Sustainable Investment in China | Impacts of Water in China for Investors

How do China’s different water issues related to quantity and quality—from overall scarcity in the north and west to massive industrial and agricultural pollution—affect companies and therefore investors?

For companies that need water in large quantities or of high quality—and at reasonable prices—local water conditions have already become an important factor in the selection of operating locations. The unpredictable availability of water, due to floods and droughts, affects companies’ operations, production costs, and supply chains. Just recently, droughts in Western China disrupted water and hydropower supplies to aluminum producers and lead smelters, and increased demand for alternative power sources such as coal.

In addition to physical availability and cost, policy factors—such as increasingly stringent water regulations—can affect a company’s reputation and access to capital. Public scrutiny from NGOs has drawn unwanted attention to polluting companies. For example, the Institute for Public and Environmental Affairs has an online water pollution map, which now includes over 40,000 cases of illegal discharge. Plans for public listing can be derailed as well. When Gold East applied for approval of their planned initial public offering in 2008, complaints from Chinese NGOs about their excessive water pollution discharge delayed government consent and triggered additional reviews—postponing the listing application process.

With increasingly informed and proactive stakeholders, water use and discharge are an important part of companies’ reputations and licenses to operate. Environmental protests have become more common in the last few years, and companies are facing higher expectations from both government and consumers to comply with local laws and to mitigate the potential environmental impacts of their operations.

Have we seen investors actively getting involved in water issues in China yet?

As more data on water risks from pollution and scarcity becomes available, investors have the opportunity to use it to inform their decision-making. The recently launched Asia Water Project provides a resource for investors on relevant news on water issues. While investors have previously focused on water issues as a fund theme or as a strategic investment area (e.g. irrigation equipment, infrastructure, treatment plants), some managers are now trying to understand how water-related risks can affect their general investment portfolios. For example, Goldman Sachs and GE are working with the World Resources Institute to develop a water index that would provide a quantitative assessment of water risks for different companies.

What can investors do to mitigate their own risks and risks to the companies they hold?

The first challenge for investors is to identify relevant data sources that can accurately represent risks to the business in terms of noncompliance, increased costs, or threats to a company’s license to operate. Simple data on water use and hydrological conditions can provide a starting point, but they only contribute one piece of a complex physical and socioeconomic context. A mapping of water risks based on local factors such as regulatory priorities, economic plans, and population characteristics can help investors understand the particular risks of a region and sector more comprehensively.

In addition, for investors that are actively involved with their portfolio companies, the water impacts of those companies’ operations and supply chains should be part of ongoing environmental, social, and governance (ESG) performance evaluation, risk management, and engagement. Investors should encourage companies to understand their current water-related risks and manage them accordingly as well as engage with stakeholders and understand how underlying trends will affect them.