Investors Face Rising Tide of Water Risks
Scottish Widows flags the breadth of exposure facing asset owners as water stress weighs on global GDP.
Water poses a growing systemic risk throughout investment portfolios and across developed and emerging markets, according to a spate of recent reports, demanding increasingly urgent action by asset owners and managers.
UK-based Scottish Widows – a life insurance and pensions company owned by Lloyds Banking Group with almost £200 billion (US$259.4 billion) in assets under administration – has highlighted its high degree of exposure to water-related risks in a new report on the nature impacts and dependencies in its funds.
Having assessed a selection of the top 1,000 companies by holding size in its funds – representing 84% of total corporate investments – Scottish Widows said water use was shown to be the highest of five key nature-related risks, as per scoring defined by ENCORE, a nature risk measurement tool maintained by Global Canopy, the UN Environment Programme’s Finance Initiative and its World Conservation Monitoring Centre.
Furthermore, the asset owner reported that 50% of companies assessed had a “high to very high” impact on water. “We have a particularly high exposure to pharmaceutical manufacturing companies across our funds,” said Scottish Widows in the report. “The pharmaceutical industry has high levels of water use in manufacturing, reflecting both an impact and a dependency that could pose significant risks for companies in this industry,” adding that this was a key factor behind its funds’ high exposure to water-related risks.
The Scottish Widows report defined the main water-related risks as water security, flooding and pollution. It flagged that unsustainable production and water use practices had negatively impacted agriculture and industry, while pollution means just 16% of the UK’s surface water is of good ecological status.
The pensions provider said it was responding to the identified water risks by means of stewardship, investment integration and capital allocation activity to manage risks and seek potential opportunities. As well as its own interactions with portfolio companies, Scottish Widows is engaged in several collaborative initiatives aiming to tackle water-related issues, including the FAIRR Initiative, Nature Action 100, and the ShareAction Pesticides Working Group.
The scale of the threat posed by water-related risks is becoming apparent to asset owners globally.
“Water risks pose a significant threat to institutional investors and asset managers [and] these risks are becoming increasingly severe and widespread, affecting businesses across all sectors,” Saurabh Sharma, Sustainable Water and Waste Fund Manager at investment firm Regnan, told ESG Investor.
“As global population grows, urbanisation accelerates, and climate change intensifies, the demand for clean water is outpacing supply in many regions creat[ing] a range of risks that can directly impact investment portfolios.”
Cross-cutting risk
A report released last week by the Global Commission on the Economics of Water highlighted that the combination of declining total water storage and a lack of access to clean water and sanitation could see high income countries’ GDP decline by 8% by 2050 on average. Lower-income countries could face a more severe decline of between 10% and 15%.
This is an increase from the World Bank’s previous estimate that water scarcity, exacerbated by climate change, could reduce GDP growth rates by up to 6% in some regions by 2050.
It has also been estimated that droughts, floods and storms could cause cumulative economic losses of US$5.6 trillion by 2050, impacting sectors including agriculture, energy and utilities, retail, and manufacturing.
Recent analysis by the World Resources Institute showed that a quarter of the world’s crops are grown in areas where the water supply is highly stressed, highly unreliable or both. At the same time, research shows the world will need to produce 56% more food calories in 2050 than it did in 2010 to feed a projected 10 billion people.
Roughly half of the world’s population currently experiences severe water scarcity for at least part of the year, with water shortages linked to 10% of the increase in migration worldwide. By 2025, two thirds of the world’s population will be subject to water stress.
A report released by the European Environment Agency last week revealed that Europe’s water resources are under serious pressure, with “no significant progress” made since 2009. According to the report, less than 40% Europe’s of surface waters, such as rivers and lakes, are currently healthy with water stress already affecting 20% of Europe’s territory and 30% of the population every year.
In the EU alone, €255 billion (US$276.7) in water investments will need to be made in the next six years to address the “growing threat” of water scarcity.
“Water risks are increasingly significant for institutional investors and their assets [and] they have a crucial role to play in addressing these risks,” said Kanatta Kyazze, Portfolio Specialist at Impax Asset Management.
Cost of inaction
Global demand for fresh water is projected to outstrip supply by 40% by 2030, with emerging and developing markets in Africa, Central Asia, and the Middle East, likely to suffer the most acute water-related stress.
Research has suggested that water security will become one of the biggest global investment themes over the next ten years, with capital employed in addressing the issue reaching US$12.6 trillion by 2034.
Regnan’s Sharma advised investors to allocate capital to water-focused thematic investments through companies providing solutions that address water challenges, as well as actively engaging with portfolio companies on water management and disclosure.
He also suggested that investors can confront challenges by integrating “comprehensive” water risk analysis into investment processes, including assessing physical water risks, regulatory landscapes, and company water management practices.
“Investors hold a crucial position in mitigating water risks [and] they can significantly influence corporate behaviour,” said Sharma. “Investors’ long-term perspective aligns well with the imperative for sustainable water management. Moreover, they have the capacity to mobilise substantial capital for investments in water infrastructure and innovative solutions.”
Impax’s Kyazze urged a rapid response to the risks, saying that the cost of inaction on water is “many times higher than the cost of acting through the innovation and solutions”, stressing the need to invest in companies that are providing solutions.
Disclosure platform CDP has estimated that the potential financial impact of water risks to businesses is over five times higher than the cost of addressing them. CDP rates corporate water-related risks at a minimum of US$225 billion.
A total 4,815 companies disclosed water-related data through CDP last year, marking a 23% rise from 2022. In June, CDP’s 2024 Non-Disclosure Campaign saw a US$21 trillion-strong group of 276 global investors, banks and insurers ask a record 1,029 high-impact companies to report data on their water-related impacts and risks. This marked a 122% year-on-year increase, highlighting growing investor focus on the topic.
“We saw a huge uptick in 2023, and in those numbers you can see how many more investors are seeking to drive this forward,” said Nicolette Bartlett, Chief Impact Officer at CDP. “Water is now the hottest topic on their lips when they speak to us, and investors have become clearer and clearer on how much of a front-line risk water security is.”
While Regnan’s Sharma said investors’ awareness of water-related issues has gradually increased, there is “still significant room for improvement”. He flagged that water is “not yet central” to their decision-making and “trailing behind” other sustainability priorities like carbon intensity.
However, Sharma suggested COP16 in Colombia and COP29 in Azerbaijan offer an opportunity to heighten focus on water. He said regulators and policymakers could support action on water risks with the implementation of mandatory and standardised reporting on water risks and usage for companies across sectors to offer investors more consistent and comparable data to assess water-related risks in their portfolios.
Sharma also recommended creating incentives for water infrastructure investments, including in ageing water infrastructure to improve water leakages, efficiency and re-use. Water infrastructure globally will require as much as US$1.5 trillion annually by 2030 to be replenished.
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