Why companies still need to engage on water

Last year we did a deep dive on water-related risk and proposed a framework to incorporate this data into the investment process. Here’s a quick recap what we found:

1. The current state of water-data reporting is low.
2. Water usage is highly concentrated.
3. The market is highly exposed to water-stressed regions.
4. Pro-active companies can be identified for positive tilting and driving change among peers.

There are still many unknowns because water risks are not widely reported by companies. We noted the need for engagement to increase corporate disclosure in cases where water is a material risk to the business.

Since then, we’ve continued to work on this topic. Here’s our update.

Water data is improving, but is still lacking

Two years after we first investigated the state of water data, we are encouraged to see that the number of companies reporting is rising quickly. Below is a comparison of companies included in the MSCI All Country World Index.

Then and now: Comparison of water data reporting for MSCI All Country World Index, by market cap

Source: MSCI ESG Research, Russell Investments

Though figures are going up, they have not improved enough to change our initial conclusions. Even with coverage above 50%, incomplete water data in portfolio positioning is likely to ignore companies whose management is particularly weak (those providing no information) and is counter-productive to encouraging improved disclosure. These reporting levels compare to approximately 78% of the MSCI ACWI index by market-cap self-reporting carbon emission data. So, while the direction of travel is encouraging, water usage data continues to have room for improvement.

Collaboration is key to increased reporting

Collaborative engagements between market participants can be particularly effective because investors can build strength in numbers. Sustainalytics, for example, has conducted multi-year engagements on the topic of water-risk management by engaging with companies on a local level. Water-stress risks are local in nature. One unit of water withdrawn in a water-rich region of Canada represents a very different level of risk from one unit of water withdrawn in a water-stressed region of Brazil. Sustainalytics worked with companies in two specific water-stressed basins: the Vaal in South Africa (the Orange tributary passing Johannesburg) and the Tiete in Brazil (the La Plata tributary passing Sao Paulo). A key theme that they uncovered was that collaboration and basin-level efforts were the most effective and cost-efficient ways to tackle water risks. Unfortunately, basin-level collaboration remains an area where water management practices have not been realized.

Engagement between companies is especially important where water management is a financially material issue. If a company is not reporting in line with the Sustainability Accounting Standards Board (SASB) framework or something comparable, they should be encouraged to improve their disclosures. Success will depend on investors’ willingness to coalesce around a standard set of sustainability metrics.

If a company is already providing SASB-aligned reporting, its important to understand how they manage the water-related risks identified. For many companies, water management isn’t just an environmental consideration, but a financial one. Businesses like these should articulate a specific financial cost they’ve assigned to water usage, as well as examples of how water costs feed into capital expenditure decisions. It is the responsibility of management to monitor and reduce their water usage and to set reduction targets following sustained engagement with their shareholders. Targets are more likely to be met when there is clear accountability on whose responsibility they are. Companies should be pressed on the issue of accountability for both targets as well as for water risk management more generally. In particular, investors will want to know if these would be included in employee KPIs (key performance indicators) or have oversight at the board level.

The bottom line

While reporting on water-related risk has improved since we last looked at the issue two years ago, there is still plenty of progress that needs to be made. Corporate engagement is an effective tool for both effecting this change and improving investors’ understanding of complex issues. We are encouraged by the quick pace of improvements in data quality and willingness of many companies to engage so far. Ultimately, this effort brings us closer to having both the data and understanding required to navigate water-related risks in equity portfolios.