Flags of convenience

Flags of convenience: Why do Shipowners prefer them and what is Charterer’s position?

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

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

The below table shows the Flags of Convenience as declared by ITF along with the recent information (Source: Central Intelligence Agency, as of January 2017) in regards to their profile (i.e. the total number of vessels and foreign vessels) under each registry:

Table 1: Flags of Convenience

Flags of Convenience in regards to the total number of vessels and foreign vessels

From the above table, we see that only 6 flags control the 77% of the total vessels which are registered under flags of convenience.

Why Shipowners prefer flags of convenience?

There are specific advantages for using flags of convenience instead of the traditional/closed flag registries the most important of which are the following:

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

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

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

Are flags of convenience of lower quality?

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

The below table describes the performance of the flags of convenience according to the Paris MOU as well as the USCG (United States Coast Guard). From what we can see, there are some flags of convenience which are included in both the white list of the Paris MOU and the high-quality list of USCG. It does not necessarily mean that the flags of convenience are of higher quality than the closed ones but it definitely shows that high-quality vessels and traditional owners prefer specific flags of convenience not in order to take benefit from a sub-standard maintenance program but mainly in order to get rid of the crew synthesis requirements which is still the fact in reputable closed flags.

Table 2: Evaluation of the flags of convenience

Performance of the flags of convenience according to the Paris MOU and the USCG

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

Table 3: Flags of Convenience in the Paris MOU and USCG

% of flags which is included in Paris MOU and USCG lists

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

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

  • 1. Traditional flags of high quality according to their PSC history
  • 2. Flags of convenience of high quality according to their PSC history
  • 3. Traditional flags of lower quality (grey zone/ black zone of the PSC MOUs)
  • 4. Flags of convenience of lower quality (grey zone/ black zone of the PSC MOUs)

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

Table 4: Detention rating of flags

Detention Rate (Detentions/Inspections) during 2013-2015 (Paris MOU)

The inspections which have taken place on vessels with such type of flags seem to be much more than the inspections made in similar quality closed flags (see table 5). And this is because the port state authorities believe that the flags of convenience are still riskier than other reputable traditional flags such as the Norway or the Greek ones. Below is a table with the number of vessels registered in both closed flags and flags of convenience along with the number of inspections reported by the Paris MOU Port State authorities during the same period (2013-2015).

Table 5: Comparison of Inspection between flags

Comparison of the countries by inspection between flags

The Greek and Cyprus flags have about the same number of registered vessels in their fleet, while their PSC evaluation is nearly the same (according to Paris MOU) however during a period of 3 years there were 2,008 inspections for Cyprus-flagged vessels and only 902 for vessels with the Greek flag. The same story exists between the Singapore flag and its comparison with two other flags of convenience (Marshall Islands and Malta). While two other flags of countries in the European region (Norway and Gibraltar) with similar PSC history seem to experience the same approach with higher inspections (proportionally compared with their registered vessels) for the country which is considered as FOC.

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

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