Financial stakeholder’s role in ship recycling

| Innsikt

The legal framework for ship recycling are yet to become watertight in a global industry and we have taken a closer look on how the stakeholders in the industry can contribute to make ship recycling more sustainable.

1. The vessels’ last voyage
When a vessel has sailed to the end of its life cycle, there remains a considerable value in its hull and steel. The shipowner will thus have an incentive to sell the vessel for recycling to the place where the highest price for the steel can be obtained. In the recent years, the traditional practice of ship recycling has  received increasing criticism, and has been met by regulations and enforcement actions, all narrowing the shipowners’ alternatives available when faced with the decision of disposing of the vessel. Ultimately however, criticism alone will not change the course globally, but the role of the financial stakeholders in shipping can influence owners towards more sustainable methods for ship recycling.

2. Wide-meshed regulations
In Europe, there are two relevant regulatory frameworks that must be considered. The first relates to the export, import and transit of waste and originates from the Basel Convention (1). The framework is implemented in the EU/EEA and enacted as a regulation. The aim of the regulation is to control, and, to an extent prevent, export of hazardous waste to developing countries. More specifically, it prohibits export of hazardous waste that is located within the EU/EEA area to non-OECD countries. Further, most vessels will commonly contain substances and materials classified as hazardous under the regulation. Consequently, export of vessels for recycling from the EU/EEA to, for example, Southeast-Asia is prohibited.

The Basel-framework targets the vessel’s geographical location at the time it is intended to be discarded. With some prior planning and positioning, it is therefore quite manageable to circumvent this regulatory regime.

The second European regulatory framework targets specifically the recycling of ships and is based on the Hong Kong Convention (2). The convention is not entered into force, but is already implemented in the EU/EEA through the EU Ship Recycling Regulation. It requires inter alia that vessels carry on board an inventory of hazardous materials and are only recycled at facilities approved and positively listed under the regulation.

The subject-vessels of the regulation are those registered in an EU/EEA state. It is likely that the regulation nevertheless would prevent selling to cash buyer for recycling to a facility outside the list of approved facilities, even if the sale entails deregistering the vessel from the EU/EEA. The regulation does not however stretch back in time to cover vessel’s flag at the time it is intended to be discarded, in comparison with the mechanism under the Basel regime. Planning ahead and changing flag well in advance of the decision to recycle will therefore make it possible to circumvent also this regulatory regime.

3. Nudging towards responsible ship recycling
Breach of regulations may lead to high fines and imprisonment. The regulatory framework remains however too wide-meshed to make a big impact globally in the ship recycling market. Other stakeholders in the industry have therefore started to set demands and articulate how they expect their shipowning counterparts to recycle their vessels.

In particular the larger shipping banks and institutional investors have raised their voice. The Dutch banks are behind the Responsible Ship Recycling Standards initiative, endorsed by several of the biggest shipping banks and investors, including DNB, Nordea and KLP. Representation and warranty clauses, undertakings and covenants that commit the owner to law-compliant and responsible recycling, are becoming the norm in loan documentation.

The time for recycling comes however not during the period of a loan facility, leaving such provisions without force of persuasion or pressure to stretch into the last phase of the vessel’s lifecycle. For the larger shipping banks and their large-fleet owners, covenants that cover the owners’ entire fleet will have greater impact (not surprisingly, we have seen that such clauses are unpopular with the owners and therefore scarce). Banks that are willing to take the unpopular stand to not finance owners that have failed to recycle responsibly can have even greater influence on the issue.

Though, ship financiers are no longer only the big banks, but include a wide range of leasing institutions, smaller lending and/or leasing funds and project financings, etc., where we still see a more lenient approach. Smaller stakeholders tend typically to be more opportunistic which comes with a higher appetite for risk.
Aside lenders, institutional investors that pull out of shipping companies that fail to recycle responsibly send a strong signal as to their expectations of acceptable business practice. The impact of that is likely felt by the blue chip shipowners, but in a global and highly privately owned shipping industry its real influence will possibly be limited.

Shipowners themselves have started paying attention to how a cash buyer is actually planning to discard of the vessel – and how the demolition work is carried out on site. Some of the western shipowners caught red-handed sending their vessels into the mud for cutting by bare hands have argued that they had included contractual obligations in the sale contract for responsible ship recycling. Will such bilateral clauses protect the owner from third parties or authorities? If the recycling is in breach of either set of regulations touched upon above, the answer is quite probably no, at least in respect of the owners’ liability towards the authorities. A contractual obligation to recycle responsibly, often with reference to the standards of the Hong Kong Convention, can nevertheless entitle the owner to a claim for breach of contract. But the prospect of pursuing such a claim against an empty special purpose company, or proving tangible losses as caused by such breach, are faint, and can deprive the clause of its teeth.

If the shipowner is serious about the objective of recycling responsibly and in a more sustainable manner, real incentives for the yard to comply should be in place. One example would be physical presence at the site, surveying the demolition work – inspecting eyes makes it harder to cheat. Another, would be collaboration between the site and the shipowner, building knowledge and awareness in the (often migrant) workers of the hazards involved, both in respect of their own health and the surrounding communities.

4. A holistic approach
In common for most challenges that relate to sustainability is the need to take a holistic approach. Although sometimes the right thing to do is to set a lower threshold for which practices can be accepted in order for the rest to have a standard to improve towards, it will sometimes be necessary to meet the challenges where they are. As the challenges for the ship recycling industry to a large extent are interconnected with the general HSE challenges in the countries in which they operate, the solution is hardly an easy one and will require that all stakeholders benefiting from the industry send their nudges the right ways.

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(1) Convention on the Control of Transboundary Movements of Hazardous Wastes and their Disposal of 1989
(2) Convention on the Safe and Environmentally Sound Recycling
of Ships of 2009