Our blog is delighted to host this opinion article on COVID-19 and sustainability in shipping by Mr Yves Kallina. Yves has close to two decades of shipping finance experience, mostly with traditional names of the German shipping finance. Having acted both as direct bilateral lender and in large syndicates and also with substantial activity in the capital markets for shipping, Yves have had a front row seat to many of the events and transactions in shipping in the last decade. Yves has been an astute observer both of the shipping industry and also of the banking industry, with special focus on regulatory banking developments and also sustainability issues affecting banking and shipping; thus, we are pleased welcoming Yves' respected opinion on the subject matter.
Today, there is only one - COVID-19, both a historic event but also as a broad buzzword.
In the previous years, one of the buzzwords was sustainability. The discussions around it prospered on the back of a global economy in continuing growth mode.
Now COVID-19 leads to a discussion around the ‘new normal’. It remains to be seen whether this new version of normality will lead to a continuation of global growth in the medium (or longer) term.
From today’s perspective it is certain that the world economy will go into a deep recession in 2020 (the least) and that this will lead to a wide-ranging challenging of business models and supply chains in particular.
Business continuity management and resilience have a good chance to become the new buzzwords of tomorrow.
A world in recession, strongly decreasing turnovers in many industries, cash-burn rates at historic levels… isn´t that the time to question the ‘luxury’ of dealing with sustainability, at least for the time being?
Short-term, there certainly might be more pressing issues. But companies who see COVID-19 as a welcome excuse to put sustainability back into the drawer (and leave it there), might have an unpleasant awakening after going successfully through the present unfolding economic situation.
Before exploring on this in further detail, it is important to reflect on the prevailing understanding of sustainability.
You can find the term sustainability also as ESG – Environmental, Social, Governance.
The focus of the recent past was related to the ‘E’ component of sustainability considerations.
The ‘E’ was shortened to climate only (a.k.a. ‘green’), climate was shortened to green-house gas (GHG) emissions and, finally, shortened to carbon emission. This lead to a situation that ‘sustainability, ‘green’ and ‘decarbonization’ are used as synonyms in discussions and often also in the media.
But talking about sustainability / ESG and reducing it to decarbonization is misleading. The COVID-19 situation clearly shows the weaknesses of such a view. There are lessons to be learned also for the ‘E’, but COVID 19 shifts the focus strongly onto the neglected letters ‘G’ and especially ‘S’.
These letters are harder to grasp, but the current economic shock gives us in our private and business lives a very profound understanding of the various consequences concerning social and governance implications.
A likely result for business activities going forward is a significantly stronger focus on the resilience of supply chains, upstream and downstream.
Business partners will try to evaluate the long-term stability of operations. Conducting new contracts and winning new client relationships will require to prove the stability and flexibility of its own company and its operations.
Additionally, supply chains will be reframed (including plans for backups) and interests of business partners be realigned.
The COVID-19 situation might bring new factors into the equation which fundamentally require a reassessment of trade patterns: near-shoring, a further boost to digitization, potential border restrictions, trade tariffs, a direct or indirect timely nationalization of companies, higher taxes for years to come and in general a more active involvement of governments and their executive bodies.
At the moment, the key priority for companies is near-term survival and managing the necessary steps to achieve this.
However, concurrently commencing contemplating the required measures to strengthen the ESG focus could bring significant advantages compared to the competition after the crisis.
It is a foregone conclusion that politics will put a lot of emphasis on stimulating the economy in a broad context.
Sustainability might for a (shorter) period of time not rank as a top priority.
It might prove costly to assume that sustainability will be dropped from the political agenda for the foreseeable future.
There is the possibility that some countries might suspend sustainability considerations longer than other countries to give the national economy as additional stimulus to rebuild quicker without sustainable ‘burdens’.
But this could backfire for two reasons:
- The necessities resulting from climate change remain unaffected from COVID-19, as the science-based targets stay the same. Allowing a short ‘break’ results in even more challenging trajectories going forward.
- There will be a demand for long-term resilience in business partners when conducting new transactions and entering new business relationships. Companies need to provide their business partners with a certain degree of comfort regarding their stability in crisis or when facing another ‘black swan’ event. This, however, requires a long-term assessment of risks (and opportunities) - and this is exactly what ESG is about.
Not being able to provide business partners with such an assessment and failure to realign common interests in an ESG sense might result in loss of future business. Additionally, companies risk to invest in assets which could be labeled as ‘stranded assets’ once the climate discussions shifts into higher gear.
For companies in the EU and for companies doing business with EU-based counterparts there is a third reason: EU legislation.
The EU commission’s very demanding schedule for 2020 regarding the EU Climate Action Plan will be partly moved to 2021, but the goals of the action plan remain unchanged.
A key consideration of the EU climate policy is the EU Taxonomy, defining the ‘green corner’ of the market. The ‘elephant in the room’ are far-reaching sustainable disclosure requirements which are connected to the taxonomy.
The information, which is necessary to fulfill these requirements, will be requested from business partners in the EU or dealing with EU companies. If a company cannot deliver such information it potentially risks negative effects on the continuation of existing relationships.
It is likely that such disclosure requirements and the information connected with them will find their way into future contracts.
The EU Taxonomy is to be considered to come into force at 31 December 2021. For financial market players an effective date of 10 March 2021 is actually in consideration for the Sustainable Finance Disclosure Regulation.
This will likely create new sets of information covenants for shipowners. Failure to deliver such information could be reflected in higher pricing or in denial of (future) financing requests.
The COVID-19 crisis shows especially the vulnerability of social relationships of all kinds, be it the situation in hospitals and retirement homes, social distancing, travelling and change in office modes. All this belongs to the ‘S’ component of ESG.
Shipping, COVID-19 and Sustainability
Shipping, an international business by its very nature, needs to ensure the fulfillment of (higher) social standards for its workforce, in particular onboard its vessels.
By no means it is the intention to suggest that seafarers are treated badly in general, but shipowners need to set the frame that seafarers are able to enjoy a well-being as well, be it physically or mentally.
Shipowners with high social standards will welcome such a development.
What such new social framing means for flags of convenience is difficult to say. It seems likely that many of them will (further) increase their standards. Such a move might pro-actively address that states and federations might set new flag requirements as a condition to do business in their waters and their ports.
Considering the huge financial stimulus programs it is important to note that someone has to pick up the bill in the years to come. The taxpayer will highly likely have to accept a large share of such bills. It remains to be seen whether the tonnage tax will stay unchanged in an environment of higher taxes.
Although COVID-19 is not associated with climate change it nevertheless has strong links to the ‘E’ component of ESG. The jumping of diseases from animals to humans, the zoonosis, is enabled through close contacts between wild animals and humans.
The destruction of natural habitats leads to a severe reduction in species respectively to wild animals moving into urban areas. Both can act as a catalyst for zoonosis.
The protection of biodiversity, currently still underestimated in significance by many, will (hopefully) move up higher in the attention of businesses going forward.
Shipowners - using the largest bioecological system of the planet, our oceans – who make a positive contribution in this field, have a good chance to differentiate from competition.
And the tide will turn for open loop scrubbers. It is not science or the public who need to prove that open loop scrubbers have a long-term negative effect on the oceans, it will be the shipowners who have to deliver such proof.
And, hopefully, the days will be gone when banks providing green financing were enamored with all scrubbers of any kind. [I probably chose the wrong word. I wanted to express that scrubbers get a certain not justified good standing as something sustainable when banks provide green finance for scrubbers.]
Shipowners have to make an active and positive contribution to the ‘blue economy’. This might be the ‘decider’ going forward and a chance to differ from competition.
COVID-19 might be considered as an once-in-a-lifetime health situation. Considering that several such once-in-a-century floods have occurred in the US within a very few years, climate change might also in the health sector lead to a situation when COVID-19 might lose its ‘uniqueness’.
The current situation will not lead to a diminishing of sustainability consideration, but to an increase in relevance of ESG. The climate discussion of the last year and the COVID-19 effects of this year will be the starting point for a step-by-step mitigation from niche to mainstream. The integration of environmental, social and governance considerations within business relationships and contract negotiations will become the rule rather than the exception. This will not happen from one day to the next, but over a period of time. With a wait-and-see-approach companies might literally might miss the boat.
In this context it is relevant to gain a good understanding of the sustainability ‘requirements catalog’ of your business partners as well as the relevance of your company for suppliers and clients.
The concept of the integrated (shipping) company will be complemented or even replaced by the concept of integrated supply chains. The management and the resilience of such supply chains, upstream and downstream, will be a deciding factor. Furthermore, supply chain finance has the potential to become a very significant field for financial departments. It will supplement corporate and asset finance of companies, also in shipping. Freight receivables finance belongs already today to the spectrum of options to optimize cash flows and manage liquidity for large corporate shipowners. Reversed factoring solutions, with due consideration of sustainability KPIs (Key Performance Indicators) and KRIs (Key Risk Indicators), are an interesting field to watch when it comes to future relations between long-term charterers and vessel providers.
So, what does that all mean for shipping companies?
- Engage with your business partners actively and constantly in discussions about their sustainability considerations and requirements.
- Do not underestimate the efforts to be able to fulfil the sustainable reporting requirements of your business partners. It is highly likely that you do not have all this data at hand at the moment.
- Focus on contract management and understand the implications of ESG, short term when it comes to shocks and long-term when it comes to the adaption of business models; develop contingency plans.
- Discuss sustainability with your finance providers. They are at various stages to implement ESG into their financing approaches. There are tremendous regulatory initiatives in the making, especially in Europe, which will have a significant influence for financial markets.
- Check the willingness of your current and potential finance providers to engage in ‘lighthouse projects’ with you. Volunteer to engage with them in data collection exercises. It is your chance to actively participate in defining the ESG small print of such finance providers and to gain valuable insights into sustainability.
- Increase your visibility in ESG discussions.
The key to success in sustainability is communication as this is the way to define integrated solutions. Communication is not primarily the exchange of data between computer systems. It is primarily the interaction between people or to say it with other words, it is a key component of people business. And this is what shipping always was, always is and always will be: people business.
Make use of this strength and define sustainability for the success of your company (and – en passant – for our all common future)!
Yves Kallina is a ship finance and sustainability expert with a finance provider. The opinions are his own and not that of any institution he is affiliated with.