The flag of convenience

There has been a searching query as to why Pakistan’s private sector is shy to invest in shipping since that industry’s demise in 1973 because of its nationalisation. Serious efforts were made to revive it, but failed to attract entrepreneurs to the shipping industry. The option in MSO 2001 for dual registry has not worked. Pakistani’s ship-owners are operating on flag of convenience, but are not willing to buy incentives offered under the Pakistani flag.

Having been associated with the industry for over five decades, I am of the opinion that Pakistan may create offshore registry as flag of convenience as some European countries have done. It is food for thought, needs brainstorming and deliberation at the Ministry of Ports and Shipping and the Planning Commission. I feel it may encourage Pakistani nationals to turn to ship-owning under the Pakistani flag.

I am giving the background of flag of convenience which attracts ship-owners around the world.

According to the United Nations Convention on the Law of the Sea 1982 (UNCLOS), every ship should sail under a state’s flag and every state (even States which have no marine borders, like Mongolia) has the right to have vessels flying its flag. The ships are subject to the jurisdiction and control of their flag state and have to comply with the state’s laws and regulations covering the standards of vessels construction and equipment, the manning of the ships including the labour convention MLC 06 onboard, the safe navigation and the protection of the environment. Since the flag will define the requirements of the vessels construction and operation, the decision of which flag to register the vessel is of utmost importance.

In open sea, we are looking at every opportunity which helps ship-owners to cut their operational costs, so I decided to analyse one more traditional way and look on it from the charterers’ perspective as well. In the past, the choice of the flag was easy since the owners registered and crewed their ships in the country where they conducted their business. However, this changed around the middle of the previous century when American owners found that there was a very high cost involved in running the ships under the American flag (mainly due to high crew wages) and it made it impossible for them to be competitive in the international shipping market. Therefore, they searched for a country/flag that would allow a foreign owning company to operate its vessels under the flag without the need for the ship-owner to have operating or financial substance in this country and would also allow the employment of crew of any nationality and without minimum wage scale, while at the same time the taxation would be minimal. Finally, they found this state of affairs in Panama and Liberia which had already established open registries. During the following decades, traditional owners from Europe and Asia adopted the same approach in an effort to lower their operating costs and become still more competitive. Therefore, a status quo was appeared with similar states/flags being known as “flags of convenience” or “free flags.”

From the statistics, we see that only six flags control 77 percent of the vessels registered under flags of convenience. But why ship-owners prefer flags of convenience? There are specific advantages for using flags of convenience instead of the traditional/closed flag registries, the most important of which are the following:

Higher flexibility: Ship-owners can register their vessels in any of these states without any requirements for citizenship or presence of the (actual) shareholders or the (actual) company. Also, they are free to change the vessel’s registry at any time without any restriction whatsoever, and without a pre-registry survey (except on specific occasions such as a vessel operating for more than 20 years).

— Lower operating costs: Ship-owners who use flags of convenience can save costs mainly on the crew’s wages and maintenance costs. Flags of convenience do not have any requirements as to why the nationalities of the crewmembers and are not subject to minimum wage scales. Since the crew’s expense is one of the most important aspects of the vessel’s OPEX (operational expenses), by not having any restrictions, ship-owner can search for the cheapest crew available anywhere in the world. Furthermore, the flags of convenience are used to have looser manning rules and more relaxed safety standards than the closed registries, which subsequently results in lower expenses on maintenance and repairs. A survey in 2010, for comparison between the US-based ship-owners those who had their vessels registered under the US flag and the US-based ship-owners who had their vessels registered under a flag of convenience showed that the average crew cost for the US-flagged vessels was about $13,600/day while the relevant average cost for those under flags of convenience was only $2,590/day. On the other hand, the average maintenance and repair cost for the US-flagged vessels was estimated at about $3,000/day while the cost for foreign-flagged vessels was at about $2,400/day. The more expensive crew wages and maintenance/repair costs for the US-flagged vessels made a huge difference on the total OPEX, which for the US-flagged vessels was about $20,000/day while for foreign-flagged vessels the daily OPEX was estimated about $7,400.

Anonymity: In order for a ship-owner to register a vessel under a flag of convenience, the only thing he needs is a P. O. Box or a virtual company/office and the actual shareholders in these jurisdictions may not be reported/disclosed at all. This might be important in order to avoid liabilities which might arise from the operation of the vessels.

Flags of convenience are generally considered registries of lower quality than the closed registries and this is because of their relaxed requirements as well as the room they give to the ship-owners to employ seamen of any nationality. In the past, the gap in quality was surely higher since the control for the implementation of the International regulations was mainly based on the flag states and the ship-owners could take advantage of their relaxed approach. Though the scene has changed in the past decades when the Port State Control regime was developed and the Port States have taken then authority to inspect foreign ships, check whether they follow the international regulations and share the results of the inspections with all the interested parties (ie, other port states, flag states, classification societies and charterers). The MoUs (ie regional memoranda of port states) also publish annual reports with an evaluation of all the flags, depending on inspection results and categorisation of all flags into white, grey and black lists.

From what we can see, there are some flags of convenience which are included in both the white list of the Paris MOU and the high-quality list of USCG. It does not necessarily mean that the flags of convenience are of higher quality than the closed ones but it definitely shows that high-quality vessels and traditional owners prefer specific flags of convenience not in order to benefit from a sub-standard maintenance programme but mainly in order to get rid of the crew synthesis requirements which is still a fact in reputable closed flags.

From the 1960s we note that less than 40 percent of the flags of convenience are included in the white list of the Paris MoU and less than 20 percent of them in the USCG Qualship21. If we also compare with the total flags included in each list we will see that about 32 percent of the Paris MoU white flags are flags of convenience and about 26 percent of all the flags described as Qualship21 are flags of convenience as well. On the other hand from the target list of the USCG, almost 65 percent are flags of convenience.

How flags of convenience affect Charterers and what is their position?

In general, when charters see a vessel, they divide flags into 4 main categories:

— Traditional flags of high quality according to their PSC history

— Flags of convenience of high quality according to their PSC history

— Traditional flags of lower quality (grey zone/black zone of the PSC MOUs)

— Flags of convenience of lower quality (grey zone/ black zone of the PSC MOUs)

Charterers would prefer to totally avoid flags categorised in (3) and (4) above, while a point of choice between (1) and (2) might exist in case of period time-charter or in case of a voyage-charter with loading and/or discharge taking place in the ports of developed countries, which are more sensitive in international regulations and the vessels’ condition. In this case, all other factors remaining the same, they would prefer to go with the (1) and in some cases, they might also pay a premium for such vessel. A problem that Charterers might face with flags of convenience is the higher cost of the cargo insurance which might be imposed on certain occasions and which would make a difference on the freight per ton. Another main problem might be a potential delay at ports due to the higher rate of PSC inspections and thus the higher risk for a long lasting detention (even if it on ship-owners’ shoulders). Despite the fact that, according to the Paris MOU’s evaluation, there are flags of convenience with better evaluation.

Inspections which have taken place on vessels with such type of flags seem to be much more than the inspections in similar quality closed flags. This is because the port state authorities believe that the flags of convenience are still riskier than other reputable traditional flags such as the Norwegian and Greek ones. The number of vessels registered in both closed flags and flags of convenience along with the number of inspections reported by the Paris MOU Port State authorities during the same period (2013-2015).

The Greek and Cyprus flags have about the same number of the registered vessels in their fleet, while their PSC evaluation is nearly the same (according to Paris MOU). However during a period of three years there were 2,008 inspections for Cyprus-flagged vessels and only 902 for vessels with the Greek flag. The same story applies to the Singapore flag and its comparison with two other flags of convenience (Marshall Islands and Malta). While two other flags of countries in the European region (Norway and Gibraltar) with similar PSC history seem to experience the same approach with higher inspections (proportionally compared with their registered vessels) for the country which is considered FOC.

Therefore, the Flags of Convenience seem not to be a bad thing and especially after the development of the Port State Control regime, there is an independent control on enforcement of the International regulations and the minimum vessel’s standards. Therefore, we see that few of the flags of convenience rated among the best quality flags in the world. On the other hand, the risk for these flags is still considered higher than the reputable closed flags and there are a lot of charterers who would still give a credit to vessels registered under such flags, especially in more specialised vessels or trades. Though, as the minimum international regulations and standards become stricter, the quality of these FOCs will also be necessarily improved in order to comply with the minimum requirement and I expect that the quality gap which still exists will further decrease in the next couple of years.

While most ship-owners are trying to increase their profits by decreasing their OPEX, the open sea marketplace helps them explore and develop more business options, find best-paying cargoes quicker than their competitors and increase their revenues. It is food for thought for our national line, which continues to make profit under close registry due to better management. However profitability will further improve by opting for open sea flags, be it a Pakistani offshore flag.