Valuing what makes life possible

Natural capital is made up of the natural assets – including minerals, soil, air, water and living ecosystems – from which humans derive a wide range of services that make life possible. While their identification and measurement are founded on the fundamental concepts of accounting, valuing these ecosystem services as they evolve and mature requires agile and innovative reporting methods.

Some natural capital assets have been recognised on balance sheets since accounting was invented, land being an obvious example. Others have emerged as markets, regulation and licensing have clarified events such as cost (eg purchase of mineral rights), control (eg exclusive licences) and future economic benefit (eg the right to harvest and sell timber).

Liabilities arising from natural capital have similarly developed. They may arise from licensing fees, environmental obligations, remediation expenses, or fines and penalties for environmental violations. Provisions are regularly made for rehabilitation, care and maintenance on mine closure, for example, and expenses recorded for water licences and water treatment.

New natural capital assets and liabilities are continuing to emerge as society seeks to influence the impacts organisations have on our environment. Carbon emissions and offsets are now routinely priced, and biodiversity credits and offsets are following closely behind.

Valuation evolves

Many natural capital assets, such as fishing licences, land and water rights, are already routinely valued. As with other types of assets, the valuation method chosen needs to be the most appropriate one for the nature of the asset, with market-based, cost-based and income-based methods commonly used. However, the valuation techniques available are evolving as the true cost and benefit of natural assets becomes more widely recognised.

For example, consider an area of virgin rainforest held by a mining company, adjacent to its mining operation. That land may historically have been recognised at cost and depreciated over time. Applying an ecosystem services valuation model is likely to change the amount recognised as services such as security of water supply, control of local microclimate and carbon credits into the value. It might also identify potential ‘latent’ value that could point towards alternative value-creating activities, such as generation of biodiversity credits, community amenity or exploitation of rainforest products for consumer goods.

The diverse and often intangible nature of natural capital assets can make valuation a complex exercise. In many cases, standards have yet to be agreed regarding valuation methods and parameters such as discount rates, ecosystem dynamics and market prices. Regardless, valuation remains a useful exercise to inform decision-making and management of risks and opportunities.

Measurement

Changes in value can occur as a result of ecosystem degradation or improvements, new or improved data, regulation or market changes such as the development of new markets for biodiversity credits. Where natural capital assets have a finite useful life, they may be subject to depreciation or amortisation.

Tracking the quantity, quality and condition of natural resources often requires new metrics and monitoring systems that can capture changes in ecosystem condition, land use patterns and resource availability over time and space.

The interconnectedness of natural resources may require a more sophisticated approach to the analysis of risk and value than the more traditional approaches used to monitor impairment of assets. Events that should be monitored to understand their impact on value include regulatory change, operational risks such as natural disasters, litigation trends, community concerns and events in related ecosystems (such as pollution in an upstream catchment).

Reporting framework

The Taskforce on Nature-related Financial Disclosures (TNFD) sets out a broad methodology for identifying and assessing nature-related risks and opportunities, underpinned by more specific (and rapidly evolving) guidance on issues such as risk assessment methodology, valuation of nature dependencies and suggested assessment metrics. Jurisdictions around the world are already moving to build the TNFD into their formal reporting requirements, and markets and other stakeholders are starting to use the TNFD framework to define and analyse the risks organisations face.

In addition to the risk and strategy disclosures required by the TNFD, disclosures in the notes to the financial statements may also be required. These may include information about the nature and extent of natural capital assets and liabilities, valuation methodologies, key assumptions and estimates, and risks and uncertainties associated with any natural capital assets or liabilities recognised.

Natural capital reporting is rapidly turning from a concept to a concrete reality, with profound implications for the future of corporate decision-making, financing, and regulation. Accountants would be well advised to engage with stakeholders, including investors, regulators, communities and non-government organisations, to anticipate potential changes and allow time to prepare for emerging requirements.