Accounting for Nature in the Climate Change Fight

The University of Waterloo’s Intact Centre on Climate Adaptation in Kitchener-Waterloo, Ontario, recently published a report entitled, “Getting Nature on the Balance Sheet.” Its introduction quotes Mike Pedersen, Chair of the Business Development Bank of Canada, and Corporate Director and Chair of the Nature Conservancy of Canada, which states:

“Wetlands, forests, saltmarshes and grasslands aren’t only vital to biodiversity. They are our frontline allies in reducing the impacts of flooding and erosion, extreme heat and drought, as well as removing carbon emissions to slow down climate change. The value of these services makes nature a sound economic driver – we need an accounting system that recognizes this reality.”

The report establishes the need to account for nature in all investment decisions noting the need to be thinking long-term. It notes that nature plays a “double-duty” role in tackling climate change because it acts like a sponge soaking up the greenhouse gas (GHG) emissions created by human activity. The preservation of nature, therefore, is essential and needs to be measured as an asset when making business decisions, and assessed as an economic value in financial statements.

Does the current ESG performance rating movement within corporations adequately address the issue? ESG looks at sustainable finance measured by environmental, social and governance performance by businesses. But is nature fully accounted for in ESG?

The report believes ESG doesn’t go far enough when looked through the lens of finance and accounting and recommends three actions:

1. 1.  Reverse natural asset accounting exclusions.
   2. Establish national natural asset guidelines and standards.
   3. Engage financial institutions in nature-positive actions.

What Are Natural Assets

These include soil, forests, wetlands, fields, rivers, lakes, coastal marshes, dunes and the ocean. Natural assets include ecosystem goods and services:

• Products like food, wood, and freshwater.
• Regulated processes such as water cycling.
• Cultural, aesthetic, and recreational benefits.

The World Economic Forum recently put a price tag on nature’s contribution to the global economy at $44 trillion USD, more than half the world’s gross domestic product (GDP).

In the mismanagement of natural assets through over-exploitation, nature’s ability to help mitigate climate change is compromised. Degraded aquifers for example lead to the need to find suitable alternative water sources. The undocumented and unknown liabilities of our indifference to nature, therefore, are costly.

The lack of recognition from the financial community to invest in nature-based solutions is another challenge. Public money may go into securing natural assets, but private finance only accounted for 14% of investments in this category in 2021. The United Nations forecasts by 2050 a $4.1 trillion USD financing gap that both governments and private investment sources need to close to ensure nature-based solutions can be implemented. The benefit is that these solutions will contribute to financial returns.

Natural Assets Tackle Climate Change

Managing natural assets reduces climate-related risks, increases carbon sequestration, and enriches biodiversity. The Insurance Bureau of Canada has noted the significant financial value of natural assets in reducing flood damage to personal property as an example. Urban forests reduce the urban heat-island effect and energy use in cities while creating better health outcomes with fewer hospitalizations from heat stroke and other medical complications.

Accounting for Natural Assets in Financial Disclosures

So how do we put a price tag on natural assets? Since 2016, Canada has been attempting to do just that by conducting inventories, modelling, and valuing natural resources. This is being done at the local as well as on a national level. Here are some examples from large to small of local valuations of natural assets related to water and carbon storage management:

• $16.3 billion for rural and urban forest and wetland carbon storage in the greater Quebec City area.
• $49.8 million annually for wetland restoration to reduce flooding in Quebec City.
• $44.2 million for wetland restoration in Hamilton, Ontario.
• $18.9 million for a 7-kilometre (4.3-mile) watershed in the city of Oshawa, Ontario.
• $5.5 million for erosion prevention in urban and rural forests in Ottawa, Ontario and Gatineau, Quebec.
• $3.5 to 4 million for naturally occurring ponds in a British Columbia park.
• $2.9 million annually for wetland preservation in Ottawa, Ontario.
• $2.4 million for naturalizing a British Columbia riverbanks to reduce downstream flood damage.
• $1.4 million for protecting wetlands in one watershed in New Brunswick.

The Methodology for Natural Asset Valuation

Using modelling and monitoring, valuing natural assets is based on the following:

1. Replacement Cost – this is simply the cost to replace or substitute through human engineering an alternative to the natural asset.
2. Revealed Preference – determining the affected market price of local goods and services impacted by a natural asset, for example, travel costs to a location.
3. Stated Preference – the cost to a community for the maintenance of a natural asset which could be reflected in taxes or fees.

More than one of these valuation techniques may apply to a natural asset.

The report notes that to calculate appropriate values for natural assets may require further analysis, but the tangibility of nature cannot be ignored in financial statements and accounting practices. In time, the discipline of determining natural asset valuations will be refined further to provide a precise and correct outcome. The standards of accounting applied to all other asset classes, therefore, should apply to natural assets.

Canada isn’t alone in making progress in determining the financial value of natural assets in accounting reporting. The U.K, the U.S., and South Africa have established accounting principles and practices for natural assets. And asset managers, institutional investors, insurance companies, and banks are also incorporating natural capital in investment decision-making. The most well-known in the asset management realm is BlackRock which stated in 2021 that “all companies rely on natural capital in some way and, as the world transitions to a low-carbon economy, we ask companies to demonstrate how they are minimizing their negative impacts on, and ideally enhancing the stock of, the natural capital on which their long-term financial performance depends.”

The Report’s Final Recommendations

For Canada, at a national level, there are three actions that this report recommends.

1. Reverse Natural Asset Accounting Exclusions – Remove the exclusion of natural assets from public sector financial statements.
2. Establish National Natural Asset Guidelines and Standards – Establish practical guidelines and national standards for inventory, management, and valuation of local government natural assets.
3. Engage Financial Institutions in Nature-Positive Action – Engage Canadian financial institutions and organizations in testing and refining a natural-asset accounting framework. At the same time, making investments to build natural capital. This includes investments to “do no harm” as well as investments in solutions to enhance and restore nature.

We need all the frontline allies we can get to slow down and reverse the effects of climate change. Natural assets are effective weapons to draw on for this fight.