Liquid Capital

Liquid capital: how investors should tackle the water crisis January 2023 Water is essential to life – it is also sometimes a threat to life. With both droughts and 昀氀oods likely to increase as temperatures and global populations rise, signi昀椀cant work is needed to mitigate and adapt to these risks. We expect investors to intensify their focus on water – whether they are screening portfolios for water risks or identifying the providers of possible solutions to the water crisis. Mélissa Bourassi Sustainability Analyst Key takeaways – In 2022, some of the most extreme water events in history – both in terms of droughts and 昀氀oods – hit the headlines. – Water is increasingly being recognised as a prominent physical risk, with significant economic and social costs. – Water security touches on many environmental and social sustainability goals, including all the 17 UN Sustainable Development Goal targets. – Water-related risk and opportunity screening is likely to escalate significantly in 2023. Guirec Thouement Sustainability Analyst Water is not only essential for human life but This paper addresses the importance of also for the global economy. Yet this seemingly understanding the full extent of the planetary, abundant resource is under threat. Most of the social and economic implications of water as a water on Earth is unfit for human consumption or resource and the role investors can play in locked in glaciers. Only 1% of water resources are mitigating risks and providing solutions. 1 available as freshwater. In addition, water Water security is targeted by Goal 6 of the UN remains unevenly distributed across the planet. Sustainable Development Goals (SDGs) that aims As a result, billions of people are living without to ensure access to clean water and sanitation for safely managed water and sanitation. It is all by 2030. Despite some recent progress, we are estimated that half the world will live under still far from reaching this goal, which intersects water-stressed conditions by 2050 unless we with other SDG goals such as poverty reduction, adopt an integrated and inclusive approach to food security and human health. In addition, the restore the balance.2 increasing global water crisis poses potentially significant financial risks: a recent study showed that water-related natural disasters could hit global GDP by USD 5.6 trillion by 2050.3 1 WWF, 2022, Freshwater 2 MIT Joint Program on the Science and Policy of Global Change 2021, Global Change, 2021 Outlook 3 GHD, 2022, Aquanomics: The economics of water risk and future resiliency

Liquid capital: how investors should tackle the water crisis The worsening water crisis Water risks Global water use is increasing faster than population When water stress combines with non-stress related factors growth. In fact, over the past century, global water use (eg, climate change or natural disasters), this aggregates has increased at more than twice the rate of population into a risk measure of the severity and likelihood of being growth.4 While the global population is projected to rise unable to source water from a particular watershed/basin. 21% from the present 8 billion to 9.7 billion in 2050,5 global (see exhibit 1.) water demand could rise by 20–30% over the same period.6 Geographically, some areas are more exposed to water A combination of increasing demand and water pollution is stress than others. For example, the Middle East is likely pushing some regions to reach their water resource limits, to be the most a昀昀ected area by 2040, according to the heightening related social risks. At the current rate, two- World Resources Institute (WRI).8 Kuwait, Palestine, Qatar, 7 thirds of the world’s population may face water shortages. Israel and Lebanon are among those nations that draw There are three elements to the water crisis: water scarcity, heavily on groundwater and desalinated sea water. As the water stress, and water risks. sourcing of such resources can be signi昀椀cantly exposed Water scarcity to geopolitical factors, including con昀氀icts, these nations risk experiencing high water stress by 2040. The US, China This is when water demand exceeds availability because and Australia are projected to experience a signi昀椀cant water supplies can be limited for several reasons. increase in water stress in the future. The WRI study Water stress also highlights that growing competition for access to Water stress covers water accessibility and quality in diminishing resources could prompt political, geopolitical addition to availability. Water stress potentially poses a and economic tensions. global systemic risk to every sector and economy around the world. In addition to direct operational risks, businesses face physical, regulatory and reputational risks. Exhibit 1: Understanding water scarcity, stress and risks Imbalanced Physical eg, floods, droughts and degraded water quality Scarcity Availability Regulatory Stricter regulation, s loss of licenses ! k Stress Quality s Ri Reputational Perception of misuse of water resources Accessibility Systemic eg, supply chain disruptions – Physical risk encompasses water quantity and quality issues and represents a major threat for water- intensive sectors like apparel, food and beverages, and agriculture. – Regulatory risk is related to the potential for local authorities to impose stricter regulations, limit use or increase the pricing. – Reputational risk is linked to the potential brand value damage coming from the perceived negative impacts on the quantity and/or quality of water resources. Source: Allianz Global Investors 4 United Nations, 2018, Water Scarcity 5 United Nations, 2022, Revision of World Population Prospects 6 nature partner journals, 2019, Reassessing the projections of the World Water Development Report 7 WWF, 2022, Water Scarcity 8 World Resources Institute research, 2015, Acqueduct projected water stress country rankings 2

Liquid capital: how investors should tackle the water crisis Water crisis is inextricably linked to climate change Water distribution is extremely uneven around the world, Climate change is likely to a昀昀ect the frequency and severity and it is only getting more so. In 2022, at the same time as of extreme events like 昀氀oods, droughts and heatwaves. many areas faced record and extreme droughts, others In recognition of the intersection of the water crisis and su昀昀ered intense 昀氀ooding. In Pakistan, for example, the climate change, the COP 27 meeting in November 2022 devastating 昀氀oods a昀昀ected 33 million people, put one- included a designated “Water Day”. The World Health third of the country under water and displaced a minimum Organization highlighted that, by 2025, half of the world’s of 7.9 million people, according to the UN Refugee Agency. population will live in water-stressed areas, mainly due to If these conditions continue, it is estimated that 1.2 billion climate change, with low-income communities facing the people could be forced from sub-Saharan Africa, Central greatest challenges and impact. Asia and the Middle East to migrate to Europe and North 10 America by 2050. The most undervalued resource on Earth? Despite some progress, signi昀椀cant challenges threaten Water is a 昀椀nite resource, but it is distributed at an 11 to undermine the promise to “leave no one behind” and arti昀椀cially low price. Furthermore, the price of water tends ensure equality of access to basic water and sanitation to be lowest in the most water-scarce regions despite services. Addressing the challenges of SDG 6 requires the the high risks of drought or damage to long-term water integration of a human rights-based approach. Water infrastructure. This evident paradox directly contributes access must be viewed as a fundamental human right and to the unsustainable management of water. A more 12 not simply a commodity to be managed. proportionate method of valuing water would not only improve water e昀케ciency, but also encourage greater investment into water and sanitation infrastructure. Spotlight on groundwater: vital but undervalued Water scarcity has social costs Groundwater makes up 99% of the Earth’s available Today, 2.1 billion people lack access to safe drinking water, freshwater and is the source of half the world’s drinking and more than 3 million die each year from water-related water, securing water needs in low-income regions. 9 However, climate change directly a昀昀ects the water diseases. In addition to the direct impact on mortality, the cycle and the availability and quality of freshwater lack of access to safe and a昀昀ordable water threatens food below ground. It is estimated that 44% of all aquifers – security, social well-being, education, and the ability to underground water supply – will be depleted because break away from the vicious cycle of poverty. 13 of climate change in the next 100 years. Read more about groundwater: www.allianzgi.com Exhibit 2: Water stress by country (2040 forecast) Low (80%) Source: World Resources Institute aqueduct water risk atlas 9 World Health Organization, 2022, Drinking Water 10 Institute for Economics and Peace (IEP), 2020, Launch of the inaugural Ecological Threat Register 11 UN, 2015, 2030 Agenda for Sustainable Development, Leave no one behind is the central, transformative promise of the 2030 Agenda for Sustainable Development and its Sustainable Development Goals. 12 The human right to safe drinking water and sanitation was 昀椀rst recognised by the UN General Assembly and the Human Rights Council in 2010, although this vote is not legally binding (see: European Parliament, 2021, The Human Right to Drinking: Impact of large-scale agriculture and industry) 13 UN, 2022, World Water Development Report: Groundwater: Making the invisible visible 3

Liquid capital: how investors should tackle the water crisis Water 昀氀ows into 昀椀nancial performance As mentioned earlier, water risks take on di昀昀erent forms Awareness appears to be increasing about how and require a thorough understanding of a company’s water – both the scarcity and excess of it – can have a entire supply chain, the locations of those activities, and the signi昀椀cant economic impact on companies. Agriculture governance around those risks. In addition, controversies is an obvious example, but many industrial activities are related to water pollution are becoming headline news, also heavily reliant on water. A less obvious example is which can translate into negative risk performance. the semiconductor industry. For instance, in 2021 Taiwan- Regulatory screening based factories had to reduce production due to droughts MiFID II and the formal Principle Adverse Impact 14 and use tankers to provide water. In turn, this raised 2(PAI) or Do No Signi昀椀cant Harm (DNSH) screens tensions with farmers, who su昀昀ered the same issue but were all introduced by European Union regulators in 2022. had to share this constrained – though vital – resource. Three of the 14 PAIs on sustainability factors are speci昀椀cally 16 How should investors quantify these impacts? While aligned to biodiversity factors with one of these speci昀椀c data continues to evolve, one relevant key performance to “emissions to water”. However, water also touches on indicator (KPI) would be the water intensity of the the notions of negative biodiversity impact and waste production process. But getting this data might be hard, management. Alongside the disclosure regulations from and the resulting 昀椀gures may not be exact. Nor does this the EU, there will be evolving country-speci昀椀c and investor- data tell the whole story: sectors such as 昀椀nance and led demands, as well as higher expectations on risk and energy have indirect exposures to water. For example, opportunity governance for companies. 昀椀nance companies may have a high revenue exposure to Impact-focused investing sectors with an aggregated high exposure to water risks. Given all the challenges, there is a signi昀椀cant In the energy sector, hydropower is evidently reliant on a 3sustainability (and 昀椀nancial) opportunity in direct supply of water, while nuclear and thermoelectric developing new solutions and technology to address the plants require signi昀椀cant amounts of water for cooling. di昀昀erent water challenges. These opportunities include: These dependencies were evident in the summer of 2022 in France when the drought impacted the functioning of – Directing capital to opportunities aligned to SDG 6: 15 UNESCO has estimated a USD 114 billion annual cost dams and power plants. We hope and expect that the understanding and measurement of water materiality in to providing the necessary infrastructure for safe sector and company pro昀椀les will increase. drinking water and sanitation in 140 low- and middle-income sovereigns. Absorbing water into investments – Water e昀케ciency solutions: these will not solely be We anticipate an increasing integration of water risk focused on minimising water intensity, but also on materiality and opportunity into investments in 2023. developing new production processes and products There is likely to be far greater disclosure and commentary that are less reliant on water, addressing pollution, and in both 昀椀nancial and sustainability reporting suites, while creating e昀케cient water infrastructure. we expect an expansion of water data and KPIs: Water risk materiality Genuine thirst for innovation For investors seeking unconstrained universes, it will Water-related challenges are already evident around the 1 be important to identify material ESG risks relating world and are likely to rise. Water solutions bene昀椀t industry, to the water impact on companies and sectors, including: society and the planetary fabric that sustains life on this planet, while those entities and companies that fail on – Water intensity: there is rising scrutiny of water usage water performance or disclosure are likely to be penalised. and management, especially for regions at high risk Putting an appropriate value on water will likely be key to of droughts or 昀氀oods. Water intensity is nuanced given protecting this essential but undervalued resource. the intensity, availability and reliance factors across a company’s supply chain. – Physical risks: the proportion of revenues, earnings or assets in locations with severe or very severe risk of droughts or 昀氀oods. – Controversies are always an indicator, but these will mostly highlight companies with direct exposure to water issues (through local pollution incidents or overuse) without revealing issues related to water dependency across the extended value chain. 14 Forbes, 2021, No Water No Microchips: What Is Happening In Taiwan? 15 World Economic Forum, 2022, 5 unexpected impacts of drought in Europe 16 PAI biodiversity factors are activities negatively a昀昀ecting biodiversity-sensitive areas, emissions to water and hazardous waste and radioactive waste ratio 4

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