Enhancing Financial Sustainability: Approaches for Natural Capital Valuation

Coauthored by Ian Trim and Nagadarsan Suresh

All economic sectors operate within the natural environment and are dependent on the services provided by natural assets. The global economic value of these ecosystem services has been estimated at over $150 trillion. This amplifies the importance of valuing natural capital, with financial institutions (FIs) playing a key role as a critical stakeholder in addressing the nature financing gap. This blog examines approaches to valuing natural capital for enhancing financial sustainability, and the challenges involved.

Understanding Natural Capital and Its Financial Implications

As noted by Dasgupta, the economy, and indeed society as a whole, operates within the environment, not alongside it. However, the value of natural capital is rarely, if ever, captured in our economic decisions, with an estimated $4.7 trillion in uncosted environmental externalities. Depleting natural capital and its associated ecosystem services therefore has implications across the economic spectrum.

Recognizing the value of natural capital is essential for FIs because it underpins production processes and contributes to overall economic well-being. While direct impact on ecosystem services through their operations is limited for FIs, there is significant impact through loans and investments. Ignoring the value of natural capital can lead to resource depletion and environmental degradation, ultimately affecting financial performance and long-term sustainability. By integrating natural capital considerations into financial decision-making, FIs can enhance risk management, improve resource efficiency, and support sustainable growth.

Approaches for Valuing Natural Capital

Effectively valuing natural capital requires a combination of strategies that capture its diverse benefits. A key approach is ecosystem service valuation (ESV), which involves quantifying the benefits provided by ecosystems, such as water purification, carbon sequestration, and pollination. An extension of this approach is corporate natural capital accounting, providing the ‘next step’ to ESV by integrating environmental accounts alongside financial statements, allowing businesses to measure and manage their environmental impact.

Valuation can lead to informed investments and nature opportunities. Investing in natural capital projects, such as reforestation and wetland restoration, also offers financial returns by enhancing ecosystem services that support long-term business operations. These strategies collectively enable businesses to recognize and preserve the value of natural capital, contributing to financial sustainability.

Nature Opportunities Can Unlock Revenue Streams

(Source: Guidehouse)

Challenges, Solutions, and the Role of Policy

Valuing natural capital presents several challenges, including data scarcity, the complexity of valuation methods, and difficulty integrating these valuations into traditional financial systems. Data scarcity often arises because ecosystem services are not always directly observable or easily measured, while the complexity of valuation methods stems from the need to account for various ecological, economic, and social factors that influence natural capital.

Unlike carbon emissions, natural capital has distinct local properties, thus cementing the importance of nature assessment at a local level. This is particularly important for FIs with limited direct impacts on nature (i.e., their own operational footprints) but far-reaching impacts through their loans and investments.

To overcome these challenges, businesses can adopt best practices such as partnering with natural capital valuation specialists and using modeling tools to improve data accuracy and valuation methods. Policy and regulation also play a pivotal role in supporting natural capital valuation, as discussed in other Guidehouse publications. Governments can create enabling environments through supportive policies, incentives, and frameworks that encourage businesses to account for natural capital. An example of this is the biodiversity net gain (BNG) regulation in the UK, which enables the creation and upkeep of natural habitats.

By addressing these challenges and leveraging supportive policies, players in the financial sector can more effectively incorporate natural capital into their financial strategies, leading to enhanced sustainability and long-term resilience. Guidehouse provides advisory services to FIs on suitable mechanisms for valuing the natural capital that they affect and on devising action plans to mitigate these impacts while realizing monetizable opportunities.

Tools and Frameworks for Effective Valuation

Valuing natural capital and biodiversity is challenging because the same natural capital asset has different values depending on its location and use; for example, an aquifer has a much higher value in areas of water stress than areas of abundance. This location-related challenge emphasizes the importance of assessing impacts in supply chains, where the impacts and risks are often far removed from the end user.

A number of tools and frameworks are available to help companies with this assessment. The Taskforce on Nature-Related Financial Disclosures (TNFD) framework provides guidance for FIs undertaking nature-related risk and opportunity assessments to inform a range of capital allocation decisions, including those related to reporting and disclosure. Tools such as ENCORE (Exploring Natural Capital Opportunities, Risks, and Exposure) and the Nature & Biodiversity Risk dataset (launched by S&P Global Sustainable1 in 2023) can support such frameworks, providing software solutions to generate common metrics that can be used to assess the impact and dependencies of companies on nature-related services.

Additionally, adopting standardized frameworks such as the Natural Capital Protocol (NCP) is crucial for further consistency and comparability. The NCP provides a structured approach for businesses to identify, measure, and value their impacts and dependencies on natural capital. For example, an FI investing in real estate could apply the NCP to evaluate the impact of new constructions on local biodiversity, with a view toward promoting sustainable development practices. By leveraging these tools and frameworks, FIs can make informed decisions that enhance their financial sustainability while protecting vital natural resources.