Podcast: What is natural capital and why is it important for investment decisions?

One of the key roles investors can play is influencing the practices of companies who impact the natural world. Over 50% of global GDP is dependent on nature, so Schroders is making nature and biodiversity central to our active engagement.

During this episode, both TCFD and TNFD are referred to. These are frameworks that companies can use to publicly disclose and report the climate-related and nature-related financial risks and opportunities on their businesses.

Here's a transcript of the conversation:

Mervyn Tang (MT): Hi, everyone. Welcome to the next episode of Making An Impact podcast. We are here today with Catherine Macaulay who is in our sustainable investment research team and who is a specialist on biodiversity and natural capital. Welcome, Catherine. Briefly, what is natural capital and why is it so important for investment decisions?

Catherine Macaulay (CM): Thanks for having me on the podcast Mervyn. People often hear natural capital and think what does that mean, not to start this off with a pun, but natural capital is really just a way of talking about nature and nature's asset. So, we're thinking about everything from soil, to rocks, coral reefs, to forests.

These assets provide what are termed ecosystem services that are fundamental to most businesses and economic activity. The World Economic Forum estimates that up to 50% of global GDP is somewhat heavily reliant on nature. So, things like crop pollination or carbon sequestration, climate regulation and flood protection.

It is hard to think of an activity or a sector that doesn't interact with nature in some way. Companies are embedded in nature, and in many instances, they rely on it for their continued operation to produce their products.

It is important for many of the same reasons that climate change is important in investment decisions. Companies are facing physical risks that could disrupt operations, as well as transitional risks, as regulation develops, and consumers and investors start to price this in and factor into purchasing and investment decisions.

I think it's really clear that the value drivers of the global economy are starting to shift, and investors need to stay ahead of the curve.

MT: That's great. It does not sound easy to put a value on natural capital assets. How do you do that and how do you identify the biggest challenges and opportunities?

CM: Ecosystem valuation is an industry that has existed for decades; it has typically been used by insurers and governments. If you think about something like an oil spill, there will be technical experts that are sent in to try to quantify the contamination impacts, and they will often use things like replacement or restoration costs.

I think one of the key challenges when you think about public markets, is the absence of being able to perform that type of detailed analysis at the local level. And often the capacity for our portfolio companies to do that is nascent or frankly non-existent. So, we really need to find proxies to try to assess company exposure to nature related risks and opportunities and really understand how companies are managing these.

Naturally, that also presents opportunities. That's something we've been doing a lot of work on, developing frameworks to understand these exposures and opportunities at a sector and an industry level. And data here is really improving all the time. So, where you have assets specific location data, for example, you can do some really fascinating analysis.

MT: I do seem to hear natural capital mentioned all the time in the media and conferences and research reports. Where do you see this kind of evolving in the coming years and what does this mean for investors?

CM: We saw at COP26 last year a huge emphasis on nature, and in particular, on land use and on deforestation. We saw commitments coming from governments, from corporates, from financial institutions, including ourselves.

I think the journey on climate is a really interesting analogy here. We saw the TCFD guide that came out in 2017, and about five years later it's becoming mandatory. We are set to see the nature equivalent to TCFD released formally next year; it's in its draft phase now. But to be clear, I think the journey on nature needs to be a lot quicker than it has been on climate, and I do think we are also in a position to move more quickly, because a lot of the groundwork has been laid.

I think we can expect a huge focus on disclosure, and investors should really be engaging with these frameworks, with their portfolio companies to improve their visibility on nature related issues. And I think focusing on those industries and sectors that have the greatest impact and dependence on nature and signalling to companies in those industries that we really need to see ambition and disclosure and ultimately progress on natural capital and biodiversity.

Mervyn, turning the tables back on you. We have been getting a lot more incoming client requests on natural capital, everything from reporting to solutions. It would be great to hear your perspective on what's driving this,

MT: It's never been investors not thinking biodiversity is important. I think they always did. It always just seemed intangible compared to climate. But I think the developments like you mentioned with TNFD, advances in data science, better disclosure by companies: it's starting to become more tangible. So, we have seen growth of products and solutions in the market, the numbers that are coming out for investors and our clients is becoming more meaningful. And so, I think this kind of data revolution, this evolution is driving interest amongst our clients, because now it's become much more actionable.

Secondly, the commercials are really important for our clients. One of the things driving direct investment in natural capital is the carbon offset market, and the capacity for a lot of natural capital assets to be able to sequester carbon and hence generate offsets.

CM: That is fascinating to hear that more clients are thinking about natural capital as an asset class and how it relates to climate change and carbon. What are the kinds of things that they are considering when directly investing in natural capital?

MT: There is the return component, where you really have to understand how carbon markets will evolve in the future and what that means for the cash flow of these natural capital assets.

But I think another factor that is increasingly relevant is that a lot of these forestry natural capital assets actually have biodiversity co-benefits. They may be homes for a lot of natural habitats, they may even act as flood plains in terms of mitigating physical risks. And so, you have to think not just about that carbon offset cashflow potential but what the potential value is of these kinds of biodiversity and other environmental factors.

I think one of the interesting developments coming out from the Singapore Climate Impact X, which will be effectively an exchange for a lot of these natural capital projects, is they will be giving descriptions of projects not just for their carbon offset potential, but also their biodiversity benefits. And with the development of these exchanges, we will see more of a pricing come through on how much these biodiversity benefits will be valued in the market.

MT: So, time has really run by quickly and unfortunately, we have to end this podcast but it's been great having you on this conversation, Catherine and I hope all the listeners enjoyed this.

CM: It has been a pleasure. Thanks, Mervyn.