In June 2012, the Natural Capital Declaration (NCD) was launched at the Rio+20 Earth Summit. Since then, 41 CEOs of financial institutions have endorsed this groundbreaking initiative, which is also supported by 23 civil society organisations in a broad and growing collaboration.
The NCD was borne from the fact that, unlike climate change, natural capital is largely unaccounted for by banks, investors or insurance firms in their products and services. Nature underpins global wealth creation. The renewable flow of goods and services provided by the earth’s ecosystems buttress our economy and yield benefits for business. But this stock of ecosystems – also known as “natural capital” – is largely invisible in financial decision-making. As a result, natural capital does not appear on the balance sheets of businesses and is largely unaccounted for in financial products.
Take, for instance, an investor in London, Shanghai or New York who finances a palm-oil development scheme in Indonesia or Africa, resulting in clearance of a large area of natural tropical rainforest. The dependency on and impacts of this investment on climate, food, energy, water and livelihood security are unlikely to be included in the cost of capital or debt, credit ratings on fixed income products, investment analysis or insurance premiums. Most finance institutions still do not believe that natural capital is material to their bottom line. In addition, for many types of financial products there are (at present) no metrics available to incorporate it into credit risk.
The aim of the NCD is to mainstream the systematic integration of natural capital considerations in loans, fixed income, equities and insurance products, as well as work towards embedding natural capital in corporate accounting and reporting frameworks.
The UN Environment Programme Finance Initiative (UNEP FI) and Global Canopy Programme (GCP), who jointly manage the NCD, will soon launch the NCD Roadmap and Business Plan to kickstart Phase II of the project. The project is seeking US$2 million over a three year period from the private sector, governments and foundations for full implementation.
What are our objectives in the next three years? First of all, we aim for the NCD to be an operational initiative that develops practical tools, frameworks and metrics that finance institutions can use to integrate natural capital – alongside other material ESG factors – into their own organisations.
The Environmental Risk Integration in Sovereign Credit analysis (E-RISC) project that UNEP FI and Global Footprint Network initiated in association with fifteen banks, investors and information providers is a good example of natural capital applied to a specific asset class: sovereign fixed income. It showed, for the first time, that natural resource and environmental risks are financially material to sovereign credit risk analysis. This topic was also the focus of the Corporate Knights ‘Global 100 – Executive Roundtable Dinner’ in Davos earlier this year. The NCD implementation phase aims to start similar types of projects focused on developing metrics for other asset classes such as corporate fixed income, various insurance lines and private equity, among others.
The second objective of the NCD is to increase the number of endorsements by financial institutions to build an even greater commitment in the sector towards taking action based upon the material importance of this topic.
Four working groups have been formed to design methodologies to implement the four core commitments of the NCD that endorsing CEOs sign up to. These are:
- Understanding: Build an understanding of the dependencies and impacts of natural capital within a financial institution’s operations, risk profile, etc.;
- Embedding: Integrate natural capital considerations into financial products and services – including loans, investments and insurance policies;
- Accounting: Work towards building a global consensus for the integration of Natural Capital into private sector accounting and decision-making; and
- Disclosing/reporting: Work towards a global consensus around the development of integrated reporting, which, includes natural capital.
A number of challenges still remain. Given that a considerable part of economic growth is likely to come from emerging markets, it will be especially important to convince finance institutions based in emerging markets to sign up to the NCD. Second, it is crucial to show how systematically embedding natural capital factors into financial products can go hand in hand with having successful business models. Even though there is an obvious need to better account for the value of ecosystems in our global economy, the current economic climate makes this particularly challenging. For many banks, the foremost focus is on shoring up their balance sheets, which makes it difficult to point them to the medium- and long-term horizon where environmental constraints will affect their bottom lines. The early response from endorsing financial institutions has been encouraging, but greater institutional support will be needed for this to become mainstream.
