Winds are blowing in sustainability-linked bond sails

IMO targets for emissions reductions

All eyes in the shipping industry are fixed on de-carbonization and environmental, social and governance (ESG) concerns. Mileposts have been set by the International Maritime Organization’s (IMO) Marine Environment Protection Committee (MEPC), requiring reductions in carbon dioxide (CO₂) emissions from shipping worldwide from 2008 levels by at least 40 percent by 2030, and at least 70 percent by 2050.[1]  In addition, to measure the energy efficiency and carbon footprint of ships, shipowners will need to calculate (among other measures) efficiency and carbon emission indexes, enabling the IMO, other government regulators and industry participants to rate ships as part of an overall carbon emissions compliance program.

With the COP26 climate conference currently underway among nations that signed the UN convention on climate change, many nations are setting targets for net zero carbon emissions, led by the United States and the European Union, which have indicated their intention to achieve this goal by 2050.[2]  The MEPC will be meeting at the end of this month (November 2021), which may result in further refinements to the IMO’s own 2050 target or the implementation of interim targets.  It has also been reported that the Poseidon Principles initiative may amend its own zero emissions target date to 2050 in light of the results of COP26 and forthcoming pronouncements of the MEPC.[3]

What are sustainability-linked bonds, or SLBs?

SLBs are debt instruments structured with the issuer’s achievement of sustainability-related targets built in.  Unlike so-called “green bonds” or straight “sustainability bonds,” proceeds from an SLB are not typically required to be applied to any particular environmentally-conscious purpose; however, the issuer will covenant to achieve stated sustainability performance targets, or SPTs.  The failure by the issuer to achieve an SPT may result in interest premiums or penalties or changes in amortization.  Typically, the targets will be measured by objective and verifiable criteria, called key performance indicators, or KPIs. 

What is the framework for an SLB issue?

The key elements of any SLB is to properly establish the SPTs and define the KPIs in a way that can be objectively measured. The covenants would set forth the method of calculation, the issuer’s related reporting and disclosure requirements, the standards upon which the reviewer would make a determination of compliance and an alternative compliance mechanism to be used as a fallback, if desired.  Also, the covenants would necessarily need to address events that could potentially affect the calculation, such as extraordinary transactions or corporate events.

Industry associations, such as the International Capital Market Association (ICMA), have delineated SLB principles, or SLBPs, which provide guidance as to the process for an SLB issue.[4]  Relatedly, the Asia Pacific Loan Market Association (APLMA), the Loan Market Association (LMA) and the Loan Syndications and Trading Association (LSTA) have published combined guidance on sustainability-linked loan principles, or SLLPs.[5] The common thread between SLBPs and SLLPs is the selection of KPIs and SPTs, and the determination of covenants, and reporting and verification mechanisms.

SLBs and shipping

SLBs can be designed to work well within the ESG and sustainability-linked framework of shipping companies, and seem well-suited for programs that relate to IMO de-carbonization expectations.  For example, in January 2021, Odfjell SE closed what has been reported as the shipping industry’s first SLB offering.[6]  The Odfjell SLB is unsecured, with proceeds to be used for the refinancing of an existing bond issue and for general corporate purposes.  Compliance is linked to its average CO₂ emission reduction targets for its controlled tanker fleet.   

Also in January 2021, container shipping stalwart Seaspan Corporation closed its first SLB, raising $200 million with a three-year term, followed in April 2021 with a $300 million five-year issue.[7] Both of these SLBs are unsecured, with an announced use of proceeds for general corporate purposes, which may include repayment of debt.  In Seaspan’s case, the SPTs and KPIs are linked to expenditures on ships that can be powered by alternative fuels. While these bonds were offered in the Norway bond market, the same principles can be applied in other bond markets, such as in the U.S. debt capital markets with their deep ESG-driven investor base.  

Certain legal considerations

As with any securities offering, applicable securities laws and regulations will apply to the SLB offering process.  For example, the issuer, the underwriters and other persons will be subject to the disclosure requirements and anti-fraud provisions as may be applicable to the offering.  Also, the jurisdiction of incorporation of the issuer, as well as the choice of law of the indenture governing the SLBs, can have important effects on the rights and obligations of the issuer, as well as the investors as creditors of the issuer, under applicable laws. Finally, an issuer of, and an investor in, an SLB offering should be aware of the tax benefits and burdens of entering into the transaction. 

Conclusion

With SLBs, a shipping company can creatively engage in balance sheet management, or finance capital expenditures, while at the same time demonstrating its commitment to de-carbonization and ESG principles.