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Investors Seek to Turn the Tide on Water Risk

Asset owners are embarking on major engagement campaigns to drive action on water risk due to investee companies undervaluing nature’s precious resource.

It can feel trite to write about the importance of water security to investors and wider society when the ‘second element’ is so vital to human life. But there’s clearly a disconnect, with asset owners telling ESG Investor that water resources remain hugely undervalued by business which has forced them, as long-term investors, to escalate action on the issue.

Belaina Negash, ESG Manager at South Africa’s Government Employees Pension Fund (GEPF), says the economic system treats water like its abundant and has no intrinsic value. Conor Constable, researcher at PIRC, which does corporate engagement work on behalf of the UK’s Local Authority Pension Fund Forum (LAPFF), says water is significantly undervalued “by almost all companies given how vital it is to business and to generating value”.

Both GEPF and LAPFF are members of the Valuing Water Finance Initiative (VWFI), a new effort to engage with companies with a high water footprint to value and act on water as a financial risk.

“The investor-led VWFI makes the business case for action on water risk ensuring that companies recognise fresh water as the world’s most precious natural resource, essential to industries, communities, and ecosystems,” says John Anzani, Executive at LAPFF. The initiative involves 64 signatories with US$9.8 trillion in assets and is about to embark on a major engagement campaign with 72 companies.

High and dry

Water is already high on the policy maker and investor agenda. The UN’s Sustainable Development Goal 6 (SDG6) seeks to ensure access to water and sanitation for all. But many misconceptions and challenges remain.

Water covers 70% of our planet, but freshwater – the stuff we drink, bathe in, irrigate our farms with – is incredibly rare, says the World Wide Fund for Nature (WWF). Only 3% of the world’s water is freshwater, and two-thirds of that is in frozen glaciers.

Today, some 1.1 billion people worldwide lack access to water and at the current global water consumption rate the situation will severely worsen. By 2025, two-thirds of the world could face water shortages  – ecosystems are not even factored into these calculations. But it’s not just water scarcity that the world needs to worry about, says John Robinson, Partner at Mazarine Ventures, noting that “too much water is killing lives more so than too little”.

Very few people currently die from drought, he says, with flooding the second biggest water-related killer. In Pakistan, deaths exceeded 1700 last year, with 2.1 million people left homeless.

The complex and potentially deadly nature of the world’s water crisis is being worsened by industry. The fashion industry alone represents 4% of global freshwater extraction as the resource is required for each step of its manufacturing from growing cotton for clothes, to dyeing fabrics, and treating the final product.

Water risks

The VWFI has already done the groundwork on identifying the specific industries which have the most impact on water and how investors should approach engagement, explains GEPF’s Negash.

Ceres, the investor network which convened the initiative, teamed up with the Global Institute of Water Security and the University of Saskatchewan to write a first-of- its-kind comprehensive scientific review and analysis of industry impacts on freshwater resources around the world.

Negash calls the work groundbreaking, and especially important for GEPF, as it can’t divest from specific sectors easily, given that its investment universe is quite small compared to its global peers.

GEPF has already started to engage with sectors with large water footprints, she says, which includes companies outside its investment universe which have a large customer base in South Africa, and a large water footprint through its supply chain in the already water-scarce nation.

Ceres has also developed an engagement framework with core expectations of companies on water risk, explains Constable, including ecosystem protection, access to water and sanitation, and board oversight. This will support the engagement drive planned by the VWFI this year, with letters already out to companies, adds Constable.

PGGM Investments, the asset manager for Dutch pension fund PFZW, and member of VWFI, values the in-depth knowledge Ceres brings to the effort, says Eloisa Menguzzo, Responsible Investment Analyst at the firm. Ceres is also working on other nature-related investor efforts such as the Global Investor Engagement on meat sourcing and the Nature Action 100 investor engagement initiative.

PGGM’s approach to assessing water risk and nature is ramping up this year with a new research project to assess the nature-related risks, impact and opportunities in its portfolio in line with the Taskforce on Nature-Related Financial Disclosures (TNFD) methodology. Under the project, PGGM will also consider the guidance of the Finance for Biodiversity Foundation, Partnership for Biodiversity Accounting Financials (PBAF) and Ceres.

Menguzzo notes that its work has limitations, as “all of this is somewhat experimental since the TNFD framework is still under development and there are significant data gaps, particularly on location data”.

“Nevertheless, we are committed to play our part in contributing to the ongoing standard development on the topic of nature,” she says.

Shallow data

GEPF and LAPFF also cite a lack of data and metrics on water as an issue.

A number of key sectors have been failing to provide investors with the information they need to assess their risks. In a report published ahead of COP15 in December, the FAIRR Initiative highlighted low levels of reporting on water risks along the supply chain of the global food system.

There has been voluntary disclosure on water metrics through the CDP, says Constable, but the big issue is that a lot of water disclosure is context-based.

“What could be an issue with water depletion and scarcity in one area of a business supply chain could be pollution and impact on biodiversity in another area,” he says, noting that additional work needs to be done to ensure that the metrics companies disclose on cover all the key area related to water issues affecting it.

It will be a balancing act to ensure a decent amount of disclosure will not be too burdensome to companies, however.

PGGM suggests TNFD could help strike the right balance.

“We certainly would like their final draft to build on the work that has already been done and thus include both water quantity and water quality metrics,” says Menguzzo. “I am confident that this will happen since I see that this is also the direction that the SBTN [Science Based Target Network] is taking.

“I believe usability to be key so my hope is that the TNFD will succeed in their intention of not adding too much reporting burden on companies but focus on few clean metrics, to be complementary to TCFD reporting,” she adds.

Alongside assessing water risks, there are of course opportunities for investors as the world moves to build climate water adaptation infrastructure.

PGGM uses a taxonomy developed with fellow Dutch asset owner APG to find relevant investment opportunities related to SDG6. But opportunities are scarce, admits Menguzzo.

“The water market is highly fragmented where current mandates require opportunities to be sizable, low-cost [and] delivering market-rate returns.” 

Robinson, whose work relates to high quality technology to map water risk, says financial asset owners, private equity and Wall Street finance have shown little investment interest. But mayors, cities and states, who are often affected by water-related crises, are investing, he adds.

Despite investor reticence in some areas, the water crisis only looks set to escalate this year, with the UN holding its first water conference in 46 years in March.

The practical information hub for asset owners looking to invest successfully and sustainably for the long term. As best practice evolves, we will share the news, insights and data to guide asset owners on their individual journey to ESG integration.

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