How Shipping Banks' GHG Focus Impacts Fleets And Freight Rates

Will a bank provide a loan to a ship owner to build a new vessel, to buy one in the second-hand market, or to refinance existing debt that's about to come due? The launch of the Poseidon Principles has brought environmental considerations explicitly into the equation.

The consequences for ocean shipping will not be immediate, but over the years ahead – if the Poseidon Principles work as designed, alongside existing regulatory pressures – the global fleet composition could change. Theoretically, the fleet of the future should be younger and greener, with shorter ship lifespans and potentially higher freight costs for cargo shippers.

To understand the shipping and banking consequences of the Poseidon Principles, FreightWaves conducted an exclusive interview with veteran banker Michael Parker, global head of shipping and logistics at Citigroup C. The drafting committee for the new principles was comprised of Citigroup, Société Generale and DNB; Parker was the chairman of the drafting committee.

What do the principles entail?

The signatory banks to the Poseidon Principles will make an annual public disclosure of the carbon intensity of the ships within their loan portfolios, in relation to a baseline.

The carbon intensity for each ship will be determined using data owners are already required to compile (on fuel type, fuel consumption, hours underway, distance traveled and ship specifications). The baseline will be comprised of the decarbonization trajectory of each vessel type necessary to meet the International Maritime Organization (IMO) target of reducing shipping's annual greenhouse gas (GHG) emissions by at least 50 percent by 2050.

The publication of the participating banks' portfolio carbon intensities, and transparency on how they are trending over time, should incentivize lenders to adjust portfolios to reduce their published carbon intensities.

How many lenders are onboard and is that enough?

One source of skepticism toward the Poseidon Principles relates to capital sources that are not involved. If enough capital providers don't sign up, wouldn't ship owners with high carbon-intensity tonnage just get their capital elsewhere, leaving Poseidon Principles signatory banks with a small share of the pie? 

The 11 initial signatory banks account for about $100 billion in senior shipping debt, out of a total of around $450 billion. The signatories are largely European lenders, a funding source for shipping that has been pulling back over the past decade, with owners shifting toward Asian funding sources. The signatory list does not yet include any Asian leasing houses or export credit agencies.

Asked by FreightWaves whether the lenders that have signed on are enough, Parker responded, "Yes, I do think there are already enough now, and I also expect more lenders to join that have indicated the likelihood of signing in the next few months. This [obtaining new signatories] is not something that ever ends.

"What we felt before launching this was that we had a significantly large minority. We're making every effort to proselytize what we're doing and there have been quite a lot of inbound inquiries. What we'd like to eventually get to is 90 percent of all lenders and I see no reason why any serious lender would not sign up, other than on some policy grounds."

Some believe future capital sourcing by ocean shipping is likely to continue trending more toward equity at the expense of debt, but here too, the green agenda is making big waves. Several shipping and financial industry executives highlighted new equity investor pressure at the Marine Money Week (MMW) conference in New York on June 17-19.

According to Andy Dacy, chief executive officer of the global transportation group at JP Morgan Asset Management, "ESG – environmental, social and governance – has become incredibly important. You cannot put institutional capital to work without looking at the ESG aspect."

According to Hugo de Stoop, CEO of tanker company Euronav EURN, "I've never had so many questions from investors related to ESG." Hew Crooks, chief financial officer of privately held Ridgebury Tankers, said at MMW that today's ESG focus has "unrecognizably increased" compared to past investor interest.

In other words, the Poseidon Principles on the senior bank debt side of the funding puzzle are merely one aspect of a much broader ESG focus that has implications across the entire capital spectrum.

How borrowing costs will be affected

The number-one question for ship-owning borrowers is how will the Poseidon Principles affect future interest-rate expense? Will owners of low carbon-intensity vessels get a break on their rates, or will those with older, less-efficient ships see their rates increase? To what extent will there be a higher spread between the two?

"The answer is, one should look at shipping no differently from other sectors," said Parker. "We've seen a shift if you look at green bonds. I think we're beginning to see a tipping point in that investors will give people credit for an environmentally positive investment, and I see shipping as no different."

He continued, "We use credit risk to determine how we rate companies and that's what drives [loan] pricing, but I do think environmental compliance behavior will begin to play a part."

An important aspect of credit risk is charter coverage. The more a borrower's ships are backed by future charter employment revenues, the lower the credit risk. If charterers start judging owners based on carbon intensity, this would lower the credit risk for good actors and help in terms of borrowing costs.

Dacy agreed. "It's not only the banks and the institutional capital, it's the long-term charter companies," he said. "If someone is going to do a five- or 10- or 15-year charter, they'll want to make sure they're leasing the asset from a company that's very good on the ESG side."

"I think that good, responsible owners with low emissions will be rewarded by the people that employ their ships," said Parker. "I think you'll see that the charterers are working on their own version of the Poseidon Principles and they may well come up with criteria that will give a benefit to environmentally responsible companies."

How and when will fleet composition be affected?

The signatory banks will immediately take the carbon intensity issue into account when considering new loans, but the effects in the global shipping fleet will take time to manifest.

"The lending decisions we're making today will include questions about climate change – we wouldn't have signed up if we hadn't accepted that – but I think the real impact will become clearer in two or three or four years," said Parker.

"To be honest, this is something that will take time. There may be knock-on effects from the Poseidon Principles that we can see are likely, others that you could argue are likely but may never happen, and others we can't foresee that may happen."

Logically, it would seem that the new banking policy should make it harder for an owner of an older, less efficient vessel to refinance existing mortgage debt and harder for a buyer to finance the acquisition of an older, less efficient vessel. This should lower the value of older ships and encourage more scrapping, decreasing average age and average lifespan.

The principles should also theoretically incentivize newbuildings, but only after new regulations and technologies are in place and owners (and their bankers) understand what kind of ship to build to reduce carbon intensity. Until more is known about which design to use for newbuildings, owners contracting them will face a higher obsolescence risk and thus a greater residual value risk – which is a major reason why newbuilding activity has decreased.

According to Parker, "I think there is a logical argument that this will lead to better managed and more rational investment decisions, because of the likely shorter life of the vessel, which would mean you'd need to ensure the debt would be repaid [in fewer years], which I think is a positive for the industry. Also, the need to finance with more equity will force owners to have more financial discipline to obtain higher returns.

"I think that with the Poseidon Principles, the expectation that owners can trot along to a bank and refinance a 10-year-old ship for another five years is now called into question. I think the likely effect that we may see in a few years' time is that more ships go to scrap at 15 years [of age, instead of 20 or more years]. What lenders are encouraging through the Poseidon Principles is that less efficient, higher-emitting ships are scrapped earlier than they have been."

What's in it for the banks?

Both the shipping and lending industries have been criticized in the past by environmentalists for their relative lack of action on GHG emissions and the climate agenda. The term ‘ESG' was rarely mentioned at previous years' MMW events in New York. A skeptic may respond to the Poseidon Principles by asking why now and what's in it for the banks?

The answer to the timing question is that the ability to compare a loan portfolio's carbon intensity to a baseline required the creation of the baseline, which was made possible when the IMO announced its 2050 GHG reduction target in April 2018. The months since were spent getting enough banks onboard for the launch of the program with a sufficient critical mass.

On the question of benefits for bankers, the shipping division of a bank competes for capital to lend to borrowers with other divisions of the same bank lending to other industries. In recent years, shipping bank divisions have lost capacity to competing divisions.

Asked whether the Poseidon Principles will give banks' shipping departments an edge due to the banks' overall ESG focus, or whether it will be a hindrance due to higher standards for borrowers, Parker responded, "I think the answer is that it's neutral, because I don't think anyone's keeping score, at least not yet.

"I do believe that for all of us who signed up, it does show to our management and the outside world and to our regulators that we are taking the initiative and doing something that is very consistent with what is being encouraged by the United Nations.

"We're not asking for additional capital because we are doing this. This doesn't give us some sort of special status. What we are actually saying is that we're going to make sure that the capital that we do have is allocated responsibly, in line with IMO commitments under the Paris Agreement, but also for lots of other reasons having to do with managing a profitable business.

"What is significant is that this is the first industry to actually take steps in the financial sector to help align the industry with global goals, so we are setting an example and I think all of us who are involved are very proud of that," he said.

Another reason banks may have acted now is that not acting has become increasingly less of an option. "This is not something that's going to go away. It's more than about economics. It's about reputation," De Stoop told MMW attendees.

He recounted a conversation with an investor who was a long-time skeptic on global warming. When De Stoop recently asked him if his views had changed, the investor responded, "I am still completely skeptical, but one thing has changed – it doesn't matter whether I'm a skeptic or not because there are enough people who are convinced about it that my business is going to be impacted."

Peter Livanos, the CEO of GasLog Ltd GLOG, said at MMW, "The environmental issues going forward are not just going to be a game changer, they're going to be a significant game changer. There's no question that financial institutions, whether they be private banking institutions lending to corporates or international lending institutions such as the World Bank, need to use their capital to assist and promote ventures that are environmentally aware and are environmental leaders."

Regarding the decision by Citigroup and the other banks to launch the Poseidon Principles, a move he commended, Livanos maintained that ultimately, "these institutions would be punished by the global community if they did not adopt them."

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