The Poseidon Principles: Can they accelerate the transition to greener vessels?

Shipping is a capital-intensive industry. However, over the past few years, the availability of capital within the sector has shrunk considerably as western banks cut their exposure to the market after struggling with bad shipping loans.

Too many regulations, especially those targeting environmental issues and climate change, have made shipping finance rather complex and unattractive when taking into account all the risks involved.

It is estimated that the withdrawal of many western banks combined with the reduction of market exposure of those that remained in the business has resulted in halving the available capital for shipowners in the syndicated and club market, from $80 billion to $40 billion over the past ten years.

The gap has been filled by Chinese lenders to a certain degree. Nonetheless, Asian lenders are not as regulated and tend to have a more lax attitude toward the environment when compared to their western counterparts.

With the growing pressure on the shipping industry to decarbonize, the banking sector has come up with a voluntary regulatory framework that could accelerate the implementation of the sector’s green agenda while charting a path forward for banks by preventing them to repeat the same mistakes from the past.

One of the worst mistakes of the banks has been providing financial support to overordering ships, resulting in overcapacity on the market.

In June 2019, eleven founding banks launched a regulatory framework for responsible financing of the shipping industry, named the Poseidon Principles.

The founding banks included ABN AMRO, Amsterdam Trade Bank, Citi Bank, Credit Agricole, Nord/Lb, Danske Bank, Danish Ship Finance, DNB, ING, Nordea, and Societe Generale.

With the latest joining of BNP Paribas, Credit Suisse, and Japan’s Sumitomo Mitsui Trust Bank, the first Asian financial institution to join, the principles now cover over $150 billion in loans to international shipping.

A.P. Møller Mærsk, Cargill, Euronav, Gram Car Carriers and Lloyd’s Register also participated in developing the principles.

At the moment the initiative has 18 signatories.

The key four principles include:

• assessment of the climate alignment of signatories’ shipping portfolios relative to established decarbonization trajectories
• accountability- committing to using IMO DCS* data and service providers approved by the IMO to calculate their shipping portfolios’ climate alignment
• enforcement mechanism via a standardized covenant clause
• transparency-reporting on the overall climate alignment

The general idea behind the framework is for the signatory banks, as capital providers, to support the objectives of the International Maritime Organization (IMO), the primary issue being climate change.

The core trajectory being followed is the IMO target of cutting the shipping industry’s greenhouse gas (GHG) emissions by 50 percent by 2050 when compared to 2008 levels.

Moving forward the second issue to be addressed would most probably be recycling and scrapping of ships, once the Hong Kong International Convention for the safe and environmentally sound recycling of ships, is ratified, where compliance with that convention would be incorporated into the Poseidon Principles.

As such, the banks can influence the type of ships being provided with capital moving forward, and basically ensure greater liquidity for greener ships supporting the energy transition.

Speaking at the Global Maritime Forum in November 2019, Michael Parker, Global Industry Head of Shipping & Logistics at Citi and Chair of the Poseidon Principles drafting committee, said he was confident that the initiative would get 80 to 90 percent of serious shipping lenders to join within one year.

The idea is for responsible banks to support responsible owners, as explained by Parker, at a time when awareness of the shareholders and consumers about the importance of sustainable operations is rising, shaping the public discourse, and urging for greater environmental and social responsibility.

”The Poseidon Principles Association Secretariat is engaged in several conversations with potential new signatories, including Asian institutions. We expect several more to sign up this year.

“Inevitably restrictions on international travel caused by Covid-19 has probably slowed the process but with other initiatives under the auspices of the Global Maritime Forum we would expect some announcements in the fourth quarter,” members of the Poseidon Principles Steering Committee told Offshore Energy-Green Marine when approached for a comment on the progress made so far.

Being a signatory to the Poseidon Principles requires a lender, lessor, or guarantor to disclose their portfolio alignment with the IMO trajectory annually, percentage-wise, based on the current methodology.

This makes the signatories accountable to regulators and shareholders about their business.

However, Poseidon Principles do not impose any specific lending conditions or criteria on a signatory and do not require banks to disclose details about their borrowers and their ship emissions, keeping the confidential ties between the two sides untouched.

Each signatory can continue to manage their own decisions as they see fit in accordance with their own policies and appetite for risk with the maritime sector.

Accordingly, a bank, who is a signatory of Poseidon Principles, can continue to provide lending to shipowners at will.

While this may be true, alignment with the IMO trajectory is each signatory’s goal, influencing decisions that will impact an individual signatory’s portfolio.

With this initiative, shipping has emerged as the first-mover in developing responsible finance, and climate-alignment.

Watson Farley & Williams, which provided legal oversight and drafting input to the banks and other lending players in drafting the Poseidon Principles, has documented leasing transactions where finance lessors who are not signatories to the PP have requested that WFW includes the clause to future proof their documentation and enable them to ask the operators for the relevant data so they can provide it to their financiers if required.

In order to achieve the IMO decarbonization goals, zero-emission ships have to enter the waters in the 2030s.

For this reason, designing the ships of the future and coming up with engineering solutions that would ensure the necessary GHG emission reductions have to be sped up.

Therefore, the idea of providing greater liquidity for green investments for shipowners should be welcome, encouraging owners to improve the environmental performance of their ships, motivating at the same time the wider shipbuilding and equipment manufacturers to speed up their innovation.

In order for the signatories of the principles to calculate the carbon intensity of a ship, they will use the elements of the same data that have to be supplied in line with the IMO data collection system requirement: fuel consumption, distance traveled, hours underway and technical characteristics of a vessel, including deadweight tonnage.

This is basically known as the annual efficiency ratio (AER) of grams of CO2 per ton-mile. 

The compiled data is reported to the flag state at the end of a calendar year and the flag state, upon determining the data is in line with the IMO’s requirements, issues a Statement of Compliance to the ship.

The data is required to be transferred to the IMO Ship Fuel Oil Consumption Database by flag states, which are expected to delegate these responsibilities to a recognized organization, usually classification societies.

Nevertheless, there has been some pushback from shipowners as they fear the DCS data for a particular ship, which is usually anonymized once provided to the IMO, could be leaked to the public.

Hence, there is still some work to be done in connection to data sharing of commercial and personalized information for shipowners to feel more comfortable.

As disclosed by the members of the Poseidon Principles Steering Committee, the concerns from shipowners primarily relate to the use of the Annual Efficiency Ratio Ed. (AER) rather than the Energy Efficiency Design Index Ed (EEDI.) as the metric to measure CO2 emissions efficiency, and ensuring that the confidentiality of the data provided to the banks is fully respected.

“We are currently in the process of collecting emissions data for the first reporting year and this process may be somewhat more manual than in future years which will smooth the entire process for shipowners. Confidentiality of all data is assured by signatory banks,” the committee said.

“Several likely new signatories are waiting for that process to be complete so they can understand how it has worked and what the alignment results show.

“As for the use of the AER, the Poseidon Principles seeks to measure the alignment of bank portfolios with the IMO trajectory for CO2 emissions over time. We are therefore committed to using the same metric as the one used by the IMO which is currently the AER.”

When it comes to the cost of this process for shipowners and the impact of refinancing vessels for existing clients, the committee said “the actual cost of providing emissions data is negligible for shipowners as they already provide the same information to their IMO-recognized organizations for regulatory purposes. “

Even though the principles are not prescriptive in any way, shipowners operating less efficient vessels may find refinancing of these vessels more difficult over time.

As disclosed, banks will manage their ship financing business on a portfolio basis and not on a ship by ship basis.

This will result in banks being prone to conduct more due diligence on the efficiency level of vessels to be refinanced by calculating the AER for previous years and will wish to communicate more with shipowners about vessel and fleet efficiency going forward.

With that in mind, Poseidon Principles banks are now including the option of pricing mechanisms within new loans to incentivize AER alignment with the IMO and penalize non-alignment.

So what happens to borrowers who breach the covenant?

WFW explained that this will depend on the financing documents.

“However, the only breach which can occur is a failure to share the relevant information. In most loan agreements there is a grace period to cure such technical breaches. There is no negative impact based on the standard Poseidon Principles clause which will penalize a shipowner based on the level of emissions for a vessel,” the law firm said.

“There is a covenant in each loan document to provide the emissions data on each financed vessel. There is no intention of banks to call an Event of Default for non-provision of information by shipowners and the covenant is fairly light having been drafted in the spirit of cooperation between banks and shipowners,” the committee members added.

In January 2020, crude oil and petroleum tanker company International Seaways secured credit facilities worth $390 million, which included a sustainability-linked pricing mechanism.

The adjustment in pricing has been linked to the carbon efficiency of the INSW fleet as it relates to reductions in CO₂ emissions year-over-year, such that it aligns with the IMO’s 2050 GHG reduction target.

The key performance indicator is calculated in a manner consistent with the de-carbonization trajectory outlined in the Poseidon Principles.

Basically, if the company succeeds in meeting the targets, the interest on the loan will be lower. If it fails, the interest rate will be higher.

This was the first loan with such a concrete incentive to encourage clients to meet the Poseidon Principles for ABN AMRO, which assisted with the structuring of the sustainability-linked pricing mechanism. 

The lenders involved in the credit facilities also included Nordea, Credit Agricole, DNB, and SEB. 

President and CEO of the tanker company Lois Zabrocky said at the time that through the sustainability-linked pricing mechanism, the company created an innovative partnership with its banks that further advances its commitment to sustainability initiatives.

“We intend to continue to focus on our ESG footprint where appropriate and align our sustainability goals with those of our various stakeholders,” she added.

Data from Watson, Farley and Williams law firm shows that at least $4.5 billion worth of loans have been granted by banks in line with the Poseidon Principles since June 2019.

“We have documented at least that value of Facility Agreements and new financings which included the Poseidon Principles reporting requirement. But this figure was as at the end of 2019. We have not done a further calculation since then but as this figure was based on loans WFW was involved in we can only assume that the actual value will be significantly higher than this,” WFW said in a statement to Offshore Energy-Green Marine.

The steering committee members could not provide our publication with an exact figure on the value of loans provided by banks since the initiative was launched a year ago.

“Given the recent formation of the Poseidon Principles no information is currently available on the volume of loans captured but will be considered as signatory banks are currently collecting data for the first year. In any event, we are optimistic that owners will cooperate and provide the information whether there are specific clauses in their loan documentation or not,” the committee said.

The energy transition is here to stay, and shipping companies across the board have committed to making that happen.

Nevertheless, many are still taking the wait and see approach when it comes to defining the concrete initiatives and action plans for their respective operations and fleets as there is a great deal of uncertainty on the market, both from the ongoing pandemic and its impact on the global economy as well as the regulatory uncertainty.

Therefore, with the regulatory framework in place in the form of Posidon Principles and the European Union tightening its requirements for companies under the Green Deal, i.e., the EU sustainable Finance Regulation, there is an increasing pressure on companies to constantly improve themselves in order to become eligible for financing.

Namely, in addition to the reduction of GHG and environmental agenda, under the new regulation, the EU is also pushing for social and corporate governance practices to be bolstered (ESG), further raising the bar for companies.

What is more, owners often feel compelled by lenders to comply with certain IMO regulations, which have not even entered into force, or at least to have action plans to do so.

That being said, there is a sense that companies can never reach the ultimate goal as the bar is constantly being raised for them.

As a result, there has been a lot of criticism that the new framework increases the burden for shipowners, further limiting their ability to secure liquidity, especially for companies with older, less efficient ships.

Indeed, the initiative will make capital less easy to obtain for inefficient vessels, which might mean that operators unwilling to rise to the occasion could be squeezed out of the business and/or that smaller players will be forced to integrate their businesses.

Consequently, a major impact could be felt among small and medium-sized owners and financial institutions looking to back their second-hand ship acquisitions.

Commenting on the impact of the initiative on the industry and potential acceleration of decarbonization efforts, one of the most candid persons in the industry Frank Coles, CEO of Wallem, said:

“We all know we need to improve the environmental footprint of shipping and decarbonise. We just don’t work together on a win-win.  The Poseidon Principles are no different, they are a self-serving set of rules for banks. As they exist they encourage new builds and scrapping even 12-year-old ships. This at a time when the industry doesn’t even agree which fuel to use in the future.

“What happens in 5 years when efficiency is not the gauge, but the type of fuels being used? Do we then scrap 5-year-old ships or change engines on all the recent newbuilds? The problem is the shipowner is always left holding the ball as charterers, banks, and other stakeholders continuously change the rule book. But none of the stakeholders want to use the carrot, it is always the stick.” 

One year into the process, Offshore Energy-Green Marine asked the committee members what have been the main impressions/challenges and perspective on the outlook for the signatories.

“The response to the Poseidon Principles has been very positive from both financial institutions and owners alike. Shipping cannot afford to ignore the groundswell of public opinion which is demanding a cleaner and more sustainable environment. The Poseidon Principles is one way in which the industry can demonstrate it takes the matter seriously and take voluntary steps rather than waiting for further legislation.”

As explained, challenges remain including encouraging more banks to participate but also streamlining the way in which member banks collect the data in order to make this as efficient as possible.

WFW also believes that banks and the maritime sector have demonstrated ‘a genuine desire’ to promote greener shipping.

“Of course, whether or not lenders are willing to lend on a pure ship mortgage/asset financing basis is not linked to the environmental framework alone. Many factors are at play and the more important factor is likely to be the cost on capital and the internal risk asset weighting placed on ship security by the banks’ capital management teams and bank regulators. The initiative is one step towards the shipping industry meeting the standards required by financiers, shareholders and investors in terms of Environmental, Social and Governance criteria,” WFW added.

It is clear that it is not profitable for the banks to continue providing bilateral loans to the shipping industry the way they used to do a couple of years ago.

Especially if you have in mind the fact that shipping, being a cyclical industry, hasn’t been profitable for almost a decade now, having reported marginal returns to shareholders.

Hence, banks have to become more stringent in the loan selection process.

On the other hand, shareholders and the shipping industry have been targeted as the main culprits for the emissions of the sector and they are the ones who need to foot the bill of decarbonization.

This should not be the case as shipowners believe the charterers and the banks should do their parts as well in facilitating the transition to more efficient ships through investments as well as more favorable terms for loans supporting decarbonization efforts.

One thing is certain, the transition to greener vessels will also mean a transition to a different type of ship financing, ushering in a shift to a greener, more sustainable, and, likely, alternative modes of access to capital.

“Finance will increasingly be directed to those industries who recognise the impact of their activities on the environment and take measures to limit this. By taking appropriate measures the shipping industry can ensure it is a beneficiary of this trend,” members of the Poseidon Principles Steering Committee concluded.

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* The IMO’s mandatory Fuel Oil Data Collection System (DCS) requires ships of 5,000 gross tonnage or above, sailing internationally, to collect and report data to an IMO database.