The South China Sea: The Spratly Islands dispute

Pictured is Alison Reef, an atoll of Spratly Islands. Image taken by NASA

Pictured is Alison Reef, an atoll of Spratly Islands. Image taken by NASA

The South China Sea: The Spratly Islands dispute

18/07/16

By Jonathan Moss, Jamie Hoffman and Sophie Lipton

On 12 July this year, an arbitration panel in The Hague issued a ruling in the long-running dispute between the Philippines and China over the South China Sea. The panel ruled in favour of the Philippines.

As part of the larger South China Sea dispute, the long-standing Spratly Islands dispute is an ongoing territorial dispute regarding ocean areas and the Spratly Islands and the Paracel Islands to the north – two island chains claimed in whole or in part by a number of countries.

The Spratly Islands consist of hundreds of islands and reefs. The 750 spits of lands that make up the Spratly Islands are small and largely uninhabited.  However it is their strategic location in the middle of several major trade routes, being the home to fishing grounds which supply people across the region, as well as the possibility of their containing natural resources which have made the islands an extremely valuable commodity. It is worth noting that there has been little detailed exploration of the area, so estimates are largely extrapolated from the mineral wealth of neighbouring areas.

By mid 2015, China had built at least seven artificial islands in the South China Sea. China has been building runways on its artificial islands for over 12 months and the recent landing of its first plane is said to have raised tension and threaten regional stability.  As well as China, the Philippines, Vietnam, Taiwan, Malaysia, and Brunei lay claim to some part of the Spratly Islands.

Award of the Permanent Court of Arbitration

‘On 22 January 2013, the Republic of the Philippines instituted arbitral proceedings against the People’s Republic of China under Annex VII to the United Nations Convention on the Law of the Sea (the “Convention”), “with respect to the dispute with China over the maritime jurisdiction of the Philippines in the West Philippine Sea.” On 19 February 2013, China presented a Note Verbale to the Philippines in which it described “the Position of China on the South China Sea issues,” and rejected and returned the Philippines’ Notification.’ Most recently, on 12 July 2016, The Permanent Court of Arbitration in The Hague gave an Award against China.

The Tribunal ‘found that China had violated the Philippines’’ sovereign rights in its exclusive economic zone by (a) interfering with Philippine fishing and petroleum exploration, (b) constructing artificial islands and (c) failing to prevent Chinese fishermen from fishing in the zone. The Tribunal also held that fishermen from the Philippines (like those from China) had traditional fishing rights at Scarborough Shoal and that China had interfered with these rights in restricting access. The Tribunal further held that Chinese law enforcement vessles had unlawfully created a serious risk of collision when they physically obstructed Philippine vessels.’

Is the Award enforceable?

The Permanent Court of Arbitration is an intergovernmental organisation providing a variety of dispute resolution services internationally. The Permanent Court of Arbitration has no sitting judges and therefore does not have any powers of enforcement. The UN-appointed tribunal adjudicates on international disputes. It produces awards not judgements to indicate for example, which maritime features are capable under international law of generating territorial rights over surrounding seas.

China has refused to accept or even truly participate in the arbitration. The Ministry of Foreign Affairs of the People’s Republic of China released a statement saying that because it was the first to have discovered and exploit the South China Sea Islands, it therefore established “territorial sovereignty and relevant rights and interests”.

Furthermore, key countries who believe they have a claim to the Islands are not accepting the ruling (for example, Taiwan, who, although not party to proceedings, has similar claims to China with respect to the Islands.)

Legal implications

From a legal perspective, one would be naïve to assume that the award of the international Tribunal represents the final outcome in this ongoing dispute. It is a decision which will likely give rise to further legal battles and potential legal sanctions depending on how each country chooses to act.

Overview of insurance implications following the outcome of the Court of Arbitration.

There are a variety of key implications for the insurance industry as a whole. The uncertainty in the region will naturally drive up premium costs. The potential for casualties in the region and the risk of higher claims will be behind this rise. There will likely be an increase in exclusions in policy contracts as an attempt to safeguard the risk in policies now created by this ruling. It will be much harder in general to insure ships and cargo whose route is through the South China Sea due to the fact it is a conflict area. Indeed, there is an increase in the ‘global diplomatic pressure on Beijing to scale back military expansion in the sensitive area.’ The fact that there are military forces in this region could force ships to access a different route or face costly consequences. China’s military claim may dissuade vessels from navigating in waters around the Spratly Islands. Indeed, China’s growing military power combined with its ambitions for modernisation of its naval capabilities is being used to reinforce its claim to sovereignty in the region.

Further details of implications and further analysis on the potential rise in insurance premiums

Looking at the situation logically, increasing tensions often brings with it increased risk and subsequent increased premiums, particularly for charterers and shipowners navigating in the region.  Therefore it is possible that insurance premiums will increase, however it is yet to be seen.  With an increased presence from China, and the clear message that ships and aircraft should not invade certain areas, it may be that insurance cover will change and evolve to exclude the path of vessels over or around the Spratly Islands.  Although unlikely war is going to break out the threat of skirmishes may ramp up the demand for War Risks cover, particularly for Insureds about to renew or looking for new cover.

Is it likely that vessels sailing towards Japan and other destinations may decide to re-route away from the area of tension?  What would it take for underwriters to start pressing owners to do that (if at all of course)?

If merchant ships and commercial planes encounter resistance from China when using paths over or around the Spratly Islands, it is possible they may seek alternative routes, especially if they feel a real threat exists due to the rising tensions.  Underwriters may not being able to press Insureds to do anything but they can obviously influence the Insured’s decision making – i.e. If an area is specifically excluded for cover from a geographical area then the Insured will presumably seek to avoid that area or risk not being covered.

What impact would a major escalation in the area have on overall shipping costs and risks?

It would likely increase shipping costs and premiums.  Vessels would have to source alternative routes which could impact on shipping time and cause delays.

Is there anything that ship owners can do given the possibility of bigger confrontations between naval forces?

It would be wise for ship owners to seek confirmation from their Insurers as to whether they should travel certain routes given the rise in tension, keep up to date with the situation and follow any advice issued from maritime organisations.

In December the Lloyd’s of London Joint War Committee removed the Sulu archipelago from its high risk list.  Could Sulu become ‎a potential alternative route if there is an escalation in the South China Sea?

As previously mentioned it is likely that merchant ships may, or depending on the situation may have to, seek alternative routes.  Although the South China Sea hosts many shipping paths and may be the cheapest and quickest for certain journeys, other routes do exist and will naturally be used more if the requirement arises.

Trade finance implications

There may be a reduction in the amount of financing of international trade within this region due to potential boycotts from various countries. A social media campaign in China has already surfaced in the few days following the ruling which calls on boycotting fruit imports from the Philippines. The BBC has revealed that ‘Even some vendors on Taobao, China’s largest e-shopping platform, pledged to boycott the Filipino snack.’ This is evidence of the beginning of the deterioration of trade between the two countries. However, there is a much larger concern that international trade will slow due to other countries wading in on the dispute. The US has made it clear it sides with the Philippines, and it is this which has the potential to lead to trading disputes between China and the US as well. Trading in the vicinity may decline in this area altogether for fear of escalating tensions.

The uncertainty in the region may even encourage trade to be re-directed through different routes, leading to riskier and costlier voyages.

Wider business implications

Firstly, the mineral wealth of the Spratly Islands is unclear. The islands have been described as ‘a maritime region believed to hold a wealth of untapped oil and gas reserves.’ If there is oil, it is likely that there will be a scramble to access it and use it for gain. The fact that China already has military forces in the region may assist them make claim to the oil, if found.

The fallout from the Award given at The Permanent Court of Arbitration is profoundly important for the wider economic outcome. The overarching implications are that if China now chooses to focus on a substantial modernisation of its maritime capabilities as well as its growing military power, there will be risks for other global econmies. For example, the US-China relationship may falter given that the US opposes China’s sovereignty in the Spratly Islands. The UK also opposes China’s claim and with Brexit, it is possible that business negotiations between China and the UK will deteriorate.

China is likely to set up an air defence zone over the South China Sea territory. China has done this before in the East China Sea. In 2013 China enforced the air defence zone which caused aircrafts flying over this region to follow a strict set of rules. The US authorities have indicated it does not normally take sides on territorial disputes, but it has previously sent B-52 bombers and a naval destroyer near the disputed islandsMilitary officials said that ‘the bombers flew within 12 nautical miles of the disputed Spratly Islands’ on their mission in November 2015. If these events unfold then the most likely overarching outcome which affects all business is that there is an armed conflict between China and the United States.

Implications of China’s moves and the growing tensions surrounding The Spratly Islands.

China’s claims on the Spratlys and the Paracel islands are based more on historic settlement rather than geographical proximity. Recently China has raised the stakes by seeking to change the geography with significant man-made islands and infrastructure. It is claimed that by May 2015 the Chinese had added 2,000 acres to their outposts in the previous 18 months.  The rate of increase of these new islands is causing anxiety for neighbouring nations.

Some countries have expressed concerns that China could host military planes and navy ships on their man-made islands.  The effect of this may cause intimidation and reinforce China’s claim over much of the disputed territory and threaten freedom of navigation in one of the world’s busiest shipping paths, potentially enabling China to control a large share of the world’s shipping.  It seems that the new strategically located islands would give China more security leeway in the disputed waters and make it difficult for other forces to assert sea control.

With the Spratly Islands falling in close proximity to a vast number of important shipping paths and given that more than half of the world’s top ten shipping ports are also located in and around the South China Sea, any change in shipping patterns through such an area has the potential to impact trade worldwide.

Building artificial islands around the Spratlys may have certain knock-on effects, such as potentially exacerbating the tension in the Senkaku/Diayou island dispute between China and Japan (although China has not created any artificial islands there yet).

Future

Looking to the future it is clear that there will be further disputes in this region around the sovereignty of the Spratly Islands. The Chinese Government adhered to the position of neither accepting nor participating in the arbitral proceedings and this reiterates its standpoint in its position paper that is quite simply does not accept the outcome of The Tribunal. China’s Vice Foreign Minister Liu described the ruling as “a piece of waste paper” at a press conference, alleging the tribunal had been “manipulated.

However, there have been reports that China’s foreign minister Wang Yi hinted that ‘Beijing would now be willing to enter into negotiations with the Philippines over the South China Sea Issue’ leading to cautious optimism that a settlement would be reached.

China is prepared to fight and defend its right to the Spratly Islands but the key question is at what cost?

Jonathan Moss is a Partner and Head of DWF’s Transport Sector, Jamie Hoffman is a Solicitor at DWF and Sophie Lipton is a Trainee Solicitor at DWF.

Ranked in Chambers Global 2015, Jonathan Moss acts for international traders, charterers, shipowners, insurers and reinsurers, handling commercial disputes. Jonathan also advises on day-to-day issues arising in the context of the sale of goods and their transportation.

DWF’s Transport Group brings together an international network of over 60 lawyers offering a full range of legal services to government and private sector clients principally across the automotive, rail, maritime and logistics industries. The firm provides advice on issues related to insurance, employment, asset finance, litigation, government procurement, and on matters as diverse as intellectual property rights and supply chain risk management. The Transport Group is organised into subsectors: Marine & Trade, Automotive, Road Haulage and Logistics, and Rail, each with their own divisional head(s) and dedicated steering committees. For more information about DWF click here.