April 21, 2010

Three Reports Detail Investment Risks in South and Southeast Asia
    by Robert Kropp

The World Resources Institute examines the potential impact of water scarcity on investment in the food and beverage, power generation, and real estate sectors in the region.

SocialFunds.com -- By March 2009, sustainable investment in emerging markets had grown to over $300 billion, an estimated $50 billion of which reflect funds specifically branded as socially responsible or sustainable, according to a survey conducted at that time by Mercer. In the study, Mercer also found that it “may take a few years yet” for environmental considerations to be incorporated by asset managers in emerging markets.

The growing risks associated with water scarcity in the emerging markets of South and Southeast Asia were briefly addressed by Mercer in its report, which mentioned the effects of drought and desertification, as well as “the effects of water shortages on investee companies.” Three reports issued last week by the World Resources Institute (WRI) and the Climate Change Centre of Excellence at HSBC offer a more nuanced appraisal of investment risks associated with water scarcity in three high-risk industry sectors.

The first of the three reports, Weeding Risk, examines the potential impacts of water scarcity on the food and beverage industry sector in India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam. According to the report, “South and Southeast Asia are particularly at risk from climate change and water scarcity due to the magnitude of predicted regional impacts and demographic trends,” and the food and beverage sector “is especially vulnerable to climate change and water scarcity because of its close ties to agricultural productivity and changing consumer preferences.”

The most significant potential consequence of water scarcity for the sector is its effect on agricultural inputs, according to the report. Decreased availability of such inputs can lead to price fluctuations over the medium to long term, and extreme weather events can lead to short-term price volatility. Operating efficiency can be compromised as well, by an increased cost to companies of water, and water supply interruptions can disrupt normal business operations.

The reputational risks for companies in the sector can be considerable as well. Food safety problems can have legal consequences and loss of revenue from contaminated and recalled products. Community relations can be negatively impacted by increased competition for dwindling resources.

The report concludes with recommendations that investors integrate water scarcity risks into their evaluations of food and beverage companies, and engage with companies to ensure that information about finances, water availability, and associated risks and opportunities is available.

The second report, Over Heating: Financial Risks from Water Constraints on Power Generation,analyzes water-related risks facing power plants in India, Malaysia, the Philippines, Thailand, and Vietnam. Because of economic and population growth, the region is projected to have the fastest growth rate of power consumption in the world, according to the report. Limited freshwater resources will be impacted by the power sector’s requirement of steady supplies of water.

Governments in the region have liberalized the power sector, in order to encourage private investment. However, “deregulated power markets may offer little or no protection to shareholders,” according to the report, and new power plant development will rely in the long term on increasingly uncertain water availability. Furthermore, more than half of existing or planned power plants are located in areas suffering water scarcity or stress. The report found that almost 80% of new capacity in India will be built in areas that are already water scarce or stressed.

The financial impacts of water scarcity in the region can lead to lost revenue and increased costs, higher capital expenditures, and delays in project execution. In order to minimize risks associated with investment in power generation in the region, investors are encouraged to analyze the effects of water scarcity and pressure companies to be transparent on the issue.

The third and final report, entitled Surveying Risk, Building Opportunity, assesses the potential financial impacts of water scarcity on the commercial building sector in the region. While energy insecurity, water scarcity, and climate change will affect the risk and return associated with investments in the sector, the report found that “Green building investments can minimize energy and water-related risks while achieving net positive returns in as few as three years.”

The potential financial impacts on the real estate sector of climate change and water scarcity include higher utility costs due to increasing costs and unreliable supply, higher operating costs due to depreciation, maintenance, and insurance premiums, and higher construction costs. According to the report, such impacts will flow through to investors and developers because of higher costs borne by real estate investment trusts (REITs) and expensive delays in development.

The report provides a framework with which investors may assess the exposure of a building due to its location, and the vulnerability of a building due to its design. In addition, because many current and planned development projects are located in cities exposed to water scarcity and climate change impacts, the report summarizes the risk exposure of many of the region’s largest cities.

The report identifies green building investments in the region as an important potential mitigating factor in addressing vulnerability to water scarcity and climate change. Although green building innovations are still in their early stages in the region, the report cites a 2008 study by the Asia Business Council that identifies several projects where new and retrofitted green buildings led to net positive returns on investment. According to the report, “Net positive returns on water and energy efficiency investments are currently achievable in approximately three to five years.”

The report calls for regulatory actions by governments that include strict building codes and mandatory green building retrofits and new construction. It also recommends that local green building councils expand guidelines to emphasize building features that improve resilience against extreme weather events.

“It is critical that governments, the private sector, and green building councils work together to improve green building awareness, invest in R&D for region-specific green building technologies, and correct misaligned incentives in the market,” the report concludes.