Water Risk Modeling

Global climate change is rapidly approaching the threshold of what is considered safe by the global climate research community. There is ample and robust evidence that extreme weather events are occurring more frequently across the globe. Also, it is now a well-established fact that the warming catalysed by the industrial revolution is caused by human emissions of greenhouse gases into the atmosphere, primarily in the form of Carbon Dioxide (CO₂). While fossil fuels have allowed society to evolve into its current modern iteration, their effects may also wreak havoc on the stable climate we depend upon in the long term. In the course of the last two centuries, scientists have determined that the planet warms with every ton of CO₂ emitted, and also that weather becomes increasingly extreme due to the associated changes in the global water cycle. Since the beginning of the rapid ‘modern’ global warming 40 years ago, many of the changes the scientific community predicted—underpinned by a very solid understanding of the physics of the atmosphere and the climate system—have indeed materialised. Heat extremes have become hotter, drought episodes have become longer, extreme rainfalls have become more extreme. In essence, it is very likely that the hydrological cycle during the wet season has already intensified. This review article introduces the theory behind warming-induced changes of the global water cycle and includes a discussion of the implications of this theory at global and regional levels. A few recent attribution studies demonstrate how the role of humans in altering the odds of extreme weather occurring is quantified.

The worsening state of water supply on a global level has highlighted the water risks posed by the textile sector. The water depletion and pollution risks posed throughout the production chain result in manufacturing, financial and environmental risks for the companies and investors engaged in the sector. This state of the industry exists despite concrete consequences that companies face, including regulatory penalties and reputational risks. The textile economy, due to its expansion to the labor-oriented developing countries, is globalized, giving rise to complex supply chains undertaking transnational outsourcing. However, unlike carbon emissions tracking, water impacts are predominantly experienced locally, thus requiring disclosure practices that reconcile these two scales. In this chapter, we first introduce a conceptual framework to relate water risks to financial risks. From this, we derive two survey instruments and use them to review the existing reporting frameworks (e.g., the Sustainability Accounting Standards Board, Climate Disclosure Standards Board, the CDP Water Questionnaire and the Global Reporting Initiative) through the lens of the textile industry and evaluate the actual disclosures as practiced by five of the main corporations. By uncovering the inadequacies at both levels, we highlight the risk modeling gaps, and we conclude by discussing the potential and limitations of science-based targets for water to quantify and manage water risks exposure in the textile industry.

Canadian homeowners are increasingly vulnerable to flooding, due to elevated levels of indebtedness and more frequent and severe weather events associated with changing climate conditions. This vulnerability imposes risks on the broader Canadian financial system, through its potential effects on mortgage holding institutions, insurance companies, and governments. It is therefore important to understand homeowners’ perceptions of flood risk and their efforts to mitigate against possible flood-related losses. Using data from a 2016 national survey of Canada, this chapter evaluates homeowners’ subjective evaluations of residential flooding risk, their likelihood of purchasing sewer backup and overland flood insurance, and their likelihood of undertaking in-home protective actions. Results show a marked difference in how prior flood experience and socioeconomic factors relate to the likelihood of purchasing flood insurance and the likelihood of undertaking in-home protective actions. These findings help to explain variations in homeowner flood mitigating behavior and offer insights into possible housing asset vulnerability that can inform disaster management policy.

Water is indispensable to life on this planet. Human, social, economic, and technological developments depend upon water. The UN’s Committee on Economic, Social, and Cultural Rights has recognized that “the human right to water is indispensable for leading a life in human dignity. It is a prerequisite for the realization of other human rights.” In the recent past, Global Risk Reports from the World Economic Forum have repeatedly identified water as one of serious risks making long term as well as sustainable water access one of the most pressing challenges of the world today.

Water poses a material risk to businesses, governments, and societies. As per the Carbon Disclosure Project, the total financial impact incurred by water-related challenges was US$ 2.5 Billion for 617 reporting major companies, and 65% of these companies have identified water as a substantive risk to their operations. These figures hint that the ‘business as usual’ approach is no longer sustainable. This chapter shifts focus toward innovative financial instruments, in particular water stewardship as a mechanism of involving businesses to assume responsibility for water management. We argue that the water stewardship approach is important to ensure just and equitable access to water and is rooted in responsible and robust water governance. Not only does it elicit responsive action from all the actors involved in water management, but it also allows them to mitigate water risks and remain viable in the longer run. As such, it puts the role and responsibility of the private sector and businesses to manage water responsibly.

Climate risks, including those which arise from global warming induced extreme weather and hydrological events, need to be considered by both institutional and underlying investors in their portfolios (Porritt, J. (2001). The world in context: beyond the business case for sustainable development. Cambridge: HRH The Prince of Wales’ Business and the Environment Programme, Cambridge Programme for Industry.; Stern, N. (2006). Stern Review executive summary. New Economics Foundation.). Emissions from carbon-intensive sectors can be linked to potential liabilities caused by extreme weather and hydrological events, such as extreme rainfall and flooding. The risks these events present may not be reflected in current equity or bond prices (Krosinsky et al., Evolutions in sustainable investing: strategies, funds and thought leadership, John Wiley & Sons, 2012). Consequently, financiers and investors need tools to assess the climate risks of portfolio holdings. Financial supervisors and regulators also need to identify downside risks.

We propose a framework which may be helpful for estimating investment losses based on firms’ historical carbon emissions. Our framework would also allow the sensitivity of losses to uncertain inputs to be explored for climate risk stress-testing. We further develop and refine Rayer et al. (2021b), with “hypothetical climate liabilities” now, in principle, being applicable to any company for which the relevant data is available. It also includes scope for a financial and economic focus to encompass moral responsibility. The principal idea is that a company’s knowledge of the climate damage its emissions have caused, together with its subsequent willingness to accept responsibility to address the harms caused is incorporated, which is likely to reflect a societal judgment.

Our framework enables financial market practitioners and policymakers to estimate, for individual listed companies, potential equity or bond price falls arising from a company’s historical emissions following climate change induced extreme weather or climate events.

Water is essential to life and is not typically included in an investment strategy. Water scarcity creates water risk which is environmental, ubiquitous across sectors and geographies, directly impacts future corporate earnings and is completely unaccounted for in equity market benchmarks. The drivers to water risk include climate change and climatic events, failing infrastructures, pollution, inadequate regulations, and poor corporate water stewardship. Energy has alternatives (solar, wind, nuclear, etc.) but there is NO substitute for water. Water stewardship will directly impact future corporate earnings. The “winners” will manage water efficiently while the “losers” will mismanage their water resources, negatively impacting their earnings and consequently their share prices. From an investment perspective, there is a big difference between water-themed indices and water security indices. Water-themed investment strategies consist of highly concentrated (30–40 stocks) portfolios of companies in the water purification and/or water recycling equipment manufacturing industry, as well as some water utilities none of which focus on water security. “Water security is the reliable availability of an acceptable quantity and quality of water for health, livelihoods and production, coupled with an acceptable level of water-related risks” (Grey and Sadoff in Water Policy 9:545–571, 2007). Because water is used by nearly all companies to some degree, water security relates to nearly all companies. Therefore, almost every company possesses some degree of water risk which enables them to be analyzed during portfolio construction to assess and control portfolio exposure to water risk with a tilt toward water security and good water stewardship. The lower the water risk, the greater the water security. There are no standards for reporting water data, therefore we need to apply statistical techniques to ensure comparability across companies and geographies before measuring water risk. Our approach creates a proper distribution from best to worst water risk at the company level. This study relates to the indices developed from Thomas Schumann Capital (TSC). The TSC Water Security Indices have demonstrated superior returns while generating a considerably lower water footprint and carbon footprint. In addition, they have similar volatility, sector exposures, dividend yields, and high correlations to their traditional equity benchmarks.

Through the Network for Greening the Financial System (NGFS), central banks and regulators globally have acknowledged that chronic climate risks such as the rise of sea levels or sea level rise (SLR) have potential financial consequences. Addressing such risks is especially urgent as the IPCC Sixth Assessment Report from Working Group I warns that the possibility of 2 m to 5 m of sea level rise (SLR) “cannot be ruled out” by 2100 and 2150; this prediction is higher than the previous IPCC worse-case scenario SLR of ~1 m by 2100. These changes to the climate risk landscape make the benchmarking proposed in China Water Risk’s (CWR’s) five-report series “CWR Coastal Capital Threat Series” in 2020 increasingly relevant. These reports highlight just how financially material chronic climate risks are: at 2.9 m of SLR, 28 million people from just 20 capitals and cities in APAC would lose their homes, and urban real estate equivalent to 22 Singapores, and 20 ports and 12 airports would be permanently submerged. These numbers are clearly financially material, yet they are conservative—local tide adjustments were not included in the benchmarking study. Given this materiality and the need for action to prevent financial shocks, central banks are now carrying out pilot stress tests in their domestic markets for both acute event-driven and chronic climaterisks, and the results of these tests reiterate how severe climate risks are for the finance sector. For example, the Hong Kong Monetary Authority’s (HKMA) pilot stress test of its banking sector involving 27 banks revealed that almost HK$1 trillion worth or 32% of participating banks’ mortgage and property lending are vulnerable to climate impacts mainly from flooding and typhoons. Yet, the results could be worse given accelerating SLR as warned by the recent IPCC AR6 WGI. Any asset being submerged earlier could face deep revaluation, similar to property value adjustment from freehold to leasehold. So, the financial sector must understand the risks presented by SLR. The CWR APAC Coastal Threat Index for 20 APAC capitals and economic hubs (CWR APACCT 20 Index) was created to assess the absolute and relative coastal threats facing 20 APAC cities. This index reflects mapped stacked locked-in SLR risks for four climate scenarios (1.5 °C, 2 °C, 3 °C and 4 °C) across key indicators (population, land area and key infrastructure assets) for each city; and also analyses storm surge threats and subsidence. It also considers government adaptation actions to reduce physical risks. This chapter explores the creation of the index with the support of over 100 finance professionals. Although far from perfect, it is a step in the right direction towards assessing coastal threats. Climate risks are rising, and economic, social, and financial shocks can only be avoided if these risks are better understood. It is hoped that the financial sector will build upon and adjust the index so that better stress tests can be carried out, and that potential maladaptation in the future can be avoided. Ideally, more capital would be allocated to decarbonisation and adaptation, as such actions would ensure long-term resilience.

Water risks and opportunities could potentially have a huge impact on investment portfolios. Hence, the importance of advancing investors’ understanding of water risks and their management. This chapter outlines ACTIAM’s management of water risks and offers guidance for investors seeking to improve their understanding and management of portfolio water risks. In 2017, ACTIAM as an asset manager set itself the goal of achieving a water neutral investment portfolio by 2030. This means that the volume of water consumed by companies in the portfolio should not be greater than the volume that nature can replenish. Both water quantity and water quality are relevant in achieving this goal. Water footprinting is a tool used for measuring progress toward the goal of water neutrality and for identifying high-priority areas in which action needs to be taken. A qualitative assessment is proposed as a means of reflecting on the water management of shortlisted portfolio companies. The results of this assessment facilitate decisions on portfolio construction and prioritized engagement.

The world is not on track to achieve Sustainable Development Goal 6 (SDG 6), which is to ensure the availability and a sustainable management of water and sanitation for all. Huge service and financial gaps hinder efforts and progress toward achieving universal access, especially in low-income countries. To close these gaps, more investments in water and sanitation are urgent. Particularly, micro, small, and medium enterprises struggle to get capital from public and private financial institutions. There is a need to provide these water and sanitation enterprises with the tools and funding they need to become sustainable and investment ready. Simultaneously, it is critical to increase access to finance for water and sanitation. In this chapter, we present the strategy and models developed by Aqua for All, an international foundation based in the Netherlands. Aqua for All implements comprehensive approaches to reduce the service gap by supporting market-based solutions and enabling SMEs to scale. At the same time, the foundation offers technical assistance (capacity building) and de-risking as well as develops innovative finance facilities in partnership with public and private investors that contribute to bridging the finance gap.

The acceleration of climate change has impacted countless sectors, and real estate is no exception. Consequently, there is a growing demand for a better understanding of climate-related risks on the industry. Regulators’ expectations surrounding risk reporting and disclosure are putting pressure on investors and business leaders who, in turn, are looking for ways to measure their exposure and the related potential financial losses. Similarly, as the effects of climate change become more acute, companies are increasingly demanding the necessary instruments to identify and quantify water risks. Due to the significant increase in the number and severity of hurricanes, severe storms, floods, and droughts—all of which are related to the extreme climate volatility—water risk is at center stage. In response, The Climate Service, now a part of S&P Global, has developed the Climanomics platform specifically to address challenges in quantifying climate-related risks, including a variety of water risks (2022). This chapter addresses the implications of water risks for the real estate sector and its stakeholders and describes the Climanomics platform’s methodology. After this thorough review, we present a short case study to show the benefits of considering climate risks in real estate investments and how Climanomics helps facilitate this analysis. Addressing the implications of water risks for real estate provides essential insights into current and future risk exposure, Listallowing various stakeholders to make the right decisions to mitigate risk and protect asset values over the long run. As we make efforts worldwide toward a greener economy and society, having tools such as Climanomics that ease this transition will only encourage more market players to join this market trend.

Due to the rising demand for water and conflicting interests among stakeholders, the price of water will increase in the future. Higher costs and limited availability of water affect the profitability and liquidity of companies. The Water Credit Risk tool developed by the German Society for International Cooperation (GIZ), Natural Capital Declaration (NCD), and German Association for Environmental Management and Sustainability in Financial Institutions (VfU) assesses the shadow price of water (SPW) as the potential future cost of water and models its impact on a company’s income and cash flow. Examining the SPW and its implications for operational and capital expenses provides indications of the companies’ vulnerability to water risk. The effects on financial ratios highlight the need for companies to develop mitigation strategies, and they alert financial investors about opportunities and threats associated with water-related investments.

The chapter addresses the SPW-related sensitivity of three selected companies from various industries with respect to changes in their operational structure across time, changes in the SPW between two different points in time, and projections of the SPW into the future. Depending on the company-specific calculation of the SPW and the firms’ business model, the results provide individual sensitivities to water challenges as well as individual potentials to respond.