Toby Webb asks Dorothy Maxwell author of Valuing Natural Capital – Future Proofing Business and Finance (Dō Sustainability, April 2015) how business and finance are engaging on natural and social capital.
|Dr Dorothy Maxwell|
TW: “Natural and social capital” are increasingly advocated as part of the corporate sustainability toolkit. Is there a business case for valuing these or is this just a trend?
DM: Natural and social capital are trending sustainability topics and it can be difficult to separate out the rhetoric from their tangible role in solving sustainability challenges.
Putting aside the jargon, the business case for maintaining the resources and critical support services nature provides (natural capital) is clear. It underpins the successful functioning of our businesses, economies and society at large.
Over 60 percent of this capital, for example, freshwater, forests and biodiversity are in decline from over-exploitation and systems such as the ability to regulate climate and flood defences are failing.
These are not just vital to our human wellbeing, financially the value of this to society is vast (social capital). Yet the market largely treats it as “free” which incentivises its degradation. However as resource constraints and the impacts of climate change continue to bite, these externalities are increasingly expected to be internalised through regulation and markets.
TW: So what is the financial value of natural capital?
DM: Conservative estimates value nature’s services to the global economy at approximately US$100 trillion/year (2011 figures).
If Mother Nature sent an invoice for the global cost of environmental damage from business activities alone such as water pollution, loss of fertile land, soil erosion, drought, overfishing and deforestation this would be over $US6trillion/year. These costs are estimated to rise to $US28 trillion by 2050 if ‘business as usual’ continues. The important message this sends is the urgent financial rationale for reducing natural capital risk.
TW: Which business sectors have the greatest risks and opportunities?
DM: Sectors with the greatest risks and opportunities are those with high natural capital dependencies. Examples are food, energy generation, extractives, forestry, water utilities, pharmaceuticals, tourism and the financial services sector underpinning them.
For example, an estimated 25–50 percent of the pharmaceutical market is derived from nature’s genetic diversity. It is estimated that one major drug is lost every two years due to natural capital degradation.
Identifying the potential for Stranded Assets in investment decisions, such as for the fossil fuel energy sector, is a particular priority in light of sustainability challenges. In addition to corporations, banks, pension funds, investors and insurers are increasingly looking at natural capital risk to inform assessment of material risks and opportunities in their portfolios.
So if you are a business, managing your natural capital will mitigate risk, secure resource supply, resilience, maintain a licence to operate, profit, reputation and ensure long-term value creation.
TW: Does natural capital valuation help to inform assessment of risk & opportunity any more than existing tools?
DM: Assessing the environmental and social impacts of business is largely mainstream. Many tools, standards and schemes exist to support this. Assessing the dependency a business and wider stakeholders have on nature’s services is not.
Measuring both impacts and dependencies gives a more holistic picture of risks and opportunities. Financially valuing these further translates this ‘non–financial’ information into ‘financial’.
This common language can play an important role in communicating and prioritising sustainability at the CFO and board level.
It can enable the most significant or ‘material’ (in financial accounting language) to be understood in commercial terms and the implications for the company and its wider business model.
TW: How are corporations and financial institutions “accounting” for sustainability?
DM: Businesses measuring the costs and benefits of their sustainability impacts and dependencies find this valuable to inform decisions on risk management, capital allocation, Net Present Value (NPV) and Return on Investment (ROI). Sustainability costs and benefits internalised in the market can be incorporated in existing management accounting techniques.
Marks and Spencer (M&S) are a good example of how measuring the costs and benefits of sustainability in business demonstrates the financial business case. Using management accounting they have shown their Plan A (now Plan A 2020) sustainability programme has delivered savings of £465 million ($US701million) plus wider benefits including staff motivation, brand enhancement and supply chain resiliency over the seven years it has been operating.
Externalities can also be estimated such as seen in the apparel company Kering Group’s Environmental P&L. They have used this information to inform raw material decisions in the supply chain. Some other examples from business are:
o The Dow Chemical Company's integration of financial valuation of wetland services identified NPV savings of $US282 million for implementing a constructed wetland instead of an effluent treatment plant over the project’s lifetime, plus a wide range of non-financial biodiversity benefits.
o The UK’s largest property and landowner, The Crown Estate determined their Windsor Estate delivers £4.4 million ($US6.6 million) per annum gross external benefit by measuring environmental, social and economic value.
As a Financial Institution, for many years, Inter-America Development Bank (IDB) has operated its Biodiversityand Ecosystems Services Program to inform its investments in Latin America and Caribbean region. This is one of the most biologically diverse regions in the world. Through this program, IDB assesses client dependency on nature’s services in ESG to inform lending decisions and to develop green investment products.
TW: Is valuation really just about commoditizing nature?
DM: This is not about commoditizing or privatizing nature, a common criticism of financially valuing nature’s services. The purpose of assigning a financial value is not to change the fundamental value of nature – which is arguably priceless.
The importance of translating natural capital considerations into financial information is that it allows more informed decision-making especially on trade-offs. At the bigger picture level having a financial value for natural capital shared by society at large, as distinct from being perceived as ‘free’ can shift behaviour away from degradation to restoration.
TW: Beyond Carbon pricing, resource taxes and other market incentives to reduce natural capital degradation are being talked about. What are the key initiatives business should watch?
DM: National accounting systems to support ‘Beyond GDP/GNP’ metrics are already being implemented in over forty countries by policy makers. This provides the foundation for future policy tools, for example, natural asset pricing, resources targets and taxation, to be developed. New markets driving carbon reductions, conservation of biodiversity, water, forests and sustainable investment are growing opportunities.
The increasing number of country’s requiring mandatory sustainability reporting is a further driver for increasing financial and non-financial accountability. There are also many initiatives focusing on standardising business metrics for “Natural Capital Accounting”. However, until regulatory or market incentives require action, using these metrics is only a voluntary exercise.
TW: What is your one take away message?
DM: Simply put – societies, business and our economies depend on healthy and functioning natural systems and the resources and services they provide. This is our natural capital and just like financial and other forms of capital it is in our interest to preserve not deplete it.
Dorothy Maxwell PhD is Director of The Sustainable Business Group and author of the new book Valuing Natural Capital – Future Proofing Business and Finance (Dō Sustainability, April 2015)
She will be speaking at Innovation Forum's London conference next week on: The Measurement and Valuation of Corporate Sustainability – does it all add up? How to put hard numbers on sustainability risk – and quantify opportunity. 29th-30th June, 2015, London
100 executives from leading companies, investors, NGOs and business schools will gather to debate the area under the Chatham House rule.