Leviathans, hydras and the labours of Hercules

February 5, 2020

Tell the shipping industry it has a problem and it will likely reply ‘yes but which one?’ High fuel costs, toxic trade relationships, potential pandemics and the challenge of decarbonisation to come, demonstrate the long and short term concerns.

To which add another; availability of equity investment. This, together with scarcity of bank debt since the financial crisis cannot strictly be called a new problem, but a structural shift in where and how capital is allocated will have potentially seismic effects on the industry.

Among the main drivers of the change is our new friend, ESG, whose principles of measuring environment, sustainability and governance are increasingly used by the institutional investment community.

As Tony Foster, CEO of boutique finance house Marine Capital told the Marine Money London conference, shipowners, charterers and even the banks will need to shift their attitudes and business models to obtain the equity investment they need to finance the next decade and beyond.

Institutional capital is money from pension and sovereign wealth funds and insurance companies which sits behind all other capital, the global investors that “own everything and can choose from anything, it gives you an idea level of control they exercise directly and indirectly,” he said.

But this leviathan is not sleeping and its mantra no longer solely return on investment but sustainable investing; it will decide who gets funded and who doesn’t.

“The ESG discussions we hear about in shipping barely scratch the surface,” said Foster. “Funds are committing to sustainable investing but the point is they have no choice. The funding requirement for shipping is huge, perhaps $1.6 trillion over the next decade, not including early obsolescence and fleet replacement.”

Fragments of this money would be funded from debt but a great deal will have to be equity investment, which is problematic since the performance of public listed companies has soured institutional investor attitudes to shipping.

What they require is uncorrelated long term cashflows, a need for scale, avoidance of open market risk, proper pricing and a workable approach to ESG, he added; “that goes far beyond self-serving discussions on scrubbers”.

Shipping does provide transaction opportunities but what holds investors back is that it doesn’t understand the market and what it does hear about – offshore jurisdictions, lack of transparency, unidentifiable equity and poor management practices – it doesn’t like.

“If the traditional shipowner is an unfettered capitalist then this version 1.0 is about to be consigned to a novel, it will not attract institutional capital.”

In this process ESG is a very big beast which Foster compared to the mythical hydra; chop off one of its heads another appears. “We already speak to investors who will not carry coal, or who will not allow us to do business with major state entities because they do not like the human rights record of the country,” he pointed out.

Investors can choose between energy companies based on whether their decarbonisation practices are acceptable or not and the price of capital for those companies not chosen is effectively irrelevant.

“This is nothing to do with compliance,” he warned. “If you think this is box-ticking exercise about fuel efficiency, safety culture and the rest, without being able to demonstrate what you are doing is progressive, then this money is not for you.”

The next problem for owners is that having met these demands, or at least addressed them, they may not find charterers as welcoming as they had hoped, partly because the ‘true cost’ of doing business is higher than the ‘paltry returns’ Foster said they have been able to foist on owners; returns which don’t reflect the new equity risk.

It could be argued, he said that some shipowners would not pass ESG requirements for finance but seemingly pass that test for their charterers. Shipmanagers, including some of the world’s most reputable and largest operations are excluded from long term transactions because of perceived risk of lower performance by charterers.

The dwindling of the pool of shipowner equity creates a dilemma for lenders too, as banks cannot lend much more money unless their clients put more equity on their balance sheets. It is, Foster said, difficult to see where that money will come from unless a rising market lifts all boats “and it’s going to have to be some rise”.

Banks too need to reconsider their risk rating models, which have in some cases been too high for customers with modest net equity while effectively penalising institutional investors for their perceived lack of track record in the sector.

But are the ‘owners of everything’ really more likely to walk away than a traditional owner, he pondered; is the banks’ business built on an emotional commitment? Rather, it’s been a convenient model has served a small group of owners, charterers and lenders, but is reaching the limits of its utility.

The challenge of bringing institutional capital into shipping is not insurmountable he concluded, but business practices have to change, not just for owners but for charterers and lenders too.

The commercial pressure from the lack of equity, the decarbonisation challenge and investor pressure for increased scrutiny on all actors is the catalyst for change. This money can be enticed into shipping but it demands a fair and transparent risk sharing model, he added.

“If we’re going to get to zero carbon then these risks need to be openly and honestly distributed.”