Over the past decade, CDP has driven action on water amongst the world’s largest, most impactful companies through the corporate water questionnaire. This evidence flows to a range of stakeholders including financial institutions (FIs) so that they are able to see how companies are addressing water risks and identifying water opportunities within their growth strategies.
For the first time ever, we bring the financial sector water disclosure results. They represent a performance baseline for increasing ambition amongst FIs to value water appropriately.
Financial institutions were invited to disclose to CDP on water for the first time in 2022.
These FIs are early adopters in water disclosure. We are shining a light on the actions they are taking, encouraging them to continue and compelling others to join in.
Our economy depends on water, so water risks are material to business and to financial institutions. 17 countries withdraw more than 80% of their available supply every year. Climate and environmental risks are the core focus of global risks perceptions over the next decade – and are the risks for which we are seen to be the least prepared.
The Network for Greening the Financial System (NGFS), the group of 108 central banks focused on climate and environmental risk management, has released reports on the materiality of nature to FIs. They are of the view that nature-related risks could have significant macroeconomic implications, and that failure to account for, mitigate, and adapt to these implications is a source of risks for individual financial institutions as well as for financial stability. Storms, floods, and droughts could cause economic losses of US$5.6 trillion by 2050. CISL studies using scenario analysis show that the credit rating of some East Asian heavy industry companies in areas of high water stress declined from investment to speculative grade if water is temporary curtailed. They also mapped nature-related risk exposure across a portfolio and found that of all the services provided by nature, water is the most important across the MSCI Inc. World Index (a proxy representation for the global economy) for companies in resource intensive industries such as agriculture, beverages, utilities, energy, and mining. There are already US$15 billion of assets stranded or at risks in the energy and mining sectors due to water risks. The global financing needs estimated for achieving SDG6 are US$1 trillion, equivalent to 1.21% of global gross product.
Nearly two-thirds of the world’s people are expected to live under water-stressed conditions by 2025, impacting levels of disease, food production, and other basic quality measures. Safe water infrastructure is a fundamental component of economic health. Research on water in the west of the USA revealed the requirement for a strategy that makes water infrastructure a higher priority in the USA and for international investment, with lessons learned shared across borders. There is an imperative globally for public and non-public sources of capital to be as coordinated as possible.
It is important that FIs address both materiality lenses by assessing not only the risks that water insecurity poses to their business, but also the impact FIs have on water security through their portfolio activities. “The TNFD framework will require organisations to implement a double materiality reporting perspective, where they disclose how nature is impacting the organisation, positively or negatively, and how the organisation impacts the natural world”. Disclosing wider risks and impacts can kickstart standardization and data transparency and reduce the risk of being exposed to greenwashing. In turn, finance can more credibly deploy capital towards nature positive activities.
The largest financial institutions are universal owners, and with exposure to every sector of the economy have a critical impact on water in various ways. On one hand, FIs exposed to water risks will need to call for stronger regulation from governments and policymakers and seek action from the companies in their portfolio to become water secure. On the other hand, FIs are polluting and destroying water systems through the business activities they finance and enable. The impact that financial institutions have on water, both environmentally and ecologically, has an economic cost for society at large, which leads to social inequality and a financial burden for taxpayers. Therefore, financial institutions have a shared responsibility for avoiding and/or mitigating adverse impacts, with disclosure and action increasingly expected from them. Tools such as CDP’s Water Watch Index and CERES’s global assessment of private sector impacts on water can support their assessments.
The message is clear. Achieving a water secure future will require a complete transformation of our global economy. The financial sector has a critical role in catalyzing this change. It can offer unique, systemic incentives for change by ensuring their investment, insurance, lending, and underwriting practices drive industrial water users to use water wisely.
Financial institutions must now move to identify, assess, and manage risks and opportunities across their portfolios. They need to act via engaging with their investees/ clients, develop ambitious targets, build governance structures, and align their investment with water crisis solutions. Disclosure is an important step in achieving this.
In its first year, of the 1,226 FIs invited to disclose, 556 responded for climate (45%) and 275 responded comprehensive water data, corresponding to a 22% water-related disclosure rate amongst the most impactful disclosers.
CDP divides the FIs into three primary activities. Additionally, disclosures cover the four portfolio activities making up core segments in the finance sector. Many financial institutions undertake more than one portfolio activity.
Water disclosures cover all six continents with 45 countries represented and a total market cap of US$3.7 trillion.
As noted above, it is increasingly clear that the impact companies are having on freshwater resources is a cost to society and something that they, and in turn their financiers, should have an interest in and a responsibility to address. Companies and their financiers should therefore assess their own water-related impacts as well as the financial materiality of water-related risks. Disclosing from both these angles and taking into account any interactions between them is necessary for comprehensive sustainability reporting, which provides a foundation for addressing freshwater risk at large.
40 FIs responded that they currently measure their portfolio impact on water security.
Primary reasons for currently not measuring portfolio impact on water security were:
It appears that banks are being supported and/or are implementing portfolio impact analysis tools more broadly than investors and insurers, according to this CDP 2022 survey. Regulatory pressure on banks may be influencing their progress. Methodologies to support banks such as ‘portfolio impact analysis tools for banks’ designed by the Principles for responsible banking (PRB) are being used by Piraeus Financial Holdings S.A; while the ‘UNEP FI Impact tool on responsible banking’ is being used by Banco Pichincha Ca, Raiffeisen Bank International AG and T.SINAİ KALKINMA BANKASI A.Ş.
Institutional investing 2022 research from Mercer on 71 participants found that 92% stated that water was important. However, water trails behind other ESG themes and investment priorities. Key gaps and challenges found included:
Financial institutions are establishing processes for water-related risk assessments. 93 FIs assessed their portfolio's exposure to water-related risks and opportunities. Of these, banks appeared to be the largest users of both qualitative and quantitative information (ie water policy, water volumes, WASH access), followed by investors (asset managers). The top processes in which water-related information was obtained were directly from the client/ investees and public data sources.
Of those not responding, reasons for not doing so yet or planning to do it soon included:
TNFD is looking into at scenario analysis, and water risks - being one of the nature realms - will be included. Countries such as UK FCA are driving TCFD reporting for FIs with scenario analysis a key part of this. 38 FIs are carrying out scenario analysis. The majority of those who conduct such analysis (29) report to have identified outcomes. FIs used more than one type of scenario analysis, with climate-related scenario analysis being the most widely used as expected (64% of 57 mentions). The analysis shows that if more FIs are to carry out scenario analysis and use methods tailored to water (ie water-focused scenario analysis), the financial sector would have a better understanding of the future risks and opportunities and will be able to make better informed decisions.
Used climate-related and water-related scenarios. Leveraging an Al-driven tool, GBL has been assessing the exposure of its investee companies to land-use change. An asset with a potential water-related risk was identified. The outcome has been integrated in GBL’s annual ESG risk review. Further analysis has been commissioned on the asset potentially exposed to water risk and the results will be shared with the investee company.
Garanti BBVA - used climate-related and water-related scenarios. This study offers a multifaceted view of physical risk exposure by sector and location, which can be tailored to the needs of specific risk assessments and implemented on broader portfolio risk. There are a total of 166 power plant projects supported by Garanti BBVA since 2007. The results show half of the projects are in the medium to very high-risk range. Garanti BBVA published its Climate Change Action Plan in October 2015, which focuses on carbon pricing, reducing deforestation, managing climate-related water risks and implementing green office standards.
48 responding FIs (18%) identified water-related risks in their portfolio with the potential to have a substantive financial or strategic impact on their business with banks leading in responses likely due to the comprehensiveness of their assessments and being requested to disclose the most.
The top water risk drivers were physical and regulatory, while the top reported financial service industry risks that had the potential to be realized were credit risk, market risk and reputational risk. The majority of FIs (70%) considered the time of realization of water risks to be short or medium term, while over half of FIs (55%) indicated that water risks had a potential high likelihood of occurring.
The maximum potential impact due to water risks from 22 FIs was US$6.4 billion while the cost of response from 20 FIs was US$85 million.
On the other hand, CDP 2020 data shows that companies assessed the maximum potential impact due to water risks at US$301 billion. These baseline financial impact assessments of water risks by FIs compared with those from companies demonstrate that more FIs should undertake these assessments to limit blind spots and mitigate their risks.
Despite the small sample of FIs reporting potential financial impact of water risks (14 banks at US$4.6 billion, four insurers at US$1.1 billion and four asset managers at US$0.7 billion); the most significant impacts reported arose from physical water risks driving increased insurance costs, increased credit risks and decreased revenues from reduced production capacity.
Technology risks drove the ‘devaluation of collateral / potential for stranded assets’ at US$1 billion for one bank.
Insurers, despite being under-represented in carrying out water risks assessments, reported significant potential financial impacts demonstrating their need to disclose these risks.
The cost of response as given by 20 FIs (including 15 banks, three asset managers and two insurers) was US$85 million, with market risk and operational risk covering the majority at US$55 million. For instance, to mitigate the ‘increased in direct costs’ (ie ‘operational risk’), Momentum Metropolitan Holdings Ltd has invested US$27 million in the installation of efficient energy and water technologies in the buildings under its management (eg smart metering, water harvesting, energy efficient chillers and lighting).
Financial institutions are starting to become aware of key opportunities. 56 responding FIs (21%) have identified water-related opportunities in their portfolio with the potential to have a substantive financial or strategic impact on their business. Within these, 27 FIs found these opportunities in the 'Development and/or expansion of financing products and solutions supporting water security’. Responders included 16 banks (including Barclays, BBVA, National Australia Bank and Piraeus Financial Holdings S.A.), seven asset managers (including Schroders and Pictet Group) and four insurers (including CNP Insurances).
The maximum potential value of opportunities from 23 FIs was US$203 billion while the potential cost to realize these opportunities from 21 FIs was US$620 million.
14 banks disclosed the largest maximum value of opportunities at US$202 billion, followed by five asset managers at US$0.8 billion and four insurers at US$0.5 billion.
21 FIs indicated they could put a value to the cost of realizing these opportunities, including 13 banks, six asset managers and two insurers.
Out of the total estimate of US$620 million, ‘Groupe Bruxelles Lambert SA’ solely accounted for the largest (87%) investment due to the ‘development and/or expansion of financing products and solutions supporting water security’. This corresponded to the acquisition in Dec 2021 of a minority stake in GEA, a global technology leader in the processing industries, recognized for the provision of water-related opportunities.
Encouragingly, 42 of responding FIs indicated a high likelihood that these opportunities will take place.
96 FIs take risks and opportunities into consideration in their strategy and/or financial planning. Of these, banks comprised the highest proportion of responders (60%), which appears in alignment with their actions on assessing risks and identify opportunities including increases in revenues from products and services, presented earlier. Regionally, European-based FIs lead the way followed by Asian-based FIs, and this may be due to increase pressure from regulators. It is encouraging to see that the knowledge base that these FIs appear to be gaining is being translated into their organization’s long-term strategies.
Governance structures that drive finance and resources towards water security by enabling accountability and incentives to achieve them is an overarching first step. The role of the board of directors and their ability to oversee water-related risks is therefore essential.
118 FIs indicated they have board level oversight of water issues. Of these, 33% indicated that they have at least one board member with competence on water-related issues. This is commendable given that they are first time responders on water and as such as are putting in place the foundations for leadership.
Regionally, European-based FIs appear to lead the way in setting governance structures followed by Asian-based FIs.
Nonetheless, most boards should account for more adequate time and attention to water-related issues since currently they are brought to light mostly ‘as important matters arise’.
97 FIs have existing products and services enabling their clients to mitigate water insecurity. The top product types offered were ‘corporate loans’ and ‘listed equity’, while the top activities financed, invested, or insured by responding FIs related to water infrastructure. 46% of responding FIs (38 out 83) currently use their ‘own internally classified methodology’ to classify their products, which appears to emphasize the gaps that exist in supporting them with guidance and standardized methodologies.
Corporate loans (Green bond principles (ICMA) classification): It has a target to execute JPY 20 trillion of green finance by 2030. Activities financed include flood/drought resilience, WASH services, wastewater treatment infrastructure, sewer networks, etc. Portfolio value at US$68 billion. These products account for 9% of total portfolio value.
Private equity (internally classified product): AXA, Unilever and Tikehau Capital created a private equity impact fund dedicated for regenerative agriculture transition with a target size of €1 billion. Core areas include preservation of water resources and soil health, and fighting climate change.
Project finance (internally classified): NAB provides project finance to water-related initiatives that address water security. In FY2021, NAB provided finance to six water-related projects that included desalination plants, irrigation schemes and wastewater treatment plants. These were in Australia, New Zealand and South America. Portfolio value at US$300.6 million, and % of total portfolio value of 2% is given as a proportion of the total project finance portfolio for NAB as reported for Equator Principles as of 30 September 2021.
Mutual funds (externally classified): AG Life Equity Aqua Fund (valued at US$416 million) focuses on a specific type of investments in water infrastructure, water treatment and water utilities. This fund qualifies under article 9 of the SFRD and attracts a specific profile of Life clients.
Currently, although 73% of 264 FIs responding to this metric do not set water-related requirements that their clients/ investees need to meet, a group of 72 firms do.
Regionally, European-based FIs appear to lead the way in formulating their internal policies, as noted in their state of governance earlier with higher levels of board oversight in that region, potentially reflecting the state of development of regulations in that region. This aspect requires further investigation.
Of those responding to this metric, banks (64%) included water-related requirements the most, followed by asset managers (19%).
Over half (59% out of 99) of responding FIs required their clients/investees to comply with their policy criteria as a prerequisite for doing business. These FIs appear to be the first movers, leading the way in valuing water by communicating their expectations to their clients/ investees.
Credit / lending policy, publicly available, 100% portfolio coverage: Complying with criteria is a prerequisite to business. Covers certain energy sectors involved in water-intensive practices, including hydraulic fracturing and oil sands activities. Barclays climate change statement includes water-related consideration as part of client enhanced due diligence (EDD).
Credit / lending policy, 100% portfolio coverage, publicly available: complying with criteria is a prerequisite to business. Commit to WASH in workplace, comply with all applicable water regulations, disclose water-related information publicly. Set targets for reduction in water withdrawals and water pollution.
Investment policy/ strategy, agriculture sector policy, publicly available: complying with criteria is a prerequisite to business. Comply with all applicable water regulations, engage/ support their suppliers to minimize negative water impacts, monitor and reduce water withdrawals and consumption, and reduce/eliminate water pollution.
If BNP Paribas is aware that a client operates outside the requirements of the policy, a dialogue will be engaged with the client in order to find an acceptable solution to improve the situation in a timely manner. If this dialogue is unfruitful, BNP Paribas may decide not to pursue any new business with such client and will place existing business under review or exclusion, taking into account existing contractual agreements.
89 FIs include covenants in their financing agreements to enforce their water policies or plan to do so within the next two years.
Bendigo and Adelaide Bank (Australia) have covenants for their agribusiness customers. If these have water rights, the bank includes obligations within their loan agreements for them to not sell the water rights without the bank’s consent.
Engagement is one of the most effective strategies to influence clients and investees. As per the Valuing Water Initiative (VWI)’s five principles, financial institutions must first recognize and reconcile the value of water so to protect its sources. They can then educate and empower their stakeholders, and invest in the institutions, infrastructure and information to realize its benefits.
Engagement can be done by interacting directly with clients / investees including through incentivization (changing their behaviour), education/ information sharing and collaboration. Indirect means include exercising voting rights. Either way, the primary aim is to communicate the need for companies to understand, disclose their water risks and opportunities, and work strategically to minimize their impacts to their business and environment.
103 FIs engage with clients/ investees on water related issues. Incentivization was the most predominant form of engagement followed by education/ information sharing. These appear to correlate with the strong emphasis of driving behaviour change through the development of product and services, investments in water infrastructure, and enactment of policies including water-related requirements criteria, as presented earlier.
Engagement & incentivization (100% portfolio coverage): Incentivise clients to reduce water footprint and improve their CDP water score through a new ‘water footprint’ KPI linked loan. Targeted at clients with increased water-related risks.
Collaboration & innovation (100% portfolio coverage): Invest in companies providing solutions to the global water shortage of clean water and wastewater services. Engagement targeted at clients with increased water-related opportunities. Increased AUM in water solutions portfolio by almost four times in three years (2018 to 2021, 300% rise).
Engagement: encourage better water-related disclosure practices including CDP reporting. Engage with water utilities to encourage water conservation when faced with drought conditions.
60 FIs currently exercise their voting rights as a shareholder on water-related issues. Reasons for not doing so varied including important but not an immediate priority, focusing on climate at present, waiting for guidance from TNFD, and not being equity shareholders.
We vote in all our shares and on all resolutions. MFS voted for a shareholder proposal at the 2020 AGM of Pilgrim's Pride Corporation that requested a report on the company's reduction of water pollution. The proposal received 15% support.
Every organization in every sector has a part to play in the transition to a water secure, decarbonized and deforestation-free economy. However, the finance sector is especially critical. Unsustainable water practices impact the economy at large and create indirect business risks that are outside the control of an individual financial institution. The financial sector therefore has a vested interest in sustainable water management and efficient water regulation. Financial institutions should engage with policy makers, regulators and relevant stakeholders on water management and publicly outline their position on specific water regulation.
The lack of water risk awareness means that FIs often fail to undertake adequate due diligence on their financial decisions as it relates to water security. Moreover, the policy, regulatory and supervisory structures that dictate how capital is allocated within the financial sector are starting now to consider and embed nature (and water) related risks, opportunities and impacts.
The regulatory landscape is evolving with standards (ie ISSB) and voluntary initiatives (ie TNFD) potentially setting the scene for future regulatory developments. Regulators and financial supervisors have a critical role to ensure rigorous and consistent rules that incentivise FIs and companies to disclose risks, opportunities and impacts, and act on water.
With support from the Dutch Valuing Water Initiative (VWI), CDP and partners Water Footprint Network (WFN), Water Footprint Implementation (WFI) and Mercer worked over the past two years to design and implement a global disclosure mechanism that aims to baseline the current state of knowledge and action of FIs on water. It has been informed by the latest scientific insights, a range of global stakeholders and aligns with and goes beyond the Task Force for Climate Related Financial Disclosure (TCFD).