Corporate Bond Water Credit Risk Analysis Tool
Demand for analytics to integrate water risk factors into investment analytics is growing in response to evidence that water crises are a significant economic risk, as highlighted in the World Economic Forum 2015 Global Risks Report. Greater unpredictability in precipitation as a result of climate change combined with a growing population could lead to a 40% gap between water supply and demand worldwide within 15 years. Increasingly, companies are finding it challenging to access sufficient quantities of water for critical business operations, especially in water-stressed regions. The costs of securing water inputs are already rising for water-intensive companies in locations vulnerable to water shortages. Since 2011 companies have spent more than $84bn worldwide on conserving, managing and obtaining water.
Seven financial institutions from Europe and the Americas – UBS, Robeco, Calvert Investments, Pax World, J Safra Sarasin, Banorte and Bancolombia – took part in the tool’s development through a partnership between the Natural Capital Declaration (NCD), the Deutsche Gesellschaft für Internationale Zusammenarbeit (GIZ) and the German Association for Environmental Management and Sustainability in Financial Institutions (VfU).
The GIZ/NCD/VfU “Corporate Bonds Water Credit Risk Tool” enables users to integrate financial risk exposure to water scarcity into standard financial models used to assess the credit strengths of corporates across water-intensive sectors including power utilities, beverages and mining. The tool addresses an information gap in traditional financial analysis. It enables analysts to identify companies that depend heavily on access to water in locations that are exposed to water stress and to quantify the potential impact of water scarcity on the company’s creditworthiness. By combining data on the quantity of corporate water use per production location with data on site-specific water supply and demand conditions, the tool allows financial analysts to quantify corporate exposure to water stress and its potential impact on a company’s credit ratios. The Excel-based tool provides investors with a systematic and practical approach to assess water risk in corporate bonds and benchmark companies against sector peers, taking account of projected changes in water availability to 2040.
Simone Dettling, who manages the Emerging Markets Dialogue on Green Finance at GIZ, states: “Water scarcity and droughts are already affecting companies across the world – from California to Sao Paulo and Chile, from South Africa to India and China. For corporate bond markets, this means that uncertain water supplies can directly affect the credit risk of corporate issuers, especially in the mining, power and food and beverage sector.“
Henrik Ohlsen, Managing Director, VfU, states: “Investors need to understand how water-intensive companies compare on exposure to water scarcity, which can damage brands and credit risk. The tool can be applied to inform company rating processes.”
Learn more about the tool
A webinar on the new Corporate Bonds Water Credit Risk Tool can be found on Youtube.
- Introduction by Simone Dettling, GIZ Emerging Markets Dialogue Green Finance
- Demo of tool with initial results and functionality – Anders Nordheim, Programme Coordinator for Biodiversity, Ecosystem Services and Water, UNEP FI
- Applications of the methodology and value add for engagement/integration – Peter van der Werf, Engagement Specialist, Robeco
- Possibilities to enhance due diligence and inform product development – Claudio Paonessa, Assistant Vice President, Asset Management Bonds & Absolute Return, J Safra Sarasin
Allan Provins, Eftec
- Integration of water credit risk tool – Kent Siefers, Senior High Yield Analyst, Pax World
Eric Usher, acting Head of UNEP Finance Initiative, said: “Access to and availability of water is a global challenge with local implications for achieving sustainable development. The finance sector needs to be alert to this and integrate water scarcity into their analysis using tools such as this newly developed Corporate Bonds Water Credit Risk Tool.”
Liesel van Ast, Programme Manager, Natural Capital Declaration states: “The Corporate Bonds Water Credit Risk Tool is an open-source model to add a water risk factor in credit assessment. It has the functionality to include water stress information in established financial models.”
A report released alongside the tool entitled “Integrating Water Stress into Corporate Bond Credit Analysis: Benchmarking Companies in Three Sectors” – highlights key findings from its application. These include:
- Exposure to water scarcity varies significantly within sectors, depending on water use in water-stressed locations, combined with sensitivity to changes in key financial ratios.
- In the beverages sector Femsa, the Mexican bottling company, is most exposed to water scarcity of the eight beverages companies analysed. Its Net Debt/EBITDA ratio would more than triple if it had to internalize the full costs of its water use.
- Of the eight mining firms analysed, Barrick Gold and Vedanta are most exposed. Barrick Gold could would see its Net Debt/EBITDA ratio rise by 20% to 3.30x in 2017 if current water shadow costs are internalised.
- Of the power companies analysed, Eskom, the South African utility, is most exposed to water stress and could see its financial position deteriorate drastically through operating restrictions or higher capital expenditure due to water shortages.
- Sempra, RWE and The Southern Company also have power plants that are exposed to water stress, and could face shut downs or operate at lower capacity in water-stressed areas. Sempra, RWE and The Southern Company see their leverage rise quite sharply, when they internalise the full cost of their water use. Sempra Energy could see its High Triple B rating fall to a non-investment grade rating: perhaps to High Double B, because its leverage rises 97% to 6.74x when we estimate current shadow water costs.
- Institutional investors such as pension funds and insurance companies can enhance their financial analysis by taking a more systematic approach to evaluating water-related financial risk. Benchmarking issuers on exposure to water stress provides a starting point to integrate water risk as a factor in corporate bond valuations.
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