Why natural capital is both the oldest asset class and the next big one

Economists are assigning high values to the services that natural capital delivers and its critical role in sustaining the economy.

FOR centuries, natural capital has been recognised as one of the three means of production, alongside capital and labour. Land not only played an integral part in any wealthy family's asset portfolio, it was often its main component.

And yet, for much of the last couple of hundred years, economists, policymakers and businesspeople have mostly ignored natural capital, save for when it could be exploited. They otherwise took it for granted, assigning essentially zero value to much of it. Perhaps unsurprisingly, this has led to massive value destruction and under-investment.

Natural capital - the assets of nature, including the land and sea, along with the biodiversity of ecosystems within them - has been destroyed at an unprecedented rate with significant negative consequences, including biodiversity collapse, increased carbon dioxide emissions, localised temperature rise, soil loss, and the spread of diseases.

However, we are now seeing economists assigning high values to the services that natural capital delivers and its critical role in sustaining the economy.

For instance, the World Economic Forum currently estimates that US$44 trillion of economic value generation, more than half the world's output, is moderately to highly dependent on nature. Its destruction is finally recognised not only as environmental risk, but as a financial one too, set to impact every country and institution in the world.

RECORDABLE ON THE BALANCE SHEETS

By preserving and enhancing natural capital, we can help to preserve the life-giving and life-enhancing services it provides us. However, natural capital is not yet currently considered a mainstream asset class, meaning that its protection is often not incorporated into investment priorities.

That said, several advances are being achieved together that may rekindle natural capital as an asset class and should encourage investor participation.

Helpfully, metrics are now being developed, at pace, to measure biodiversity. The mean species abundance (MSA) metric quantifies the impact of humans on biodiversity: 100 per cent represents a pristine original nature state, while zero per cent translates to full depletion.

Such metrics allow investors to monitor the quality of their assets. These metrics will also help businesses identify, measure, value and prioritise their impacts and dependencies on biodiversity and the ecosystem, ultimately providing new insight into their exposure and risks.

Firms are also starting to recognise that natural capital can be measured and recorded on their balance sheets. Just as companies put money aside to maintain the life of their physical assets, so they can be encouraged to invest in their natural assets, to offset depreciation, and allow the asset to keep on providing services. Improved data and reporting allow investors to better assess the opportunities available, thus improving participation.

Innovations in agriculture and forestry are also challenging today's industrialised approach. New restorative techniques pursue increased profit and resiliency. This new approach, coupled with nascent carbon and biodiversity markets, allows natural capital owners to "stack" the cash flows derived from their assets.

Stacking involves monetising several natural capital services from a single site. For example, landowners can enjoy sustainable timber or regenerative agriculture cash flows. But in addition, they may secure funds from carbon markets and the nascent biodiversity credit market. Sites may also benefit from eco-tourism. For agricultural assets, input costs can fall as fertilisers and pesticides are dispensed with, and water is used more efficiently.

For natural capital investors, the ability of the asset owner to secure cash flows from the natural capital to meet maintenance capex and interest payments, via means such as stacking, is vital and a key component in preventing natural capital being replaced with alternatives such as cattle grazing, palm oil or mining, which may appear more profitable in the short term.

PROFIT FROM BIODIVERSITY

Finally, and perhaps most importantly, deals are starting to be done, and although many are put together on the fringes of the green bond or carbon markets, such initiatives demonstrate a determination to use all instruments currently available to preserve and enhance natural capital.

If restorative projects are profitable today, the potential upside is huge if we eventually see appropriate pricing for carbon, biodiversity and water, plus appropriate fines or taxes for pollution and excessive chemical use. With a rising number of countries and businesses making net-zero commitments, for investors who move into this asset class early when biodiversity is afforded little value, the upside potential is significant.

It is, of course, with these points in mind that last year, HSBC Asset Management has entered into a joint venture with Pollination Group Holdings, a specialist climate change advisory and investment firm, to establish HSBC Pollination Climate Asset Management. The partnership aims to create the world's largest natural capital manager and is the first large-scale venture to mainstream natural capital as an asset class.

The fact is, investors are increasingly focused on environmental matters. And while financial returns still matter and will be a priority to most, investors are also concerned about creating a positive impact on the world's biodiversity which will be felt for generations to come. And when they invest in natural capital, they are investing in the resilience of their portfolios.

  • The writer is CEO and head of South-east Asia, HSBC Asset Management (Singapore).

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