Leasing is expected to grow at a ‘significant’ pace over the next five years

By Jaye Bhogal and Lianjun Li, Reed Smith

 

Traditionally, the most common way of financing ships has been through debt and equity financing. However, over the past decade, ship leasing has become a very significant competitor and alternative for the provision of finance for the acquisition of ships. Recent market studies are expecting the global ship lease market to grow at a significant pace over the next five years – and that is already taking into account the expansion of Chinese leasing companies into the market over more recent years as well as the potential impact of Covid-19.

Recognising this growth and appetite for ship leasing transactions, the world’s largest international shipping association, BIMCO, set its sights on developing the industry’s first ship sale and leaseback standardised term sheet. The sale and leaseback term sheet ‘SHIPLEASE’ was released last month and will be rolled out to support shipowners, leasing companies, financial brokers and lawyers when negotiating and drawing up sale and leaseback agreements.

But what is ship leasing and why is it such a strong trend in shipping? We explore this growing market and look at what is in store for market players in these new and challenging times.

 

What is ship leasing? 

In the context of shipping, a lessor (as legal owner/leasing company) will give to a lessee (the operator/shipping company) in consideration of regular lease/hire payments, full possession and operational control of the ship for an agreed period. There are different types of ship leasing transactions with the most common types of leasing structures being: the operating lease, and the finance lease. These structures and terms are also significant from an accounting treatment perspective.

Operating leases are typically used for short to mid-term charter of the ship and at the end of such term, the ship is returned to the lessor. The lease can usually be terminated at the lessee’s discretion and it will (subject to the applicable accounting treatment) generally not appear on its balance sheet. On the contrary, finance leases are more commonly used for long term finance of ships. Here, the lessor acts as the financier and has little involvement with the ship other than owning it. The principle is based on the premise that the lessee should enjoy the benefits, and be subject to the risks, of ownership of a vessel because during the term of the lease, it will have possession and operational control of the ship. Finance leases will contain a ‘hell or high water’ clause meaning the lessee cannot in any circumstances terminate the lease or be excused from paying hire. If the lease is terminated early, the lessee must compensate the lessor.