By Dorothy Maxwell PhD, Director, The Sustainable Business Group
The latest in the DōShorts Sustainable Business Collection, Valuing Natural Capital – Future Proofing Business and Finance (Dō Sustainability, 2015) written by Dorothy Maxwell provides the need to know facts on this emerging topic. It provides the latest thinking across leaders in business, finance, government and NGOs. Quotes and case examples from senior executives (CFO, CEO and Heads of Sustainability) in early adopter businesses (Kingfisher Group, Dow Chemical Company, Marks & Spencer, Patagonia®, Otto Group, United Utilities (UK) and The Crown Estate (UK)) and Financial Institutions (Inter-American Development Bank (IDB), Citi Group and Credit Suisse) show the way.
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
OFFER: EcoInnovator readers can use code ECOIN15 to save 15% at www.dosustainability.com. (Offer ends 30 June 2015.)
A new kind of global debt crisis is brewing—this time, due to decades of over-borrowing from our planet’s “natural capital” asset base. Natural capital, the resources and critical support services nature provides, underpins our entire global economy. However, over 60 percent of this capital, for example, freshwater, forests and biodiversity are in decline from overexploitation and critical support systems such as the ability to regulate climate and flood defences are failing. The World Economic Forum and McKinsey identify water crises, climate change, extreme weather events, biodiversity loss and ecosystem collapse as urgent global risk factors for business and investors.
The most conservative estimates value nature’s services to the global economy at $US50 trillion/ year (compared to global GDP at $US63 trillion/year (2010 figures)). Higher estimates suggest the value is closer to US$125 trillion/year (2011 figures). 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 $US6 trillion/year. These costs are estimated to rise to $US28 trillion by 2050 if ‘business as usual’ continues. While there are many assumptions and uncertainties built into the calculations of these costs, the important message is the urgent financial rationale for reducing natural capital risk. This is particularly the case for sectors with high natural capital dependencies, for example, food, energy generation, extractives, forestry, water utilities, pharmaceuticals and tourism. 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.
This business case for managing natural capital has existed for many years, but there is still little real action for change. 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 most of nature’s services are externalities, not valued in the market. As a result they are treated as “free”, and perversely incentivise degradation of the natural services essential to our success. At the bigger picture, the challenge is that success of national economies and businesses are dictated by financial metrics alone, for example, GDP/GNP, 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. 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.
The future shock for business is the potential for profit to be wiped out as natural capital is “internalized” through regulation, taxation and markets. According to Sir Ian Cheshire, former group CEO, Kingfisher plc: “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.” We are already seeing national accounting systems to support ‘Beyond GDP/GNP’ metrics being implemented in over forty countries. This will enable 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. 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. Identifying the potential for Stranded Assets in investment decisions is a particular priority in light of sustainability challenges.
Part of the challenge with “natural capital” is that it is yet another term in the jargon-overloaded world of sustainability. There are many initiatives emerging on this trending topic, but little clarity on the end game for business and finance. It can be difficult to separate out the rhetoric from its tangible role in solving sustainability challenges for business. Over the last 20 years the natural capital agenda has emerged from sustainability practitioners in NGOs, policy and research. The engagement with business, and particularly finance and accounting, is a relatively recent phenomenon. Much of what is termed as “natural capital” already exists in the sustainability and financial toolbox business already knows, but the connections have not been made. Whatever we call it, its real value is using the common language of finance to assess sustainability risks or opportunities. Businesses already measuring the costs and benefits of their sustainability impacts and dependencies find this valuable to inform decisions on risk management, capital allocation and return on investment. For example:
- The Dow Chemical Company’s integration of financial valuation of wetland services identified Net Present Value (NPV) savings of $US282 million for implementing a constructed wetland instead of an effluent treatment plant over the project’s lifetime, plus a wide range of non-financial biodiversity benefits.
- The UK’s largest property and landowner, The Crown Estate determined their Windsor Estate delivers £4.4 million ($US6.6 million) per annum gross external benefit by measuring environmental, social and economic value.
- Marks and Spencer (M&S) 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.
As sustainability challenges continue, businesses and their investors will need to understand their natural capital risks and opportunities. So whether we call it “natural capital accounting” or just plain “management accounting “(as most of these businesses do), the language of finance provides a powerful approach for communicating and prioritizing sustainability at CFO, CEO and board level. According to surveys by Accenture and Deloitte, the CFOs’ involvement in the 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 financials speak for themselves. 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. Company’s who ‘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 is author of Valuing Natural Capital – Future Proofing Business and Finance (Dō Sustainability, 2015). She has 24 years working experience in sustainability with businesses, government and NGOs in the EU, Asia Pacific and USA. She has a PhD in Environmental Science and Masters in Environmental Economics & Law from Imperial College London. She has worked with Accenture, Willis risk management and been an environmental policy maker with the European Commission, Irish government and United Nations Environment Program. She is Founding Director of The Sustainable Business Group consultancy since 2006. In this context she has been a Special Advisor to The Prince of Wales’s International Sustainability Unit, the UK Department of the Environment, Food and Rural Affairs (DEFRA) Sustainable Products and Green Economy programs and Executive Director of the Natural Capital Coalition. She is a visiting lecturer at Imperial College London on sustainable business.