Know Your Counterparty’s Counterparty (KYCC): Looking over the risk horizon

Over the last 24 years, Infospectrum’s robust and dynamic “Know Your Counterparty” (KYC) processes have helped clients navigate credit and sanctions-related risks presented by geopolitics, increasing interest rates, recessionary headwinds, and rapidly evolving regulatory legislation, among others.

 

Today, these heightened risk factors also vitally underscore Infospectrum’s long-standing and recommended approach to an integrated risk appraisal process, namely the need to conduct KYCC (Know Your Counterparty’s Counterparty).

 

The importance of KYCC has been reinforced by the Financial Conduct Authority which has highlighted the need for all the companies in “a transaction chain to have an effective surveillance system rather than leaving it to others to monitor transactions”. Maritime stakeholders (ship owners, charterers, lenders, trade financiers) have historically often been unaware of their counterparty’s counterparty chain, let alone impose restrictions on how this chain should be policed and audited. While this mindset has undoubtedly improved, the market environment has become more complex, whether it be the obligations concerning attestation systems for the oil supply chain, or decarbonisation regulations, both of which introduce new considerations in the financier-owner-operator-charterer chain.

 

Beyond the vital compliance requirement, there is a strong commercial incentive to minimise the risk of contagion from seemingly unrelated events arising from these “indirect counterparties”. The issue is exacerbated in the maritime industry, wherein the relative ease of vessel arrests, while a useful tool for recourse, can be a double-edged sword with the seemingly ancillary, yet potentially critical, freight component causing operational and financial disruptions.

 

Known Unknowns

 

The maritime industry is characterised by registrations in low disclosure domiciles and transaction structures typically span multiple legal jurisdictions. Companies are almost exclusively registered offshore to benefit from reduced taxation and, perhaps more ominously, to conceal the identities of the company's shareholders and directors. Again, these structures are known and anticipated, but if one then factors in the potential for multiple low-disclosure/low-profile entities within occasionally extended chartering chains, or multiple low-profile cargo interests, a default or sanctions breach anywhere in the chain can have a ripple effect across the chain resulting in unanticipated cost and time overruns, and potentially severe penalties (financial, reputational, and criminal).

 

The problem also extends to ship finance, where a lender extending a loan to an owner to acquire a vessel which has long term employment (at possibly a lucrative rate) with an operator or charterer is also exposed to KYCC risk. If the owner (or the vessel under that ownership structure) is reliant on the income from the possibly vulnerable charterer, viability of that loan will get materially compromised if charterhire payments are delayed or suspended, or if the vessel is prematurely redelivered during a period of prevailing weak market conditions unable to generate sufficient replacement income to cover its debt obligations. Since the ship itself provides a tangible asset cover, assessing the potential risk of a vessel being arrested in case of non-payment of financial liabilities, requires ascertaining the sustainability of the vessel’s mortgage/lease relative to the vessel’s earning capability in prevailing market conditions, ability of the ship owner to refinance obligations, and the relationship between ship owner and financier that may mitigate the risk of untimely arrest through the use of backroom channels.

 

The Ripple Effect: A Case Study

 

A Panamax bulk carrier was chartered-out to a European head-charterer, and in turn relet to an Asian operator. The vessel was carrying a full cargo of a soft (perishable) commodity. However, the owners of the vessel defaulted on their principal and interest repayment obligations and the lenders arrested the vessel in Singapore, refusing requests to allow the vessel (now on charter to, carrying cargo for, and financed by unrelated parties) to reach the discharging port where it could have been re-arrested. After transshipment attempts also failed, protracted delays in negotiations led to the loss of most of the cargo. Infospectrum had been aware of the issues between the lender and the owner and had been monitoring the issue as early as nine months prior to the eventual arrest of the vessel. Referring to an online Infospectrum due diligence report on the vessel would have warned the relevant parties of the potential risks of a subsequent vessel arrest and could have prevented the cargo loss and other related expenses.

 

Group Contagion: A Case Study

 

Dealing with a single ship owning Special Purpose Vehicle (SPV) registered in an offshore jurisdiction that can potentially isolate recourse to a single vessel of the fleet, also does not provide absolute immunity from contagion risk. In certain cases, claimants are known to have arrested group vessels, which adds an element of risk by disrupting an unrelated commodity freight transaction. While isolated ownership structures make legal enforcement of recourse difficult in such cases, arrests can nevertheless prove detrimental to unrelated transactions. After a SPV, presumably intentionally, sold its only vessel, a claimant with claims predating the sale was prevented from enforcing recourse from a now asset-less SPV. Consequently, the claimant arrested two group-owned vessels circa 4-5 years after the original claim, demonstrating the extended timelines and difficulties in securing recourse. In one instance, perishable cargo worth USD 13m is noted to have been temporarily stuck on board one of the group’s arrested vessels, inflicting losses to stakeholders not involved in the original default. The intelligence provided by Infospectrum’s pre-fixture solution would have identified the risk that the persevering claimant posed to tonnage beneficially owned by the defaulting principal.

 

Sanctions Contagion: A Case Study

 

A well-known ship owner found one of its vessels blacklisted by the US Government for allegedly carrying oil traded above the US-enforced price cap. The owner is understood to have based its due diligence on attestations from charterers, and support of its P&I Club. While the owner intends to appeal, it has drawn its ship and the wider group into a complex sanctions environment, and what may be a prolonged and costly attempt to clear its name (not least from commonly-used sanctions databases employed by banks etc). Infospectrum’s pre-fixture solutions, which are used on a daily basis in the oil shipping sector, would have bolstered the owner’s defence file, and highlighted any red flags within the chartering chain linked to the vessel concerned.

 

Ensuring your Knowns are Known

 

Infospectrum’s diligence products for direct and “indirect” counterparties leverage a multiple factor verification framework that combines rigorous data analytics with human intelligence to contextualise the risks characteristic of the maritime and commodities sectors. This comprehensive process encompasses quantitative and qualitative aspects such as identifying legal and ultimate beneficial ownership details, understanding perceived principal support, evaluating track record of the entity/ its principals/affiliates, and assessing payment performance.

 

This process provides protection, but the benefits can be amplified if conducted not just on the counterparty but also the counterparty’s counterparty, providing the best available cost-effective solution to minimise the probability of a freight-related eventuality across the chain resulting in losses, even in those instances where there is a possibility of recourse. Without adding material burden to the transaction costs, timely KYCC enables risk identification, allows for informed decisions and smart negotiations, and protects reputational integrity. In the maritime sector, prevention is certainly better than cure.

 

 

Find out more about Infospectrum's Counterparty Risk Appraisal and Compliance solutions here.