Wednesday, May 8, 2013

Natural Capital: Gaining Currency with Integrated Reporting

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Natural Capital may be priceless, but it is due to increasingly make its way into the annual reports of corporations world-wide. Consider Natural Capital at Risk - The Top 100 Externalities of Business - published last month by the TEEB for Business Coalition in the same week that the IIRC published a new draft of its Integrated Reporting (IR) Framework. Its findings on exposure to Natural Capital risks have serious implications for sustainable sourcing and integrated business planning, food for thought as many start to examine the IR Consultation Draft.

The Coalition report identified coal-powered energy (e.g. in Eastern Asia) and cattle ranching (e.g. in South America) as the most environmentally costly businesses. Monetising the value of unpriced Natural Capital, the study signals to companies and investors their direct exposure as well as indirect risks through supply chains. Sectors such as food and timber processing were found to be most at risk from these costs being brought on to balance sheets through their supply chains.

Externalities, their potential or actual business impact and disclosure of related non-financial or financial information is a matter of growing concern to sustainability and financial officers alike. The International Integrated Reporting Council (IIRC) has a special take on this. Other than target audience (investors versus all stakeholders), the basis on which it differentiates the IR from the sustainability report is the following suggestion: Sustainability reporting "focuses on impacts on the environment, society and the economy, rather than on the effects of the capitals on value creation over time" (as is the case with IR).

This highlights a key distinction employed by a series of reports on the Economics of Ecosystems and Biodiversity (TEEB) in recent years, namely that between "impacts and dependencies". The IIRC argument suggests that sustainability reporters have tended to focus on the impact of their businesses on their external environment. They have done this at the cost of the reverse perspective, considering more specifically the consequences of changes in the external (natural) environment on the business of the reporting entity itself and its value chain.

Differentiating between pollutant impacts and consumption of Natural Capital, the research by Trucost for the TEEB Coalition focussed on six main categories of indicators: land use, water use, GHG emissions, air pollution, waste, land and water pollution. As far as the consumption, use or dependence side of the equation is concerned, the concept of "ecosystem services" has also been gaining currency in the last decade. Both the International Finance Corporation (IFC) Performance Standard 6 and ISO 26000 Clause 6.5 refer to "ecosystem services" - such as food, water, fuel, flood control, soil, pollinators, natural fibres, recreation and the absorption of pollution and waste. Signalling integration, ISO 26000 recognises the interdependence between its seven core subjects (environment and others).

In coming years, many companies will be asking themselves how the overall stock and flow of capitals, including Natural Capital, impacts their ability to create value in the short, medium and long term - as required by the IR Framework. The IIRC recognizes the complexities of these developments, and the dilemmas that possible trade-offs between the capitals or their components may pose businesses. It also recognizes that much of the capital involved may be unpriced and/or fall beyond the ownership or control of a business. Yet if material (directly or indirectly), key trends in its availability, quality and affordability need to be reported.

The vulnerability of a business to natural resource changes is increasingly recognized, among others by  strategic investors. This is also the case with the forthcoming G4 version of the Global Reporting Initiative (GRI) Guidelines, recognising impacts and dependencies on natural resources as well as biodiversity values. In addition to its core focus on the (often global) value chain, G4 also addresses cases of sharing natural resources with other (often local) communities. If a business were to treat Nature as a valued supplier, what are the capabilities and qualities of that supplier? What would an inventory of that supplier look like? Answers to this can be found in international research captured by the Millennium Ecosystem Assessment (MEA) and follow-up reports such as the TEEB series. It among others provides latest scientific agreement on how supplies from Nature can be best categorized, and what key trends in its current stocks and flows globally tell us.

The lesson for some industries is that they may be out of business in the medium to long term. This relates, among others, to what a top US military official recently described as the biggest long-term security threat in the Asia-Pacific: climate change. In its Sustainable Industry Classification System (SICS) the Sustainability Accounting Standards Board (SASB) has revised traditional industry classification into 10 thematic sectors based on "common sustainability challenges and opportunities" they face. The UNEP Green Economy Report (2011) focussed on 10 "key sectors considered to be driving the defining trends of the transition". Its macro-economic modelling by the Millennium Institute was unique in including natural resources as a factor of production. Examples of the direct dependence of output (GDP) on Natural Capital cited were the availability of fish and forest stocks for the fisheries and forestry sectors, as well as the availability of fossil fuels to power the capital needed to catch fish and harvest timber. Other natural resources and resource efficiency factors considered in the scenario modelling were water stress, waste recycling, materials re-use and energy prices.

How can a business start to unpack its relation to these developments? What are the key pressure points it needs to consider in defining strategic risks and opportunities for its own workings? In how far should it revise or rewrite its business model, considering its use of Natural Capital stocks and services? What tools are available to facilitate its assessment and decision-making in the process? What qualitative and quantitative indicators are most relevant in determining how the use of energy, water, land, biomass and related resources by itself and its suppliers materially affect the viability of their collective enterprise? What exactly is the "integrated thinking" that investors would expect the business to display when it describes its business model and its relation to Natural Capital?

These are questions we will be tackling in a series of ACCSR seminars this coming June in Australia (Brisbane, Sydney, Melbourne, Perth - see ACCSR), with support of National Australia Bank.

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