Nature on the Balance Sheet – the fundamental solution to the nature crisis

Environmental Crises and Planetary Boundaries

The world is yet to recognize the magnitude of the crisis we are facing incurred by nature’s collapse. The stable and resilient natural system is the very foundation of our prosperity, but our current economic system has been eating up its foundation to the extent which is irrecoverable. Scientists have been alerting us that we have transgressed many of the boundaries of the planetary system and that we do not have much time left if we are to change the course to come back to the earth’s safe operating zone. 

Environmental crises that we have been witnessing, be it climate change, biodiversity loss, water stress, land use change and ocean acidification, is a testament of the clash between the economic system and the planetary system. In the past, the planet earth was vast while our economic world was small, so our impacts on the planet was rather limited and insignificant. Now we have achieved remarkable economic development – at the expense of the earth’s health – and have reached the carrying capacity of the planetary system. If we continue the current trajectory, we will soon go beyond the safe operating zone which would no longer support human wellbeing as it used to.

Transforming the Current Economic System

The only way to save ourselves from such tragedy is to transform our current economic system so that we can live in harmony with nature. How can we do it? The fundamental problem of the current economic system is that it does not account for the full value of certain types of capital, most notably the natural capital. It was OK not to account for natural capital when our economic activities were relatively small and natural system was big. Nature seemed abundant and we exploited it as free goods. But the situation has changed completely for the past half century. We have increasingly seen climate change intensifying and nature loss accelerating, which has impacted on our day-to-day life. It is time to recognize that a fundamental change is required to update our economic system and account for the full value of nature in our economic decision making, including production, consumption and investment. 

But how can we achieve this heroic task when the reality is that nature is not yet integrated into our economic decision making as valued capital? There is a lot of discussion and effort to protect nature and mobilize finance for nature. However, the sheer fact is that nature finance is currently limited to only US$154 billion, 80% of which derives from public finance. Private finance is even more limited, smaller scale, and fragmented. Governments have established nature protected areas but much of nature loss takes place outside these areas.       

It should be noted that in recent years, we have seen great efforts made to assess and disclose the economic value of natural capital. TNFD has made a significant step forward following the similar effort by TCFD. Several municipalities and progressive corporates have started natural capital accounting using the UNSEEA framework. This reflects increasing awareness of the need to address risks derived from nature loss. But those efforts do not yet bring natural capital as assets in financial accounting. 

We need to address the fundamental challenges behind those limited successes and change the way our economic system operates so that our economic decision-making accounts for the full value of natural capital.

Nature-on-the-Balance Sheet

How can we make natural capital accounting an integral part of financial accounting, not as non-financial information or mirror account of financial statement? (Please refer to the attached Figure 1.) 

To move from the “Assessment backet” and the “Quantification backet” towards the “Recognition backet” in Figure 1, we need to go through certain trigger events such as market transactions or contract agreements, so that assessed value can be recognized as the value of financial capital. This journey towards recognition backet, which challenges the existing accounting system, requires a coordinated shift of the entire market infrastructure, including market regulators, exchanges, central banks, rating agencies as well as capital market participants. (Please refer to the attached Figure 2.) 

The key message is that to change the current accounting practice and fully value the natural capital as a financial asset, holistic change is needed to the market infrastructure beyond the accounting system. This goal sounds naïve and simply impossible, but without making this impossible to possible, we continue to destroy the natural system, the very foundation of our prosperity. If the accounting system is our own creation, why can we not change it? 

This shift will bring about two major benefits. First, once our economic and accounting system values nature as a financial asset, we will reward activities which safeguard the value of nature and penalize those who exploit nature. Consequently, those rewards or penalties will appear on the balance sheet. Activities enhancing the value of nature would get financed with better conditions as a result. Second, under this updated economic system, the reward would be distributed fairly to those who have been safeguarding nature but historically not been financially recognized. The beneficiaries would include indigenous people and local communities, forest people, small holder farmers and local fishermen, the true guardians of natural capital. Their efforts will be economically paid off and will bring much needed justice to the global economy.

Note: “Nature on the Balance Sheet” is the initiative jointly organized and promoted by the author, Naoko Ishii of University of Tokyo and Mark Gough of Capitals Coalition, Guido Schmidt-Traub of Systemiq, and Martin R. Stuchtey of The Landbanking Group.