Lenders to shipping are increasingly considering climate performance when setting loan margins, a study has found. However, their focus remains on the corporate level rather than the asset level, potentially limiting their ability to mitigate transition risks.
The Lower margins are tied to companies’ climate performance rather than to low-carbon assets study by Marie Fricaudet, Sophia Parker, Nadia Ameli, and Tristan Smith, published in Cell Reports Sustainability, examines the lending practices of shipping debt providers. The researchers found that banks, particularly those signed up to the Poseidon Principles, have begun to price in the climate score of shipowners they lend to. This shift is largely attributed to the Paris Agreement and growing pressure for decarbonisation within the shipping sector.
However, despite the increasing importance of climate performance, the study highlights that lenders are not differentiating their margins based on a ship’s carbon intensity. This suggests that while they are considering climate factors at the corporate level, they are not yet fully addressing the transition risks associated with individual assets.
Financial risks
The researchers argue that this approach could lead to significant financial risks for lenders, particularly given the long-term nature of shipping loans. If the value of ship assets decreases due to climate-related factors, lenders could face losses, especially if the borrower defaults.
“The potential transition risks that ship assets carry may affect ship lenders in two ways. First, like in any other industry, the deterioration of profitability of the companies affected by transition risks can have cascade effects on their lenders by increasing their default rate, which could be amplified by lenders’ interlinkages,” the study found. “This channel has proven to have had a substantial impact on shipping lenders in the past. For example, the oversupply of ship capacity and low shipping earnings following the 2007–2008 financial crisis resulted in a 40% nonperforming loans ratio in the shipping book of German banks, leading to their partial exit from the shipping market and a large impairment in shipping loans.
This would impact lenders in the event of a borrower’s bankruptcy because the value of the ship could be the only way to recover the initial amount provided, although ship repossession is, in practice, only used as a last resort.
To mitigate these risks, the study recommends stronger regulation and enforcement actions. This could include carbon pricing, stricter performance standards, and subsidies for alternative fuels. Additionally, the researchers emphasise the need for improved metrics to measure climate performance at both the corporate and asset levels.
Disclosure limits
The study also highlights the limitations of current disclosure initiatives, such as the Poseidon Principles, in influencing investment outlays. While these initiatives have increased transparency and raised awareness of climate-related risks, they have not yet led to a significant shift in lending practices.
“This could be related to its recent implementation and the fact that shipping markets have been affected by the consequences of the Covid-19 pandemic, which led to a preference for companies with a higher climate score.
“The fact that lenders price in the climate score of the borrower means that they might be indirectly promoting low-carbon ships if shipowners with a higher climate score were financing more carbon-efficient ships. However, there is no guarantee of this outcome.”
To address these challenges, the researchers recommend a multi-faceted approach. This includes strengthening regulation, improving metrics, and promoting greater transparency and accountability. By taking these steps, lenders can better manage climate-related risks and contribute to a more sustainable future.
Furthermore, the study raises important questions about the role of the financial sector in the transition to a low-carbon economy. While lenders are increasingly aware of climate-related risks, they are not yet fully pricing them into their loan margins. This suggests that additional measures are needed to incentivise sustainable investments and mitigate the financial risks associated with climate change.
One potential solution is to strengthen regulations that require lenders to assess and disclose the climate impact of their portfolios. This could include mandating the use of standardised metrics for measuring climate performance and imposing penalties for non-compliance. Additionally, regulators could consider implementing green monetary policies that provide incentives for lenders to finance sustainable projects.
Another approach is to promote the development of new financial instruments that can help to manage climate-related risks. For example, climate-linked bonds could be used to transfer the risk of climate-related losses from lenders to investors. Additionally, green loans could be offered at preferential rates to borrowers that invest in sustainable projects.
Decarbonisation projects
In addition to the findings presented in the study, there are broader implications of lenders’ climate risk exposure. The shipping industry is a contributor to greenhouse gas emissions, and the transition to a low-carbon economy will require substantial investments in new technologies and infrastructure. Lenders play a critical role in facilitating these investments by providing the necessary financing.
This could hinder the adoption of new technologies and slow down the transition to a low-carbon economy.
To address this, it is essential that lenders develop a more comprehensive understanding of climate-related risks and the potential financial implications of these risks. This will require the development of new risk assessment methodologies and the integration of climate data into lending decision-making processes.
Furthermore, regulators need to provide clear guidance and support to lenders. This could include developing standards for climate-related disclosures, providing incentives for sustainable lending, and supporting the development of new financial instruments.
Source: Baltic Exchange
