ESG Decarbonisation in the Shipping Industry

Published 4 July 2023

The global shipping industry is said to produce around 2.9% of the world's carbon emissions by human activity and 1,076 million tonnes of CO2. If the shipping industry continued to emit emissions on this scale and grow as expected, it was feared that it would undermine the work and objectives of the Paris Agreement.   In this article, we look briefly at the Initial Strategy set by the International Maritime Organisation (IMO) and how it has been integrated by financial institutions and marine insurers.

On 12 December 2015 at the UN Climate Conference (COP21) in Paris, France 196 signatories adopted a legally binding international treaty on climate change, the Paris Agreement. The Paris Agreement entered into force on 4 November 2016.

The overarching goal was to hold the increase in the global average temperature to below 2°C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5°C.

The IMO was said to welcome the achievement of the Paris Agreement and recognised the need for international shipping to support global efforts to mitigate the impact of climate change.

The IMO's Initial Strategy

In 2018, the IMO published its Initial Strategy on the reduction of greenhouse emissions from the shipping industry. It aims to: (i) cut greenhouse gas emissions from international shipping by at least half by 2050 (compared with 2008 levels); and (ii) to work towards phasing out greenhouse gas emissions from the shipping industry entirely as soon as possible in this century.

The IMO's Initial Strategy aimed to reduce carbon intensity of international shipping as an average by 40% by 2030 and to pursue efforts of reduction by 70% by 2050.

The Initial Strategy was widely criticised as not going far enough and not aligning with many of the world's nations' net targets to achieve net zero by 2050. The IMO has been encouraged to adopt the same net zero emission targets and it is widely expected that the IMO will amend its Initial Strategy at the Marine Environment Protection Committee Meeting in July 2023.

The Carbon Intensity Indicator

In July 2021, the IMO adopted further key mandatory measures, including the Carbon Intensity Indicator, or CII rating. The requirements entered into force on 1 November 2022 and the first ratings will be given in January 2024.

The purpose of these measures is to quantify how efficiently a vessel transports goods or passengers. The new measures will require vessels to calculate both their attained Energy Efficiency Existing Ship Index (EEXI) and to establish their annual CII rating relating to carbon intensity, or more specifically, the CO2 emitted per cargo carrying capacity and nautical mile.

Based on the data provided, vessels will be given an energy efficiency rating between A and E (A being the best) and if a vessel is rated D for three consecutive years or is rated E for one year, the vessel's owners will be required to submit a corrective plan to show how it can achieve a rating of C or above.

There have been some criticisms of the rating system, in particular, because some of the factors that result in a poor rating may not always be in the control of owners and charterers, for example, adverse weather, voyage distances, port infrastructure and port congestion.

There will also be a number of legal issues arising out of this rating system, including who will bear the responsibility contractually and there will be a balance to be struck between owners' and charterers' obligations.

Poseidon Principles

The Poseidon Principles are a framework between the ship financing sector and the shipping industry to integrate the IMO's policies on climate change into ship finance decision-making processes. The Principles were launched in New York in 2019 by 11 founding Signatories (ABN Amro, Amsterdam Trade Bank, Citi Bank, Credit Agricole CIB, Danish Ship Finance, Danske Bank, DNB, DVB, ING, Nordea and Société Générale) and a further 7 Signatories have since signed up (BNP Paribas, bpfinance, CIC, Credit Suisse Eksport Kredit, Sparebanken Vest and SuMi Trust.)

Between the 18 Signatories, they control a large share of the finance market for the global shipping fleet and are obliged to ensure that their ship finance portfolios are aligned with the targets set in the IMO's Initial Strategy on greenhouse gas emissions. They must apply the Principles to all credit products where a vessel falls within the remit of the IMO ( i.e. vessels with a gross tonnage of 5,000 or more or are engaged in international trade activities).  

What are the Principles?

• Assessment of climate alignment: Signatories will, on an annual basis, measure the carbon intensity and assess climate alignment of their shipping portfolios. Climate alignment will be based on the degree to which a vessel, or the Signatories' products or portfolios, is in line with a trajectory that meets the IMO's Initial Strategy. The Principles will rely on various parameters, including fuel consumption, distance travelled and deadweight tonnage. The trajectory will represent how many grams of CO2 one single vessel can emit, whilst moving one tonne of cargo, one nautical mile, over a specific time period. A vessel's annual carbon intensity will be compared with the trajectory of a vessel of the same type and class.

• Accountability: For each step in the assessment of climate alignment, the Signatories will be obliged to exclusively commit to using data types, sources, standards and service providers established by the IMO to calculate their shipping portfolio's climate alignment.

• Enforcement: Signatories are obliged to work with their clients and partners to covenant the provision of necessary information to calculate carbon intensity and climate alignment. The Principles also include a standardised but non-mandatory clause for use in any new loan agreement, covering more specific information so that vessel owners do not have to renegotiate the same clause with each different lender.

• Transparency: On an annual basis, the Signatories are obliged to report the overall climate alignment of their shipping portfolios by no later than 15 November. For any new signatories, this will take effect in the calendar year following the year that it became a Signatory. The Principles' Secretariat will collect the submissions and by 31 December of each calendar year, the Signatories' climate alignment scores will be published online.

How is it working?

The latest Annual Disclosure Report was published in December 2022. The results showed that 7 of the Signatories' portfolios aligned with the IMO's Initial Strategy, representing a quarter of the current total number of Signatories.

The overarching theme was that the global outbreak of COVID-19 had an impact on the results, particularly in relation to passenger vessels. In addition, passenger vessels can be much higher in value than freight carrying vessels and are associated with a larger debt exposure. As such, a Signatory with a portfolio containing only a small number of passenger vessels may be negatively affected compared to a Signatory with a portfolio containing a higher number of non-passenger carrying vessels, which impacts on their score.

In relation to cargo carrying vessels, the Signatories attributed their misaligned scores to supply chain issues, higher than normal wait times at ports, higher speeds, and port congestion following the pandemic.

The Signatories will start to collect data from the owners of the vessels in their portfolios from June/July 2023 onwards, with a view to reporting that data to the Secretariat on 15 November 2023. The next results will be published around 31 December 2023.

Poseidon Principles for Marine Insurance

In recognition of the role that insurers play in the global shipping industry, several insurers (Swiss Re, Gard, Hellenic Hull, Scor, Victor, Norwegian Hull Club, Fidelis MGU, Navium, AXA and Skuld) agreed to set a benchmark as to what it means to be a responsible insurer in the maritime sector and provide actionable guidance on how insurers can achieve that benchmark, consistent with the policies and ambitions of the IMO's Initial Strategy.

The Poseidon Principles for Marine Insurers are applicable to those hull and machinery policies. However, in recognition that the key players in the marine insurance industry extend well beyond those with H&M policies, there is an affiliate membership opportunity applicable to brokers, insurance associations, unions and P&I clubs.

Based on the Principles set by the ship financing sector, the Poseidon Principles for Marine Insurers are set out below.

• Assessment: Signatories will, on an annual basis, measure the carbon intensity and assess climate alignment of their hull and machinery portfolio using methodology established by the Poseidon Principles for Marine Insurance.

• Accountability: For each step in the assessment, signatories will exclusively rely on the data types, data sources and service providers set by the IMO.

• Enforcement: Signatories will agree to work with shipowners, clients, brokers and business partners to collect and process the information necessary to calculate carbon intensity and to assess climate alignment.

• Transparency: On an annual basis, the signatories will report the overall climate alignment of its shipping portfolio no later than 9 December.

So how do the results compare to the Annual Disclosure Report for the Principles for the ship financing sector?

As part of the annual reporting requirements, Signatories were asked to provide two climate alignment scores to assess their portfolio's alignment against two individual decarbonisation goals established by the IMO (the Initial Strategy) and the Paris Agreement.

A climate alignment score of 0% represents a portfolio which is exactly in line with the decarbonisation trajectory, whereas a positive score indicates that the carbon intensity of the portfolio is lower than required by the trajectory.

In the Annual Disclosure Report published in December 2022, the average score was +12.7%, with a range between +1.9% and +24.6%. Only two signatories reported scores of less than +5%.

The scores were aligned against a 50% reduction trajectory. Based on a 100% trajectory, i.e. a trajectory which aligns more closely with a net zero target by 2050, the average score was +20.8%.

Unlike the results for the Signatories in the financing sector, the Signatories to the Principles for Marine Insurers did not cite the outbreak of COVID-19 as being the overall reason for the results, albeit that was still quoted as having had some impact, particularly given that in the first half of 2021, vessels were still being impacted by port congestion and speeds. Instead, Signatories reported having a small number of vessels with a higher DWT and an ageing fleet as the reason for increased exposure.


What next?

1. Decarbonisation in the shipping industry is evolving. Whilst a lot of the world's fleet might meet the emissions targets set today, there will be a need for those targets to become more stringent overtime. It is at that point when many vessels will no longer be on a trajectory to continue meeting future targets.

2. The IMO is under increasing pressure to overhaul its 2018 Initial Strategy and set more stringent targets for reducing maritime emissions. A 'Declaration on Zero Emission Shipping by 2050'was signed in Glasgow in November 2021 at COP26 by 14 countries, including the UK. There is clearly mounting pressure for the IMO to accept the goal of net zero by 2050 and it remains to be seen if the IMO will be able to reach a consensus on this at the meeting in July 2023.

3. The first CII ratings will be given from January 2024 onwards. It will be interesting to see the impact of ratings on charterers and whether the IMO is quick to introduce more stringent consequence for vessels which are low rated.

This is the first in a series of articles looking at this highly evolving area. If you would like to know more, please do not hesitate to contact the authors or your usual DACB contact.