Corporates Neglect Water Risks
Nature-focused scenario mapping and valuation are deemed pivotal to managing water stress as global warming worsens.
Most companies globally are still failing to account for water-related risks in their business operations and supply chains, industry experts warned during Rathbones Greenbank’s 27th Investor Day.
“Last year, we saw the first year of 1.5°C warming, and that is having a flywheel effect on the hydrological cycle,” said Claire Elsdon, Head of Capital Markets at environmental disclosure platform CDP. “We have seen parts of the Rhine closed to shipping due to heavy rains, while the Panama Canal grappled with severe drought. Floods halt[ed] industrial production in Japan and water scarcity in Taiwan threatened the global supply of semiconductors, which underpin our digital economy.”
As water-related risks worsen, an increasing number of companies are seeking to understand, disclose and mitigate their exposures to those, Eldson stressed. But progress continues to lag compared to other climate and nature-related themes.
Although almost 5,000 companies reported to CDP on water in 2023 – a 23% increase from 2022 – this only represented a quarter of companies disclosing to CDP on other climate-related risks, Elsdon noted.
Only 4% of companies reporting to CDP have set water-related targets specifically for their supply chains. The apparel sector led the way, with 26% of companies in the sector having set such goals, according to the report. Of those that have set water-related supply chain targets, nearly 70% are “on track” to achieving them.
The report did, however, note some improvements. For instance, 20% of companies disclosing annually reported supply chain water risks in 2023, representing a rise from 16% in 2021. “The cost of mitigating supply chain water risk is almost three times cheaper than the cost of impact,” CDP noted.
To accelerate progress, companies should look to better incentivise their executives to address water-related risks, Elsdon suggested.
“Only 14% of companies reporting via CDP have C-suite or board-level incentives in place for the management of supply chain water-related issues,” she said.
Under current circumstances, around 57% of people globally are expected to live in water scarce areas by 2050. CDP has previously estimated that the financial impact of water risks could reach US$392 billion.
Miscalculation
Company estimations about their exposure to water risk are often built based on estimates that price the resource too cheaply.
“It’s one of the cheapest resources that businesses and people can access, but it’s fundamentally mispriced,” Elsdon said. “Businesses will often operate assuming the value of water is the cost price, and that is a problem.”
Both investors and companies must understand that the value of water is more wide-reaching than that, Elston insisted. “A litre of water in one geography doesn’t have an equivalency to a litre of water anywhere else in the world – it’s a localised issue,” she added.
Last year, investor network Ceres published its inaugural water stewardship benchmark, which assessed 72 water-intensive firms on issues such as water quantity, quality and board oversight. None of the assessed companies were found to be “leading the way” on these themes, but 11 companies – including Coca Cola – were ranked as “on track”, meeting at least 50% of the ambition spectrum.
In addition, none of the companies had assessed the full value of water to their business and society, with only a handful using basic metrics for water pricing.
Just as it is important to understand present day exposures to water-related risks, it is crucial that companies and financial institutions “bake nature-related risks into their balance sheets”, Elsdon continued. “At what point do we start to consider stress testing balance sheets for nature-related risks? The data isn’t there yet, but this is the direction of travel.”
In 2022, the University of Cambridge Institute for Sustainability Leadership (CISL) and HSBC published a use-case scenario outlining the potential future risk of water stress to select heavy industry companies in East Asia.
The findings forecasted a 20% increase of risk-weighted assets for assessed companies, alongside a significant deterioration of the average portfolio credit-risk rating and more than a third of the companies likely to move from ‘Investment Grade’ to ‘Speculative’.
The report underscored the importance of further assessments of nature-related financial risks such as water insecurity, the inclusion of water-related risks in financial institutions’ risk frameworks, and better data and risk identification tools to enable more robust assessments.
In March last year, the UN held its first water conference in 46 years. UN Secretary General António Guterres called for a “dramatic acceleration” in investment to ensure all countries achieve the sixth UN Sustainable Development Goal: ‘Clean Water and Sanitation’.
“The risks of a water-poor or water-scarce future cut right across all sectors of our economy, our way of life, and our civil society,” said Clive Bannister, Chair of Rathbones. “Pushing water security higher up the agenda will benefit us all.”
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