Natural capital went from overlooked to unstoppable

"We are facing a global crisis. We are totally dependent upon the natural world. It supplies us with every oxygen-laden breath we take and every mouthful of food we eat. But we are currently damaging it so profoundly that many of its natural systems are now on the verge of breakdown”: Wrote David Attenborough in his foreword to The Economics of Biodiversity: The Dasgupta Review.

The ‘Review’ released in early 2021 reminded, as Dr. Partha Dasgupta explains, about “Nature’s worth to society - the true value of the various goods and services it provides - is not reflected in market prices because much of it is open to all at no monetary charge. These pricing distortions have led us to invest relatively more in other assets, such as produced capital, and underinvest in our natural assets... Many of our institutions have proved unfit to manage the externalities. Governments almost everywhere exacerbate the problem by paying people more to exploit Nature than to protect it, and to prioritise unsustainable economic activities. A conservative estimate of the total cost globally of subsidies that damage Nature is around US$4 to 6 trillion per year. And we lack the institutional arrangements needed to protect global public goods, such as the ocean or the world’s rainforests."

A front-page story that wasn’t

Some possibilities - taming the money pipelines like banking, asset managers and insurance - have been squandered with the dissolution of respective net zero initiatives. Here is something I draw from Matthew Ross’s post on LinkedIn that rekindles some hope. “The world's largest sovereign wealth fund has quietly acknowledged that nearly every dollar under their management is exposed to the single greatest repricing event in financial history. Norwegian Sovereign Wealth Fund - guardian of $1.6 trillion in assets - has executed what may be the most consequential financial manoeuvre of the 21st century. They've placed 96% of their entire portfolio under natural capital risk assessment”. A front-page story that wasn’t. Perhaps it is too hard to swallow for dying print media.

Taking nature for granted can have serious consequences, alerts PWC. We all rely on natural capital; our atmosphere, oceans, ecosystems and minerals. We also depend on the goods and services this natural capital provides - goods like food, fuel, fibre and medicines; and services like climate regulation, water filtration and erosion control. But all too often these goods and services are unpriced. At best this means they are under-valued by business, at worst, they may be economically invisible. These unseen dependencies on natural capital result in unmanaged business risks. Risks which can have material impacts on the bottom line.

Similarly, many of the impacts we have on Natural Capital currently bear no cost. Our emissions to air, discharges to water and the use of land and other natural resources frequently impose impacts on others for which they are not properly compensated. These uncompensated environmental impacts are called ‘externalities’ and they too can result in serious business risks. New regulation, legal action, consumer boycotts and brand damage can all lead to ‘internalised,’ resulting in costs to the business. As a result they need to be treated like any other serious ‘off balance sheet liability.’ Carefully understood, measured and managed. Understanding environmental impacts can also create new value, by enabling innovation, reducing costs and enhancing reputation. This is recognition of a fundamental truth that will recalibrate every market on earth. 

Natural capital risk assessment 

Natural capital is a way of thinking about nature as a stock that provides a flow of benefits to people and the economy, explains PWC. It consists of natural capital assets such as water, forests and clean air that enable economic activity by providing businesses with materials, inputs to production, protection from natural disasters and absorption of the pollution they emit. Any adverse change in a natural capital asset can have a negative effect on the businesses that depend on it; in much the same way as the impairment of a conventional asset might affect the cashflows of the business owning it. The portfolios of financial institutions are exposed to these natural capital risks that affect the businesses that they lend to, insure or invest in. 

By focusing on risks to businesses resulting from environmental degradation, rather than on the businesses’ environmental impacts which have traditionally been the focus of environmental risk assessment, natural capital risk analysis allows financial institutions to see the risks that they are exposed to in a new light. Needless to mention - this is not an either/ or situation. Murderous (causing biodiversity loss) over suicidal instinct (allowing biodiversity vulnerabilities to adversely impact any balance sheet). Double materiality remains material. 

The Natural Capital Finance Alliance (NCFA) has developed a process that enables financial institutions to easily assess natural capital risks in their portfolio. This rapid natural capital risk assessment process focuses on identifying the ways in which businesses depend on the environment, how these dependencies are threatened by environmental change, and the resulting risks for financial institutions.

Norway’s ‘natural capital risk assessment’ - is says Sheridan Tatsuno - “pricing externalities typically missing from markets and corporate balance sheets - rising climate risks, insurance, mitigation, adaptation, healthcare, disaster management, and other off-spreadsheet costs, which impact ALL bank and corporate assets, even though they ignore them as they have done historically”. For years, sustainability consultants and academics have pedaled comfortable half-truths about natural capital's importance. 

PwC's widely-cited claim that "55% of global GDP depends on nature" appears enlightened on the surface. But Norges Bank's actions reveal this estimate for what it is: a catastrophic underestimation of reality, says Ross. They are deploying actual capital based on a brutal financial calculation: virtually every financial asset on earth faces imminent repricing based on its relationship to natural systems. They've explicitly stated these moves are made to "support value creation and manage the fund's climate and nature risk exposure". The world's largest sovereign wealth fund has quietly acknowledged that nearly every dollar under their management is exposed to the single greatest repricing event in financial history, highlights Ross. This represents a tectonic shift and a wake-up call for boards, accountants, actuaries, auditors, rating agencies, et al.

Climate change is the greatest market failure the world has ever seen, and it interacts with other market imperfections…. Warned Nicholas Stern on the 15th anniversary of ‘The Economics of Climate Change: The Stern Review’ (first published in October 2006): “it shows us how, by bringing economics and ecology together, we can help save the natural world at what may be the last minute - and in doing so, save ourselves.”

Could Norway be finally accomplishing just that? What was once invisible in global finance is now unstoppable. Watch out!

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