Natural and social capital – separating the rhetoric from the action

Natural and social capital are trending sustainability topics and it can be difficult to separate out the rhetoric from their tangible role in solving sustainability challenges. 

Putting aside the jargon, the business case for maintaining the resources and critical support services nature provides (natural capital) is clear. It underpins the successful functioning of our businesses, economies and society at large. 

Over 60% of this capital – including freshwater, forests and biodiversity – are in decline from over-exploitation, and systems such as the ability to regulate climate and flood defences are failing. 

There are not just vital to our human wellbeing, financially the value of this to society is vast (social capital). Yet the market largely treats it as “free” which incentivises its degradation. However as resource constraints and the impacts of climate change continue to bite, these externalities will increasingly be internalised through regulation and markets.

Conservative estimates value nature’s services to the global economy at approximately $100tn/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 alone would be over $6tn/year. These costs are estimated to rise to $28tn by 2050 if ‘business as usual’ continues. The important message this sends is the urgent financial rationale for reducing natural capital risk.

Sectors with the greatest risks and opportunities are those with high natural capital dependencies. Examples are food, energy generation, extractives, forestry, water utilities, pharmaceuticals, tourism and the financial services sector underpinning them. 

For example, an estimated 25-50% of the pharmaceutical market is derived from nature’s genetic diversity. Studies estimate that one major drug is lost every two years due to natural capital degradation.

Identifying the potential for stranded assets in investment decisions, such as for the fossil fuel energy sector, is a particular priority in light of sustainability challenges. 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. 

So, if you are a business, managing your natural capital will mitigate risk, secure resource supply, resilience, maintain a licence to operate, profit, reputation and ensure long-term value creation.

Assessing the environmental and social impacts of business is largely mainstream. Many tools, standards and schemes exist to support this. Assessing the dependency a business and wider stakeholders have on nature’s services is not. 

Measuring both impacts and dependencies gives a more holistic picture of risks and opportunities. Financially valuing these further translates this “non-financial” information into “financial”. This common language can play an important role in communicating and prioritising sustainability at the CFO and board level. 

It can enable the most significant or “material” (in financial accounting language) to be understood in commercial terms and the implications for the company and its wider business model.

Businesses measuring the costs and benefits of their sustainability impacts and dependencies find this valuable to inform decisions on risk management, capital allocation, net present value (NPV) and return on investment (ROI). Sustainability costs and benefits internalised in the market can be incorporated in existing management accounting techniques.

Marks & Spencer 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 sustainability programme has delivered savings of £465m ($701m) 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 P&L. They have used this information to inform raw material decisions in the supply chain. Some other examples from business are:

For many years, Inter-America Development Bank (IDB) has operated its biodiversity and ecosystems services programme for its investments in Latin America and Caribbean region. This is one of the most biologically diverse regions in the world. Through this programme, IDB assesses client dependency on nature’s services to inform lending decisions and to develop green investment products.

This is not about commoditising or privatising nature, which is 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. At the bigger picture level having a financial value for natural capital shared by society at large, as distinct from being perceived as “free”, can shift behaviour away from degradation to restoration.

Beyond carbon pricing, there are resource taxes and other market incentives to reduce natural capital degradation. What are the key initiatives business should watch? 

National accounting systems to support “beyond GDP/GNP” metrics are already being implemented in over 40 countries by policy makers. This provides the foundation for future policy tools –  such as 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 countries requiring mandatory sustainability reporting is a further driver for increasing financial and non-financial accountability. There are also many initiatives focusing on standardising business metrics for natural capital accounting. However, until regulatory or market incentives require action, using these metrics is only a voluntary exercise.

Simply put: societies, business and our economies depend on healthy and functioning natural systems and the resources and services they provide. This is our natural capital and just like financial and other forms of capital it is in our interest to preserve not deplete it.