have been gradually increasing over the past few years despite the sluggish sea freight market. From less than HK$70 billion in June 2011 loans have increased to about HK$101 billion in June 2016, accounting for 2% of Hong Kong’s total bank loans.
A strong financial services cluster is essential for the development of ship finance. In this regard, Hong Kong has a unique advantage in light of the high concentration of banks providing financing services to the shipping community. This ranges from the traditional players like Credit Agricole and BNP Paribas, to emerging players including the Bank of China, China Minsheng Bank and China Construction Bank.
At present, some other mainland banks, including ICBC, Bank of Communications and China Merchants Bank, have their ship finance teams located in either Shanghai or Beijing. In addition to catering to the needs of their domestic clients, these banks are increasingly interested in making deals with overseas shipping companies. As such, Hong Kong should grasp the opportunity of its role as a “super connector” for mainland banks that are setting shop in the city to better connect with their prospective regional and international clients. Hong Kong should also reinforce this “super connector” role by lining up with international shipping companies to make use of the city’s shipping finance platform.
Reflecting the confidence in Hong Kong’s facilitating role to help reach out to the international market, China COSCO launched its new setup COSCO Shipping Financial Holding in Hong Kong in June 2016 to provide financial services in areas of vessel leasing, investment, finance management and insurance.
Hong Kong capable of offering sophisticated ship finance services
Under the 13th Five-year Plan (2016-2020), the Chinese government has expressed its support for Hong Kong’s consolidation and enhancement of its position as an international transportation centre. This, coupled with another Chinese scheme to promote a world-class maritime centre in Shanghai by 2020, has created many opportunities for Hong Kong’s maritime industry to explore, as Hong Kong and Shanghai can complement each other to a great extent.
While Shanghai boasts the world’s busiest container port and some of the largest shipyards in the country, it has yet to develop a mature and full-fledged shipping service sector. Hong Kong, on the other hand, has a vibrant maritime services cluster that is ready to offer comprehensive services to clients from the Chinese mainland.
While the US dollar is the preferred currency for the bulk of shipping transactions, the RMB is likely to gain popularity over the medium to long term as one of the payment currencies alongside the rise of China’s maritime industry. With Hong Kong thriving on its institutional strengths, and strong free market principle, imposing neither capital nor exchange controls, the city is expected to benefit from its role as the world’s largest RMB offshore centre in offering RMB settlement services for the regional and international shipping community.
As mentioned, ship financing typically involves a significant amount of investment. While traditional ship mortgaging is still popular, the ship finance industry has become increasingly sophisticated and ship finance banks may also be involved in some sale and leaseback transactions as well as related IPO activities. Therefore, when searching for funding options, ship owners and operators should consider the administrative and taxation arrangements available in different regimes carefully in their overall decision-making process.
While alternative financing has yet to become mainstream, as stated above, Hong Kong as a low-and-simple-tax regime is also well poised to offer new financial products specifically designed for the shipping industry, taking advantage of its strong capital market and huge amount of available financing options. To this end, Hong Kong can readily formulate special tax structures for the use of shipping companies on the Chinese mainland.
Building Community Ties to Spur Future Growth
Hong Kong has established a world-renowned ship registry, ranking fourth globally after Panama, Liberia and Marshall Islands. There are more than 2,500 vessels registered on the Hong Kong Shipping Register (HKSR). Hong Kong also boasts a vibrant maritime cluster of over 700 companies, which are able to provide a wide spectrum of shipping services, including sophisticated, multi-currency financial services.
To enhance Hong Kong’s competitiveness as a key ship finance centre, Hong Kong has to ensure that a virtuous cycle of building a diversified cluster of shipping companies and attracting “commercial principals” is in place, while leveraging its unique institutional strengths. Undoubtedly, commercial principals like ship owners and ship management companies are the prime drivers for the value-chain activities of the shipping community. Once they are present, service providers, including ship finance providers, will follow. On top of the expertise and experience required to conclude a ship finance deal, ship finance providers need to capture business opportunities through effective communication with ship owners and companies, capitalising on the extensive business networks available in Hong Kong.
In a bid to bolster the presence of commercial principals, Hong Kong is taking steps to promote an effective communication flow among different stakeholders within the shipping community, including ship owners, technical managers and the government. In particular, the Hong Kong Maritime and Port Board (HKMPB) was set up in April 2016 with a view to facilitating collaboration between different players in the industry and creating a maritime business-friendly environment.
Building on its existing historical, institutional and professional foundation, Hong Kong shows great potential in further developing its ship finance sector through a multi-pronged approach to encouraging active participation of both private and public sectors. The increased Chinese mainland presence in the regional and international maritime market will also continue to bring more shipping finance opportunities to Hong Kong.