ANALYSIS

Transport, Shipping and Aviation: The shipping forecast

Statistics show that in 2006, China contracted for 24% and produced 20% of the total number of new ships built globally, taking third position (behind Korea and Japan) in both categories. Further gains were made during 2007 and, by some measures, China overtook both Korea and Japan in the first half of the year in relation to new building contracts concluded. It is no secret that China has set its sights on becoming the world's number one shipbuilder, and official statements indicate this will be achieved by 2015. The 8km-long quay of the new Jiangnan Shipyard on Changxing Island is a good reflection of the ambition of Chinese shipyards. Following the boom in the shipping industry over the past few years, foreign owners have been flocking to China to order new ships at Chinese shipyards. All the large state-owned shipyards have full order books for the next few years. As a result, many owners have had to turn their attention to some of the privately-owned small- and medium-sized shipyards, many of which are located in the neighbouring Zhejiang and Jiangsu Provinces.In China, the refund guarantee is an essential document for the buyers and their financiers, as it is often the only pre-delivery security they receive from the shipyard in the event that the ship is not delivered. The importance of refund guarantees is magnified by the fact that a large number of Chinese shipyards require the buyers to advance the majority of the purchase price prior to delivery. With rising newbuilding prices and increasingly tight order books and credit lines, small- and medium-sized private shipyards are finding it much more difficult to persuade their banks to issue refund guarantees to their buyers in relation to the pre-delivery instalment payments. As a result, transactions sometimes fail to materialise solely due to the unavailability of the refund guarantee. Some transactions are also thrown into jeopardy because the refund guarantee in question is due to expire prior to the completion of construction and the shipyards are unable to arrange for an extension of the refund guarantee.A refund guarantee remains the preferred method of pre-delivery security for buyers and their financiers. However, many owners and financiers have been looking at alternative forms of pre-delivery security. One possibility would be the registration of a ship construction mortgage. Unlike the English common law legal system where a ship construction mortgage is not recognised, it is not a new concept under the Chinese legal system. As a substantive right, it has been incorporated in the Maritime Code of China 1993. The national Ship Registration Regulations of China 1994 set out the requirements for registration of a ship mortgage, and there are arguments that the same requirements apply to the registration of a ship construction mortgage. However, this legislation does not expressly refer to the registration of a ship construction mortgage, nor does it distinguish between the registration of a ship construction mortgage and that of a ship mortgage (of a completed ship). The common view is that registration of ownership is a precondition for registering a ship mortgage. However, in the absence of clear regulations concerning the registration of ownership of a newbuilding with Chinese ship registry the Maritime Safety Administration (MSA), the generally accepted position in the past was that no construction mortgage could be registered. A common response we have received from various MSA branches was that they were unclear as to how the construction mortgage should be registered and that they had little or no experience of doing so. There has, therefore, been something of a stalemate, with the registration of ship construction mortgages deemed as being difficult to achieve.In the absence of a central ship registration system in China (although this may change), some provincial government authorities have attempted to take the initiative and establish local regulations to enable a ship construction mortgage to be registered. As a result, motivated by the enormous demand for pre-delivery financing, the local governments of some Chinese provinces have issued Regulations on Mortgage Finance of Ships under Construction on Pilot Basis (known as the 'Pilot Regulations'), setting out detailed requirements and procedures for the registration of construction mortgages for vessels under construction in these provinces. In one local pilot scheme, it expressly provided that ownership registration for ships under construction shall be a precondition for the registration of construction mortgages.Since the establishment of the Pilot Regulations, provincial MSAs have approved and registered several construction mortgages over new buildings under construction in local shipyards. However, the pilot scheme has a restricted scope - it is only applicable to securing loans made by a list of state-owned financial institutions to a selection of large-scale shipyards. While this means that such regulations may not extend to foreign buyers purchasing new buildings from Chinese shipyards, it is nevertheless an indication that the system is evolving to meet the demands of the market. Further, we have been advised by one local MSA that the central Government has been monitoring the implementation of the Pilot Regulations and that it may consider adopting similar regulations at a national level.While the Pilot Regulations have sought to establish a clearer set of procedural and practical requirements, the next step may be for these or similar regulations to be enacted nationally and for them to enable ship construction mortgages to be registered by both domestic and foreign buyers. China is developing at a rapid pace and it is not unusual for there to be some uncertainty as to how laws such as the registration of ship construction mortgages are implemented in practice. The Chinese Maritime Code has only been in place for 15 years whereas the laws of other countries have evolved over a much longer period. Great strides have been made during the past 15 years, but it is inevitable that continued developments and changes will need to be made to further improve the system. We will have to wait and see whether the central Chinese Government will enact further laws or issue new guidelines to enable ship construction mortgages to be registered in favour of foreign entities. Should this occur, it will be a significant step in supporting China's expanding shipbuilding industry. nPaul Ho is a partner and John Lin and Vincent Xu are solicitors at Ince & Co in Shanghai.

January 16, 2008 at 09:06 PM

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