In June 2018, the International Maritime Organization (“IMO”) announced the adoption of an initial strategy to reduce total greenhouse gas (“GHG”) emissions attributable to the international shipping sector by at least 50% by 2050.[1]
While the IMO and the EU are both considering expanding and adopting regulations that would create enforceable reporting and shipping emissions reduction standards, a group of global financial institutions have created their own voluntary framework to assess the alignment of their shipping portfolios with the IMO’s goal. Called the Poseidon Principles, this framework sets forth a methodology for participating financial intuitions to use standardized methods to calculate and report on the alignment of their activities in the shipping sector with an emissions trajectory that is consistent with meeting the IMO’s 2050 goal.[1]
Announced in June 2019, the Poseidon Principles are significant because they are the first effort to quantify and report on GHG emissions from the international shipping sector in a manner that expects progress towards a GHG reduction goal. While the Principles themselves do not require that participating financial institutions undertake particular actions to reduce the GHG emissions from their shipping portfolios, it is reasonable to expect that signatories to this voluntary framework may take steps to demonstrate that their own shipping portfolios are aligned with the IMO goal. As such, the implementation of the Poseidon Principles first reporting period in November 2020 is a significant marker in the assessment of climate risks and opportunities for GHG emissions reductions in the international shipping sector.
The Principles
The Principles do not impose substantive requirements on the shipping assets that financial institutions hold or acquire. They are, instead, a common framework that signatory financial institutions agree to use to assess and disclose whether their lending portfolios are in sync with annual emissions targets tied to the IMO’s 2050 GHG emissions reduction goals. The Principles require signatories to adhere to the following:
Assessment: Signatories must annually calculate the average CO2 emissions of all vessels in which they hold an ownership or security interest and create an assessment comparing those averages to emissions targets set annually by the Poseidon Principles Association, which are designed to lead to compliance with the IMO’s goal of reducing shipping emissions by 50% of 2008 levels by 2050.
To make this assessment, each signatory first calculates the “carbon intensity” of each vessel in the financial institution’s portfolio. The carbon intensity of a vessel is simply the grams of CO2 the vessel releases in moving one tonne one nautical mile. The financial institution then calculates the “climate alignment” of each vessel by comparing the vessel’s carbon intensity to an emissions target based on the vessel’s type and size. Each financial institution then calculates its own portfolio-level climate alignment score by aggregating the ship-level climate alignment scores of all the vessels in the financial institution’s shipping portfolio.
Accountability: Signatories agree to use the data sources and methods identified in the Poseidon Principles technical guidance. However, the Principles allow some flexibility for producing assessments and permit signatories to use either: (1) a preferred pathway or (2) an allowed pathway. Under the preferred pathway, vessel-level emissions data is sourced and analyzed by an organization recognized and approved by the IMO, while under the allowed pathway, data may be sourced directly from shipowners, and may be analyzed by the financial institution, an IMO-recognized organization, or any other third party without commercial vessel interests.
Enforcement: Signatories agree to require that clients and partners—as a condition of obtaining credit from a signatory—aid the signatory in complying with the Principles by providing necessary data and by agreeing to the signatory sharing that data with third-parties for the purposes of calculating and compiling vessel- and portfolio-level climate alignment scores. The Principles include a standard covenant clause for inclusion in finance agreements in order to relieve parties of the effort and expense involved in negotiating a unique covenant for every shipping finance agreement.
Transparency:: Each signatory must, on an annual basis, report the overall compliance of its shipping portfolio with the Poseidon Principles’ Association’s emissions targets. These reports are due to the Secretariat of the Poseidon Principles Association no later than November 30. The Poseidon Principles Association will publicly publish climate alignment scores reflecting compliance with emissions targets for each signatory’s portfolio on December 31. Subsequently, each signatory must publish the overall climate alignment of its portfolio in its “relevant institutional reports.”[2]
Although the Principles themselves are brief, the Poseidon Principles Association has produced a technical guidance document to elaborate on these Principles, available here.
Becoming a Signatory & Maintaining Compliance
Any financial institution with a shipping portfolio is eligible to become a signatory to the Principles. Qualifying institutions may be lenders, lessors, financial guarantors, or export credit agencies. Institutions wishing to become signatories must submit an application and a declaration of intent to follow the Principles’ requirements. Once the application is approved, the new signatory has five months to complete and submit a self-assessment detailing the steps it has taken and is taking to comply with the Principles. As noted above, signatories are then required to report the overall climate alignment of their shipping portfolios to the Poseidon Principles Association on an annual basis, and to publish matching information in relevant institutional reports. So long as the financial institution produces and publishes the required reports, there does not seem to be a mechanism for auditing the reports or removing the institution from the Poseidon Principles Association.
Possible Future Developments
If enforceable emissions standards based on the IMO’s 2050 emissions reduction target are adopted, financial institutions that have started to bring their portfolios in line with the IMO’s targets will likely be well-positioned to complete that transition with fewer incremental costs compared to non-signatory institutions. Such institutions might also confront less risk associated with holding security interests in high-emission vessels should they proactively take steps to support emissions-reduction efforts for the vessels that may otherwise have been unable to come into compliance with such new requirements.
Beyond financial institution signatories, vessel owners themselves may face growing pressure to cut GHG emissions to continue attracting financing or to retrofit higher-emitting vessels with energy efficient technologies, either independently or with their financers’ support. The Poseidon Principles Association has circulated an article encouraging signatories to facilitate this process by either: (1) consider refinancing vessels that are in need of retrofitting, or (2) assist vessel owners in obtaining green or climate bonds to finance retrofitting.
Conclusion
The Principles establish a common framework for signatory financial institutions to assess climate risk to their shipping portfolios, in the hope that conducting such assessments may encourage more environmentally-conscious investments. Overall, the Principles provide a vehicle for financial institutions to obtain reputational and risk-reduction benefits relating to their ship finance portfolios. Although not directly subject to the Principles, shipping companies also need to be familiar with the Principles and how the Principles’ emissions targets may affect the future cost or availability of vessel financing.
Source: Vinson & Elkins LLP