Professional Accountants: Changing Business for the Planet — A Simple Guide to Natural Capital Management, Part One
Hello and welcome to Professional Accountants Changing Business for the Planet. My name is Sharon Machado, and I'll be providing a simple guide to natural capital management. In this series, the connected world I talk about is not just an international trade one, or a digital one, but one that's evolved over millennia.
Natural capital is creating risks and opportunities for business. This introduction — Part One of the series — will outline the call for businesses to act, the strategic actions they should take, and the role of the professional accountant, which the future parts of the series will explore. There is a guide for each accountancy realm, so I'm going to start with the call for business action: why should businesses better manage natural capital?
What Is Natural Capital?
Natural capital is the planet's renewable and non-renewable environmental resources and processes that support organisations and, in turn, society's prosperity — from air, water, land, minerals, and forests, to biodiversity and ecosystem health.
To aid understanding of its importance and potential materiality, think about the types of resource, or capital, a business uses across its value chain. The International Integrated Reporting Framework identifies six interconnected, interdependent capitals that drive business value creation.
Now let's consider: are these capitals recorded in the balance sheet or profit and loss in the same way as financial capital? The answer is no. But just like financial capital, they are enhanced or eroded — in fact, there is a constant trade-off between them, making it crucial for businesses to properly understand their connections. That understanding is made more likely when the capitals are recognised, measured, and reported. Without sufficient understanding, ineffective natural capital management is more likely, and that can lead to a vicious cycle.
Take Scottish Highlands whisky, whose success is due in part to the mineral composition and purity of the water used. This water is free and naturally occurring, so under current financial accounting rules the water itself would not be recognised. However, the financial costs associated with processing it would be. Yet climate and local activity can easily impact water availability and quality, creating business risks — whether through additional costs or even impairing the viability of the product itself. If the water is not properly appreciated — recognised and measured, even for internal purposes — risk management controls may not be effective or efficient.
A 2019 CSR Europe study suggested that over half of companies consider biodiversity to be material, yet it isn't sufficiently integrated into internal and external reporting, and therefore into decision-making. However, when it is integrated through risk and opportunity assessment, it can lead to sustainable business models — and with that, virtuous cycles. In virtuous cycles, risks are known and are being mitigated, which provides confidence to stakeholders, who can then justify investment in further natural capital management strategies, continuing the virtuous cycle.
How Real Is the Risk of a Vicious Cycle?
Up until 1960, the natural capital ecosystem was broadly balanced, so the prospect of a vicious cycle wasn't that high. Fast forward to today, and there seems to be very little left for wildlife: 96% of all mammalian life on Earth is made up of humans and the farmed animals we consume. As of 2020, it's estimated that humanity has wiped out 83% of wild mammals and half of all plants — meaning the natural capital ecosystem is likely out of balance. That will have ramifications for business, from supply chains through to business models, and therefore for society too.
As of 2020, at a macro level, estimates indicate that more than 50% of global GDP — around $44 trillion USD — is moderately or highly dependent on nature, with no industry truly spared. So this macro problem is likely to be a material issue at a micro level too, for many organisations.
Other Calls to Action
We've considered the call for business to act driven by the demands of nature, but there are other calls to action.
The call from society: society demands greater care for the environment. A 2020 McKinsey survey found that two-thirds of consumers believe it's vital to limit the impacts of climate change, with 88% wanting more attention paid to reducing pollution. Consumers are acting on this: 57% are making changes to their lifestyle to lessen their environmental impact, and more than 60% are recycling and only buying products with environmentally friendly packaging. COVID-19 has heightened this view, and it's expected to continue — younger generations are reviving the secondhand market, and more people are demanding more durable products, reducing total consumption. While these findings relate to fashion, the same impact is being seen across other industry sectors, sending a strong signal for businesses to adapt what they do and how they do it.
The push from policymakers: driven by net-zero ambitions, policymakers are setting regulation, providing incentives, and penalising negative impacts — driving business model transformation. The EU, for example, is committed to action as part of its Green Deal, whether through direct investment, incentives, or penalties — for instance, reviewing indirect tax exemptions for air and maritime passenger transport. Another example is U.S. wind farm incentives via tax credits, which make otherwise unviable projects feasible. These incentives allow organisations to balance multi-capital stakeholder needs as they transition to more sustainable operations. Many organisations are asking for help to better understand these policies, including how to fairly reflect them in their investment and management appraisal systems.
Standards and Framework Development
At a national level, focus on natural capital began as early as 1992, at the Rio de Janeiro Earth Summit, where nations identified the need to integrate environmental and economic information in order to manage the transition to more sustainable economies. These national principles have filtered into guidance and mandatory requirements for organisations, in the form of standards and frameworks. There are so many that organisations are asking for help identifying which to use, and how.
Investors, too, are increasingly choosing green — wanting to better understand governance, strategy, risk, and metrics aligned to recommended frameworks such as the TCFD. Organisations like BlackRock, State Street, HSBC, and Pollination Climate Asset Management require investee organisations to know and report against these issues. However, there are multiple information gaps that are difficult to reliably close. Organisations need support — from information systems, analysis, and competency — for the recognition, measurement, and reporting of risks and opportunities connected to the capitals.
Demand for information is increasing: in the year to May 2020, there was a 24% increase in demand for better understanding of supply and value chain business dependency and impact on nature. Other organisations are developing AI-powered tools for investors, financial institutions, and governments, helping them visualise and explore organisational data on deforestation and other environmental risks, as well as business policy violations — and creating watch lists that bring a systematic approach to comparing organisations.
What Businesses Can Do
As a business, you can enhance stakeholder understanding of what your business does by providing supplementary information. As we've seen, a better understanding of natural capital also gives you greater scope to act — averting vicious cycles and creating virtuous ones — with the opportunity to reap reputational benefits, whether through recognition by media or more official channels.
In January 2020, for example, one company was ranked the most sustainable company by Corporate Knights — an official channel. That accolade came from being clear on strategy and scope, and then developing the required business model and quality information systems to deliver on that strategy.
The Four R's of Strategy
So what action must business take? Starting with strategy: businesses need to follow one or a combination of the four R's — Remove, Reduce, Restore, and Reimagine success. This series will explore the four R's in more depth, specifically how the accountancy profession should support formulating, executing, evaluating, and reporting on strategy that removes impact, for example phasing out polluting activity; reduces impact, by addressing resource and waste utilisation, taking only what's necessary or what can be naturally restored; restores, potentially starting with already-damaged areas, such as deforested land, and replanting it; and reimagines success, most importantly founded on a mindset change that considers success across all material capitals, leading to transformative innovation, such as employing circular economy principles where waste becomes useful for another process.
Going back to the Scottish whisky example: the barley used in whisky production, once it has served its purpose, doesn't have to carry a disposal liability — instead it can be treated as stock for sale as animal feed.
Many organisations have already begun their four R's journey. To deliver their strategies, they answer some fundamental questions: What is our natural capital dependency and impact on nature? What are our risks? What should we do, and how, and over what timescale? And how do we measure success? Central to all of this is communication — bringing stakeholders along on that journey.
The Role of the Accountant
Delivering the four R's requires business activities of investment and process, underpinned by quality communication, data, and evaluation. ACCA's report Accountants' Purpose and Sustainable Organisations highlights the vital role of the profession in supporting the value creation, protection, and communication that brings natural capital management strategies to life.
Accountants are well placed to do this because they can think holistically, bringing together financial and non-financial capitals to close information gaps and drive forward-looking, quality decision-making — acting ethically and in the public interest, with technical expertise combined with professional skill that enables risk management and opportunities to be realised.
Accountants take on a multitude of roles in business and on behalf of society, performing interwoven functions: strategy formulation, evaluation, execution, and reporting — leveraging technology and collaborating with other experts, such as data and natural capital scientists.
In the remainder of this series, we'll explore how these interwoven functions — evaluate, formulate, execute, and report — relate to four professional accountancy roles: business leader, who connects financial and non-financial issues at a strategic level, driving holistic decision-making, identifying and managing strategic options together with associated finance, and setting the tone and culture required to implement policies and processes; performance manager, who identifies information requirements, owns the information process, and spots the triggers to drive required interventions, using integrated thinking to connect the capitals to business issues and strategy; corporate reporter, who employs the tenets of good corporate reporting, telling the holistic story of value creation by connecting the multi-capitals, which indirectly recognises the multiple stakeholders who provide them; and auditor and assurer, who provides functions related to the reliability and integrity of operations, both reported and potential, together with an assessment of the controls behind them.
While this series doesn't cover the role of the tax professional, we know how important they are in shaping policy — see our report Tax as a Force for Good, which outlines the potential policy actions that drive greener business.
What's Next in the Series
For each role, we'll provide an outline of the key how-to principles for supporting natural capital management, together with illustrations to bring the insight to life, and links to further sources of information for those who want to know more.
Our insight has been drawn from our own desk-based research, as well as from our contributors, whom we'll hear from throughout the series — and a big thank you to them.
