Flags of Convenience

Foreign flagging, also known as ‘flags of convenience’ (FoC), is the practice of registering vessels in countries other than the natural country of the owner/operator of the vessel in order to enjoy a more beneficial ‘citizenship’ that may be on offer. A ships registry that accepts vessels from around the world is known as an ‘open registry’, and these open registries have in the past given rise to some controversy.

In the simplest terms, open registries seek to attract vessel registrations in order to earn taxes & other income from ship-owners for the state concerned. In order to be attractive in the open market, there are many areas of cost to ship-owners that are made less onerous by the open registries. Areas such as registration fees, annual tonnage taxes, labour requirements, safety requirements etc are generally reduced and in so doing, vessels operating costs are significantly reduced. In extreme cases, completely landlocked countries such as Mongolia offer a ships registry, enabling vessels to fly the Mongolian flag, and have little or no statutory constraints. Moreover, if these open registry states are not signatories to international maritime agreements, then, by implication, their vessels are not bound by such agreements and can roam the high seas with reduced responsibilities.

One of the significant advantages that flags of convenience have been able to offer is that of reduced or minimal labour regulation. Employment conditions, levels of pay, and general crew safety are often left conveniently under-regulated for unscrupulous vessel operators to exploit in their quest for improved profitability.

Indeed, each ‘open registry’ will have its own subtle nuances to attract vessel registrations as they deem best. Combinations of different levels of compliance with international labour, maritime, environmental and financial law creates a range of different offerings worldwide.

Open registries and flags of convenience started gaining traction after WW2, and reached very high levels by the 60’s and 70’s. It seemed, at that time, that there was competition amongst the FoC states, and those that offered the lowest levels of regulation attracted the greatest amount of business. It was a ‘race to the bottom’ of regulatory enforcement, and FoC’s became frowned upon from many quarters, including environmental agencies & groupings, and international labour unions. (There are approximately 47 significant labour agreements currently negotiated under the International Labour Organisation (ILO), of which different flag states subscribe to in varying degrees.) Similar situations are apparent in environmental matters, governed by the International Marine Organisation (IMO).)

And so, from a conservative perspective, vessels using FoC’s are accepted as high risk vessels in terms of safety, age, labour practices, maintenance, crew quality, structural soundness etc. It is understandable that such vessels are treated with little respect, and all manner of problems are expected from this fleet.

Despite the poor picture described above, some 50% of the world’s gross shipping deadweight tonnage is registered on various open registries. Indeed, our very own Safmarine operates a significant fleet of vessels (both owned and chartered), and only one of these vessels are registered on the South African registry. The rest fly FoC’s.

The ‘race to the bottom’ has resulted in a backlash of international action/reaction, and there are many initiatives that have put a harsh handbrake on this ‘race’. One of the most effective measures is ‘Port State Control’. Under this activity, sovereign ports exercise strict local regulatory inspections on vessels entering or leaving ports and harbours. Vessels that are found to be unseaworthy in any respect are detained in port until they have satisfied port authorities that they are fit to proceed on their journey. With most developed and developing countries involved in high levels of import/export, the bulk of international tonnage finds its way into or out of well regulated ports with active Port State Control practices employed. A vessel not complying with local regulations quickly finds itself detained and high costs are a result.

Similarly, dockside labour unions identify vessels flagged by a registry that ignores human rights, or that exploits crew, and local stevedores refuse to load or unload such vessels.

Any maritime incidents are recorded by international agencies, and tabulated against the flag state resulting in a log of flag states highlighting ‘worst offenders by flag’. i.e. the flag with proportionately the highest level of incidents or vessel detentions tops the offenders list. Countries with developed regulatory environments actively target such vessels for inspections/detentions to the point that such FoC’s have become very unattractive, and the ‘race to the bottom’ is ultimately lost by the states who were leading the race. In fact, open registries are learning that they need to be enforcing improved levels of regulatory compliance, while at the same time, sovereign registries are leaning towards relaxing their maritime registry requirements in certain areas, knowing that other activities such as Port State Control will help to keep acceptable standards in territorial waters. And so, the ‘race to the bottom’ has become a ‘race to the middle’.

As mentioned above, Open Registries are monitored in various ways, and statistical data is made public in the maritime community. A simple comparison of registries would be to take all international maritime regulations and determine which registries have adopted or have not adopted these regulations for enforcement on their flagged fleet. Recent statistics have shown that the Norwegian International Registry has accepted 91.6% of environmental, 94.7% of safety, and 68% of labour agreements pertaining to ships. By contrast, Mongolia has adopted 25% of environmental, 15.8% of safety and 6.4% of labour agreements. It is therefore most unlikely that any Mongolian flagged vessel will get into a SA port without being swarmed by Port State Control officials. It is even less likely that anyone will load or unload any cargo that needs loading. (As an outlier, the USA notoriously does not subscribe to most international agreements, yet their domestic shipping regulations are suitably stringent.)

By way of further example, the Round Table of international associations (BIMCO, International Chamber of Shipping/International Shipping Federation, INTERCARGO and INTERTANKO) have published their latest “Shipping Industry Flag State Performance Table”, which is updated on an annual basis.

The Table, which accompanies the well established “Shipping Industry Guidelines on Flag State Performance”, summarises factual information, derived from the public domain. The intention is to provide a general appreciation of a flag’s performance and to encourage ship operators to reflect on a flag’s quality before using it.

As the table demonstrates, the vast majority of the world fleet is registered with flag states which take their responsibilities very seriously. Most flags have ratified most of the key International Maritime Organization (IMO) Conventions, the adequate enforcement of which is shown by their Port State Control records. There is always room for improvement and most flags continue to receive a small number of potential negative performance indicators (black blobs). However, many flags have improved on their performance in previous years, some dramatically, and notably six flags had no potential negative performance indicators at all in 2010. Since the Table was first compiled in 2003, there has been a noticeable decline in the number of flag states that appear on the black lists of regional Port State Control authorities.

Unfortunately, there are still a number of poorly performing ship registers, and for 2010 the list of the very worst performing flags, which the Round Table believes shipowners should think very carefully about before using, includes: Albania, Bolivia, Cambodia, Columbia, Costa Rica, Cote d’Ivoire, Democratic Republic of Congo, Georgia, Honduras, Lebanon, St Kitts and Nevis, Sao Tome and Principe, and Sierra Leone.

In taking some of the above conclusions, namely;

  1. 50% of the worlds shipping is registered on ‘open registers’, and fly ‘flags of convenience’.
  2. The ‘race to the bottom’ of regulatory compliance is over, and registries are becoming more balanced as a result of countervailing initiatives such as ‘Port State Control’.
  3. Public data quickly identifies the worst ‘flags’, and such fleets enjoy little benefit any more from their FoC ;

we can now take a re-considered view of a vessel owner’s need to finance a vessel that flies a FoC.

A Financiers Perspective

Many SA ship financiers will not contemplate lending to a vessel that is not registered on the SA registry. While it has been said that the SA register is driven, in part, by national labour policy, forcing, say, 14 crew onto a vessel that is to perform tasks that do not require such numbers of deck crew will have the opposite effect to what the overall registry policy seeks to achieve. By forcing SA Registry compliance, an all-or-nothing situation is put forward, and there will be losers irrespective of which way the vessel-owner chooses to go in terms of registration.

Of course, by being more compliant (subject to ultimate guidance by good marine attorneys like BG,) financiers can begin to take steps in gaining a deeper understanding of the dynamics of open registries, and can move closer to becoming respected players in the marine finance industry in SA, ultimately attracting larger marine transactions. There is local opportunity for finance houses to take a leading role in SA by employing some ‘blue ocean strategy’.  (i.e. operating in markets which are open and uncontested.)

From a financier’s perspective, an understanding of the technicalities involved should always be tempered with thorough credit knowledge of the potential borrower. An appreciation for the customer’s level of knowledge and experience should be sought because this is where the primary lending risks lie. If lenders can trust the vessel owner’s experience and integrity, then they should also place some reliance on the fact that  the owner too does not seek to lose any vessels.