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November 21, 2013

What price the priceless?

By Vincent Huck

As natural resources become scarce, businesses may need to incorporate nature in their balance sheets and financial statements by giving a price to natural assets such as air, ancient woodlands or natural habitats. Vincent Huck looks at the latest trend in natural capital accounting.

Legend has it that the Chagga tribe, which lives on the slopes of Kilimanjaro, believed the mountain was sacred.

This belief was rooted in the fact that when they tried to climb the mountain to get to the shining precious stone at the top, they would feel ill and dizzy. And if they did make it to the top, the shining precious stone would have turned into water by the time they came back down again.

Of course we now know that altitude was the cause of their illness, and what they thought to be shining precious stones was in fact snow. This legend is a good allegory for our knowledge of, and relationship with, nature, and it links to a more current debate about natural capital, and natural capital accounting (NCA).

Natural capital refers to the stock of capital derived from natural resources. In other words, it refers to the elements of nature which directly benefit or underpin human well-being. NCA, in the words of the Institute of Chartered Accountants of England and Wales (ICAEW) head of sustainability Richard Spencer, is "a new discipline which highlights the impact of business activities on the natural world".

At the heart of the debate is the question of how to account for a company’s impact on nature in order to protect the natural resources which are essential to its activities, but also to make these activities more profitable.

Or as the World Forum on Natural Capital programme director Jonathan Hughes explains: "Are we using natural resources in a way that the renewing part of these resources can renew themselves quickly enough? We are running a natural capital debt that we won’t be able to pay back."

Natural capital has been discussed, debated, written about, criticised and promoted for the past 30 years, but mostly behind closed doors and in academic circles.

Widening debateIn recent years the debate has widened to a global audience, due partly to the rising importance given to ethics in business practice, but also because businesses have now perceived that a shortage of natural resources is an existing threat and a tremendous risk to the survival of their activity. As KPMG UK lead specialist in natural capital Stephanie Hime explains: "Natural capital has moved from a reputational issue to one of operational significance for businesses."

Spencer says this shift in businesses’ perception was very clearly apparent at the Rio+20 United Nations Conference on Sustainable Development last year.

"The main difference between Rio+20 and the original Rio conference in 1992 is the number of businesses that attended," he says. "The same ideas were discussed at both conferences, but at the original conference there were no businesses present, whereas last year plenty of leading businesses attended."

At the moment, NCA is at a debate stage with many initiatives independent of each other trying to bring ideas into practice."Through the Natural Capital Committee, the UK is looking at developing NCA at state level, and therefore is one of the leaders in the debate," says Association of Certified Chartered Accountant (ACCA) sustainability advisor Gordon Hewitt. "But a lot has also been done elsewhere through initiatives such as the Wealth Accounting and the Valuation of Ecosystem Services (WAVES)."

WAVES is a global partnership launched in 2010 with Botswana, Colombia, Costa Rica, Madagascar and the Philippines as the initial core implementing countries. The partnership now counts 65 countries.

Since its inception WAVES has tested the feasibility of NCA across five countries. The implementation phase in those countries has now started and is expected to last four years.

"Australia is also very active on the NCA front," Spencer says. "It’s the only country which has adopted an accounting standard with regards to natural capital."

In 2007, Australia’s Bureau of Meteorology set up the Water Accounting Development Committee, which two years later became the Water Accounting Standards Board (WASB).

The exposure draft of the first Australian Water Accounting Standard (AWAS 1) was published in 2010, followed a year later by the publication of the AWAS 2 exposure draft. Both standards were finalised in 2012.

Another major initiative in the field of NCA was launched in 2012 when The Economics of Ecosystems & Biodiversity for Business Coalition (TEEB for Business) was formed in Singapore. Among the founding organisations and supporters are the ICAEW, the Prince of Wales’s Accounting for Sustainability Project, the International Union for Conservation of Nature, the World Business Council for Sustainable Development (WBCSD), The Global Reporting Initiative and the World Bank.

Natural and social capital valuationTEEB for Business aims at supporting the development of methods for natural and social capital valuation in business. And herein lies the main issue around NCA: it is widely accepted that natural capital should appear in a company or a state’s accounts, but how, and in which form, is still unclear.

For many, this is where accountants have an important role to play. The debate has reached a turning point where ideas have to be put into practice, and accountants appear to be best suited to help the process.

As Climate Disclosure Standards Board (CDSB) executive director Lois Guthrie says: "Accountants have a 100-year-plus history of accounting for money and things that businesses need to flourish.

"Although accountants focused on money, we now know it’s not the only thing companies needs to flourish. They have to look at things such as ecosystems, biodiversity, water, healthy soil, timber, medicine, fuel."

This represents a challenge for businesses as NCA is still at a development stage, and there’s no single universally accepted way of incorporating natural capital into a business’s accounts.

"There are no universal standards at the moment," says ACCA’s Hewitt, "so different groups and organisations are looking at ways of doing things, and accountants with their skills and experience should get involved in this type of thinking."For KPMG’s Hime, there will be two ways of including natural capital in a company’s account. "One is to use environmental economics modelling to estimate the cost of impact and dependencies," she says. "And the other is to look at current accounting rules and apply them with natural capital in mind."

The latter is preferred by Guthrie, who believes accountants have the necessary tools to engage with natural capital. She says they should follow a four-step methodology. "First, natural capital has to be characterised," she says. "Whether it’s an asset, a liability, an option or a conditional promise, unless you characterise, it’s very difficult to know where to place them in the system of accounting."

The second step is to measure and account depending on the characterisation that has been chosen. This is a tricky part that divides most stakeholders. Some believe that natural capital should be given a monetary valuation – in other words putting a price tag on priceless ecosystems and natural resources.

But another way to account for the extent of a business’s impact on nature would be to look at quantities such as litres or metric tons. "You need an underlining unit which represents the extent of the impact," Guthrie says. "And the unit itself can be as informative as the financial value of that same unit."

Even though putting a financial value on natural assets is only one of the options discussed, it has become the main controversial question around NCA.

"There is some debate about the financial valuation because some say it leads to the commoditisation of nature and others believe that some things are just priceless for spiritual or historical reasons," Hewitt says.

"All those arguments are valid, but I think it’s more dangerous not to try and quantify natural capital in monetary terms, because what we are trying to do is incorporate it in economic decisions, and it’s very hard to do that if you don’t have a comparable figure."

The main argument for those in favour of putting a price tag on natural assets is that money is a language that businesses understand.

"Monetary valuation serves a purpose as being a language to understand the relative magnitude of different outcomes," Guthrie at the CDSB says. "We don’t have any other language available at the moment."

Hughes from the World Forum on Natural Capital agrees, and even though he says putting a value on natural assets will always be approximate, he adds "it gives an understanding of the importance and value of these assets in a way that was invisible before, and that can now help businesses to make decisions on how to manage those assets".

The third step, according to Guthrie, is the reporting which derives directly from the first two steps: characterisation, and measuring and accounting.

"If you look at it in terms of financial value or quantitative value, these are figures that can appear in a balance sheet," ICAEW’s Spencer explains. "But if you look at it in terms of quality, it will be in the narrative part of your reporting."

Despite agreeing that financial valuation of natural assets can be controversial, Hughes is against the qualitative narrative approach. "You can’t just include a couple of projects in your final report and that’s your corporate social responsibility ticked," he says. "There needs to be a rooted systematic mechanism by which you explain your relationship as a company with the environment in which you operate. It’s a much more rigorous approach than telling the nice story."

Hughes believes this rigorous approach will be a great tool against ‘greenwashing’, the term referring to PR work used to promote the perception that an organisation’s products, aims and policies are environmentally friendly.

"We are talking about an objective natural capital accounting approach where it’s much more difficult to spin the findings because, as we move towards common standards and proper auditing of the results, it will be real figures and much harder to get away with greenwash," he says.

He’s quick to remind everyone that NCA is not a threat to businesses but an opportunity. "It will ensure a stable supply of natural resources to run a business and minimise price volatility," he says. "But it’s not that if you do NCA you suddenly become sustainable. It will only enable businesses to make more informed decisions."

This idea goes hand-in-hand with the CDSB’s Guthrie’s fourth step, which is the purpose. "To what use will this information be put? Who uses it and what will they do with it?" she asks.

Spencer agrees: "Scaling and valuing is great, but what are you going to do about it? Do we want to use this value to design new regulations, or is it to change consumer behaviour, or to change the business model?"

An important consensus behind the idea of NCA is that it is not only about nature preservation, but also about enhancing businesses’ profits.

"We have always known that we had lost the ecological value," Hughes says. "But what we failed to understand is that we lost the economic value as well."

Risk management and savingsACCA’s Hewitt agrees and believes more companies should start considering natural capital as they will benefit from better risk management and cost savings.

For Hime at KPMG, the purpose of NCA should be the starting point of the debate. She says the main challenge will be the choice of language.

"There are several definitions of natural capital," she says. "And each uses language that need defining too. The main challenge at the moment is that we are still in the process of getting the debate out of the academic world and putting the ideas into practice. It’s obvious accountants have a role to play in this process because they ultimately govern what goes in the financial statement."

Another challenge, she says, is that there are so many different frameworks being developed at the moment it creates scepticism as the message is refined.

With different actors looking at different ways to account for natural capital, and no organisation taking the lead in coordinating those efforts into building a single universally recognised framework, it seems NCA still has a long way to go before it becomes standard practice.

But at the end of November the first World Forum on Natural Capital will take place in Edinburgh. Hughes, as part of the organising committee, explains the primary goal of the forum is to highlight the critical obstacles and start to agree on common elements for a standard.

"In a nutshell, we want the forum to be the turning point from rhetoric to reality," he says. "And the really exciting thing about the forum is that it will bring together governments, NGOs, academics, businesses, accountants and conservationist."

MilestoneGuthrie says that even though the forum hasn’t taken place yet it already has been described as a milestone. "It will be the opportunity to start establishing networks and agreements," she says.

While natural capital makes its way through a wider audience and installs itself as a necessity for business survival, Hughes suggests it will slowly become "a new market for firms to get involved in, there will be a need in the future for this service to be provided so it makes sense for firms to understand this concept".

There is no doubt that in the dangerous act of valuing or pricing our environment, accountants will have the tough responsibility of keeping the balance between price and value.

But in a world increasingly looking anxiously at the effects our actions are having on our world, the march forward of NCA would seem to be unstoppable.

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