For governments and the financial world, most of the last century was focused on the need to rebuild the economies devastated by war and reduce levels of absolute poverty in much of Africa, Asia and Latin America.
As a consequence, it was natural to focus on the accumulation of produced capital (roads, machines, buildings, factories and ports) and what is termed human capital (health and education).
With almost every week that passes, the impact of climate change has become more pressing and apparent.
Sustainable Development Goals (SDGs) came into force at the beginning of 2016 with the objective of setting a new global development agenda to eradicate poverty and shifting the world onto a sustainable development path by 2030.
Understanding and measuring natural capital will not happen immediately
The 17 SDGs and their 169 targets include goals to reduce poverty and promote education, health, the environment and peaceful and inclusive societies. SDG 17 aims to “strengthen the means of implementation and revitalise the global partnership for sustainable development” with 17.19 specifying the following goal:
By 2030, build on existing initiatives to develop measurements of progress on sustainable development that complement gross domestic product (GDP), and support statistical capacity building in developing countries.
Setting a common framework for assessing sustainable development is therefore a key component to delivering SDG 17, and one of the tools for achieving this is the further development of natural capital.
Earlier this year, The Treasurer introduced the concept in an article outlining the background and concept, using the Forum for the Future definition of natural capital (which other sources sometimes refer to as environmental or ecological capital). That definition comprises “any stock or flow of energy and material that produces goods and services”.
The following is an example of what happens when we ignore natural capital:
A woodland is destroyed to build a shopping centre. GDP calculations record an increase in produced capital. However, there is no adjustment for any impact on natural capital and the environment that currently absorbs carbon, prevents soil erosion, creates a habitat for much-needed pollinators and provides direct benefits such as recreation (which can reduce burdens on health services).
Such losses carry economic costs, which are currently not recognised, let alone measured.
In 2021, we have seen two key milestones in the development of natural capital:
1. The release of the 610-page The Economics of Biodiversity: Dasgupta Review; and
2. BS8623, issued by the British Standards Institute, which provides specifications and guidance on the preparation of natural capital accounts.
The remainder of this article focuses on the Dasgupta Review and what it may mean for treasurers.
In his 2019 Spring Statement, the then Chancellor of the Exchequer Philip Hammond announced plans to commission a comprehensive global review of the link between biodiversity and economic growth to support the plans to mandate biodiversity net gain for development in the UK.
Hammond recognised that other targets (such as delivery of infrastructure and housing) should not be achieved at the expense of biodiversity.
The resulting Dasgupta Review includes the following thoughts:
• If society is to address the rapid decline of biodiversity that threatens civilisation itself, it can no longer measure success using conventional metrics such as GDP.
• Demands on nature far exceed its capacity to supply them, putting biodiversity under huge pressure and society at risk.
• The stock of natural capital per person declined by nearly 40% between 1992 and 2014, a period when produced capital per person doubled, and human capital per person increased by about 13%.
• Sustaining and growing natural capital must become a central pillar of global economic decision-making.
A combination of technological developments and a move towards more sustainable food systems will have an impact. However, this is unlikely to be enough in both the long and short term, and changes to consumption and production methods will also be required.
Legislation through new taxes and standards on recycling coupled with the embedding of environmental objectives across supply chains will also need to play a role.
The management of legally protected areas must be improved.
Investment in nature-based solutions that address biodiversity loss, contribute to climate change mitigation and adaptation, and create jobs is also necessary. The report noted that it is far less expensive to conserve nature than to restore damaged or degraded resources.
The current measure – GDP as a sign of national economic output – has been the primary measure of economic success.
However, it has been criticised for its failure to take account of natural capital and for incentivising activity that depletes ecosystems and habitats.
Some countries have taken steps to incorporate natural capital and ecosystem services into national economic metrics, for instance, China with its Gross Ecosystem Product and New Zealand with its Living Standards Framework.
These measure how well societal wellbeing is being protected by aggregating the value of produced capital, human capital and natural capital.
Approaches such as these highlight the benefits from investing in natural assets and allow for a more balanced trade-off between produced, human and natural capital when it came to investment and business decisions.
The report expects that conserving and restoring natural assets will reduce poverty, given that natural capital forms the bulk of wealth in low-income countries, and those on low incomes tend to rely more directly on nature.
Significant design and measurement challenges remain with work required to boost reporting and create assessment frameworks that accurately value soil, trees, water, air, minerals and other resources.
There needs to be international collaboration on the construction of new natural capital accounting methodology to ensure standardised data and modelling approaches.
The current system is characterised by significant subsidies to exploit natural resources and relatively limited investment in improving the stock of natural capital.
The report insists this has to change with the public sector (through governments and central banks) and private financial institutions working together to improve biodiversity, support measures to increase sustainable consumption and production, and encourage the reporting of nature-based financial disclosures by businesses.
Governments and regulators will at some point turn their attention towards natural capital in the same way as they have on environmental, social and governance (ESG).
When they do, companies will need to be ready. Whatever the agreed methodology of accounting is adopted, it may have a material impact on balance sheets, income statements and how investment projects are appraised.
There is already guidance from a number of different sources on natural capital methodology and calculations, such as:
• UK government;
• Capitals Coalition; and
• System of Environmental Economic Accounting (SEEA).
Understanding and measuring natural capital will not happen immediately given the complexities involved, and it is so important that boards and other stakeholders are encouraged to understand the concepts.
Corporate treasurers are ideally placed to lead these conversations in conjunction with their sustainability teams.
This will become increasingly important as government subsidies that are currently typically skewed towards nature-negative activities (often involving the exploitation of a scarce resource) pivot towards nature-positive activities.
Businesses will need to assess the impact of this, as nature-positive activities will be well positioned to pick up additional public subsidy and investment from the ESG-conscious private sector.
Naresh Aggarwal is associate director in the Association of Corporate Treasurers’ policy and technical team
This article was taken from Issue 3, 2021 of The Treasurer magazine. For more great insights, log in to view the full issue or sign up for eAffiliate membership
