Water risk is receiving growing recognition as a significant business risk. Many high-priority climate change effects tie to water. From drought and flooding to potential conflict over water resources, climate change mitigation is inseparable from water governance.
Shareholder water risk can be physical or transitional. The former includes actual events, such as sea level rise and drought, that can negatively impact a company’s supply chain or operations. In contrast, transition risk stems from failing to anticipate and adapt to regulations and market changes related to sustainable development and the transformation to a low-carbon economy.
The public sector is putting pressure on companies to take accountability for these risks and assist in combating climate change. The Biden administration hosted the 2021 Earth Day Summit, re-establishing US leadership and pledging to take stronger actions on climate change. Additionally, the SEC is tightening its climate reporting regulations by emphasising the need for material risk disclosures.
Investors are also seeking information on corporate water risks and impacts. More investors are beginning to factor water data into their equity valuations. They are also considering the levels of company transparency and governance when making investment decisions.
There are increasing demands on all fronts for company leaders to act. Further, there is a strong business case for board water stewardship. Without a comprehensive water risk management strategy, getting hammered by hurricanes or experiencing prolonged water stress is sure to negatively impact the bottom line of any business. It may even be enough to close the doors of companies in water-intensive industries.
Therefore, boards must grasp these risks and their business implications to successfully navigate management decisions and remain profitable during this transition period to a sustainable society.
However, according to the PWC 2020 Annual Corporate Directors Survey, only about half of the participating directors thought that their boards sufficiently understood environmental, social, and governance (ESG) issues like water stress and natural disasters.
Improving board understanding of ESG criteria is critical for long-term company success. Board members do not need to be experts on water risks, but a foundational understanding of these risks and their business implications is imperative for effective leadership.
With this knowledge, boards can guide management in assessing, mitigating and communicating relevant water risks to stakeholders, including investors, customers and regulators. Putting water risk on the agenda is another preliminary step boards can take to bring awareness to these issues within the company.
Additionally, the World Economic Forum has developed guidelines for how corporate boards can establish climate governance. The report highlights water crises as one of the top global environmental issues boards should consider in their risk management and decision-making.
According to these guidelines, boards can take the following steps to manage water risks:
Learn about current water risks and opportunities.
Adjust the board structure to understand, manage, and report water risks and opportunities.
Direct management to assess water risk materiality for the company in the short, medium and long term.
Take necessary actions to develop long-term resilience to water risks.
Direct management to integrate water risks into company strategy, investment decisions and risk management planning.
Align executive incentives with indicators of long-term success such as water-related targets if appropriate.
Disclose relevant water risks and opportunities and corresponding strategic decisions to stakeholders in financial reports.
Communicate with peers, policymakers and experts to stay on top of current best practices.
Boards currently have the opportunity to enhance their business strategy and risk management while simultaneously promoting sustainable development. Understanding and incorporating water risk and ESG factors into company strategy and operations can also help boards avoid financial, reputational and legal ramifications.
As company leaders, board members have the power to shift the strategic thinking of management and assist in the global transition to a better world. Implementing strong water governance from the top down sends a message to stakeholders that the company is resilient and prepared for the future.
Thomas Schumann is the founder of Thomas Schumann Capital (TSC), which helps global capital markets to integrate water risk in equities and portfolios into investment decisions.
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