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Design financial products to drive sustainable ship recycling

In our previous post, we shed light on the hidden sustainability problems of the shipping sector: ships that are obsolete and the dangerous and polluting ship – breaking methods associated with their disposal. We also examined what makes this problem so difficult to deal with – namely that shipowners profit financially from scrapping their ships at substandard shipyards, generally in the third world, as these can offer the highest scrap prices.

There is little that insurers can do to deal with this directly. Few ships end their lives as insurance depreciation. And although protection can of course be denied to ship operators who do not have an environmentally friendly ship recycling policy, nothing prevents them just by shopping elsewhere. All this raises the question … Can insurers play an indirect role instead?

To answer this, we must acknowledge a simple truth about our industry: insurance is a lever. It has no power in itself, but it can turn other parties' risk into premiums and these premiums into positive change ̵

1; first in the form of shared safety nets and secondly as an incentive structure for good behavior.

Applying this to the maritime sector, it is clear that insurers cannot force shipowners to have a social conscience. But when companies begin to face some risk due to their poor ship recycling practices — any threat of real reputation or financial damage — then insurance companies will have something to work with. Right now, "ESG risk" in shipping is limited. To see how fast it can become a factor, we just need to look at what has happened in other industries.

In recent decades, major energy, logistics and manufacturing brands – both B2B and B2C – have been transformed by consumer pressure, both directly and according to referrals by investors, lenders and partners. The lack of widespread industry reporting has so far protected shipowners from much of this change. But greater ESG transparency is on the way. And with it a greater ESG risk – and a need for reliable ESG solutions.

Driving transparency on ESG metrics will lead to more responsible shipwreck

One program that anchors greater transparency in the sector is the Ship Recycling Transparency Initiative (SRTI). Hosted by the Sustainable Shipping Initiative, this is an information sharing platform that connects shipowners to their broader ecosystem on the issue of ship recycling and policy.

The aim is to promote competition between shipowners in ESG matters by giving key stakeholders – including cargo owners and financiers – the opportunity to commercially reward or punish players based on their ship recycling tasks. Investors and lenders are getting really serious about the green in their portfolios; meanwhile, cargo owners are increasingly marketing to end consumers about their ethically impeccable supply chains, which of course includes the ships used to ship their products.

Shipowners can not give their customers and financiers the same wide berth that they can sometimes have, give regulators. And this changes the game. It converts ship-breaking assets – full of valuable scrap metal – into ship-breaking liabilities laden with financial and judgment risk. And those who lack sustainability or refuse to disclose will ultimately have a disadvantage over their competitors.

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Source: Ship Recycling Transparency Initiative Progress Report 2021

To date, only 12 shipowners are registered for the Ship Recycling Transparency Initiative (SRTI), representing ~ 7% of the global merchant fleet by number of vessels. But if this group can generate competitive advantages by publishing its good practice – for example, more favorable financing terms – then it may be enough to move the market.

As the consequences of making mistakes increase, we expect freighters to be proactive in raising – and reporting on – their recycling standards. This is relatively easy to do for those of their ships they scrap themselves. But things get more complex when ships are resold, which often happens as they age or are chartered in from another owner.

Managing third-party recycling risk through financial guarantees

Being generally less well-known, second-hand operators are less exposed to ESG-related stresses than the primary owners who sell to them. As a result, they can simply act in their best economic interest and scrap acquired vessels for high prices at substandard shipyards.

In these cases, ESG-aware primary owners can still contribute indirectly to social and environmental tolls of shipwreck. In fact, the narrow focus on certain ESG policies on owners' direct footprints has long been a battleground.

One solution is to incorporate restrictive agreements in ship sales, which determine where and how new owners must recycle their used ships. Another is to offer buyers some form of financial incentive for responsible scrapping. 10 out of 12 of the shipowners' signatories to SRTI use one or both of the mechanisms to drive better results for sold ships, in some cases extending this to ships they have chartered and then returning to the original owners:

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Source: Ship Recycling Transparency Initiative Progress Report 2021

Both mechanisms have their problems. Covenants can be unrealizable or susceptible to loopholes, and additional complexity arises if a ship is sold a second time. incentives in the meantime may not be convincing enough.

To be fail-safe, a responsible recycling incentive must compensate second-hand owners for anything they sacrifice by choosing a higher cost regulated yard over an unregulated one. It only has to cover one door – but one door that fluctuates a lot, depending on the price of steel. And where there is uncertainty, there are potential niches for insurance companies.

It would be possible to structure a ship recycling fund with both a saving and a premium component, the latter guaranteeing that, at scrapping, the accumulated savings are sufficient to cover the gap between the best scrap price and the most responsible. What we end up with is a talent or overall policy — only for one ship, not one person.

If the recovery fund could be linked to a specific vessel, possibly via a distributed ledger, it would then act as a barrier – only paying out if the final owner meets the agreed criteria for vessel recovery. This would enable primary owners to ensure that there is a strong financial incentive to do the right thing with their ship, not only for second-hand owners but for all subsequent owners. especially given its open maturity, the potential for long ownership chains and underlying market risk — but the idea is exciting enough to have motivated new discussion by the European Commission. whether the appetite outweighs the impracticalities in marine insurance remains to be seen. What is already clear, if we look wider, is that unforeseen recycling costs are an important reason why corners are cut when recycling. If financial institutions, governments and manufacturers can find a mechanism to secure these, it will reduce perverse incentives in the user base and significantly increase the circular economy.

When we look back at the maritime sector, we see that ships are not alone in a worrying life story … In the next part of this ongoing series, we turn our attention to offshore energy and how insurers can help with the settlement. of old carbon dioxide resources and the smooth launch of green energy at sea.

If you want to contact me in the meantime, contact me.

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Disclaimer: This content is provided for general information purposes only and is not intended to be used in consultation with our professional advisors.

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