Water is another natural capital that must be factored into corporate risk assessment. Pervasive drought can strand assets, especially in water dependent industries including mining, energy, agriculture, and food processing. Mining companies worldwide spent about US$12 billion on water infrastructure in 2014, a 253 per cent increase of the US$3.4 billion spent in 2009.[14] A pioneering effort by Bloomberg LP and the Natural Capital Declaration enables financial analysts and portfolio managers to integrate water risks in the valuation of mining companies through a discounted cash flow model. The Water Risk Valuation Tool adjusts a mining company’s future revenue and costs based on how much production may be affected by water.[15]
2. Reforming the regulatory regime
Financing the transition towards more sustainable development will require a redirection of capital flows towards critical priorities, and away from assets that deplete natural capital.[16] Without regulatory changes to the financial system this is unlikely to happen at the scale needed.
Climate change, water scarcity, and other forms of environmental risk do affect the economy and are a potential source of systemic material risk for the world economy. This risk threat in turn can provide the basis to engage bank supervisors, such as the Basel Committee on Bank Supervision, to stress test financial institutions on their exposure to material environmental risks and to identify opportunities for reform to reduce exposure.[17] The 2015 UNEP Inquiry into the Design of a Sustainable Financial System found over 100 exemplary policy measures across 40 countries that facilitate financial system support of sustainable development.[11]
In China, for example, greening finance is a growing focus through the promotion of green credit, green securities, and green insurance. Green credit has been the key policy for green finance in China’s banking-dominated system.[18] In 2007 the State Environmental Protection Administration, the People’s Bank of China, and the China Banking Regulatory Commission jointly called on banks to make compliance with environmental laws and regulations a necessary condition for loan approval. As a result green investment in China exceeded US$200 billion in 2012 or about 2.4% of China’s GDP.
While these government initiatives are encouraging signs, more financial regulatory reforms are needed to accelerate the shift towards a green economy. Ultimately this means that the risk-adjusted return of an investment or loan will have to favour environmentally-sound assets.
Definitions
IFC Performance Standards
The Performance Standards issued by the International Finance Corporation are a set of qualitative environmental and social standards, which are endorsed by financial institutions that cover about 80% of the project finance market effectively creating a level-playing field
Water Risk Valuation Tool
The Water Risk Valuation Tool (WRVT) maps specific mine assets against water scarcity indicators projected through 2030. Water risk is then integrated into the model through two primary pathways:
1. Revenue: the value of potentially unextractable ore due to water scarcity can be calculated; and
2. Cost: a so-called “shadow price” is modeled based on a holistic value of water for citizens, agriculture and ecosystems
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