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Opinion

Ever Given saga reveals the beauty of risk-spreading

Techniques developed in 17th century serve as linchpins of modern global economy

| Japan
Tug boats and diggers work to free the Ever Given on Mar 28, which was lodged across the Suez Canal on Mar. 23: the container ship is covered by a protection and indemnity policy.   © Suez Canal Authority/AP

Stephen Givens is a corporate lawyer based in Tokyo.

The process of resolving multiple legal claims from the grounding of the Ever Given reminds us of the complexity and ingenuity of risk spreading techniques, first developed over 400 years ago, without which the global economy would grind to a halt.

Start with the complex ownership and operating structure of the Ever Given, a mega-container ship as long as the Empire State Building is tall, with a capacity for 20,000 20-foot containers stacked 10 high.

The Ever Given's owner is Shoei Kisen, part of Japan's Imabari Shipbuilding Group, a century-old family business based in western Japan's Ehime Prefecture on the island of Shikoku that just happens to be Japan's largest shipbuilder and the fourth-largest in the world. Shoei Kisen is one of the entities through which the parent charters custom-built vessels to its customers -- in the case of the Ever Given, to Taiwan-based Evergreen Line, the world's fifth-largest container shipping company.

That the ship's actual operator, Evergreen, can shift the risks of ownership to someone else illustrates one of the liberating innovations of modern finance -- the decoupling of operating risk from asset risk. The same basic technique allows Apple to make iPads and iPhones without owning a single factory, and Marriott to operate and manage hotels without owning a single hotel property.

The Ever Given's owner, for its part, will have hedged and spread its ownership risk by borrowing against the ship on a limited recourse basis. The limited recourse loan, in turn, will be securitized and spread among multiple institutions in the secondary debt markets.

The ability to create different mixes of risk and reward along the debt-equity spectrum, and to spread that risk through securitization, are innovations that have made it possible for large-scale projects, like building and operating a container ship or sending people to outer space for profit, to get off the ground in the first place. Even without insurance, were the Ever Given to sink without a trace, the loss would have been spread over multiple parties.

But, happily, insurance exists. It is no accident that the London Stock Exchange's predecessor and the Royal Exchange, where the original Lloyd's marine and fire insurance market was located, grew up side by side in mid-17th-century London. Both were cornerstones of the risk-spreading mechanisms that underwrote maritime ventures to bring spices from India and tobacco from America to England.

Shoei Kisen President Yukito Higaki, second right, and executives bow for an apology during a press conference in Imabari, Ehime, on Mar. 26: but, happily, insurance exists. (Photo by Hiroki Sakuragi)

The Ever Given is covered by a protection and indemnity, or P&I, policy issued by the UK P&I Club, a London-based mutual association of shipowners founded in 1869, the year the Suez Canal opened; a cargo insurance policy; and a hull and machinery policy issued by Japanese marine insurers Mitsui Sumitomo Insurance, Tokio Marine & Nichido Fire Insurance and Sompo Japan Insurance. The discrete categories of risk under the separate primary policies, in turn, were offloaded in layers to the reinsurance market.

Maritime law also contributes to beneficial risk-spreading. The Ever Given has invoked general average, an old maritime legal concept under which cargo owners are required to share the cost of the 11 tugboats and two dredgers used to refloat the Ever Given.

The law of salvage provides incentives for raising sunken ships and rescuing ships in distress by guaranteeing salvagers the cost of their services. A more recent international treaty that the Ever Given has invoked in the Admiralty Court in London, if the court finds it applies, would limit total liability to about 100 million pounds, based on the vessel's gross tonnage.

These are basic building blocks of capitalism and modern finance beautifully devised over the last four centuries to encourage productive risk-taking by ensuring that the cost of inevitable failures along the way will be collectively absorbed.

Of course, the process of settling claims from a maritime accident is not always efficient. Not surprising given that most accidents take place on the high seas beyond the jurisdiction of local courts, and the rules are a patchwork of international treaties, local law and industry custom.

More than three months after it was refloated and Suez traffic resumed, the Ever Given and its 25 member crew were kept under "arrest" in the Great Bitter Lake under the control of the SCA.

The SCA initially demanded $1 billion in damages, including $300 million in reputation damages and another $300 million in undocumented salvage expenses. The markets, however, quickly discounted this as blustery posturing, given that the estimated liquidation value of the vessel and its cargo is less than a third of the amount SCA was demanding.

In late June the SCA and the Ever Given's insurers announced a negotiated agreement in principle, leading this week to the release of the Ever Given and its cargo for an undisclosed amount -- probably close to one-tenth the value of the $1 billion SCA initially demanded.

Hundreds of collateral claims, from cargo owners and ships delayed for six days as a result of the Ever Given being founded, remain in the pipeline. There will be wrangling between primary insurers and reinsurers. Most will be resolved without litigation, by insurance claims adjusters.

The innovations to raise capital on a large scale and spread related risks across multiple sources first developed four centuries ago continue today to make it possible to build and operate ships the length of five football fields.

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