Investors Say: Water Risk is Beyond Pricing

By Debra Tan 11 July, 2012

NBIM, APG, GIC, HSBC and APG on why the value of water lies in business continuity & value of brands

USD1.8 trillion of assets under management, now that’s a lot of money speaking about water risks in one morning session during Singapore International Water Week (SIWW). The seminar to discuss water and its related risks and opportunities was hosted by Anne Kvam, global head of ownership strategies of Norges Bank Investment Management (NBIM). The five strong panel speakers were APG, HSBC, GIC, NBIM and PGGM and moderated by Marcus Norton, the Head of Investor CDP and CDP Water Disclosure. As Anne Kvam pointed out in her round up, there was more talk about water risks than opportunities, with only GIC touching on different water segments for investing. Here’s what they had to say about risk…

“water needs to be a part of a company’s risk management policy and not independent of it”

“Water is local, but supply chain is global … just because where you operate is not facing water risk in terms of scarcity or pollution locally, doesn’t mean your supply chain is not exposed to it”

Professor Upmanu Lall, Director of the Columbia Water Center

Professor Upmanu Lall, Director of the Columbia Water Center and leading expert on hydroclimatoglogy, climate change adaptation and risk analysis and mitigation kicked off the session with his keynote speech. He set the stage by stating “water needs to be a part of a company’s risk management policy and not independent of it”. He notes that most companies only start looking at water risks because of reputation risk to the brand or when there is a possibility that it threatens the license to operate. This is a good start, but companies need to move beyond this to incorporate exogenous factors like supply chain risks. “Water is local, but supply chain is global”, he warns, “just because where you operate is not facing water risk in terms of scarcity or pollution locally, doesn’t mean your supply chain is not exposed to it”.

He urges mapping of the corporate supply chain over geographical and sector related water risks and cautions corporates and investors not to confuse this with CSR. Whilst CSR works to provide offsets locally so the company can continue to operate in that location, it does not address the underlying risk and therefore a short term fix. Mitigation of the risk may involve the moving of operations to ensure long term continuity. More research is required in order to make this decision. There is little data at the moment but it is not impossible to gather, but companies/investors have yet to invest in this.

Marcus Norton agrees; water is a relatively new issue: investors understand carbon more than water. CDP started in 2003 whereas CDP Water Disclosure only took off in 2010. Companies are starting to measure their risk and working towards standardized and meaningful disclosure of such risks for investors.

“misunderstanding is that price reflects the value of water, but really the value lies in business continuity and the value of brands.”

Marcus Norton, Head of Investor CDP and CDP Water Disclosure

He expects this to be a long and difficult road, much like running a marathon. But a marathon is too one dimensional. Marcus believes that understanding and mitigating water risks is like a triathlon with difficult and different segments. We are now at the ‘measuring part’of the triathlon, let alone looking beyond to exogenous factors to determine business continuity that Lall mentioned.

Although, this “measuring part” may take time and there will be gaps in data, it is important to keep moving as the “misunderstanding is that price reflects the value of water, but really the value lies in business continuity and the value of brands.”

NBIM, is not new to water either. As the manager of a USD600 billion Norway Government Pension Fund Global, NBIM wants to invest in companies that will be around for a long time. NBIM is one of the lead sponsors of CDP Water Disclosure and water management is one of its cornerstone investment polices.

“water is multifaceted – it impacts and is impacted by population, the economy, climate, pollution and environment and could cost a company its license to operate and at the same time throw out investment opportunities”

Loic Dujardin, Senior Analyst Ownership Policy, NBIM

Loic Dujardin, the senior analyst in ownership policy, explains the reason for this focus: “water is multifaceted – it impacts and is impacted by population, the economy, climate, pollution and environment and could cost a company its license to operate and at the same time throw out investment opportunities”. Risks he worries about the most include compensation for an environmental incident, suspension of operations, new regulations cost, rise in insurance premiums and new capex. Industries of particular focus are water utilities, power, metals & mining, forestry & paper, pharmaceuticals and the F&B sectors.

As a result, NBIM has worked to gather water data on 447 companies in its investment portfolios across these six sectors as part of their Sector Compliance Report. NBIM would like to see a move by corporates to form clear water management strategies, implement sustainable water management practices and good governance structure from board-level involvement, to clear reporting lines and targets.

PGGM’s Piet Klop is also a water expert; he was previously at the World Resources Institute and how leads PGGM’s engagement with companies in the Food, Utility and Chemical sectors, as well as on the cross-sectoral theme of water risk. He weighs in on the price-is-not-the-key-driver-of-water-risk argument.

“Impact on the environment is important but so is impact of the environment on the business”

“being efficient in using water does not necessary mean being secure”

“Quantifying water risk will be complex but there is no other alternative; just because it is complex doesn’t mean we don’t try get there”

Piet Klop, Senior Advisor Responsible Investment, PGGM

For Klop, key water risks are security, cost of compliance and business continuity. All three are not financial risks, but neither are they “environmentally fuzzy” risks. They have massive implications on businesses. “Impact on the environment is important but so is impact of the environment on the business”.

He notes that whilst measurement is useful in allowing us to improve in water use, “being efficient in using water does not necessary mean being secure”. He uses the power sector to highlight his point, power plants could be water efficient by using a close-looped system for cooling but they could still be at risk of having no water at all. He highlights that the impact of the environment on business is harder to quantify and yet there is less research/ information to help form decisions.

That said, he caveats his appeal for data, “whilst data is important, data without context gets lost.” He wishes for a simple metric/ multiple like water use/water security to be readily available on Bloomberg/Reuters with the push of a button. (Don’t we all!)

Nevertheless, he still thinks information is the way to go in mitigating water risk. “Quantifying water risk will be complex but there is no other alternative; just because it is complex doesn’t mean we don’t try get there”.

So is everyone starting to formally evaluate water risks?

Enter GIC, the government of Singapore’s investment management company. Yong Chye Lee, their global macro portfolio manager starts of by admitting that GIC is at a “grassroots level” in water risks compared with NBIM and PGGM. “To be honest, we have yet to incorporate a formal water risk valuation mechanism into our analysis or investment process but we are studying this now”. He talked about opportunities instead.

“To be honest, we have yet to incorporate a formal water risk valuation mechanism into our analysis or investment process but we are studying this now”

Yong Chye Lee, Global Macro Portfolio Manager, GIC

He highlights that water innovation is key. He noted that Citi has estimated the market for global water subsectors to be worth USD450 million. That said, he cautioned that the industry players are extremely fragmented and it is therefore difficult for innovators to reach critical mass. Resistance of public authorities to private sector investment could also be a dampener. The other key stumbling block for new technology is a point in common with the other institutional funds: water is mispriced. Unfortunately, in areas which need water, the price often does not allow for installation of water technology to address the shortage. He added that Singapore through its Economic Development Board (EDB) and Public Utilities Board (PUB) is trying to help water innovators commercialise as part of Singapore’s drive to be a global hydrohub. (Read our interview with EDB here.) SIWW is exactly that, bringing people together from around the world to have a conversation on water.

Xavier Desmadryl is the Global Head of ESG Research and PRI of HSBC Global Asset Management with assets managed at around US$400 billion at his last count. He didn’t talk about opportunities in water but gave us an insight into how HSBC selects its stocks. Whilst water is factored into the decision making process, it is not the only parameter. As Desmadryl says, “water is one part of the ESG equation”.

“water is one part of the ESG equation”

Xavier Desmadryl, Global Head of ESG Research and PRI, HSBC Global Asset Management

HSBC is a bottom up stock picker but it is not just about the Return on Equity (ROE), is it also about the sustainability of profits. He used shale gas as an example. Many believe shale gas could be a game changer but Xavier wants to know if its high ROE will last. Will water which is essential in its extraction process through hydraulic fracturing (or fracking as it is commonly known) be a constraint, could other related issues like pollution threaten its license to operate.

Outside of asset management, HSBC Holdings is also worried about water. At the group level, HSBC recently commissioned a report exploring the link between water and economic growth from Frontier Research, which showed that fresh water supplies are under pressure. The case was so compelling that HSBC recently set aside USD100 million to secure access to safe drinking water and water protection projects around the world.

Yoo-Kyung Park, the senior Investment Advisor at APG, which manages over 30% of all collective pension schemes in the Netherlands, wrapped up the session. With an AUM of just under USD400 billion, Park says the most difficult question is what to do with your investment when an ESG assessment is below par. She asks “do you divest or engage the company to adopt policies that would mitigate water risk and ensure business and brand continuity?”

“do you divest or engage the company to adopt policies that would mitigate water risk and ensure business and brand continuity?”

Yoo-Kyung Park, Senior Investment Advisor, APG

Here, she makes a plea for collaboration between like-minded institutional investors to club together for more leverage. But she notes that this is a luxury for liquid investments only because if stakeholder engagement fails, the risk is removed by ‘dumping the stock’. However, in cases where APG invests directly in a project (usually of an infrastructure/real estate nature) a negative fallout event, like water contamination, could damage APG’s name indefinitely. So in such illiquid investments, ESG assessment is particularly stringent. She laments that despite such significant risk, there is a lack of standard mechanisms in place to assess the risk and engage companies.

In agreement with Piet that these risks need to be benchmarked, YK said institutional real estate investors formed the Global Real Estate Sustainability Benchmark (GRESB) in 2009. GRESB is now used by institutional investors to engage with their investments with the aim to improve the sustainability performance of their investment portfolio, and the global property sector at large. YK would of course like to see more GRESB’s formed for each sector alongside more active collaboration between funds on stakeholder engagement. We couldn’t agree more! We are of course happy to participate – contact us if you are interested.

It appears that they all singing from the same song sheet – “Water Risk is Beyond Pricing”. This coincides with what we have been saying too. Not surprising then that all these funds read and subscribe to China Water Risk. Piet Klop of PGGM told us over coffee that chinawaterrisk.org is his new favourite website. We are raising this not to sing our praises but rather to illustrate the interest/ concerns over water issues in China affecting value. Corporates and financial institutions are concerned; otherwise HSBC’s Head of Global Banking, Asia-Pacific would not have hosted a Water Risk Forum for us on the day our site went live on 27 October 2011 and Asia Bamboo, a company listed in Germany and operating in China presenting later that morning would not have used our Big Picture infographics in their presentation. The fact that we have also been invited to present/participate at investor conferences as well as to corporates and global brands, just points to the lack of information that is out there on water risks in China (let alone info arranged by sector), which was the impetus for CWR in the first place.

“we may not have all the answers but the fact that we are talking about it is significant in itself”

Marcus Norton, Head of Investor CDP and CDP Water Disclosure

“there is no one-size-fits-all strategy that a company may use to manage water resources across all its operations”

Anne Kvam, Global Head of Ownership Strategies, NBIM

Asia is usually a few steps behind Europe. However with water, we are more water-scarce with China and India facing water crises. So although we may have just started the water triathlon, we have an opportunity to leap frog ahead. The urgent need to address the crisis with new pollution targets and quotas set by China’s central government bring new risks to businesses and investors in China and the global supply chain. Anne Kvam sums this up well: “there is no one-size-fits-all strategy that a company may use to manage water resources across all its operations”. But as Marcus Norton says, “we may not have all the answers but the fact that we are talking about it is significant in itself”.

We are here to help companies and investors understand and mitigate China’s water risk: to look beyond price, fill-in-the-gaps in information, host roundtable discussions and seminars for corporates and investors. Basically, we want to swim, cycle and run this whole water triathlon and by the looks of the morning session, so does this pool of investors worth USD 1.8 trillion.