Transition-linked financing: The transition to a greener shipping industry
A group of Nordic market participants have through the Green Shipping Programme produced a new set of Guidelines for Transition-Linked Financing (TLF) supporting the transition to net zero emissions in the shipping industry by 2050.
A general challenge for the shipping industry is that low- and zero-emission technology and infrastructure may not yet be available or commercially viable for large scale operations. Within the shipping industry in general there is thus a need for transition linked finance arrangements which can complement Green Loans or Green Bonds (see text box) that (for now) are more suitable for bespoke projects in this sector. Sustainability linked finance guidelines and principles have been introduced in the wider market in respect of green activities and performance improvements for owners, but there has until now not been any specific methodology or recommendations for transitional activities for the shipping sector with clear and sufficiently ambitious environmental objectives. The lack of standardised principles for the industry increases the risk of greenwashing and makes it difficult for investors and lenders to compare projects and owners.
The new guidelines for TLF particularises from an industry specific perspective how to align performance towards net-zero by 2050 in line with the Paris Agreement as well as towards compliance with the “do no significant harm” criteria under the environmental objective for climate change mitigation in the EU Taxonomy.
The guidelines for TLF adopt the same structure and methodology as the SLLPs/SLLBs guidelines (see text box), but are tailored for the shipping sector and focus on (1) how to select transitional Key Performance Indicators (KPIs), as well as defining specific reporting requirements addressing a need for increased transparency and accountability. The key elements of these principles are as follows:
- (1) Key Performance Indicators: Owners should select KPIs that are material to the company’s transition strategy, measurable, externally verifiable and benchmarkable. More specifically, owners should report performance on selected KPIs for decarbonisation, with the emission intensity indicator “Annual Efficiency Ratio” as a starting point. In addition, owners should take steps towards alignment with the “do no significant harm” criteria of the EU Taxonomy, which includes reporting on circular economy transitions (i.e. waste handling and ship recycling) and protection and restoration of biodiversity and ecosystems (i.e. underwater noise and vibration and biofouling).
- (2) Sustainability Performance Targets: Calibration of targets should represent measurable, material improvements in KPIs and should go demonstrably beyond “business as usual”. The guidelines provide further guidance on KPI selection, trajectory construction and guidelines for calculating and reporting for different companies – providing a goal setting framework both for owners with emissions at or below the relevant trajectory (“transition leaders”), and owners with emissions above the relevant trajectory (“transition accelerators”). For decarbonisation, SPTs should match the target for zero green house gas emissions in 2050 and the owners must meet the transitional target set within the tenure of the loan or bond.
Targets should be based on best available technologies and operating practices, not expectations of what could become available in the future. It should be also noted that using carbon credits will not count towards the company’s achievement of the SPTs.
- (3) Loan characteristics: This follows the SLBPs/SSLPs, so that an economic outcome (e.g. a lower margin on the interest rate) is linked to whether the selected SPT(s) are met.
- (4) Reporting: The SLLPs/SLBPs also apply to reporting requirements, but the guidance for TRF places greater emphasis on owners’ disclosure of and accountability for its transitional activities and measures. Owners will have to report their compliance to the financial institution on an annual basis, which shall include carbon intensity, compliance with targets, assessment of performance and the “do not significantly harm” criteria. As a means of creating increased levels of trust and accountability, the guide encourages owners to publicly disclose their performance, their overall environmental strategy and ambition levels.
- (5) Verification: This criteria also follows the SLLPs/SLBPs, so that the owner must obtain independent and external verification of its performance level against each SPT and each KPI.
In addition to the above factors, the TLF guidelines note that as part of an owner’s plan to transition into a sustainable business model, owners are as a matter of best practice encouraged to follow the recommendations set out in ICMA’s Climate Transition Finance Handbook.
In our view the TLF guidelines provide a very useful financial framework that will be beneficial for both lenders and owners in the shipping industry for two main reasons:
- The guidelines recognise the need for a transitional period for the shipping industry to reach net zero, whilst encouraging transition within the timescales set out in the Paris Agreement and linked to alignment with the EU Taxonomy.
- By providing a sector specific framework it also reduces the risk of green washing (and allegations of greenwashing), and makes it possible to make meaningful comparisons between owners and loans. In the short term, the guidelines can provide a framework giving owners access to better financing terms. In the longer term however - with increasing expectations to sustainability and transparency - demonstrating a real commitment and results towards a more sustainable business is likely to become critical in order for owners to continue to access financing.
We are encouraged by the efforts made to develop these guidelines, and hope to see them actively used in the negotiation of loan agreements going forward.
Loans and bond instruments used exclusively to fund specific green projects and which are often either asset-linked and/or define a specific purpose or use of proceeds that have a beneficial effect on the environment, preferably made in compliance with the Green Loan Principles (GLPs) and Green Bond Principles (GBPs) respectively.
Key components of GLPs and GBPs:
- Use of proceeds
- Process for project evaluation and selection
- Management of proceeds
Loans and bond instruments that are linked to a borrower/issuer’s own sustainability performance and can be applied towards general corporate purposes. These debt instruments are tied to predefined sustainability or ESG targets and are designed to incentivise the borrower/issuer’s achievement of such targets. SLLs and SLBs are preferably granted on the basis of the Sustainability Linked Loan Principles (SLLPs) and Sustainability-Linked Bond Principles (SLBPs) respectively.
Key components of SLLPs and SLBPs:
- Selection of Key Performance Indicators (KPIs)
- Calibration of Sustainability Performance Targets (SPTs)
- Loan / Bond characteristics