The complex and localised nature of water and the mix of qualitative and quantitative information available makes it difficult for investors to integrate water risk data into their company analyses.
This section outlines some of the techniques that investors are using to integrate water data into listed equity analysis. Water integration through fundamental analysis and company valuations are related to stages one and two of the PRI integration model below. Stage four is relevant when using engagement data to inform and improve company analysis as well as to inform engagement.
The table below outlines the types of strategies investors are using to integrate water data. More information and detailed descriptions of the techniques can be found in Chapter 1 of A practical guide to ESG integration for listed equity, which illustrates how ESG integration is applied in practice.
|1. Qualitative ESG analysis||The identification of ESG issues that are likely to affect corporate performance and investment performance of a company. The analysis will often create a shortlist of material ESG issues and an ESG score for each company.||A. Integrating water stewardship – General Mills
B. Reducing portfolio water risk by assessing issue management
|2. Quantitative ESG analysis||The evaluation of the materiality of ESG factors through adjustment(s) to a company’s forecasted financial statements (revenue/operating costs/ operating margins/book value/Capex) and/or valuation model (terminal value/discount rate/portfolio weightings).||Managing water risks to mitigate community concerns|
|3. Sensitivity/scenario analysis||The evaluation of the materiality of ESG factors through applying different ESG scenarios that adjust a company’s forecasted financial statements (revenue/operating costs/operating margins/book value/Capex) and/or valuation model (terminal value/discount rate/portfolio weightings).||Applying the Corporate Credit Water Risk Tool|
|4. Engagement||Company engagement to obtain more information and understand the company’s water security, dependency and management of water risk.||A. Long-term engagement on water risk management in the supply chain
B. Investor collaboration to engage on water risks in agricultural supply chains
Investors seek water data for financial and ESG analysis as well as to understand a company’s risk exposure and approach to managing this.
Corporate disclosure provides data to investors. The level of disclosure can be used as a proxy for the company’s approach to governance and transparency. Currently, public data is used by data and research providers to create ESG scores, benchmarks and peer comparisons, sectoral analysis and individual company analysis. Investors are using these third-party datasets, analysis and estimations to supplement company analysis – in some cases as a positive or negative screening tool (for selection and exclusion).
Despite efforts by the industry, investors and the NGO community to standardise water data, there are still discrepancies in the way water data is reported and accounted for. Similarly, while data on company value affected by water risk issues is growing, there are no standardised formats to date.
Investors continue to request data through engagement to complement existing data and make the case to companies that investors do use the data in their analyses. Obtaining water data via engagement is also a way for investors to verify and improve current datasets from third parties due to the differing approaches that data providers take.
Data challenges and opportunities
While investors are integrating quantitative and qualitative water data, as shown by the case studies (see table), there are limits to the accuracy of the data available and whether this gives the full picture of a company’s value at risk. Coverage and granularity of data required remain a challenge for some investors and companies. However, as investors increasingly ask companies for water data, information quantity and quality may improve over time. This would allow for more quantitative portfolio-level analysis and scenario analysis (as recommended by the Task Force on Climate-Related Financial Disclosure) on climaterelated water risk.
However, recent developments including the emergence of data collection technologies could prompt additional collection and complement company reporting efforts. Technologies such as satellite and drone remote sensing could give companies a near-real time picture of their operations and suppliers. Remote sensing, combined with remote data loggers, could potentially facilitate companies’ understanding of dynamic crop water use and response. While these technologies show promise, their uptake among companies as of early 2018 is still at a very early stage, even among leading companies.
Financial valuation tools
|Shadow pricing||The assignment of a (water risk-adjusted) dollar value to an abstract commodity that is not ordinarily quantifiable as having a market price, but needs to be assigned a valuation to conduct a cost-benefit analysis.|
|Value at risk||Value at risk (VaR) is a statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over a specific time frame66.|
|Probabilistic value adjustment||The assignment of a risk-weighted dollar value modification to aspects of financial statements.|
|Financial impact disclosure||The actual (past) financial value impacted and driven by water-related factors as disclosed by companies to investors - typically via specialised disclosure initiatives or footnotes in annual financial reports.|
Some of the relevant tools that investors can use when assessing water risk in different sectors are shown in the table below.
|Tool||Audience (and target)||Methodology||Water risks||Developers||In their own words|
|Bloomberg Water Risk Valution Tool||Investors (extractive companies)||Shadow pricing (costs using shadow pricing based on TEV + Capex costs) and revenue of specific mine assets||Water scarcity||NCD (UNEP FI & GCP), Bloomberg, GIZ||“A practical, high-level demonstration tool that illustrates how water risk can be incorporated into company valuation in the mining sector using familiar financial modelling techniques.”|
|Columbia Water Center Water Risk Valuation Model||Investors (mining)||Probabilistic value adjustment (extensive model focused on water risks associated with mining, the causality between environmental factors and the financial performance of companies, and perspectives on legal and regulatory risks)||Extreme weather events, legal and regulatory water risks||Columbia Water Center, NBIM||“A modelling platform for quantitatively assessing environmental risks associated with mining and their financial implications.”|
|Corporate Bonds Water Credit Risk Tool||Investors (corporate bonds) Companies (beverages, mining and power utilities)||Shadow pricing (costs using shadow pricing based on water scarcity and population pressure to look at future Opex)||Water scarcity||NCD (UNEP FI & GCP)/GIZ/VfU)||“This tool for financial institutions to incorporate water risk in corporate bond credit risk analysis allows users to integrate water stress into company credit analysis.”|
|Drought Stress Testing Tool||Banks (for Brazil, China, Mexico and US to assess drought in 19 industry sectors)||Probabilistic value adjustment (event probabilities used to adjust disaggregated cost and revenue figures to adjust financial statements and credit rating)||Drought||NCFA – NCD (UNEP FI & GCP)/ RMS/GIZ||“Tool allows financial institutions to input their own high resolution loan data, and determine how drought scenario events change expected default rates.”|
|True Cost of Water Tool||Companies||Probabilistic value adjustment (user-driven estimates and likelihoods) Financial impact disclosure (direct costs such as capex and opex, plus indirect costs such as admin)||Operational, financial, regulatory and reputational water risk||Veolia||“A tool that combines traditional Capex and Opex calculations with analysis of water risks and their financial implications.”|
|Water Risk Filter – Valuation Module||Companies||Probabilistic value adjustment (user-driven estimates and likelihoods)||Physical, regulatory and reputational water risks||WWF||“A tool that draws on water risk assessment results to help identify relevant water risk events and financial impacts and thereby better understand and calculate potential water-related financial impacts.”|
|Water Risk Monetizer 2.0||Companies||Shadow pricing (costs adjusted via shadow pricing based on TEV + GWI data; quality impacts) Probabilistic value adjustment (revenue at risk)||Water scarcity, water quality, regulatory and reputational water risk||Ecolab, Trucost, Microsoft||“A publicly available online tool that provides actionable information to help businesses around the world understand the impact of water scarcity to their business and quantify those risks in financial terms to inform decisions that enable growth.”|
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Investor guide on water risks in agricultural supply chains
Growing water risk resilience: an investor guide on agricultural supply chains
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