Is natural capital a material issue?An evaluation of the relevance of biodiversity and ecosystemservices to accountancy professionals and the private sector A report from ACCA, Fauna & Flora International and KPMG
We are on the brink of a potential crisis from the combined effects of ecological degradation and population growth. Natural resources on which society and business are dependent are being lost at an unprecedented rate. This loss of natural capital is posing a new array of risks to business ranging from increasingly severe competition for access to resources, to tightening regulation and greater and more costly hurdles to accessing finance. The Rio+20 meeting saw over 50 countries and 89 private sector organisations make formal commitments on natural capital. A trend is emerging that attempts to use accounting practices to give better understanding of the implications of the loss of natural capital for governments and for business. How prepared is the accounting profession to respond? About ACCA www.accaglobal.com ACCA (the Association of Chartered Certified Accountants) is the global body for professional accountants, supporting 154,000 members and 432,000 students throughout their careers, and providing services through a network of over 80 offices and centres. ACCA works to strengthen a global profession that is based on the application of consistent standards, which ACCA believes provide the best support for international business and the desire of talented people to have successful, international careers. ACCA champions the needs of small and medium-sized business (SMEs) and emerging economies, and promotes the value of sustainable business. About Fauna & Flora International www.fauna-flora.org Fauna & Flora International (FFI) protects threatened species and ecosystems worldwide, choosing solutions that are sustainable, on the basis of sound science and taking account of human needs. Operating in more than 40 countries worldwide – mainly in the developing world – FFI saves species from extinction and habitats from destruction, while improving the livelihoods of local people. Founded in 1903, FFI is the world’s longest-established international conservation body and a registered charity. Through its global corporate partnerships, within the Business and Biodiversity Programme, FFI aspires to create an environment where business has a long-term positive impact on biodiversity conservation. FFI leads the Natural Value Initiative (NVI) collaboration (www.fauna-flora.org/initiatives/nvi). To date, the NVI has released a series of valuable publications and tools that address biodiversity and ecosystem services within the finance, extractive, pharmaceutical, and agricultural sectors. About KPMG www.kpmg.co.uk As sustainability and climate change issues move to the top of corporate agendas, KPMG in the UK’s Climate Change and Sustainability Services (CC&S) practice assists organisations by providing sustainability and climate change Assurance, Tax and Advisory services to organisations, helping them apply sustainability as a strategic lens to their business operations in order to better understand the complex and evolving environment, optimising their sustainability strategy. For more information, please visit our website: www.kpmg.com/UK/en/services/Audit/Pages/ClimateChangeandSustainabilityServices.aspx2 | Is natural capital a material issue?
ContentsForeword 4Executive summary 61. Introduction 102. Biodiversity, ecosystem services and corporate performance 113. Biodiversity and ecosystem services as a business risk and opportunity 144. Are biodiversity and ecosystem services issues material? 195. Biodiversity and ecosystem services in reporting 236. Valuing biodiversity and ecosystem services – trends and current practice 287. Conclusions and recommendations 34Appendix 1: Interviews 36Appendix 2: Financial statements and Financial reporting standards 37Appendix 3: Disclosure survey of high-risk sectors 41Authors 42Endnotes 43 Is natural capital a material issue? | 3
Foreword Business and government leaders from around the world are increasingly sounding the alarm about the significant impact of human activities on the natural environment – affecting its capacity to provide the goods and services we rely upon, and consequently resulting in a clear cost to business. Such is the concern of business and government that the recent Rio+20 UN conference on sustainable development saw CEOs of 39 financial institutions, including banks, investment funds, and insurance companies, make a formal commitment to work towards integrating natural capital considerations into their products and services. Shareholders are becoming increasingly engaged with the issue. Alongside this, governments are exploring regulatory or policy changes to encourage the sustainable use of biodiversity and ecosystem services (BES) through the development of frameworks for national ecosystem services accounting. The commitment at Rio+20 demonstrates the growing realisation that all economic activity is either directly or indirectly linked to natural capital, and action is needed. Nonetheless, this link has yet to be measured and addressed widely by the corporate sector. As all aspects of business are ultimately linked to and influenced by trends in natural capital, this highlights a risk to business, which could ultimately lead to business failure. The question remains: how do we effectively measure, assess and report to business on the economic impacts of natural capital on business? ACCA has long recognised that companies ignore the need to account for non-financial issues: natural capital is no exception. The accountancy profession and the business world need to start urgently considering the extent to which they are drawing down natural capital and how the erosion of such capital will affect business. New accounting, valuation and reporting techniques are required; different approaches to risk identification, materiality processes and the internalisation of externalities are needed. ACCA, together with its partners KPMG and Fauna & Flora International, has been exploring the relevance of natural capital to accountancy professionals and the corporate sector. This report aims to continue to show the relevance of non-financial accounting to its members and students, as well as demonstrating the tangible role the profession can play in managing corporate impacts and dependencies on natural capital. It demonstrates how some among the business community are integrating natural capital into their decisions, and that accounting for it is paramount. Helen Brand, Chief Executive, ACCA4 | Is natural capital a material issue?
ForewordNature underpins business in countless ways. For many years humanity has failed to place a value on the resourcesobtained from the environment – freshwater, healthy soils, stable climates, pollination. Our days of securing suchresources at no cost are numbered. As biodiversity and ecosystems are degraded, the ecosystem services that arederived from them (and form a large part of the natural capital on which we rely) decline. Society, and business as apart of that, is increasingly living off the capital of the natural world rather than the interest. Basic economic theorysuggests that this is unsustainable.FFI welcomes a move by regulators to understand the true value of these services to mankind and business and totake steps to protect them. Such steps are giving rise to a range of risks and opportunities for businesses. These arehitting their bottom line. As the issue becomes increasingly material to companies, it will increasingly feature in theirrisk analyses and disclosures. FFI believes that the measurement and disclosure of this issue is absolutely key toenabling stakeholders such as investors, government and civil society to hold to account poor performers whilerewarding those who adopt a proactive stance on the issue.Mark Rose, CEO, Fauna & Flora InternationalKPMG’s UK Climate Change and Sustainability practice helps clients to understand how global sustainability mega-forcesaffect their businesses and to implement sensible solutions that reduce the risks and unlock opportunities. ‘Ecosystemsand Biodiversity’ is one of ten mega-forces that KPMG highlighted in the report Expect the Unexpected, published earlierthis year; KPMG is convinced that businesses will increasingly be held to account for their impacts on the naturalenvironment and that they need to think now about how they should respond.Further evidence of the trend came at the recent Rio+20 UN Conference on Sustainable Development, where the CEOsof 39 financial institutions, including banks, investment funds, and insurance companies, committed to working towardsintegrating natural capital considerations into their products and services. This means they will take account ofecosystem impacts when deciding whether and how to provide finance.As a result, many businesses could find that their impacts on nature directly affect their credit worthiness, balance sheetsand company values within the next five to ten years, as moves to place an economic value on ‘natural capital’ accelerate.With that in mind, urgent work should be done to find practical ways to assess and report on the natural capital impactsof business and to use those assessments in formulating future strategy. CFOs and accounting professionals must be atthe centre of this work, which is why KPMG’s UK Climate Change and Sustainability practice, has been pleased to joinwith ACCA and Flora & Fauna International on this important report. By setting out a series of recommendations onnatural capital loss, materiality and disclosure, the report makes a timely and useful contribution to this process.Vincent Neate, Head of Climate Change and Sustainability, KPMG in the UK Is natural capital a material issue? | 5
Executive summary This report investigates the concept of materiality and how it is used to identify issues for management and Box 1: Definitions of biodiversity and disclosure. It is aimed at accountancy professionals ecosystem services (BES) and business leaders. It explores the extent to which Biodiversity: The variability among living organisms from materiality definitions currently reflect the increasing all sources at a species, habitat and genetic level – a significance of natural capital as a business issue. constituent of natural capital. A survey of over 200 accountancy professionals, interviews with CFOs/senior management from eight Ecosystem: A dynamic complex of plant, animal, and micro- major companies, a disclosure survey of corporate organism communities and their non-living environment reporting by 40 organisations in specific sectors, and interacting as a functional unit, e.g. ecosystems include desk-based research into relevant literature and work deserts, coral reefs, wetlands or rainforests. in the field were all undertaken as part of this work. Ecosystem services: The benefits, closely dependent on The report focuses on biodiversity and ecosystems, biodiversity, which human beings obtain from ecosystems. which are specific constituents of natural capital that give rise to ecosystem services (see Box 1 for definitions of these scientific terms, see Box 4, page 11 for more details). The report does not consider the specific impacts Box 2: The value of ecosystem services (ES) on geological resources as these are routinely included in • loss of the pollination services from bees in Britain The market transactions and accountancy practices. would cost the UK economy GBP 1.8 billion per annum2 Natural capital is the stock of capital derived from natural • onserving forests avoids greenhouse gas emissions worth C resources such as biological diversity and ecosystems, in US$ 3.7 trillion over the long term (net present value)3 addition to geological resources such as fossil fuels and mineral deposits. It provides the ecosystem products and • costs of cumulative losses of ecosystem services in The services that underpin our economy and provide inputs or the 50-year period to 2050 will be equivalent to 7% of indirect benefits to business. GDP by 20504. Biodiversity and ecosystem services (BES) are in decline globally. This trend is predicted to continue as the world’s Figure 1.1: Risk and opportunity identification population grows and demands on natural resources increase (see Box 2). Loss of BES exposes the corporate sector to a range of new risks and opportunities that can Global issues and trends affect profit, asset values and cash flow. Yet BES issues Risk and opportunity identification filter are often overlooked in materiality assessments1 owing to low or uncalculated market-based values. Corporate risks and opportunities The concept of materiality as a driver of action Materiality filter As part of overall corporate governance, companies may go through a risk-prioritisation process to identify those Company issue issues on which to focus management effort. Further disclosure filters may then be employed if companies choose to disclose specific issues to stakeholders (see Figure 1.1).6 | Is natural capital a material issue?
Executive summary Only a very short time ago, we were drawing blank looks when we mentioned natural capital accounting… At Rio, everyone is talking about it.i Rachel Kyte, Vice President for Sustainable Development, World BankMaterial issues are those issues that could influence Natural capital and materialitythe users of financial accounts. Key stakeholders such As shareholder attention on BES issues grows, theseas investors still largely judge corporate performance issues are beginning to feature in management disclosureon the basis of measures of financial materiality. Many and analysis – the qualitative part of the annual reportenvironmental and social issues, including BES, are and accounts, or within separate sustainability reports.rarely considered to be material by companies, despite There are also some instances where an item or issueincreasing concern from civil society. The concept of might be measurable in financial terms and thereforemateriality underlies principles of corporate disclosure. included in the quantitative elements of the accounts.7Unless the materiality of BES as an issue can bedemonstrated, the arguments for its inclusion within • here have been planning restrictions as a result of Tcorporate disclosures, and by association corporate impacts on natural capital and associated decreases instrategy and management systems, are weak. Yet action company share price. For example, in 2012 the Canadianby civil society suggests that BES loss is an increasingly Gold mining company, Infinito Gold, lost permission tosignificant issue for business and society as a whole. develop a mine as a result of the potentially significant impacts on agriculture, forests and endangeredA changing landscape of risks species.8 This led to a decrease in share value of 50%The Principles for Responsible Investmentii show that 50% (see Figure 4.1, page 20) and a reference in the annualof company earnings could be at risk from environmental report to material uncertainties regarding the company’sexternalities – equivalent to 11% of global gross domestic ability to continue as a going concern.9product.5 In addition, full environmental costs ofproduction in 11 key industry sectors could account for • lean-up costs from the 2010 Gulf of Mexico oil spill Ca considerable proportion of earnings (earnings before and associated compensation claims for ecologicalinterest, taxes, depreciation and amortisation – EBITDA), damage have affected both BP’s balance sheet andthis would have amounted to 41% in 2010.6 It is becoming its profit and loss. The company’s 2011 annual reportincreasingly accepted that a significant volume of financial included a $3.5 billion provision related to clean-upflows are not accounted for in corporate accounts. costs and a $7.8 billion provision related to litigationFurthermore, it is becoming clear that the costs of these and claims associated with the spill.externalities are being borne primarily by governments • here have been delays in securing permission to Tand society more broadly. At least some of these develop as a result of concerns about natural capital.externalities will at some point be internalised. Thus, the For example, Newmont Mining Corporation in Perulinks between BES and corporate value through impacts experienced significant delays as a result of concernson share price are strengthening. Shareholders are about the impacts of the mine on water availability. Thisbecoming increasingly engaged on the issue. Alongside not only resulted in costs associated with the delay,this, governments are exploring regulatory or policy but also required an investment of approximately $150changes to encourage the sustainable use of BES through million from the investment partner, Minera Yanacocha.10the development of frameworks for national ecosystemservices accounting and by evaluating the status andeconomic value of ecosystem services.Source: http://blogs.worldbank.org/voices/rios-buzzing-about-natural-capital-accountingi The United Nations-backed Principles for Responsible Investment have been devised by the investment community to provide a voluntary framework by which all investors caniiincorporate ESG issues into their decision-making and ownership practices and so better align their objectives with those of society at large. Is natural capital a material issue? | 7
Executive summary Key findings the perceived immateriality of the issue. In fact, this is at Perceptions of risks and opportunities associated with odds with stakeholder expectations, including those of BES are variable within the accountancy profession: not some of the investment community who are looking to all companies that are considered high risk in terms of companies to disclose on the matter. their impacts or dependence on BES by stakeholders Existing financial reporting and disclosure standards can evaluate that risk. Nonetheless, some of the accountancy be applied to the issue of BES: in some cases, an item profession routinely include such issues within business or issue relating to BES is measurable in financial terms risk evaluations (see Box 3). Furthermore, a small but and, therefore, included in the quantitative elements significant proportion of companies, such as Iberdrola of the accounts. The interpretation and application of and EON, include BES in their materiality reviews. In International Financial Reporting Standards (IFRS), such general, however, the focus on financial measurement as those on business combinations, and International for determining materiality acts as a barrier to the Accounting Standards (IAS), such as those on impairment identification of BES issues as material. of assets, agricultural or intangible assets, could be influenced by natural capital loss in some sectors. In Box 3: Highlights from a survey of the ACCA practice, many significant risks and opportunities are membership unquantified, cannot be easily valued, and are therefore excluded from the accounts. A survey was sent out to the ACCA membership to gather their views and activities on natural capital. Respondents Companies in a range of sectors are exploring the use were skewed towards those in senior management posts, of valuation techniques to assist in decision making, such as CFOs, CEOs or other senior managers. alongside other means of identifying and evaluating risk: some, such as Rio Tinto and Eni, are testing the use of Key findings included: environmental economic valuation in informing business • 60% of respondents agreed that the natural world was decisions; others are using stakeholder dialogue or important to their business enhanced environmental impact assessment processes • more than half of the respondents had included that include consideration of BES. natural capital issues in their company’s business risk evaluations at some point There are a number of barriers to corporate action: these impede companies from effectively determining risk and • 49% identified natural capital as a material issue for opportunity exposure on BES. These barriers include the their business and linked it to operational, regulatory, lack of a standardised business case, low and lacking reputational and financial risks market values for BES and certain accounting principles. • there was a relatively low response rate of less than 1% The accounting and business communities also lack (218 members) compared with an average response rate awareness on natural capital issues. of around 3% in other ACCA surveys. Understanding of the concepts and terminology: although there is broad understanding of terms such as biodiversity and ecosystems, the terms ecosystem services and natural Corporate BES disclosures, as currently practised, are capital are less well known, reflecting the relatively recent too limited to provide insights into risk management: a emergence of these issues as business risks. handful of companies in sectors with high environmental impact are reporting substantial detail on BES, but the majority are reporting little or no information owing to8 | Is natural capital a material issue?
Executive summaryRecommendations • onsider whether natural capital can be incorporated cTargeting its two key audiences – CFOs and accountants – into financial accounts, and engage with the IASBthis report’s recommendations are focused on the five key or local accounting standard setters on how currentthemes that form the overarching issues discussed within accounting standards can be improved to address thethe report as follows: topic more fully• ngage with experts and develop skills: follow E • ngage with organisations such as IIRC or NCDiii that e guidance being produced by expert groups on how want to develop tools to account for natural capital to address BES. • earn from those already engaged with these issues, l• dentify externalities to internalise impacts on BES. I and consider how the tools that are used by these companies can be applied to their own operations.• efine materiality to ensure that all risks and D opportunities posed by BES are picked up. Accountants should: • raw on their core skills and expertise in accountancy d• onsider the use of valuation methods if and when C to contribute to the development of potential appropriate. natural capital accounting methodologies to aid the quantification and management of company externalities• nhance disclosures on natural capital. E • all on accountancy bodies to provide guidance on cCFOs should: how to address natural capital within company annual• ngage with experts to understand the level to which e reports and accounts, as well as sustainability reports their organisations depend on natural capital; this would include understanding the degree to which • ollow and track new guidance that becomes available f company revenues, costs and going concern status rely within the area of natural capital on natural capital (both directly and indirectly) • ngage with experts to increase skills through e• nsure that risk and materiality assessments consider e workshops and training natural capital; by doing so, CFOs will be able to determine if the various risks posed by declining • ilot or trial natural capital accounting methodologies p natural capital will have a material impact on their with clients, where appropriate, and use this experience organisations and implement mitigation strategies to to work with regulators on disclosure guidance and avoid negative impacts on corporate value assurance practices.• ork with finance teams to develop the skills and w An emerging challenge capacity for accurate assessment of a company’s impact The challenge for the accountancy profession will be to or dependence on natural capital determine when the loss of natural capital will require an enhanced understanding and approach to business-• isclose material natural capital impacts and d risk assessment and corporate disclosure. Doing so too dependencies, guiding the development of robust late may lead to failures when anticipating future risks disclosure and assurance systems to ensure data quality and their associated costs to business. It may also lead• se their board position to educate other board u to overlooked opportunities to increase supply chain members on the importance of BES within key resilience, secure and maintain licences to operate, and management and strategic decisions enter new markets.iii Natural Capital Declaration Is natural capital a material issue? | 9
1. Introduction To reflect their significance, the challenge to CFOs and accountants is to ensure BES related externalities are incorporated into risk and materiality assessments, financial accounts and reporting cycles. Helen Brand, Chief Executive, ACCA The Association of Chartered Certified Accountants (ACCA), production, utilities and construction. The review was KPMG and Fauna Flora International’s Natural Value based on annual reports, sustainability reports and Initiative (NVI) have come together to investigate the website disclosures. concept and existing use of materiality and its conflicts in light of the increasing significance of natural capital as • survey of the ACCA membership was conducted A a business risk. This report focuses specifically on issues on natural capital issues (see Box 5, page 13), with of biodiversity and ecosystem services (BES), which form responses from over 200 professionals. a part of natural capital. It asks the question, are current The work was guided by an expert panel with approaches and guidance on BES enough to enable representatives from industry, academia and the corporate management of risk and opportunity? accountancy profession. The rest of the report is divided This report is aimed at chief financial officers (CFOs), into the following sections. accountancy professionals and business leaders as key • hapter 2 explains what is meant by natural capital C gatekeepers of corporate strategy, accounting, reporting and how it links to BES, business risk, strategy and and disclosure. It explores the current response to BES corporate valuation and performance. issues within the accountancy profession. • hapter 3 explores BES as a business risk and C The approach used combined desk research with other opportunity, and examines corporate approaches methodologies. to identifying and understanding these risks and • emi-structured interviews were conducted with eight S opportunities. CFOs and senior managers (see Appendix 1 for details) • hapter 4 considers the materiality concept and how it C covering the following questions: is currently applied to BES issues. o ow are company risk and materiality assessments H • hapter 5 reviews current reporting practices, standards C performed, and how do they relate to BES? and guidance on BES and identifies potential gaps and o hat is the impact of BES-related issues on their W areas for development. businesses? • hapter 6 considers how BES are currently valued C o ow well equipped is the current financial and H within company disclosures, and the development and sustainability reporting model to consider such issues? adoption of new valuation methodologies. • review was carried out of disclosure practices within A • hapter 7 sets out the report’s conclusions and a series C 40 companies across four sectors broadly considered of recommendations for CFOs and accountancy and to be high risk with regard to BES: forestry, food audit professionals.10 | Is natural capital a material issue?
2. iodiversity, ecosystem services B and corporate performanceThis section defines key terms and concepts used withinthis report and set out the links between natural capital, Box 4: Definitionsbiodiversity and ecosystem services (BES) and overall A number of the terms used throughout the report arecorporate performance. defined below.Biodiversity, ecosystem services and Natural capital: The stock of capital derived from naturalnatural capital resources.Stocks of capital interact to support economic activity. Biodiversity: The variability among living organisms fromSuch capital can be classified into six categories: all sources at a species, habitat and genetic level – amanufactured, human, social, intellectual, financial constituent of natural capital.12and natural.11 Ecosystem: A dynamic complex of plant, animal, and micro-Natural capital is the stock of capital derived from natural organism communities and their non-living environmentresources, such as biological diversity and ecosystems interacting as a functional unit,13 e.g. ecosystems includealong with geological resources such as fossil fuels and deserts, coral reefs, wetlands or rainforests.mineral deposits. It provides the ecosystem products andservices that underpin the global economy and provide Ecosystem services: The benefits, closely dependent oninputs or indirect benefits to business (see Box 4). biodiversity, that human beings obtain from ecosystems. These can be classified into four categories:This report focuses on biodiversity and ecosystems, provisioning services: goods that ecosystems produce, • specific constituents of natural capital that give rise such as food and waterto ecosystem services. Geological resources are notconsidered because they are routinely included in regulating services: natural processes regulated by • market transactions and accountancy practices. ecosystems such as flood and disease control cultural services: benefits obtained from ecosystems • Business is dependent on ecosystem services such as recreation and spiritual valuesFigure 2.1 (page 12) shows the links between naturalcapital, BES and corporate value. It shows that, in supporting services: services that maintain the • addition to being reliant on the other types of capital (i.e. conditions for life on Earth and all other ecosystemhuman, manufactured, etc.) that are perhaps more familiar services, e.g. photosynthesis.14to the corporate world, business is dependent on the Biodiversity offset: Measurable conservation outcomesBES aspects of natural capital and the ecosystem services resulting from compensation for significant residualderived from them. adverse biodiversity impact, in particular, those that persistCompanies also have the potential to have impacts on even after appropriate prevention and mitigation measuressources of natural capital through their activities and have been taken.15outputs. Importantly, these impacts can be either positiveor negative, resulting in changes in corporate value suchas improved asset values or decreasing profit margins. Is natural capital a material issue? | 11
2. Biodiversity, ecosystem services and corporate performance Figure 2.1: Links between natural capital, biodiversity, ecosystem services and corporate value. Capital Dependencies Manufactured Human Social Economy and society Impact Intellectual Other Financial Business Interactions n Dependencies: raw materials, provision of a stable operating environment, etc. n Impacts: e.g. may be negative through pollution Dependencies Natural or overexploitation, or may be positive through Ecosystem conservation activities Biodiversity services Impact Impact on corporate value n Changing asset values/share price n Impact on intangible assets n Going concern issues Links between BES and performance unlikely that the plant would remain economically viable Two-thirds of the biodiversity and ecosystem services owing to high water costs.18 (BES) on which society and business relies are either The links between BES and corporate value through degraded or in decline.16 The costs of these cumulative impacts on share price are strengthening as the extent losses of BES from 2000 to 2050 will be equivalent to 7% of corporate reliance on BES becomes clearer. These of GDP by 2050.17 This continued loss of BES will have links are likely to strengthen further as governments implications for long-term business performance. take steps to maintain stocks of natural capital in the BES are aspects of natural capital that are rarely valued face of increasingly competing demands of resource by financial markets despite their potential to influence users. Over 30 countries now have some form of corporate performance significantly by exposing legislation in place to enable compensation for the organisations to different risks and opportunities. impacts of development on BES. The emergence of For example, a Volkswagen plant in Puebla, Mexico, national-level reviews of the status of BES in countries faced significant water scarcity issues. The company such as Brazil, India, the UK, Germany and the helped fund the reforestation of the catchment area that Netherlands may lead to further regulation19 as feeds the water table and, thus, has avoided significant governments act to address the findings. In the UK, loss of invested capital. Without this investment it is for example, a National Ecosystem Assessmentiv showed The UK National Ecosystem Assessment (UK NEA) was the first analysis of the UK’s natural environment in terms of the benefits it provides to society and continuing economic iv prosperity. Part of the Living With Environmental Change (LWEC) initiative, the UK NEA commenced in mid-2009 and reported in June 2011.12 | Is natural capital a material issue?
2. Biodiversity, ecosystem services and corporate performance Indiscriminate draw-down of Natural Capital poses a risk to our business today and much more so in the future. The severe under valuation and degradation of Natural Capital constitute a real challenge to businesses in general, in achieving longer term strategic objectives. James Singh, Executive Vice President Chief Financial Officer (recently retired), Nestléthat 30% of the UK’s ES were degraded or in decline.The UK has put in place a range of advisory groups and Box 5: Insights from the ACCA membership surveypilot projects to inform future policy action to address The global ACCA membership was surveyed to capturethis decline.20 members’ views on natural capital. In all, 218 membersThe issue is changing from one of reputational risk, responded (less than a 1% response rate). A normalimpacts on intangible assets and weak links to response rate is in the region of 3%. A significant proportionshareholder value, to one of operational, financial, and (18%) of these were senior personnel– a higher levelmarket risk and competitive advantage, all of which have than for most ACCA member surveys (approximately 13%),greater links to shareholder value. Hence, for some suggesting that the issue had captured attention at asectors, BES loss is becoming an issue that can constrain senior level.corporate success through impacts on corporate value and Key findingscorporate performance. Associated British Ports, the UK’s The issue is perceived to be important, but not broadlylargest port operator, lost 10% of its stock market value understood; the low response rate suggests that theafter the UK government prevented its development of a accountancy profession does not consider natural capitalcontainer terminal. The decision was made as a result of issues routinely.concerns over the potential impact on important wildlife.21 • ACCA members had some understanding of the termsHow does an ecosystem services (ES) ‘biodiversity’ and ‘ecosystems’.approach build on traditional environmental • term ‘ecosystem services’, however, was less well Themanagement? recognised.ES approaches are a holistic way of examiningenvironmental change. Analyses include understanding • 60% of respondents agreed that the natural world wascurrent ES availability and identifying those who use or important to their business.rely on them. This can be extended to consider the impactof new projects, policies and schemes and thecorresponding change in ES, in terms of both the leveland change in the types of ES available. Certain Key messages • ES are part of natural capital, and business is Bcategories of ES are underpinned by ‘supporting services’ dependent on them.and these in turn are underpinned by biodiversity. ESapproaches consider the broader needs of stakeholders • he decline in BES is giving rise to a range of risks Tand the overall system in which the impact is occurring, and opportunities to which business is exposed.rather than a single output or impact. These approachescan be used to build an understanding of access to ES in • urrent knowledge of these issues and risks is Cthe future and may provide greater insights into future limited within the accountancy profession.limits of natural resources. Thus, the outputs of suchanalyses can aid the development of regulatoryrequirements, risk-mitigation strategies and opportunities.The next section will explore how the issue of BES hasbecome increasingly important to business, and considerhow the issue links to corporate risk and opportunity. Is natural capital a material issue? | 13
3. iodiversity and ecosystem services B as a business risk and opportunity The following section sets out the business risks and If the UK Company Law Reform were opportunities associated with BES. It identifies the status conducted now, it would undoubtedly of BES risk evaluation, and considers the tools available make specific reference to biodiversity to companies. and ecosystem services risks. Risk and opportunities management Mike Kelly, Head of Corporate Social Undertaking a broad evaluation of corporate risk and Responsibility, KPMG in the UK maintaining a risk register are considered routine parts of strong governance procedures. Companies must go through a risk prioritisation process to identify those Figure 3.1: Risk and opportunity identification issues on which to focus management effort. Further filters are then employed to decide which issues are sufficiently material for disclosure in communication to stakeholders (see Figure 3.1). Global issues and trends The 2006 reform of UK Company Law22 made specific Risk and opportunity identification filter reference to the fact that company directors have a responsibility to consider a range of issues that influence Corporate risks and corporate performance, including environmental issues, opportunities and, in the case of quoted companies, are expected to report on such issues where to do so is necessary for Materiality filter an understanding of the development, performance and position of the business. Company issue disclosure Linking BES loss and risk and opportunity management Impacts and dependence on BES can create business risks and opportunities through changes in: the supply of inputs or resources; regulation and licensing conditions; and customer demand and access to markets, including the securing of finance and insurance (see Table 3.1)23,24,27 Financiers from the international agribusiness company, Olam, have indicated that they examine BES management when making decisions on plantation expansion, believing that a proactive stance on BES can facilitate access to finance. By integrating BES issues into decision making and forward planning, businesses can enhance their performance by reducing and mitigating the associated risks, and realising opportunities.2514 | Is natural capital a material issue?
3. Biodiversity and ecosystem services as a business risk and opportunityTable 3.1: Risks and opportunities associated with BES 26 Type Risks (blue) and Opportunities (green) Examples Scarcity and/or reduced quality of raw Profit impacts: Loss of access to pollination may lead to declining crop yields; a study in Costa materials, reduced output and productivity, Rica showed coffee yields to increase by 20% in proximity to forest edges, where access to disruptions to business operations, supply pollinators was higher.27 This may lead to a need to write down stock value and affect profits of Operational chain risks companies supplying those pesticides recently implicated in the global loss of pollinators. Four European Union countries have enforced suspensions/bans on the use of these pesticides.28 Improvement to quality of raw materials, increased output and productivity, Raw material quality: In order to protect the quality of the raw water United Utilities supplies sustainability of business operations, supply to its customers, the company has implemented the Sustainable Catchment Management chain reliability Programme. The programme started in 2005 and seeks to restore 20,000 hectares of land owned by the company, which will improve the quality and reliability of the water table.29 Restrictions on land access, litigation, Litigation risks: In 2011, Australian logging company, Concord Pacific Limited, was ordered to pay Regulatory and legal resources quotas, pricing and compensation up to US$97 million for environmental damage caused by illegal logging it had carried out.30 mechanisms Anticipation of regulation: Infrastructure group Balfour Beatty has undertaken a pilot test Land access, meeting legislation and resource linked to Defra’s biodiversity offsetting consultation programme. The group’s participation will quotas (including lower transition costs assist in ensuring that appropriate legislation is developed, while Balfour Beatty will benefit from by early anticipation of such), proactive developing positive working relations with the government, enhancing skills, and demonstrating implementation of compensation measures leadership in the field. Potential damage to brand or the licence to Reputational risks: Greenpeace targeted Nestlé in a high-profile campaign linked to the operate company’s product KitKat and its use of palm oil from sources linked to rainforest destruction. Reputational The company has since put in a range of measures to ensure sustainable sourcing of palm oil.31 Potential improvements to brand or the One of the world’s largest paper manufacturers, APP, has been targeted by Greenpeace following licence to operate the NGO’s exposé of illegal logging practices in which APP has been involved, resulting in the withdrawal/suspension of contracts from clients, including from significant purchasers such as Xerox and Danone.32 Failing to match developments in consumer Access to markets: The Union for Ethical Biotrade surveyed 8,000 people in eight countries preferences, failing to meet purchaser (Brazil, France, Germany, India, Peru, Switzerland, UK, USA), finding that 85% of consumers look Market and products requirements for natural ingredients in cosmetic products and 69% are concerned with the sustainability of ingredient sourcing.33 Sales growth: The launch of Unilever’s Rainforest Alliance Certified tea in Australia saw 12% Matching developments in consumer growth in sales.34 preferences, meeting purchaser requirements Purchaser requirements: UK government procurement policy requiring all timber-based products used internally to be from legal and sustainable (including BES considerations) sources.35 Increased cost of capital and/or the inability Cashflow, operating costs and licence to operate: German bank West LB recently adopted a Financing to meet lending requirements new environmental policy which precludes the firm from financing offshore activities in the Arctic, owing to concerns about technical and environmental risks. In addition, insurer Lloyd’s of London Ability to potentially reduce cost of capital has published a report discussing the vulnerability of ecosystems in the Arctic, emphasising that and/or meet lending requirements the risks associated with drilling in the region are significant.36 Is natural capital a material issue? | 15
3. Biodiversity and ecosystem services as a business risk and opportunity Table 3.2: Sectoral risk, biodiversity and ecosystem services Sector 38 Related ecosystem and biotechnology Financial services Household goods General retailers Pharmaceuticals Real estate and Leisure, hotels Food and drug Type of risk 37 infrastructure Construction and tourism Oil and gas Agriculture services Telecoms and food retailers Forestry Utilities Mining Operational Scarcity or quality of raw materials: limited natural P,R resources, e.g. timber, fish stocks, fresh water ü ü ü ü ü ü ü ü ü ü ü ü Reduced output or productivity: degraded natural R,S processes, e.g. water cycling, soil nutrients, ü ü ü ü pollination Disruptions to business operations: natural R hazards due to degraded ecosystems, e.g. flooding ü ü ü ü ü ü ü ü ü ü ü ü ü ü Supply chain risks: impacts on downstream P,R,C,S operators and consequently security of supply or ü ü ü ü ü ü ü ü increased costs Regulatory and legal Restrictions on land access: restriction to P,C operation in ecologically sensitive sites, e.g. ü ü ü ü ü ü ü ü protected areas Litigation: if causing or have caused damage to P,R,C ecosystems ü ü ü ü ü ü ü ü ü ü Resource quotes: restrictions on businesses using P ecosystem services ü ü Pricing and compensation: growth of compensation P,R,C,S mechanisms and price differentials linked to issue ü ü ü ü ü Reputational Damage to brand or licence to operate: if associated P,R,C,S with adverse impact on ecosystem services ü ü ü ü ü ü ü ü ü ü ü ü ü ü Market and products Consumer preferences: trends and preferences for P,C products with reduced ecosystem services impacts ü ü ü ü ü ü ü ü ü Purchaser requirements: supply chain P,R,C,S requirements that include safeguards on ecosystem ü ü ü ü ü ü ü ü services Financing Cost of capital or lending requirements: P,R,C restrictions on finance to companies negatively ü ü ü ü ü ü ü ü ü affecting ecosystem services P= Provisioning services, R= Regulating services, C= Cultural services, S= Supporting services; Colour code for level of risk of each sector: n High risk n Medium/High risk n Medium risk n Low risk16 | Is natural capital a material issue?
3. Biodiversity and ecosystem services as a business risk and opportunity Natural resources such as timber and water are fundamental to Mondi. There is a strong link between license to operate and these issues. They are potentially an area of critical risk for the company. Andrew King, CFO, MondiDifferent sectors vary in their risk and • wareness: the understanding of ecosystem services Aopportunity profile and their links to business performance is relativelySectors vary in their exposure to BES risks and low within the accountancy profession39 – less thanopportunities. Table 3.2 sets out this sector variation one-third of responding ACCA members were familiar(particularly focusing on risks), compiling the results with the term ‘ecosystem services’of a series of studies from investors, advisers to the • kills: the industry currently lacks the skills and Sinvestment industry and professional services firms experience to be able to understand ES issues and their(as referenced in the table). potential impact on corporate value and performance –Approaches to identifying risks and 70% of ACCA members surveyed said that they neededopportunities training on the issue. Opportunities to build thisThe study involved interviews with CFOs and senior capacity are emerging through specific training courses.managers of companies operating in high-risk sectors, See Box 7 (page 18).or organisations that are taking a leadership position • nherent challenges: evaluating the risks and Iin their management of natural capital. These highlighted opportunities associated with BES is inherently difficult.a range of different approaches to identifying risk Estimating their financial value for use in makingand opportunities related to BES components of decisions is challenging and methodologies to enablenatural capital. this are still developing.40 Additionally, the period overIn some cases, the approach was driven largely by which BES issues become significant may frequentlyregulatory obligations while other approaches were much exceed that over which business risks and opportunitiesbroader, taking into account the views of stakeholders are identified.from inside and outside the company. • ompetitiveness issues: being a ‘first mover’ on BES CAn approach common to many of the interviewees was issues could confer competitive advantage to proactivethe use of a risk register to monitor and manage risk. companies through differentiation, increased brandCompany directors reported that they would periodically value or the anticipation of regulatory change andreview their operations and pull together a long list of all associated costs.the risks affecting their businesses. In order to prioritise • etrics: There is a lack of straightforward and Mthe risks, an estimate of the probability and financial internationally accepted metrics for BES issues, makingimpact of each would be made. Mitigation plans would them more difficult to report, manage and monitorbe driven by this assessment, and the register would be consistently.tracked over time to ensure that the risk register andmitigation plans are kept up-to-date. • otential for increased risks: there is concern that P measuring or valuing impacts and dependence onBarriers to understanding/acting upon BES may leave companies open to additional costs,BES-related risks and opportunities reputational risks or increased regulation.A number of barriers to companies’ effective determinationof risk and opportunity exposure on BES were identifiedthrough interviews with CFOs, a survey of ACCA members,and through desk-based research, as follows. Is natural capital a material issue? | 17
3. Biodiversity and ecosystem services as a business risk and opportunity Tools and guidance available Box 6: Insights from the ACCA membership A number of approaches, assessments and tools have survey: natural capital and business risk been developed to assist the integration of BES risks and opportunities into business performance systems.41 The accountancy professionals who responded to the ACCA Business for Social Responsibilityv has undertaken a survey identified a range of risks associated with natural series of analyses of ecosystem-services-related tools and capital. The most significant were as follows. approaches which are useful sources of further guidance, • Reputational risk featured as a key concern. such as the WBCSD’s Corporate Ecosystem Services • More than 50% of respondents considered disruption Review (ESR) and the NVI’s The Ecosystems Services to physical operations, supply chain risk and regulatory Benchmark. risks as potentially significant or currently significant. • 77% of respondents had identified natural capital as Key messages a significant business risk at some point, and 25% had • ES issues are being included in the risk B identified such risks often or always within a business evaluations of some companies. risk evaluation. • ools are being developed to assist companies T • 34% of members in sectors considered ‘high risk’ in identifying BES risks and opportunities. (as identified in Table 3.2) in terms of BES impact/ dependencies have never considered natural capital • arriers such as lack of awareness and expertise, B issues within their business-risk evaluation. competitiveness issues, concerns regarding risk exposure and the long-term nature of BES risks are hampering further integration of BES into business risk and opportunity evaluations. Box 7: Case Study: Business Ecosystems Training (BET) developed for the World Business Council for Sustainable Development (WBCSD) by KPMG WBCSD, in conjunction with KPMG and a member company steering group, developed and launched ‘Business Ecosystems Training’ in 2012 to improve the understanding of managers and employees of their membership company’s direct and indirect impact and dependence on BES. The course was commissioned following a survey of member companies by the WBCSD, which identified an appetite for increased awareness of BES issues and concepts. So far, KPMG has trained over 60 representatives across a range of business sectors in different countries, with other international NGOs also making use of the materials available. A global business membership organisation, based in the USA, that promotes sustainability in businesses. v18 | Is natural capital a material issue?
4. re biodiversity and ecosystem A services issues material?This section looks at the extent to which BES areconsidered a material issue for public disclosure, and Box 8: Definitions 45whether or not this corresponds with those companies Materiality: In financial reporting and auditing, an itemand sectors that have been identified by investors and (usually economic in nature) is material if its omission orother stakeholders as having material issues. The misstatement could influence the users of the financialprocesses that companies are using to reach a conclusion accounts, with ‘users’ frequently defined as shareholders,on materiality are also identified. investors and lenders.The importance of materiality Externalities: A consequence of an action that affectsThe concept of materiality relates to issues that could someone other than the company undertaking that action,influence the users of financial accounts (see Box 8). and for which the company is neither compensated norSustainability reporting has its own definition of penalised through the markets. Externalities can be eithermateriality, which includes impacts on broader corporate positive or negative.stakeholders42 and focuses on a broader set of issues Environmental externalities: include externalities toover longer periods.43 ecosystems and ecosystem services that may affect people,Key stakeholders, such as investors, still largely judge buildings and infrastructure, and other economic activitiescorporate performance on the basis of measures of (e.g. from air emissions).financial materiality. Many environmental and socialissues are rarely considered to be material by companies,despite increasing concern from civil society. BES Chinese construction and materials industries wasmanagement is one such issue. estimated at US$12.2 billion47 annually. If this is compared with the unit cost of timber using the prevailing marketThe concept of materiality underlies principles of price, it is clear that the price paid for timber by thecorporate disclosure. Unless the materiality of an issue Chinese construction market does not reflect its truecan be demonstrated, the arguments for its inclusion cost48 in terms of lost ES such as watershed protection,within corporate disclosures, and by association corporate erosion control and recreational opportunity.strategy and management systems, are weak. If a broaddefinition of materiality is followed that includes The materiality of an issue is determined on the basis ofconsideration of stakeholder views (investors, its financial impact and probability of occurrence. It flowscommunities, civil society and government) and longer- directly from broader business risk and opportunityterm business risks (see Chapter 3), BES issues are more evaluations. Interviews with a number of CFOs identifiedlikely to be considered material, enabling companies to that BES issues are rarely considered material as theirconsider an emerging set of risks and opportunities.44 economic impacts are often small or occur in the future. Despite this, BES issues (see Chapter 3) are beginning toNatural capital and materiality feature in management disclosure and analysis, theUsing the BES elements of natural capital rarely represents qualitative part of the annual report and accounts, asa direct cost of doing business unless they are used as a identified in a number of the companies examined in thespecific input into production, e.g. timber, but instead disclosure survey of this report (see Chapter 5).affects wider society in the form of environmentalexternalities. As a result, BES are often overlooked in The survey of ACCA members suggests that 82% of riskstraditional materiality calculations46 owing to low values and opportunities highlighted in company assessmentsor values that are not based on markets. For example, an are short to medium term (up to five years) with onlyanalysis of the value of forest lost as a result of the 11% perceived as affecting businesses in the long term Is natural capital a material issue? | 19
4. Are biodiversity and ecosystem services issues material? (up to ten years). Favouring short- to medium-term Figure 4.1: Infinito Gold lost more than half its value when projections when identifying material issues tends to the Costa Rican court annulled a gold mine concession 51, 52 counter the recognition of BES issues as material because they tend to manifest over longer periods. 24th November 2010 Costa Rican government annulled Infinito’s gold There are, however, some instances where an item or mine concession owing to concerns 0.5 issue might be measurable in financial terms and about its potential impacts on forests, endangered species and agricultural therefore included in the quantitative elements of the livelihoods 30th November 2011 Costa Rican government 0.4 accounts. Some examples are given here.49 upholds its decision • ignificant and sustained drops in share price may S 0.3 occur as a result of the refusal of planning permission motivated by environmental concerns. Canadian gold 0.2 mining company, Infinito Gold, lost over 50% of its share value as a result of the withdrawal of a mining 0.1 concession in Costa Rica due to concerns about the potential impacts on agriculture, endangered species and forests (see Figure 4.1). This led to a reference in Oct 2010 Apr Jul 24/11/2010 Apr Jul Oct 2012 the audit accounts to material uncertainties regarding the company’s ability to continue as a going concern • lean-up costs from the 2010 Gulf of Mexico oil spill, C Interest among the traditional users of financial and associated compensation claims for ecological accounts is increasing damage, affected both BP’s balance sheet and its There is evidence that interest in these issues among the profit and loss. In the company’s 2011 annual report, traditional users of financial accounts is growing. In 2011 a $3.5 billion provision related to clean-up costs, and alone the following events occurred. a $7.8 billion provision related to litigation and claims • he International Finance Corporation’s performance T associated with the spill. standards were reworked to place greater safeguards • ewmont mining company in Peru experienced N on BES. This will significantly affect project finance significant delays as a result of concerns regarding through the 72 financial institutions currently committed the impact of the mine on water availability. to the Equator Principles. These now require companies Overcoming these concerns has required a $150 million to demonstrate no net loss of biodiversity in areas investment from partner, Minera Yanacocha, to build identified as ‘natural habitats’. In critical habitats, water reservoirs to compensate for the mine’s impact a company must demonstrate a net gain in biodiversity. on local water supplies.50 This may lead to increases in the level of rehabilitation provisions required at locations operating in ecologically Such incidents may, for example, result in impairment of sensitive sites. Failure to comply with the requirements assets, profit reductions, and even a need for increased of potential financiers may significantly reduce provisions or qualifications regarding the company’s investment return53 for those companies reliant on ability to continue as a going concern. such finance.20 | Is natural capital a material issue?