Far-reaching impacts of our natural capital

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By Richard Howitt – CEO, International Integrated Reporting Council

 

 

The all-encompassing focus of boards has traditionally been their bottom line. For years, annual reports paid tunnel-vision attention only to the company’s financial progress.

However, with the increased uptake in integrated reporting internationally and a growing awareness of the benefits of this to a company – to its investment potential and profit margin, too – there is now a greater understanding among blue chip c-suites that such a narrow financial focus is in fact detrimental to the company.

Integrated reporting is an increasingly prevalent form of reporting that addresses the fact that corporations draw on more than one capital, including human, social and natural capital. It is an approach that crucially addresses broader value creation and long-term potential – rather than just short-term financials alone.

It is now beyond argument that companies – international and regional – are subject to magnified scrutiny by the public and media on the effect companies have on the environment, whether that is land, air or sea.

While through integrated reporting a business can alter the way it thinks, acts and communicates on what the international Integrated Reporting (IR) Framework defines as six capitals, it is natural capital accounting which is arguably most advanced, as we develop multi-capital thinking in business.

The world’s economy is transitioning not just to low-carbon growth but it is, and will continue to be, underpinned by a parallel change in attitude towards what has been labelled sustainable finance. This is not an issue coming from campaigners any longer, but from the major institutions in the world.

The Taskforce on Climate-related Financial Disclosure created by the Financial Stability Board, has finally tilted the balance of the argument that climate change is an economic as well as an ecological issue.

The Paris Agreement signed by more than 170 countries has already seen nearly 50  introduce carbon pricing, which will have a profound and widespread impact across business in terms of energy costs, transportation and manufacturing and agricultural processes.

Meanwhile, the Sustainable Development Goals of the United Nations set the economic trajectory for the entire world into an environmentally sustainable context. Far from being just an issue of cost, the Business Commission for Sustainable Development, which represented the principal business voice behind the SDGs, describes the economic transition they will bring about as a $12trillion market opportunity for the world’s businesses.

So, whether it is cost, access to finance or market opportunity, no responsible board director can afford to ignore this new reality. Of course, there are countless examples of various corporations having a negative impact on the natural world and the environment in which they are situated or use. The difference today is that current and potential investors now look negatively on any corporation that does not attempt to curb or remedy its effect on its immediate and wider natural environment.

Even more so, investors look badly on companies that do not understand the impact natural capital has on their own ability to create value. It is investors more than activists today who understand long-term risk and returns are as dependent on natural as well as financial capital.

The Deepwater Horizon disaster in the Gulf of Mexico in April 2010 is one of the most famous examples where a corporation’s reputation was not only hugely damaged because of environmental incompetence, but also whose share price dropped dramatically in the immediate wake of the disaster.

It wasn’t just natural capital that was affected by the disaster – it was its social and relationship capital as well. The company’s reputation, its brand, its relationship with society, the trust consumers placed in it was for a long time incredibly damaged.

But if you’re not from an extractive company, this isn’t just about carbon. A beverage company needs to think about water conservation, an agri-food company deforestation, any industrial development its impact on habitats and biodiversity.

For each one of these, value can be created, preserved or depleted, and with it the ability of the company to continue to operate with the same business model in the years ahead. For any company that fails to comprehend this, it should contemplate its own potential ‘Gulf of Mexico’ moment.

2030 Sustainable Development Goals

That’s why the 2030 Sustainable Development Goals say they are ‘integral’ to each other, and why Sustainable Development Goal (SDG) Target 12.6 specifically calls on business to ‘integrate sustainability in corporate reporting’. It is a clarion call to business for integration.

In putting them together, the United Nations community was clear – these are issues that need to be tackled by private and public sectors together. And businesses have responded to acknowledge that by achieving these goals we will be creating the conditions for businesses to flourish.

With thanks to author Professor Carol Adams of Durham University and funding from the Institute of Chartered Accountants of Scotland, the International Integrated Reporting Council has published a guide to help organisations enhance their contribution to the SDGs, while reducing corporate risk and increasing opportunities that arise from sustainable development.

The preservation and use of natural capital, including affordable and clean energy, clean water and sanitation, and sustainable cities and communities, feature heavily in the 17 goals. The weight of importance attached to the world’s corporations and governments striving towards these goals are well-publicised. In turn, they have set the expectation level for investors when assessing a company’s overall sustainability and interaction with the natural environment.

Step change: Puma

Almost eight years ago, sports brand Puma published its very first environmental profit and loss account (EP&L). This wasn’t simply a new twist on a CSR report; this was a step change for integrated reporting. Instead of only measuring emissions or energy use, Puma made a clear effort to put a monetary figure on natural capital in order to run its business. Accounting for the environmental impact caused by greenhouse gas emissions, water use, land use, air pollution and waste in 2010, the figure came to €145m (£121m). This was a corporation actually acknowledging the environmental debt that it owed to the planet.

Our report quotes Jonathan Hughes, forum director and deputy chief executive of the Scottish Wildlife Trust, explaining that natural capital is a concept whose time is long overdue: “What [natural capital reporting] does is make visible the value of the natural world that we have taken for granted for so long, and that has been completely invisible to economic decision makers up until now. The current crisis in natural capital is comparable to the financial bubble that burst in 2008. We’re creating a natural capital debt bubble… If we continue to take resources from the planet at the rate we’re taking them, then we will eventually reach a tipping point.”

Professor Judge Mervyn King, founding chair of the International Integrated Reporting Council, describing how integrated reporting is helping business meet the SDGs, puts it even more succinctly: “The goal is to achieve this by 2030 otherwise planet earth may not be sustainable for those who come after us by the end of this century.”

We are already perilously close. According to the Millennium Ecosystems Assessment, more than 60 per cent of the world’s ecosystems are already degraded. Climate change and extreme weather events are a reality. The global species extinction rate is running at around a thousand times the background rate recorded by the fossil record.

“What high-profile stories from the last decade prove, is that ignoring natural capital puts you on a fast track to losing trust. Trust has become a critical asset – one that boards need to nurture to sustain organisational success”

To halt the ongoing damage to our resources and biodiversity, natural capital reporting could allow corporations and governments to measure and manage resources sustainably. The work we are doing at the IIRC takes this a step further. We say that natural capital reporting is only relevant if the story you are telling is integrated into the holistic story of value creation within the organisation. If it is siphoned off into a different department and not part of the central business model of the organisation, we will never make the changes the world needs.

In undertaking this work, we draw on the work of IIRC Council members, such as the World Business Council for Sustainable Development, US-based Ceres and the World Wide Fund for Nature, as well as partnering with the Natural Capital Coalition, which specifically endorses integrated reporting.

Does this mean that all business-caused environmental impact can be described in precisely economic terms? Can you monetise nature, which many say is priceless?

To which we would say: it is priceless but it’s not valueless. We have to understand the value of nature in all aspects of our lives in order to convince the unconverted, the hard-nosed economists, to actually think of it as having a value as well.

In a fast-changing and unstable world marked by economic and social turmoil, businesses need to earn the trust of many stakeholders: not only shareholders, but also customers, employees, governments, regulators and others. And what high-profile stories from the last decade prove, is that ignoring natural capital puts you on a fast track to losing trust. Trust has become a critical asset – one that boards need to nurture to sustain organisational success.

How to create this?

Corporate communications agency Black Sun has identified six principles of trust: purpose, culture, stakeholders, diversity, wider value creation and long-term thinking. They state that: “Individually and collectively, these principles contribute to developing corporate trust and are rooted in long-term thinking, planning and preparedness.”

As a tool for growing trust across these areas, integrated reporting comes into its own. It helps entities understand the interplay between the many interconnected risks they face – partly by challenging a ‘silo’ mentality and encouraging communication across disparate functions. By capturing material risks and opportunities in a single integrated report, organisations provide investors and other stakeholders with a more complete picture of long-term potential than is achieved by traditional financial and sustainability reporting. The OECD sees enhanced corporate reporting as an important element in an effective governance framework.

Integrated reporting is also winning the backing of stock exchanges (from India to Brazil), government ministries (from Japan to New Zealand), corporate governance codes (from South Africa to the United Kingdom) and international bodies (the Global Network of Director Institutes and the World Bank). These organisations see integrated reporting as an important tool for encouraging more stable capital markets and crucial to the planet – long-term, sustainable growth, which will in turn help these companies to attract long-term investors.

So, whether it is tackling concerns over natural capital, or building your social and relationship capital, I urge board directors to take a look at the International Integrated Reporting Framework and consider how you could benefit from broadening your understanding of value creation.

 

About the Author:

Richard Howitt is Chief Executive Officer of the International Integrated Reporting Council. For five years prior to becoming CEO of the IIRC, he acted as a voluntary IIRC Ambassador, promoting Integrated Reporting within the policy and business communities. He took over from the previous CEO Paul Druckman. He was Member of the European Parliament for the Labour Party for the East of England between 1994 and 2016