For years, you diligently turned off the tap every time you brushed your teeth. You’ve replaced harsh cleaning chemicals with more natural alternatives and even installed a low-flow showerhead. What more can you do to preserve our planet’s limited water supply?
While the above individual efforts are commendable, household use accounts for only 11% of global water withdrawals each year. The real culprits, that is to say those who can contribute the most to preserving our water resources, are the companies. While there are many reasons why companies should assess their water management practices, we focus here on the financial risks of poor water management. Without further ado, here are three that could well rain down on investor runways:
Reduced (or more expensive) production capacities and supply chain disruptions, which have the potential to have a significant impact on businesses across everything Industries. After all, water is essential for the cultivation and production of raw materials, the manufacturing process and the distribution of products. In fact, the far-reaching effects of climate change-induced water scarcity can already be seen in Europe, where a summer of severe droughts threatened livestock production and crop yields. Vital rivers such as the Rhone, Danube and Po are drying up, hampering the transport of goods and the production of nuclear energy.
The timing, arguably, couldn’t be worse for a continent that is already struggling with runaway inflation and energy shortages following Russia’s invasion of Ukraine earlier this year. But nature waits for no one, and the effects of our collective procrastination are now producing noticeable economic effects in the form of high shipping costs, supply shortages and likely production curtailments. Some economists have warned that dry conditions in Germany, long considered continental Europe’s economic powerhouse, could dampen the country’s overall economic growth by up to half a percentage point this year.
Legal action and damage to reputation, as companies are reprimanded for their role in overusing or contaminating water. Recent research has indicated that half of the waterways in the United States are now so polluted that they are considered “impaired”, meaning they are not safe for swimming, fishing or drinking. Among the contaminants that are increasingly attracting public attention are per- and polyfluoroalkyl substances (PFAS), commonly referred to as “permanent chemicals” because they do not break down easily. These man-made substances, which have been associated with a variety of negative health impacts on humans and animals, are now so ubiquitous that they can be found even in the most remote areas of the world.
As awareness of PFAs increases, efforts to hold companies accountable for releasing these harmful chemicals into surrounding waterways are also increasing – more than 1,200 PFAS-related lawsuits have been filed in the states. States last year. Corporate defendants could subsequently find themselves embroiled in protracted litigation, spending heavily on legal defense, settlements, judgments and crisis management communications. For some companies, the financial risks are enormous – well-known chemical manufacturer 3M devoted 15 full pages in its annual report last year to its legal risks related to PFAS.
Assets blocked in regions under water stress, often emanating from inaccurate projections regarding water availability and access, failure to implement appropriate risk mitigation and management plans, and/or unfavorable regulatory responses. Stranded assets, in case you were wondering, are those that no longer generate revenue for a business. They often arise as a result of adverse environmental conditions (yes, that includes drought) or significant disruptions in consumer demand, regulatory activity, and technological innovation.
Again, this is not a hypothetical scenario: some large publicly traded companies have already seen their assets turn into albatrosses as a result of water-related events. A particularly stark example is that of mining giant Barrick Gold, which has spent two decades and billions of dollars trying to get its once-vaunted Pascua Lama mining project off the ground. This Andean project, which straddles the borders of Chile and Argentina, has faced stubborn and relentless opposition from environmental groups and local actors concerned about its destruction of nearby glaciers, as well as the depletion and contamination of the local water supply. These concerns were apparently not unfounded and in 2013, after determining that Barrick Gold had failed to have adequate protocols in place to prevent water pollution, a Chilean court imposed a $16 million fine and ordered the company to suspend the construction of the project (class action by furious investors). Last month, drawing a line under the sad saga, the Supreme Court of Chile ratified the permanent closure of the Pascua Lama project.
Far from being a cash cow, Pascua Lama has become a cautionary tale for other companies, and its fate now hangs in the balance. Barrick Gold is currently investigating whether the Argentinian side of the mine remains viable, but for now, the project represents an extremely costly spine for the company.
What is the role of financial advisers in the face of the water crisis?
Financial advisors, well placed to help their clients identify and manage water-related risks in their portfolios. Given the politicized and polarized nature of recent dialogue surrounding environmental, social and governance (ESG) investing, some advisers may be reluctant to raise such questions with their clients. However, regardless of the political leanings of customers, they may already be experiencing the daily effects of protracted dithering on water issues. Droughts could affect their livelihoods. Water pollution can impact their ability to pursue popular hobbies such as fishing, scuba diving or boating. They might even have good reason to doubt that their domestic water supply is safe to drink.
Importantly, advisors wanting to help their clients target the water crisis are not limited to just ESG funds, which have contributed to skepticism about the broader sustainable investing movement (particularly in regarding the lack of transparency regarding the underlying selection criteria of these funds). Rather, direct indexing solutions allow advisors to customize portfolios based on clients’ specific values, financial preferences and tax situations. Many such platforms also offer investors the option to decide whether divestment or engagement is their preferred impact approach; indeed, some independent shareholders have recently lent their support to proposals encouraging the disclosure and mitigation of water-related risks.
The time to act is now — the water crisis is not a nebulous, theoretical concept. It’s here, and it’s already having profound social and economic impacts. As other industry players have observed, “by ignoring water security in financial decision-making, financial markets contribute to large financial flows that increase exposure and vulnerability to water-related risks in the global economy”. Advisors should not be afraid to discuss this financially important issue with clients; it is part of their fiduciary duty.
Emma Smith is Director of Communications at Ethic. Ethic is an independent provider of personalized direct indexing strategies for financial intermediaries. Its scalable technology platform allows advisors to create personalized portfolios tailored to clients’ unique values, financial goals and tax preferences.