This article was originally published in Responsible Investor. Click here to read the full piece.
By Mark Gough and Marie Morice
A public consultation on the Finance Sector Supplement to the Natural Capital Protocol, aimed at banks, investors and insurers has been launched
Climate change is now firmly on the agenda for many financial institutions, and when the Financial Stability Board announced its new Task Force on Climate-Related Finance Disclosures (TCFD), many felt it was a “hugely welcome step”.
Climate change is impacting on the natural world and the services that nature provides to us and on which we depend. Traditionally, we have taken these services for granted. Failing to include them in our decisions, and decreasing their capacity to support life is only worsening this situation.
In order to address this, a new concept for valuing natural capital has been picked up by many organizations.
The Natural Capital Protocol provides a flexible decision-making framework which allows organizations to identify, measure and value their impacts and dependencies on the natural world. The new draft Finance Sector Supplement provides guidance to financial institutions to help them consider natural capital impacts and dependencies in their lending, investment and insurance practices and portfolios.
It also supports the TCFD program and their four thematic areas; governance, strategy, risk management, and metrics and targets.
The Supplement is being developed by The Natural Capital Coalition, the Natural Capital Finance Alliance (NCFA) – which is supported by a secretariat formed of the UN Environment Programme’s Finance Initiative and the Global Canopy Programme, and VBDO (the Dutch Social Investment Forum).
The Finance Sector Supplement will help the finance community to move beyond measuring their impacts, to also measuring and valuing the dependencies they have through their financial activity on the natural world.
Organizations can then ask themselves, “What impacts am I having on the stocks of natural capital on which I depend, how does this translate into risk, and can I calculate how and when this externality might internalise?”.
In this way, such assessments can be used as forward looking risk radars that allow organizations to make better decisions that protect their access to natural capital, by protecting natural capital itself.
These risk radars can be applied in a vast number of circumstances, and by applying various tools and methodologies. The NCFA’s recently released drought stress testing tool allows financial institutions (FIs) to form these risk radars in relation to water security and its effect on their portfolios.
Failure to understand relationships to natural capital like fresh water, can be disastrous, both for businesses, and for the FIs who have insured, invested, or lent to them.
Between 2014 and 2016, Brazil experienced a drought which slowed corporate activity to a trickle. Sao Paulo, home to over 20 million people, and one of Brazil’s main production areas, was particularly affected, with parts of the city without running water for days on end, and available water under strict rationing programs in the region’s smaller cities.
Chemicals firm Rhodia halted a number of operations due to low water levels, and Brazil’s largest beef producer, JBS, was forced to make 800 redundancies.
In extreme cases, businesses, who collectively account for as much as 30 percent of Sao Paulo’s water use, turned to capturing rainwater to avoid relying on the crippled network.
As approximately 75% of the country’s electricity comes from hydroelectric power, high-cost natural gas-powered thermal plants were forced to run at their peak around the clock.
In this way, failure to understand business dependencies on natural capital, and to mitigate against them effectively, led not only to economic costs, but also to increased environmental and social costs, associated with the increased levels of pollution.
The Finance Sector Supplement will help FIs to determine what areas of their portfolios are vulnerable to these shocks and, through forming the relevant risk radars, how they can minimise the risk that these externalities internalise.
In the vast majority, if not in all cases, mitigating this risk is not only beneficial to businesses, but additionally has many social and environmental benefits.
On May 16, we launched the draft Finance Sector Supplement for public consultation at The Rockefeller Foundation HQ in New York. The process of development is collaborative, and we encourage participation from all interested stakeholders, although the Supplement’s development must be led by the finance sector if it is to be robust and fit for purpose.
The consultation will run for four months, ending on 25 August, 2017, and will consist of a series of interactive webinars, a piloting program, workshops in several major geographies, and an open public consultation on the online platform Collaborase, where the draft Supplement is available for comment from all stakeholders.
We hope that this collaborative and open consultation will seed fascinating discussions between banks, asset owners, asset managers, insurance firms and consultancies, on how to best identify, measure and value natural capital impact and dependencies in their operations, and ultimately provide market-based financial solutions that both protect the natural environment and secure long term operational success.
For more information on the development of the Finance Sector Supplement to the Natural Capital Protocol, please click here.