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1 What is the current state of the shipping industry in your country?
Japan is one of the three leading shipbuilding nations in the world today, ranking third after China and the Republic of Korea. Japan’s merchant fleet is one of the largest worldwide and Japan produces between 20 and 25 per cent of the world’s trading vessels. The order value for vessels in Japan continues to be on the rise, with the order value in 2021 being ¥1,531.36 billion, as compared to ¥908.23 billion in 2020 (www.statista.com/topics/8888/shipbuilding-industry-in-japan/#dossierKeyfigures).
In addition to facing a highly competitive market, Japan’s shipping, shipbuilding and marine engineering industries face the challenge of making Japanese maritime shipping carbon-neutral by 2050.
2 What are the prevailing shipping market trends affecting your country? What has been the impact of the covid-19 pandemic?
Japanese shipowners are in a good position as container shipping prices continue to be high due to increased demand not only from increased consumption during the covid-19 pandemic but also in light of the disruption of airline routes due to the war in Ukraine. At the time of writing, the Freightos Baltic Index, a benchmark for major shipping routes, remains high at over US$7,000 for a voyage from East Asia to the west coast of the United States (https://fbx.freightos.com). That said, three factors expected to flatten growth in trade flows are (1) Russia’s invasion of Ukraine affecting consumer confidence in Europe; (2) the continuation of disruption to supply chains beginning during the covid-19 pandemic; and (3) restrictions on China trade resulting from its zero-covid policy (S&P, ‘Shipping market outlook – Container vs Dry bulk: Q2 2022 update’).
3 Are there any recent domestic or international political or legislative developments that may have an impact on your country’s shipping market?
In May 2022, the Japanese government submitted a proposal to the International Maritime Organization to financially incentivise decarbonising shipping (www.maritime-executive.com/article/japan-submits-ambitious-carbon-tax-proposal-for-mepc-78). The proposal called for a global carbon tax that would see the shipping industry pay US$56 per tonne of CO2 starting in 2025. If imposed, the tax is forecast to raise over US$50 billion a year. The current proposal would see the tax increase every five years, to US$135 per tonne of CO2 in 2030, US$324 per tonne in 2035, and as high as US$637 per tonne by 2040. The carbon tax for bunkers would be three times higher, given that each tonne of bunker fuel produces approximately three tonnes of CO2 (https://news.bloombergtax.com/daily-tax-report-international/carbon-taxes-in-the-shipping-industry-assessing-japans-proposal).
The Japanese government has noted that its proposal would enable the use of money generated by the taxes to subsidise zero-emission ships.
Japan is also aiming to become carbon-neutral by 2050 and has set a carbon-neutral target for total greenhouse gas emissions from international shipping by 2050. To achieve carbon neutrality, a switch must be made to zero-emission vessels using new alternative fuels such as hydrogen, ammonia and carbon-recycled methane. However, zero-emissions are not expected to be fully deployed until sometime in the 2030s, and it is unclear whether an international hydrogen and ammonia fuel supply infrastructure will be in place by such time. It is also unclear whether hydrogen, ammonia, or methane will become the main alternative fuel. Given this uncertainty, Japan has decided to develop hydrogen-fuelled ships, commercialise ammonia-fuelled ships, and develop technologies to drastically reduce methane slip in LNG fuel (www.sajn.or.jp/files/view/articles_doc/src/7ebd54fffe4c58b128393fef30b2dffb.pdf).
To achieve carbon neutrality by 2050, not only in the maritime industry but also in Japan’s energy and industrial sectors, the Japanese government has established the Green Innovation Fund to accelerate innovation and encourage investment. Funding will be provided to the New Energy and Industrial Technology Development Organization (NEDO) to support reach and development, testing, and social implementation. A maximum of ¥35 billion has been budgeted for the ‘Next Generation Vessel Development Project’ to achieve the commercial operation of zero-emission vessels. A total of 12 companies, including shipping companies, shipyards, engine manufacturers, and trading companies will collaborate in the project.
Japan continues to develop eco-friendly vessels. For example, technology firm ABB has helped to develop Japan’s first battery-powered tugboat. The tug is due for delivery by the end of 2022 and will operate emissions-free at the ports of Tokyo Bay (https://shipandbunker.com/news/apac/900490-abb-develops-japans-first-battery-powered-tugboat).
4 What are the key regulatory and compliance issues for your country’s shipping market? What’s coming up in the near future?
General
There are a number of Japanese laws broadly applying to the marine transportation business in relation to vessels. For example, the Ships Act stipulates the requirements for owners of Japanese-flagged vessels, the Marine Transportation Act sets the rules on marine transportation and ship chartering businesses, the Mariners Act sets the rules on working conditions for crew on Japanese-flagged vessels, the Ships Safety Act stipulates standards for the navigation of vessels for the safety of human life, and the Shipbuilding Act stipulates requirements for the shipbuilding business located in Japan.
In many cases, prior notification to the Ministry of Land, Infrastructure, Transport and Tourism or its local agency is required in relation to the transportation of passengers or cargo in Japan. In particular, persons intending to operate a coastal shipping business should be aware that the Coastal Shipping Business Act will be applied to such business.
Registration
Under the Ships Act, there are statutory requirements for owners of Japanese-flagged vessels, which limit ownership to: (1) the Japanese government or public authorities; (2) Japanese nationals; or (3) legal entities incorporated under Japanese law, of which the representative director and two-thirds of the executive officers must be Japanese nationals.
Registration of ownership or mortgages on Japanese vessels takes place in accordance with the Ships Act, the Ship Registration Rules or the relevant regulations. In terms of maritime liens and ship mortgages, which concern financiers, Japan has ratified neither the International Convention for the Unification of Certain Rules relating to Maritime Liens and Mortgages of 1967 nor the International Convention on Maritime Liens and Mortgages of 1993. Enforcement of liens and mortgages on ships is dealt with under either the Civil Code or the Commercial Code of Japan. Chapter 3 of the Commercial Code (maritime law) broadly covers commercial transactions or issues concerning shipping, maritime and admiralty.
Safety and environmental standards
When entering into the shipping market in Japan, both foreign and Japanese vessels need to meet safety and environmental standards based on the Ships Safety Act. The Ships Safety Act prescribes requirements similar to those of the SOLAS Convention and other international conventions ratified by Japan; however, it should be noted that the Ships Safety Act contains a number of more stringent requirements. In addition, Japanese vessels must also satisfy the requirements of MARPOL, which are implemented by government ordinance and similar rules.
Since the amendment to MARPOL took effect in January 2020, many vessel operators and shipowners began equipping their vessels with scrubbers for emission gases. In Japan there remain a number of legal issues regarding whether scrubbers installed by an operator or person other than the vessel owner will form part of the vessel and be the property of the vessel owner or alternatively be the property of the operator or other third person.
Although not specific to Japan, the IMO has decided that the greenhouse gas emission standards will take effect in January 2023 and will not be postponed. This is an urgent matter for Japan’s shipping and shipbuilding industries, especially for ocean-going vessels.
Recent sanctions
As in the US and many European countries, various economic sanctions have been imposed on Russia by the Japanese government in response to Russia’s invasion of Ukraine in February 2022. The measures include a wide range of restrictions, such as the freezing of assets, a ban on the export of certain goods, etc. Where the maritime industry is concerned, the following import/export-related sanctions are particularly important:
Import restrictions
Under the previous sanctions measures, which took effect in 2014, approval from the Minister of Economy, Trade and Industry was required for the import of goods originating in the Autonomous Republic of Crimea or Sevastopol. Following the invasion of Ukraine by Russia this year, approval is now also required for the import of goods originating in the non-government-controlled areas of Donetsk and Luhansk. Furthermore, since April 2022, a ban on the import of alcoholic beverages, timber and machinery and electrical machinery from the Russian Federation has been in effect.
Export restrictions
Following the Russian invasion of Ukraine, the following sanctions measures became effective from July 2022:
The number of designated persons or entities subject to the sanctions above has been increasing with the continued invasion of Ukraine, and the number of items subject to export controls has also been increasing. Therefore, when exporting certain goods from Japan to Russia or Belarus, it is necessary to confirm that the transactions are not subject to any of the sanctions above.
5 What are the shipping industry’s current sources of finance? How do you predict they will develop, and what are the advantages and challenges to financing a vessel in your country?
Bank debt
Like other countries, bank debt is a major source of finance in the Japanese shipping industry. Major shipping companies commonly raise funds through loans from banks for ordering and purchasing their fleet vessels. Ship loans to ship-owning companies are often full-recourse loans but in some cases limited-recourse loans secured only by the ship and related project assets may be acceptable to Japanese lenders. Most of the principal Japanese international and domestic banks and leasing companies are experienced in ship finance matters. Japanese banks and leasing companies continue to face the challenge of competitive funding from Chinese financiers.
Japanese Operating Lease with Call Option
In ship finance, Japanese Operating Lease with Call Option (JOLCO) transactions are often adopted as a financial tool by ship operators. The prevalent structures are either that of a silent partnership or a voluntary partnership, and ownership of the vessel is held by the operator or the voluntary partnership. A call option by the charterer to purchase the vessel is granted under the charter agreement, and the charter and loan will be back-to-back. In recent years, the number of cross-border JOLCO transactions – where ships are owned by Japanese partnerships or special purpose vehicles (SPVs) and then chartered to non-Japanese shipping companies – has been increasing and this market remains solid despite the covid-19 pandemic. Using a similar structure, JOLCO transactions in relation to containers are also being arranged by Japanese and non-Japanese shipping companies, lease companies, and financial institutions.
Other lease financing
As well as JOLCOs, Japanese leasing companies continue to offer and arrange a variety of lease financing options for both Japanese and foreign customers including traditional sale and leasebacks. Recently, a number of foreign owners have been seeking to take advantage of competitive financing from regional Japanese banks to order newbuild at local yards.
Investment funds
Although there are fewer funds in Japan compared to other jurisdictions, Japanese investment funds specialising in ship investment also provide money to shipping companies for expanding their fleets.
6 Have there been any recent significant domestic or foreign court decisions or arbitration awards that impact on your country’s shipping market?
A decision rendered by the Tokyo District Court on 12 February 2020 regarding ‘an order to confiscate the certificate of the vessel’s nationality’ highlights an issue relating to Japan’s civil preservation system for ships.
Under Japan’s Civil Provisional Remedies Act, there is a procedure called ‘an order to confiscate the certificate of the vessel’s nationality’ (the ‘Order to Confiscate Nationality Certificate’), which can be used to prevent a vessel from evading arrest or seizure before a formal vessel execution procedure is conducted. Although the petitioner is required to submit certain evidence for an Order to Confiscate Nationality Certificate, there is usually no opportunity for the respondent to respond to the petition before the order is issued, as oral arguments are not required during the proceedings due to the need for a quick provisional remedy.
In this particular case, the petition and execution of the Order to Confiscate Nationality Certificate by the respondent delayed the operation of the vessel owned by the plaintiff and caused damages, but in the subsequent hearing, it was found that the respondent had no claim against the plaintiff, and therefore, there were no grounds for requesting such an order. The plaintiff’s claim for damages against the defendant was therefore allowed.
The defendant’s negligence was recognised by the court, and as a result, the claim for damages was successful. However, if there had been a means to release the vessel from the Order to Confiscate Nationality Certificate in the first place, the vessel’s operation schedule would not have been delayed and the amount of the shipowner’s damages would not have increased.
Under the formal procedure for seizure of a vessel under Japan’s Civil Execution Act, a shipowner whose vessel has been seized may request to have the vessel released by providing a guarantee, such as a letter of guarantee from a P&I club. However, such release of a vessel by provision of a guarantee does not apply to an Order to Confiscate Nationality Certificate, and therefore, the vessel may not be released from the order even if the shipowner or other person may provide a guarantee. In other words, if there is evidence of a claim, an Order to Confiscate Nationality Certificate may be issued without any opportunity for the defendant to respond, and furthermore, since there is no opportunity to release the vessel from proceedings by the provision of a guarantee, a vessel may be ordered to cease operating even if the order contains no real grounds for doing so.
This case highlights problems with Japan’s civil preservation system for vessels and further discussions of which may lead to a future revision of the system under Japan’s Civil Provisional Remedies Act.
7 What is the outlook for your country’s shipping market? Which sectors are likely to grow, and which not?
After a strong 2021, a year-on-year correction in dry bulk and container earnings seems a possibility with the container market being affected by higher inflation, more newbuilds and easing of congestion and dry bulk growth falling due to the Russia invasion of Ukraine and weaker demand from China.
The tanker market looks set to improve, with a tightening of the supply/demand balance acerbated by greater decarbonisation regulation but with downward pressure from increased deliveries in 2022 and concerns over the growth in inflation (BIMCO, 7 June 2022 Webinar and article).
With the increase in demand for LNG stemming from the war in Ukraine along with higher prices for LNG carriers and the need for Japan to maintain the security of energy procurement, there has been speculation regarding Japanese shipyards returning to the LNG carrier construction (TradeWinds, 28 June 2022).
The Inside Track
What are the particular skills that clients are looking for in an effective shipping lawyer?
The ability to keep up with new developments in the industry is crucial.The effects of supply chain disruption, beginning with covid-19 and now the Ukraine war, have accelerated a number of long-term trends from energy transition to green shipping to vessel automation. Shipping lawyers are expected to keep up to date with these trends and to anticipate and plan with clients how to embrace opportunities and mitigate challenges. Clients also expect lawyers to provide a full legal service ranging from advising on operational matters, vessel sale and purchase and asset financing to project finance, green shipping, tax, insurance, M&A, competition, sanctions and dispute resolution matters, each tailored to the standards of the market and the unique demands of the shipping industry. In Japan, clients increasingly expect their advisers to be able to negotiate and advise quickly in Japanese and English and for their advisory teams to contain specialist shipping lawyers qualified in England, New York, Singapore and Hong Kong as well as Japan. This is in contrast to the more traditional smaller specialised domestic Japanese practices or non-Japanese firms where the shipping lawyers are usually based outside of Japan.
What are the key considerations for clients and their lawyers when arranging finance for a shipping transaction?
Bankability and concerns over cost remain a key consideration. Also, owners, charterers, financiers and ECAs are aligned in needing to anticipate and embrace the opportunities and challenges of energy transition and green shipping, technological innovation, an increasingly complex regulatory environment and challenges resulting from increasing tensions between the US and China in the APAC region.
What are the most interesting and challenging cases you have dealt with in the past year?
Despite the challenges brought by the covid-19 pandemic and the Russian invasion of Ukraine, we have been able to advise a variety of clients, including shipowners, charterers and financers, on a number of matters including green shipping deals; cross-border and domestic financings (principally SLBs, debt financings and JOLCOs); the effect of green shipping regulations on commercial contracts and financing arrangements; limited-recourse LNG carrier project financings and restructuring of LNG offtake arrangements; a government-backed investment into a shipping JV; complex cross-border restructurings and workouts; and sanctions matters.
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