How will decarbonisation be financed? ICS webinar

Dec 07 2021

Who will provide the funding for environmentally friendly vessels, and how will they be incentivised? One method is to try to reduce funding available to less environmentally friendly vessels, but this might backfire, we heard in an ICS webinar.

Amid all the talk in the shipping industry about decarbonisation, nobody has yet worked out how it will be financed and what the incentives will be.


One mechanism could be for banks to set a minimum level of environmental standards for the ships they are willing to finance.


But if this did not include every bank in the world, it might mean that other banks would be willing to finance less environmentally friendly vessels, with both the owners and the banks making more profit, because they are less expensive.


The International Chamber of Shipping held a webinar on June 16 to explore further, with representatives of banks Société Générale and Standard Chartered, and shipping company NYK. The webinar was called “Financing Shipping's 4th Propulsion Revolution - Pathway to COP 26”.


The International Chamber of Shipping refers to the move to zero emission technologies as shipping’s “4th propulsion revolution”, following moves to sail, coal and then diesel in the past.


Société Générale

Paul Taylor, managing director, global head of shipping and offshore, Société Générale, and Vice Chair, Poseidon Principles, said that the starting point for Poseidon Principles was that banks are in a position to make an impact on shipping, because they make decisions about which vessels to finance.


The banking sector altogether provides $450m of “senior debt” to the shipping industry, covering 70,000 commercial vessels.


Signatories to the Poseidon Principles agree to measure and publicly report, annually, the carbon footprint of their portfolio, and compare the rate of improvement to the IMO’s trajectory.


Since the launch two years ago, the number of signatories has increased from 11 banks to 27. “We expect more to follow shortly, including Chinese leasing companies and Korean banks.”


“If banks can align their portfolios to support the IMO target, we will go a long way to supporting the industry's ambitions regarding decarbonisation,” he said.


The first year’s reporting, already submitted, showed that most banks were already misaligned with the IMO trajectory. That is to say, the vessels in their portfolio were not decarbonising at a fast enough rate to reach IMO’s targets.


The misalignment was “not so much”, he said. “But it shows a need for an initiative like Poseidon Principles.”


The second year of Poseidon Principles ends December 2021. Covid should help keep vessels on the trajectory, if it has reduced demand for transport and pushed some vessels to be deployed differently, he said.


Mr Taylor’s own bank, Société Générale, is making climate risks a central part of its lending decision making, on an equal footing to the credit risk, the ability of the client to pay back a loan.


There has been some criticism that the Poseidon Principles do not go far enough. Although when it was launched 2 years ago, some people made the opposite criticism, that it is too ambitious, he noted.


One concern is that if the big banks are increasingly focussing on only the bigger customers, it will push medium sized shipowners, such as with 15-20 ships, towards less reputable banks, he said.


“It won't work for every shipowner, and that's the way it is going forward.”


“We can't force all banks to sign up. We have 27 today, we have most of the serious banks in shipping finance - apart from some of the Asian banks.”


Poseidon Principles “is going to channel liquidity, capital, to those shipowners who have high standards of maritime stewardship and who want to align themselves with industry goals. It will take capital away from some of the other owners, who haven't got an ESG policy.”


The Poseidon Principles should be seen as only a starting point. “No-one said, this is where they are going to be forever and you're going to see immediate impact and reaction from banks,” he said.


It seems likely that the United Nations COP 26 meeting in November 2021 will set new targets for shipping to decarbonise, which will be passed on to IMO, he said. The Poseidon Committee has already agreed that if this happens, the Poseidon targets will be adjusted accordingly.


Mr Taylor said he is concerned that some climate initiatives, including climate bonds and EU regulations, could push investment out of high-quality shipping.


“My concern is the way this is drafted is going to close the door on what we have today in shipping and close the door on the transition. They are focussing on the destination of zero carbon, not on the journey we have to undertake. I think that could drive away investment from the shipping industry to other sectors.”


“Investment in assets, infrastructure, not just ships, the whole value chain of shipping, is under threat.”


And for the needed low carbon fuel infrastructure, “you can't just look to shipowners, or fuel suppliers, or ports, or banks.”


Standard Chartered

Abhishek Pandey, Managing Director, Global Head Shipping Finance, Standard Chartered in Singapore, noted that the amount of funding available to ships from traditional banks is gradually reducing.


According to his calculations, in 2008, $350bn was available to shipping from the top 20 banks. In 2020 that was $250bn.


There is a greater drop in Europe. In 2008 all the top 10 lenders were European. In 2020, only 50 per cent of the top 10 were European.


“We've seen in Singapore, quite a number of European banks have ceased to provide shipping financing through their Singapore subsidiaries.”


A number of factors have had an impact on the lending terms available to shipping, including ESG requirements and Basel IV standards for bank capital requirements.


The loan to valuation ratio also reduced, so owners are not able to take out such a large loan for the same valuation of vessel.


One issue is that larger banks are focussing more on their top tier clients, at the expense of the rest, which is “creating a bit of polarisation in the industry.”


This pushes shipping companies to alternative financing and leasing structures, with the growth of Chinese leasing companies being particularly big.


“We know Chinese leasing has taken up quite a lot of this slack, if I can put it that way.”


In terms of numbers, Mr Pandey estimates that $120bn of maritime lending was taken out of the market over 2013 to 2019. Meanwhile Chinese leasing was $47bn in 2017, $52.5bn in 2018, and $60bn in 2019. There was additional Chinese investment of $12bn in 2017 and $16bn in 2019.


“The advent of leasing companies and alternative financing shows us there is an element of liquidity which can take this risk. But it needs to be priced right.”


In a normal market situation, if there is less supply (of lending for ships in this case), prices (interest rates in this case) should go up.


Bank lending is typically at between 0 and 4 per cent interest, while leasing companies typically go from 4 to 8 per cent interest, so it means an increase in cost of capital.


“Risk - reward is often not debated,” he said. “Knowing the volatility in this industry, the lurking question in banking is 'was it priced right.


Were the terms right.’”


“We've seen it all before, private equity, hedge funds, coming in and burning themselves out.


Standard Chartered has played on both sides, making loans for ‘senior debt’ at 0 to 3-4 per cent, and also buying assets, doing operating leases, so taking 100 per cent investment risk, he said.


“When you have done both sides of it, you come to a conclusion, the lower side [of interest rates] wasn't really balanced with the amount of risk.”


And only large companies with very strong credit ratings can get the lower rates.


“It is important that everybody understands, let me put it bluntly and simple. When you invest in a ship you are investing in a cyclical industry. You want all the upside, and you want to pass all the downside to a lender. Lenders are getting smart.”


Mr Pandey calculates that 14 of the top 24 banks lending to shipping are now signatories to the Poseidon Principles, including Standard Chartered which “signed up a couple of months ago,” he said.


Mr Pandey noted that there is still a bank sitting behind every leasing house, and if that bank is a signatory to the Poseidon Principles, that will mean the ships being leased are under its net.


Another factor is that shipowners are maybe not ready to invest in vessels which are very different. “Someone said to me yesterday, you need to be a very brave shipowner if you want to order something which is an unorthodox design.”


So the money for new designs of vessel may come from unusual sources such as private equity funds, or sovereign debt funds investing in leasing platforms.


NYK Group

Svein Steimler, President and CEO, NYK Group, Europe, noted that shipping is still an extremely conservative business. “We change late, we adopt late, we are a bunch of individualists,” he said.


“The only way to get aligned is to get a set of rules and regulations which clearly tell us where to go,” he said. “I'm embarrassed to be part of an industry which has done so little over so long to do the necessary changes.”


“It took 40 years to ratify the ballast water convention.”


“We are not the worst in the world, look at the textile industry which is far worse than us. But comparing one industry to another will not bring us anywhere, we need to look after ourselves.”


“What baffles me, a few years ago we were all talking about SOx,NOx, particulate emissions. Today it is all about CO2. SOx and NOx and particulates seems to be forgotten completely.”


NYK Line is currently renewing its fleet on the basis of “technology which is currently out there,” so LNG fuel.


“we’ve said we will do something now. This is where I get a little bit frustrated with my colleagues around the world who say let's wait for something better, let's wait for ammonia and hydrogen. That is going to get us nowhere. It is an unserious and a conservative way of looking at our industry.”


Mr Steimler dismisses the Poseidon Principles as more talk than substance, and sees that banks are still reluctant to lend to greener ships. “I respect the Poseidon Principles. [But] have we seen much stuff? No we have not. I said, ‘show me the colour of your money’. So far we have not seen much at all.”


It is important that any environmental regulations are applied globally. “We are in an industry which is global. To have different rules and regulations is going to make trade hopeless,” he said.


Another issue is that “the majority of shipowners have not got the financial [resources] to look into technical development,” he said.


“Engine manufactures do. Large shipping companies like NYK do spend money. They are looking into ammonia, hydrogen, electricity.


But this makes it more important to “make sure that rules are channelled through one international organisation,” he said.


But otherwise, people will end up sitting in different groups.


Future shipping will still have a mix of fuels, “Some old ships, some LNG, some electricity, some ultimately hydrogen and ammonia,” he said.

I don't for a minute believe there will be stranded assets.”


“I am not advocating to convert older vessels,” he said. “There's got to be economy in this. You cannot spend millions of dollars to convert an older vessel.”


“To me - when we build vessels today - it is for a lifespan of 20-25 years roughly. This issue will take care of itself.”


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