You are currently viewing Natural Capital Accounting: A Tool for Sustainable Investment and Climate Finance

Natural Capital Accounting: A Tool for Sustainable Investment and Climate Finance

Natural capital, encompassing resources such as air, land, water, and biodiversity, plays a vital role in providing ecosystem services, crucial for climate change mitigation and adaptation. In the upcoming decade, biodiversity loss and ecosystem collapse has emerged as one of the greatest risks to the economy, natural resources, and people, in World Economic Forum’s annual Global Risks Report 2024. Despite its significance, Nature-based Solutions (NbS) are underfunded, receiving only US $200 billion globally per year, less than a third of the annual amount needed by 2030 to meet climate, biodiversity, and land degradation goals.

Many Small Island Developing States or emerging markets are already facing the rapidly worsening impacts of biodiversity collapse and climate change. The Maldives, for example, has a critical need for sustainable practices and investment in natural capital. Despite its heavy reliance on natural resources, particularly in tourism and fisheries (accounting for 50% of GDP and employment), the country faces threats from coastal development, pollution, and overexploitation. These factors endanger marine ecosystems, coral reefs, and coastal areas vital for climate resilience, with potential annual flood damage equivalent to 8% of the nation’s GDP due to coral reef degradation.

Such environmental challenges highlight how nature risks can significantly impact financial institutions (FIs). These risks manifest as physical risks from extreme weather events and natural disasters, leading to asset damage, increased insurance claims, and operational disruptions. Nature based contingencies can give rise to transition risks, potentially causing asset devaluation and stranded assets as industries adapt to stricter environmental regulations and market changes. Additionally, reputational risk can arise from negative perceptions or publicity related to environmental issues. For FIs, reputational risks can lead to loss of trust and credibility among stakeholders, including investors, customers, and regulators.

In response to such challenges, banks and investors are increasingly recognising the necessity of integrating natural capital considerations into their investment strategies, as these could have implications for the financial viability of projects and investments. Natural Capital Accounting (NCA) has emerged as a significant framework for valuing ecosystem services, enabling the integration of environmental considerations into financial decision-making processes. By quantifying the economic value of ecosystem services, one can better understand the dependencies and impacts of their activities on natural capital, leading to more informed and sustainable decisions.

Benefits of integrating NCA into climate finance 

NCA provides insights into how the environment contributes to the economy and how economic activities impact the environment. For example, the decline in ecosystem services such as wild pollination and marine fisheries could result in a global GDP decline of $2.7 trillion annually by 2030. NCA ensures that economic decisions account for the full value of natural assets and their contributions to human well-being.

NCA can significantly contribute to climate finance by providing a comprehensive framework for valuing ecosystem services and identifying high-value conservation and restoration projects. For instance, peatlands, which occupy a mere 3% of the Earth’s land surface, store twice as much carbon as all the world’s forests combined. Protecting and restoring these areas can yield substantial climate benefits.

The convergence of regulatory mandates, industry standards, and stakeholder expectations is compelling FIs to embrace NCA as a critical tool for managing nature-related risks and opportunities. Initiatives like the EU’s Biodiversity Strategy for 2030, which emphasises NbS in urban planning, and the Network for Greening the Financial System‘s call for stress-testing biodiversity-related financial risks, are pushing banks to adopt NCA to measure and mitigate these impacts.

However, adopting NCA presents several challenges for banks and other FIs, such as:

  • Data availability and quality: Reliable and consistent data on natural capital is currently lacking, especially at regional levels, which makes it difficult for banks to assess the environmental impacts of their investments accurately
  • Complexity of measurement: Natural capital is diverse an includes various elements such as biodiversity, water resources, and ecosystem services. Measuring and quantifying these elements in monetary terms can be complex and require training and modelling techniques
  • Standardisation: There is a lack of globally recognised, standardised methodologies for NCA, making it challenging for banks to compare and benchmark their performance across different regions and sectors
  • Divergence in valuation: Assigning a monetary value to natural capital is subjective and can vary depending on the context. Different stakeholders may have different opinions on how to value natural resources and ecosystem services
  • Risk management: Assessing and managing environmental risks associated with natural capital depletion is challenging, especially for banks with diverse portfolios spanning multiple sectors and geographies
  • Integration with financial reporting: Integrating NCA into financial reporting is a complex process that requires changes to accounting standards and practices
  • Capacity and expertise: Building internal capacity and expertise in NCA can be challenging for banks, especially smaller institutions due to the specialized knowledge required and limited resources for training and education

While adopting NCA presents significant challenges including data availability, measurement complexity, and capacity constraints, several measures can be adopted to benefit from its full potential:

  • Accelerate technology: Using technology to collect and share high-quality nature data and analytics to inform investment decisions and scaling up investments in NbS. For instance, off-the-shelf tools like ENCORE, developed by the Natural Capital Finance Alliance, can help model nature-related impacts and dependencies by sector and geography
  • Adopt science-based targets: Implementing science-based target-setting frameworks and globally recognised standards to assess, manage, and disclose nature and climate-related impacts, risks, and dependencies are essential. For example, last year, the Science Based Targets Network (SBTN) for nature, which is a component of the Global Commons Alliance, launched the first corporate science-based targets for nature
  • Collaborate with stakeholders: Work collaboratively with governments, Development Finance Institutions (DFIs), Multilateral Development Banks (MDBs), and philanthropies to mobilise private capital for NbS. Initiatives like the Good Food Finance Network (GFFN) bring together stakeholders to identify impacts, measure performance, and set science-based targets for sustainable investments in the value chain
  • Assess natural capital risk exposure: Understand the connection between natural capital risk and financial risk to integrate natural capital risk assessments within credit risk assessments. By identifying high-risk areas and significant dependencies, banks can focus their NCA efforts on the most relevant and impactful aspects
  • Scale catalytic initiatives: Support NbS by identifying and scaling high-impact conservation and restoration projects. For example, ASN Bank targets a net positive biodiversity impact by 2030. Through NCA, banks can promote pilot projects like Costa Rica’s “Payment for Environmental Services Program (PES),” which compensates landowners for forest conservation, leading to significant reforestation and carbon emission reductions
  • Integrated reporting: Integrate natural capital dimensions into financial and sustainability reports to disclose nature-related risks and provide quantitative data on the stock and flow of natural resources, enabling banks to assess their dependencies on natural capital. The Taskforce on Nature-related Financial Disclosures (TNFD) provides a framework for identifying and reporting nature-related risks and opportunities, giving stakeholders transparent information on environmental performance. Following its release in 2023, approximately 320 entities pledged to incorporate nature-related disclosures into their annual corporate reporting for the next three fiscal years, with 33% of these entities being FIs

Integrating NCA into FIs’ strategies is essential for advancing climate finance and sustainable development. By valuing ecosystem services and recognising the economic contributions of natural assets, NCA enables banks, investors and businesses to make informed investment decisions.