Time to open the flood gates for green water bonds
Changing demographics and climate disasters are putting water infrastructure under increasing pressure: 4.5 billion people globally are without access to adequate sanitation, 2.1 billion lack access to clean drinking water and flood damage to urban property is estimated to cost US$120 billion annually. It is expected that the investment shortfall in water services and sanitation alone will amount to US$1.7 trillion by 2030, with overall financing requirements for water infrastructure forecast to total US$6.7 trillion. However, only 1.5% of green-labelled bonds finance water assets under a use of proceeds structure, which points to some significant market barriers, as well as missed opportunities for investment.
Why water bonds?
Water-themed finance can be many shades of blue – the spectrum ranges from drinking water supply and waste water treatment to ecological preservation, to name just a few. Earlier this year, the Seychelles issued a ‘Blue Bond’ to support sustainable fishing and oceanic ecosystems. Other, green-labelled sovereign issues – those of Nigeria, Fiji and France - have also included marine assets in their frameworks, a reflection of how conservation can fall within the remit of sovereign issuers.
The Climate Bond Initiative (CBI) taxonomy for green bonds does, in fact, permit a range of water-related sectors. It is, therefore, somewhat surprising that water services and sanitation are so underrepresented in the labelled market – green issues dedicated solely to water constitute only 1.5% of the total market, which is worth $330 billion, not including US municipalities. These raise plenty of debt for water assets, although rarely under a ‘use of proceeds’ structure: there are over 470 water bonds issued by US municipals currently outstanding, only 32 of which are self-labelled ‘green’, and only a fraction of those have proceeds earmarked for designated assets.
It appears even more paradoxical when considering how the importance of water, both as an environmental and social good, is cemented in various SDGs (not only the water-specific goals 6 and 14, but also goals 3, 11, 12 and 15), as well as in international protocols such as UNECE. Access to clean drinking water and sanitation has been recognised as a basic human right - in the UK and in France, for instance, it is against the law to disconnect an individual’s water supply, even if they are unable to pay their bills. Severe disruption to a water supply or steep tariff hikes can trigger social unrest or even a water war, as is reported to be brewing in South Africa.
As the SDGs suggest, good water management can create impact on many different fronts. High-quality water supply and effective waste water processing are vital for public health, which is why water companies tend to be strictly regulated. UK operators, such as United Utilities and Severn Trent, normally achieve over 99% of their regulatory target for water quality and are penalised for even marginal underperformances. The consequences of inadequate water treatment can be dire, such as in the case of Flint in the United States: the city’s water supply was contaminated with lead, making hundreds of people ill. While work to replace the lead-tainted pipes has proceeded, the State of Michigan has had to provide bottled water and filters to all residents.
On the environmental side, sustainable water sourcing can reduce the strain on aquifers, many of which are at risk of depletion due to over-use and adverse climate conditions. A leaky infrastructure, for example, taxes water resources unnecessarily and may also fail to meet overall demand. ‘Thirsty’ industrials add to the stress through their water-intensive operations and may engage environmental operators such as Suez to reduce their water footprints, eg through sustainable techniques such as water re-use and temporary withdrawal.
The decarbonisation impact of the water sector should not be overlooked, either: anaerobic treatment of wastewater captures methane, a greenhouse gas (GHG) that is up to 25 times more potent than CO2. Utilities generally use this biogas to ‘green’ their own energy consumption, or they may choose to feed it into the grid.
Utilities can leverage their sustainable practices by encouraging private households to consume responsibly, specifically by installing smart meters, offering rebates for efficient appliances and through consumer education. Environmental problems are best tackled from all angles and water companies are clearly in a position to bridge the supply and demand sides. Considering that few labelled bonds have, so far, addressed responsible consumption, more issuance by water operators could help fill this sustainability gap.
The devastation caused by a series of climate disasters last year made it clear that more funding is also needed for flood and drought protection. The green bond market has supported some important resilience projects so far. For example, NWB’s green bond channels finance to water authorities for flood controls in Holland, a country that is mostly under sea level. And, the city of Cape Town, which is facing its worst water shortage in 113 years, came to market with a largely water-focussed issue last year. British water operators may be motivated to follow suit since, due to the UK’s climate vulnerability, they are now required by law to implement adaptation strategies.
If water management is so critical, why haven’t we seen more labelled issuance?
This question has yet to be formally explored and, therefore, has to be answered somewhat speculatively. Decarbonisation has – rightfully - been dominating the environmental agenda, but it may also have eclipsed the criticality of water in investors’ minds. The exception is water risk in relation to corporate assets, which is more from an equity- rather than fixed-income perspective. Possibly a case in point is Anglian Water’s issue targeting GHG reductions in addition to climate adaptation. It is unclear whether this choice was based on perceived investor appetite or project availability.
Maintaining water infrastructure is capex-intensive and one of the prime reasons for utilities to raise debt. In the labelled market, it can be challenging to prove additionality, even when the use of proceeds extends beyond general maintenance. For example, Anglian Water’s bond was excluded from the Bloomberg Barclays MSCI Green Bond Index because it was deemed “business as usual”, since it, reportedly, didn’t exceed regulatory requirements. It seems that, in the ongoing debate about additionality, water companies do not have an intrinsic advantage over other market participants.
It could be argued that supporting the regulatory status quo is at least as important as additionality when it comes to essential goods and services - one just needs to imagine what a colossal market failure their absence, or even scarcity, can cause. A partnership led by the World Resources Institute (WRI) has looked at the bigger picture and developed an early warning system to forecast social instability, economic damage and cross-border migration as a result of water crises. This reinforces the view held by those water companies who consider all their infrastructure investments to be sustainability-related, despite that it is counter to current market narrative.
Whilst additionality is desirable for investors, they also demand a reasonable level of transparency and disclosure in order to demonstrate impact. Industry guidelines, such as ICMA’s (International Capital Market Association), propose reporting performance indicators for water management that come from quite different angles: operational indicators, such as annual water savings, and social indicators, such as number of beneficiaries reached. Depending on context, one category may be more meaningful than the other - or insignificant without the other - so issuers may view impact reporting in this area as somewhat ambiguous.
Reporting becomes even more complex when it comes to adaptation projects, eg drainage installations or physical barriers to protect against floods and landslides. These generate impact by preventing deaths and economic damage; however, something that has not yet occurred can only be estimated and few issuers will possess the necessary risk modelling tools. Proxies, such as metres of protection wall built, for example, are undeniably tangible and verifiable, but do not reveal the actual gains in resilience. As a result, many industry bodies such as the NPSI (Nordic Public Sector Issuers) keep their recommendations on this topic very high-level.
Issuers and investors most likely find carbon metrics comparatively easy to work with, even if carbon standards have yet to be harmonised. Nevertheless, while the metric CO2 emissions avoided has become industry best practice, particularly in the energy sector, the water sector has yet to follow suit with an equivalent. A number of harmonisation initiatives, such as the High-Level Expert Group on Sustainable Finance’s (HLEG) action plan for sustainable finance, are underway and may potentially give more concrete guidance. However, this is still on the distant horizon.
Sustainable water management deserves to be more than just a niche in the labelled bond market. It supports many critical ESG sectors but its value extends beyond impact diversity. As researchers and policy makers explore longer time horizons, and the nexus between social and environmental concerns, the importance of water for socio-economic stability is receiving more attention. For water operators in many countries, this is resulting in stricter regulation, which can only be a positive signal for ESG-conscious investors.
The US municipal bond market is just one indicator of the amount of potential issuance that remains, if not untapped, at least unlabelled. Both investors and issuers seem hesitant to expand this niche, possibly due to criteria around impact reporting and additionality – two of the pillars of the labelled market – remaining ambiguous. Although industry initiatives may bring more clarity in time, a change in narrative is also required in order for us to see more green issues that contain a hue of blue.
 Bloomberg data as of 31 March 2018
 Bloomberg data as of 31 March 2018