Water risks will shake up
countries and companies
More and more companies are realizing that water scarcity
and the deterioration of oceanic habitats pose significant
risks to their businesses. To mitigate these, companies
cannot rely solely on governments; they must act themselves.
“Water-related risks pose a growing challenge, especially inemerging markets. Through engagement and funding we aim
to help companies address these issues and make a lasting
and meaningful impact,” asserts Tongai Kunorubwe, head of
ESG fixed income, and Matt Lawton, manager of the GlobalImpact Credit Strategy at T. Rowe Price.
The Earth is called the Blue Planet for good reason: 75% of theglobe is covered in water. However, only 3% of our planet’s wateris fresh water, and only 1% is suitable for human and industrial
consumption. This makes water one of the most valuable
natural resources and essential for human life: we cannot
survive without it for more than three days. It is also a crucial
commodity for major industries that play a significant role ineveryday life, like the food and energy sector.
In most regions, water scarcity has long been a problem forhumankind. Despite all technological progress, many people still
struggle to get access to clean drinking water. The problem isworsening: water use has been increasing at more than double
the rate of population growth, according to the United Nations.

Water stress – the degree ofavailability of freshwater – will
be one of the top challenges forhumanity in the next decade andone of the important risks toglobal GDP growth.
– Tongai Kunorubwe– Head of ESG fixed income

Tongai Kunorubwe explains: “The growing global population
is expected to reach around 10 billion by 2050, which implies
even greater food and energy demand. Food and energy areheavy water users. The World Resources Institute, for instance,
estimates that around 30% of the world’s GDP will be exposed tohigh water stress by 2050.”

A quest for clean water and healthy oceans
Water scarcity is one part of the water crisis. The deteriorationand pollution of our oceans and rivers are another. Both arerecognized by the UN as major challenges. Two of the seventeen
Sustainable Development Goals of the UN are water-related:
SDG 6 (clean water) and SDG 14 (life below water).
The stakes are high. Two-thirds of the global economy is moderately
or highly dependent on ocean resources. Sectors such as fisheries,tourism, renewable energy, and maritime transport are highly
dependent on the health of our oceans. Rivers are an importantfreshwater source for water companies and agricultural irrigation.
Healthy oceans are also crucial in mitigating climate change,
another major risk for emerging markets. Oceans absorb about
90% of the warming generated from climate change. “We believethat the interconnections between climate change and water risks
are becoming apparent: climate risk is water risk, and it is therefore
important that we engage with companies on this topic,” argues
Matt Lawton, manager of the Global Impact Credit Strategy.
The scarcity of freshwater is a potential problem for many more
sectors that use water in their production processes. People andindustries will compete for access to dwindling water supplies,
forcing companies to invest in new equipment and switch to lesswater-consuming production methods.
Kunorubwe explains: “An industrial user like a pulp mill or a power
station, consuming huge quantities of water while the population ishaving its water use rationed, creates a potentially very challenging
dynamic between population, industry, and political parties who will
have to enact and enforce water use regulations. For instance, in
Latin America, select countries have imposed a maximum volumeof water extraction to which industry players must comply.”
Companies will want to mitigate water risks for the sake of
their business model, but will also experience increasing publicpressure to assist governments in big clean-up or infrastructural
water projects. For this, they need expertise and funding.

For investment professionals only. Not for further distribution.

A thriving blue bond market can deliver themuch-needed funding

A path to stricter definitions and company
guidance

Companies will need capital to fund the necessary investments.
This is a major challenge. The vibrant green bond market
focuses primarily on climate issues and very little on waterrelated matters. Blue bonds, a new subsection of green bonds
specifically targeting water projects, could be a solution. Theycreate a focus that can galvanize investors and companies
and thereby bridge the funding gap. Lawton remarks: “In anycase, with green bonds, the funding gap hasn’t been solved. We
think that blue bonds offer a more appropriate and dedicatedinstrument for funding blue projects.”

According to Lawton, stricter definitions of the criteria for blue
bonds will make the instrument more appealing to investors andincrease the likelihood of securing funding for blue projects. “Asinvestors, we will of course share our standards for blue bonds,
but in order to create a thriving blue bond market, we need more
uniformity in this market segment,” states Lawton.

Lawton is convinced that blue bonds can mimic the successof green bonds. The blue bond market, however, is still
relatively small.
While the blue bond market holds significant promise, it also
faces challenges. One of the primary challenges is the lack ofstandardization and clear definitions for what constitutes a bluebond. This can create confusion, hinder the market’s growth,and discourage companies from issuing a blue bond.

To help this market flourish,T. Rowe Price and theInternational FinanceCorporation (part of the WorldBank Group) are partnering
to grow the blue bond market
to address the planetary andsocietal risks posed by thecurrent underfunding of theblue economy.
– Matt Lawton– Portfolio manager of the
Global Impact Credit Strategy

Progress is being made in this area. Several organizations,
including the International Capital Market Association (ICMA),
have developed guidelines for blue bonds. These guidelines help
ensure that blue bonds meet high standards for transparency,
accountability, and environmental impact. Additionally, they
provide companies with an effective framework for issuing ablue bond, including clarity on eligible projects and possible key
performance indicators.
Many companies also need some guidance in finding solutions
for the water issues they face. It is therefore crucial to help
companies better understand their water-related risks. “Mostof our water engagements take the form of constructive
dialogue, where we provide our view on best practices in water
management. We believe a company-specific approach resultsin the highest impact because it aligns with our core investment
approach: active management rooted in fundamental
investment analysis”, notes Kunorubwe.
Another challenge is the fact that issuing blue bonds
entails marginally higher costs. This is due to the additional
requirements for monitoring and reporting on the use ofproceeds and their environmental impact. However, as themarket matures and more issuers enter the space, these costs
are expected to decrease even further, according to Lawton.
In addition, impact investors might be willing to offer morefavourable funding terms.
Lawton identifies three benefits of blue bonds:
1. Access to a larger and more diverse investor base, providing
a deeper pool of funding.
2. Reputational benefits for the issuer through the credibility andambition of the blue bond.
3. Internal benefits for companies, such as better embedding
sustainability and water considerations into corporate culture
and business decisions. Blue bonds can enable companies
to better identify and manage risks regarding how water
affects their enterprise from both an operational and financial
perspective.

2A closer look at water-related risks

A constructive dialogue with companies

So far, companies have taken a reactive rather than proactive
approach to water issues. This will change as more extreme
weather events and regulatory scrutiny bring water-relatedrisks into the spotlight. Another engagement discussion pointis that mitigating water risks is often linked to direct business
operations. However, for many industries, water risks lie
upstream in the supply chain or downstream when their productis used. Kunorubwe emphasizes: “It is important to recognizethat water dependencies and impacts can occur anywhere in thevalue chain.”

The complexity of water-related issues and the novelty of blue
bonds will make it necessary for companies to seek support.
T. Rowe Price is doing that on the ground in different regions
and sectors, with local visits and expertise. In Latin America, forinstance, agriculture is the most exposed to water risks since it
represents almost 70% share of water usage. The energy sector
is also a heavy user of water: the energy generation matrix is
almost 50% hydro. Even thermal plants are very water intensive
since they use water for cooling to be able to operate.

Water risks are location-specific and influenced by local climate,rainfall, and water supplies, making geographic assessment
crucial. Additionally, complex socioeconomic factors likepopulation growth, economic expansion, inadequate water
governance, and insufficient infrastructure investment drive
water insecurity. “Reputational risks for corporations are highest
at the intersection of these socioeconomic risk factors and local
basin risk,” states Kunorubwe.
Kunorubwe adds that ideally there should be targets specificto high-water stress areas. “In the medium term, as withclimate, we expect companies to adopt science-based target
approaches for water. However, due to the localization aspect,companies should set individual freshwater targets for eachpriority basin. Some companies could be perceived to bluewash
their water ambitions by not incorporating the localized natureof water risk or not considering where in the value chain therisk lies.”

Lawton notes: “We have spoken with companies across many
sectors to understand how they’re attempting to mitigate waterrelated risk. How they’re changing their practices and operations
to reduce water use, and whether they’re able to switch water
sources for a particular asset. But also, actions that can lower
freshwater use, like desalination equipment or upgrading coolingsystems. And a big part of our discussions with issuers focuseson the oversight of these issues. So, who’s responsible forassessing and managing these water-related risks at a company.”
By addressing water issues proactively, companies can help
ensure a sustainable future for both the environment and theirbusiness. Blue bonds can be a solid funding instrument for thenecessary investments. They provide companies with a unique
opportunity to enhance their reputation, access a broader
investor base, and potentially secure favourable financing terms.
Kunorubwe: “We expect the blue bond market to grow rapidly,given the need for investment in blue sustainable development.
Ultimately this will lead to tangible results in tackling our world’s
water crises.”T. Rowe Price and the International Finance Corporation are
not affiliated companies.

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Risks: Blue bonds carry investment risks, which include credit risk and interest rate risk. There is no assurance that a favorable
outcome will be achieved.

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