TRANSPORT

ADVISORY

Shipping insightsIssue 3

Thriving in a changing world

Introduction 2

Anti-bribery and corruption issues 4

The future cost of climate change 11

Raising finance 15

New lease accounting proposals 19

A view from Asia 24

Contents

Introduction

Welcometoourthirdpublicationinour“ShippingInsights”series.Perhapsit’saclichétosay“weliveinunprecedentedtimes”,butit’saclichéthatseemstofit.Navigatingthroughoperationalandfinancialregulationhasbecomemorechallenging,butthereareopportunitiesforship-owningandship-managingcompaniestothriveinachangingworld.

Astheshippingsectoradaptstodealwiththeaftermathofahugelyturbulenttimeintheglobaleconomy,someoptimismisstartingtoenterthemarket.Tosome,theincreasingregulationisburdensome,toothersitprovidesanopportunitytodevelopstrategiesand“stealamarch”oncompetitors.

Issue3ofInsightsrecognizesthattherangeoftopicsbeingcoveredinBoardroomsiseverexpanding,andwehopethiseditionprovidesthought-provokingviewsinrelevantareas.

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In this issue we:

Considertheanti-briberyandcorruptionissuesfacingthesector – with the advent of new legislation in certain territories, we look at how some organizations see effective and robust anti-bribery and corruption policies as a “blessing in disguise”;

Outlinethefuturedirectionofacarbon-efficienteconomy – managing the effects of climate change is a global challenge, and the manner in which shipping companies respond will have material consequences to company profits and sustainability;

Lookatthechallengesofraisingnewfinance – with the severe tightening of the capital markets abating, we look at ways in which shipping companies can achieve funding targets;

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JohnLuke KPMG, Global

Head of Shipping

Assesstheimplicationsofnewfinancialaccountingstandards – rarely do accounting standards affect the operating model. However with new proposals issued by the International and US accounting standards setting bodies, many shipping companies may re-look at ways in which they finance and operate;

ProvideanassessmentofthepaceofrecoveryintheFarEast – we are seeing some green-shoots of recovery, but the view from our member firms in the Far East is that this remains fragile – for the time being at least.

If any of our articles provoke debate, we would be delighted to hear from you.

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Shipping Insights 3

Anti-bribery and corruption issues in the global shipping industry

Non-compliance with anti-corruption laws can have serious implications for companies with extensive overseas operations and especially those doing business in countries with recognized corruption risks. With the US Government strengthening its stance on enforcement of the Foreign Corrupt Practices Act, with the introduction in the UK of the Bribery Act and more countries looking to bolster local bribery laws, it is imperative that companies ensure that their global networks operate under robust anti-bribery and corruption compliance programs. Indeed, the implementation of a robust anti-corruption compliance program could secure long term advantages to a company in terms of corporate culture and control.

Introduction

Today’s global shipping and logistics companies operate in a highly challenging global regulatory and enforcement environment. Despite the global economic downturn, companies are expected now, more than ever, to operate within an anti-corruption framework that is set by a range of far-reaching legal and regulatory requirements.

The penalties for “getting it wrong” and for falling foul of these anti-corruption laws can be severe – including heavy fines, imprisonment and debarment from participating in government business, as well as damage to corporate reputation and, ultimately, to the company’s bottom line.

The US Foreign Corrupt Practices Act (FCPA) and UK Bribery Act are not the only anti-corruption laws that the industry should be aware of. In 1997, 32 countries, including the United States and United Kingdom, signed the OECD Convention against Bribery of Foreign Public Officials in International Business Transactions, which imposed on all the signatories the obligation to enforce the Convention under local law; that number has now risen to 38 countries. Today, most global corporations will be based in an OECD country that will have their own local anti-bribery laws.

Additionally, the US Government operates a number of other far-reaching regulatory obligations such as US Trade Sanctions/ Export Controls, the USA Patriot Act and Anti-boycott Regulations. If companies undertake transactions using the US banking system, liability may also attach under these laws.

This article will present an overview of two of the primary pieces of legislation in this area, the FCPA and the UK Bribery Act, and how these will affect the global shipping and transport industries.

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TheUSForeignCorruptPracticesAct1997

In terms of global anti-corruption enforcement trends, the FCPA truly represents the so-called “long arm” of American jurisdiction in terms of the US Government’s desire to root out corrupt activities in any entity’s overseas operations where that entity has the required US footprint.

The FCPA is in two parts. Under the first, as enforced by the Department of Justice (DOJ), the FCPA’s anti-bribery provisions make it a crime to offer or pay money or “anything of value” to a foreign government official with the intention of winning or retaining business. The provisions apply primarily to U.S. companies and citizens, foreign companies listed on a US stock exchange or with the appropriate nexus to the United States and to any person acting while in the United States.

Under the second, as enforced by the Securities & Exchange Commission (SEC), the FCPA’s books-and-records and internal controls provisions require companies that trade securities on US stock exchanges to keep accurate books and records and to maintain an adequate system of internal financial and accounting controls.

Penalties for breaches of the FCPA can be severe on both the corporate entity and individuals including fines, imprisonment, disgorgement of profits and debarment from participating in US Government business.

The FCPA applies for the most part to US companies and citizens, non-US companies listed on a US stock exchange and any person acting while in the United States. Over recent years, the US Government has been aggressively applying the Act’s reach to include jurisdiction over non-US companies and individuals that they consider have the appropriate nexus with the United States.

Enforcementtrends

Since the late 1990s, the DOJ and SEC have adopted increasingly aggressive and high-profile tactics in investigating and enforcing FCPA violations against both individuals and organizations. The current focus is on the so-called “high-risk” industries and against non-US companies and individuals for stepped-up enforcement. This puts the global shipping and logistics companies – as well as the companies who utilize transoceanic shipping companies – in the spotlight.

The following illustrate some of these enforcement trends as they relate to the industry:

Recordfines. Some of the world’s biggest companies have incurred – and will likely continue to incur – very substantial penalties as a result of FCPA violations. By way of example, Siemens AG in 2008 resolved its long-running, global investigation into corrupt payments made through third parties in multiple jurisdictions by the payment of US$800 million to the US DOJ and SEC in fines, penalties and disgorgement of profits. In 2009, KBR/Halliburton paid US$579 million in respect of bribes paid to Nigerian customs officials. In June 2010, Technip S.A. paid US$338 million again in respect of bribes paid to Nigerian government officials.

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Applicationtonon-USindividualsandcompanies. The DOJ and the SEC have been focusing attention on expanding the FCPA to combat corruption carried out by non-US individuals and companies. Global shipping companies need to take this trend seriously. To establish jurisdiction, the only requirement is that the authorities consider the target company has a nexus or contact with the United States. In recent enforcement actions, this has been established in part by the use of the US banking system and by email servers being located in the United States.

In theory and in practice, this means that (for example) a European shipping company with a limited corporate footprint in the United States and which conducts no business to or from the United States but that uses the US banking system in respect of its overseas operations could unwittingly come under the jurisdiction of the FCPA.

Individualsaregoingtojail. Since 2009, individual prosecutions have become an enforcement priority for the DOJ and these cases often are focused on the individuals who pay bribes and those who facilitate them.

“Small”bribesarestillbribes. The FCPA does not have a materiality threshold or minimum. In both the cases of Panalpina and Con-way, the individual sums paid to customs agents were considered relatively small.

Paymentsbysubsidiariesandbusinesspartners. Companies with overseas operations in multiple geographies will usually by necessity if not by local law require the legitimate services of local business partners and advisors – achieved by means of subsidiaries, joint ventures or through acquisition. Under the FCPA (and Bribery Act), the parent company can be held liable for bribes paid on its behalf by its third party business partners regardless of the lack of any actual, day-to-day oversight of the partner’s operations.

Through the FCPA, the US Government has been seeking to level the playing field of US companies doing business overseas in a business climate where bribery and corruption should be not tolerated. The DOJ and SEC appeared determined to continue aggressively to focus on particular industries for stepped-up enforcement.

TheUKBriberyAct

The UK Bribery Act 2010, passed into law in April 2010 and likely to be implemented by spring 2011, is designed to demonstrate the UK Government’s resolve to “get tough” on bribery. On paper, the Act creates arguably the toughest enforcement regime in any jurisdiction – indeed some of its key features go beyond the requirements of the FCPA.

The Bribery Act creates four separate offences: offering or paying a bribe to any person; requesting or being paid a bribe by any person; bribing a foreign public official; and the strict liability corporate offence of failure to prevent bribery.

A corporate body found guilty of any of these offences can be subject to monetary penalties which may be unlimited in cases of failure to prevent bribery, and individuals may be fined or imprisoned.

The Bribery Act applies to UK companies, citizens and residents regardless of where in the world the alleged bribery occurs. It will also apply to non-UK companies with operations in the UK even if the bribery took place in another country. In theory, a European shipping company with UK operations that engages in bribery outside the UK could be prosecuted under the Bribery Act in the UK for its failure to prevent bribery in its overseas operations.

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Of particular note, the Bribery Act goes beyond the requirements of the FCPA in a number of key areas:

The Act prohibits the payment of bribes to, and the receipt of bribes from, any person (not just a foreign public official), anywhere in the world.

Senior officers of a company can be held personally liable for offences committed by the company if those offences have been carried out with their “consent” or “connivance”. It is foreseeable that this could apply to a country manager who knows but chooses to ignore the fact that his local sales team “do what it takes”, i.e. pays bribes, to win business in a competitive, new market.

The corporate offence of failure to prevent bribery can be established when the bribe is carried out by an “associated person” of the company. This can include payments made by a third party agent, subsidiary, joint venture partner etc. so long as that individual is “performing services” on the company’s behalf. Whether the parent company has any direct control over that individual may not be relevant.

Under the strict liability offence, the company itself can be prosecuted for its failure to prevent the bribery from having been committed. The legal burden then shifts on to the company for it to prove that it had “adequate procedures” in place that would – or should – have prevented the bribe from having occurred in the first place. There is no definition in the Act of what constitutes “adequate procedures” although the Act requires that the UK Ministry of Justice should issue guidance, expected in autumn 2010 roughly six months before implementation of the Act.

When the Act goes live, the expectation is that it will be enforced aggressively by the Serious Fraud Office (SFO). The Bribery Act has “teeth” and the SFO’s prosecutors are deploying accordingly.

Relevancetotheshippingindustry

We have identified in broad terms four main areas where the activities of the global shipping industry is likely to be at risk in respect of where its primary corruption risks will lie. The four areas are:

Operating in the so-called high risk jurisdictions, in fragile democratic systems and in countries with known corruption risks;

Interacting with public officials, for example in connection with payments made to port and customs officials to evade tariffs, avoid storage costs, obtain licenses, release confiscated goods or services and demurrage;

Providing transportation services to other, high-risk sectors such as defence, construction and energy and natural resources; and

Using in-country agents, subsidiaries or entering into joint ventures, including cooperation with local businesses, or using commission-based incentive structures, and handling transactions which might be related to politically exposed persons (PEPs).

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Shipping Insights 7

These corruption risks are of course in addition to the fraud risks that typically will occur to any company with global operations and decentralized structures, such as manipulation of financial statements, cash skimming, payment fraud, procurement fraud and revenue leakage.

Compliance

These anti-corruption laws are far-reaching and they place considerable operational and corporate governance requirements on any company let alone those with global operations. In KPMG’s view, this means that the development, implementation and monitoring of a robust Anti-Bribery and Corruption (ABC) compliance program should be not just a corporate imperative but could also be seen as a “blessing in disguise” for those companies who realize and act upon the implications in terms of the benefit to the company’s corporate culture and control.

At its simplest, an effective ABC compliance program needs to consider and address what specific corruption risks are faced by the company in its various lines of business, who its customers are, who its suppliers and partners are, and where in the world it operates.

An ABC program should be carefully tailored to allow head office and local management to have sufficient control and visibility over the company’s operations.

To begin with, the success of any ABC program will depend upon three key factors. The first is the “tone from the top” in terms of how the program is set and driven by the board. The second is the “tone from the middle” which requires that senior and local management are fully brought in to the policies and also given the resources to maintain and enforce the policies across their regions, business lines and staff. Finally, the company’s on-the-ground, outward/customer-facing employees should also be fully conversant with and adhere to the company’s ABC code. By necessity, this means that the training of all staff depending upon levels of seniority will be crucial, as will be continuous monitoring to help ensure that there is adherence to the policy.

Whilst the need for an ABC program is clear for those companies operating directly within the scope of the FCPA and Bribery Act, it is also now clear that companies that wish to partner with US and UK/EU companies also need to demonstrate that they have similar ABC programs in place. Indeed, the existence and operation of such programs is now seen as a distinct business advantage if not requirement, or the absence of one a possible hindrance, during the selection process.

On a related note, and primarily because the corrupt actions of a third party can result in liability attaching to the parent company, this has further emphasized the need for companies to undertake detailed due diligence enquiries of potential business partners during the selection process. This will likely occur in any M&A or Know Your Customer context and will be in addition to the legal and accounting due diligence. Areas to analyze include: the identity, reputation, track record and other corporate relationships held by the target company’s officers, board members and shareholders; an examination of their sources of wealth, connection to PEPs and government entities; a flow of funds analysis and review of the company’s books and records for corruption indicators.

Similarly, post-relationship, many companies are also insisting upon and exercising monitoring rights over their business partners, to include cascading audit rights and the requirement that the local entity complies with and or adopts the company’s ABC policy.

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Finally, companies are also preparing corporate response plans in the event of an investigation or regulatory matter, when typically time of response will be of the essence. Included in these plans is to delineate the roles played internally by key functions such as legal, internal audit, IT and externally by outside counsel and forensic experts.

ThefoundationsofanABCcomplianceprogram

Given the established guidance and field of cases regarding the FCPA and other bribery and corruption laws, and based on our firms’ experience gained from these in regard to better practices, it is likely that a robust ABC compliance program should include the following:

Boards taking responsibility for ABC;

Appointing a senior officer accountable for oversight;

A clear statement of the company’s anti-corruption culture;

Documented policies and a code of ethics, applicable regardless of local laws or culture, which must also apply to business partners;

Consistent disciplinary processes providing for individual accountability;

Assessing risks specific to the organization;

Financial controls and record-keeping to reduce the risk of bribery;

Policies and procedures on gifts and hospitality, including a hospitality register, and facilitation payments;

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Shipping Insights 9

A policy and procedures on the use of outside advisers/third parties including vetting, due diligence and appropriate risk assessments;

A policy covering political contributions and lobbying activities;

Training to help ensure dissemination of the anti-corruption culture to all staff;

Establishing whistle blowing procedures e.g., a helpline;

Regular and risk-based checks and auditing;

Wherever possible, implementation of procurement and contract management procedures to minimise the opportunity for corruption by subcontractors and suppliers;

Monitoring for compliance, including the execution of third party audit rights; and

A documented response strategy and investigative procedures.

Conclusion

By nature of where, how and with who it operates, the global shipping industry carries with it certain inherent bribery and corruption risks, but it must also operate under a legal and regulatory framework that is increasingly onerous and far-reaching. In our view, one of the most productive ways for the industry to respond to these challenges is by embracing their requirements by building “fit for purpose” ABC compliance programs. Some of the essential benefits include the effective, proactive management of risk and the long-term business advantages this can bring.

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KPMG contact:

TomHopkinson Tel. +44 207 694 5304 tom.hopkinson@kpmg.co.uk

KPMG’s Anti-Bribery & Corruption practice provides services to our firms’ global Transport clients relating to implementation of the Bribery Act, maintaining compliance

with the FCPA and related legislation, and investigating alleged violations and financial irregularities. Our services are split into three core areas:

Compliance – advising on the development and implementation of effective compliance programs to help prevent, detect and respond to ABC issues;

M&A and integrity duediligenceenquiries – assisting organizations to identify potential corruption issues as well as advising organizations on making informed decisions about the individuals and third parties they wish to conduct business with; and

Investigations – providing cross-border investigations of violations, accounting irregularities and asset misappropriation, using a range of forensic accounting, technology and investigative skills.

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10 Shipping Insights

Bringing the price of carbon onto the balance sheet and boardroom agenda

Climate change is a truly global challenge. Across industries businesses are responding to the human contribution to climate change through the management and reduction of green house gases (GHGs) most significantly the release of carbon dioxide (CO2).

The aim of this article is to highlight areas where, despite transportation’s exclusion from the Kyoto Protocol, major shipping companies nevertheless have to plan for and deal now with climate change related challenges. We also look at what may happen in international regulation to address the issue of climate change and the maritime sector.

Background

Established by the United Nations (UN) the Kyoto Protocol is the International agreement for the reduction of carbon dioxide through which ratifying countries established CO2 reduction targets. The protocol also established market mechanisms to incentivize emission reductions including carbon trading, the clean development mechanism and the joint initiative.

International transportation was not included in the Kyoto Protocol as it was considered to be the responsibility of the two main UN organizations overseeing international shipping (International Maritime Organisation – IMO) and aviation (International Civil Aviation Organisation – ICAO). Hence, the Kyoto Protocol has a reference to the pursuance of such emission reductions by the IMO and ICAO. As yet, neither the IMO nor ICAO have developed mechanisms equivalent to those established at Kyoto.

Both organizations are actively considering the steps they might take but, as yet, neither have come forward with processes likely to achieve equivalence with those established at Kyoto.

Consequently the EU has introduced regulation to include the aviation sector into the EU emissions trading scheme (ETS) as of 2012 and is considering doing the same for international shipping.

For shipping business there is the additional challenge, UN negotiations will be ongoing through 2010 and 2011 with the intention of developing a legally binding international agreement to succeed Kyoto. It is almost certain such an agreement will take consideration of both aviation and maritime CO2 emissions.

Shipping’scontributiontoclimatechange

International shipping provides the overall lowest carbon intensity for long haul transportation and needs to incorporate this into making the case for an appropriate sector reduction mechanism.

Shipping Insights 11

However in 2007 international shipping emissions were estimated to be 870 million tonnes of CO2. This is 2.7 percent of all global emissions. Mid-range projections indicate that without a concerted policy approach this will increase by between 150 percent and 250 percent by 2050(1).

As other sources of CO2 are stabilized and reduced, for example through the EU ETS, the relative contribution from an unabated shipping industry will proportionately increase putting even greater pressure to act.

Theeffectsofclimatechangeonshipping

The physical effects of climate change will pose challenges for international shipping and the maritime sector as a whole. The predicted increase in frequency and severity of weather events is likely to increase, with impacts on routing, journey times, insurance cover etc.

Counter balance this with possible positive effects like the opening of Arctic routes with the subsequent shortening of shipping journey times.

Overall the predicted effects of climate change on the maritime sector pose significant future challenges, challenges which should now be factored into strategic planning and corporate risk management.

Optionsformanagingclimatechangeinthemaritimesector

The IMO through its Marine Environment Pollution Committee (MEPC) has been working hard to develop policy responses that are intended to stabilize and reduce the release of GHGs from the sector, whilst at the same time, meeting the expectations of the EU and its wider global stakeholders.

Options being considered are both technical and market based. Technical options include a mandatory energy efficiency design index and ship efficiency management plans.

The most commonly spoken about market mechanisms are a maritime emissions trading scheme (METS) and an international compensation fund (ICF) to be financed by a levy on marine bunkers.

In March 2010 an expert group was set up by the IMO to conduct a feasibility study on the development and implementation of market mechanisms as a policy tool. A number of proposals have been put forward to the MEPC including those by France, Germany, Norway and the UK.

These proposals have a common central idea of a global METS based on the allocation and surrender of carbon allowances and advocate allowance auctioning as opposed to the free allocation of allowances which characterized the initial phases of the EU ETS and led to problems including windfall profits and market distortions.

Pricing carbon emissions is widely seen as the best stimulus for development of new low carbon maritime technologies. Emerging technologies that are likely to benefit include the use of new and improved propulsion devices such as contra-rotating propellers, steam plant improvements and electronically controlled engines. As the price mechanism takes effect, technologies such as wind generators, kite assisted

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propulsion, solar panels and fixed sails or wings become more and more viable as retrofits or incorporated in the new design and build of ships. Innovations in hull condition, improved hull coatings and the introduction of air cavity/hull lubrication technologies will also emerge. The options for strategic approaches to voyage planning will also be more frequently used to improve performance and emissions including engine monitoring, slow steaming and weather routing.

Challenges

Developing a globally applicable market based mechanism on the necessary scale poses fundamental and important challenges. For example, such schemes need a qualifying threshold for participation, a baseline year, a cap on emissions and an emissions reduction path over a given period of time.

Other challenges include establishing the governance and operations of a coordinating administrative body, establishing global oversight and enforcement of the scheme, and enabling a robust process for carbon allowance auctioning.

The co-ordinating body will have much to do addressing such things as the interaction of maritime allowances with other existing and developing carbon markets. Highly fungible allowances will stimulate a higher level of carbon trading and more options for trading and hedging strategies.

Howmuchwillthiscostandwhowillpay?

The price of carbon is based on a number of market factors. The EUA (equivalent to 1 tonne of CO2) spot price is currently around US$20. Some analysts predict that if the EU were to increase its 2020 emissions reduction target from 20 percent to 30 percent this would take the price to US$25. Market analysts also predict that the average price of carbon for phase III EU ETS (2013 to 2020) will be between US$38 to 50 but may jump above that higher end value towards the end of the period (2).

The cost implications for international shipping and the price of transported commodities will vary dependent upon fuel prices and the cost of carbon at any given time. Recent cost modelling(3) indicated the CO2 cost percentage of operating and voyage costs for different types of vessel range from 14 percent for handysize bulkers and tankers to 18 percent for capes and VLCCs and 22 percent for container main liners. The modelled impact of the additional transport costs on the price of goods was 1 percent for agricultural, 2 to 3 percent for ores and coal, 0.4 percent for crude oil and 0.4 to 0.8 percent for manufactured goods.

In a global carbon trading mechanism the majority of the cost increases associated with the METS will be passed onto the consumer of the goods and materials transported. There are a relatively large number of different players involved in the shipping industry. Clarity will be needed to determine which party has what emissions responsibilities – owners, operators, ship managers, charterers or the ship despondent owner.

Auctioning of allowances will generate a significant fund, the size of which will depend on the proportion of allowance auctioned, the price of allowances during the auction and linkage with other schemes. It has been estimated(4) that full auctioning will generate in the order of US$15 to 30 billion with a carbon price range of US$15 to 30 per year.

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The use and management of these funds is also a matter for further consideration: to use them to offset negative effects of the scheme on developing country participants; to assist developing country climate change mitigation and adaptation projects; and to support technological research and development within the maritime sector.

Conclusion

International climate change attention is now firmly focused on the transportation sector and, in particular shipping operations.

Pressure from the EU emphasizes the urgency for a workable and equitable solution to be developed quickly. Failure to do so may well result in the sector being brought into the EU ETS.

Work at the IMO is focusing on a number of options and it is likely that there will be a combination of technological and market based solutions adopted. Whatever the outcome, the sector as a whole (including the supply chain as shipping customers become more carbon sensitive) will soon need to factor in the price of carbon.

Experience shows that proactive, strategic approaches by new entrants to carbon markets leads to significant cost and operational risk reduction and, in a number of cases, delivers market and competitive advantage.

1. Second IMO GHG Study 2009, update of the 2000 IMO GHG Study MEPC 59/4/7

2. Point Carbon News, Carbon Market Daily Volume 06 Issue 82 4th May 2010

3. CE Delft et.al.2010 (cost increase ratios depend on fuel price and allowance price assumptions (2007). Calculations based on a fuel price of USD360 per metric tonne and an allowance price of USD 30 per metric tonne of CO2).

4. MEPC 60/4/54 Impact assessment of an emissions trading scheme with a particular view on developing countries

KPMG contact:

SimonDavies Tel. +44 207 694 3377 simon.davies2@kpmg.co.uk

KPMG firms are assisting companies to understand and plan for the future financial and commercial climate change risks and opportunities on national, regional and international levels.

We can help you integrate these considerations into your day to day considerations and into your short, medium and long-term business plans.

KPMG firms provide strategic advice and tactical assistance to the maritime sector in the areas of climate change and carbon and sustainability. We help clients develop robust and effective internal programmes that are designed to reduce current and future risks and at the same time help clients prepare for the opportunities that moving to a low carbon economy will present.

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The sudden and severe shortfall in demand, coupled with substantial overcapacity has significantly reduced asset values and company profitability. This trend may well continue, with medium forecasts indicating large oversupply across the three main shipping sectors (oil, bulk and containers).

Note: Excess supply is based on Drewry base case projections and takes into account replacement requirements; oversupply is forecast in all three demand scenarios (low, base and high); slippage, cancellations and negotiated delays may reduce excess supply somewhat but are unlikely to result in balance.

Source: Clarkson Research; Drewry, Feb 2010

Container shipsBulk carriersOil tankers

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Scheduleddeliveries2009-2013

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Scheduleddeliveries2009-2013

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Forecastrequirement2009-2013

Scheduleddeliveries2009-2013

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Million cgt Million cgt Million cgt

Portsaresqueezed; Until middle of 2008, the main worries for most port operators

were congestion and a lack of infrastructure to cope with growing demand. Now, with

shipping companies trying to save money by minimizing port calls, operators also face

leaner times (source: The International Herald Tribune – January 16, 2010).

Challenging times for Shipping companies in achieving funding targets?

Over the last two years the shipping sector has been severely hit by the effects of the economic crisis. Depressing headlines were common place.

Crisisrivertransportintensifies; The river transport section is suffering from overcapacity up to 20-30% in the dry bulk segment. Because of the crisis, demand for inland cargo shipping has decreased sharply (source: Financieel Dagblad – February 3, 2010).

Shippingcompanieshitbydownturn;

The [shipping] industry has been hit hard by

the collapse in global trade. Attempts to save

money have left many vessels out of service

(source: BBC News – March 4, 2010).

Anunprecedentedshortfallinroadfreightcarryings: The European road freight market is in crisis. Even the strongest companies have experienced significantly falling volumes and certain sectors have seen a reduction of up to 50% (source: Logistics handling – August 5, 2009).

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The plight of ship owners has been shared – in part at least – across the full supply chain. Port operators are also under pressure as projects to increase capacity have come on line just at the wrong time.

Aglobaltransportandshippingcrises

Perhaps the shipping sector isn’t quite in crisis, but the speed at which the markets changed surprised us all – major and minor players together with their financiers were severely hit. To put it in some context, the combined 2009 losses of shipping line companies have been in excess of US$20 billion.

All have had to take actions to shore up balance sheets and cash flows. In KPMG firms’ experience, the most common responses have been to undertake major cost reduction programmes through staff redundancies, laying up of vessels (either hot or cold), slow steaming, cancelling leases or new build contracts, renegotiating charter rates or postponement of maintenance. Other companies have been looking at ways of improving working capital, initiating bond and share issues and (trying to) renegotiate loans and financing arrangements.

Theroadtorecovery

The first signs of recovery have become apparent in recent months. Shipping and port companies are reporting second quarter increases in volumes, better rates and improved operating margins. Truck deliveries have been steadily increasing suggesting further market strengthening. KPMG member firms have seen a pick-up in global M&A activity across the sector. With volumes now gradually climbing back to pre-crises levels, one of the key questions now remains whether rates will follow a similar pattern in the short to medium term?

Source: Drewry, Annual Review of Global Container Terminal Operators, 2009.

International Herald Tribune, As shipping industry cuts back, ports are squeezed, January 16 2010.

Global port container throughput versus container capacity growth development

20092008 2010Capacity Throughput

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619580542507476471

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Moreriskadverseinvestorsandfinancialinstitutions

The flexibility of banks and other financial institutions has been put to the test with the increased need for cash and credit. Several industry research studies and our own observations have highlighted the difficulties in successfully (re)negotiating and securing loans and other lines of credit. In KPMG firms’ experience, smaller and medium sized companies have had more acute problems, with the larger operators evidently exercising more bargaining power with not just the banks and other financial institutions, but also customers and suppliers as payment terms and rates have been flexed and altered.

We have seen banks and other financial institutions becoming more risk adverse. As margins and cash flows of shipping companies have deteriorated covenants have been put at risk. With risk policies tightened within banks and other financial institutions they are assessing the strength of shipping companies in a much wider context. The “domino effect” whereby consideration is given to the impact across the entire value chain is forming an integral part of their risk analysis.

Amoreproactiveapproach

Providers of finance have also started to show a greater interest in the management teams of distressed companies. Those with relevant experiences of navigating companies through periods of financial stress or economic downturns appear to be looked upon more favourably. Lenders have also taken steps to recommend outside support to management teams, and in the severest of cases parachuting one of their own representatives into the organization to assist in the financial turnaround. This approach is not too dissimilar to the operating philosophy of private equity.

But “the right team” is only half the story. Funding partners, by default focus on the company’s structural risks (where is the loan positioned, what are the redemption options, should the loan burden be shared, what should the risk premium be). In this context it is important to what information and what level of detail should be provided. Lenders are requesting more detailed information, more frequently and on a transparent basis. Some companies have struggled with this intrusive approach. Annual budgets and reforecasts are no longer considered sufficient. Banks and other financial institutions increasingly require more detailed, substantiated business plans, which contain comprehensive analysis and set out a clear vision for the business going forward.

But more than this, lenders want to understand and challenge the business model risk profile and in this context scenario analysis (or “stress testing”) is essential. It is not uncommon for lenders to ask companies to run a whole range of sensitivities for them to get a better grip of the drivers of profit and cash.

Presentingthebusinessplan

KPMG firms’ advice is simple – never go and meet a funding partner with a “half cooked plan”. Robustly challenge your own assertions, build solid relationships with debt providers and, from time-to-time at least, put yourself in their shoes.

Shipping Insights 17

KPMG contact:

EdwinvanderStam Tel. +31 104 534332 vanderstam.edwin@kpmg.nl

KPMG’s Transport and Logistics practice provides a range of Advisory services including Business effectiveness,

IT advisory, Restructuring, Risk and Transaction Services.

What does the current debt position look like?

�

What has been the basis of preparation of the

business plan?

3

What are the Company’s key markets and

what is the Company’s competitive position?

�

What is the Company’s strategy and what is

the outlook?

�

What (financial) results have been achieved in

the recent past?

7

What sensitivities have been identified, including

a substantiated view on a downward and

worst case scenario?

9

Realistic view of management on the business

plan (and if appropriate of an independent third

party expert)

10

What is the current operating model?

1

What are the key business drivers and

their influencing factors?

�

What does the (financial) forecast look like for the next 3 to 5 years, including conditions

and assumptions?

�

1� Shipping Insights

The aim of the exposure draft is to respond to longstanding criticisms that lease accounting has been too permissive of off-balance sheet treatment by lessees, overly complex and dominated by arbitrary rules. A key component of the Boards’ proposals has been the intention to eliminate the requirement to classify a lease as an operating or finance lease and instead propose a consistent lease accounting model for all lessees and lessors.

Leasing is an important source of finance and investors want a complete picture with comparability. Credit providers often employ various techniques such as present value method (capitalize the present value of disclosed lease commitments) or a factor method (e.g. seven times operating rent expense) to adjust financial statements to reflect notional capitalization of operating leases. The intention is that the new standard will provide all users of accounts better, more reliable information.

As the Boards move toward finalising their proposals companies have the opportunity to voice any concerns. With a comprehensive consultation process now underway, companies have until 15 December 2010 to digest the proposals and provide the IASB and FASB with their views.

Do you enter into a charter agreement and work out the accounting impact later… maybe it’s time you changed?

The International Accounting Standards Board (IASB) together with the US Financial Accounting Standards Board (FASB) have recently published an exposure draft (ED) on lease accounting. The proposals, if accepted, will have significant consequences for ship owning and operating companies.

Shipping Insights 19

Keyimpacts

The right-of-use model

For lessees, the Boards propose the right-of-use model, in which the lessee recognizes an asset for its right to use the underlying asset and a liability for its obligation to make future lease payments. That is, all leases will be “on-balance sheet” for lessees, subject to certain scope exemptions.

The right-of-use asset would be recorded initially at the present value of the lease payments, plus initial direct costs. It would then be amortized over the life of the lease and tested for impairment. A lessee could revalue its right-of-use assets. The right-of-use asset would be presented within the property, plant and equipment category on the balance sheet but separately from assets that the lessee owns. The liability would be measured at amortized cost, using the effective interest rate method, with an interest expense recognised in the income statement. The discount rate would be the lessee’s incremental borrowing rate, or the rate the lesser charges the lessee if readily determinable.

The Boards have recently devoted significant time to lessor accounting issues and decided to expose two significantly different lessor accounting models for comment: the performance obligation model and the derecognition model.

Lessors would be required to assess which model to apply on a lease-by-lease basis. If a lessor retains exposure to significant risks or benefits associated with the underlying asset, then it would apply the performance obligation model, otherwise it would apply the derecognition model.

The performance obligation model

The performance obligation model focuses on the additional rights and obligations created by the lease contract. Under this model, the lessor continues to recognize its interest in the underlying asset and recognizes a new asset for its right to receive future lease payments (or lease receivable) and a corresponding liability for its obligation to deliver use of the leased asset to the lessee (or performance obligation liability).

During the lease term, the lessor will continue to recognize depreciation on the underlying asset, and recognizes finance income on amounts receivable from the lessee and lease income arising from amortization of the performance obligation.

The lessor will not recognize a gain on commencement of a lease under this model, assuming that the lessor has a single performance obligation, being its obligation to grant the lessee the right to use the asset for the lease term.

�0 Shipping Insights

Right-of-usemodel

Balancesheet Right-of-use asset X Liability to make lease payments (X)

Incomestatement Amortization expense (X) Interest expense (X) Impairment (X)

leas

ere

nta

ls

rig

ht

tou

se

leas

eda

sset

s

Lessee

Lessor

NO

Performanceobligationmodel

YES

Derecognitionmodel

Balancesheet Underlying asset X Right to receive lease payments X Lease liability (X)

Incomestatement Lease income X Depreciation expense (X) Interest income X Impairment (X)

Balancesheet Residual asset X Right to receive lease payments X

Incomestatement Revenue X Cost of sales (X) (gross or net based on business model) Interest income X Up-front gain X Impairment (X)

Isthereatransferofsignificantrisksorbenefitsoftheunderlyingasset?

The derecognition model

The derecognition model views the lease contract as if it has transferred a portion of the underlying asset to the lessee. Under this model, a lessor derecognizes a portion of the leased asset, reclassifies the remaining portion of the underlying asset as a residual value asset and recognizes a lease receivable due from the lessee.

During the lease term, the lessor will recognize finance income on the lease receivable and any impairments in the income statement.

The lessor may recognize a gain on commencement of the lease under this model, if the initial carrying amount of the lease receivable exceeds the carrying amount of the portion of the leased asset that is derecognized.The lessor presents the lease income and expense on a net or gross basis to reflect the lessor’s business model.

Shipping Insights �1

Other considerations

In contrast to the current lease term (being the minimum contracted period plus any additional periods for which it is reasonably certain that the lessee will extend the lease), the proposals would require lessees and lessors to determine the lease assets and liabilities on the basis of the longest possible lease term that is more likely than not to occur. Purchase options should be excluded from lease accounting as these are considered a termination of the lease contract when exercised.

To address concerns that the cost of tracking information could outweigh benefits the proposals include simplified accounting for short-term leases, with a maximum possible lease term of less than 12 months. Under this simplified model the lessee would recognize a right-of-use asset and a liability measured at the undiscounted value of the lease payments, and the lessor would use accrual accounting.

The ED proposes that an intermediate lessee/lessor should apply the proposed lessee accounting model to its head lease and the proposed lessor accounting models to its sub leases. It appears that these requirements may result in an economically identical head lease and sub-lease being measured differently.

In-substance purchases (lessee) and sales (lessor) will be exempted from the proposals, i.e., transactions in which control passes to the lessee at the end of the contract, and the risks and rewards retained by the lessor are not more than trivial. Accordingly, many existing finance leases will become in-substance purchases outside the scope of the proposals, with the contractual payments falling within the scope of IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9 Financial Instruments.

Whatdoesthismeanforyou?

Our view of the potential impact for leases in the shipping industry is as follows:

Consequencesoftheproposals

The devil is often in the detail and the proposed change to lease accounting will require companies to reasses their lease arrangements.

The scope of the proposed standard will become a key focus area for structuring opportunities in the future. With in-substance purchases not in scope, this will be a significant area of judgement, similar to the determination of operating or finance leases currently. Lessors and lessees are likely to have different drivers when arranging finance.

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•

•

Type of contract Current IFRS treatment Future impact

Voyage charter Outside scope Likely to be outside scope, seen as a purchase of servicesContract of affreightment Outside scope

Time charter Operating lease Recognize assets, liabilities and additional charges in the income statementBareboat charter Finance/Operating lease

�� Shipping Insights

Structuring of shorter term leases under 12 months may become more common to take advantage of the simplified accounting proposed in the ED, in order to simplfy the accounting or to reduce impact on the balance sheet.

The proposal to exclude the exercise price of purchase options from lease payments might also create structuring opertunities, given that the purchase option maybe economically similar to a renewal option in some cases.

Companies will need to check whether they negotiated frozen GAAP covenants, or start to engage with lenders to address the conseqences.

EBITDA ratios are a key profit measure for the industry, investor communications will need to be adapted. Additionally bonus schemes and employee share plan targets are often based upon measures of EBITDA. These will need to be adjusted or reconsidered by Human Resource departments.

With more countries adopting IFRS, shipping companies across the world are likely to be affected.

Change,changeandmorechange!

As we reported in Insights 2, a significant number of proposals are being issued by accounting standard setting bodies. Both the international standard setter and the US standard setter continue to work together to converge US GAAP and IFRS.

Many of the projects being considered will impact shipping companies. In addition to the lease accounting discussions, finance teams are also trying to unpick proposals for revenue recognition, financial instruments and financial statement presentation. Depending upon where you sit in the supply chain, you might end up recognizing revenue at a different point in time and may well need to invest in changes to systems capturing revenue data.

•

•

•

•

•

KPMG contact:

IanGriffiths Tel. +44 2 07311 6379 ian.griffiths@kpmg.co.uk

KPMG’s Accounting Advisory Group has practical experience of assisting companies with expected or actual changes to accounting standards. KPMG member firms are already

helping companies review existing lease contracts to establish the impact of these proposals and assisting companies plan for these changes through consideration of investor communication, process documentation and staff training.

Shipping Insights �3

A view from Asia

We cannot recall a period of such turbulence in the global shipping market and operators in all regions have been similarly affected.

Two years ago everyone in the sector was focused on increasing port and terminal facilities – the race to build bigger, more efficient ships was hot and the global shipping market was booming. Then the markets changed… freight rates dropped right off as demand plummeted just at the time when the global fleet was expanding. Laying up was the only option for many, with previously fit companies looking to survive.

In Asia, we’ve started to see the “bounce-back”. Idle ships are coming back into service and there is a renewed sense of optimism in the air. But the challenge for all operators is to understand how firm the recovery will be and how best to navigate to enable them to take advantage of the opportunities presented.

In this brief article, we assess the strength of recovery in the container and dry-bulk sectors in Asia.

Container

Over the past year the Asian economies have led the recovery of international container trade volumes to such an extent that there may be a re-emergence of the pre-recession pressure on freight infrastructure.

Intra-Asia was already one of the world’s largest container markets and we see this trend continuing as Asian economies and consumer markets further develop. Along with China and India, which are driving expansion in the Asia Pacific, encouragingly South East Asian economies such as Vietnam and Indonesia are also on the growth trajectory in 2010.

However, for the medium term at least, China and India will remain the two main drivers of growth in Asia. The IMF forecasts that these economies will grow 9.9 percent and 8.4 percent respectively in 2011. The investment in infrastructure and urbanization process in China and India will help to enable the continuous rapid growth of these economies for the next 20 years. Perhaps the next phase of development will be the growth of rail infrastructure which will further open the countries’ interiors to increased export production.

Positivedemandexpected

The recent hints of recovery appear to be driven by genuine demand for cargo. Consumer spending is in the midst of a trend recovery, underwritten importantly by the rebound in jobs and incomes. On top of genuine demand recovery, the continuous inventory re-stocking will also help boost container traffic in the next few years. Consumers are more positive about the economy and retailers are building up their inventories to meet that demand.

�� Shipping Insights

The global PMI (Purchasing Managers Index) data supports the view that the industrial production momentum can be sustained. The global manufacturing PMI rose in the most recent months, as did its forward-looking new orders component. In Europe the German, Swiss and UK manufacturing PMIs rose close to or reached all-time highs. Similarly the Japanese manufacturing PMI has been rising. One positive feature worth highlighting is the extent of export rises among the PMI components.

Historically, the Chinese PMI new export orders data precedes port throughput by a few months. Growing new export orders from China is a good indicator of further growth in the sector next year.

Supplyside

Actual supply growth has slowed on new order delays, cancellations and pick-up in scrapping as many ship-owners were successful in renegotiating with the ship yards. Idle ships are coming back into service – approximately half of laid up vessels being successfully reintroduced into the active container fleet. Encouragingly, load factors have remained high and the vessel charter rates have rebounded from the bottom. The remaining idle fleet is small in size, and therefore we can expect further rate improvements in second half of 2010, driven by the implementation of peak season surcharges on various routes. That said; sudden ill-discipline amongst the industry players in supply of container vessels could quickly put pressure on again.

Pricing

Towards second half of 2009 as partial economic recovery signs picked up with a drive for re-stocking of inventory. Given the urgency of this demand there was a sudden surge in shipping and air traffic volumes. Shippers resorted to aggressive pricing by levy of various surcharges on the transpacific routes.

Carriers historically have not had much pricing power. However, this time round, with strong demand recovery and industry-wide effort to manage capacity, freight rates and load factors on the Asia/Europe trades have been on the rise and close to historically high levels. Shipping lines have added capacity on the transpacific routes, but their slow steaming has partially offset the increased capacity. It is expected that for the short term, the pricing power will remain in the hand of operators.

Europeanexposure

Europe is a key market for the Asian shipping carriers. Asian carriers have an estimated revenue exposure to the Asia/Europe trade of 5-35 percent. However, the exposure specifically to economically troubled European economies could account for only about 5-6 percent of Asian carriers’ revenue.

Germany is the most important trading nation in Europe, accounting for a 30 percent share of the top 12 European ports’ throughput and 19 percent of Asian exports. Moreover, it is expected that there shall be a strong global recovery and, within that, a strong recovery in the larger European economies. The growth prospect is positive if the financial difficulties get out of the way. Some economists expect Europe’s GDP growth to be 1.5 percent in 2010, but on the back of a strong Germany, GDP growth in the Euro zone this year could be stronger than expected.

Shipping Insights ��

Drybulk

The outlook for 2009 for the dry bulk market was fairly negative. The freight rates had collapsed and industry counterparty risks were a primary concern. However, the actual market performance in 2009 exceeded expectations. In the second half of 2009 the economic recovery started and the market shifted favorably towards the ship owners with increasing freight rates. Although new ship deliveries were higher than at any time previously, they were 40 percent lower than as projected at the start of 2009. Demand had also recovered more strongly than projected which has benefitted the dry bulk industry. Furthermore, activity also returned to the dry bulk vessels sales and purchase market giving greater reliability to vessel values.

China and, to a lesser extent India’s, enormous commodity import volumes reflect their influence on the dry bulk market.

Going forward, the increasing commodity import volumes and location will drive the dry bulk freight rates higher, however due to the uncertain global economic outlook and hasty capsize capacity expansion will weigh on the strength and sustainability of the dry bulk freight rates. Clarksons forecast capsize capacity to grow by 20 percent in 2010 which will create substantial downward pressure on the dry bulk freight rates.

Although the shorter term view may be unpredictable due to the above factors, long-term it is expected that strong demand from Asian countries and recovery from the economic crisis from OECD countries coupled with tempered supply is expected to create positive outlook for the dry bulk market.

Asiandominance

As outlined, the Asian market continues to dominate trends in global shipping. There is starting to be a real interest from new market entrants – either those choosing to relocate from other parts of the World (to be closer to operations and to take advantage of fiscal regimes) or start-ups who believe that assets are cheap.

KPMG contact:

WahYeowTan Tel. +65 6411 8338 wahyeowtan@kpmg.com.sg

KPMG in Singapore is assisting many operators re-locate, re-optimize cost bases and re-assess approaches to risk

management and control. Our Singapore shipping practice leads our support to shipping companies in Asia, specializing in a range of audit, tax and advisory services.

�� Shipping Insights

Shipping Insights �7

KPMG’s Global Shipping Practice contacts

JohnLuke

KPMG in the United Kingdom Global Head of Shipping

Tel. +44 20 7311 6461john.luke@kpmg.co.uk

Australia

MalcolmRamsay Tel. +61 (2) 9335 8228 malramsay@kpmg.com.au

Belgium

SergeCosijins Tel. +32 0 382 11807 serge.cosijns@kpmg.be

Canada

JimPickles Tel. +16046913572 jpickles@kpmg.ca

Chile

AlejandroCerda Tel. +56 2 631 1441 acerda@kpmg.com

China

AndrewWeir Tel. +852 2826 7243 andrew.weir@kpmg.com.hk

Cyprus

DemetrisVakis Tel. +357 222 0900 Demetris.Vakis@kpmg.com.cy

Denmark

JesperR.Olsen Tel. +45 3 818 3593 jesperolsen@kpmg.dk

Finland

PauliSalminen Tel. +358 20760 3683 pauli.salminen@kpmg.fi

France

PhillipeArnaud Tel. +33 1 55686477 parnaud@kpmg.fr

Germany

NicholausSchadeck Tel. +49 421 33557-7109 nschadeck@kpmg.com

Greece

DimitraCaravelis Tel. +30 210 6062188 dcaravelis@kpmg.gr

India

ManishSaigal Tel. +912230902410 msaigal@kpmg.com

Japan

SuminoriIkeda Tel. +81 3 3539 5301 suminoriikeda@kpmg.com

Korea

DaeGilJung/SeBongHur Tel. +82 2 2112 0233/0212 dgjung@kr.kpmg.com sebonghur@kr.kpmg.com

Netherlands

HermanvanMeel Tel. +31 20 6567222 vanmeel.herman@kpmg.nl

Norway

JohnThomasSørhaug Tel. +4740639293 john.thomas.sorhaug@kpmg.no

Russia

AlexeiRomanenko Tel. +7(495)6638490 Aromanenko@kpmg.ru

Singapore

WahYeowTan Tel. +65 6411 8338 wahyeowtan@kpmg.com.sg

SouthAfrica

PatrickFarrand Tel. +27 21 408 7496 patrick.farrand@kpmg.co.za

Spain

DavidHohn Tel. +34 914563497 dhohn@kpmg.es

Switzerland

BeatNyffenegger Tel. +41 22 704 1601 bnyffenegger@kpmg.ch

Sweden

BjörnHallin Tel. +46(8)7239626 bjorn.hallin@kpmg.se

Taiwan

FionChen Tel. +886281016666 fionchen@kpmg.com.tw

UAE

RobertHall Tel. +971(4)4030300 rhall1@kpmg.com

UnitedStates

ChrisXystros Tel. +1 757 616 7009 cmxystros@kpmg.com

Vietnam

JohnDitty Tel. +84838219266 jditty@kpmg.com.vn

�� Shipping Insights

kpmg.com

© 2010 KPMG International Cooperative (“KPMG International”), a Swiss entity. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in the United Kingdom. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative, a Swiss entity. Designed and produced by KPMG LLP (UK)’s Design ServicesPublication name: Shipping Insights 3

Publication number: RRD-218021

Publication date: September 2010Printed on recycled material.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

For further information please contact:

JohnLuke

KPMG in the United Kingdom Global Head of Shipping

Tel. +44 20 7311 6461john.luke@kpmg.co.uk