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Executive Perspectives

EXECUTIVE PERSPECTIVE: A Roadmap Towards Quantifying and Managing Natural Capital Risk

“Despite mounting evidence, natural capital is hardly accounted for by capital and insurance markets. The Natural Capital Declaration aims to provide solutions.”

(Ivo Mulder, is the Programme Officer on biodiversity and water issues at UNEP Finance Initiative;  Liesel van Ast is a Project Manager, Natural Capital Declaration, and Rachel Mountain is Head of Communications, Global Canopy Program).

The Natural Capital Declaration (NCD) was launched at the ‘Rio+20’ Earth Summit last year amid significant interest from finance executives, media and Heads of State. It is the culmination of a process that started in 2010 with a range of meetings with financial institutions and other stakeholders to develop a commitment by the financial sector to focus on the materiality of natural capital. It is currently endorsed by 44 CEOs of financial institutions and 27 non-financial organisations, making it arguably the largest natural capital coalition for the financial sector. But how relevant is natural capital really for banks, investors and insurance firms and what has happened since its launch?

Nature underpins global wealth creation. The renewable flow of goods and services provided by the earth’s ecosystems buttress our economy and yield benefits for business. But this stock of ecosystems – also known as “natural capital” – is largely invisible in financial decision-making and does not appear on companies’ balance sheets.  As a result degradation continues unabated in many places.  Economists, for example, estimate that costs to natural capital total US$7.3 trillion per year and come from global production (i.e. agriculture, forestry, fisheries, mining, oil and gas exploration, utilities), and industrial processing (i.e. cement, steel, pulp and paper, petrochemicals).  This unallocated risk equates to 13% of the global economic output.  [1]

Take for instance an investor in London, Shanghai or New York who finances a palm-oil development scheme in Indonesia or Africa, resulting in clearance of a large area of tropical rainforest. The dependency on and impacts of this investment on climate, food, energy, water and livelihood security are unlikely to be included in the cost of capital, credit ratings on fixed income products, share prices or insurance premiums. However, depending on the reputational, operational, and regulatory risks related to natural capital, it will end up on someone’s balance sheet and the level of exposure for the institution in question remains hidden.

A growing body of evidence highlights the magnitude of the exposure of some types of companies and sectors with either heavy impacts and/or heavy dependencies on the natural environment. A recent report by Carbon Tracker[2], for example compared the amount of available carbon we are able to burn to likely stay within a 2 degrees Celsius scenario (compared to pre-industrial temperatures) with the amount of listed oil, gas and coal companies reserves. The research concluded that 60 – 80% of these proven fossil fuel reserves will not be able to be used if we are to stay within the 2 degrees Celsius scenario and avoid catastrophic climate change. Eventually this need to reduce greenhouse gas emissions to secure a stable climate poses an ever increasing regulatory risk as politicians need to take decisive action to limit fossil fuel combustion, with the likely knock-on effects on the valuations of exposed energy companies. If politicians do not act soon, then the risks from more frequent and severe floods and droughts and changes in rainfall patterns will be greater for exposed assets such as food and beverage, agriculture, forestry, utilities, real estate, tourism and mining. The magnitude of the risk in question has been enough for some investors to divest from the most exposed companies.

A further example concerns a recently released report by UNEP FI and the Global Footprint Network, which together with a number of banks and investors, assessed the materiality of natural resource risks for sovereign bond investors. They concluded that risks related to the price volatility of commodity markets and the need to import more resources when a country erodes its own natural capital are potentially significant enough to affect its credit rating and thereby the price it pays to issue debt on the global bond market[3].

These and other examples provide a much needed wake up call for financial institutions to uncover currently hidden environmental and social risks embedded in products and services. The Natural Capital Declaration aims to provide guidance to institutions that have endorsed it by working together to uncover these risks. UNEP FI and the Global Canopy Programme have formed a Secretariat to support the development of methodologies to enable professionals in asset management, corporate finance, treasury, and other departments to integrate natural capital factors in the structuring of new products and the risk management of new and existing products. The governance structure which the NCD has developed in order to catalyse these changes utililses four working groups. These working groups are currently developing plans to provide practical solutions to financial institutions in meeting the NCD commitments to:

  • Build an understanding of the impacts and dependencies of natural capital relevant to their value chains.
  • Support the development of methodologies that can integrate natural capital considerations into financial products and services.
  • Work towards building a global consensus for the integration of natural capital into private sector accounting and decision-making.
  • Develop methods to disclose and report on natural capital using an Integrated Reporting approach

A NCD Steering Committee, consisting of 5 financial institutions and 2 non-financial supporters, will be established shortly to oversee implementation of the NCD Roadmap to integrate natural capital in all relevant financial products, as well as in disclosure, financial accounting and reporting frameworks. We envision that this simple and lean governance structure, focused on providing solutions, will create a significant leap forward in the understanding, assessment and integration of natural capital considerations by the financial sector.

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