The global asset manager considers company misuse of water a systemic risk and prioritises it as an engagement theme.
A framework that puts a cost on company impacts on water resources has been “extremely helpful” in informing engagement on water risk, according to Piers Hugh Smith, Head of Stewardship, Global at Franklin Templeton.
The framework, which estimates the cost of addressing water-related externalities in value chains, has been developed by US-based investor network Ceres in partnership with water risk consultant Bluerisk, S&P Global Sustainable1, and DWS Group.
Ceres has said it will continue conversations with its partners to build on the work and further develop a cost-benefit analysis that resonates with company leadership.
Speaking on a Ceres webinar about the framework, Smith said that it had been very useful in helping Franklin Templeton manage water risk, which it considers a systemic risk.
Corporations are the world’s largest water users, according to the Nature Conservancy with nearly two-thirds of all water consumption going into producing ingredients for corporate supply chains.
“The role of systems to investors is fundamentally financially material. In a traditional portfolio, around 75-95% of the return comes from market risk, which we can traditionally proxy with beta,” said Smith. “So, the health of the system is totally linked to investor financial materiality, and there’s a feedback loop between the financial system and the system in which all of our investee companies operate.”
More granular engagement
Smith said costs (negative impact) and contributions (positive impact) of a company to a system’s health had been “exceptionally difficult to qualify, despite its importance in the investment decision-making process”. He said having a framework with a quantitative assessment, which works on a social return on investment (SROI) model, allowed it to understand the overall system-level impact that a company was making and which companies to prioritise for engagement based on this.
He added that the framework allowed Franklin Templeton to have “more clearly informed engagement” on systemic contributions and costs with companies through being able to move away from quite high-level, theoretical assessments or requests, to being able to quickly identify specific business lines and specific actions corporates can take, hence making engagements more granular and effective.
“All of our engagements are aiming to be as collaborative as possible with companies,” he said. “And the more information that we can add will make our ask more appropriate, better considered and more likely to get the company to negotiate. That’s going to create a better outcome both for the issuer and for us as investors across very diverse portfolios.”
Smith added that alongside talk about externalised costs of companies, there was insufficient recognition of externalised benefits. “There are companies that are creating significant benefits on a lot of these capital stocks, and that’s something that we feel as investors should be better reflected as well.”
Overall, he said the framework allowed Franklin Templeton to build a much more informed strategy with companies from the outset. “We may only get three-to-six hours with a company board or company management a year to discuss these issues. So, we can’t spend hours working through these issues from first principles with the company.”
Smith said it was also particularly useful as it fit very well into its existing notion of fiduciary duty and its existing role as an investor pricing risk and allocating capital for repeatable returns, by quantifying system-level costs and being able to express them in a way that’s material to the individual issuer.
Water risk is high on Ceres’ agenda, with it launching the Valuing Water Finance Initiative in 2022, as a global investor-led effort to engage 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.
Last year, the investor network published a report noting that threats such as groundwater depletion, metals contamination, plastic pollution, diversion and transfer of water, and eutrophication were being caused by the activities of firms across multiple industries.
A recent report from financial services firm Moody’s Investor Service said that water shortages have the potential to “disrupt economic activity and cause social turmoil”, with rising water stress and inadequate water management able to “heighten exposure to social risk”.