Key developments & the latest trends in the UK – from a legal perspective

This Chapter sets out the key developments and latest trends in the ship finance market from an English law perspective.

Green and sustainable finance

Decarbonising the global shipping fleet remains a key focus as shipping companies strive to comply with regulatory frameworks and initiatives developing at the UK level¹E.g. the Merchant Shipping (Prevention of Air Pollution on Ships) Regulations 2008 as amended in 2019; the Merchant Shipping (Monitoring, Reporting and Verification of Carbon Dioxide Emissions) and the Port State Control; Maritime 2050, UK Clean Maritime Plan, etc., the European level²E.g. Directives on the reduction in the sulphur content of certain liquid fuels and on the monitoring, reporting and verification of carbon dioxide emissions from maritime transport; EU Emission Trading System, etc. and the international level³E.g. MARPOL convention, Ballast Water management convention, etc.. In particular, to achieve the target of the International Maritime Organisation (“IMO”) of reaching net zero by 2050, shipowners require finance to purchase cleaner newbuild vessels powered by alternative fuels (such as liquified natural gas, liquified biogas, hydrogen and ammonia) or to improve the carbon impact of their existing fleet with engine retrofits and the installation of new energy saving technologies.

Having signed up to the Poseidon Principles, joined the Getting to Zero Coalition or implemented internal goals for the carbon intensity of their shipping portfolio, many financiers feel more pressure to justify their investment choices in a transparent manner based on sustainability and environmental risk. Many borrowers are therefore now required to provide their fleet renewal plans and climate objectives at loan inception stage.

This has led to various developments in English law loan agreements⁴Further reading: Green shoots: the rise of the green finance revolution (shlegal.com) and Ship finance green finance bulletin (shlegal.com)..

Green loans

In 2018, the Loan Market Association (“LMA”) published the Green Loan Principles⁵These were updated in 2021 and 2023. to define a green loan and create a framework for the green loan market. Green loans are designed to finance or refinance a new or existing “Green Project”.

These loans are scarce in ship finance other than for some well-established shipowners. Green loans typically take the form of a green tranche in a new or existing loan facility to finance, for example, fitting a more fuel-efficient propeller, research and development costs for low-carbon or decarbonisation solutions or fitting a dual LNG engine. On rare occasions, the entire loan facility is used to purchase a “greener” vessel.

In an English law loan agreement, this translates into the need for a clear definition of the Green Project, a requirement to use the proceeds of the loan for the project, some annual reporting requirements and independent expert verification.

The key challenge for shipowners when seeking finance for retrofits relates to the strength of the security; existing vessels will normally already be encumbered by a first priority mortgage and financiers are reluctant to rely solely on security over equipment or chattels or on a second priority mortgage.

Sustainability-linked loans (“SLLs”)

In comparison, the volume of SLLs is growing, although the pace slowed down in 2023/2024. The purpose of SLLs is to motivate borrowers to become “greener” by introducing sustainability targets in the operation of their business. Financiers typically offer better interest margins if borrowers meet key performance indicators (“KPI”).

In 2017, the LMA published the Sustainability Linked Loan Principles⁶These were updated in 2021 and 2023., which are voluntary guidelines to create a high-level recommended framework for loans to be recognised as “sustainable”. The emphasis of a SLL is on the “ESG” performance (“E” for Environment, “S” for Social and “G” for Governance). In 2023, the LMA also published draft model provisions that can be inserted (and adapted) into English law LMA-based loan agreements. However, the choice of KPIs remains market-specific and any definitions and provisions in this respect require bespoke drafting.

In ship finance, the most commonly used KPI is the fleet’s annual efficiency ratio (“AER”) – i.e. the ratio of the fleet’s carbon emissions per actual capacity-distance (e.g., deadweight/nautical miles sailed). The AER uses the parameters of fuel consumption, distance travelled, and design deadweight tonnage. Some loans will also refer to Social KPIs (e.g., the annual number of crew training hours, the number of female seafarers or the total number of annual recordable crew injuries).

Offshore wind finance

One sector that has been flourishing in the UK and Europe is the offshore wind market. Due to the high capital requirement of a wind power project, funding usually comes from several sources. Most often, this is based on a traditional pre-delivery loan provided by a syndicate of lenders with a maturity of up to 15 years after the completion of construction. Other sources of capital include loans from international financial institutions, private or public placement of bonds, leasing instruments, loans from suppliers and manufacturers⁷For an example of funding from UK shipyard Diverse Marine, see: Diverse Marine Launch UK First Finance & Lease Programme., government support⁸For an example of UK government backing for offshore wind, see: Offshore wind wins big in advance of the fourth CfD allocation round (shlegal.com). and ECA backing.

Sector-specific considerations for financiers include the shipowner’s experience in the sector, the quality of the management team, whether the project is speculative and whether the vessel’s design and technology will meet the market requirements and be competitive. It is also important for financiers to review the building contract, refund guarantee(s) and charter(s) as early as possible to mitigate general and sector-specific risks.

EU ETS

From 1 January 2024, Directive 2003/87/EC, establishing a system for greenhouse gas emission allowance trading within the European Union (“EU”) as amended by Directive (EU) 2023/959 (“EU ETS”), was extended to cover CO2 emissions from all vessels of 5,000+ gross tonnage (“GT”) transporting cargo or passengers for commercial purposes which call at EU ports, regardless of the flag they fly and the country of incorporation of their owner⁹The UK has implemented its own emissions trading scheme through the Greenhouse Gas Emissions Trading Scheme Order 2020. This largely mirrors its EU counterpart but it does not cover international maritime transport (this is expected to be included sometime in 2026).. From January 2025, vessels between 400 GT and 5,000 GT and offshore vessels over 5,000 GT which call at EU ports will also become subject to the scheme.

Shipowners and operators are now required to measure and report on the carbon emissions of their vessels which call at EU ports over each calendar year. The report must be externally verified and submitted to the relevant EU authority by 31 March of the following year. For each ton of CO2 (or CO2 equivalent) emitted, the shipping company is required to purchase and surrender one EU allowance by 30 September of that same year. Failure to do so will lead to (a) the shipping company being put on a public list of entities in breach of EU ETS, (b) penalties and (c) the risk that the affected vessels will be expelled from, or detained in, EU ports.

This has led to additional provisions in relevant English law charterparties, management agreements, lease documents and sale and purchase documents covering which entity will be responsible for, and bear the costs of, purchasing such Allowances. BIMCO has published some template provisions that parties can use, however, many shipping companies prefer to use bespoke provisions to reflect their different structures and relationships.

Financiers therefore require that (a) their borrowers comply with their EU ETS obligations so that they are not subject to penalties and (b) any vessel being financed which trades in the EU is not prevented from trading in the EU or liable to detention by a Member State as a result of non-compliance with the EU ETS. This is because any penalty or suspension in trade may affect the borrower’s ability to service its loan. While the general compliance with laws and environmental laws provisions address the issue, when the vessel financed is expected to call at EU ports during the loan period, financiers may wish to add express provisions to ensure compliance with the EU ETS¹⁰Further reading: Demystifying decarbonisation: putting a price on decarbonisation – emissions trading (shlegal.com) and Microsoft Word – 102142895_1 (esglegalhub.com)..

Vessel recycling

The International Convention for the Safe and Environmentally Sound Recycling of Ships, also known as the Hong Kong Convention, is set to enter into force on 26 June 2025. It will apply to (a) vessels of at least 500 GT entitled to fly the flag of a country signatory to the Convention or operating under its authority; and (b) vessel recycling facilities operating under the jurisdiction of a country signatory to the Convention. Qualifying vessels will need to maintain an Inventory of Hazardous Materials prepared, verified, and regularly updated in accordance with the IMO’s guidelines. Therefore, increasingly, English law loan agreements contain covenants in respect of vessel recycling.

Sanctions against Russia

The UK regulatory framework for sanctions against Russia (contained in the Russia (Sanctions) (EU Exit) Regulations 2019, as amended from time to time by amendment regulations) broadly mirrors the EU sanctions packages from Council Regulation (EU) No. 833/2014 of 31 July 2014 (as amended from time to time).

The sanctions packages include some restrictions that affect shipping, such as (a) a requirement to include a no-export to Russia clause in some contracts when EU entities’ vessels transport some restricted goods to third party countries¹¹This requirement has not yet been implemented in the UK sanctions regulations., (b) a prohibition to supply crude oil or petroleum oil to Russia¹²Further reading: UK sanctions: prohibition on the maritime transportation of crude and petroleum oil and products (shlegal.com)., (c) a prohibition on the sale of tankers that transport crude oil or petroleum oil to Russian nationals or entities and (d) a prohibition on processing any payment in any currency to/from designated Russian individuals and entities¹³Further reading: UK sanctions: Russian-owned customers? Beware extended payment terms (shlegal.com)..

While these sanctions packages have affected ship finance transactions as borrowers, financiers, lessors/lessees and escrow agents perform tighter KYC checks on their counterparts and divest themselves of connections with Russia and Russian nationals and entities, they have not had a significant impact on English law documentation because existing sanctions provisions are wide enough to capture the latest restrictions. However, some entities request the inclusion of bespoke clauses for certain types of vessels, especially in leasing documentation.

UK Government Shipbuilding Credit Guarantee Scheme

In July 2023, the UK Department for Business and Trade (“DBT”) launched its Shipbuilding Credit Guarantee Scheme. Under the scheme a partial government guarantee is issued in favour of the lender to cover the buyer/borrower’s repayment obligations under a loan made to finance newbuildings, or to undertake refits or retrofits for, or repairs to, existing vessels, at UK shipyards. The partial guarantee will cover up to 80% of the risk to the lender¹⁴Compared against China and Korean government export credit support at 90-95%, this is a relatively low percentage..

The eligibility criteria disclosed to date are that the shipyard must be carrying on business in the UK and the lender as well as the underlying financials and contractual structure must be “acceptable”.

Other details of the scheme presently remain unclear (e.g., when the guaranteed obligations can be triggered to enable the lender to recover its loan). Needless to say, this information will be critical in assessing the usefulness of the scheme. Further, there is no clear guidance on the cost of the scheme, as the DBT only states that the premium is determined “on a case-by-case basis”.

While this scheme is unlikely to materially change a lender’s credit committee’s decision-making, it gives lenders an additional level of protection and may well encourage them to support projects that would not otherwise proceed¹⁵Further reading: UK government unveils its Shipbuilding Credit Guarantee Scheme (shlegal.com)..

Basel IV impact on lending

The deadline for all eurozone banks to implement Basel IV is 1 January 2025. In the UK, the rules will be introduced from 1 July 2025 and phased in over 4.5 years to ensure full implementation by 1 January 2030.

As a result, many European banks will need to revise their methodology to calculate their capital requirements and adapt their internal processes. This is likely to lead to higher margins for shipping loans (this could be somewhere between 20 and 40 bps) and the exit of more European banks from the shipping market (or at least a reduction in the size of their shipping loan portfolios).

Banks who choose to continue to lend to shipping companies are expected to apply increasingly stringent criteria in evaluating credit risk. This means that European banks are likely to shift away from lending to small to medium sized companies and focus on larger long-established shipping companies with better credit ratings.

As a result, the recourse to alternative sources of ship finance is expected to increase. There may be an increasing number of syndicated English law loans offered exclusively by Asian banks (rather than a combination of European and Asian banks). The role of private equity is also set to become even more prominent and lead to increasingly complex financing structures that broaden credit exposure, with syndicates of UK and European banks providing senior debt finance to equity funds which, in turn, would provide financing to shipping companies. Finally, sales and leasebacks (from traditional structures to newer ones in shipping, such as JOLCOs) are expected to become more prevalent.

From a documentation perspective, negotiations around the exclusions to the increased costs provisions are likely to reopen between ship finance borrowers and their financiers¹⁶Further reading: What Basel IV means for maritime finance (shlegal.com)..

Interest rates

Following the discontinuation of USD LIBOR¹⁷Background reading on LIBOR discontinuation Transition from LIBOR to risk-free rates | Bank of England., most financiers in ship finance have settled for their preferred replacement reference rate for dollars. The LMA also published various drafting options for English law loan agreements depending on whether the parties wish to use Term SOFR ¹⁸For information on Term SOFR, refer to Term SOFR – CME Group. or Daily Non-Cumulative Compounded SOFR¹⁹For information on Daily Non-Cumulative Compounded SOFR, refer to ARRC_SOFR_Synd_Loan_Conventions.pdf (newyorkfed.org).. Sophisticated financiers tend to offer both rates to their customers, sometimes with an option to switch (once or a number of times) from one to the other during the loan period. Smaller financiers favour the use of Term SOFR to minimise complex calculations for each interest period²⁰Further reading: USD loans – Countdown to SOFR … but which one? (shlegal.com) and Current US dollar LIBOR transition options for ship finance lenders, agents and borrowers (shlegal. com)..

While the LMA has published various drafting options for euro loans to incorporate a temporary switch or permanent switch to Term €STER or Compounded €STER ²¹For more information of €STER, refer to Euro short-term rate (€STR) (europa.eu).should EURIBOR cease to be available, most ship finance parties hesitate to incorporate such provisions in their English law loan agreements as to date there has been no formal announcement that EURIBOR will be discontinued.

Our Maritime, Trade and Offshore Finance team is here to help you navigate this period of transition in the ship finance market.