Supply Chain

Capital Goes Back to Nature

“Natural capital” may be a new concept for many CFOs, but it could be one of the most important assets not on their companies' balance sheets.
Andrew SawersNovember 20, 2012

Are the resources essential to human survival and economic activity a material business issue? To what extent are they covered by current financial reporting frameworks? A recent report by KPMG and the Association of Chartered Certified Accountants (ACCA) examines “natural capital” – “the stock of capital derived from natural resources such as biological diversity and ecosystems,” as well as fossil fuels and mineral deposits.

The report also looks at the measurement, assessment, and reporting of its economic impacts. Natural capital “provides the ecosystem, products, and services that underpin our economy and [are] inputs or indirect benefits to businesses,” the report says. But although natural capital is as crucial to some companies as human or intellectual capital is, they may not be accounting for it accordingly.

Sarah Nolleth, program director of the Accounting for Sustainability (A4S) Project, explained in a recent ACCA web seminar why natural capital matters: “Our economy depends on somewhere between $33 trillion and $72 trillion of ‘free services’ that we get from nature,” she said. That guesstimate is the money that the human race would have to spend to get similar ecosystem services and products if they didn’t exist in nature – fresh water, forestry, even pollination of crops by bees.

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Those costs are known in the sustainability world as “externalities.” They “underpin a lot of our corporate and national activities [but] aren’t being taken into account in our day-to-day decision-making and they aren’t reflected in our P&L[s] and balance sheet[s],” Nolleth said. “Without that, how will [businesses] allocate capital? How are they going to make the right decisions that are sustainable in the long term?”

Loss of biodiversity and ecosystem services (BES) exposes corporates to new risks: sources of food and fiber could be lost if, for example, topsoil erosion were severe or if water supplies dried up. Food manufacturers can’t sell food that can’t be grown. 

Half of company earnings worldwide could be at risk from environmental externalities, the ACCA report says – equivalent to 11% of worldwide gross domestic product. The costs of these externalities is being borne by governments and society at large, but, as the report warns, “It is becoming clear that the costs of these externalities will at some point be internalized. Thus the links between BES and corporate value through impacts on share price are strengthening.”

The report lists some examples of this, such as Canadian mining company Infinito Gold losing permission to develop a mine in Costa Rica because of the impact on agriculture, forests, and endangered species.

In many cases, then, natural capital could be of material importance to a business. In fact, in a survey conducted as part of the report, 60% of 218 CFOs and CEOs said that the natural world was important to their business. Encouragingly, more than half had actually included natural capital concerns in their company’s business-risk evaluations. However, most companies report little or no information about them to investors.

Shareholders aren’t yet showing much interest, say some executives. “Natural resources such as timber and water are fundamental to Mondi,” said Andrew King, CFO of the paper and packaging company, in the ACCA report. “There is a strong link between license to operate and these issues. They are potentially an area of critical risk for the company.” 

And yet, King said, “Mondi is generally not being quizzed on water, ecosystem services, or wetlands by investors. Some investors with specific relevant investment criteria ask questions, but [they] are in the minority.”

What to do about accounting for natural capital is another question. Some businesses are looking at valuation models for natural capital, hoping that they will help decision-making. Others are approaching the issue from the point of view of stakeholder communications.

The report recommends that CFOs start talking with experts to get a clearer idea of their business’s dependence on natural capital. Organizations such as the International Integrated Reporting Council or the Natural Capital Declaration can also provide information. CFOs should ensure that risk and materiality assessments include an appraisal of natural capital, and they should also develop the necessary skills in their teams and start to disclose material natural capital impacts.

Finally, CFOs need to explain all this to the board, because it is a board-level issue. James Singh, the recently retired CFO of Nestlé, told the ACCA report writers: “Indiscriminate draw-down of natural capital poses a risk to our business today and much more so in the future. The severe undervaluation and degradation of natural capital constitute a real challenge to businesses in general, in achieving longer term strategic objectives.”

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