Christine Loh

The plight of the Hong Kong- and Shanghai-listed Zijin Mining Group, China’s leading gold producer and major copper supplier, may have opened a new chapter for environmental protection. Between 4pm on July 3 and 2.30pm the following day, 9,100 cubic metres of waste water (nearly four Olympic-sized swimming pools) spewed from a blown-out tank at its copper smelter into the Ting River in Fujian province, killing 1,700 tonnes of fish and poisoning the river.

The company delayed disclosing the toxic spew for nine days. On July 12, it filed a notice to the Hong Kong and Shanghai exchanges but had the audacity to put the blame on rainfall – stating that the spill was primarily related to a natural disaster and “impossible to predict” – when the real cause was poor management of infrastructure facilities.

Under intense media attention, the company said it did not disclose the spill earlier because it didn’t want to cause alarm.

The poisoned waste water eventually washed downriver, and on July 16 a second leak of 500 cubic metres pushed copper levels up by two-thirds in the Guangdong section of the river. Guangdong banned fishing there and is considering a claim against the company, as is Fujian province.

Not surprisingly, the company’s stock price nosedived. The delayed disclosure became a media cause célèbre on the mainland. Reports showed that Zijin was previously a government-owned enterprise and still has close ties to the local government; officials hold Zijin shares, and many work for the company after leaving public service. Environmental groups were also highly critical of Zijin’s irresponsibility.

On July 19, the company finally apologised for the leak and acknowledged it was overconfident, lacked crisis awareness and did not “properly handle the balance between economic efficiency, ecological benefit and public interest”. On the same day, the China Securities Regulatory Commission, the securities regulator, issued a notice to investigate a breach of the rules concerning disclosure of information, since listed companies should disclose complete and accurate information on a timely basis.

Zijin’s story follows a well-trodden path. It first tried to hide and fudge, then claimed its silence was for good reason. Only when the problem was too big to disappear did it capitulate. A number of its executives have been detained, and three local government officials have been sacked.

Zijin has a history of environmental violations, according to official records. Yet, it was lauded by Forbes magazine last year as a candidate to enter its “Fab 50” list of Asia’s top private companies with the best long-term prospects. Only since the spill are investment analysts starting to report that the company’s low-cost and old mining methods pose significant environmental risks to investors. Before its fall, such inappropriate practices boosted profits, and investors and analysts didn’t seem to care. Now it is fashionable for them to talk about the importance of environmental protection and corporate social responsibility.

Zijin’s scandalous behaviour is not unusual on the mainland. Well-connected companies often ignore environmental and safety rules. How many similar accidents are waiting to happen? The central authorities seem to want to make Zijin the whipping boy as a warning to other businesses and government officials and to promote better governance and accountability.

Just as the Ministry of Environmental Protection is paying close attention to the case and the securities regulator is investigating the delayed disclosure, the Hong Kong stock exchange also has a role to play by demanding full and timely disclosure.

A group of 11 mainland non-governmental organisations have called on the Hong Kong stock exchange to play its part. Hong Kong NGOs, too, as well as our government and regulatory officials, should seize this opportunity for Hong Kong to take the lead in environmental governance – otherwise we will be out of step with the mainland.

July 2010

Published initially in the South China Morning Post. Reprinted with permission from the author.

All energy systems need water: extraction of coal, oil, natural gas, and uranium result in contamination of water tables and depletion of groundwater, thermal power requires water for steam generation or cooling, silicon solar panels use water in production, and perhaps the most obvious, water as feedstock for hydropower plants. Energy, on the other hand, is required to clean, purify, and distribute water as well as treat wastewater. Agriculture needs both energy and water to grow, process and distribute food. The links are obvious, the implications profound.

In a new report, The Food-Energy-Water Nexus: An Integrated Approach to Understanding China’s Resource Challenges, China and climate change analyst Julian Wong argues that in an increasingly resource constrained China, a holistic approach that recognizes trade-offs between food, energy and water is the future of natural resource management and the basis of a sustainable economy and national security policy.

AWP asks Julian Wong to define watergy, the links between water and energy, the challenges that China faces in managing its already scarce resources and the new role of agriculture.

AWP: What is “watergy” or the water-energy nexus, and how is it relevant to China?

The water-energy nexus recognizes the inextricable link between two physical systems critical to our survival—water and energy.  Simply put, the way we manage and use one system has profound consequences for the other because many forms of energy resources we tap into require the use and consumption of water, while our continued use of water requires much energy for extracting, cleaning and delivering it to our homes, factories or fields.

We should care about this because of the very real limits to freshwater and traditional energy sources.  In China, these shortages are particularly acute. China has 20% of the world’s population but just 7% of the world’s freshwater resources.  At the same time, it imports most of its oil and gas, and even its supposed vast coal resources will eventually run out.

AWP: How does food fit into the picture?

There are two additional elements to be considered in the watergy paradigm– food and climate change.  Food has strong interlinkages with watergy, which means that it will be affected by whatever happens to our water and energy systems.

The real kicker is what climate change will do to all three systems. We are already seeing how increased warming is drying out many parts of China and reducing water availability, which in turn impacts agriculture. It gets even more complicated as China turns to building massive water diversion channels to move water from the south to the thirsty north. Such massive construction requires equally massive amounts of energy and also bulldozes over precious farmland.

As oil becomes an increasingly scarce resource, and also as an attempt to mitigate its carbon emissions, biofuels is explored as an alternative. The mass production of biofuels, if China reaches this stage, will compete with food (if not directly in terms of using corn for fuel instead of food, then indirectly in terms of using arable land) and water supply.

AWP: How does the Chinese government view “watergy”? Are there existing policies that integrate water, food and energy issues?

Julian: Well, this is tough. This is not just a problem in China, but in fact everywhere.  No government I know effectively looks at these interlinkages, although that said, there is a bill in the current U.S. Congress that seeks to begin to examine the water-energy nexus.  But in reality, no government is addressing this issue in planning decisions.  For China, given both the kind of constraints to all three systems and their particular vulnerability to climate change, which exacerbates shortages in all three resources, the need to incorporate integrated planning is particularly urgent.  This is something the government needs to be paying attention to quickly.

AWP: In your report, The Food-Energy-Water Nexus, you mention that raising water prices can have the unintended effect of farmers reducing crop output or overexploiting groundwater, which is already a serious issue in North China. Then there’s the fear of social unrest. How can China establish an appropriate value for water?

Julian: The biggest challenge is cushioning the social disruption that comes with raising water prices in the agricultural sector from essentially zero to something significant enough to influence behavior.  Increasing water tariffs has the potential to provoke unrest among farmers, something that the Chinese authorities will be careful to manage.  The rural agricultural sector, let’s not forget, is the traditional political base of the ruling Party.

So there is no easy way to do this other than to phase in price increases gradually, but this must also be complemented by increased support given to farmers in other areas to offset the impact of heightened water costs.

AWP: You mention that revitalizing the agricultural sector can offset the impacts of urbanization which is exacting huge pressures on water and energy resources. Can you talk more about how this could happen?

Julian: Well there first needs to be a proof of concept.  What I am suggesting is that we should not accept as a given that the only way to boost economic productivity is by urbanization, which is where the minds of China’s planners seem to be.  Urbanization inevitably creates a demand for all sorts of things, not least building materials, commodities to build infrastructure, power and energy, water, etc. However, the scale of urbanization, some 300 million people over the next two decades or so moving from rural to urban areas, is simply staggering.

It is hard to imagine any scenario in which China’s resource limits are not tested.  If that’s the case, it is worth re-examining how economic wealth can continue to be created in the countryside, and what role agriculture can play in that.  Are there ways to boost yields and extend the lifecycles of the land?  But in the back of my mind is the question of whether it is fair to prevent the rural farmer from seeking the comforts of an urban lifestyle.  This leads me to wonder if there is a useful role for agriculture in urban environments.  This is one area that deserves further work.

AWP: Another recently released report says subsistence farming will play a vital role in helping low income countries adapt to climate change. Would this be something China can embrace?

Julian: This will probably be the path that Chinese agricultural communities will have to embrace in order to sustain their agricultural activities. This is already taking shape in certain places such as the Loess Plateau.  Industrial farming, like operations in the West, are just not going to be sustainable in the long run for anyone in a resource-constrained world.  Smaller farms will be more sustainable.

July 2010

Chris Nolan, BSR

In the wake of Zijin Mining Group Co.’s acid-laced waste spill in Shanghang, Fujian province on 3 July, investors, industry observers and non-governmental organizations may rightly ask, “Is this emblematic of a larger trend in the Chinese mining industry?” While this disaster was one of the industry’s worst spill in two years, it may be helpful to examine this accident within the context of the industry’s global environmental management trends to tease out its root causes.

Are environmental mining disasters becoming a thing of the past?

From exploration to mine closure, the global mining industry has no doubt come a long way over the past 20 years. International practices have evolved to reflect stakeholder concerns around environmental impacts and respond to increasingly stringent regulatory requirements in many countries. Environmental impact assessments (EIA) have become a feature process for companies and an increasing number of host countries require them to be completed before projects are approved– from Canada and Australia to the Philippines and Papua New Guinea. EIAs have also been enshrined in the Equator Principles, a voluntary set of standards for private sector banks to assess environmental risk in project financing.

Though vastly improved, the picture internationally remains mixed. Even when we look at some of the largest companies. It was only eight years ago, for example, when BHP Billiton, severed ties with Ok Tedi Mining Ltd, which was responsible for a tailings spill that cost Papua New Guinea tens of billions of dollars in environmental damage.

While clearly the industry in China is by no means alone in its environmental challenges, the global mining industry has at least taken and is continuing to take steps in the right direction. From a regulatory standpoint, the August 2007 “Circular on Environmental Protection Verification of Highly Polluting Industries to Further Standardize the Production and Management of Companies Applying for Public Listing or Refinancing” issued by China’s Ministry of Environmental Protection (MEP) and the 2003 law on environmental impact assessment were positive developments. However the industry has yet to demonstrate broad-based commitment to meeting and exceeding the standards put forth.

What are we to make of tailings management these days?

Though details of the disaster are still becoming known, one problem, in addition to apparent shortcomings in core environmental management systems, was a systematic failure with the tailings damn at Zijin’s Shanghang site. According to Leading Practice Sustainable Development Program, Tailings Management, a working group of experts from the Australian mining industry, a basic requirement of a tailings storage facility is to provide safe, stable and economical storage of tailings that present negligible public health and safety risks and low environmental impacts during operations. Best practice in tailings management requires a systematic, risk-based approach. Basic requirements and best practice were clearly not met on 3 July, despite the available knowledge of such practices and numerous downside risks that previous tailings failures painfully illustrate.

Tailings management only part of the picture

Internationally, responsible tailings management is only one part of what the global mining industry is slowly continuing to embrace, which is a more sustainable approach to mining. Though poor tailings management has a clear impact on a company’s bottom-line (see Zijin and the quest for materiality), the impetus for quality management is also tied to a company’s need for a social license to operate – something mining companies in China are simply not accustomed to seeking. To date, the global industry has taken some of the above mentioned steps because it was pushed to by external stakeholders. Such drivers of the growing commitment to sustainable mining are largely absent in China or not serious enough to ‘move’ the industry in a significant way.

Paired with operational shortcomings is the issue of ‘resource governance’. Resource governance – the administration of applicable laws and regulations that safeguard the public and the environment against negative impacts and maximize positive national benefits from resource development – establishes a baseline for minimum performance even in well regulated markets such as Australia. Companies must then go beyond this minimum baseline to achieve best practice.  In China, the regulatory authorities at the provincial and national levels appear to have failed to even enforce such a clear baseline for minimum performance.

The challenges clearly go beyond poor tailings management. The tailings damn failure in Shanghang does in fact point to a certain stagnation in the mining industry in China in relation to sustainability and responsible business practice. Some of the driving issues include:

• The lack of a well-enforced regulatory baseline for the industry,
• Company environmental management systems that have yet to embrace best practice and;
• The lack of external incentives (e.g. need for social license to operate) that pressure companies to adopt more sustainable approaches to mining

Better disclosure will help investors map the risks, but much more must be done before the bar is raised on performance standards in China’s mining industry. And if the above issues go unaddressed, the recent disaster will not be the last of its kind.

July 2010

Ma Jun, water expert and environmental advocate

In April this year, 35 Chinese NGOs, concerned about the growing number of heavy metal poisoning incidents in the provinces of Hunan, Shaanxi, Fujian, Jiangsu and Guangdong, initiated a dialogue with 27 of the world’s leading electronics companies. The NGOs were concerned that these companies’ supply chains were contributing to the dumping of heavy metals in China’s water bodies.

Since the campaign was launched, Ma Jun, director of the Institute of Public and Environmental Affairs, in collaboration with the NGO coalition, have traded emails and letters with companies such as Samsung, HP, Panasonic, Intel, Nokia, British Telecoms, Motorola, Vodafone, IBM. In June, the NGOs released a report detailing the responses the NGOs received from the companies.  A month later, partly in response to publicity generated by US based NGOs Pacific Environment and Business and Human Rights Resource Centre (BHRRC), some of the previously reticent companies began to engage the Chinese NGOs.

Of particular interest has been the Chinese government’s unspoken but clear support for the campaign– the launch of the first report was released at a seminar organised by the Environmental Protection magazine, a publication affiliated with the Ministry of Environmental Protection (MEP). The campaign was also extensively reported in Chinese media by CCTV, People’s Daily, China Daily and China Youth Daily. This tells us two things: First, that the government recognises the issue’s urgency; and second, that it will require support from a variety of stakeholders to resolve it. The coalition of NGOs, according to Ma Jun, has made it clear to the government that they are keen to assist in its efforts to control heavy metal pollution.

Ma Jun talks to AWP about the roots of this campaign, how it has gained ground and the next steps.

AWP:  How did the campaign start? And how has it escalated?

Ma Jun: The whole thing started when we were investigating a series of heavy metal pollution incidents. In September 2009, IPE met product manufacturers to discuss heavy metal pollution, and they were open about their links to brand name companies. When we approached one of their buyer brands, they told us that to review the environmental performance of 5,000 suppliers was too much of an effort for them.

It was clear that we needed more information to convince the brands to take this seriously. We went through IPE’s database to identify companies with heavy metal violations. We found mining companies, tanneries, smelters, chemical companies, and quite a few IT manufacturers. The IT companies (PCB and battery production) involved pretty serious cases. We found that many of these IT companies were suppliers to brand name companies, so we decided to push on ahead with a letter writing campaign targeting these global companies.

We had help from Pacific Environment and the Business and Human Rights Resource Centre, and we were able to mobilize more than 1,000 Chinese consumers to send letters to companies who did not respond to our letters. [Ed’s note: For the list of companies, click here.] Steve Jobs received 1,000 letters from Chinese consumers and hundreds more from Americans!

AWP: Why have the consumers taken so quickly to this campaign?

Ma Jun: Perhaps they understand the irony of the situation- that an industry focused on delivering information is lacking precisely this, information. Also, and this is only a guess, it could be that their attachment to these gadgets they use and carry around with them everyday makes this a personal issue.

AWP: Environmental violations are often committed by 2^nd tier suppliers, so brands are unaware of these companies. Considering the intricacies of the IT industry’s supply chain, how should companies drill down their supply chain?

Ma Jun: The first step is actually quite simple. Some of the companies we interacted with don’t know the official Chinese name of their suppliers. Which means that they have been unable to use our database to check if any of their suppliers are polluters.

The second step involves rethinking their supply chain management strategy. A good model to use is getting their 1^st tier suppliers to commit to addressing their environmental issues, and then reviewing their own supply chain. And the 2^nd tier supplier does the same. So you start to go deeper into the supply chain.

AWP: Which companies are moving forward? And which ones need more nudging?

Ma Jun: Both HP and Samsung, one of the first ones to respond, are moving fast– they are working to encourage their 1^st tier suppliers to review their own suppliers. Canon and IBM have also responded saying that they have reviewed their supply chain and are addressing the issue. The next step for these companies is to publicly disclose the problems and corrective actions they have taken.

They also need to begin building a system that will allow them to track the environmental performances of companies, rather than wait for NGOs to alert them. We don’t really want to do this! We don’t want to be seen as being anti-corporate or anti-development. We need these companies to make the products we all use.

AWP: What were the challenges to getting companies to respond?

Ma Jun: The secrecy in this industry means companies are less open to dialogue and exchange of information. The customer and supplier relationships are also different and more complex than other industries. Apple, for example, seems to have a policy of not issuing any comments on their suppliers. But they are no worse than others.

Across the board, the industry is secretive and not used to engaging with NGOs. From our experience, we see that “environmental commitments” of many IT companies is empty talk. They tell us that they have a supplier code of conduct that says that if their tier two suppliers have a problem, they will work with their tier one suppliers to solve this. But many don’t even know who their tier two suppliers are.

AWP: Is this fairly common that global companies will respond to Western NGOs before they speak to Chinese groups?

Ma Jun: Again I think this behavior is more pronounced with the IT industry. And also some of the Western NGOs have had more contact with this industry compared to Chinese NGOs, so it’s natural that the IT companies engage them first.

Then there’s also the fact that Chinese NGOs are less respected and trusted because many global companies don’t know many Chinese NGOs. We have much to do in this area. The companies need to communicate more with Chinese NGOs. And we NGOs need to make sure our work is science-based, professional and our overall attitude is collaborative.

AWP: What’s the next phase of the campaign?

Ma Jun: We are coming out with our third report in August which will document the communication with the brands, analyse the progress made and the gaps that still exist, and provide recommendations for corrective actions. This report will also form the basis for consumer initiatives. There’s still much to be done!

July 2010

Ina Pozon, AWP

When news first broke that Zijin Mining Group Co. (2899:HK; 601899:SH) was forced to shut down its copper plant in Shanghang, Fujian province, after a 2.4 million gallon toxic spill contaminated the local river and poisoned 2,000 metric tons of fish, the first question that investors asked was: Is this material? Meaning, will this hurt Zijin’s, China’s largest gold producer, ability to meet earnings expectations, expand current operations, or hurt their competitive position? Zijin’s already weakened stock price plunged 12% on July 13, the day after it announced the leak. The initial share price drop could not be read as much more than a quick change in momentum. Zijin, like most metals companies, is a highly cyclical stock and share price movements always reflect a diverse range of factors, not just the environment.

But in the week that followed, it became clear that the Chinese government was going to make an example of Zijin to show that the government was serious about the new environmental standards for commodity producers issued last year¹:

• July 14:  Three managing personnel² of Zijin’s copper plant have been detained. Shanghang county chief Qiu Heqing and top county environmental official Chen Junan were forced to resign.
• July 15:  China’s Fujian province indicated it would take legal action against government officials and executives of Zijin, according to a Xinhua news report. The company may be fined as much as 500m RMB for the pollution.³
• July 15: A nine-day delay in Zijin’s disclosure of the July 3 spill prompted the China Securities Regulatory Commission (CSRC) to investigate.

• July 16: Zijin announced its intention to invest 100m RMB (USD 15 million) in a water plant near the mine, in addition to 200m RMB it plans to spend on environmental and risk measures within a year as part of its restructuring plan after the incident⁴.
• July 20: Ministry of Environmental Protection officials in Guangdong issued an urgent notice to their colleagues in Fujian that the toxic leak at the Zijin copper plant had reached the lower reaches of the Tingjiang River in Guangdong.

One takeaway for investors here is the critical importance of disclosure. Zijin is now under investigation by the CSRC for its delay in disclosing the leak, which some investors have blamed for their financial losses as Zijin’s stock price nosedived. While this nine-day delay will bring sanctions against Zijin, the larger issue is the growing need to capture environmental risks in mainstream investment decision-making.

In the case of Zijin, there were enough indicators if investors knew where to look. Zijin has been cited for environmental violations every year since 2005. In March this year, the Asia Water Project released a report authored by the Institute of Public and Environmental Affairs (IPE) and Civic Exchange, which identified Zijin among the 175 companies listed on the Hong Kong Stock Exchange (HKEx) with environmental infraction records on the mainland. The report reveals that from 2005, Zijing Mining Group Co. has had a series of environmental violations and pollution incidents in Hebei, Xinjiang and Guizhou.

China’s Environmental Information Disclosure Measures (EIDM), passed in May 2008, require disclosure from companies that exceed national or local discharge standards, or exceed the total volume quota authorized by local governments, to be made within 30 days through the media. But as indicated in the report, Zijin failed to disclose environmental data relating to its violations in the years after the EIDM was passed. If Zijin had taken its obligations more seriously, and complied with the disclosure standards, it seems safe to assume that it would have addressed its environmental performance gaps more quickly and investors would not be struggling now to assess both this breakdown in trust and its implications for the company’s ability to gain needed regulatory support for continued growth.

Nearly two weeks after the first news piece on Zijin’s mining accident, the shares are beginning to recover. (See graph below.) Bloomberg’s graph tracking Zijin’s stock price, reveals that the lowest point was between the 16^th and 20^th July, at the height of the media coverage. The rebound is natural as there are investors now betting that all the bad news is out, that the worst is over and that from here on the company will be able to demonstrate their ability to manage the problems. It is interesting to note that investors seem encouraged by the promise of better management.

Source: http://www.bloomberg.com/apps/quote?ticker=2899:HK

Responsible investors often view events like this as a validation of the investment community’s growing concern about sustainability issues. But what is more interesting, although nothing new, is that this case tells us that when governments enforce regulations, both investors and companies respond, immediately. In Zijin’s case, the central government needed to step in given the close relationship between the local government and Zijin Mining. According to Xinhua News Agency, Zijin’s senior management is composed largely of former government officials. This is a common scenario—Zijin apparently accounted for 60% of the county’s total revenue in 2009.

So is this toxic spill “material”, in the sense that it will hurt Zijin’s ability to access capital and win government permits to expand operations? On July 28, the Shanghang government ordered Zijin to reduce its gold output by one ton. Is this material? The one ton reduction translates to RMB 254m– but compare this with Zijin’s profits which hit RMB 5.02b in 2009, and you see that it doesn’t account for much.

At the end of the day, it is this longer term positioning which is material, not the short-term price movements. Zijin’s promise to clean up not just the Shangshang spill, but their entire operations across China may help them avoid painful long-term government sanctions. But investors and civil society should know better than to take this at face value. Disclosure of relevant environmental performance data is critical for investors, and utilising this data even more so. Last July 23, eleven environmental non-governmental organizations from mainland China wrote to the Hong Kong Stock Exchange and the Shanghai Stock Exchange calling for greater disclosure⁵ from listed companies. To read the letter, click here. To read HK Stock Exchange’s response, click here.

Better disclosure will help investors map the risks, and maybe even raise the bar of performance standards in China’s mining industry.

July 2010

Jim Coburn, CERES

In February, the U.S. Securities and Exchange Commission (SEC) released the world’s first economy-wide guidance outlining climate change disclosure companies should be providing in financial filings.  The guidance, backed by SEC enforcement authority, is likely to improve reporting of climate risks and opportunities, including those related to water.  It’s an important first step towards standardized reporting of climate issues for the benefit of investors.  Moreover, it is expected to spur increased corporate scrutiny and disclosure of climate and water risks in overseas supply chains.

The SEC guidance was issued in response to petitions in 2007, 2008 and 2009 from investors representing $1.5 trillion in assets. The petitioners included 11 U.S. state and city treasurers and comptrollers, as well as the nation’s two largest public pension funds, CalPERS and CalSTRS.  The requests for guidance also received letters of support from 50 additional European and U.S. investors representing $6.5 trillion in assets.

The guidance covers regulatory risks and opportunities, such as the financial impacts of proposed climate legislation before the U.S. Congress and existing regional greenhouse gas (GHG) agreements.  It also covers physical risks—including impacts on water availability and quality—and indirect consequences of regulation or business trends, such as increased demand for lower-emitting products or decreased demand for goods that produce significant GHG emissions.

In addition, it clarifies how climate reporting fits into long-established SEC regulations requiring forward-looking disclosure of material environmental risks.  Companies should have been reporting these risks for years, but multiple reports released in the past few years show that corporate disclosure has been inadequate.¹

Water risks and supply chains

The SEC guidance calls attention to the impacts of climate change on water availability and quality, both in a corporation’s direct operations and in its supply chain:

• “There may be significant physical effects of climate change that have the potential to have a material effect on registrants [companies] . . . . . Changes in the availability or quality of water, or other natural resources on which the registrant’s business depends . . . can have material effects on companies.”²

• “Significant physical effects of climate change, such as . . . the arability of farmland, and water availability and quality, have the potential to affect a registrant’s operations and results.”³

• The guidance also notes that the physical effects of climate change “can impact a registrant’s personnel, physical assets, supply chain and distribution chain.”⁴

This focus on water impacts has been well received by investors concerned that water risks have been under-disclosed.  A 2010 Ceres study found that while many water-intensive companies publicly report some risk information, few reference specific at-risk operations or supply chains, and none attempt to quantify or monetize this exposure.

Because the SEC guidance mentions the strong links between climate change and water availability issues, it could lead to significant new reporting about water risks.  In its 2009 10-K filing, the Coca-Cola Company disclosed that ”water scarcity and poor quality could negatively impact the Coca-Cola system’s production costs and capacity” and stated that “climate change may also exacerbate water scarcity and cause a further deterioration of water quality in affected regions, which could limit water availability for our system’s bottling operations.”  In future filings, Coca-Cola and similarly situated companies may provide additional material information by highlighting specific geographies and operations facing higher levels of water risk.  For example, it is likely that high growth markets—like China and India—are precisely those areas where these risks are most significant.

Strengths and weaknesses of the guidance

The SEC should be commended for discussing the material risks from climate change in a fairly comprehensive fashion, addressing physical, regulatory, and indirect risks and opportunities.  The guidance is applicable to all sectors, an acknowledgement that adaptation risks could impact a wide range of industries and may have the most impact on companies with extensive global supply chains.  For high emitting sectors, the Commission pointed out that laws on all levels matter—local, national and international—so companies should consider all of them when calculating regulatory risks.

However, the guidance has potential shortcomings in two ways: first, disclosure is left up to the discretion of company management.  This means that the culture of a company and its attitude towards investors, transparency, and regulation in general could affect the quality of disclosure.  Failures to disclose material risks in SEC filings—as demonstrated by the financial sector before the subprime mortgage crisis—could potentially recur with climate change risks.

Second, because robust climate reporting depends on these corporate governance decisions, a strong investor-focused SEC is needed to enforce the guidance.  However, the SEC’s emphasis on enforcement has varied in the past depending upon the Chairman’s priorities, and will probably do so in the future.  Material climate risks are a serious problem which has arguably risen above the level of management discretion to disclose, and should be enshrined in new SEC rules with clear disclosure criteria.

Next steps for securities regulators

Although the SEC guidance is an important development and could embed climate risk management in many companies that never examined the issue before, additional guidance or rulemaking is needed.  Since the SEC’s mission is to protect investors, partly by ensuring that companies disclose material issues, new SEC action must keep investors’ needs at the forefront.

The SEC should look first to investors’ frameworks about the disclosure they require.  The Global Framework for Climate Risk Disclosure, created by investors in 2006, asks companies to disclose carbon-related emissions data and emissions management plans in securities filings.  The emissions data can be used by investors to assess regulatory risks, and the emissions management plans can be used to assess the quality of a company’s governance.  This type of standardized reporting is vital for helping investors compare companies within an industry.  Although the SEC guidance does not address these topics, new SEC action could.

Also, securities regulators in other countries, including China, should follow the SEC’s lead and issue guidance or rules related to climate change disclosure.  The Ontario Securities Commission is the first regulator poised to do this; the OSC has committed to issuing environmental disclosure guidance by December 2010.  However, the materiality of both climate and water risks dictates that other securities regulators should not adopt a wait-and-see stance, but should examine the SEC’s and OSC’s work now and plan similar moves.

Finally, securities regulators should look at water risks and opportunities in their own right, and not only in relation to climate change.  Investors are paying more attention to material water issues by filing shareholder resolutions with U.S. companies and supporting voluntary disclosure efforts.  In addition, 41 investors with approximately $1.4 trillion in assets wrote to the SEC in June 2009, asking the Commission to “require disclosure of material environmental, social, and governance (ESG) risks,” including water scarcity issues. Securities regulators should improve disclosure of water risks and opportunities by examining the adequacy of current reporting and determining if additional action is required.

Lindsay Cooper, fund manager

In 1996 Lindsay Cooper, James Alexandroff and Torquil McAlpine co-founded Arisaig Partners, a fund management company headquartered in Singapore with USD1.7 billion of funds under management.  The firm manages three long-only equities funds covering Asia (ex-Japan), Africa and Latin America, which are all focused on investments in listed dominant consumer companies.  As at the end of June 2010 approximately 40% of the Fund’s net asset value was in China-related holdings – c.22% in dominant F&B producers and c.18% in supermarket companies.

Arisaig Partners was the first fund management company to join the United Nations PRI initiative and has subsequently begun working with ESG specialists such as Singapore-based Responsible Research to help develop its knowledge of ESG issues and raise awareness of the challenges that these issues face with the management teams of the companies in which it invests. AWP interviews Lindsay Cooper on Arisaig’s exposure and management of water risks.

AWP:  What is the rationale behind focusing your investment strategy on dominant consumer companies?

Lindsay:  When we started Arisaig Partners we had a consumer staples bias to our investment strategy but we also invested in discretionary consumer companies providing education or healthcare services, as well as consumer related manufacturing businesses, finance businesses and property companies.  Through our years of experience and extensive back testing we believe that the companies best placed to deliver superior returns to investors are the dominant consumer staples companies – businesses with leading market positions, strong brands, and excellent distribution networks which all lead to strong cash generation to fuel organic growth or M&A expansion.  It’s taken twelve years to get here but these days only if a company (a) provides something that the emerging markets consumer can eat, drink, clean with, wear or shop in and (b) dominates that market, are we interested.

AWP:  What are the opportunities for the beverage industry in Asia?

Lindsay:  The opportunities for the leading players are huge.  Driven by favourable demographics and broad social tailwinds including urbanisation and increasing affluence, consumers in Asia’s developing markets are purchasing alcoholic and soft drinks at rates far exceeding developed markets.

An extract from Coca Cola’s 2008 annual report noted the scale of such social tailwinds in emerging markets: “Estimates show that over the next 12 years the worldwide population will grow by more than 800 million people. In addition, 1 billion new people will have entered the middle class, and nearly 900 million people will have migrated to urban centres.  That means more consumers with more money, who have the ability to purchase more ready-to-drink beverages.”  As far as branded beverage consumption is concerned, Asia is just getting started.

AWP:  How serious are the water risks facing the beverage industry in Asia?

Lindsay:  As highlighted in the Beverages in Asia report we commissioned Responsible Research to write, we believe water scarcity is the issue that will define the future of Asia’s beverage industry.  However, while most of the consumer companies in Asia are alive to the issue of water quality, it is generally only the multi-national companies that are acutely aware of the likelihood for water prices in regions such as China to rise and are hence focused on improving water usage efficiency.

AWP:  What are the key challenges/risks facing water intensive companies?

Lindsay:  Broadly speaking we believe that the beverage sector needs to mitigate water risks in five areas so that business performance and hence returns to investors are not negatively impacted:

1. Physical Risk:  Ability to secure a stable supply of good quality water to meet production needs would be foremost here.
2. Business Risk:  Many consumer companies should be factoring in higher water supply and treatment costs into their business models – particularly with respect to projections for cost of goods sold and capex requirements.
3. Regulatory Risk:  Companies should be alive to the potential for water consumption to be rationed in future and minimum efficiency standards increased with penalties for failing to do so.
4. Reputational Risk:  We recognise that companies who reduce water tables through over usage or whose waste pollutes water courses are increasingly likely to face severe negative reactions which could have a very damaging impact on consumer demand; this is particularly critical given that the products made by our portfolio companies are all sold in the same markets in which they are produced.
5. Litigation Risk:  It is in all our interests that judicial systems across Asia ensure that heavy environmental abusers are brought to task; given the growing pressure on current water supply across the region we would hope that there will be increased enforcement of environmental protection.

AWP:  How do you measure Arisaig’s vulnerability to water risks?

Lindsay:  Following on from the Beverages in Asia report we will be working to produce a checklist of questions which are investment research team can use when engaging with our holdings companies to examine the extent to which the risks outlined above – particularly with respect to water sourcing, water efficiency and wastage management – are being addressed.

AWP:  In your understanding, what are the key solutions that need to be taken on board by government and business to address the water problems?

Lindsay: We would advocate that governments force both stock exchanges and lenders to companies of a certain scale to ensure that such companies produce, together with their ESG policies and goals, key metrics with respect to a company’s water footprint which have to be included within the audited financial statements.  Maybe it’s because I used to be one but perhaps accountants can actually play a positive role in saving the planet here!  Hopefully the leading companies will get well ahead of the regulatory curve and potential laggards will be forced to stay on it.

AWP:  If you have engaged companies in dialogue regarding water, how open have they been to discussing water concerns?

Lindsay: The Beverages in Asia report was published in June and we have subsequently written letters highlighting issues raised by the report to the senior management teams of our holdings companies.  It will be interesting to see the reaction – particularly from those classified as laggards as a result of the benchmarking exercise.  Hopefully by pointing such companies towards peers who have taken a lead in these matters and by introducing third party ESG specialists to the more receptive management teams we will see improvements.  Already at least two companies in our universe have taken their low scores to heart and are in discussions with a third party to help them address issues raised.

AWP:  How does Arisaig plan to incorporate consideration of ESG issues into its investment research in the future?

Lindsay:  Following on from the Beverages in Asia report, we have commissioned Responsible Research to produce a report exploring ESG disclosure amongst our universe of food producers in Asia, which we hope will be completed in September.  We also intend re-do the ESG benchmarking exercise for our portfolio companies on an annual basis to determine if positive developments are happening.  Finally, we are in discussions to add a new member to the research team who will be responsible for assessing ESG considerations across our Asia, Africa and Latam funds.

AWP:  To what extent have your investors commented on Arisaig’s increased emphasis on ESG considerations within its investment research?

Lindsay:  Interestingly, although ESG issues were never raised by investors prior to us disclosing that we had joined the UN’s PRI initiative, since we have done so, the reaction has been extremely positive and supportive.  I get the sense that investors are increasingly keen for their fund managers to factor ESG considerations into their investment analysis because we have started to see this becoming an area of meaningful due diligence for potential clients.  I think that many of the larger, more sophisticated, publicly accountable sources of capital (e.g. sovereign wealth funds, superannuation funds, endowment funds etc.) increasingly recognise that ESG issues are genuine investment risks and therefore they would like to see their fund managers at least having an appreciation of them, and perhaps, for firms like Arisaig who have long-term holding periods, see those managers quantifying the risks and pointing company management teams towards best practices, thereby de-risking the portfolios.

Emil Efthimides, Bloomberg

Bloomberg chairman Peter Grauer, at the recent Responsible Investors conference n New York, staked Bloomberg’s role in driving responsible investment. The media group, Grauer was quoted as saying, will work towards integrating Environment Social and Governance (ESG) issues into the “decision-making process of the capital markets.”

In 2009, Bloomberg bought environmental data provider New Energy Finance and released the ESG Disclosure Score– a tool that ranks a company’s ESG disclosure. The score ranges from 0 for companies that do not disclose ESG data to 100 for those that disclose every datapoint collected by Bloomberg. Each datapoint is weighted in terms of importance and also tailored to industry sectors. Its most recent scoring was released this March 2010. The tool contains data on water such as water consumption, wastewater, discharges, and water intensity.

Will Bloomberg pushing ESG convince investors of ESG’s value? Will this change the face of investing? AWP interviews Bloomberg’s ESG data manager Emil Efthimides, who explains that the next challenge is tackling the disclosure gaps revealed by their ESG Disclosure Score.

AWP:  How does Bloomberg see its role in driving the trend towards responsible investing?

Emil: As a financial data provider Bloomberg makes available raw data which money managers and analysts use every day in making investment decisions.  By adding ESG data to our platform we add new, different and important metrics to the standard arsenal of financial ratios and measures, which our users have at their disposal.  It is said that financial statements provide about 20% of the relevant information on a company.  ESG measures seek to cover the remaining 80% of extra-financial data.  It can help distinguish two companies which are very similar financially, but which may have significant differences in their carbon footprint, workforce practices and board of directors’ policies.  All of these may not be reflected in the company’s current financials but could significantly affect its future outlook.

A year ago, on July 1, 2009, Bloomberg launched its ESG product.  We now have the raw data of ESG for companies around the world; we know which companies disclose and which do not.  We also know there are many gaps in the data.  Very few countries require mandatory disclosure.  Our next challenge is to fill in those blanks, by aggressively contacting companies with our survey, and by considering ways to evaluate even those companies that refuse to disclose.

AWP: How do you view the ESG disclosure trend?

Emil: We envision ESG disclosure only growing in coming years.  In the one year that we have been researching ESG, we have seen public awareness of ESG issues increase and along with it pressure on companies to disclose ESG data. Projecting this trend into the future we expect the current universe of 3,500 companies that disclose ESG data to grow exponentially going forward.

AWP: What are the main challenges to disclosure?

Emil: The main obstacle to disclosure is that it is not mandated by law in most countries. Where we have excellent disclosure, as in Japan, it is because the government requires it.  That said, the trend is in our favor.  For example, in the United States the Securities and Exchange Commission issued guidance on Jan. 27 requiring disclosure by companies of any climate-related impacts on their business.  Although this measure does not require disclosure of specific items such as greenhouse gas emissions, it is a move in the right direction.

AWP: What are the challenges in standardizing ESG data?

Emil: Because disclosure is not mandated, companies disclose as they see fit.  Chances are that if it does not make them look good they will not disclose.  As a result many data points are reported differently by different companies.  Ultimately it is up to our analysts’ judgment to include or exclude a particular disclosure, and our analysts by now have looked at hundreds if not thousands of company reports.

AWP: Are there are issues with the end users of the data?

Emil: There are two distinct groups among Bloomberg users.  The core group of users for ESG data is the traditional SRI or socially responsible investor.  They are familiar with ESG, have been using it for years in their investment process and are enthused about Bloomberg entering this space.  Beyond that group is the mainstream investor.  We see Bloomberg’s role as helping to bridge the divide between SRI and mainstream.  We have done that by integrating ESG data into all the Bloomberg analytics.  When you screen data on our Equity screener (the EQS function) or relative value screener (RV) or when you download data from the Bloomberg to your proprietary Excel model, you can use the 114 ESG data points and 62 ESG ratios right alongside all our other price data, fundamental data, financial ratios and anything else on our database.  Through a sales campaign we have reached out to all our users to let them know ESG is on the terminal.  We want to be at the forefront of ESG data integration, and think it is quickly going from niche to mainstream.

AWP: Of the three, which data (environmental, social and governance) is most difficult to procure and standardise?

Emil: Social data is hard to come by.  This is information on a company’s workforce, and companies are very cautious to release this.  We look for data on employee turnover, workforce accidents, the existence of policies on health and safety.  We understand a company’s sensitivities about releasing this information, and we realize that short of a regulatory requirement to disclose we will continue to face hurdles.

As for standardization, emissions data can be disclosed in a variety of units of measure.  More importantly, we need to have data for the consolidated company as a whole, and often companies disclose a patchwork of local and country data.  Again, it is up to our analysts to decide what to take in and what to leave out.  If the national regulatory bodies ever require standardized disclosure of emissions data, it would take a lot of the fun out of our work!

Josephine Wu, fund manager

China’s water sector is weighed down by the huge need for water and wastewater infrastructure. While the Chinese government recognises the urgency of the water crisis, investment in water facilities continues to lag behind other sectors: Of China’s US 130bn stimulus package in 2009, water was allocated only 9% of the pie. But with the increasing prioritisation of water– also seen in the proposed 12th Five-Year Plan that promises RMB 75bn to build sewage treatment plants–private investors see opportunity. AWP asks Josephine Wu, a veteran investor in the region’s water, if China’s blue water is turning gold.

AWP: Many in the investment community are hesitant to go into the China’s water sector citing issues such as corruption, protectionism, lack of guarantee on returns, and low tariffs. Are any of these issues a deal-breaker for you?

Josephine: China is still an emerging market, so there certainly are inefficiencies in the market. The water sector, specifically, has been a very fragmented and policy-driven sector.  A real concern for me is the lack of transparency and disclosure in terms of the water pricing mechanism. The local governments dictate pricing sometimes without being able to present a valid (and believable) argument. There is also the lack of decent size companies to invest in, companies that have the right governance structures and business models. The majority of the listed companies tend to be small to mid-cap.

But as an investment manager, you understand that there are no guarantees, and therefore you need to strike that balance between risks and rewards. I believe in taking calculated risks– backed by extensive due diligence and constant dialogue with industry experts of countries I invest in. China’s water sector still provides a lot of opportunities, if you know where to look and what to expect.

AWP: Focusing on allegations of China’s “protectionist” tendencies in the water sector, do you think that the current model of public–private partnerships is good for China?

Josephine: Because water is a very important resource and a scarce commodity without any substitute, China will continue to focus on protectionism. The current model of public-private partnership has been running for many years and most foreign companies have accepted the fact that they will have to play by the rules and partner up with Chinese firms to get into the market.  Veolia spent more than 10 years in China before they finally started making money.

In the short term, foreign players with solid experience in wastewater and water supply should have access to juicy management contracts with smaller Chinese firms. In the longer-term, companies with advanced water technologies will flourish in China, and in the region.

AWP: How do you understand the issues around tariff setting?

Josephine: Tariffs in China are among the lowest in the world. However due to sensitive issues around CPI inflation, harmonious society policy by the central government, and farmers being the biggest user of water in China, it is difficult to have one-time tariff adjustment across the board. But provinces and cities, specifically the wealthier ones, are now allowed to adjust their tariffs. This tells us that China’s water price will go up eventually, along with the economic development of different provinces.

AWP: What are the common misconceptions that investors have about China’s water sector?

Josephine: I find it very interesting that investors believe that the sewage business is the most profitable or holds the most potential. When in fact, one only has to look at the annual returns of these companies to see that this is far from the truth. Collecting money from government is always difficult and delayed. In addition, any tariffs hike won’t benefit sewage operators as most of these projects are BOT projects, which means the internal rate of return has been determined at the time when contracts are signed.  Also, investors should be focusing on utilization rates on the capacity rather than the pure increment of the capacity, because in the long run, companies are paid on utilisation rates not on capacity installed.

AWP: How should investors set out to play in China’s water sector?

Josephine: Investors need to adjust their expectations when looking at the China water market. And they have to look very carefully at how the water sector value chain works in the different provinces rather than looking at the sector as a whole, because the water sector is still driven by local provincial policies or approvals rather than by central government decisions.

Fundamentally, investors need to understand that water is a long-term commitment and not a quick turn-around money-making sector. I tend to invest in companies that are vertically integrated, asset acquisitions based and least account receivables, as they will benefit from the continued growth of the water sector on a long term basis.

Ina Pozon

1. The water issue needs a re-think

You know an issue has hit the proverbial wall when experts call for a paradigm shift. The current thinking is deemed inadequate to meet existing problems, and only an overhaul of the framework will do. We saw this ten years ago, when energy and climate experts began debating the outlines of a “new energy paradigm.” At this year’s Singapore International Water Week (SIWW), experts called for a “water governance makeover.”

Urbanisation is the new stressor in the mix. Migration from rural to urban areas has increasingly become the context for discussing water, and other environmental and social issues. According to the UN, by 2030 Asia will host 63% of the world’s urban population. The crowding of urban areas as well as the increasingly demanding lifestyles of city dwellers means that cities need to be built differently. The cities of the future are not just infrastructure, but complex living ecosystems. And water its sustaining lifeblood.

Arjun Thapan, special advisor to Asia Development Bank (ADB) president, stresses that with Asia’s growing water concerns, where demand outstrips supply, a transformational water paradigm is critical. What does this new paradigm involve? Thapan says inclusiveness needs to be at the center of this transformation: Because water is a local issue, the agenda will have to be informed by local stakeholders. There is also the importance of increased private sector involvement, a water price that reflects water’s real value, and planning that recognises the interdependence between food, water and energy.

These recommendations are not new per se; what Thapan refers to as “new water governance” is the integration of these elements –opposed to the usual practice of cherry picking from a slew of solutions. The problem with water, says Thapan, is at the stage where a wholistic approach is key if we are to avoid massive “social and economic disruption in our way of life.”

(Coming soon: AWP interviews Arjun Thapan on the outlines of Asia’s water governance).

2. Water’s Cinderella story

The perennial question: Why isn’t more funding being pumped into the water sector? Why in spite of all the brokerage firms pushing sell on blue-gold investments, the water sector remains the “Cinderella of all sectors”– ignored, undervalued, and yet brimming with potential.

According to experts present at SIWW, finance is not an obstacle to building (and re-building) Asia’s water sector. Looking beyond the public sector, there is a range of funding sources that are a good fit for water sector investments such as infrastructure funds, pensions funds, private equity, venture capital, and financial institutions.

The real issue, according to the experts, is that risk metrics have not been aligned to allow the private sector to move in with confidence. This concern lays much of the blame or credit on government– does the government have the ability to guarantee that a project will move forward even in the face of local community concerns or local government politics? Can the government ensure a “right” price for water is mandated to allow a return on investment? Managing risks is essentially asking if government can guarantee the right environment for business to invest in water.

Unfortunately the risk metrics question also gets at the heart of the water debate– what is government’s role in water provision? And the inevitable follow-up question– what is business’? And we know how this debate spirals…

3. Context, context, context

A water footprint is a number that tells you how much water has gone into the production of a good or service. While it has it uses in helping a consumer understand how water-intensive a product is (which may or may not sway one’s purchasing decision), it falls short on presenting the risks of where that water is sourced and used i.e. the local context.

Coca-Cola’s director for Water Stewardship, Greg Koch, explains during a session at SIWW, how water management is not just about water use but, more importantly, about context. Where is the water used? What proportion does this represent of the entire resource in the area? Does its use present risks to the environment, community or to business?

While a number may seem a convenient tool to help us understand water use– and it is a good first step– ignoring local context means that water risks are not correctly assessed and can lead to conflicts later on. An example: Coke and Pepsi Cola’s ongoing conflict with the Kerala government over accusations of company plants’ over-extraction of water and pollution.

4. Where’s the beef?

The links between water and food security were made repeatedly at the SIWW. We understand that because most of our planet’s resources are used for food, decline in water quantity and quality bring risks to the agricultural sector. In China, recently we saw how the droughts in the South have affected tea, coffee, sugar, potato, and rapeseed production.

With water being an integral component of agriculture, why the obvious absence of food producers at the SIWW?

5. On an optimistic note: The Yellow River Conservancy Commission (YRCC) won this year’s Lee Kuan Yew Water Prize.

The Lee Kuan Yew water prize recognizes contributions towards solving global water problems through application of technologies or implementing of policies and programmes. This year, the Lee Kuan Yew Water Prize Council recognised YRCC’s integrated water allocation programme, which balances water availability with social, economic and ecological developments. Along with improved and reliable supply of water, large areas of wetlands and biodiversity in the Yellow River Delta have also been restored as a result.

Another key feature is YRCC’s inclusiveness policy: with nine provinces and regions along the 5,464-kilometres long river, YRCC adopts a consultative approach to secure the support of the provincial governments and the people for its water allocation initiatives, thus preventing abuse and over-exploitation of water resources.

One wonders why the YRCC won this year’s prize considering reports on Yellow River’s increasing pollution and recent flooding. The answer is reflected in the YRCC’s commissioner’s speech: “The YRCC is deeply honoured to receive the Lee Kuan Yew Water Prize for our efforts in revitalising the Yellow River. We recognise that more can be done to enhance the ecosystem along a river that plays such a vital role in China’s economic development and holds an important position in the hearts of its people. This endorsement reaffirms our long-term commitment to nurturing and improving the quality of life along the river through sustainable river management strategies,” said Li Guoying, Commissioner, YRCC.

We need to applaud every effort from China. In a country that thrives on competition and imitation, recognizing YRCC could very well push other governments in interesting places.

July 2010