Hot Take: Why Companies Will Focus More on Water Sustainability (not quantity/quality related)
We should expect to see corporations, particularly publicly traded companies, focus more on water sustainability in the coming years. Here are 3 reasons why...
1. Sustainability & the Disappearance of Low Hanging Fruit
Corporations that aim to achieve or maintain their position on sustainability indices (such as the Dow Jones Sustainability Index) must go through an annual assessment. It's not enough to set and achieve a few meager goals. Companies are held to a continuous improvement standard; they must demonstrate they are setting and working toward new targets as they achieve and move beyond old goals.
What I believe we're seeing now is that corporations with more mature sustainability programs have already picked off the "low hanging fruit."
Solid Waste as 1 example: Consider the multitude of companies that have achieved 'zero waste to landfill' at multiple manufacturing sites, including Nestle (at 23 factories), Subaru (celebrating 10 years of zero waste manufacturing), and Procter and Gamble (at 45 factories). Once they are operating sustainably in such a category, what might they move to next?
As we see companies sustainability programs mature, I believe we will begin see more focus on the seemingly more difficult to tackle issues, like water.
2. The Financial Community Interest in Water
In the context of water sustainability for corporations, water risk is inextricably linked to climate risk. Climate change is expected to increase rainfall in some places (read flooding) and decrease it in others (potential for groundwater depletion). It's expected to increase drought in some regions, meaning the potential for an increase in water competition and decrease in both quantity and quality access. And even if a facility you're considering right now is somehow not impacted by these things, it's likely that its suppliers will be.
Two reports have been published recently that underscore the financial community's growing interest in understanding corporation's climate and (therefore) water risk. I will highlight what I think is poignant but of course recommend reviewing them for yourself.
The Fitch Report on Water Risk and Sovereign Ratings
Fitch Ratings is one of the three nationally recognized statistical rating organizations designated by the U.S. Securities and Exchange Commission, or SEC. They published a report titled “The Fitch Report on Water Risk and Sovereign Ratings”, which features their take on the ratings of countries. This is indirectly relevant to water sustainability in the private sector because of where companies may have operations, manufacturing, or suppliers.
Context: Water demand has grown by about 250% from 1960 to 2014 and it continues to rise by about 1% per year. The increase in demand is attributed to economic development, increased urbanization, and rising income levels and its associated change of consumer demands. Approximately half of the increase was from an increase in irrigation, directly related to the demand for water intensive goods, such as meat consumption and natural fiber garments.
The World Bank has stated that - should we fail to make global strides in water efficiency gains, water demand is expected to exceed available reliable supply by more than 50% in fast-growing, developing countries (those that are home to 1/3rd of world population) in 2030.
Key Report Highlights
Water scarcity or extreme water events (like droughts and floods), can have consequences for groups' livelihoods, health, food security, economic growth, public finances, and social stability. Put another way, there is an intersection of climate, demographic, economic and political risks, with implications for creditworthiness and sovereign ratings
Sovereign credit ratings can give investors insights into risk associated with investing in a country. Obtaining a good sovereign credit rating is usually essential for developing countries that want access to funding in international bond markets.
The report explicitly states that water risk is expected to become rating driver, particularly with anticipated increase in consequences from climate change.
The report predicts that an increasingly uneven global distribution of water resources will alter production specialization and structure across the world. There may be a decreased ability to extract hydrocarbons in water stressed regions. There is an anticipated decrease in ability to produce electricity, cascading impacts to industries, such as manufacturing.
With an expected decrease in electricity supply, risk of disruptions to production and welfare loss may rise. This will come with associated increase in electricity costs, potentially meaning less profitable manufacturing and decreasing spending power of individual households.
So, the Fitch report drew links between a country’s financial risks and its geographic based
water risks, particularly in light of climate change. The next report hits closer to home.
Managing Climate Risk in the US Financial System
The Commodity Futures Trading Commission (CFTC) is an independent agency of the US government created in 1974. It oversees the derivatives markets by encouraging competitiveness and efficiency, ensuring their integrity, protecting market participants against manipulation, abusive trading practices, fraud, and ensuring the financial integrity of clearing processes.
The CFTC committee for Market Risk Advisory advises the Commission on stuff relating to evolving market structures and movement of risk (across clearinghouses, exchanges, intermediaries, end-users and the like). It examines issues that threaten the stability of markets, and makes recommendations on how to improve market structure and mitigate risk.
One of the Market Risk Advisory subcommittees is focused on Climate Related Market Risk. It’s this subcommittee that produced a 200 page report published in 2020 titled "Managing Climate Risk in the US Financial System". Read the report here; read a Harvard Law school synopsis here.
Context: The intent of this report was to make the financial community aware, or perhaps to reiterate, that most markets are subject to climate change risks and that investors, as well as people with fiduciary responsibilities, need to consider this seriously. The report identifies individual impacts and numerous cascading risks to markets and their players.
Here's an important piece I want to convey verbatim.
“There are open questions about the extent to which officers, directors and other fiduciaries may be violating fiduciary duties by investing in, or failing to disinvest in, various carbon-intensive or otherwise highly exposed assets, companies, and industries (Gary, 2019). A second challenge arises from uncertain legal liability for public and private sector actors who fail to adequately disclose material physical risks on debt offerings and other contracts (Keenan, 2018). For public entities, a broader range of legal liabilities relate to limits on sovereign immunity arising from negligent mismanagement of physical risks (Klein, 2015). Finally, professionals such as, architects, engineers, and corporate directors face significant questions about the consideration of climate change risks and their duty of care (Hill and Martinez-Diaz, 2019).”
The subcommittee is suggesting ethical implications for many players within the system, not just the company itself, but advisors who make recommendations for investing in such entities.
Let's hone in on a company's materiality disclosure responsibilities for a moment. The SEC states, "companies are prohibited from omitting material information that is needed to make the disclosure not misleading.” This essentially means (publicly traded) companies must disclose things that are 'materially' important to their operations. Put another way, if a thing, such as a raw substance, is critical to making the company’s product and there is risk the company can’t get that substance, they must disclose the materiality of the substance to their operations in the 10-K.
We see this on the water front for companies like Coca-Cola (see page 8 under Raw Materials). Coca-Cola directly discloses in their 10-K that reliable water supply is materially critical to their operations and long-term success.
While not all companies are manufacturing water based products most (dare I say all) are critically dependent on water (for cooling, high-purity applications, rinsing, washing, sanitizing, etc.)
The materiality of water is becoming more widely understood by investors. We can see companies' interest in getting ahead of the water management curve by engaging with entities such as the Alliance for Water Stewardship, and its standard for water stewardship in the industrial setting.
Key Report Highlights
Climate change risks to the U.S. financial system include:
Disorderly price adjustments in various asset classes, with possible spillovers into different parts of the financial system.
Disruption of the proper functioning of financial markets.
The process of combating climate change itself—which (in their words) "demands a large-scale transition to a net-zero emissions economy"— will itself pose risks to the financial system if market participants do not or cannot adapt to the rapid changes in policy, technology, and consumer preferences anticipated.
Financial system stress may further exacerbate economic disruptions, for example, by limiting the availability of credit, or reducing access to certain financial products, like hedging instruments and insurance.
Degradation in lifecycle performance is expected to compromise long-term earnings and creditworthiness of "revenue-producing assets" in the private and public sectors.
The bottom line is this: investors are interested in understanding climate change risks and for companies to disclose these risks. Regulatory entities (financial) have this squarely on their radar. The industry currently lacks appropriate guidance and rules for water and climate risk disclosure. Still, the trend is moving towards greater risk disclosure.
3. A Water Consultant View: Water as the Next "Energy"
At the anecdotal level, and beyond our immediate clients seeking ways to reuse industrial water, we are seeing our energy efficiency partners coming to us with opportunities to engage with their clients on water sustainability. This indicates that corporations that have invested in and achieved goals related to energy and carbon are looking for what's next. And they're exploring investing in their water management to move the needle in their ongoing sustainability journey.
There are direct water sustainability challenges we hear about often: water quantity access, degradation of water quality, and increasing regulations for emerging contaminants, like PFAS. Here, I highlight a few other potential drivers for companies' future investment in water sustainability.
To summarize, I'm anticipating a rise in focus and investment in corporate water risk mitigation and sustainability efforts because:
Much of the low hanging sustainability fruits have been picked.
The financial and investor community is demanding greater disclosure in areas related to water materiality and water and climate related risks.
Corporations with mature sustainability programs have made great strides in carbon/energy related goals and are now leaning into water as the next challenge.
If you represent a corporation seeking to understand your water risk or improve your water sustainability, the Carollo Engineers' Private Sector Group can help. Contact us to set up an exploratory conversation.
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