Interim Evaluation of the Structured Financing Facility
This interim evaluation of the Structured Financing Facility (SFF) is being conducted mid-way in the Program's mandate, with the purpose of looking at results to date and to determine whether the SFF is on track to meeting its objectives. The study focuses on issues identified in the Results-Based Management and Accountability Framework (RMAF): Structured Financing Facility, March 31 2003, which includes questions on relevance, alternatives and cost-effectiveness, reach, success, and design and delivery. Hickling Arthurs Low (HAL) Corporation was engaged by Industry Canada to conduct this study.
Background on the Program
The objective of the SFF program is to stimulate demand for Canadian-built vessels and increase innovation in Canadian shipyards. Specifically, the SFF was designed to respond to requests from industry to modify the tax regulations to exempt owners from the Specified Leasing Property (SLP) restrictions in situations where Canadian built vessels are sold to leasing companies rather than to operators. 1 Specified Leasing Property restrictions of the tax regulations prevent lessors from benefiting from accelerated capital cost provisions. Rather than change the tax regulations, the SFF was established. SFF, at a 15% level of support, provides an equivalent benefit to the accelerated capital cost allowance when compared with regular Class 7 depreciation. Any recipient of SFF is required to waive his right to accelerated capital cost allowance.
The SFF has three components:
- an interest rate support component (IRS), a non-repayable contribution towards interest costs;
- a credit insurance component (CIC), a non-repayable contribution towards the cost of loan insurance provided by the private sector; and
- credit insurance support (CIS), for loan insurance provided by the federal government.
The maximum level of support from CIC and CIS, either individually or combined, is equal to 10% of the value of the purchased vessel. As of January 2003, the maximum level of support from IRS was increased from 10% to 15%. Finally, the maximum level of SFF support from a combination of CIC, CIS and IRS remains 15%.
The study approach involves three lines of enquiry: document and database reviews; interviews with SFF managers and other stakeholders in industry and government; and, development of case studies of projects benefiting from SFF and projects not benefiting from SFF.
Consultations: Interviews were held with individuals representing the interview groups listed below. The interviewees were selected in consultation with the client. Consultations were by telephone, except for those in Ottawa.
|Interview Groups||Interviews Planned||Interviews Added||Interviews Completed|
|SFF program managers (Industry Canada)||3||2||5|
|Federal departments/agencies (Finance, EDC, PEI Ministry of Development and Technology)||3||6||9|
|Shipyards benefiting from SFF||4||0||4|
|Shipyards not yet benefiting from SFF||4||0||4|
|Successful domestic SFF applicants||7||1||5|
|Successful offshore SFF applicants||3||1||3|
|Shipping companies that have not used SFF||5||1||3|
Case Studies: Three case studies were undertaken, two of orders for new vessels that went offshore (Algoma Central's order to China for a Great Lakes tanker, and Oceanex'order of a containership from Germany) and one of a new vessel ordered from a Canadian shipyard with the support of SFF (Persistence Shipping's purchase of a live salmon transport from Groupe Maritime Verreault). The studies explore the decisions to source offshore and to use or not use SFF. Data was collected through interviews (a minimum of six for each case) and document review.
Conclusions and Recommendations
State of Shipbuilding in Canada and Worldwide
The world shipbuilding industry has operated for years under state subsidies and protectionism. While many countries, including Canada, have moved unilaterally to end these practices, there are many major shipbuilding and ship owning countries that continue to favour them. This has resulted in artificially low prices, and countries in Europe and North America have seen their market share decline dramatically as a result.
Some countries, notably Australia and the Netherlands, have been successful at using government support to attract a domestic market, and moving into niche foreign markets.
- The Canadian government should increase pressure within international trade groups, such as WTO, OECD and NAFTA, to eliminate subsidies and protectionism in shipbuilding. In particular, the government should monitor US attempts to extend Jones Act provisions to smaller ships and yachts.
- The success of Australia and the Netherlands in building viable shipbuilding industries should be examined in detail to determine lessons of value to developing the Canadian industry.
Rationale and Relevance
SFF fills a need in supporting the shipbuilding industry. The level of support provided has been sufficient to attract foreign buyers to Canadian yards but so far has not been successful in attracting the Canadian domestic market.
SFF is consistent with Industry Canada and government-wide priorities, with two exceptions:
- SFF is non-repayable unlike other Industry Canada programs of support to industry, and
- the less favourable tax treatment of shipbuilding lessors compared to road and rail transport lessors discriminates against shipping, a more environmentally friendly mode of transport, which is at odds with the government's environment policies. It would be difficult to redesign the program to be repayable and it would cause the program to be even more unattractive.
SFF complements and does not duplicate other forms of support available to Canadian yards.
- SFF should be retained by Industry Canada as a non-repayable incentive to the Canadian shipbuilding industry.
- Industry Canada should consider with the Department of Finance means of ensuring that the tax treatment of shipbuilding lessors is equivalent to that of lessors in road and rail.
- The benefits of the SFF to the industry should be enhanced by means of the changes to the program's design and delivery recommended in this report.
Program Design and Delivery
Despite the slow start in designing application details, the SFF program has been well administered, including working with yards and buyers in completing the necessary documentation and monitoring the progress of the projects. However, there are some major domestic ship fleet owners who are not aware of SFF. Further targeted marketing is necessary.
The credit insurance components have not been used in contrast with the interest rate support component because they have been poorly-communicated and difficult to get approved. Industry Canada reacted to early lack of interest in the program by raising the limits for IRS. When the IRS support was raised to 15%, it began to attract a great deal more interest from foreign ship buyers. It is still the case that few domestic shipowners have been attracted to the program and that must be seen as a major failure of SFF.
The major exclusions to SFF support are minor repair and overhaul (R&O) work (though major refurbishments are eligible), and boats and yachts. The R&O and boats and yachts exclusions let SFF focus on the weakest sector of the Canadian industry, new builds of large hulls. It is apparent to us that R&O and the small boat sector, both of which are doing relatively well, should benefit from the same program, as the success of yards doing that work will contribute to the industrial strategy and jobs creation goals of the policy framework. Also, we noticed that Canadian builders of small boats and yachts demonstrated more R&D and innovation than builders of larger hulls. We realize that making R&O and small boats eligible for SFF will create a much larger volume of files through Energy and Marine Branch, so appropriate resources will need to be put in place.
Without some financial engineering, ship owners wanting to pay cash for their new ships are ineligible for support. We understand that it would be possible to circumvent this hurdle by financing the ship with a loan with an option to discharge it early, take delivery of the ship, accept the SFF payment, then discharge the loan with the cash which had been earmarked for the ship purchase in the first place. Industry Canada, however, does not encourage this financial engineering strategy because it risks violating the terms and conditions of the SFF program. If, for example, the loan is discharged after a year or two, the SFF contribution could be an overpayment and the Department may have to retrieve the overpayment especially if there had been a misrepresentation on the part of the applicant. Industry Canada's position on this possible financial strategy does not appear to be known to shipyards and ship owners. The degree of innovation caused by SFF–supported projects self-reported by the shipyards over-estimates what is occurring in reality. Industry Canada needs to develop a better way of measuring these effects. Orders for new types of vessels or actual man-hours of labour per existing vessels in subsequent builds might be more objective measures of innovation.
The short time frame remaining for SFF is causing difficulties for yards in attracting new orders.
- Industry Canada should increase the awareness of SFF amongst Canadian fleet operators by making personal contact with the acquisition decision makers within each Canadian fleet. Non-members of the Canadian Shipowners Association should receive particular attention. The Department should share its market research on upcoming fleet acquisitions with the shipbuilding industry.
- The term of SFF should be extended beyond five years (that is beyond 2006) for a possible two to three years, at a minimum by grandfathering contracts signed before the end of the current program period, to allow Canadian industry more time to increase its market share and develop a good set of reference customers.
- The CIS and CIC components should be retained. Industry Canada and the Department of Finance should create procedures that will facilitate the application process and Industry Canada should communicate the benefit of these components better to the shipyards.
- SFF should be extended to all R&O work and to yachts.
- The current practice of determining incrementality by requiring foreign quotes should be replaced by a certification process with the ship buyer.
- Industry Canada should communicate to the shipbuilding industry that early discharge of loans receiving SFF support is not allowed. Industry Canada should also review with the Department of Finance means for providing an incentive to cash purchasers of ships who are not eligible for SFF support. Possible incentives for domestic cash buyers would be to increase the ACCA amortization rate or to allow amortization during the ship's construction.
- Industry Canada should introduce new measures such as orders for new types of vessels to improve the assessment of innovation in Canadian shipyards.
The federal government has delivered on its commitment as stated in its June 2001 policy to establish and market the SFF and to facilitate the use of export financing through the EDC. SFF has been a key factor influencing offshore owners to source from Canadian yards, but has had limited success in attracting the Canadian domestic market.
It is clear that no single measure or program, such as SFF, can fix the economics of the industry. Rather, a suite of measures and programs may be needed such as moving ahead on government fleet procurement, combining ACCA and SFF, extending the term of EDC financing, promoting innovation, and providing performance guarantees to prospective buyers. It is noted that EDC can match terms offered by competing countries but normally doesn't initiate transgressing the OECD guidelines which includes limiting the financing period to 12 years.
Without these measures, further consolidation in the shipbuilding industry may be necessary to keep the industry viable. Practically, there is enough work on large ships to keep two or three yards usefully open.
There is some evidence to indicate that smaller yards working in niche markets are able to effectively compete internationally. Obtaining access to foreign markets is the main barrier. These “smaller niche yards” can also benefit from SFF and other complementary measures and programs. Inclusion of smaller repair and refit contract work within SFF eligibility would also help smaller Canadian shipyards.
- The Government of Canada and relevant provinces, along with Crown Corporations, such as BC Ferries and Marine Atlantic, should embark on a coordinated, multiyear fleet replacement program, with Canadian shipyards getting preferential treatment to win contracts.
- Industry Canada should work with the Department of Finance to allow ACCA and SFF to be applied simultaneously.
- Industry Canada together with the Department of Finance should consider strengthening the balance sheets of Canadian shipyards by providing guarantee performance bonds, in much the same way that that Investment Quebec does.
- Industry Canada should review with EDC the provision in the shipbuilding policy that allows EDC to match financing terms when competitors for a project transgress OECD guidelines to ensure that applicants for SFF can bid with competitive support.
- The Marine and Ocean Industry Technology Roadmap (TRM) should be followed up to determine its impact on the Canadian shipbuilding industry and propose actions necessary to improve the level of innovation in the industry.
- Industry Canada should make Canadian shipyards and labour organizations aware that they are losing commercial work because of their reputation for late deliveries and cost overruns.
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