Water Risk and Its Impact on the Financial Markets and Society

Water risks, such as scarcity, floods, or pollution, are receiving an increased attention by corporations and the financial community for the physical, regulatory, and reputational risks that they embed. Frameworks, metrics, and datasets are necessary to quantify water risks and assess their potential impacts. In this chapter, we describe the fast-evolving complex ecosystem of actors involved in the assessment and disclosure of water risks. We then review the content of corporate sustainability reports, the tools they rely on, and the underlying datasets in order to evaluate the gap between intention and actuality. Admittedly, water risks assessments are complex due to their multi-scale nature: They manifest locally, are sector specific, and are a function of climate and global trends, and ripple through the supply chains. However, the tremendous data gaps and blind spots that currently plague water-related disclosures in ESG reports may not only raise suspicion of blue washing corporate responsibility, but also hide significant financial vulnerability. We conclude with a discussion of the main data risks and propose strategies to address them.

While the assessment of greenhouse gas (GHG) emissions and other climate-related factors have been considered by many financial market participants for several years, the issue of water has only recently been gathering increased attention. The water risk assessment of an organization is increasingly considered an essential step in integrating Environmental, Social, and Governance (ESG) issues into investment analysis, as risks associated with water scarcity and quality can significantly affect the valuation of an issuer. This chapter looks at the issue of water from the perspectives of investors and of corporate issuers and aims to show how the responsible management of water can present opportunities and mitigate risks. Global challenges are covered, such as plastics in the ocean and biodiversity loss, as well as a variety of sector-specific water issues, from freshwater use in the agriculture sector, to cooling needs for technology companies. Tools available to corporate issues in managing their water risks are provided, along with some tools that investors may use to gauge the risk. This chapter includes an overview of how water is currently integrated into financial products, such as public and private equity and fixed income, and how investors measure the potential impacts and outcomes of water risks and/or opportunities to assess portfolio risk exposure, through stress testing, scenario analysis, and impact measurement. The chapter highlights the importance of responsible corporate water stewardship by public issuers and how they can enact positive change through conscientious water stewardship. Opportunities related to water are discussed, with reference to the circular economy, smart water networks, and ‘blue’ investments, demonstrating opportunities arising out of more efficient and innovative ways of managing water at both a local and a global level.

Most industries require water to fulfill their production and some of their functions. Water scarcity can affect operational productivity, in which case company profits and stock prices will be affected. To cope with water scarcity, companies may have to invest in or modify their infrastructure and/or operations to reduce the regulatory and reputational risks. Climate change exacerbates and complicates these water risks through extreme weather events, such as floods, drought, and typhoons. The financial sector is exposed to these water risks yet valuing them is difficult due to their complex and interlinked nature. In this chapter, two existing methodologies dealing with different types of freshwater risks are introduced and analyzed: the Shadow Price Model and Balance Sheet Exposure. The case studies of the above methodologies including all the charts in this chapter are summarized with permission from China Water Risk (CWR) and sourced from the report “Toward Water Risk Valuation – Investor Feedback on Various Methodologies Applied to 10 Energy ListCo’s” (CWR in Toward water risk valuation—Investor feedback on various methodologies applied to 10 energy ListCo’s, 2016). Over 70 investment professionals and asset owners across various asset types from more than 50 financial institutions or funds provided feedback on various valuation methods and tools to help build consensus toward water risk valuation. Although published in 2016, the report is considered groundbreaking, and the case studies included in the report are still useful to illustrate water risk assessment.

Climate-related risks pose inevitable threats to investors and the assets in which they invest; therefore, institutional investors have become increasingly concerned about climate-related risks, but physical risks are difficult to measure and manage because it requires physical hazard data, asset exposure, and vulnerability. Water-related risks are prominent physical risks that affect a wide range of industries, including the thermal power sector. Using traditional financial analysis and econometric techniques, this paper introduces a new methodology to quantify the financial impacts of water shortages on India’s thermal power sector. The methodology leverages asset-level data from the World Resources Institute’s 2018 working paper, Parched Power: Water Demands, Risks, and Opportunities for India’s Power Sector, and combines it with geospatial physical risk and corporate financial data to analyze the financial impacts of water-shortage-induced electricity generation outages at five publicly listed Indian thermal power companies from FY 2014–2017. The paper uses India power sector as an example because its electricity regulator publishes daily generation and outages data, which is essential to apply this methodology. It also uses outputs from Intergovernmental Panel on Climate Change (IPCC) climate models to project the impact of future water shortages on electricity production at the five companies. This paper serves as a tool for investors to understand, analyze, and engage more effectively with thermal power companies on water-shortage risks.

Concerns about water security often inform climate risk-related decisions made by environmentally focused investors (Porritt, The world in context: Beyond the business case for sustainable development. HRH The Prince of Wales’ Business and the Environment Programme, Cambridge Programme for Industry, 2001; Stern, Stern Review executive summary. New Economics Foundation, 2006). Yet, potential liabilities for damage caused by extreme flood and drought events linked to global warming present risks that are not always reflected in share prices (Krosinsky et al., Evolutions in sustainable investing: Strategies, funds and thought leadership. John Wiley & Sons, 2012). Considering the highly destructive nature of such events, we query whether companies, or specific sectors, could and should be held at least partially liable for their emission-releasing business activities. Recent articles (Rayer & Millar, Citywire Wealth Manager®, (429), p. 36, 2018a; Rayer et al., Ecological, societal, and technological risks and the financial sector, Palgrave Macmillan, pp. 39–68, 2020) estimate that under a hypothetical climate liability regime, North Atlantic hurricane seasons might increasingly generate 1–2% losses on market capitalizations (or share prices) for the top seven carbon-emitting, publicly listed companies. In this chapter, we extend the concept of the climate liability regime to estimate the impact of global flood- and drought-related damages on the share prices of nine fossil-fuel firms (including the seven mentioned by Rayer et al. [Ecological, societal, and technological risks and the financial sector, Palgrave Macmillan, pp. 39–68, 2020]). Following Rayer et al. (Global warming and extreme weather investment risks (abstract) [Conference session], 2019; Ecological, societal, and technological risks and the financial sector, Palgrave Macmillan, pp. 39–68, 2020), we use incremental climate impacts and historical corporate emissions to estimate that climate change-related global flood and drought damages for the period of 2012 to 2016 amount to approximately 2–3% of the top nine carbon-emitting companies’ market capitalizations. Quantifying impacts from extreme weather events increase salience and serve as an example of how science can identify and address the important business questions, pertinent to both investors and companies that arise from a changing climate.

Climate change will drastically redraw coastlines threatening capital cities, economic growth, and livelihoods. These risks might seem far in the future, but on our current path, three meters of sea level rise (SLR) is plausible by 2100, which would permanently submerge the equivalent of 22 Singapores of urban real estate from just 20 APAC capitals and economic hubs. Central Banks and regulators around the world have formed an 80+ member strong coalition to prepare for such systemic risks due to the clustering of assets and people in vulnerable locations. With the financial sector waking up to these significant tail risks, valuation adjustments are inevitable. This is not about natural capital accounting but real risk adjustments; the same way leasehold property is afforded a lower valuation compared to freehold assets, SLR will have a clear downward impact on valuations in coastal areas as the permanent loss of land will shorten the lifespan of all assets located there. As such locked-in threats question the going concern status of these assets, this should lead to the re-assessment of discount rates, terminal values, capital adequacy ratios, and the cost of capital, which will all affect sovereign and credit ratings as well as equity or project valuations. However, although chronic risks from sea level rise are recognized, there is still no consensus on the path forward regarding their assessment or valuation, which has led to a negative finance feedback loop. This chapter delves into the magnitude of these coastal threats and their ability to trigger systemic shocks. We explain why assessing them is important, how to start assessing risks facing coastal assets or portfolios, and why we should re-value today’s assets.

Ensuring sufficient quantity and quality of water resources is a necessary requisite for social well-being, economic prosperity, and environmental integrity. Water resources are continuously being threatened due to increasing population, economic activities as well as uncertainty posed by climate change. Moreover, risk to water security is a multi-dimensional construct of quantity, quality, access, and public perception that needs to be tethered together in policies and investments for a sustainable future. Given the wide social, economic, and ecological implications, it becomes necessary to conceptualize, assess, and manage interdisciplinary water risks as a means to ensure water security. As major users of this economically significant resource, businesses and financial investors fueling these businesses have a crucial role in designing sustainable water management practices by accounting for various water risks and response strategies. While existing literature on water disclosure and risk assessment highlights actions undertaken by businesses and investors in currently water-stressed regions, there is a gap in understanding current and future interdisciplinary water risks in regions perceived to be water-rich. Therefore, this chapter investigates different dimensions of water risk assessment, including an overview of current literature, gaps, and opportunities for sustainable water investment. Then using a case study approach, granular interdisciplinary water risk evidence is gathered for the Province of Ontario, Canada, and synthesized into a conceptual framework that can help design proactive decision support tools and guide the integration of sustainable water management principles in corporate and financial decision-making for a water-secure and sustainable future.

This chapter explores the increasing use of water in Indian agriculture with a special focus on groundwater consumption and aims to make agriculture sustainable through linking its use to the water footprint of each agricultural commodity. The paper builds on a broader literature of research that has highlighted the skewness in water management even in a water scarce country like India which increasingly exports water-intensive crops, hence becoming a virtual exporter of water. The focus is on establishing a robust water market by changing the dynamics of social and ecological factors, keeping in view that groundwater is becoming expensive to extract. This is done by expressing total water consumption per unit value of output in a farmland as a rough approximation of the embedded water in agri-production. The value obtained is then used to analyze the water demand to grow the same quantity of crops in the next agri-cycle. This is done by applying the formula of forward pricing of contracts, thereby treating embedded water as a commodity. The chapter discusses the impacts on trade as well as suggestions for future research.

Drinking water systems can misbehave in a variety of ways: pipe breaks, loss of pressure, inadequate flow, poor quality water, and others. Yet, the costs and consequences associated with these misbehaving systems are seldom comprehensively evaluated when systems are designed, operated, and maintained. These costs are often borne by a variety of stakeholders, including utility companies, consumers, and taxpayers. However, these costs can also cascade to other parties rarely considered, with possible impacts on couriers, public transport infrastructure, firefighters, homeowners, businesses, and institutions, often in ways that are difficult to quantify. Adding to the complexity, some initially bad consequences can occasionally have unexpected benefits, particularly when the resulting lessons lead to better ways of designing, operating, or rehabilitating systems. This paper explores some of this complexity with the goals of provoking greater discussion and increasing our understanding of how water systems can misbehave, and how much this misbehavior can cost, with the ultimate goal of better understanding the evaluation of risk.

Extreme weather events can leave a lasting impact on financial markets and our society; however, the probability of their occurrence and the ensuing damage is rarely quantified. In this chapter, we focus on the mining sector as a case study on how a data-driven analysis of extreme events related to water can be applied across industries. We examine the impact of climate variability and change on a decadal time scale across geographies at the individual asset level using daily rainfall data. Our approach identifies the stakeholders most exposed to extreme rainfall events based on both incidence and likely damage. We build on an index we have previously developed for financial exposure of climatic extremes aggregated across company assets using recent data on production stoppages, care, and maintenance costs and permanent impairment for mining companies impacted by the COVID-19 pandemic. We draw inferences around the likely impact to broader financial and commodity markets in simulated scenarios depending on how widespread the ramifications of any such event are likely to be. We highlight the externalities that influence water-related decision-making processes and discuss how companies can incorporate environmental, climate change, legal, social, political, and reputational factors into their existing valuation models.

As discussed throughout this book, water risk affects every part of our society and economy differently: An overabundance of water related, e.g., to floods can be just as destructive as a shortage stemming from droughts. Similarly, water pollution can have devastating effects on our flora, fauna, and our own (human) lives. While water risk affects us on a global scale, certain locations, industries, and even segments of our population are more affected than others. This chapter reviews the challenges water risk imposes on businesses, regulators, and our broader society. It draws on the insights provided by the contributors to this book and offers a series of recommendations for future work in the area to help us overcome and address many of the pressing academic, regulatory, and practical challenges water risk inflicts on us.