Water risks: why investors care about sustainability

Heatwaves and droughts are some of the effects of climate change that have become evident in recent years. The intensity and frequency of these occurrences has increased. But since these events are not new, it could be years before some people are motivated to address climate change. While the effects of climate change may therefore seem far removed, water-related risks are widespread. Water is arguably the medium through which we feel the effects of climate change most.

Some 2.2 billion people lack access to safe drinking water while various business industries are continuing to drive this global pressure. Agriculture, fashion, energy, meat, beverage, automotive, construction and mining industries are some of the highest water consumers.

Global water demand (in water withdrawals) is projected to increase by 55 percent by 2050, mainly because of growing demands from manufacturing (400% increase). 90% of global power generation is water intensive. Additionally, businesses rely on energy mainly produced through intensive and non-reusable water models that are not sustainable.

A CDP Worldwide survey of 357 companies found that the cost of water risks are five times greater (US$301 billion) than the cost of taking action to address those risks (US$55 billion). In 2020, 515 investors with US$106 trillion in assets requested companies to disclose their impacts on water security and take action to reduce them. Water must be at the front of corporate climate strategies and investors care about this. Here is why.

Who is in charge?

Investors want to get ahead of these risks by financing businesses that are strategically incorporating water and other environmental, social and governance (ESG) issues into their plans, and showing how sustainable business activities will navigate through these risks with profit. In CDSB’s The state of EU environmental disclosure in 2020,  a review of 50 companies with a combined market capital of US$3.5 trillion, none of the companies disclosed the water-related resilience of their organisation’s strategy to future scenarios.

For investors, disclosing this information is not only an element of transparency but shows them the type of leadership they have at the helm. With strong and strategic governance that presents a clear direction on avoiding and mitigating water-risks, confidence in the business can be instilled. Corporate leaders additionally need to forecast risks and include innovative solutions to convey suitable sustainability plans.

Good corporate governance is not merely a display of corporate social responsibility (CSR) – making the world a better place. Many business managers unfortunately associate sustainability with CSR. The problem with CSR is that it is typically viewed as achievable through a financial loss for the greater good. Undoubtably a company’s good reputation has positive impact on financial gains. But CSR is a rather limited and dated corporate strategy.

Investing in sustainable business is no longer just driven by the ethical need to do good. American economists, Michael E. Porter and Forest L. Reinhardt, say, “Companies that persist in treating climate change solely as a corporate social responsibility issue, rather than a business problem, will risk the greatest consequences.”

Investors are pushing for corporate disclosure to include ESG issues. This allows for full disclosure that gives them decision-useful information. With ESG, water-related risks, climate change and biodiversity loss are no longer an afterthought but become a part of mainstream reporting.

Sustainably integrated businesses perform better

Companies worldwide are facing higher risks from water-related risks and investors are worried. Studies show that companies with high ESG ratings outperform those with low ESG ratings and investors are responding to that. In 2021, according to the Bank of America, an estimated one third of global equity inflows went into ESG funds.

Ensuring a business has high ESG ratings against water-risks however involves a shift in thinking. Managers can mitigate water use within their business operations through reducing consumption and changing to efficient processing methods, for example. But this does not necessarily solve the problems upstream and downstream, which requires a combined social effort and responsibility – water stewardship. Becoming a water steward means shifting from conventional water efficiency and compliance thinking to collective water risk management.

A Corporate Water Stewardship Initiative in Colombia enabled companies to take water management beyond their typical operations and engage other actors that shared water risks from the same source. This meant collectively investing into an upstream wetland restoration to maintain sufficient water flow through dry seasons. The benefit of stewardship is that it involves participants of the shared resource that potentially pose an additional risk to the business if expectations are not managed. High water consumers such as the beverage and mining industries are best positioned as water stewards.

Sustainability outweighs traditional shareholder objectives

Most corporate leaders of water dependent firms understand the role businesses must play in addressing water risks. But does water stewardship counter the goals of their shareholders? Harvard Business Review conducted an interview of 70 senior executives from 43 global institutional investing firms, including some of the biggest asset managers in the world (BlackRock, Vanguard and State Street) and revealed that ESG was priority concern for them.

In 2006, the UN-backed Principles for Responsible Investment (PRI) was launched with 63 investment companies (asset owners, asset managers and service providers) that managed US$6.5 trillion assets. By 2020, they had more than 3,000 members with assets under management exceeding US$100 trillion.  Of the six key principles driving PRI, three of them include incorporating ESG issues into investment analysis and decision-making processes; incorporating ESG issues into ownership policies and practices; and appropriate disclosure on ESG issues by the entities in which they invest. Demand for ESG disclosure, which includes water risks, is therefore increasing.

Lowering regulatory risks

Investors can and do play a critical role in helping governments to achieve their targets to fight climate change. Governments need to meet the goals set out in the 2015 Paris climate accord. To do this, they are turning the wrench on businesses by sanctioning climate change, biodiversity and water-related disclosure reporting directives.

In a study by a Swiss bank, J. Safra Sarasin, of about 1,500 firms, global temperatures were estimated to rise by more than three degrees Celsius by 2050 if companies worldwide did not reduce their emissions. This falls way short of the two degrees Celsius goal of the Paris agreement, preferably 1.5 degrees Celsius. Recently the G7 backed making climate risk disclosure mandatory, which builds momentum towards stricter regulations that seek conformity. Both corporates and investors are naturally being pushed to comply to lower regulatory risks.

Water, being the sensory end through which we feel the effects of climate change, is poised to face stiffer regulations. Taking positive action now against water risks will ensure company sustainability.

Disclosure ambiguity

Although more and more companies are disclosing water-related risks, there is ambiguity. CDSB’s Water-related disclosure briefing found that 26% of companies surveyed mentioned natural capital or resources in their business models but not explicitly water. But they then disclosed water metrics, which creates ambiguity on their materiality assessment: is water material for their business or not? CDSB’s Application guidance for water-related disclosures (Water Guidance) recommends that corporates explicitly describe the material interactions between water and the specific organisation in the business model description, and clearly explain how water-related policies are integrated in the overall business strategy.

The Water Guidance is part of a series of improvements to CDSB’s framework for corporate reporting on sustainability disclosures. As a standard setter, it disambiguates reporting standards by providing, clear, coherent, consistent decision-useful information.

Download your copy of the Water Guidance, available in several formats and languages, here.

Written by CDSB’s Enock Chinyenze, Senior Communications Executive (enock.chinyenze@cdsb.net) and Francesca Recanati, Environmental Specialist (francesca.recanati@cdsb.net).