Container ship

The rise of sustainable finance and its impact on the shipping industry

Partners, Gary Wong (Hong Kong), Janice Lee (HongKong), Beatrice Russ (London), and Senior Associate, Alberta Longanesi Cattani (London), have contributed again this year, on behalf of Ince & Co, to the annual edition of Port of Hong Kong Handbook and Directory 2023, commissioned by the Hong Kong Maritime Hub. The article was drafted in June 2023.

Everyone is talking about sustainable finance: what is it?

A number of initiatives contributed to the development of sustainable finance, but the adoption of the Paris Agreement and the publication of the United Nation’s (UN)Sustainable Developments Goals in 2015 are the keydrivers behind the introduction of environmental, social and governance (ESG) considerations into investment decisions.

There is at present no single worldwide definition of sustainable finance and, as of April 2022, about 868 policy tools and guidance were identified in this context by the UN-supported Principles for Responsible Investment(PRI)’s database, with the highest regional concentration of regulatory measures being in Europe.

What ESG criteria are particularly relevant to the maritime industry?

Shipping companies’ ESG strategies and sustainability performance play an increasingly important role in the financiers’ lending decisions. Not only is there increasing regulatory and commercial pressure on the ship owners to decarbonise, but the financial institutions must comply with their own ESG obligations too and need to be extra careful in monitoring the ESG standard of the projects they invest in.

Even though sustainable finance is meant to be addressing all the three elements of ESG, its application to the shipping sector currently mainly reflects the ambitions and standards outlined by the International Maritime Organisation (IMO) concerning the decarbonisation of the industry, therefore focussing on the “E” element.

With reference to “S” and “G” factors, although these parameters are not being assigned the same level of urgency by the IMO, the financiers are under growing pressure to satisfy their own ESG obligations at corporate level and, as a result, often go beyond standard governance checks when making their investment decisions.

More transparency is and will be expected from shipowners beyond the usual KYC/AML requirements, covering a range of factors including crew welfare, diversity, onshoring,sanctions, just to give a few examples.

Can you explain in more detail what “E” means in the shipping context?

Back in 2018 the IMO filled the gaps left by the Paris Agreement by defining the decarbonisation targets for the shipping sector, (the Initial IMO Strategy), which identified a trajectory for cutting and phasing out greenhouse gas (GHG) emissions from the industry, as well as reducing its carbon intensity and improving energy efficiency for ships.

Measures introduced by the IMO in this context include setting the upper limit of the sulphur content of ships’ fuel oil, the requirement for all ships to calculate their attained Energy Efficiency Existing Ship Index (EEXI) to measure their energy efficiency, and the collection of data for the reporting of ships’ annual operational carbon intensity indicator (CII) and CII rating.

Crucially, the revision of the Initial IMO Strategy is set to take place during the next Marine Environment Protection Committee meeting this Summer (MEPC 80), scheduled at the IMO between 3 -7 July 2023. It is widely recognised that the current objectives set out in the Initial IMO Strategy are not ambitious enough and it is expected that a more ambitious strategy will be adopted. MEPC 80 is,therefore, of fundamental importance and will determine the future of shipping’s decarbonisation (or, if a revision of the Initial IMO Strategy is not delivered, in the opinion of some, whether the IMO will continue to be the main regulator of shipping going forward).

How are sustainable finance principles implemented in Ship Finance, in practice?

There is not a legal framework specifically regulating sustainability-linked finance in the shipping sector.

The Loan Market Association (LMA)’s guidelines for green loans and sustainability linked loans and the EU Taxonomy, which both apply across industries, together with the sector-specific Poseidon Principles initiative, constitute altogether the key framework for sustainable finance in the maritime sector. The Climate Bond Initiative, the Net-Zero Banking Alliance, the Green Shipping Programme and the Climate Transition Finance Handbook of the ICMA are also often used as reference material in this context, depending on the type of lending.

In practice, sustainable ship finance generally takes theshape of green, sustainability-linked (SLL) or transition loans. Depending on the type of loan, Key Performance Indicators (KPIs) and Sustainability Performance Targets (SPTs) may be required and monitored.

Additional commitments aiming to align the investment and portfolio with IMO regulations and the Paris Agreement targets will be made if the Poseidon Principles are applied to the loan, as they set out a framework for assessing and disclosing the climate alignment of ship finance portfolios.

In summary, what is the key ESG strategic objective for the shipping industry currently demanded by financiers?

With reference to ESG parameters, it is very clear that the key current strategic objective for the industry is the emission reduction, but there is not an agreement as yet on what the future fuel source and technology will be, as well as on who will assume the financial risk of supporting the development of the required innovation.

In this context, even though key future investments will be funding future fuels, innovative technologies and related infrastructure, the majority of shipping banks’ current lending objectives between now and 2050 appear to be primarily focused on financing retrofits reducing consumption and/or increasing efficiency of the existing fleet, rather than in financing new vessels propelled by future fuels.

It is expected that over the next couple of years considerable progress will be made from an emission-measuring perspective and that an increased demand for 1.5 aligned strategies will be required by various industry players, ranging from cargo owners, banks and end-consumers. For example, next year many banks, signatories of the Poseidon Principles, will have to commit to targets for 2030 under their membership to the Net-Zero Banking Alliance, and the pressure from organisations such as the Cargo Owners For Zero Emission Vessels (coZEV) and the Zero Emission Maritime Buyers Alliance (ZEMBA) is also growing.

The pressure is on for the maritime industry to decarbonise and MEPC 80, set to take place in July 2023, will be of historic importance in defining the future of the sector’s decarbonisation journey.

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