The increasing emphasis on environmental, social, and governance (ESG) factors in institutional investment and business decisions will be the major driver of change in the shipping industry.
This is the view of Tony Foster, chief executive officer (CEO) and chief investment officer of shipowner and operator Marine Capital. He spoke with Fairplay at his London offices last week. Foster speaks out regularly on the need for shipping to do more to embrace its ESG responsibilities and was one of the 34 maritime CEOs who recently signed the widely publicised call for action in support of decarbonisation of the industry at the Global Maritime Forum in Hong Kong.
Foster’s cognizance of ESG issues is driven by the fact that he spends much of his time interacting with pension fund investors. Many of these long-term institutions are adopting investment strategies that seek to address issues like climate change, which, says Foster, “obliges us to rethink some of the deals we might be doing”.
He cites as an example, Canadian pension fund La Caisse de Dépôt et Placement du Québec (CDPQ), which manages more than USD300 billion in assets worldwide. CDPQ has been integrating ESG factors into its investment processes for many years but recently has become more explicit, declaring publically that “the climate will factor into each investment decision”. The firm’s goal is now to “contribute constructively to the fundamental transition [to the low-carbon future] the world is facing”.
According to the most recent figures from the Global Sustainable Investment Alliance (GSIA), some USD23 trillion of professionally managed assets now use ESG and other responsible investment strategies. This is an increase of 25% from 2014 and represents about 26% of all assets managed globally. In Europe, more than 50% of assets are now managed in this way, although many of these are still exposed to climate change risk.
Foster has been actively talking to pension funds for seven or eight years. “We made a conscious decision to target pension fund investors because they have the necessary long-term perspective and can provide the permanent capital that shipping needs.” He sees funding from private equity investors as being too short-term and often targeting unrealistically high returns.
For the past two years, he has been building interest in the idea of a new marine asset investment vehicle among large institutional investors. This is now expected to launch in early 2019 with about USD500 million of fresh capital and a final target of having USD1 billion under management.
The new fund will aim for “long-term annual net returns in excess of 7%” and have discretion to invest in any marine assets while taking ESG factors into account. Foster’s main strategy is to match the long-term investment horizons and liabilities of his investors with long-term time charters of up to 10 years, thus locking in returns and avoiding the cyclicality of the market.
One of the challenges that Marine Capital has faced in engaging with potential investors is that, in many cases, they are still formulating their ESG frameworks, trying to define how to apply ESG criteria and how to measure outcomes. This is particularly true in the case of alternative assets and especially so in relation to shipping, which, to many, is still a new and unfamiliar asset class. As a result, investors often have distinct ESG requirements.
Some may be wary of investing in a shipping venture involved in transporting coal. Others may be less concerned about the type of cargo carried, but require the ship to be powered by liquefied natural gas or another alternative fuel, considered by their criteria, to be cleaner than heavy fuel oil. For Marine Capital as the investment manager, this means having to put ESG questions into context and being able to demonstrate consistent improvement in ESG outcomes.
Despite the differences in approach among investors, Foster is in little doubt about the direction of travel. He sees pressure continuing to build on the industry to embrace ESG, specifically in relation to climate change, not just from pension funds, but from governments, banks, and other financial investors, as well as from individual shareholders and consumers, particularly younger ones.
In the United Kingdom, the government recently published new rules requiring pension funds to explain their approach to ESG factors, while non-governmental organisations (NGOs) such as ShareAction are putting pressure on banks at annual general meetings to justify their lending practices, including to the shipping industry.
A recent paper from Oxford University’s Oxford Martin School, Fossil fuel divestment and engagement on climate change, sets out the “significant financial and ethical challenges” faced by investors in companies in the fossil fuel industry and in other industries, such as shipping, that are making long-term capital investments in “polluting assets”. The paper provides advice on how investors can ensure that the financial risks to their portfolios from decarbonisation of the global economy are being properly assessed, particularly the risks from exposure to “stranded assets” – assets that will have no value in a zero-carbon world.
Speaking to Fairplay at the weekend, Bill Hemmings, director of aviation and shipping at Brussels-based NGO Transport & Environment (T&E), suggested that climate risk should be factored into every shipping company’s annual report. He welcomed the call for action by CEOs at the Global Maritime Forum (GMF), seeing it as “a sign of growing awareness” in the industry of the potential impact of climate change. “The fact that GMF is talking about decarbonisation is fantastic”, a big change from just three years ago when the issue was “barely on the radar”.
Hemmings hopes this increased awareness will translate into shipowners thinking much more carefully about the question, “what sort of ship should I order in the future?” And he expects bankers and investors to become much more discriminating about the kinds of shipping projects in which they are willing to lend or invest.
One problem for the industry, as Foster has found in talking to his investors, is to agree on the metrics. “If we can’t agree on what a green ship is, how can we persuade others to invest?” asks Hemmings. As a starting point, Hemmings advocates creating an efficiency measure for existing ships to complement the Energy Efficiency Design Index (EEDI) for newbuildings. The second step will be to achieve some consensus on which low- or zero-carbon fuels can be considered compatible with achieving the goal of decarbonising the industry.
A new, relatively succinct report from T&E published in the past few days, Roadmap to decarbonising European shipping, provides a fresh perspective on this issue and also assesses the likely impact of decarbonisation on renewable energy demand in the European Union.
The report comes out strongly in favour of batteries, hydrogen, and ammonia as the future means of propulsion for ships. These produce no greenhouse-gas emissions at the vessel level and the amount of renewable energy required to produce them is far smaller than for alternatives such as synthetic hydrocarbons using CO₂ captured from the air, including electro-methane and electro-diesel.
The report is particularly scathing about the idea of using biofuels in shipping due to “unique enforcement and sustainability challenges, which … would appear to be insurmountable from a regulatory point of view”. T&E’s concern is that there would inevitably be a big increase in use and production of non-sustainable crop-based biofuels such as palm oil and ethanol. These produce higher lifecycle CO₂ emissions than the fossil fuels they would replace and would also cause further deforestation in Brazil, Indonesia, Malaysia, and elsewhere.
Investors will increasingly demand clarity on these and other issues as efforts to combat climate change intensify and as the realisation grows that polluting assets will likely be rendered unusable within three decades if the goals of the Paris Agreement are to be met. Not only will this drive change at the corporate level but it should also help to put some much-needed wind in the sails of the International Maritime Organization as it strives to introduce the regulatory changes needed to develop its GHG strategy for the shipping industry over the next few years.
Reproduced with permission from Paul Smith’s article in IHS Fairplay 19/11/2018.
