The water investment universe

China’s water pollution and scarcity issues create considerable risks and opportunities for both investors in China’s water sector and for companies with significant water exposure. There is greater clarity around the Chinese water sector, because of an increase in availability of information and interest from the investment community. There is still however little transparency when it comes to assessing industrial water-related risks. Investor interest has to a certain extent driven information, and as one of Asia Water Project’s advisors, IDFC Capital managing director Melissa Brown, explains investors have grasped the obvious opportunities in the water sector, but have not yet focused on the larger water-related risks of a nation grappling with water shortage. “China-focused investors have chosen to buy into a remarkably one-dimensional version of the investment picture,” states Brown, “by focusing on a small universe of so-called ’solution providers’ with little realistic understanding of the broad-based competitive impacts of the water policy challenge.”

The lack of transparency has been a long-standing concern for responsible investors, who appreciate the opportunities in China’s growing market offers but are cautious of the landmines that come with unknown terrain. And in the absence of meaningful regulations to encourage reporting on environmental issues, combined with the pressure for short-term profit, when Chinese companies do disclose, their reports often fail to cover potential material risks and do not facilitate in-depth investor analysis. For more discussion on corporate disclosure trends in China, click here.

For industrial water-intensive users, business risks can translate into risks to earnings from events such as unforecasted compensation payments following pollution incidents, increased cash flow volatility (such as when a plant suspends production from lack of water) and ’soft’ payments to local officials to approve plant construction or increased costs of water treatment from upstream discharges. We draw attention to the well-publicised case of Fountainset, and as recently as January 2010, the Chinese government fined a Zhejiang-based pharmaceutical company RMB 2.2 million ($322,200) for dumping more than 1,000 barrels of unprocessed, noxious waste in neighboring Anhui province in December 2009. According to a China Daily report¹, the chemical waste contains dichloromethane methanol and methane, which are categorized as hazardous waste chemicals under national regulations in China.

Acknowledging the complexity of China’s political landscape, an evolving regulatory framework, increasing water tariffs, and the growing number of public protests triggered by water pollution, experts advise that the only way for investors to navigate China’s rough waters is to actively engage companies in dialogue.

As the website develops, topics to be addressed will include:

• Investor due diligence and risk assessment;
• Trends in socially Responsible Investing: Water;
• Shareholder activism; and
• Technology.

For related reading, click here