United States
    Environmental Protection
    Agency
EPA 817-S-14-001
September 2014
RISKS & RESILIENCE:
Considering the Integration of Climate
Readiness into Financial Analyses of
Drinking Water & Wastewater Utilities
             CLIMATE READY
                WATER UTILITIES
                       &ER&

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                                     Table of Contents
Issue Overview	2
Description of the Risks & Resilience Stakeholder Process	3
Summary of Findings from the Risks & Resilience Stakeholder Process	4
Water Sector Perception and Management of Climate Risk	5
Financial Sector Perception and Accounting of Climate Risk	5
Opportunities for Future Discussion	6
Path Forward: Potential Venues and Mechanisms for Further Discussion	9
Attachment A: List of Participants	11
         Prepared for the U.S. Environmental Protection Agency under contract EP-C-10-060

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                                          Issue Overview

Climate change projections indicate a range of potential impacts that could affect drinking water and
wastewater utilities (water sector) including rising temperatures, shifting precipitation patterns, rising
sea level and more frequent extreme flood and drought events. As these trends play out on regional and
local scales, they could exacerbate existing challenges the water sector faces such as accessing adequate
and quality water supplies, maintaining infrastructure and managing water demand. Such challenges are
reflective of the variety of climate risks that may affect water utility operations and financial health.

Drinking water and wastewater utilities currently manage a wide range of risks in operations
management and long-term planning. The risk posed by potential climate change impacts is an emerging
issue that some utilities are beginning to address. For utilities in parts of the country experiencing
environmental changes, climate risk is becoming an increasingly prominent concern.1 This growing
concern  is focusing attention on strategies for managing both direct and indirect (i.e., economic or
demographic shifts that cause changes in revenue base) climate risks. Some utilities are already taking
proactive steps to adapt their operations to account for climate change impacts while others are just
beginning to view climate change as a noteworthy risk. Understanding the trade-offs involved  with
managing climate risk and adapting to climate change could help bolster utilities' pursuit of climate
readiness and capacity for effective utility management.2

For investors who purchase utilities' debt obligations, evaluation of a utility's operational risks as they
relate to the probability of defaulting on debt repayment, typically over a 5- to 30-year timespan, is
critical to the credit assessment process and their ability to make financially sound investments.
Currently, climate risk and readiness  do not have their own metrics in credit rating methodologies (or
other types of financial analysis), but are potentially assessed indirectly through other metrics. If market
actors eventually determine that climate change impacts pose a threat to water utilities' financial
standing or solvency, analyses of water and wastewater credit worthiness by the financial sector could
be affected more directly.
 Climate risk, in the context of this dialogue process, was defined as the anticipated vulnerability of existing systems and
services to climate impacts and consequences of these impacts to maintaining safe drinking water and clean water services.
These risks include, but are not limited to public health, financial, regulatory, community, regional and other consequences
related to operational challenges, natural disasters and hydrologic changes driven by changing climate conditions.
2 The U.S. EPA's Climate Ready Water Utilities (CRWU) initiative defines climate ready water utilities as those drinking water,
wastewater and stormwater utilities that are engaged in the process of: conducting activities to better understand their climate
risks; planning to address climate impacts; and implementing adaptation measures to reduce the consequences of climate
change. For more background on EPA's CRWU initiative, see: www.epa.gov/climatereadyutilities. For more information about
EPA's program on effective utility management, see: http://water.epa.gov/infrastructure/sustain/watereum.cfm.

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Wastewater Utilities                                                                                    2

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Description of the Risks & Resilience Stakeholder Process

The U.S. Environmental Protection Agency (EPA), under its Climate Ready Water Utilities (CRWU)
initiative3, invited representatives from water sector utilities, water associations and financial
institutions to participate in a discussion about whether or how water sector utility climate readiness
might be reflected in credit or bond ratings, and other financial analyses (see Attachment 1 for a list of
participants' organizations). This was a strictly exploratory process intended to foster information
sharing and learning between the two sectors. Although many key groups were represented, some
important stakeholder groups not involved in the dialogue include small water and wastewater utilities
(those typically not able to issue bonds), representatives from State Revolving Funds and bond counsel.

Discussions launched in September 2013 with an initial webinar to review the proposed process and
identify priority discussion topics. The project planning team4 subsequently interviewed a selection of
participants to identify key issues and questions, elicit topics of interest and gather input regarding
useful  outcomes. Those interviews informed the development of the agenda for a November 2013 in-
person meeting in Denver, Colorado. Participants, including  representatives from credit rating agencies,
investment firms, water and wastewater utilities and water  associations, shared views on perceptions
and management of climate risk within the water and financial sectors. The group also discussed the
appropriateness and feasibility of integrating information  about climate readiness into credit
assessment and other financial analyses of water and wastewater utilities through quantitative and
qualitative means.

The discussions in Denver made it clear that climate readiness is not currently a significant factor in the
assessment of water sector utility credit worthiness by the financial sector. Based on that key outcome
and feedback from participating stakeholders, the project team shifted focus to generating this
document, which is intended to synthesize input and lessons learned from stakeholder discussions and
summarize the current state of the issues. With the completion of this document, EPA will conclude its
role as the convener of the Risks & Resilience stakeholder process. The balance of this document
summarizes the following aspects of climate risk and financial analysis of water and wastewater utilities
explored through the process:

      Water Sector Perception and Management of Climate Risk.
      Financial Sector Perception and Accounting of Climate Risk.
      Opportunities for Future Discussion.
      Path Forward: Potential Venues and Mechanisms for Further Discussion.
3 EPA's CRWU initiative's mission is to provide the water sector (drinking water, wastewater and stormwater utilities) with the
practical tools, training, and technical assistance needed to adapt to climate change by promoting a clear understanding of
climate science and adaptation options.
4 The project team included staff from EPA's Climate Ready Water Utilities program, Ceres, Computer Sciences Corporation
(CSC), and Meridian Institute.

Risks & Resilience: Considering the Integration of Climate Readiness into Financial Analyses of Drinking Water and
Wastewater Utilities                                                                                 '.

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  Summary of Findings from the Risks & Resilience Stakeholder Process
     Climate change has the potential to exacerbate risks water sector utilities traditionally manage
      and present long term planning challenges. Utility preparations for and adaptive responses to
      climate change will be reflected in planning efforts, level of service objectives, operating and
      capital improvement budgets and financial plans. Financial analyses of a utility's credit
      worthiness consider these factors, but are primarily focused on the probability of default on
      debt obligations.
     The development of commonly applicable quantitative metrics to measure climate readiness is
      premature at this time and may not be statistically possible because of the uncertainty of
      climate science and the place based differences of climate impacts.
     Markets and investor decision making are currently driven more by immediate economic and
      political circumstances than by longer term factors such as climate change. Credit rating
      agencies indicated that criteria such as global economic trends, community employment trends
      and local politics are more influential with regard to utility risk assessment for bond ratings.
     It is extremely difficult to definitively attribute observed local changes in weather and climate
      patterns to climate change. Utilities have to manage considerable uncertainty specific to their
      local or regional geographic context when making long term decisions to prepare for potential
      future climate change impacts.
     Water sector utilities plan, design and build facilities that generally have useful lives of 50 years
      or more, whereas credit rating agencies are concerned with evaluating a utility's relative risk of
      default on its outstanding debt, typically over a 5 year to 30 year period.
     Water sector and financial sector professional associations can work together to: a) advance
      discussion of these important issues; b) promote sharing of information and  experience
      regarding how others are addressing these issues; and c) determine if, when, and in what form,
      qualitative or quantitative factors can be established to help both sectors achieve their
      objectives.
     Participants identified the following four opportunity areas for potential future cross sector
      discussion:
      1)  Explore Mechanisms to Share Qualitative Information: Identify appropriate mechanisms
          for water utilities to transmit qualitative information about their application of climate
          science and associated adaptation measures to credit rating agencies and investors.
      2)  Clarify Existing Ratings Factors: Identify existing factors used in credit ratings that may be
          affected by climate change impacts and how they could influence overall ratings.
      3)  Understand Time Horizons: Share information and insights about the time horizons used by
          water  utilities in capital planning, the horizons that influence financial analyses and the
          horizons used to study climate change.
      4)  Examine Decision Triggers: Share additional information and insights about the factors and
          thresholds that trigger important decisions in both sectors.
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Water Sector Perception and Management of Climate Risk

Adaptive management is central to utilities' risk management strategy, since the possibility of changing
circumstances (including both a shifting climate and increased regulatory obligations) in the longer-term
requires flexibility in near-term planning. Utility managers already integrate a wide range of
uncertainties into long-term planning, including projected population changes, water supply and
demand, infrastructure demands and rate adjustments to meet operational needs. Many of these risks
may be exacerbated or otherwise influenced by regional or local climate change impacts. Direct and
indirect impacts that could affect water and wastewater utilities include, but are not necessarily limited
to:5

      Changes in service demand due to demographic shifts (migration away from coasts to inland
        locations, migration due to heat and supply shortages).
      Changes in water quantity (drought-induced  water shortages,  reduced groundwater recharge,
        influx from flooding, changes in runoff patterns, snowpack depletion).
      Changes in water quality (saltwater intrusion, flooding or increased turbidity resulting in
        potential regulatory and permitting compliance issues).
      Increasing damage to infrastructure from wildfire impacts and stronger, more frequent storm
        events, among others.

Preparing for and responding to changing conditions influenced by climate may result in increased
operating and capital costs, which will have implications for utilities' long-term financial planning and
considerations of service affordability. Long-term planning is also complicated by the uncertainty about
the magnitude of climate risks as well as the possible timing of impacts relative to the life of assets and
the duration of loans.  Utilities face an ongoing challenge in striking a balance between debt financing for
near-term expenditures (e.g.,  regulatory compliance) and  longer-term investments (e.g., upgrading
facilities). As they move forward with adapting to climate change, utilities will also need to consider how
future climate change impacts might  affect vulnerable assets (e.g., coastal assets threatened by sea level
rise or storm surge) and what technologies or adaptation strategies are available to protect them.

Financial Sector Perception  and Accounting of Climate Risk

Critical drivers behind investor decision making include likelihood of repayment, pricing, and liquidity, in
addition to the market environment on  the day a bond is issued, the size of a bond, and the diversity
and strength of the issuer's economy. Credit ratings are determined based on the extent to which a
particular action or set of behaviors will increase or decrease the probability of default. At present, the
immediate political and economic circumstances of a utility's community play a much more significant
role in credit assessment and investor decisions than long-term, uncertain risks like climate change
impacts. Credit rating  agencies (CRAs) are only likely to integrate metrics that reflect climate risk into
ratings if and when available data show that they have a material effect on utilities' probability of
 U.S. Global Change Research Program. Global Change Impacts in the United States (Second National Climate Assessment).
2009. http://www.globalchange.gov/what-we-do/assessment/previous-assessments/global-climate-change-impacts-in-the-us-
2009 (accessed Aug 30, 2013)

Risks & Resilience: Considering the Integration of Climate Readiness into Financial Analyses of Drinking Water and
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default. In addition, since drawing causal links between climate change and specific weather events or
natural disasters is extremely difficult, attempting to analyze climate readiness as a standalone credit
assessment metric may be inappropriate.

The development of commonly applicable quantitative metrics to measure climate readiness is
premature at this time and may not be statistically possible because of the uncertainty of climate
science and the place-based differences of climate impacts. However, certain actors in the financial
sector have interest in obtaining qualitative information about utilities' climate adaptation efforts.  Each
CRA considers qualitative data  provided by water and wastewater utilities differently, but generally
CRAs do incorporate it into their assessment of probability of default and the final ratings they issue. In
addition, CRAs have the leeway to maintain ratings based on qualitative information about capital
investment decisions. Thoughtful, well planned, investments in climate readiness could be viewed by
CRAs as credit neutral  or even credit positive. However, utilities need to be careful about expending
their reserve funds in pursuit of climate readiness (or any other capital programs) if the long-term
benefit does not clearly offset the potential for reductions in liquidity or higher debt levels.

Therefore, voluntarily sharing information about steps to proactively manage risks, climate or otherwise,
can help a utility build shared understanding with a rating agency regarding the purpose of their capital
expenditures.  For example, providing a thorough explanation of the rationale for a large capital
campaign to harden infrastructure against storm damage could alleviate concerns a CRA may have
about the effect of the campaign on a utility's financial portfolio.  There is also a small  but growing
segment of investors interested in supporting sustainable enterprises,  who pay particular attention to
environmental, social and corporate governance (ESG) variables.  ESG investors represent another
audience for proactive utilities  to transmit qualitative information about their climate adaptation
activities.

Opportunities for Future Discussion

The following section highlights four areas that came to the forefront during this process and represent
opportunities for other parties to convene future discussions.

Opportunity 1) Explore Mechanisms to Share Qualitative Information: Identify appropriate
mechanisms for water utilities to transmit qualitative information about their application of climate
science and associated adaptation measures to credit rating agencies and investors.

Rating agencies, financial analysts and investors actively consider qualitative information regarding
utilities' rationale for significant capital expenditures, including climate adaptation projects. Information
about climate adaptation efforts may be of particular interest to ESG investors who want to gain a
better understanding of how utilities are addressing climate risk in their capital planning and operations
management.  Utilities can describe risk management activities such as redundancy planning, hardening
infrastructure and emergency preparedness in official disclosures, but  are limited in drawing specific
conclusions regarding what those actions might mean for their level of climate readiness. Utilities can
and do currently use their websites to convey important information about their operations and long-
term planning processes related to climate change. There may also be  opportunities for utilities to
convey qualitative information directly to investors in forums such as non-deal-related investor
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roadshows, or in fact sheets or other descriptive pieces that some investors use to assess bond issuers'
ESG profiles. Collaborating with the financial sector to identify appropriate ways to communicate
qualitative information now could benefit the water sector over the long-term, if and when climate risk
becomes a significant concern in financial analysis.

Specific questions that could inform future discussion regarding the communication of qualitative
information about water sector climate adaptation efforts include:
    1)   Are there examples from other sectors regarding the sharing of qualitative information relevant
        to the management of operational and financial risk that could be instructive for drinking water
        and wastewater utilities? If so, what effect did sharing that information have on the credit
        assessment process for those entities?
    2)   Are there certain investors (e.g., ESG investors) looking for information beyond that which
        utilities already provide?  If so, how and when can utilities communicate the desired
        information?
    3)   How are utilities currently reporting management activities they are undertaking to evaluate,
        assess and respond to known or potential but uncertain climate change impacts? Is there an
        opportunity to improve how that information is translated for the purpose of financial analysis?
    4)   How might the financial and water sectors collaborate in the future on the development of
        principles or assessment questions that could be used to account for climate readiness in
        financial analyses?
Opportunity 2) Clarify Existing Ratings Factors: Identify existing factors used in credit ratings that may
be affected by climate change impacts and how they could influence overall ratings.

Several representatives from the  water sector identified an interest in clarifying which of the criteria
CRAs currently use may be affected by climate in some way (e.g., line breaks, spills, density of customer
base, future demand forecasting, and affordability). One important question around  which future
discussion could be organized is whether climate change is already sufficiently reflected in rating agency
criteria. Addressing this question  in the near-term could help create a common understanding of how
financial institutions may be indirectly factoring climate risk into their current  analyses, which could
potentially generate mutual benefits for the sectors over the long-term. The water sector could continue
building their understanding of how financial institutions are considering climate risk and refine their
reporting accordingly. Meanwhile, rating agencies could gain greater insight into the  science, planning
practices and adaptation measures water utilities are developing to cope with climate risk, which could
help ensure that any updates in the rating process align with water sector practices. In particular,
greater understanding between the two sectors could be valuable in the event the financial sector
someday decides to consider new assessment factors related to climate readiness.
Risks & Resilience: Considering the Integration of Climate Readiness into Financial Analyses of Drinking Water and
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Opportunity 3) Understand Time Horizons: Share information and insights about the time horizons
used by water utilities in capital planning, the horizons that influence financial analyses and the
horizons used to study climate change.

Differing time horizons pose a challenge for aligning the financial and water sectors' consideration and
treatment of climate change impacts and climate risk because water utilities focus on long-term
planning while financial analysts often focus on shorter-term risks and returns. In addition, the uncertain
and evolving  nature of climate science  requires utilities to decipher what constitutes actionable science
as they develop capital improvement plans. For example, the decadal time horizon of climate change
impacts may  be an important  consideration for future water supply planning because many
infrastructure decisions are made based on expected infrastructure asset life cycles on a similar
timeframe. The fact that the time frame typically used by the financial sector to evaluate investments
tends to be shorter complicates the relationship  between utility planning activities and financial
institution decision-making. However, the water  sector's adaptive management planning approach
effectively moves their decadal planning horizons closer to the shorter-term horizons used by rating
agencies and other financial analysts. The differences between the planning time horizons of the two
sectors present an  opportunity for additional discussion about the implications they may have for
consideration of climate risk and  readiness, and other uncertainties in the future.

Specific questions that could inform further discussion about planning time horizons include:
    1) How  might water utilities' adaptive management approach to planning align with or influence
       rating agencies' periodic re-evaluation of ratings?
    2) What strategies can water sector utilities and financial institutions use to calibrate planning time
       horizons in mutually beneficial ways while accounting for the different interests they possess
       regarding long-range risks?

Opportunity 4) Examine Decision Triggers: Share additional information and insights about the factors
and thresholds that trigger important decisions  in both sectors.

There may also be  an opportunity for the two sectors to explore and compare the variables and timing
associated with key decision points (i.e., decision triggers) in their respective sectors. For example, it
would be helpful for financial analysts to understand what factors inform a wastewater utility's decision
to build a new treatment plant. On the other hand, it would be helpful for water sector managers to
understand what statistical changes in  ratings criteria prompt an agency to downgrade or upgrade a
utility, or to change their assessment factors. Exploring these issues could help both sectors develop a
better understanding of how their respective practices might influence one another and how climate
risk and readiness might factor into decision-making.
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Specific questions that could inform further discussion about decision triggers include:
    1)  What are the variables and thresholds in the water sector that trigger a utility to seek financing
       for capital improvements?
    2)  What are the variables and thresholds in the financial sector that trigger ratings upgrades or
       downgrades?
    3)  What magnitude or frequency of extreme weather events or natural disasters could potentially
       catalyze a shift in how the financial sector perceives the relative significance of climate risk?
    4)  How does the financial sector determine thresholds beyond which a risk is deemed sufficiently
       material to be included in the Official Statement or other forms of disclosure (e.g., if the time
       horizon of a debt's maturity overlaps with the time horizon of a risk to a physical asset, is it
       material enough to disclose)?

Path Forward:  Potential Venues and Mechanisms for Further Discussion

The Risks and Resilience stakeholder process generated mutual benefits associated with opening lines of
communication between the water and financial sectors. Representatives from both sectors expressed
interest in learning more about one another's perceptions of and practices for managing climate risk,
and indicated that mechanisms for ongoing communication and coordination could be helpful as climate
science, utilities'  practices and market priorities evolve. Sustaining lines of communication between the
sectors regarding climate change issues will help foster ongoing mutual learning about new
developments, emerging questions and prospective changes in practice.

Water sector and financial  sector associations or other organizations interested in the intersection of
climate change and water infrastructure financing could convene future discussions to continue
exploring the issues captured in this document.  Participants suggested the following water sector
venues as potential mechanisms for future cross-sector interaction:

      The American Water Works Association (AWWA) Climate Change Committee could be one
       venue for initiating additional discussions, as well  as AWWA's annual conference or one of its
       specialty conferences including the Sustainable Water Management Conference or Utility
       Management Conference.
      The Association of  Metropolitan Water Agencies (AMWA) is another water sector association
       that regularly explores financial issues that  affect its members and could serve as a potential
       convenor of formal or informal dialogue with financial sector representatives or associations.
      The Water Environment Federation (WEF) has a Utility Management Committee that may have
       interest in engaging with financial  sector representatives, and the Water Environment
       Federation's Annual Technical Exhibition and  Conference (WEFTEC) also offers a major event to
       explore issues of risk and implications for financial analysis of wastewater utilities.
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Participants suggested the following financial sector venues as potential platforms to convene
interested parties in the future:
      The National Federation of Municipal Analysts (NFMA), whose members focus on the
       creditworthiness of municipal bonds, is the most likely financial sector association to have
       interest in exploring issues related to climate change impacts and financial analysis of water and
       wastewater utilities.
      The Bond Dealers of America, which represents securities dealers and banks predominantly
       focused on the U.S. fixed income markets, is another possible association to engage in cross-
       sector conversation.
      As ESG investment grows as a potential source of financing for water and wastewater utilities,
       events such as The Forum for Sustainable and Responsible Investment and the SRI Conference
       on Sustainable, Responsible, Impact Investing offer possible venues for water and wastewater
       utilities to showcase their climate adaptation and sustainability activities.

It is important to recognize credit assessment methods may evolve over time as new factors become
relevant. While climate change impacts have not been a great enough concern to affect ratings to date,
CRAs could eventually develop new factors if the market perceives a material risk associated with
climate change impacts in the future. Because much of the evidence CRAs use to develop ratings is
largely theoretical, the uncertainty inherent in climate change projections does not necessarily preclude
the integration of exposure and vulnerability to climate change impacts into financial analyses.

In the short-term, discussions between the sectors may have a broader focus than climate risk and
readiness, but ongoing communication between the sectors on topics of interest today could help lay
groundwork for an efficient, transparent and collaborative approach to integrating climate risk and
readiness if or when they become significant factors in financial analyses of drinking water and
wastewater utilities.
Risks & Resilience: Considering the Integration of Climate Readiness into Financial Analyses of Drinking Water and
Wastewater Utilities                                                                              10

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ATTACHMENT  A:  LIST  OF PARTICIPANT ORGANIZATIONS
Representatives from the following water sector and financial sector organizations participated in one or
more meetings of the Risks & Resilience discussions or otherwise provided input during the process. The
views expressed by participating individuals were their own personal perspectives on the issues
discussed and did not represent the official positions of their  respective organizations. Additional
stakeholders in both sectors were kept apprised of the process via electronic communications.

Water Sector

       American Water
       American Water Works Association (AWWA)
       Association of Metropolitan Water Agencies (AMWA)
       Austin Water Utility
       DC Water
       Denver Water
       Hampton  Roads Sanitation  District
       Las Vegas Valley Water District/Southern Nevada Water Authority
       Miami-Dade Water and Sewer
       Orange Water and Sewer Authority
       Philadelphia Water Department
       San Francisco Public Utilities Commission
       Seattle Public Utilities Commission
       Sonoma County Water Agency
       Tampa Bay Water
       Water Environment Federation (WEF)

Financial Sector

       Bayern LB
       Breckinridge Capital Advisors
       Fitch Ratings
       Goldman Sachs
       Moody's Investors Services, Inc.
       Rural Community Assistance Corporation
       Piper Jaffray
       UNC Environmental Finance Center
Risks & Resilience: Considering the Integration of Climate Readiness into Financial Analyses of Drinking Water and
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RISKS & RESILIENCE: Considering the Integration
of Climate Readiness into Financial Analyses of
Drinking Water & Wastewater Utilities
             CLIMATE READY
                 .WATER UTILITIES
       Office of Water (4608-T) EPA 817-S-14-001  September 2014

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