Want investors to care about natural resources? Put a price on them

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum.

Author: Alison Tarditi, Chief Investment Officer, Australian Commonwealth Superannuation Corporation & Tim Hodgson, Co-head, Thinking Ahead Group, Willis Towers Watson

• Long-term investors are part of the solution to one of humanity’s most pressing problems – the rapid degradation of natural-ecosystem services and resources.
• A mechanism to enable ecosystem assets to be priced, would signal their scarcity and, thereby, their value to everyone.
• Real markets would be forced to ration consumption of ecosystem assets in their production processes, as they now do for the use of physical, technological, and human capital.
• Financial markets would be better able to identify and ration capital to companies whose franchise values were are risk from the inefficient use of ecosystem assets.

Covid-19 has laid bare deep divisions in society, and its impact has not been felt equally. In a similar way, we do not expect climate change and the degradation of natural resources to have equal effects on communities. The impacts will likely include uneven local effects, increasing numbers of climate refugees, relative price shocks and other opportunity costs.

Anyone paying attention to the news over the past couple of years will be aware that the focus on climate change has increased markedly. School children are striking, and lives are being lost to wildfires, floods, droughts, famines and intense storms. Carbon emissions receive a lot of attention, but other natural ecosystem resources are also showing signs of stress.

Fresh water is less available, the oceans and associated fish stocks are less healthy, and species are being lost at an accelerating rate. And yet, all of us are still free riders, consuming goods and services whose prices do not account for the costs of the ecosystem assets used up in their production.

This challenge is particularly acute in the face of rising inequality within nations (even as inequality between regions reduces), where living standards are already perceived to be under threat and trust in political systems has weakened.

What should be the role of investors?

Sovereign wealth funds, insurance companies and individual savers (as represented by pension funds), can and should be part of the solution to reducing ecosystem asset depletion.

Such long-term investors should already be thinking about the risks to corporate franchise value arising from inefficient use of natural ecosystem-assets. A number of institutions are already thinking about this, but some are more advanced than others.

A recent World Economic Forum white paper, conducted in collaboration with Mercer, surveyed 30 asset owners representing over $3.4 trillion in total assets. The study found that there was significant variation in how asset owners integrate global systemic trends, such as natural resource degradation and inequality, into their strategic decision-making and more needs to be done to accelerate progress and impact.

Financing Sustainable Development

The world’s economies are already absorbing the costs of climate change and a “business as usual” approach that is obsolete. Both scientific evidence and the dislocation of people are highlighting the urgent need to create a sustainable, inclusive and climate-resilient future.

This will require no less than a transformation of our current economic model into one that generates long-term value by balancing natural, social, human and financial conditions. Cooperation between different stakeholders will be vital to developing the innovative strategies, partnerships and markets that will drive this transformation and allow us to raise the trillions of dollars in investments that are needed.

To tackle these challenges, Financing Sustainable Development is one of the four focus areas at the World Economic Forum’s 2019 Sustainable Development Impact summit. A range of sessions will spotlight the innovative financial models, pioneering solutions and scalable best practices that can mobilize capital for the the world’s sustainable development goals. It will focus on the conditions that both public and private institutions should create to enable large-scale financing of sustainable development. It will also explore the role that governments, corporations, investors, philanthropists and consumers could play to deliver new ways of financing sustainable development.

This matters to everyone – not just long-term investors. It matters for the quality of the air you breath and the water you drink. And it matters financially, because these risks can threaten the quality of long-term investor portfolios thereby affecting their capacity to payout your future pension entitlements or insurance claims.

This matters to everyone – not just long-term investors. It matters for the quality of the air you breath and the water you drink. And it matters financially, because these risks can threaten the quality of long-term investor portfolios thereby affecting their capacity to payout your future pension entitlements or insurance claims.

We need to put a price on natural resources

The capitalist system that has been so successful in lifting billions out of poverty allocates resources in response to price signals. The more expensive something is, the more the system seeks to economize on it. The cheaper something is, the more the system will use it. So, if natural ecosystem assets are free to use, we will over-consume them (as we have done so) – until the resource is in credible danger of running out. Cape Town’s response to the threat of running out of water is a highly instructive case study.

We do not pretend that introducing prices for previously free resources will be easy. The gilets jaunes protests in France and the toll road protests in Norway both show that there will be resistance to even small increases in prices looking to conserve natural resources, even in rich countries.

No one wants their standard of living to fall. The practical constraints on the UN’s REDD+ programme attest to some more of the challenges involved. This programme attempted to price the immense amount of carbon in the world’s last remaining rainforests to effectively give value and payment for their preservation, partly funded by carbon offsets. But complexities of land ownership and, to paraphrase David Attenborough, “the attraction of greed to value”, undermined this intent.

Failure, however, is part of the journey to success. We believe that the introduction of such prices is a way to accelerate the capacity of markets to properly account for the use of precious ecosystem assets that to date have been consumed for free.

Where would we start?

A blog post cannot offer complete solutions to problems as complex as these. But we offer the following ideas to seed the debate and hopefully to encourage action.

1. Investors: If the constraints on capital markets were suddenly eliminated and natural ecosystem assets could be efficiently priced according to their limited supplies and fragile quality, how would the weights change to existing listed companies in the world’s equity and debt market indices? What would the optimized ‘planetary health’ or ‘as if’ portfolio look like?

2. Governments and regulators: The opportunity and the challenge for regulators and governments is to lead through the introduction of pricing systems for natural ecosystem resources. How should these pricing frameworks be designed for robust transition to a full pricing of all factors of production, and not just the man-made ones?

3. Consumers: The opportunity and the challenge for consumers is to recognize that the cost of many of the goods and services we enjoy is currently being heavily subsidized by the planet. What would the ‘true price of …’ be, if the water and bio costs of production were included? We know the amount of water, for example, that is required to produce a hamburger or a pair of jeans. But we do not pay for it in the price of those goods.

If we could account for these costs alongside consideration of capital, labour and technology input costs, we could show that the true price of many goods would be multiples of their existing market prices and would incentivize substitution towards goods whose production places far less demands on our natural ecosystem.

We know the amount of water, for example, that is required to produce a hamburger or a pair of jeans. But we do not pay for it in the price of those goods.

4. Sovereign wealth funds: These funds, which serve the interests of current and future taxpayers, could assume more of the character of sovereign development funds. This could involve a target of, say, 10% of assets devoted to investments designed to impact welfare and support biodiversity and natural ecosystem-asset preservation in the regions from which their investment returns are drawn.

5. Financial industry participants: We can encourage transparency across the financial industry with respect to the TCFD framework, integrated reporting and the ambitions of the UN sustainable development goals.

6. Impact products: We could consider a mutual rating system, like those for accommodation or transport, so that issuers of, and investors in, sustainability-related securities rate each other – a potential protection against green- or rainbow-washing.

This article is part of a series authored by current and former members of the Global Future Council on Investing.