Valuing natural capital - 'beyond GDP'?
The case to stop degradation of natural capital and incentivise enhancement is clear and urgent, but getting there has many challenges. Dr. Dorothy Maxwell explores the current trends in natural capital and status of moving “beyond GDP” in reality.
Natural capital - the resources and critical support services nature provides underpins the successful functioning of our society, economies and businesses. As a result, the case for maintaining and enhancing it is common sense. So why is it so difficult to do this?
Looking at the financial case alone, conservative estimates “value” nature’s services to the global economy at US$125 trillion/year (2011 figures). As illustrated below, services from forests, wetlands and marine ecosystems contribute significant social and economic value worth billions and trillions per annum. The benefits from Ireland’s biodiversity alone, is estimated to contribute US$3 bn (€2.6 bn) / year (2008 figures).
Estimated financial values for a sample of nature’s services (base years vary) Source: Image from Shutterstock, used under standard Content Usage Agreement from Valuing Natural Capital - Future Proofing Business and Finance (Dō Sustainability, 2015)
Yet despite this enormous value, the many benefits of natural capital are often assumed to be 'free'. As a result, over 60 percent of this capital, for example, freshwater, forests and biodiversity are in decline from overexploitation and systems such as the ability to regulate climate and flood defences are failing. This stripping of natural assets is causing a new type of debt crisis that threatens not only governments and businesses, but human wellbeing.
The challenges for managing and enhancing natural capital At the big picture, the challenge is that success of national economies and businesses are mainly dictated by financial metrics alone, for example, GDP, profit, revenues, earnings per share and cash flow. Wider non-financial measures of success, for example, societal well being, resilient ecosystems and available resources are often not factored in. Capitalist business models, based on short-termism and the singular profit maximisation mindset, are a major barrier for mainstreaming action at country and business levels to value and manage natural capital.
According to the Chartered Institute of Management Accounting (CIMA), ‘Natural Capital is the Elephant in the Boardroom’ – invisible in the vast majority of corporate decisions, accounts and economic models. The reason is the costs and benefits associated with most of nature’s services are externalities, not valued in the market. This is the reason they are treated as “free”, and perversely incentivise degradation of the natural services essential to our success. This is an economic market failure requiring regulation and financial instruments to correct.
Natural capital state of play and key trends Irrespective of the fact that the natural capital concept has existed for many years, its application in government policy and business is only starting to gain traction and is at an early stage of development. For some time many initiatives across government, academia and NGOs have been generating the science and tools to support action. While we still need to connect the dots across these, there are still few incentives to drive action!
In government, national accounting systems that can ultimately support ‘Beyond GDP’ or ”GDP Plus” indicators of performance are being implemented in countries under policies including the UN System of Environmental and Economic Accounts (SEEA) and Convention on Biological Diversity. They focus on ensuring valuation of natures assets are reflected in national growth strategies and accounts. As noted by Nobel Laureate economist Joseph Stiglitz, moving “Beyond GDP” will give a much more informed view of national assets.
“A private company is judged by both its income and balance sheet, but most countries only compile an income statement (GDP) and know very little about the national balance sheet.” Joseph Stiglitz, http://www.josephstiglitz.com/
In theory, this provides the foundation for future policy tools to incentivise action, for example, natural asset pricing, resources targets and taxation. However, the current intent of SEEA is to enable natural assets to be included in accounting frameworks as a first step.
From a market perspective, new markets driving carbon reductions, conservation of biodiversity, water, forests and sustainable investment are growing opportunities. For example over three hundred Payments for Ecosystem Services (PES) schemes for water quality protection and forest conservation, are estimated to operate around the world. The recent EU Natural Capital Finance Facility aims to support more projects that prove the business case for management and enhancement of natural capital. For mainstream business natural capital is largely new, but awareness is growing.
Where and how natural capital fits in the existing sustainability and financial toolbox is still evolving. There are many initiatives focusing on metrics for corporate “Natural Capital Accounting” such as from the EU Business and Biodiversity Platform , UK Natural Capital Committee, Natural Capital Coalition, Natural Capital Declaration and the International Standards Organisation. These support integrating natural capital into decision-making, management, financial accounting and reporting. However, until regulatory or market incentives require inclusion of natural capital on the Balance Sheet or Profit and Loss Statement, this is a voluntary exercise unlikely to mainstream.
At the bigger picture level, there is a growing debate on the need to re-boot the purpose of economies, capital markets and business within frameworks that deliver societal well-being, healthy ecosystems, resilience, employment, equality and prosperity, now and in the future. Frameworks for business models focusing on ‘value creation’ beyond profit maximisation alone are emerging. Examples are Integrated Thinking and Integrated Reporting which link the six capitals of business – financial, manufactured, human, intellectual, social and natural.
Another trend is the on-going debate as to whether financial valuation of nature’s services is ethical and whether it can really drive environmental improvements in practice. A common criticism is that it will lead to commoditising or privatising nature. While this is not the intent, these unintended consequences need to be taken seriously. 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. This is more likely to result in action from key decision-makers who generally deal in financial terms. For example, in business one of the key barriers is communicating the urgency of environmental challenges to the CFO or board. There is a language barrier. Translating environmental considerations into the language of finance provides a powerful approach for communicating trade-offs and prioritising sustainability at CFO, CEO and board level.
Business engagement and examples from corporations and financial institutions As environmental challenges such as climate change and resource constraints continue to escalate, businesses and their investors need to understand their natural capital risks and opportunities. This will enable them to mitigate risk, secure their resource supplies, create long-term value and enhance their resilience, reputation and competitive advantage. Interest in this business case is slowly gaining traction in corporations and also banks, pension funds, investors and insurers. From a risk perspective, identifying the potential for “stranded assets” in investment decisions is a particular priority in light of environmental challenges. This can cause significant reductions in the long-term value of entire sectors and companies, for example, fossil fuel-based energy generation, food and pharmaceuticals.
Businesses measuring the costs and benefits of their environmental impacts and dependencies currently use this to inform decisions on risk management, capital allocation, Net Present Value (NPV) and Return on Investment (ROI). Interestingly few companies call this “Natural Capital Accounting”. Environmental 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 2020 sustainability programme has delivered savings of $US700 million (£465 million) 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 Profit & Loss. They have used this information to inform raw material decisions in the supply chain. Some other examples from business are:
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.The UK’s largest property and landowner, The Crown Estate determined their Windsor Estate delivers $US6.6 million (£4.4 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 Biodiversity and 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 Environmental, Social and Governance (ESG) to inform lending decisions and to develop green investment products.
Priority Next Steps? Moving economic success factors ‘Beyond GDP’ to put natural capital on an equal footing with financial and other capitals is a key step to drive action. Then the financial systems, market pricing and incentive structures to enable this can more easily be put in place. Without incentives, regulatory and market, business action will remain in a small group of pioneering early adopters and not scale to the mainstream. In the words of one of these pioneers: “Instead of the goal of maximum linear growth in GDP, we should be thinking of maximum wellbeing for minimal planetary input.” Sir Ian Cheshire, former CEO, Kingfisher Group PLC, from The Independent, December 2014
Dr. Dorothy Maxwell is author of Valuing Natural Capital – Future Proofing Business and Finance (Dō Sustainability, April 2015), Director at The Sustainable Business Group and a visiting lecturer on sustainable business at Imperial College London. She will be running a Webinar on Valuing Natural Capital on 18 Nov and 02 Dec 2015 – click for more information and to register.
Dorothy is Irish, an alumnus of UCD and currently living in London. She is 24 years working in sustainability with businesses, government and NGOs in the EU, Asia Pacific and US. She previously worked with Accenture, Willis, Enterprise Ireland’s EnviroCentre and as an Irish environmental policy representative to the European Commission and UNEP. With The Sustainable Business Group since 2007, she has been Special Advisor to The Prince of Wales’s International Sustainability Unit, UK Dept of the Environment (DEFRA) and founding Executive Director for the Natural Capital Coalition (2012-14).
Valuing Natural Capital Futureproofing Business and Finance Author: Dorothy Maxwell Foreword: Sir Ian Cheshire, former Group CEO Kingfisher plc Dō Sustainability * April 2015 Part of the DōShorts Sustainable Business Collection: www.dosustainability.com
Valuing Natural Capital – Future Proofing Business and Finance provides an expert, independent account of the topic based on the latest thinking across leaders in business, finance, government and NGOs. These are illustrated with views and case examples from CEOs, CFOs and Head of Sustainability across business including Kingfisher, Dow, M&S, Patagonia, Crown Estate, Inter America Development Bank, Credit Suisse, Citi and United Utilities. OFFER: Use code IFNC15 to save 15% off this book at www.dosustainability.com. Offer ends 30 December 2015.
Webinar: The Sustainable Business Group is running two webinars titled 'Valuing Natural Capital' on November 18th and December 2nd 2015. For more information, see here.