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Asking the right questions on water risk

Investors need to intensify their due diligence and commitment to a whole range of water-related problems in addition to scarcity and pollution.

by Edoardo Borgomeo
05 March 2020
11 min read
byEdoardo Borgomeo
05 March 2020
11 min read

For many businesses and investors, 2020 started with a wake-up call. Larry Fink, the CEO of the world’s largest asset management firm BlackRock, signed his annual letter to chief executives urging them to act on climate. Fink’s message is clear: if businesses are to thrive under climate change, then environmental and social concerns need to be put on par with the quest for financial returns. And Fink is not alone. In the World Economic Forum’s Global Risks Report of 2020, the top five global risks in terms of likelihood are all environmental. These include extreme weather events, failure of climate change mitigation and major biodiversity collapse.

Among these top global risks, there is one which holds the dubious achievement of having been in the World Economic Forum’s list for ten years in a row: water. Since 2011, freshwater crises have remained among the top five most pressing issues of our time in terms of impact. This is concerning, because it means that over the past ten years little has been done by governments, but also investors and businesses, to mitigate water risk. It means that nothing is being done about a risk that we are all aware of. Why is that?

Perhaps the reason is that water has always been a source of risk for society, and so we feel that we can’t do much about it. From the Book of Genesis to the Shatapatha Brahmana, world religions are replete with myths of the great flood submerging everything. Even in language, water often acquires the meaning of a risk. The word rival comes from the Latin rivalis, which originally meant the person using the same stream as another. That person easily became an enemy, a competitor, a threat. And water appears to be a greater risk in times of climate change. Water will be the claws and teeth of climate change, now and in the future. The water risks that we face are numerous: floods, droughts, polluted rivers, drained wetlands, loss of freshwater biodiversity. 

It is out of the question that society today faces numerous water risks. However, this is not the reason why we are not doing enough about them. Perhaps the reason millions of people still die because of lack to safe access to water and sanitation and billions of dollars are lost to water risks is because we fail to ask the right questions. We try to predict when the next water crisis will be, without examining the conditions that lead to crisis in the first instance. We fail to see that the story of water is more hopeful. Water is not the new oil, and, in modern history states have not fought over water. Water is not just floods and droughts, it’s also food security and energy production. Successful water management is at heart of some of civilization’s greatest achievements, from public health to the marvels of Dutch polders.  

To make sure that water stops being a top global risk, we need to rethink the way we understand water risks. Through an improved understanding of water risks, we can work with water to create value, mitigate climate change and adapt to some of its inevitable impacts. This is particularly important for businesses and investors, as failure to understand and mitigate water risks can have costly consequences extending across supply chains. In 2011, massive floods and inadequate management responses in Thailand resulted in 884 deaths, 1.5 million homes and 7500 industrial plants damaged. The indirect damage to the global economy was massive: computer prices spiked owing to shortages of hard drives and motor vehicle production was similarly hit, with Toyota losing 2.3 billion dollars because of the interrupted production in its Thai factories.

What businesses typically do

To date, most businesses have focused on reporting their physical water risks and enhancing their operations to mitigate them. The most recent report from the CDP, who runs a global environmental disclosure system for businesses, looked at 296 large corporations and their water risk. Of these businesses, 75% reported only two water risks: water quantity and quality, that is, too little water, or dirty water. To address them, businesses enhance water use efficiency, augment their water treatment capacity and diversify their water supplies. 

Some businesses, however, don’t even bother with water risks.  In 2018, institutional investors invited some 1,536 of the world's largest publicly listed companies to disclose their water-related information through the Climate Disclosure Project. As the recent report Treading Water suggest, only about half responded and even fewer showed progress in monitoring and reducing their water use. Most businesses actually showed that their water consumption was increasing. There has been an almost 50% rise in the number of businesses reporting higher water withdrawals, including from energy companies who already account for more than 15% of freshwater withdrawals around the world.

As this experience shows, businesses’ understanding of water risks is incomplete. Despite reporting and target setting efforts, water risks are still underestimated and poorly accounted for by businesses and investors. The focus on reporting and disclosures is perhaps a distraction from the need to take a broader look at water and role of business in valuing it. It’s complicated, but there are ways to improve. There are four questions companies and investors should ask when it comes to water risk.

Four questions to ask about water risk

Mitigating water risks is not just thinking about the physical quantity and quality of water. Water risks arise when people’s access to water is compromised, or when the water needs of ecosystems are not guaranteed. So, the first question companies need to ask is: with whom are we sharing the water? Water is a shared resource, so companies need to consider the water context where they operate, what water scientists call the river basin. At the most basic level, this implies understanding not just one’s water risks, but also the risks faced by other actors in a river basin- and their ability to mitigate them. Trees, for example, can help mitigate water risks. In the State of New York, large forests are protected in order to provide clean water to New York City. This eliminated the need for a $10 billion water-treatment plant that would have cost $100 million per year to run. Hence it will no longer be sufficient to undertake water use efficiency and pollution reduction activities. Companies will have to align their targets with public policy, and demonstrate to investors how their activities contribute towards water security of other users in a river basin.

Developing a robust understanding of water risks is complex and will also require the use of new tools, metrics, and analytics. Climate change adds uncertainty to business and investment decisions, making traditional risk assessment approaches inappropriate for our times. So, investors and companies alike need to ask: what’s the best approach to quantify water risks and how can new data and models help? Traditionally, assessments of water risks are based on estimates of future water availability and needs. These estimates are based on past observations, which means that we look at how much rain or well water there was in the past and then assume that there will be as much in the future. Typically, this results in risk estimates under “normal” conditions. However, under climate change the future will be significantly different from anything imagined. We will have to leave more water in the rivers for aquatic ecosystems to thrive. We will have to deal with more erratic rainfall. Therefore, businesses need to expand their risk estimation procedures to take into account these changing patterns in the data and use all available information, not just past historical records. 

Advanced computational methods and visualization can help in this effort. These approaches can be used in conjunction with existing scenario analysis exercises carried out by companies to quantitatively understand impacts and responses. Water utilities already use these approaches to assess water risks to their business and to inform their investment planning. In London, for example, thousands to millions different scenarios of water quantity and quality were used to inform the city’s water utility infrastructure investment plans. These computer-simulation based approaches help utilities identify water risks – and robust options that can mitigate them. When it comes to assessing water risks, the knowledge and experience accumulated in the water sector can guide efforts in other business areas, notably energy and food. As these sectors gear up to understand their water risks, they need to tap into these advanced computer simulation techniques to improve the way in which they quantify risks.

More than numbers alone, the multiple values of water

Not all information relevant to understand water risk can be reduced to numbers. Water is embedded in social and cultural relations, water is sacred. In 2019, more than 100 million people gathered for the Kumbh Mela to bathe in the sacred waters at the confluence of the Ganges, the Yamuna and the Saraswati rivers. So, a third question relates to the importance of mapping the multiple values attached to water, and demonstrating ways in which business activities can protect – and in some cases enhance- these values. Across the world, we see unsustainable water abstraction. The draining of the Aral Sea is the most well-known example, but around the world more than 35% of our wetlands of lakes and swamps were lost due to over abstraction. These trends reflect that water’s environmental services are undervalued relative to other economic values. Yet, this failure to recognize the environmental services linked to water engenders greater water risks. Hence, the immateriality of water needs to become material to the reporting and disclosure efforts of companies, who need to clarify how their activities impact water’s multiple values, not just its ability to generate economic returns as a factor of production.

Finally, without internal controls, audit and board oversight, corporate water risk assessments and disclosures — whatever the standard or framework used — are not worth much. So, to understand water risks companies need to look at their internal processes, raise the profile of water issues in their agendas and request strong board oversight on water risks.

So current business actions on water risks are not enough. They fail investors, as they do not properly assess risks to business activities and returns. And they also fail society. When it comes to achieving the Sustainable Development Goal of clean water and sanitation for all, reporting water quantity and quality risks and optimizing water use in business operations alone will not do it. The world is nowhere near achieving this goal, and companies need to step up their effort if they are serious about their claims. For too long companies have got away with incomplete and dishonest reporting of sustainability issues including water that would not be tolerated in financial reporting. Investors need to step up their due diligence and engagement across a range of water issues, not just water scarcity and pollution. At the end, this will require putting more resources to understand and take action on water risks.


The author: Edoardo Borgomeo

Is a research at the Environmental Change Institute, University of Oxford. He works with UN agencies and development banks on strategies and projects to enhance water management and climate adaptation in low-income countries. His book: Oro Blu. Storie di acqua e cambiamento climatico has been published on February 2020 by Laterza.