New ideas for sustainable finance are being put into action, beginning with the way we measure nature’s worth
Historians looking back on the first half of 2022 will likely zero in on two themes: the scramble among central banks to stem inflation and the record-shattering heatwaves that pulsed across China, Europe, Africa, and North America.
Inflationary spirals and scorching temperatures appear to have little in common. However, there is a growing sense that the financial and climate breakdowns are part of the same trend.
In a sobering indication of this, S&P data shows that fossil fuels were about the only reliable stock returns in 2022, with 19 of the top-ranking 20 companies having some connection to oil or gas. Many of the biggest private equity firms, exempt from certain financial disclosure rules, remain deeply imbricated in fracking and oil drilling. Much of our pensions, higher education, and charities depend on these companies.
Although the ESG concept has swept the financial community in recent years, more have capitalised on reputational gains than have taken substantive measures to green their investing. ESG’s credibility will continue to suffer for as long as it remains ill-defined and under-regulated.
What is nature worth?
There is an even bigger obstacle to incentivising green investing. All mainstream macro- and microeconomic measures of wealth exclude environmental impacts. There is no agreed standard for evaluating how costly economic activities are from an ecological perspective. The market, in effect, is eco-blind.
For seventy years, nations have universally regarded GDP as the most important measure of economic success – a metric that rewards increased economic productivity without capturing the environmental costs of how this is achieved. Similarly, attempts to augment company accounting with the triple bottom line have floundered. Uptake has been limited and the triple bottom line remains mostly a conceptual innovation without stringent regulatory underpinning.
For decades, a minority of economists have criticised GDP and equivalent micro-economic frameworks as flawed measures of wealth and value. Alternative economic indicators that factor in long-term environmental health have remained only a theoretical possibility until very recently.
Accounting for nature
Calls for more ecologically sensitive accounting metrics have become more vocal, organised, and well-received.
In March 2021, 89 nations took tentative steps towards institutionalising an eco-centric measure of economic development by adopting the UN’s System of Environmental-Economic Account (SEEA).
SEEA is a method for calculating the economic value of natural resources such as air, water, soils, and energy. What makes it particularly innovative is that, on top of standard measures like carbon emissions, it tackles trickier variables like ecosystem diversity, extent, condition, and services.
These ecosystem resources, most of which have zero value according to conventional econometric frameworks, underpin our quality of life and survival. Yet as the 2019 Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services Global Assessment have revealed, these irreplaceable life-support systems are rapidly deteriorating.
Investing in nature
Many think that stalling the decline of under- or unvalued natural resources demands a government-managed bank that operates using the SEEA standard. A group of economists and environmental scientists – Michael Vardon, Peter Burnett, Heather Keith, and Peter Burnett – recently proposed a Natural Capital Bank that does just this.
A Natural Capital Bank would resemble a conventional central bank in its authority and functions. Just as central banks are responsible for holding government money, controlling the supply of money, fostering growth, mitigating unemployment, and reaching inflation targets, the Natural Capital Bank would coordinate existing institutions and divert the flow of capital to support environmental stability. The bank would use SEEA data on the value of environmental features to guide its investment and governance decisions.
Some, however, remain cautious and even the new banks’ advocates concede their idea will be politically contentious. Perhaps for this reason, the World Economic Forum remains agnostic on specific approaches towards valuing nature, advising that existing private and public institutions be re-purposed to roll out sustainability investing at scale. The organisation urged in a 2022 report that business leaders pressure the public sector to “redesign public support schemes and create the policy and regulatory conditions needed for investments in nature to become more financially attractive”. It also listed eight concrete steps that companies can take in upholding their commitments to investing in nature.
What a Natural Capital Bank would offer the bioeconomy
Circular and biomaterials enterprises would reap enormous benefits from a Natural Capital Bank. Innovative low-carbon substitutes for petrochemical products offer exactly the kinds of benefits that are obscured by conventional risk assessments for investing. Existing measures are simply unable to put a figure on the social and environmental benefits of manufacturing processes and commodities that cut carbon emissions and improve biodiversity health.
There has long been demand for natural capital accounting in the bioeconomy. For example, the organisation Circle Economy recently pointed out that a new approach towards risk is needed to “steer capital away from non-circular (and often riskier) businesses, and towards ones that promise long-term stable value creation and positive impact”. Initiatives along these lines have been floated over the years but have tended to be sector-specific, limiting uptake within the wider investment community.
Private initiatives for valuing natural capital
Although proponents of a Natural Capital Bank are aware of potential political objections to their proposal, they justify their idea by pointing to the fact that environmental assets are often ‘fragmented among nations, within different institutions of government or largely outside existing institutions”.
The character of natural assets, and the scale of decarbonisation needed, means that voluntary action alone would be too slow, ineffectual, or both. Consider, for example, that although 70 percent of investment for new power generation in 2021 went towards renewables, clean energy investment would still need to double in the 2020s to maintain temperatures below a 2 degree rise by the end of the century.
Within the bioeconomy specifically, the largest private natural capital initiative is the Lombard Odier fund, set up in 2020. It now holds $937 million in assets that include regenerative farming and waste management projects. While projects like this are welcome, the narrow time-frame for implementing a low-carbon transition makes more centralised efforts paramount.
The inefficiencies of relying upon private initiative in affecting rapid decarbonisation are exemplified by the travails of carbon offsetting. Although the mechanism has been around for twenty years, and despite surging demand over the last two, carbon credit markets would still have to scale 15 times the volumes traded in 2019 to meet its 2 gigatonnes offset target by 2030.
This should offer a cautionary tale for the bioeconomy. While private capital flows into the biomaterials and circular sectors are increasing, they are still not informed by any universal accounting scale. As a result, there can be no consistent cross-comparison between portfolio options in terms of their environmental impacts and climate risks. A single standard, enforced and used by a central authority, would enable private investments to become more targeted, rationalised, and likely to yield environmental benefits.
A public institution for financing economic activities that support biodiversity and planetary health is also a compelling proposal given unresolved problems within carbon offsetting and ESG. Almost all the weaknesses of these market-based approaches to environmental protection can be traced to a lack of central oversight and clear definitions of key terms.
Within carbon credits, for example, there are numerous standards for assessing how much and for how long offsetting projects remove or reduce carbon emissions. This has led to questions over the environmental integrity of carbon offsetting, the true market worth of credits, and a fragmented market. The uncertainty around a novel and under-regulated initiative like offsetting also means that investors and business leaders are unable to properly assess the commercial risks of engaging with them. This inhibits market scaling and, ultimately, the concrete environmental benefits of such schemes.
National monetary institutions that deploy rigorous methods for identifying ecologically sound enterprises would be the fastest way to scale biomaterial and circular industries enough they can be leveraged towards wholesale decarbonisation.
A step in the right direction
Over 2022, global environmental and financial crises have unfolded in stark parallel. It is becoming more difficult to ignore the role that financial institutions are playing in pushing the planet beyond habitable limits. Without new investment metrics and institutions that implement them rapidly and at scale, existing channels will not be able to divert enough capital in time to avert catastrophe.
Natural Capital Banks based on the new SEEA accounting standard offer the most promising routes toward wholesale change within the financial system. They would be the fastest, most reliable instruments of coordinated investment into the developing biomaterials and circular sectors.
These institutions would be particularly instrumental in ensuring that green products finally become competitive with cheaper petrochemical commodities, whose market advantage currently rests on the fact that their prices do not capture environmental harms caused by their extraction, manufacturing, and disposal.