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FRESHWATER RISKS & OPPORTUNITIES: AN OVERVIEW AND CALL TO ACTION FOR THE FINANCIAL SECTOR

Contents1

Introduction 4

2 Voluntary and Regulatory measures: TCFD and the EU Action Plan

6

3 Water as a risk 10

4 Water as an opportunity

16

5 Overcoming obstacles to advancing water in finance

18

6 Recommendations

21

Imprint

Published by:

WW

F Germ

anyD

ate: N

ovember 2019

Authors:

Alexis Morgan (W

WF G

ermany)

Contact:

Alexis Morgan (W

WF G

ermany), Alexis.M

organ@w

wf.de

Acknow

ledgment:

Ariane Laporte-Bisquit, Chris Holm

es, Matthias K

opp, R

ichard Lee, Parisa Shahyari, Juliane Vatter, Philipp Wagnitz

Designed by:

Silke Roßbach, m

ail@silke-rossbach.de

Printed by:

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Druckhaus Berlin-M

itte Gm

bH

Paper:

Printedon100%recycledw

astepaper,BlueAngelcertified.P

roduced by: M

aro Ballach (WW

F Germ

any) P

hoto credits: G

etty Images (S.2), Sun X

iaodong (S.17), WW

F (S.5; S.23; Title)

© 2019 W

WF G

ermany, Berlin

Freshwater risks &

opportunities | 3

1. Introduction

Over the past decade, w

ater-related risks have consistently emerged near the top of the

World Econom

ic Forum’s G

lobal Risk R

eport. The CDP reported corporate losses of over

US$30 billion in 2018 alone due to w

ater risks year after year. From the droughts that

materially im

pacted Europe’s economy to the m

ulti-million dollar im

pacts of water scarcity

in cities like Cape Town and Chennai, w

ater issues impact investors around the globe.

Thisshortbriefingoutlineshowwaterisbothafinanciallym

aterialriskandanopportunityfor investors.

Thebriefingacknowledgesinitiativesbythefinancialcom

munityasw

ellasgovernments,

includingtheEuropeancommunity,toim

provefinancialreportinganddisclosurerelated to clim

ate change. It stresses that investors need to broaden their assessments and take

water challenges far m

ore seriously than they have so far – either through voluntary or regulatorym

easures.Thisbriefingalsohighlightshowstakeholdersengagedatthenexus

ofwaterandclim

atechangecanplayasignificantroleinstrengthening and accelerating the specificw

orkofinstitutionsthathaveembarkedontheroadtofinancialdisclosurerelated

to water and clim

ate.

4

It is our belief that the TCFD fram

ework provides an opportunity to exam

ine water-

related risks and opportunities in relation to climate change m

ore closely. Better disclosure of m

aterial water issues w

ill provide critical information for investors in com

panies exposed to w

ater risks in their supply chain, as well as opportunities to invest in business

models that contribute to w

ater security and climate resilience.

Another opportunity for increased awareness of w

ater related impacts and risks w

ill arise due to the extension of the EU

Taxonomy to W

ater from 2020. In M

arch 2018, the European Com

missionreleaseditsactionplanforfinancingsustainablegrow

th.Theplanisaresponseto the H

igh-Level Expert Group (H

LEG) on Sustainable Finance’s recom

mendations

submitted to the Com

mission on 31 January 2018. The four legislative proposals adopted

in May 2018 address several areas of the action plan. A Technical Expert G

roup (TEG) to

support the legislative proposals with m

ore detailed technical elements w

as also established. The TEG

’s taxonomy discussion is w

orking on the conditions and framew

ork that will lead

toaunifiedclassificationsystem(ortaxonom

y)onwhatcanbeconsideredenvironm

entallysustainable econom

ic activities. 2

ThisEUsustainablefinancetaxonom

ywoulddotw

othings.First,sincetheregulationdeterm

ines the scope of the taxonomy’s application, any proposed regulation m

ay require w

ide system exposure for review

given that the taxonomy currently is restricted to apply

onlytogreenfinancialproducts.

2 P

RI (n.a.)

2. Voluntary and Regulatory measures: TCFD and the EU Action Plan

1 TC

FD (2017)

In June 2017, the Task Force on Climate related Financial D

isclosure (TCFD) issued its

recommendationsforconsistent,clim

ate-relatedfinancialdisclosuresforinvestors,lenders,insurers,andotherfinancialservicescom

panies.SixmonthslaterduringtheO

nePlanetSum

mitinParis,237com

panies(including150fromthefinancialsector)w

ithUS$6trillion

in combined m

arket capitalization and US$82 trillion in assets under m

anagement com

-mittedtoTCFD

.Sincethen,financialregulatorsandfinancialsectorcompanieshavebegun

on implem

enting the TCFD recom

mendations. M

ost of the focus has been on scenario analyses and the assum

ptions that need to be built into those analyses to make them

truly helpfulforthefinancialinstitutionsconductingtheanalysis,asw

ellasfortheinvestorsw

ho need to understand what the disclosures m

ean. TCFD has had a strong focus on scenar-

ios analysis, however, to date, m

ost of the scenario work has focused on carbon transition

scenarios and the resulting risks. Under such transition risk assessm

ents, water related risks

and implications have not yet em

erged as the leading edge of climate im

pacts. 1

Despitethefactthatw

aterissuesdrivemanyofclim

atechange’sfinancialimpacts,w

aterrisksgarnernow

herenearthesamelevelofaw

arenessoftheirsystemicrisktothefinancial

system as do risks from

exposure to fossil fuels.

6Freshw

ater risks & opportunities | 7

As laid-out in the taxonomy regulation, the objective w

ould be to adopt the second and third delegated acts by m

id-2021 and mid-2022 respectively – covering the other four environ-

mental objectives. W

hile all of the EU action plan activities address w

ider sustainability aspects,includingfreshw

aterlinks,thenexttaxonomyw

illfocusspecificallyonwater-related

issues in relation to marine system

s and river basins.

In 2019, the Task Force on Climate R

elated Financial Disclosures (TCFD

) issued a status report.Thetaskforcenotedtherelevanceofclim

aterelatedriskstotoday’sfinancial decisions and the need for greater transparency. It also noted that nearly 800 public and private sector organizations have announced their support for the TCFD

, including global financialfirm

sresponsibleforassetsinexcessofUS$118trillion.TheTaskForcereport

conveyedthattheNetw

orkforGreeningtheFinancialSystem

,agroupof36centralbanksandsupervisors,recognizesclim

aterelatedrisksasasourceoffinancialriskandtheim-

portanceofcentralbanksandsupervisorsinensuringthatthefinancialsystemsisresilient

tosuchrisks.TheTCFDobservedthatw

hilecompaniesarem

akingprogressonfinancialdisclosure regarding clim

ate risks, much m

ore needs to be done. The paper highlights that watersectorstakeholderscanm

akeasignificantcontributiontostrengtheningtherangeanddepthoffinancialdisclosurerelatedtow

ateranditsintersectionwithclim

atematters,

most notably under adaptation and resilience.

Second, the TEG w

ould determine critical m

etrics and threshold conditions that those econom

ic activities would need to com

ply with to substantially and positively contribute

to at least one of the six EU environm

ental objectives as set out in the regulation: 3

1) Clim

ate change m

itigation;

2) Clim

ate change adaptation

;

3) Sustainable use an

d protection of w

ater and m

arine resources;

4) Transition

to a circular econom

y, waste preven

tion an

d recycling;

5) Pollution

prevention

and con

trol; and

6) Protection

of healthy ecosystems.

Thetaxonomyregulationandthefirstdelegatedactcoveringclim

atechangeadaptationand m

itigation objectives could be adopted by year-end 2019 as the EU negotiation

process began in October 2019.

3 E

uropean Com

mission (2018)

8Freshw

ater risks & opportunities | 9

3. Water as a risk

4 O

rr, S. &

Pegram

, G. C

. (2014)

Water is a dynam

ic resource, varying in space and time (see Figure 1), and it is a shared

resourceamongstdifferenttypesofactors.Thescaleandnatureofw

aterriskexposurewilldifferdependingontw

okeyfactors:1)theasset’slocationdefinesthebasinwaterrisk

(e.g.,scarcity,floods,pollution)and2)theasset’simpactsanddependenciesonw

aterde-finetheoperationalw

aterrisk(e.g.,howwaterintensivetheoperationis). 4 D

epending on the natureoftheirbusiness,differentsectorsarem

ore,orless,exposedtowaterrisks. In addition

to heavy water users – such as the food, beverage, pow

er generation, or mining sectors – that

are highly exposed to basin water scarcity risks, those w

ho may consum

e less water but

pollute–suchasthetextilesorelectronicssectors–canalsofacesignificantwaterrisks

(e.g.,regulatorychangesonemissionsorcom

munityconflictsoverw

aterquality).Indeed,watercanaffectissuessuchaslogistics(e.g.,bargetraffi

c)forevennon-waterintensive

sectors,alongwithregulatoryandreputationalissues,w

hichcanmateriallyaffectprofits

and losses.

How

ever, water risk exposure (basin and operational) is only half of the story; w

ater risks have the potential to be m

anaged and mitigated. O

ften, businesses that are well-prepared

to face water risks can outperform

their competitors in locations w

ith high basin water risks.

These companies represent an excellent investm

ent opportunity, making risk exposure and

response information a crucial investm

ent quality measurem

ent for investors.

Water risk exposure (basin and operational) can be referred to as the inherent risks,

before responses are accounted for (also sometim

es referred to as controls), which results

in residual water risk, as illustrated in the w

ater risk-response framew

ork in Figure 2. A risk-response approach enables com

panies and investors to adopt a more nuanced

approach to water risk that optim

izes risk-reward value creation.

Water is dynam

ic in both time and space, m

eaning a regularly updated understanding of asset-level exposure to w

ater risks as well as response is critical to ascertain risk.

With grow

ing amounts of corporate w

ater disclosure data, we are beginning to gain

strongerinsightsintospecificallyhowwaterriskeventstriggerdifferenttypesoffinancial

impacts. First analysis show

s that the price of water m

ay be largely irrelevant to bottom

linefinancials,butwaterhasasignificantandm

aterialabilitytoaffectcostsandrevenues, makingthevalueofw

aterfarbeyondwhatcom

paniespayintermsoftariffs.O

perational interruptions, cost of goods sold, perm

itting delays, and decreased production are all exam

plesofbusinessimpactsthataredirectlyaffectedbyw

aterriskeventssuchasdroughts, floods,spills,policyshifts,andcom

munityw

aterconflicts.

It is high time that investors begin to recognize w

ater risks for what they are: a m

aterial issue thatneedstobeaccountedforinthedecisionm

akingofanymodernfinancialinstitution. 5

5 M

organ & O

rr (2015)

10Freshw

ater risks & opportunities | 11

Figure 2: WW

F Water R

isk Filter map of drought probability in

2019

Figure 1: WW

F Water R

isk Filter map of drought probability in

200

0

Water R

isk FilterD

rought frequency probability

Very Low R

isk

020

4060

Very High R

iskA

rid regions

80100%

Water R

isk FilterD

rought frequency probability

Very Low R

isk

020

4060

Very High R

iskA

rid regions

80100%

12Freshw

ater risks & opportunities | 13

Unpacking Value and Water Risk Assessingw

aterriskprioritiesisoneissuebutcalculatingthepotentialfinancialimpacts

of water risks is another. R

ecent years have seen a strong push to better understand how

waterriskscanim

pactfinancials,butchallengesremain.W

WF,incollaborationw

ith W

ater Foundry, and powered by CD

P, will soon launch the W

ater And ValuE (WAVE)

tool. WAVE w

ill draw upon W

ater Risk Filter data and com

bine it with high resolution

waterriskprobabilitydataanduserfinancialdatatom

odelhowwaterhastheabilityto

affectcashflowsform

aterialsites.Theproliferationoftoolsandapproachestoassigningfinancialnum

berstowaterrisksinrecentyearshasm

adeitincreasinglyimportantto

allowdifferentaudiencestofindtherighttoolforthejob.A

ccordingly,WWFhasjust

released the Valuing Water D

atabase in the Water R

isk Filter, which allow

s users to identify the best tool(s) for valuing w

ater depending upon their needs.

Figure 2: A w

ater risk-response fram

ework

W

ater risk event business im

pacts

!

Operational &

Maintenance

Expenditures

Adm

inistrative &C

ompliance

Expenditures

Capital

Expenditures

Financial &Shareholder costs

Revenue im

pacts

Financial Im

pactsC

ontrols (risk transfer or

acceptance)

Controls

(risk avoidance &

mitigation or

acceptance)

Residual

water risks

Inherentw

ater risks

Water risk mitigation

responses

Financial impact mitigation responses

Basin &

O

perational W

ater Risks

Basin &

O

perational W

ater Risks

Basin &

O

perational W

ater Risks

14Freshw

ater risks & opportunities | 15

For companies (and their investors) w

ho are truly astute, there is an opportunity to create new

serviceofferingsandproducts.Onesuchopportunityistolinkinstitutionalbrandsto

purpose–namely:strivingtoachieveSustainableD

evelopmentG

oal6onWater.Inturn,

this will create loyalty from

customers and provide an increasingly im

portant edge in attracting and retaining the next generation of w

orkers. In a world facing grow

ing challenges tow

aterresources,thosefocusingonsolvingtheworld’sw

aterchallengeshavesignificantgrow

th potential as investments.

Simplyput,w

ateroffersnumerousopportunitiestothefinancialsectortogrow

andprofit,w

hile simultaneously serving people and the planet.

4. Water as an opportunity

Climate change m

anifests itself in water; thus, those w

ho manage w

ater properly, will be

some of the m

ost resilient businesses and safest havens for both debt and equity. As such, w

ater is not simply an issue of risk, but also one of the largest opportunities for investors if

they take the time to understand it.From

actingasaforcethatwilldifferentiatecom

petitorsin w

ater stressed regions, to the opportunities that arise from the huge m

ulti-trillion dollar waterinfrastructurefinancinggapsalreadyfacingw

aterutilities,therearesignificantoppor-tunitiesforfinanciersw

hoarepayingattentiontowaterissues–opportunitiesthatareonly

likely to grow in the com

ing decades. Water investm

ents can rapidly pay back not just the price of w

ater, but also via energy and chemical savings, and increasing the service life of

capital assets.

Water is intricately connected w

ith food, energy, and urban issues. When w

ater is saved, so too is energy, generating considerable paybacks. Indeed, w

ater investments are often

overlooked,butcanoffergreatinvestmentopportunitiesforthosew

hoareastute.When

universal access to water is provided to w

omen and children, new

clients emerge. W

hen hydropow

er and water-hungry pow

er generation such as coal and nuclear is retired, oppor-tunitiestoinvestinsolarandw

indemerge.Cities,inparticular,w

illneedsignificantnew

investments to ensure their resilience in the face of clim

ate instability, which w

ill create a large dem

and for capital from investors.

16Freshw

ater risks & opportunities | 17

Such a limited approach provides skew

ed results and is largely disconnected from the true

materiality of these issues. N

ew approaches that better account for an array of basin w

ater risks, operational w

ater risks, and a more nuanced view

of responses would provide a m

uch m

ore accurate picture of the performance, risk, and opportunity of investm

ents. Given

the existence of freely available water risk tools, such as W

WF’s W

ater Risk Filter, W

RI’s

Aqueduct and WBCSD

’s India Water Tool, com

bined with the grow

ing availability of asset- level data, there is the capacity to close this gap. It should also be noted that like TCFD

carbon-transition scenarios, w

ater should be explored through a scenario lens. To date, ESG

dataprovidershavenotofferedmuchinthew

ayofscenariosinthewaterspace,nor

has TCFD dem

anded such approaches that look at the impact scenarios (largely borne out

through water).

Lack of regulatory approaches on water risk disclosure and reporting Regulatoryrequirem

entsforwaterriskdisclosureandreportingforfinancialinstitutions

arebroadlylacking.However,inthepastfew

years,centralbanksandfinancialmarket

regulators,especiallyinEurope,havebeguntoincreasetheireffortstoaddressrisks (e.g., w

ithin the Netw

ork on Greening the Financial System

) or in the space of integrated reporting.TheEU

Commissionissueditsactionplanforfinancingsustainablegrow

thinearly 2018, resulting in a num

ber of concrete legislative proposals with the potential to

significantlyimprovethegapsindisclosure.Theproposedregulationsaim

toaddressanum

ber of existing obstacles:

5. Overcoming obstacles to advance water in finance

Givenallthat’sbeenoutlinedinthisbriefing,w

hat’sholdingbackthefloodoffinanceforw

ater? Several issues:

The price focus Waterisstillperceivedasaveryinexpensive,oftenfree,resourceduetothefocusontariff

and imm

ediate cost. Understanding the true risk-inclusive cost and hence seeing the value

of water requires com

panies and investors to re-direct their focus.

Insufficient water literacy to see and seize opportunities Thefinancialsectorneedstobecom

emuchm

orewaterliteratetotrulyunderstandw

ater’svalue and the opportunity it brings. Access to clean drinking w

ater and sanitation (i.e., waterserviceproviders/utilities),im

provedefficiency,cleanerandcircularproduction,

urban urban resilience, and energy savings are all examples of the huge infrastructure

financingneedsinthefreshwaterspace.

Lack of meaningful transparency in Environmental, Social and Governance (ESG) data Current approaches to w

ater within m

ainstream ESG

data typically cover water risk and

response through singular values. Typically, basin water stress or scarcity is used as the

proxyforwaterriskexposure,w

hilecorporate-levelwateruseeffi

ciencyisusedastheproxy of w

ater risk response.

18Freshw

ater risks & opportunities | 19

6 Recommendations

6 W

WF (2018)

WW

F believes that the time is here to dem

and greater attention to water. W

ithout question, we

are facing crises in climate and biodiversity, but it is through freshw

ater that impacts of clim

ate change m

ost often manifest and it is freshw

ater biodiversity that is the canary in the coal mine

telling us of the troubles we have created. Freshw

ater species have declined by more than

83% since 1970 – m

ore than any other species type – telling us just how im

periled freshwater

resources are. 6 Freshwater is at a crisis point and w

ithout action, we w

ill soon see knock on effectsonfood,fiber,energy,andultim

atelybothsocietyandtheglobaleconomyw

iththe latteralreadybeingm

easurable.Withthisinm

ind,WWFiscallinguponthefinancialsectorto:

1)Ackn

owledgethevalueofw

aterandm

obilizefinancetoshiftbusin

ess throughim

provedinternalprocesses,governancestructures,andofferings.Weneedtonot

onlyshiftthewaybusinessisbeingdone,butw

ealsoneedtoincreasetheflowoffinance

tacklingwaterchallengesandseethisflow

gofrombillionstotrillions,andrapidly.Invest-

inginwatercancreatestrongreturnsforinvestors,w

hilesimultaneouslybenefittingboth

people and planet.

2) Request im

provements to the m

anner in which w

ater is handled by ESG

data providers –

we need m

ore standardized and nuanced approaches to evaluating water

risk and response that harness asset-level data, cover a broader array of basin risks,

• Address the lack of regulatory requirem

ents to identify and disclose substantial negative financialim

pactsoninvestmentportfolios,w

ithwaterasthenextfocusareaafterclim

ate.

• Ensurestandardisationandclassifi

cationofsustainabilityperformance.

This will be accom

plished via the EU taxonom

y for sustainability objectives, which focuses on the

weakness of current m

arkets to properly asses the environmental perform

ance of economic activ-

ities. As with disclosure requirem

ents, water is the next focus area to w

ork on until 2021 following

theclimatefocuseddiscussioninthefirstphase.H

avingclear,easytounderstandperformance

data will help m

arkets incorporate environmental perform

ance into capital allocation decisions.

• Clarify m

andates and duties: regulatory guidance on how to address environm

ental issues (includingprecautionaryprinciples)inm

eetingfiduciarydutieshaslonglackedclarity.Thepro-posed EU

action plan addresses this lack of clarity, as well as em

bedding additional clarity into ESG

-relatedrequirements.W

hiletheexactdetailsanddefinitionsonwater-relatedim

pactsareyettobedeveloped,thisprom

isestoimprovetheregulatoryaspectsofw

aterandfinance.

Furthermore, a num

ber of additional activities have been launched within the EU

on relevant areas in the investm

ent process. For instance, within ESG

risk disclosures with banks, there is a push

for impact transparency w

ith the client advisory process in the investment advice process. H

ope-fully, these em

erging trends are the leading edge of greater regulatory clarity around how w

ater can, and m

ust, be accounted for by both companies and investors given its im

pacts on both social andfinancialvalue.

20

accountforbothoperationalriskandresponse,andconsidermaterialityoffinancial

impactsunderdifferentscenarios.Inshort,w

eneedmeaningfulESG

datatohelpmobilizefinanceintherightdirectionsforw

ater.Inthisregard,wecalluponESG

dataproviders to w

ork with us and others to create m

ore meaningful, actionable, and consistent

information on w

ater for investors to harness in their decision making.

3) Urge regulators to strengthen w

ater-related disclosure requirements w

ithin mandatorydisclosuresforcom

paniesandrelevantfinancialinstitutions.Thedualimpact

perspective (outside in/inside out) should become the norm

. The EU should use the

upcomingreview

oftheNon-FinancialR

eportingDirectivetosignificantlytightenand

sharpen the water risk disclosure aspects of this directive. W

WF believes that scenario-

based reporting should be made an integral part of reporting requirem

ents. This could be linked to TCFD

-related disclosure requirements to ensure that w

ater risks are explicitly considered in clim

ate-related impacts. Publicly listed com

panies should be a major focus,

especially those who are m

aterially exposed to water-related clim

ate impacts due to

value chain geographies and operational nature. Furthermore, public institutions should

serve as front runners in disclosing water-related im

pacts, risks, and opportunities in existing portfolios from

a dual materiality perspective – both im

pact on the portfolio (financialrisk)andim

pactoftheportfolioonwaterresources.

22