The concept of Nature as Capital – double materiality comme il faut

The current situation is an expression of market failure, in that the market and economic systems have failed to factor in the systemic value of natural resources.

When we talk about Nature as Capital, we are talking about a paradigm shift in our economic system. Nature as 'capital' is about treating nature as an asset, with a systematic value, and recognizing and quantifying the socio-economic value we derive from such a natural asset. As a society reliant on a global economic system, we've only recently begun to examine the dependence of our economic system on this asset, nature.

Simultaneously, the global economy is going through a period of major change. In previous periods of economic change, the environmental dimension was usually ignored. But this time, there is a growing understanding that environmental threats will undermine the well-being and prosperity of present and future generations if not tackled properly (IPCC, 2021).

When it comes to how we manage this economic transition, these are important considerations:

1.) Materiality of nature loss is twofold

Human activity is driving the decline of natural capital. As natural capital declines, its capacity to provide 'ecosystem services' on which a company may depend is reduced either temporarily or permanently. For example, a pharmaceuticals company relies on certain natural ingredients for its products, and these natural ingredients rely in turn on pollination by insects in the biosphere to recreate every season. Therefore the health of the natural environment (air, biosphere, seasonal climate factors) represents a physical source of risk for the company and those financing it. Equally, the variety of responses to nature loss creates multiple transition sources of risk for the organizations.

When an ecosystem service degrades it has implications for the financial world by undermining, for instance, the ability of the company to operate. Equally, when a company negatively impacts nature it also becomes exposed to future transition or liability risks, such as environmental litigation, that in turn pose financial risks to banks, investors and insurers (Seega N, 2022).

This then leads to "double materiality" of nature loss.

First, that nature is material to companies, yet if ecosystem services degrade, company profitability and operations are at risk. Second, that companies can have a materially negative impact on nature, which warrants measurement and reporting. This reporting of negative impact can, furthermore, indicate the exposure of the company to possible future action from regulators, government, litigators, and consumers to protect and/or restore nature.

2.) Finite resources and policy paradoxes

The planetary crisis shows that natural resources are finite. We therefore have to manage them with great care, and make sure that there are not any undesirable effects from climate or other environmental measures.

The paradox of climate mitigation and emission reduction is that the measures we take to reduce CO2 emissions might cause the exact opposite. For example, this could happen through fossil resource suppliers extracting more in anticipation of lower prices in future and/or tighter regulation, thus increasing CO2 emissions. This paradox has implications, for example, in that the interests and possible responses of fossil resource suppliers must be taken into account as governments frame environmental measures. Understanding the dilemma is paramount to achieving the goals (e.g. net- zero) we are aiming for. As I noted above, mankind is currently facing a paradigm shift, as environmental pressures will be accompanied by social and governance pressures as economies and sectors restructure to address multiple dimensions of change. Tensions between different desirable, but interdependent and conflicting, sustainability objectives arise when focusing on the leap to a sustainable future (Lai, A and Cui, L, 2021; Tavares, A.R. and Robaina M, 2021). This problem is, of course, compounded by the fact that there is generally little incentive for individuals to show consideration for what is available to everyone (nature).

?3.) We need frameworks

The changes that will occur within this transformation to a sustainable future are threefold: first, economies need to resort to nature-based solutions, but they also need, second, technology and, third, structural change (rethinking economic structure and consumption). We need frameworks to measure and assess such changes. Some key ones are briefly summarised below.

• SEA - System of Environmental-Economic Accounting

The so-called SEA Central Framework is a set of international statistical standards with the purpose of measuring the environment and its relationship with the economy. SEA is an established information system whose utility goes beyond providing economic and environmental data. Using it can improve the quality of data and provide a coherent and comprehensive framework. More importantly, SEA forces sectors to identify areas of imperfect understanding or conceptual disagreement and also enables identification of issues of poor data quality. For information systems, regular accounting means systematically compiling data from multiple sources, which means assessing accuracy and presenting information in a coherent form that facilitates accessibility and interpretability (SEEA 2012)

• ?TNFD - Taskforce on Nature-related Financial Disclosures

TNFD is aiming to develop and deliver a risk management and disclosure framework for organizations to report and act on evolving nature-related risks, with the ultimate aim of supporting a shift in global financial flows away from nature-negative outcomes and toward nature-positive outcomes. The Taskforce consists of 34 individual taskforce members representing financial institutions, corporates and market service providers with US$19.4trn in assets (TNFD).

• ?NEA Initiative - National Ecosystem Assessment, the IPBES approach

The NEA Initiative supports countries in tailoring the process developed by the Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services (IPBES) to carry out ecosystem assessments. The aim is to adapt national ecosystem assessments to specific national needs and circumstances, empowering greater support for decision-making. The approach involves a years-long process. Since 2017, the NEA Initiative has helped 14 nations with national environment assessments. They engage with UNDP and UNESCO through the Biodiversity and Ecosystem Services Network.

• ?ISSB - International Sustainability Standards Board

ISSB has published the first two drafts of its sustainability standards: IFRS SI and IFRS SII. IRFS SI contains general requirements for the disclosure of sustainability-related financial information. The objective of the ISSB sustainability standards lies in the presentation of material sustainability-related opportunities and risks of the reporting entity, which are useful to the primary users of general purpose financial reporting in deciding whether to allocate resources to the respective entity. IFRS SII (climate related disclosure) is the ISSB's first thematic draft standard and contains regulations on climate-related disclosures. It requires entities to report, among other things, the effects of material climate-related risks and opportunities on the entity's value, and the entity's response to and ability to adapt to those risks and opportunities.

Takeaway:

To successfully manage the transition, market participants need to understand the present situation. The current situation is an expression of market failure, in that the market and economic systems have failed to factor in the systemic value of natural resources. This has so far resulted in misleading signals about economic growth and even disruption to economic activity. Solving this problem will require joint action from regulators, governments, companies, financial institutions and consumers alike. Initiatives like SEEA are a good step into the right direction (The World Bank, 2010).

Looking ahead, as the global economy seeks continued growth with the same (finite) resources, there is still no pricing mechanism in place to fully price in the systematic value of nature and all of its services and externalities.

Moving to a new more sustainable path will first require transition inputs and services in order to achieve higher economic growth through a wave of new investments. Secondly, extreme weather events or natural disasters (such as wildfires or floods) will cause further disruptions which will not only negatively impact our economy, but also our overall quality of life. The economic and societal damage caused by these occurrences may serve as a catalyst for ongoing developments towards a more sustainable economy.

Therefore, there is an imperative to further develop appropriate methods for assessing nature, develops necessary technologies and rethink the modern economic model. Mandatory accounting of social and environmental effects is required to examine and evaluate impact performance, as it is similarly assessed for financial profit. One of the most crucial things that needs to be done is the development of an accounting system that enables monetary values to be assigned to both instances of ESG principles being violated, and instances where these principles have been successfully followed, ESG is the embodiment of all these developments within the financial sector.

Natural accounting is double materiality comme il faut - worth for a society of the 21st century to start distinguishing between stock and flow, value and price. Let us go back to the fundamentals of economics and using it as it should be.

References:

IPCC (2021). Climate Change 2021: The Physical Science Basis. https://www.ipcc.ch/report/ar6/wg1/

Lai, A. Wang, Q. & Cui, L. (2022). "Can market segmentation lead to green paradox? Evidence from China,"?Energy, Elsevier, vol. 254(PC).

SEEA (2012). System of Environmental-Economic Accounting 2012 Central Framework.,?https://seea.un.org/content/seea-central-framework.

Seega, N (2022). The double materiality of nature loss. Deutsche Bank, CIO Special, The new playing field for ESG assessment. https://deutschewealth.com/content/dam/deutschewealth/cio-perspectives/cio-special-assets/biodiversity-new-playing-field/deutsche-cio-biodiversity-esg-assessment-report-april-2022.pdf

Tavares AR., Robaina M. (2021). Drivers of the Green Paradox in Europe: An empirical application. Environ Sci Pollut Res Int. 2021 Nov 11. doi: 10.1007/s11356-021-16856-1. Epub ahead of print. PMID: 34761319.

The World Bank. 2010.?Environmental Valuation and Greening the National Accounts : Challenges and Initial Practical Steps. Washington, DC. https://openknowledge.worldbank.org/handle/10986/16098 License: CC BY 3.0 IGO.

TNFD. https://tnfd.global/about/