Water-related risks need our attention

What’s happening? A Planet Tracker and CDP report has said financial companies face losses of more than $225bn because of water-related risks and that one-third of them are not taking remedial action. The report follows UN warnings that if water production and use remain unchanged, supply will fall by 40% by 2030 and that risks including floods, droughts and water pollution will become an increasingly serious corporate issue. Planet Tracker and CDP studied more than 1,000 companies, of which 69% said water security risks threaten a “substantive” impact with 33% admitting to not assessing their water risk exposure. (Reuters)

Why does this matter? The World Bank expects that increasing scarcity of high-quality water supply could cost up to 6% of GDP by 2050. With financial institutions continuing to allocate capital to the activities most exposed to this potential future water crisis, this could pose a significant threat to financial stability. Despite this, CDP found that 33% of listed financial institutions were not measuring the exposure of their activities to water risks.

What risks does water pose? According to the CDP report, a mismatch between supply and demand means that a stable supply of freshwater can no longer be guaranteed. This could result in assets becoming stranded in water-stressed regions if assumptions made about future water availability by firms are inaccurate.

Unless investor attitudes to water change, the situation is likely to worsen. Research projects that business-as-usual levels of water productivity and economic growth will put 45% of global GDP at risk by 2050 due to water stress.

Most recently, a reassessment of the planetary boundary for freshwater, which was updated to include rainfall, soil moisture and evaporation – or so-called “green water” – has found that the boundary has been “considerably transgressed” due to human activity, according to research led by the Stockholm Resilience Centre.

How do water risks cause stranded assets? The CDP report outlined four different water risk factors that could result in stranded assets: physical risks, regulatory risks, reputational and market risks, and technological risks.

The report provides the example of the Oyster Creek nuclear power station in the US, which owner Exelon decided to close 11 years early in 2018 after New Jersey’s updated water-use rules would have required it to build cooling towers costing around $800m. The change in water-related regulation removed 10 years of extended-life optimal return in this case.

The role of the largest money managers – The report said financial institutions should understand their exposure to water risks and mitigate the risk of water-stranding events negatively impacting their financial performance. It identified BlackRock, Vanguard and State Street as the asset managers with the greatest exposure to the largest firms in resource-intensive industries. The report suggests that voting action by a few shareholders could make a big difference in encouraging such firms to value water appropriately. It also noted, however, that most of these holdings are under passive management.

What are the solutions? The CDP report emphasises the need for financial institutions develop an engagement strategy which communicates their commitment to advancing water security. The report said one of the most effective approaches to engagement with portfolio companies will be encouraging increased water-related transparency and disclosure.

The report also said financial institutions themselves should assess the water risks in their portfolios and make water-related disclosures. The CDP is planning to issue a water-related information request to around 1,200 publicly listed financial institutions.

Other water-related risks – In April, Ceres outlined five key-water-related risks that could threaten investments. These include metals contamination, groundwater depletion, plastic pollution and nutrient loading by a range of sectors including food, drink and household goods. Ceres outlined seven actions firms should be taking, including supporting efforts to improve clean water access, and ensuring firms are not impacting water availability, or polluting and degrading ecosystems.

Further thought – In March, BlackRock said it will offer US and UK institutional investors, representing around 40% of $4.8tn in index equity assets, “pass-through” proxy voting from this year. Analysts said it was unclear how many of BlackRock’s institutional clients would take up the enhanced voting power, but said the move would be adopted by rivals including State Street and Vanguard sooner rather than later. It would be interesting to see how passive investors with new voting powers could engage with firms on water-related risks.

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