Finance sector building with trees

Addressing the Nature Financing Gap: The role of natural capital accounting and natural asset companies

Could the enthusiasm surrounding natural asset companies drive changes in accounting standards for natural capital? 

By Edoardo Carlucci on January 4, 2023

With a new Global Biodiversity Framework now reached after the Convention on Biological Diversity’s COP 15 in Montreal, one of the key challenges ahead for the international community is not just about implementation of these goals to curb biodiversity loss: it also involves resolving the massive gap in finance needed for a nature-positive future.

New data from the United Nations Environment Programme, for instance, indicates that current financial flows to nature-based solutions, which they value at USD 154 billion annually, must triple by the end of the decade if we are to tackle converging sustainability crises—more specifically climate change, biodiversity loss, and land degradation.

These figures have reinforced that massive changes are needed to help make up that gap, and fast. One crucial change will be a rethink of current accounting practices to value natural capital, which are not fit for responding to these challenges effectively.

What Accounting Practices Look Like Now 

Accounting practices have been conceived in a world of abundance of natural resources. Capital, labour, and flow of goods and services are the main components recorded in a company balance sheet. But under these practices, natural stock and the underlying ecosystem services are treated as being available for free, meaning that companies often overlook how these factors are interdependent with the company’s activities.

This failure to integrate natural capital into company balance sheets has contributed to undermining the environment and the ecosystem. While natural resources such as oil, gas, and minerals are well accounted for, other types of natural stocks, such as water and soil, are usually omitted. This is one of several factors that have enabled the unsustainable exploitation of natural resources to continue while also contributing to the degradation of the environment. Also absent from company balance sheets are biodiversity values, even though biodiversity is essential for well-functioning ecosystem services.

Transitioning to natural capital accounting would both encourage companies to foster conservation practices and help reduce the nature financing gap.

There has been some progress in recent years: there is greater recognition of the need to change the way company balance sheets work, and there have been notable advances in developing accounting solutions that integrate natural assets and the underlying ecosystem services. However, these practices are far from being widely adopted. Significant advances in recent years include the System of Environmental-Economic Accounting developed by the United Nations, the European Commission, the Food and Agriculture Organization of the United Nations, the Organisation for Economic Co-operation and Development, the International Monetary Fund, and the World Bank Group. Among other functions, this system provides a valuation tool for ecosystem changes and services, and it has been adopted by the UN Statistical Commission.

The European Commission is also proposing a review of the regulation on European Environmental Economic Accounts (EEEA) to align natural capital accounting practices with the UN accounting systems. At the national level, additional initiatives are taking place, such as the Natural Capital Accounting standards provided by the British Standards Institution, which serves as the British national standards-setting body.

Natural Asset Companies: A way to spur the conversation forward

Just over one year ago, the New York Stock Exchange and Intrinsic Exchange Group made a landmark announcement: they would be introducing an innovative financing solution known as natural asset companies (NACs). These NACs are companies that hold rights to the preservation and conservation of a natural asset and its underlying ecosystem services. While still in the early stages, they have the potential to push forward the discussion on natural capital accounting.

For example, a company that protects a wetland raises capital through an initial public offering. The proceeds are then used for the protection of the wetland and the ecosystem services, such as water purification and carbon sequestration.

The innovation of this new asset class lies in the establishment of a long-term equity structure based on natural capital accounting. How much this new investment structure can help change companies’ decision making on nature depends on several factors.

First, robust natural accounting standards can provide strong incentives to invest in nature. For example, the Financial Accounting Board Standard has helped define the accounting and reporting standards of NACs. This has the potential to inform international guidance on how to value natural assets and streamline natural accounting practices.

Initial public offering requirements also play a key role, as they help ensure NACs’ credibility and transparency. For example, a company that wants to be listed on the New York Stock Exchange should satisfy governance requirements that ensure the independence and competence of the board. However, transparent governance, accompanied by strong third-party auditing, should allow investors to verify the restoration and conservation practices of the company. Second, by going public, the company has the potential to reach a large pool of investors, ranging from professional to retail investors. The shareholders will benefit from the shares' performance, which is influenced by the revenue stream that the underlying ecosystem benefits generate. Additional revenue streams can materialize in the long term, such as from increased tourism activities and carbon credits. If these NACs become more common, they can contribute to reducing the nature financing gap by unlocking further capital for nature conservation and fostering the standardization of natural capital accounting.

Third, biodiversity considerations can have a significant role in NAC operations. Highly endangered and degraded areas can benefit from regenerative models adopted by the NAC, producing long-term benefits for local communities. The Intrinsic Exchange Group refers to regenerative models such as regenerative farming that improve soil health, biodiversity, and food production.

Therefore, biodiversity can become a crucial ecological indicator for the accounting models adopted by the NACs. 

Putting the Right Safeguards in Place

However, while NACs have significant potential, this new investment vehicle also comes with risks. One major concern involves the privatization of nature. Generally, NACs only hold rights to the production or sustainable use of the ecosystem services, while the ownership of the natural asset remains with the initial possessor, which can be a public entity, government, or farmer.

As there is no direct transfer of ownership from the owner to the asset company, investors and regulators should pay particular attention to how the company handles the rights for the use of ecosystem services. The asset company should not hinder local communities’ rights to access the natural asset. This is particularly crucial when it comes to Indigenous Peoples and minorities who have often seen their rights violated. On the contrary, NACs’ valuations on the natural assets should be interlinked with the prosperity of local communities. This should be in line with sustainable investment practices that integrate both environmental and social considerations.

NACs should not become another speculative financial instrument causing more harm than good, as happened in 2008, when speculations on food futures caused an overvaluation of food prices. The result, at that time, was a market bubble that forced millions of people in low-income countries into extreme poverty. Supervisory and regulatory requirements can provide additional protection by preventing harmful practices.

NACs have enormous potential to mobilize large amounts of capital to finance nature at a global level by valuing and accounting nature. This can only be achieved if market practices are aligned to benefit nature and local communities.