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Environmental, Social and Governance (ESG) framework in Shipping

ESG framework is the broad concept that covers the Environmental, Social, and Governance practices of an organization. In the past year, the ‘E’ of the ESG has attracted more focus than others and for obvious reasons. It’ll still be an understatement if the current situation is declared a global climate emergency.

There is no time left to address and reduce global warming if not stop altogether. Green House Gases(GHG) like carbon dioxide, methane, and other hydrocarbon gases are responsible for heating the earth’s atmosphere at a rapid pace. According to the Paris Climate agreement, it is imperative to keep the earth’s average temperature rise below 2 deg Celsius from the pre-industrial times at the end of this century. Unfortunately, the way emissions are happening today, most likely the goal shall remain unachieved. The consequential temperature rise will cause irreversible changes to the earth’s climatic pattern. The onus is on all to reduce, stop and perhaps reverse the carbon emission, if possible.

Carbon is the leading contributor in the GHG emission group in the form of carbon dioxide, carbon monoxide from the exhaust, and flue gases. The power generating sector is the largest contributor of carbon emission, followed by the transportation and industrial sectors.

In the context of the maritime sector and its ESG practices, it is important to establish how shipping companies are aligning to the greater global climate goal. Maritime business accounts for less than 3% of the global emissions while transporting between 80-90% of the world’s goods. The year 2021 is proving to be a pivotal year in the race to combat climate change. Many shipping companies have now publicly committed to becoming carbon neutral much before the International Maritime Organization’s(IMO) ambition of reducing carbon intensity by 70% in 2050. Though it was previously considered a moon-shot ambition of IMO by many, is already being seen as a ‘less than adequate’ measure to address the impending climate catastrophe. To give a global perspective, one out of five 2000 largest publicly listed companies have now committed to net-zero emissions much before 2050 itself. Together, they represent over USD 14 Trillion in sales! It is not hard to imagine how fast the dynamics around the subject are changing.

It may sound ironic but the maritime industry expects IMO to make their climate goals even more stringent that will ensure companies do more in tackling the situation at hand. Traditionally, regulators and policymakers have been major drivers in bringing about the change in the shipping industry. There is a great shift in the approach now. Investors, shareholders, and even customers are playing a significant role in directing the maritime business and policies governing them. Credit must also be shared with the industry itself for the sense of maturity and responsibility shown to push regulators for stricter emission legislation. IMO will reveal their plans during the upcoming Marine Environment Protection Committee(MEPC)77 meeting later this year.

Conventionally, companies have been active in reporting their Scope 1 and 2 types of emissions. Scope 1 emissions are generated directly from the operations that are owned and controlled by the company like factories, ships, etc. While Scope 2 emissions are more of indirect types like purchasing electricity and accounting it appropriately in terms of carbon emission generated during power production. Renewable or nuclear energy generated electricity has a significantly lesser carbon footprint than coal-fired power plant generated one. Companies have now started to expand the depth and breadth of their emission reporting by including the Scope 3 emission in the carbon accounting system. It includes indirect emissions extending deep into their supply chains and investments. For example, if a shipping company orders a ship from a shipyard, the decision-makers are taking into account how sustainably the steel is being produced to build that ship. The level of detail is tremendously increasing with time.

From a finance perspective, decarbonization is primarily being driven by the demand side of the business. The institutional investors, the shareholders, and the consumers are integrating ESG practices into their investment decisions. These stakeholders want companies to embed the effective ESG framework into their core business strategy. It has started to have a direct financial impact on the business. For companies that become thought leaders in ESG practices and truly try to integrate sustainability into their business strategy are witnessing a positive impact both on the company’s valuation and the cost of capital. The cost of capital for low carbon-intensive companies is lower when compared to high carbon-intensive ones. It is no longer a stand-alone, nice-to-have item in the kitty. It is seen that the ESG discussions in the companies have now gone from the periphery to the core. The investors and consumers expect that this is a part of the discussion of the Chief Executive Officer(CEO) and executive board of the company.

Companies must view the ESG practices as a growth strategy, not as a punishment. Companies can lose the business if their ESG ratings are lower than the competitors but they can’t essentially win by just having a good rating. There is a need to have an ESG profile that is aligned to the core business strategy and not something that is just an attached item. It has to be part of the overall narrative. If it is just about some tick-the-box exercise in the name of ESG strategy, it is going to become highly obvious to the investors, shareholders, and more importantly to the customers. Sadly, it will be doomed to fail.

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