David Bowie and Queen’s timeless tune “Under Pressure,” released some forty years ago, has little relation to the shipping industry, but pressure is what many in the shipping industry now face amid ever-increasing calls, from both within and without the industry, to address climate change and implement broad environmental, social and governance (“ESG”) policies.[1]  While these issues have broad impacts across many global industries, their impact on the shipping industry, and in particular the ship finance industry, is continually changing, creating ever-evolving challenges for shipowners, managers, operators, lenders and others.

If it seems that you have heard the term ESG more often recently, you are absolutely right, as ESG has found its way into conversations in many areas, particularly with an increase in ESG investing. The Forum for Sustainable and Responsible Investment (“US SIF”) first measured sustainable investment[2] in the United States in 1995 at just $639 billion.[3] By the start of 2020, that number had increased 25-fold, with the most rapid growth occurring since 2012, and from the beginning of 2018 to the beginning of 2020, the amount of U.S.-domiciled assets under management using sustainable investing strategies grew from $12 trillion to $17.1 trillion.[4]  Not only was this a 42% increase, but it also represented nearly one-third of total United States assets under professional management at that time.[5] Regardless of the impetus behind the increase in awareness of ESG principles, they are here to stay, and many industries, including the shipping industry, are incorporating ESG principles into their business models.

Increased interest in ESG has not been the only factor driving change in this area.  Various sources of capital, including institutional lenders and pension funds, are now either required to report ESG investment or are diversifying their portfolios to include or actively seeking to deploy new capital into ESG-conscious investments.[6]  New loan structures have been and continue to be developed that offer financial incentives based on borrowers’ performance as measured against target metrics.  The Loan Syndications and Trading Association (“LSTA”), the advocacy and education association for the $1.2 trillion institutional leveraged loan market in the United States, published its ESG Questionnaire in 2020 to facilitate information-sharing on the part of corporate borrowers and to give borrowers access to a standardized tool intended to improve the dissemination of reliable ESG-related information about their businesses to their lenders.[7]  Credit-rating agencies have also begun to offer ESG-related products. In recent months, credit-rating agency Fitch Ratings announced the launch of a platform offering ESG ratings products that will eventually focus on all fixed-income asset classes.[8] 

Nowhere else has the pressure to adopt ESG principles been more evident than in efforts currently underway to reduce dramatically, if not completely eliminate, the impact of the global shipping industry on climate change.  Numerous shipowners and other shipping industry participants have come together to form coalitions dedicated to finding ways to reduce shipping’s greenhouse gas (“GHG”) emissions footprint.[9]  In shipping finance, twenty-eight leading lenders with a combined global shipping loan portfolio of more than $185 billion have committed to the Poseidon Principles, which are intended as “a global framework for assessing and disclosing the climate alignment of ship finance portfolios consistent with the policies and ambitions”[10] of the International Maritime Organization (the “IMO”). The IMO, the United Nations agency established in 1948 that is responsible for improving the safety and security of international shipping and preventing pollution from ships,[11] has adopted policies and ambitions, as referenced above, that include a reduction in “shipping’s total annual GHG emissions by at least 50% by 2050”[12] (more on that below).  With the recent broad and marked increase in ESG-conscious investing, these developments reaffirm the growing recognition of the importance of ESG as it relates to capital and will no doubt have far-reaching effects on the shipping industry.

Aside from capital-side ESG requirements, corporate governance and regulation by governmental and non-governmental organizations have also begun to steer moves toward environmental sustainability in shipping.  Publicly listed shipowners striving to maintain or improve their public image as environmentally conscious and private shipowners seeking to incorporate ESG requirements into their business models must now take note.[13]  Adding to this movement from within the shipping industry, European and U.S. governments, as well as international organizations, have begun promulgating regulations and aspirational targets aimed at reducing GHG emissions in the coming years and decades, which will have particular impact on the shipping industry.

As indicated above, the IMO, the specialized agency of the United Nations tasked with regulating the shipping industry, has set ambitious goals for the reduction of carbon emissions by ships.  In 2011, in an amendment to the International Convention for the Prevention of Pollution from Ships (“MARPOL”), the IMO set out its first set of mandatory measures to improve ships’ energy efficiency.[14]  Since those initial measures, the IMO has continued to push for reductions in GHG emissions from shipping, in both the short term and the long term.  In 2018, the IMO adopted its Initial Strategy for reducing GHG emissions, which identified ambitions including “to reduce CO₂ emissions per transport work, as an average across international shipping, by at least 40% by 2030, pursuing efforts towards 70% by 2050, compared to 2008, . . . to peak GHG emissions from international shipping as soon as possible and to reduce the total annual GHG emissions by at least 50% by 2050 compared to 2008 whilst pursuing efforts towards phasing them out . . . on a pathway of CO₂ emissions reduction” consistent with the temperature goals of the 2015 Paris Agreement on climate change.[15] In June 2021, the IMO adopted amendments to MARPOL Annex VI that are expected to come into force in November 2022 and combine technical and operational approaches to improve ships’ energy efficiency and cut the carbon intensity of international shipping in line with the IMO’s 2018 initial strategy.[16]  Aside from reduction of carbon emissions, as many in the industry are familiar, the IMO in 2020 also implemented a more stringent cap on the sulfur content in the fuel oil used on board ships, significantly lowering the limit outside designated operating areas to 0.5% mass-by-mass from the prior limit of 3.5%, with the stated effect of “major health and environmental benefits for the world, particularly for populations living close to ports and coasts.”[17]

Some in the shipping industry have argued that the IMO’s target of a 50% reduction in shipping GHG emissions does not go far enough[18] and proposed the adoption of even more strict standards at the 77th meeting of the IMO’s Maritime Environment Protection Committee (“MEPC77”) during the week of November 22, 2021.[19]  While MEPC77 acknowledged that the search for new fuels and other decarbonization strategies for shipping has never been more urgent[20] and agreed to initiate a revision of its GHG reduction targets by 2023,[21] it failed to commit to a statement that it would aim for net-zero GHG emissions from shipping by 2050[22] and delayed any decision on the establishment of a $5 billion decarbonization research fund until this year’s meeting of the Intersessional Working Group on the Reduction of Greenhouse Gas Emissions from Ships.[23]

In Europe, as restrictions on emissions have been steadily imposed, the shipping industry has been pushed more rapidly to reduce carbon emissions. This past summer, the European Commission released an ambitious plan for reducing GHG emissions in the European Union by at least 55% (from 1990 levels) by 2030 with a carbon pricing plan called the European Union Emissions Trading System (“ETS”) covering every sector and all modes of transportation and which would be extended to maritime transport.[24] In referencing the IMO’s proposals, the European Commission noted that they fall short of decarbonizing shipping in line with international climate objectives and proposed a series of measures to increase the contribution of the EU maritime community to climate efforts, including the deployment of renewable alternative transport fuels and a review of the current exemption from taxation of fuel used by ships in addition to the extension of the ETS to maritime transport.[25]

In the United States, the change in administrations has brought a change in policy regarding reductions in GHG emissions and new plans for cutting emissions.  In reference to a recent Executive Order aimed at coordinating regulatory efforts to assess climate-related financial risks and risks to financial stability,[26] U.S. Secretary of the Treasury Janet Yellen noted that the global financial sector will be a crucial player in achieving net-zero emissions in the United States by helping to bring capital into transformational investments.[27]  This investment-focused approach can be seen in the launch of investment vehicles, including exchange-traded funds, specifically investing in maritime technology tied to carbon reduction.[28]

Shipowners have begun to heed these calls to action in reducing GHG emissions and many are using a range of approaches and tactics to meet the challenges laid down by national and international governments.  Additional pressure has come from farther down the supply chain, as many charterers have called for sustainable transportation solutions as the default option in shipping.[29]  Shipowners are ordering air lubrication systems, which are anticipated to facilitate typical fuel savings of between 5 and 10% when deployed in certain types of vessels by introducing a layer of air micro-bubbles between a vessel’s hull and seawater, for installation on newbuild and existing vessels.[30]  Some shipowners are committing to alternative fuels as either low-GHG or GHG-neutral solutions, including liquified natural gas,[31] carbon neutral e-methanol and sustainable bio-methanol,[32] green ammonia,[33] green hydrogen,[34] and even nuclear,[35] with no one fuel seen as the solution.[36] Shipowners are also collaborating with maritime technology companies, fuel suppliers and each other to find ways to transition to these fuels, to develop the infrastructure needed to transport, store and deliver them,[37] and to promote wind-assisted propulsion technologies, including sails and Flettner rotors,[38] to reduce the consumption of GHG-producing fuels in response to the greater awareness of the threats posed by global warming and external pressures like charterers’ ESG strategies, the European Union’s ETS and other means of carbon pricing, and IMO regulations.[39]

Unlike some other transportation sectors, the shipping industry has at times been relatively slow to embrace technological change, but the increasing internal and external pressures to reduce and eliminate GHG emissions are forcing technological innovations in shipping not seen since sail-powered vessels were replaced by the coal-fired steamships of the mid-nineteenth century and coal-fired steamships were replaced by the oil-fired ships of the early and mid-twentieth century. With the first IMO and EU regulatory milestones less than a decade away, the decarbonization of shipping is already upon us and will almost certainly have profound and lasting effects on the shipping industry.

This article has been updated through December 1, 2021.  For an update on subsequent developments or more information on the topics of ESG and the reduction and elimination of GHG in shipping, please contact the authors, John F. Imhof Jr., at jimhof@vedderprice.com or +1 212 407 6984, and John H. Geager, at jgeager@vedderprice.com or +1 212 407 7642.