Liesel van Ast
Natural Capital Declaration Programme Manager, Global Canopy Programme
Water as a critical resource is virtually invisible to capital markets. Yet the landmark international climate-change agreement adopted in Paris in December 2015 invites financial institutions to provide information on how climate finance will incorporate “climate-proofing.” The deal aims to strengthen the global response to climate change by making “finance flows” consistent with a pathway toward low greenhouse gas emissions and climate-resilient development. Implementation will need to include assessing risks from changes in water availability and understanding the financial implications for sectors that include mining, food and beverages, and power utilities. A transition to a low-carbon economy could either increase or decrease water use for electricity production, depending on the choice of technologies and cooling systems. Investments made to decarbonize sectors will need to take into account exposure to more frequent and severe droughts and floods, along with related unanticipated costs, reduced cash flows, or stranded assets. Energy is often among the biggest water users in a country, while the water sector can be among the biggest energy users. The financing of both climate-change mitigation and adaptation must take place concurrently.
Many investors and the rating agencies Moody’s and Standard & Poor’s are at the early stages of exploring ways to evaluate the implications of water risk for credit quality or investment risk. One of the challenges is that water shortages have localized impacts in certain regions, such as parts of Brazil, California, South Africa, Thailand, and India, and thus are not major drivers of global ratings across issuers in any sector. The Natural Capital Declaration (NCD), a joint initiative between the UN Environment Programme Finance Initiative and the think tank Global Canopy Programme, released two tools in 2015 to raise the bar on integrating water-risk factors into financial analysis. The NCD worked with Bloomberg to co-develop the Water Risk Valuation Tool to include water stress in copper- and gold-mining equity valuations. The tool models potential asset stranding based on future physical water scarcity and estimates the effects of this water risk factor on earnings and share price.
UBS, Robeco, J. Safra Sarasin, Pax World, and Calvert were among financial institutions that road-tested a Corporate Bonds Water Credit Risk Analysis tool co-developed with partners, including the German Society for International Cooperation (GIZ) GmbH Emerging Markets Dialogue on Green Finance. This tool enables users to evaluate exposure to water stress through bond issuers in the power utilities, diversified mining, and beverages sectors. Applications include peer analysis to inform investment analysis, engagement programs, due diligence on individual securities, and product development.
Both tools include the option to apply a “shadow price” of water as a proxy to quantify financial risk from water stress. This calculation can be used to test sensitivity to water-related costs that could be internalized through higher capex or opex costs, reduced cash flows, or the loss of a social license to operate, for instance. The tools provide value from data on physical water stress and water use, which analysts would usually find difficult to synthesize and directly link to financial outcomes. They include information on future water availability that can be used for modeling exposure to changing operating conditions.
Expanding the tools to evaluate companies and sectors further would require companies to disclose their water use at a global level, as well as their operating or ownership data at a facility level. The Global Reporting Initiative disclosure guidelines, used by most multinational companies, include the following indicators:
- Total water withdrawal by source (for example, surface water and ground water).
- Water sources significantly affected by withdrawal of water (for example, the size of water source and whether or not it is designated as a protected area).
More detailed data is needed on where companies are using water—in operations or supply chains— in order to assess and manage exposure to water shortages.
Water Investment Opportunities
Investment in green and grey infrastructure can be among the actions taken to mitigate risks from water stress. An estimated US$1 trillion in new investments in infrastructure are needed in the U.S. alone, over the next 25 years. Water-related equity funds have evolved over the past 10 years, largely focused on water supply, infrastructure treatment, and the companies providing water-related technologies. Morningstar lists 52 water equity funds from managers, including J Safra Sarasin, RobecoSAM, UBS, Pictet, and BNP Paribas. For fixed income options, investments in water projects are rare in the green-bond universe, which has mostly focused on renewable energy and energy efficiency over the past five years. One of the few green bonds to include water projects is the US$500 million issuance by the African Development Bank in December 2015, which includes sustainable water upgrades and water management.
Water projects supported by green bonds are set to grow. Sustainable water management is among categories of green projects identified in the high-level ICMA Centre Green Bond Principles 2015, while the Climate Bonds Initiative is consulting until 12 February 2016 on a draft Water Climate Bonds Standard with proposed eligibility criteria for water projects. The protection or restoration of natural infrastructure (forests, aquifers, wetlands, and so on) is increasingly likely to feature alongside the investment in “hard” water infrastructure. Establishing green-bond standards to clarify definitions and processes for the use of proceeds could help to expand water-related bond issuance. In turn, “Blue Bonds” with greater liquidity could attract investors looking to drive capital toward water-related projects and assets. Projects that are financed to increase resilience could also be designed to provide measurable financial benefits from reduced risks.
Additional drivers for water-related investments include the increasing significance of regulatory controls, access to freshwater, and security of supply among industrial users. These considerations prompted Resonance Asset Management to raise more than US$100 million in 2015 for an industrial water fund to provide equity financing for projects of some US$20 million with typical 10-year horizons. Its first investment supports a high-recovery wastewater-treatment system for a chemicals company.
Water-related financing will also be boosted by the international UN Sustainable Development Goals and targets agreed on in September 2015. It includes targets to improve water quality; increase water-use efficiency across all sectors and ensure sustainable withdrawals; protect water-related ecosystems; and ensure sustainable management and the efficient use of natural resources.
Liesel van Ast is the Programme Manager for the Natural Capital Declaration, a joint initiative between Global Canopy Programme and UNEP Finance Initiative. She manages a work programme to build capacity for financial institutions to strengthen management of environmental risks and opportunities. As part of the NCD Secretariat, she oversees practical projects to support implementation of commitments to understand, embed, account for, and report on natural capital.
 The Paris Agreement under United Nations Framework Convention on Climate Change. December 12, 2015. “Adoption of the Paris Agreement.” Draft decision-/CP.21. http://unfccc.int/resource/docs/2015/cop21/eng/l09.pdf.
 Macknick, Jordan, Robin Newmark, Garvin Heath, and K. C. Hallett. 2011. A Review of Operational Water Consumption and Withdrawal Factors for Electricity Generating Technologies. Prepared under Task No. DOCC. 1005 U.S. Department of Energy, National Renewable Energy Laboratory. Available from http://apps2.eere.energy.gov/wind/windexchange/pdfs/2011_water_consumption_electricity.pdf.
 Moody’s Investors Service, Moody’s Approach to Assessing the Credit Impacts of Environmental Risks, 30 November 2015.
 Natural Capital Declaration (NCD). Resources. http://www.naturalcapitaldeclaration.org/resources/.
 African Development Bank Returns to Green Bond Market. 2015. Environmental Finance, 9 December.
 Climate Bonds Initiative. 2015. “Water Climate Bonds Standard: Defining Expectations for Water-Related Climate Bonds in a Dynamic Climate.” Water technical working group. Background Paper to Eligibility Criteria, November. https://www.climatebonds.net/standards/water.
 Ian Elkins. “Resonance Fires up Industrial Water Fund.” 2015. Global Water Intelligence (GWI), September 16(9).
 United Nations. 2016. Post-2015 Sustainable Development Agenda: Goals, Targets, and Indicators. UN Sustainable Development Knowledge Platform. Available from https://sustainabledevelopment.un.org/index.php?page=view&type=400&nr=775&menu=1515.