Treasury Practice

Understanding natural capital

Published: Jul 2022

While climate change has become an increasingly high-profile topic, less attention has so far been paid to natural capital – in other words, the world’s supply of natural resources. So why is natural capital important, how are companies addressing this topic, and what does it mean for treasury?

The focus on ESG and sustainability has never been higher. But while the issue of climate change has gained significant awareness in recent years, less attention has so far been paid to another pressing environmental topic: natural capital.

So what is natural capital? In a nutshell, it describes the world’s supply of natural resources, including rivers, forests, geology, air and ecosystems. People derive value from natural capital via ecosystem services, which include the provision of food and water, the flood control service provided by forests, the role played by insects in pollinating crops – and even non-essential cultural services that arise from physical settings, such as recreation, tourism and relaxation.

“Quite simply, natural capital is a way to frame the value of nature in economic terms,” explains Marcelo Bacci, Chief Financial and Investor Relations Officer at Brazilian pulp and paper company Suzano. He notes that this includes a variety of renewable and non-renewable resources, such as trees and fish, minerals and fossil fuels. “It also includes ecosystem services, such as the hydrological cycle providing fresh water, renewable energy sources, insects pollinating crops, or fungi and bacteria breaking down organic waste.”

Safeguarding natural capital

Bacci explains that natural capital can be spent or managed wisely – or alternatively, it can be squandered and deployed on harmful and unproductive projects. “There is a finite supply, and we need to ensure we think carefully about how we safeguard and use it,” he adds.

More broadly, natural capital can be viewed as part of a broader view of society called the ‘capitals approach’, explains Dr Beccy Wilebore, Chief of Science at Natural Capital Research, a science-based data company which produces a tool for mapping natural capital in the UK. “So we think about natural capital underpinning everything that we have in society, and upon that we can build our social capital, our human capital, our built capital and our financial capital,” she says.

In the UK, a notable development was the 25 Year Environment Plan (25YEP) published in 2018, which put natural capital at its core. The report argued that the value of natural capital “is routinely understated”, adding that “when we use a natural capital approach, we are more likely to take better and more efficient decisions that can support environmental enhancement and help deliver benefits such as reduced long-term flood risk, increases in wildlife, and a boost to long-term prosperity.” This, in turn, has been reflected in the Environment Act 2021 and the 2020 Agriculture Bill.

In 2021, meanwhile, the United Nations (UN) adopted a new framework to ensure that natural capital is recognised in economic reporting. The new framework, the System of Environmental-Economic Accounting – Ecosystem Accounting (SEEA EA), recognises the importance of ecosystems in delivering services that generate benefits for people.

What are companies doing?

The concept of natural capital is already affecting businesses in a number of different ways. In England, for example, the Environment Act will require all new developments to show a 10% net gain in biodiversity from 2023 – a shift that Wilebore says is driving a biodiversity offset market, especially on degraded agricultural land. At the same time, agricultural subsidies are changing towards public money for public goods – “and we’re very much seeing carbon markets and the race to net zero as a driver for lots of companies at the moment.”

For companies starting to look at this topic, Wilebore recommends companies that own or manage real assets – in other words, land of any kind – should start with a baseline: “Understand what you have now, what condition it’s in, and then look at the opportunities you have to enhance that even further. Once you know what those opportunities are, you can align them with available revenue streams such as offset markets for biodiversity, carbon or nutrients.”

Natural capital is also increasingly relevant for investors. Eoin Fahy, Head of Responsible Investing, Chief Economist at KBI Global Investors, notes that a concept such as natural capital “is an excellent framework for investors to use when looking at the impact that their portfolios are having on the environment, whether from a climate point of view, or in terms of pollution, biodiversity and a range of related issues.”

He adds that companies are approaching the issue of natural capital in myriad ways – “and in our view many companies are taking natural capital into account even if they never use the term at all!” For example, explains Fahy, a company that considers the biodiversity impact of its operations is considering the impact of its operations on natural capital, whether it realises this or not – “as is a company which takes measures to reduce its carbon footprint, or to measure the benefits to the environment of (for example) deforested land with fresh native forest plantations.”

Likewise, he says, companies that report to CDP (formerly the Carbon Disclosure Project) “are taking very significant steps towards properly considering natural capital issues, while again they may not necessarily think in those terms at all.”

Impact on treasury

So what does natural carbon mean for treasurers? Suzano’s Bacci points out that treasurers need to think carefully about risk management and regulation, and that companies are not turning their attention to natural capital solely due to pressure from stakeholders. “There is a growing acknowledgement that in order to secure the long-term financial health of a business, it must make the connection between natural capital and financial capital and actively implement changes to address this in their strategies and business models,” he says. “Governments and regulators around the world are already acting to ensure that these links are enshrined in law.”

“For Suzano, taking care of natural resources is not only the right thing to do, but is also critical to the future value of the company,” Bacci explains. “Our forest plantations rely on the availability of water and healthy soil and we need to maintain this, from one seven-year planting cycle to the next. If we deplete groundwater levels or strip soil of its nutrients, we will be left with degraded land and diminished future value creation opportunities.” Conversely, he says, “the company can increase the stock of natural capital by restoring degraded pastureland, and turning it into productive plantation forests that are comparatively better for biodiversity.”

Tesco is one retailer that has been proactive in addressing sustainability, with notable initiatives including the company’s sustainability-linked supply chain finance scheme. Alex Ashby, Head of Treasury – Markets, argues that in the last few years, natural capital has come to the forefront of economic and business sentiment with more prominence. He says this follows the growing realisation that the use of fossil fuels needs to decline aggressively – “but also the realisation that our planet’s resources really are finite in many more areas than just this, such as marine, soil quality and erosion and British hedgerows – not just carbon emissions and nickel for electric vehicles!”

Ashby notes that treasury is always at the heart of the risk management associated with movements in finite resources, and advising the Board on what these impacts mean to the business, now and in the future. “The ongoing growth of sustainability-linked finance is using financial capital and incentives to encourage the preservation of our planet’s natural capital,” he adds. “Different companies and industries are rightly focusing on their own natural priorities, but with a strong overhanging banner of climate change and awareness.”

Moving forward together

It’s clear that there is much to be gained by focusing on natural capital – but what are the risks of failing to address this topic? “Companies that do not take natural capital into account risk being seen as ‘laggards’ when it comes to this and other ESG issues,” comments Fahy. “For listed companies, this could significantly reduce their attractiveness to investors. But it may also raise regulatory issues, as there is no doubt that regulations such as the EU Sustainable Economy, the Corporate Sustainability Reporting Directive and others in the pipeline will increasingly require companies to report on these issues in the not-too-distant future.”

Wilebore, likewise, highlights the risk of missing out: “Getting in there early, and getting your assessments done early, will put you in the best position to engage with these markets when they come to fruition.” She notes that reputational risk is also a concern for companies that do not engage fully with this topic, citing the negative publicity that can arise for companies that are accused of greenwashing. “So it’s important to engage with this – but it’s also important to get it right, and to do so in a way that is scientifically robust and verifiable.”

Crucially, this is not a topic that companies can address in isolation. As Bacci points out, “Ultimately, business has an important role to play in protecting our natural habitats, but this must be done jointly with governments and society. We must collectively look to promote nature-based solutions to protect, restore and better manage ecosystems.”

Case Study

Marcelo Bacci
Chief Financial and Investor Relations Officer

Managing natural resources

“Suzano is one of Brazil’s largest private landowners. We are responsible for millions of hectares of both farmland, which we use to grow our eucalyptus crops, and native forests, which we permanently set aside for conservation. So, it’s our responsibility to ensure that we preserve and protect this capital for future generations.

“As a business, we constantly review all stages of our operations to ensure that long-term responsible management of natural resources is our first priority. We are not tempted to pursue short-term financial profits and higher yields at the expense of our natural environment. For instance, we have adopted advanced planting and harvesting technologies, use an integrated pest management approach and optimise the application of fertilizers, all to ensure the long-term health of the soils we harvest.

“Alongside this, we are focused on protecting bodies of water located in our land. Our production model is based on integrating eucalyptus-planted areas with native vegetation in the landscape, to form mosaics which are beneficial for the long-term conservation of soil, water and biodiversity. These mosaics are made up of conservation areas and eucalyptus forests, allowing for the formation of ecological corridors so that fauna and flora can move freely between habitats in harmonious coexistence with the landscape. All of this is beneficial both for biodiversity and for the productivity of the land, demonstrating how business and nature can work hand in hand.

“As well as employing responsible forest management techniques, we see ourselves as active stewards of the native forests surrounding our plantations and we carefully monitor every hectare of the land we own, whether used for farming or reserved for conservation. We closely monitor for biodiversity, maintaining records of over 2,700 records of plant, bird and mammal species, including new and endangered species.”

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