Water risks such as floods, scarcity and pollution are increasingly chipping into corporate bottom lines. The financial sector is taking notice – and taking action.

Calvert Investments asked HanesBrands to evaluate its losses from cotton-supply shortages due to the 2011 US drought, determining that the company lost $5.2bn. Trillium Asset Management is now asking companies in its portfolio to factor water risk into their financial projections. And Moody's Investor Service released warnings about risk to credit ratings in the mining industry, as companies spend more on infrastructure in response to growing water risks.

More and more investors are clamouring for sustainability reports and disclosure initiatives to identify corporate water risks, but the process of actually evaluating water supply risks is challenging. Definitions and interpretations of several key concepts have proven to be difficult to define and track in a consistent way. This hurdle was discussed earlier this month at Stockholm Water Week's UN Global Compact CEO Water Mandate meeting – and soon, there may be a solution.

Inconsistent terminology, inconsistent results

A growing number of corporate assessment tools – such as the World Resources Institute's Aqueduct Water Risk Atlas, WWF Water Risk Filter, and WBCSD Global Water Tool – are available to help companies evaluate their water risks. The issue is that all of these tools were created using varying parameters, and their underlying methodologies continue to evolve. These differences have created a wide range of definitions and sometimes competing interpretations of terms such as water stress, scarcity and risk.

This is problematic because consistency in reporting methods and terminology are critical if investors are to adequately compare water risks among their portfolio companies. Companies also need to identify their water risks as accurately as possible. Reporting more or less risk than they actually face could be misleading to investors and other stakeholders. It could also lead companies to make poor decisions around where and how to respond to risks.

Water risk reporting to avoid power cuts

The experiences of Exelon Corp offer a prime example. As the US power generator analysed water risks for its 2012 sustainability report, it saw definition-related challenges firsthand.

Evaluating and mitigating water-related risks is a top priority for Exelon. Most of the company's 35,000 MW of electric generating capacity nationwide relies on adequate, affordable and reliable sources of water. The majority of Exelon's fossil fuel and nuclear power plants, which supply electricity to millions of customers annually, need water. And thermal power plants rely on water to dissipate excess heat created during power production. Changes in supply and usage can also affect surrounding communities, businesses and the environment, because each depends on the same watersheds that the power plants do.

Exelon recently used the water risk atlas, finding that it faced low to medium water stress in the Mississippi and surrounding watersheds, where approximately 40% of its operations are located. This finding was significantly different than results of a prior assessment. Previously, the company used the UN definition of water stress – an average of 1,700 cubic metres of available water per person. Under this definition, none of the company's facilities faced water stress.

Evaluating water risk is the first step in mitigating it. Conflicting definitions, then, can ultimately hinder a company's ability to create a comprehensive strategy for overcoming water risks. Exelon's more detailed understanding of water stress will help the company communicate its risks and mitigation strategies, and better equip it to work with communities, businesses, and other decision-makers to ensure ongoing water availability.

Settling the differences

Exelon's experience is just one example of the challenges companies face due to inconsistent terminology and risk reporting methodologies. But the good news is that there's an initiative to streamline corporate water risk reporting.

The UN Global Compact CEO Water Mandate asked a team of experts – including the WRI – to reconcile the differences between various terms and reporting methodologies. While the results of this initiative won't be published until the revised UN Global Compact CEO Water Mandate Corporate Water Disclosure Guidelines come out in 2014, the discussions are already yielding practical results.

The working group is uncovering some of the important differences among scarcity, stress, and risk as captured in these working definitions:

• Water scarcity assesses the health of a river system by evaluating the amount of water available within a given area. Scarcity describes the total supply in an area minus a specific type of demand, called consumptive use (eg water consumed by crops as they grow).

• Water stress illustrates where there's competition and potential conflict among all water users, including human and ecological uses. It takes into account total water supply as well as consumptive demand, but also includes all other water demand, or non-consumptive demand (eg power plant water used for cooling that is returned to river where it can be used downstream).

• Water risk is a comprehensive term, describing all water-related concerns, such as pollution, social and regulatory issues, that may affect governments, communities, businesses and other water users.

The 2014 CEO Water Mandate guidelines will be an important first step in reconciling these differences and advancing corporate water risk reporting for investors and businesses alike.

As more and more companies use the same definitions, investors will be able to accurately compare companies in their portfolios, and therefore make better investment decisions. The companies themselves will benefit, too. Environmental managers will be able to make more informed decisions about which stress, scarcity, and risk reporting processes to use. This will allow them to more accurately identify their water-related risks, and put in place strategies to protect their bottom lines.

Of course, companies must decide whether they will report with common metrics at all. Several major international corporations faced scrutiny this month for reporting carbon emissions with their own internal metrics, rather than through the standardised CDP carbon emissions report. Companies will face similar questions about water stewardship within five years, and those who join the standardised definition and reporting processes now – through initiatives like the CDP Water programme – will have a valuable headstart.

Tien Shiao is a senior associate for the World Resources Institute's Aqueduct project. Paul Reig is an associate for Aqueduct.

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