B. THE BACKGROUND
B.1. FINANCING A SHIPBUILDING CONTRACT
As is the case with all large capital goods the construction of a commercial vessel is particularly capital intensive while a substantial period of time may lapse between the signing of the contract and the time of delivery of the vessel. In almost all shipbuilding contracts, therefore, arrangements need to be made to provide for the financing of the transaction by both the shipbuilder and the purchaser. Furthermore, any financing arrangements will in almost all cases need to be accompanied by appropriate guarantees.
The mechanisms of such financing anangements are briefly explained below for the purposes of facilitating an understanding of the programmes investigated.
B.1.1 Shipbuilder's financing
A shipbuilder can in theory finance construction of a vessel by using own funds and/or by relying on credit extended by its subcontractors. However, due to the large sums involved, he would normally finance construction through (i) advance payments made by the buyer, and/or (ii) loans from financial institutions4.
(i) Advance payments made by the buyer
Advance payments may constitute an important source of working capital for a yard. Payment terms are, therefore, a crucial part in any shipbuilding contract. Generally, the payment terms vary significantly per shipyard and contract. It is commonly accepted, however, that the standard payment terms would consist of an initial payment upon the signing of the contract with further payments made upon construction reaching specific stages such as: steel cutting, keel laying, launching and delivery of the vessel. For example, payment could consist of five (5) equal instalments of 20% - this is considered as "standard" in Korea. Alternatively top heavy (eg payment of 50% to 90% of the price within 6 months of signature of the contract), or tail heavy (eg payment of 70% upon delivery) payment terms may be agreed.
If payment terms extend beyond delivery, then the shipyard would be providing credit to the buyer; this is, therefore, discussed under the buyer's financing section immediately below.
Payment terms obviously have a direct effect on the price of the vessel as, for example, tail heavy terms entail higher expenses for the yard and, therefore, in theory would result in a higher price and vice versa.
(ii) Loans from financial institutions
Notwithstanding the payment terms agreed with the buyer, a shipyard often needs additional financing to finance its operations during the period of construction of the vessel. The precise terms of such financing depend upon the shipyard's financial position, the amount of funding needed and the period of time for which it is required
Such financing necessarily depends on the creditworthiness of a yard; the interest rate at which financing may be obtained can, therefore, affect the price of a vessel. For example, a yard in a dire financial position would need to pay higher interest rates than a yard in a strong financial position to allow for the higher risk it presents to creditors. Similarly, the provision of a subsidised loan would permit the shipyard to offer a lower price than that would be the case if financing at commercial rates was available. Such financing arrangements are often not disclosed to the buyer.
B.1.2 Buyer's financing (Exprt credit)
A buyer can finance the purchase of a vessel using own funds. However, due to the sums involved a buyer would normally finance the purchase through credit obtained either (i) from a bank of its choice (which is tahtamount to using own funds) (ii) from the shipyard5 (supplier's credit), or (iii) from financial institutions of the country of the supplier shipyard (buyer's credit). In the two last cases the credit obtained would be repayable over an extended period after delivery of the vessel.
Those two last types of credit are called "export credit"6, because the financing arrangements:
-(i) are always to the benefit of the foreign buyer7,
-(ii) are provided by financial institutions established in the country of the supplier, and
-(iii) they extend to the period afier delivery_of the vessel.
Export credit arrangements (both buyer's and supplier's credit) may not necessarily influence the sale price of a vessel as they largely depend on the creditworthiness of the buyer rather than of the shipyard involved.
When they are officially supported, export credits could be offered with more favourable terms than the buyer could get on a commercial basis, but those officially supported practices are regulated by the Arrangement on guidelines for officially supported export credits, Annex I to which deals specifically with ships. This Arrangement seeks to encourage competition among exporters based on quality and price rather on the most favourable officially supported terms, so as to avoid that better officially supported terms determine the choice of a country or a yard. (see under B.2 below)
The financing arrangements described above, are usually accompanied by a variety of guarantees on behalf and to the benefit of both the shipyard and the buyer. Such guarantees take many forms such as letters of credit offered by financial institutions, collateral offered by the buyer on other assets, mortgage on the vessel financed or a combination of these.
Below, we examine two types of guarantees of interest to the present investigation, namely, advance payment refund guarantees offered by the shipyard and export credit guarantees/insurance .
(i)Advance payment refund guarantees by the shipyard
In order to safeguard the buyer's pre-delivery payments to the shipyard, a refund guarantee is almost always provided by the shipyard to the buyer. This guarantee ensures that in case of default on the part of the shipyard, the buyer will get back - usually with interest - all sums paid in advance. The refund guarantee is to be provided by a bank acceptable to the buyer which could include a govemment export credit agency. The granting of the guarantee necessarily entails an extra cost for the shipyard in the form of premia payable to the guarantor. The amount of the premia vary depending essentially on the reliability and creditworthiness of the shipyard concerned.
Considering that the existence of a guarantee is an essential element for the signing of a contract, the provision of a guarantee on behalf of the shipyard on non commercial terms (e.g. by charging lower than market premia) can influence both the choice of the yard and the level of the price offered by the shipyard. Furthermore, the availability of the guarantee ensures that the shipyard will get advanced payments which are an important source of working capital; in the absence of the guarantees a buyer may be reluctant to pay more than the absolutely minimum necessary, or demand money to be put in an secured account, forcing the shipyard to find alternative sources of financing construction .
(ii)Export credit guarantees/insurance
Export credit guarantees are granted to ensure that, in case of a foreign buyer's default of payment, the necessary payments in execution of the credit terms agreed with the shipyard (supplier's credit) or the lending financial institution (buyer's credit) will still be made. The guarantees in question are provided by a third party (usually the lending bank or an export credit agency) in favour of the shipyard or the financial institution that provided the credit; for example, an export credit agency issues a guarantee in favour of a bank that has financed the purchase of a Korean made vessel. The price of the guarantee/insurance, the premium is charged to the buyer up-front or on top of the interest rate of the export credit.
Availability of an export credit guarantee is crucial for obtaining export credit. In its absence shipyards or financial institutions may be reluctant to provide the necessary credit to the foreign buyer, because of the amounts and length of credit at stake.
In order to limit the distorting effect of officially supported export credits (ie credits granted to foreign buyers of exported goods and backed by government), OECD countries developed the Arrangement on Guidelines for Officially Slpported Export Credits ("the Arrangement"). The Arrangement applies to all official support for exports of goods and/or services, or to financial leases, which have repayment terms of two years or more. This is regardless of whether the official support for export credits is given by means of direct credits/financing, refinancing, interest rate support, guarantee or insurance .
The Arrangement applies for all goods except for certain sectors for which special guidelines apply such as for ships. In particular, the special rules for ships are set out in the Sector Understanding on Export Credits for Ships ("the Understanding") which is contained in Annex I to the Arrangement and provides the most favourable terms that can be provided to buyers of ships8.
In particular, the Understanding provides that no offrcial facilities9 on export credits should be introduced which would provide for:
||a maximum duration exceeding eight-and-a-half years10
from delivery and repayment other than by equal instalments at regular intervals
of normally six months and a maximum of twelve months;
||payment by delivery of less than 20% of the contract price;
||an interest rate of less than 8%, net of all charges11.
Paragraph 2 of the Understanding provides that the minimum interest rate of 8% will apply to the credit granted with official support by the shipbuilder to the buyer (in a supplier-credit transaction) or by a bank or any other party in the shipbuilder's country to the buyer or any other party in the buyer's country (in a buyer-credit transaction) whether the official support is given for the whole amount of the credit or only part of it.
Furthermore, paragraph 3 of the Understanding provides
that the minimum interest rate will also apply to the credit granted with support
by governments participating in the Understanding, in the shipbuilder's country
to the shipbuilder or to any other party, to enable credit to be given to the
shipowner or to any other party in the shipowner's country, whether this official
support is given for the whole amount of the credit or only part of it.
As a general comment, it must be pointed out that all the provisions of the Understanding cover official support ultimately benefiting the buyer of ships . The Understanding does not address issues of support to the shipyard which do not involve some form of export credit to the buyer whether it be direct (in a buyer-credit transaction) or indirect (in a supplier-credit transaction or in the case of credit granted to the shipbuilder with a view to extending credit to the buyer).
The Understanding obliges Participants to make their best endeavours to ensure that no more favourable terms than those set out above will be offered to buyers by any other means. Where a Participant intends to support terms for a ship covered by the Understanding that would be more favourable than those terms permitted by the Arrangement, the Participant must notify all other Participants of such terms. The appropriate procedures for notification are set out in Article 49 of the Arrangement.
4 Alternatively, although more rarely, other means may be used such as through the issuance of bonds. Such operations have no bearing on the price of the vessel.
5 In such a case it
is normally highly unlikely that a shipyard, would bear itself the cost of the
credit to the buyer. The shipyard would normally ask a bank for a dis counting
of the credit; in other words, the bank would, upon delivery of the vessel, or
shortly thereafter, pay the full amount (minus the discounted price) to the shipyard,
although the latter would formally remain the creditor, i.e. responsible for any
claims that could arise.
6 See the OECD Sector
Understanding on Export Credits for Ships discussed at the next section.
7 As opposed to financing
solely benefiting the shipyard.
8 On the contrary,
the Arrangement applies to ships not covered by the Understanding on Export Credits
for Ships. However, all commercial vessels covered by this investigation fall
within the Understanding.
9 Official facilities
are those which enable credits to be insured, guaranteed or financed by governments,
by governmental institutions, or with any form of direct or indirect governmental
10 Given the Special
nature of the transactions for vessels transporting liquefied natural gas, the
duration of authorised credit for this type of ship only is increased to ten years.
11 Interest rate,
net of all charges, means that part ot the credit costs (excluding any credit
insurance premia and/or any banking charges) which is paid at regular intervals
throughout the credit period and which is directly related to the amount of credit.