Investors wake up to water risks

COP28 will highlight the need for investors to reassess how they analyse, disclose and manage water-related risks.

No resource plays a more vital role in sustaining life than water. Yet as climate change accelerates, water shortages are increasing around the world. The growing recognition that climate and water are inextricably linked means all eyes are on COP28 to find solutions to the pressing issues surrounding water scarcity and quality.

The location of COP28 in Dubai gives the summit added significance for water. The Gulf is one of the most water-stressed places on the planet, and delegates attending COP will do well to imagine how, unless they take action on climate and water risks, the region’s arid climate and lengthy droughts may become a more common feature around the rest of the world.

The UAE unveiled an extensive water agenda for COP28 during this year’s World Water Week held in Stockholm in August. The agenda focuses on preserving and restoring freshwater ecosystems, strengthening urban water resilience and enhancing water-resilient food systems.

The fact water will feature prominently in the agenda of this year’s COP could provide impetus to encourage investors and other stakeholders to make water a priority.

Sofía Condés, head of investor outreach at the non-profit FAIRR Initiative, says that, with water included in COP28’s agenda, “there’s a movement towards more systemic thinking, and less of the old ways of tackling climate in a silo”.

Opportunity and risk

Rising global temperatures have brought a cascade of extreme weather, with more floods and heavy rains, as well as more intense dry spells, wildfires and a 29 percent increase in droughts since 2000, according to the World Meteorological Organisation.

Technologies such as desalination that sustain human life in Dubai are not necessarily affordable in lower-income areas, while the environmental side effects of desalination mean the world needs to find better ways to combat water stress.

The effects of climate change are disrupting the global water cycle, which inevitably presents risks for businesses and investments dependent on it. “If climate change is a shark, water is its teeth,” says Marc-Olivier Buffle, head of client portfolio managers and research at Pictet Asset Management.

For investors, exposure to physical water risk means their investee companies can face operational disruption and increased costs, while investments could be devalued when infrastructure is damaged. Meanwhile, public concerns over water usage and environmental practices present reputational risks to companies.

Regulatory risks, on the other hand, are emerging through stricter water-related regulations and permit challenges, which impose compliance costs and operational changes for companies.

Yet investors have made mixed progress in systematically assessing their risks, dependencies and impacts in relation to water. CDP warned last year that financial institutions could face losses of up to $225 billion from risks associated with water – but said 33 percent of listed financial institutions are still not assessing their exposure to water risks.

However, some investors are beginning to realise that water risks can be incorporated through both exclusionary and inclusionary strategies.

“Issuers’ water risks due to activities in water-stressed regions, water-intensive industries or inadequate water management, can be a powerful resource for portfolio allocation and a forward-looking investment strategy,” says Cosima Reiff, ESG methodology lead for SDG impact and thematic solutions at ISS ESG.

And there are pockets of opportunity alongside risk. Buffle argues that companies specialising in water efficiency, leak prevention and water quality remain on track for strong growth, despite global water scarcity concerns.

‘Red flag’ on data

Transparency around water risks is key to help investors make informed decisions, enable scenario analysis and support risk mitigation strategies. Yet, currently, the consensus is that the quality and quantity of corporate data on water usage and efficiency falls short. The lack of data being disclosed by companies presents a “red flag” for investors, says Condés.

More than 23,000 companies disclosed through the CDP on climate change in 2023, but less than 5,000 disclosed on water security.

It is at least a positive sign that initiatives such as the CDP are providing a framework for disclosure on water security. The number of companies disclosing through the CDP on water increased by 23 percent since last year. The Taskforce on Nature-related Financial Disclosures has also emphasised the importance of freshwater as a key part of its disclosure framework.

As these frameworks gain traction, they will increase pressure on companies to prioritise disclosing water-related data, which should make it easier to compare company performance.

“If climate change
is a shark,
water is its teeth”

Marc-Olivier Buffle
Pictet Asset Management

Yet no single metric tells the whole story on water. Thalia Vounaki, senior manager of research and engagements at FAIRR, says there are not necessarily global thresholds to measure performance, due to regional and sectoral differences in how water is used.

Vounaki calls for companies to conduct materiality assessments themselves and determine what a meaningful target means for them to reduce water consumption across their supply chain. The disclosure of this process to stakeholders is key to ensure credibility, she says.

A challenge with water-related risk data is the potential to oversimplify when aggregating numbers. Instead, Buffle says the focus should be on companies’ processes to address water-related risks, including tools, policies, metrics and local management.

He adds that auditors should verify the effectiveness of these processes, and research providers should offer insights to investors rather than just providing final numbers. A one-size-fits-all reporting of numbers cannot provide a nuanced understanding of water risk management.

Engagement tools

A range of hard and soft laws such as stewardship codes, and the EU’s Shareholder Rights Directive II and Sustainable Finance Disclosure Regulation, are “pushing investors to actively seek to monitor, influence and report on the companies they are invested in”, says Reiff.

“There is big room for macro engagement,” adds Condés. Advocacy for better governance and regulations on safeguarding water resources is increasing, she says.

One example of this is the livestock industry, a major consumer of water resources. More companies are focusing on meat and dairy alternatives to reduce their water footprint, according to FAIRR. The non-profit has developed a checklist of questions and respective best practice examples for investors to use during dialogues with investee companies in the protein value chain.

Ceres’ Valuing Water Finance Initiative (VWFI) launched in August 2022 and is another example of a collective engagement effort. The initiative focuses on “engaging companies with a high water footprint to value and act on water as a financial risk, and drive the necessary large-scale change to better protect water systems”.

Buffle, whose firm Pictet is a signatory of the VWFI, says these types of initiatives bring further leverage to conversations with companies with a higher water footprint, as well as those most affected by the water crisis. Buffle stresses that such initiatives have driven companies to increase their efforts on managing water resources.

Whether COP28 can provide further clarity on the next steps for the water agenda remains to be seen. However, it is abundantly clear that a significant share of the responsibility for tackling the worldwide strain on water resources will fall upon investors.

Those who adopt a holistic strategy for water risk assessment, while embracing comprehensive data and active engagement, are likely to emerge as the vanguards shaping the water landscape in the decade ahead.

A double materiality approach to water

Companies can have an equally disastrous effect on the climate as climate change can have on them

“Companies need to have better disclosure over how they’re managing physical, regulatory and transitional risks, but also of their own impact on them within their operations, as well as on water contamination and the strategies that they’re using to address them,” says FAIRR’s Sofía Condés. 

She adds that FAIRR encourages partner firms to declare full risk assessments on biodiversity, waste and pollution, along with their reliance on different sources of natural capital.

“Both financial and impact materiality are closely interconnected,” says Cosima Reiff from ISS ESG, adding that impacts resulting from companies’ business operations on stakeholders and the environment can affect the economic value of a company over the short, medium or long term. 

Companies’ actions that impact the environment and surrounding water  affect them both in terms of financial viability, as well as indirectly through climate change. FAIRR’s Thalia Vounaki agrees that the disclosure of financially material events related to various ESG issues, particularly droughts, floods and heat stress, is crucial since these environmental factors directly affect the companies’ operations and, in more extreme cases, their business.