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Insights from accounting and financial markets

The term natural capital accounting has become a hot topic in recent years, and we are very excited to see it being rolled out in many different circumstances, countries and sectors. Here, we step back to reflect on the purpose of accounting and refocus the contribution that natural capital accounts can make to global environmental challenges by drawing some analogies with the operation of financial markets.

No doubt most of our readers saw the massive crash in financial markets after information was released on the likely ramifications of the COVID pandemic. Financial markets update their expectations about company profitability based on information they receive in press releases, government reports etc. Financial accounts and reports provide an opportunity for the market to validate and update their expectations and make comparative assessments across companies, sectors, and countries. The numbers underpinning financial reports are independently verified and provide a degree of assurance for markets in what is otherwise a tempest of information. Thus, accounting provides part of the total set of available information to financial markets. This information is fundamental to the operation and allocation of resources.

If we shift our focus to sustainability and embedding natural capital into markets, then one of the most important roles of accounting must be to generate information that enables sustainable investment decisions to be made. What are the characteristics of the information needed to make sustainable investment decisions? As with financial information, it needs to be coherent across stocks and flows (and across environmental, social and economic themes in the new world), it needs to be comparable across businesses and it needs to be expressed using a common language that people understand.

With these requirements in mind, to make today’s markets congruous with the challenges of today, the uptake of a globally agreed and recognised approach to accounting for natural capital is required. Current disclosures on sustainability are many and varied and we risk corporations gaming the sustainability agenda, commonly referred to as green washing. Indeed, we need to learn from the development path taken by financial accounting which took a long time to move to standardization and hence reduce the scope for management ‘to regard accounting statements as tactical or strategic weapons . . . instead of intelligence reports for the world at large’ (Edey, 1977: 303).

In comparison to the leisurely pace that financial accounting standards were developed and implemented, we must act quickly to standardise environmental accounting, measurement and reporting as our needs are far more pressing, and the potential impacts may be irreversible. A movement towards greater standardization will remove one of the possible barriers to efficient operation of markets embedded with natural capital. By eliminating the variation of each company’s environmental disclosures, it will become more feasible to use reported company profits and sustainability as a means of assessing relative performance.

Some of our readers may question the analogies we make to financial markets here, for some believe that markets are the reason we are in this mess in the first place. While we acknowledge that markets are not perfect, we see that markets can be an ally for the sustainability movement provided there are sound and agreed accounting conventions and practices for natural capital at the heart of the information published by companies and governments.