Future-proofing against natural capital debt

A new kind of global debt crisis is brewing - due to decades of over-borrowing from our planet’s natural capital asset base. The future shock for business is the potential for profit to be wiped out, says Dorothy Maxwell, author of a new book on natural capital and business.

Natural capital, the resources and critical support services that nature provides, underpins the successful functioning of our businesses, economies and society at large. Conservative estimates value nature’s services to the global economy at US$125 trillion a year.

Yet despite its vast social and economic value, the many benefits of natural capital are often assumed to be ‘free’ and ‘free for all’. As a result, over 60 per cent of this capital, such as freshwater, forests and biodiversity are in decline from over-exploitation, and these systems’ ability to regulate climate and act as flood defences are failing.

This stripping of natural assets is causing a debt crisis hat threatens not only businesses, but human wellbeing.

Sectors with high natural capital dependencies have the greatest risks. But they also have the greatest opportunities. These industries include food, energy generation, extractives, forestries, fisheries, water utilities, pharmaceuticals and tourism. For example, an estimated 25–50 per cent of the pharmaceutical market is derived from nature’s genetic diversity. And because of natural capital degradation, it is estimated that one major drug is lost every two years.

Many of these sectors are core to the ASEAN region from a natural asset and economic perspective, for example, paper/pulp and palm oil in Indonesia or fossil fuel energy generation in China are dependent on natural resources. And If Mother Nature sent an invoice for the global cost of environmental damage from business activities such as water pollution, loss of fertile land, soil erosion, drought, overfishing and deforestation this would be over $6 trillion per year.

These costs are estimated to rise to $28 trillion by 2050 if ‘business as usual’ continues. As sustainability challenges escalate, businesses, investors and governments need to understand their role in conserving natural capital and the associated risks and opportunities.

In addition to the existing sustainability toolkit, the language of finance provides a powerful approach for communicating trade-offs and prioritising sustainability at the CFO, CEO and board level.

Measuring sustainability costs and benefits

Measuring the costs and benefits of sustainability impact and dependencies more fully informs decisions on risk management, capital allocation, new investments, market opportunities and return on investment.

For example, by analysing natural resource risk, associated price volatility and other sustainability improvements implemented, Unilever has saved more than US$370 million  since 2008.

The Dow Chemical Company (Dow)’s integration of financial valuation of wetland services identified net present value (NPV) savings of $282 million for implementing a constructed wetland instead of an effluent treatment plant over the project’s lifetime. The decision also reaped  wide range of non-financial biodiversity benefits.

More generally, measuring the costs and benefits of sustainability in business demonstrates a business case. Marks and Spencer (M&S) has shown its Plan A (now Plan A 2020) sustainability programme has delivered savings of £465 million (US$701 million) as well as wider benefits, including more motivated employees, enhanced brand value and supply chain resilience, over the seven years it has been operating.

Interest in this business case is not only gaining traction in corporations, but also with banks, pension funds, investors and insurers.

From a risk perspective, integrating natural capital considerations into Environmental, Social and Governance (ESG) guidelines is a growing area of focus. In particular, identifying the potential for stranded assets in investment decisions is a priority in light of sustainability 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.

According to Ben Ridley, head of sustainability affairs, Asia Pacific, Credit Suisse: “Natural capital underpins the value chains from which financial wealth is generated, but accounting for major adverse impacts on natural capital, and/or upon communities that rely on it, is a work in progress. Parallel efforts to redefine materiality are underway in many global financial institutions too, as evidenced by ESG integration in equity research and in the development of financial products and services.”

Challenges to managing 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 that are not valued in the market. As a result, they are treated as “free”, and this perversely incentivises degradation of the natural services that are essential to our success.

The bigger picture is: the success of national economies and businesses are mainly measured by financial metrics alone, for example, GDP/GNP, profit, revenues, earnings per share and cash flow. Wider non-financial indicators of success such as societal well-being, resilient ecosystems and available resources are often not factored in.

Our capitalist business models, based on short-termism and the singular profit maximization mindset, are also a major barrier for mainstreaming action at country and business levels to value and manage natural capital.

While incentives to drive change are still limited, innovators see this changing. Sir Ian Cheshire, former group CEO, Kingfisher, says: “If you think water will continue to be nearly free, if timber will be available at current prices for ever, if waste is a zero cost issue, then your business model will be obsolete in less than ten years. The externalities will be priced in one way or another.”

Trends to watch

National accounting systems to support ‘Beyond GDP/GNP’ metrics are already being implemented in more than forty countries. This provides the foundation for future policy tools, such as natural asset pricing, resources targets and taxation, to be developed.

New markets driving carbon reduction, conservation of biodiversity, water, forests and sustainable investment are  expanding. The increasing number of countries making sustainability reporting mandatory (including China and Singapore) is a further driver of increasing financial and non-financial accountability.

There is also a growing trend towards business models focusing on ‘value creation’ which move beyond profit maximisation alone. Emerging developments include:

  • Evolving business models linking the six capitals of business to support ‘integrated thinking’ and ‘integrated reporting‘. This provides a framework for use of integrated metrics, both non-financial and financial, to support effective decision-making. According to Paul Druckman, CEO of the International Integrated Reporting Council, “Leading businesses understand the drivers of value – all the capitals they use and affect - and the impact, including risks, they have on their business model. These in turn are leading to strategic benefits, including better decision-making, understanding of risks and opportunities and better engagement with the board about goals and targets.”
  • A growing shift away from environmental impact reduction models based on “doing less bad” to creating a ‘Net Positive’ or ‘Net Benefit’ for nature.
  • A growing recognition for the need to shift from short- to long-term investment cycles, and link remuneration/bonuses to non-financial or long-term performance indicators.
  • A growing narrative on the need to reboot 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.

Growing role of the CFO and financial professionals in sustainability

As interest in natural capital grows, financial, accounting and sustainability professionals find their worlds colliding. According to surveys by Accenture and Deloitte, the CFOs’ involvement in business sustainability strategies is growing. Engaging a busy CFO with many capital requests across the business on sustainability is a challenge. This is where financial valuation of natural capital provides an additional powerful engagement tool where the numbers speak for themselves.

The role of the CFO is key to effectively integrating material natural capital considerations into the business and making the business case to the board. Companies that ‘future-proof’ now will position themselves to thrive in a resource-constrained world. They will mitigate risk, secure their resource supplies, create long-term value and enhance their resilience, reputation and competitive advantage.

Dorothy Maxwell (PhD) is director of The Sustainable Business Group, the founding executive director of the Singapore-based Natural Capital Coalition in 2012-2014 and author of Valuing Natural Capital – Future Proofing Business and Finance. This title is the latest in the DōShorts Sustainable Business Collection.

OFFER: EcoBusiness readers can use code ECOB15 to save 15 per cent on any DoShort title at www.dosustainability.com. (Offer ends 30 July 2015.)

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