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Beyond Profit: Making natural capital matter

With sustainability so integral to allocation decisions for asset owners across Asia, what is the value of 'natural capital' to portfolios? Schroders believes that understanding - and embracing - this amid the ongoing changes to the climate, physical environment and biodiversity is key to avoiding nature-related financial risks.
<i>Beyond Profit:</i> Making natural capital matter

Natural resources are the most important input to the global economy. From raw materials and water, to flood protection, biodiversity or pollination, nature provides most of the capital businesses need to produce goods and services.

We all have a role to play, therefore, in protecting these resources and associated societal benefits so humans can continue to benefit for generations to come.

This is putting a spotlight on ‘natural capital’ – elements of nature that provide important benefits called "ecosystem services". These include CO2 sequestration or removal, protection from soil erosion and flood risk, habitats for wildlife, pollination and spaces for recreation and wellbeing.

The combination of soils, species, communities, habitats and landscapes which provides these ecosystems services are often referred to as "assets".

In line with this, the idea of viewing nature as natural capital, recognising the true value of nature's assets, is rapidly increasing in popularity. There are even calls for it to be viewed as an economic asset, with the UN urging governments to look beyond GDP.

“Natural capital is different from other sources of capital because it’s not produced,” says Dieter Helm, professor of economic policy and Fellow in Economics at New College, Oxford. He points out that oil and gas are natural resources that are derived from nature itself and are free for us to use at their starting point.

Is natural capital valuable in financial terms?

Natural capital is not typically considered an economic asset despite it being central to our survival and development. This means nature’s pivotal role is not being accounted for in measurements of economic growth and wellbeing.

To change this, the UN’s landmark economic framework, the System of Environmental-Economic Accounting, will enable natural resources to be more accurately valued. At the same time, the Economics of Ecosystems and Biodiversity, aims to mainstream natural capital accounting by following a structured approach to the valuation of natural resources.

Meanwhile, the Capitals Coalition, made up of 380 global initiatives and businesses, is also trying to get most of the world’s businesses, financial institutions and governments to account for natural capital in their decision making by 2030.

These pioneering initiatives will facilitate nature being considered an asset that can appear on the same balance sheet as a company’s other resources.

Schroders is also playing an increasing part in elevating the role of natural capital for investors. For instance, the firm has joined the Natural Capital Investment Alliance, which aims to accelerate the development of natural capital as a mainstream investment theme. In addition, in conjunction with Oxford Sciences Innovation, Schroders has invested in Natural Capital Research, a data-led, science-based organisation specialising in measuring natural capital assets globally.

“There is huge potential for investing in natural capital assets; potential not only for offsetting carbon and ESG, but also for halting global biodiversity loss and restoring some of the most important ecosystems in the world," explained Kathy Willis, a professor of biodiversity at Oxford University and director at Natural Capital Research.

Should natural capital really be the concern of investors?

The scope is bigger than many people realise. For example, more than half of the world’s total GDP, or $44 trillion, involves activities that are moderately or highly dependent on nature, according to the World Economic Forum.

“The degradation of natural capital, including the loss of biodiversity and depletion of renewable stocks, poses a real risk for businesses, their earnings and investors,” said Andy Howard, Schroders’ head of sustainable investment.

In practical terms, business, banks and investors could face increased insurance risks, higher costs of capital and a loss of investment opportunities.

“Sectors like agriculture, food and marine which are overly-reliant on ecosystem services that are currently not valued, or are undervalued, may see company valuations affected when these are eventually accurately valued,” added Howard.

In addition, regulatory and policy pressures are already building. For example, the EU Green Deal contains a significant element on biodiversity. “These could have direct revenue impacts”, he said.

The World Wildlife Fund estimates a direct cost of $10 trillion globally between 2011 and 2050.

What have investors done so far?

Most investors do not yet fully appreciate biodiversity-related financial risks. Plus, there are very few commitments or policies in place to address it. But momentum is gathering.

This includes efforts by the World Bank and global investors to establish collaborative engagement along similar lines to the Climate Action 100+. “The so-called Nature Action 100+ would seek to drive change at the top 100 companies having the biggest negative impact on nature,” said Hannah Simons, Schroders’ head of sustainability strategy.

Work has begun on a Taskforce for Nature-related Financial Disclosures with a plan to create a framework – similar to the Taskforce for Climate-related Financial Disclosures – for firms to disclose their exposure to nature-related financial risks by the end of 2023.

“Science-based targets for nature are in the early stages of development by the Science-Based Targets Network,” she explained. “These targets are a way in which businesses can align their individual sustainability action with globally agreed environmental goals.”

What more needs to be done by investors regarding natural capital?

Investors can play their part by allocating capital towards investments that preserve our natural environment and by understanding how companies in their portfolios use and rely on natural capital.

“We can act as active owners of our investments, using available data to determine leaders from laggards and drive change, especially among laggards, to help them improve business practices,” said Howard.

Simons believes it is also the responsibility of investors to encourage third parties to collect and disseminate consistent and comparable nature-related data, and urge companies to get involved in the Taskforce for Nature-related Financial Disclosures pilots.

Click here to learn more about how Schroders views sustainability. 

Investment involves risks. This material is issued by Schroder Investment Management (Hong Kong) Limited and has not been reviewed by the SFC.

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