Climate change is an issue which affects and is affected by every industry, and there is a very clear need for a unified and comprehensive approach with a view to address the problem.
The transition to a green economy will play a very important role in this regard and, as the topic of sustainability and climate change continues to permeate almost every industry and political agenda, the role of finance increasingly takes prominence as one of the tools aimed at overcoming climate concerns.
Within the context of the ship finance industry, stakeholders are increasingly looking towards the use of green fuels and the implementation of more energy-efficient practices.
Such projects often require significant initial (and ongoing) expenditure which demand the support of financial institutions to assist in this transition to greener shipping.
The Loan Market Association (LMA) is one such example of the efforts being made by the finance community. Formed in 1996 with the intention of developing industry best practice and standardised documentation across financial markets, the LMA has published its own ‘green loan principles’, with the aim of creating a standardised green loan market.
This effort to align the finance industry with green and environmental principles has been further substantiated with the LMA’s publication of the ‘sustainability-linked loan principles’ (‘SLLPs’).
The terms ‘green loans’ and ‘sustainability-linked loans’ are often used interchangeably, although they frequently refer to two distinct products. Green and sustainable may not always be analogous, but each contribute towards climate targets to varying degrees. For instance, green loans are advanced to a borrower for a green purpose, where the proceeds of a loan are applied towards an environmentally friendly project.
An example of green projects includes the financing of vessels running on sustainable fuels. Danish container shipping line Maersk is proving to be a market leader in this regard, with the world’s first carbon-neutral containership expected to become operational by 2023 and not less than 12 containerships running on green methanol expected to form part of the Maersk fleet by 2025.
To date, the concept of green loans has been predominantly limited to a green tranche within a wider loan facility to finance a part or apparel of a vessel, such as scrubbers in the vessels’ exhaust, ballast water treatment systems or propeller cap fins.
Green and sustainable shipping is the future- Peter Grima
The frequency of green financings has been low as a percentage of the overall ship finance market, but this is expected to change as purely green financing projects for green fuel vessels is expected to become more prevalent in the run up to 2030 and beyond.
In comparison to green loans, sustainability-linked loans are not concerned with the application of the proceeds of loans for green projects. More specifically, they do not need to be applied to an environmentally friendly purpose.
Rather, a sustainability-linked loan links the lender’s pricing to the borrower’s sustainability performance, thereby adjusting the interest rate margins throughout the lifetime of the loan, based on the borrower’s meeting pre-agreed sustainability criteria. The pre-agreed criteria may for instance include a percentage use of recyclable materials or energy-efficiency measures.
SSLPs, while slightly more common than green financings, still represent a small percentage of overall ship finance deals. SSLPs are an alternative measure for borrowers who may lack the resources to invest in green projects in the short term, but who are nonetheless able to adopt more achievable sustainability targets and policies.
Indeed, SLLPs were borne from this necessity to improve the borrower’s sustainability profile in instances where wholly green measures are not attainable.
Borrowers are encouraged to publicly report all information on sustainability performance targets and, where this is not possible, to report directly to financiers at least once a year. In the instances where a borrower fails to publish information, a third party such as a rating agency or environmental consultant may be appointed to conduct an external review and assess the borrower’s performance.
Presently, the percentage of SSLPs and green loans in the overall ship finance market collectively amounts to circa 10 per cent, a figure which is anticipated to steadily increase in view of the global pressure to reach at least a 50 per cent reduction of the 2008 carbon emissions baseline by 2050.
These targets are the culmination of the United Nations Climate Change Conference and the ensuing Paris Agreement of 2015, where no less than 196 countries legally committed themselves to address climate change.
This landmark multilateral agreement aims to limit global warming to well below 2 degrees Celsius and preferably to 1.5 degrees Celsius, compared to pre-industrial levels, an objective which will require countries to reach global peak greenhouse gas emissions as soon as possible.
One of the goals of the Paris Agreement is to make financings consistent with a pathway towards low greenhouse-gas emissions and climate-resilient development. In order to achieve these targets, it is estimated that $1.4 to $1.9 trillion of investment would be required, necessitating an increased availability of financing for green and sustainability projects.
It is widely accepted that green and sustainable shipping is the future, and the availability of finance can lead the way in providing the necessary liquidity to combine economic growth with the delivery of climate change targets.
Peter Grima is a senior associate within the ship finance department at Fenech & Fenech Advocates.
This article is part II of a two-part series of articles on green measures and green financings in the maritime sector. The author would like to thank Diane Cutajar, student intern at Fenech & Fenech Advocates, for her invaluable help in drafting this article.