1. Quantifying the natural capital risk exposure of financial institutions in brazil
Presentation of the joint study
Dr Richard Mattison, CEO
Trucost Plc
December 2014

2. Contents Introduction to Trucost Importance of this study
What is natural capital and how to we account for it?
Why is this relevant for Brazilian financial institutions in particular?
What are the drivers for internalising environmental costs and why is it a risk now?
Key findings of the report
Case study
Integrating natural capital analysis in equity analysis
Recommendations

3. About Trucost
Trucost helps investors to understand the economic consequences of natural capital dependency in order to identify risk and opportunity from growing natural resource pressures and environmental costs.

4. Importance of this study
Some drivers take a long time to materialize and require government intervention but there are other mechanisms by which external costs can be rapidly internalised by economies, companies, investors.
This study is a first step to demonstrate how natural capital accounting can be used to analyse companies, portfolios and loans.
Investors and banks will need to apply the approach to their own investments in order to quantify the risks.
Risk teams need to anticipate these material issues, first quantifying risks to investments and then financing.
A recent example is the 2014 drought in the south-east of Brazil - the worst drought in 80 years - which affected approximately 70 municipalities in Sao Paulo state alone. Estimated losses just to the agribusiness sector in the region have already reached R$30,000m. (Estadao, 2014)

5. What is natural capital and how do we account for it?

6. NATURAL CAPITAL

7. NATURAL CAPITAL ACCOUNTING
Costs per tonne

8. $2.2tn >50% WHAT IS THE SCALE?
Environmental damage caused by world’s largest 3,000 companies
Link to report:
According to Trucost analysis, Global Environmental Impacts are valued $6.6tr or 11% of global GDP – 18% more than the combined losses of OECD pension funds by the end of 2008 as a consequence of the Global Financial Crisis (see for reference statistics)
The top 3000 listed companies and their supply chains are responsible for a third of that or $2.2tr. If these companies had to pay for their pollution and use of ecosystems this would amount to greater than 50% of their profit.
>50%
Proportion of company earnings that could be at risk from environmental costs

9. VALUING NATURAL CAPITAL HELPS US TO:
DETERMINE IMPACT MATERIALITY
ASSESS ENVIRONMENTAL TRADE-OFFS
UNDERSTAND REGIONAL RISK DIFFERENCES
INTEGRATE THE RESULTS WITH BUSINESS METRICS
COMMUNICATE THE RESULTS TO A GENERAL AUDIENCE
LCAs are great
Life cycle thinking is a holistic and systematic way to address environmental performance. It enables companies to…

10. TRENDS IN NATURAL CAPITAL ACCOUNTING
LEADERSHIP INITIATIVES
INVESTORS
SOVEREIGN
NGOs
CORPORATIONS
MULTI-STAKEHOLDER GROUPS

11. Why is this relevant for Brazilian financial institutions in particular?

12. LACK OF A FRAMEWORK FOR TAKING ACCOUNT OF NATURAL CAPITAL RISK
Relevance for Brazilian financial institutions
Economic reliance on natural capital
Agriculture accounted for 22% of Brazil’s GDP in 2012
Demand and supply side pressures
Rapidly growing population
Strengthening legislation
Potential compliance or litigation costs
Equity investments
28% of PF assets invested in equities - high exposure to companies facing natural capital costs
The economy is predicted to continue to grow strongly, but this growth is dependent on these industries continuing to thrive, fueled by natural capital as the engine of the Brazilian economy.
Deforestation not only depletes natural capital, it also exacerbates the stresses on it through climate change. Even though Brazil has low levels of carbon emissions per capita, if the emissions relating to deforestation are taken into account, the country is one of the largest carbon emitters (UNDP ).
Corporate bonds
Internalising costs could lead companies to default
Corporate lending
Food and bev = largest sector for lending and highly dependent on natural capital
LACK OF A FRAMEWORK FOR TAKING ACCOUNT OF NATURAL CAPITAL RISK

13. What are the drivers for internalising environmental costs and why is it a risk now?

14. Factors that internalise an externality

15. why is internalisation a risk now?
Changing demographic
Public awareness
Increasing regulation/voluntary commitments
Market dynamics
Stakeholder action
Climate risks
Resource depletion
Population and wealth growth are increasing negative externalities (such as pollution and ecosystem damage) due to higher consumption patterns
Digital connectivity is spreading information widely and rapidly, therefore our understanding of corporate externalities is growing
Offering financial incentives for companies to increase positive externalities or imposing fines for corporate negative externalities
Resource pressures and market disruption are creating new risks and opportunities
Actions of NGOs, communities and other stakeholders are becoming from frequent and impactful
Risks includes adaptation and mitigations risks from factors such as global warming leading to shifting production zones and disruption to roads and transport infrastructure caused by changing weather patterns and extreme weather events. This may require major investment in irrigation, flood defences or new land.
Risk from resources on which a company depends being depleted or degraded so the asset base is eroding or input costs are likely to increase. This is particularly likely to affect the agricultural commodities and forestry sectors.

16. Key findings from the report

17. Key findings from the report
Unpriced natural capital costs of companies could be as much as R$1,646bn
Banks are most exposed through financing of cattle ranching, fishing, food and beverages and agriculture
Pension funds are most exposed through investments in food and beverage companies
The natural capital risk exposure of financial institutions can vary significantly

18. Key findings from the report
The sectors cattle ranching, soya bean farming, crude petroleum and natural gas extraction have the highest natural capital costs
The highest natural capital intensity sectors (unpriced natural capital costs per R$m of production) include cattle ranching, fats & oil refining, aquaculture, cotton farming, sugarcane farming and cement manufacturing
The North of the country has the highest land use conversion cost because it is principally made up of Amazon rainforest
There is a marked difference in the natural capital impacts of soy production in the two principal production zones

19. Credit exposure of two banks

20. NATURAL CAPITAL RISK BY INDICATOR AND NCEx RATIO

21. Natural capital cost - direct and supply chain - and natural capital intensity per sector (WITH AND WITHOUT CATTLE RANCHING)

22. Environmental impact analysis by sector

23. GHG and water impacts through the supply chain

24. REGIONAL COMPARISON

25. Case Study

26. Beef cattle ranching in brazil
Cattle ranching is responsible for 75% of the deforestation in Brazil
This study estimates the total natural capital costs from this sector alone to be R$2,629,205m

27. Regional differences

28. Risk matrix

29. Integrating natural capital analysis in equity analysis

30. INTEGRATING NATURAL CAPITAL IN FUNDAMENTAL EQUITY VALUATION

31. Recommendations

32. FINANCIAL INSTITUTION
OPPORTUNITIES
VALUATION
PROJECT DELIVERY
BUSINESS OPTIMISATION
REVENUE GROWTH
New client services
Low carbon business opportunities
Environmental trading
Low carbon client solutions
ESG asset management
Green retail banking products
Resource efficiency
Partnership opportunities
RISK REDUCTION
Natural capital exposure
Climate volatility
Policy risks
Insurance costs
Resource cost volatility
Client resilience
Mega trends
FINANCIAL INSTITUTION
Julie
REPUTATION
Stakeholder pressure
Peer ranking
Talent retention
Branding and image

33. Recommendations Quantify portfolio-level natural capital exposure
Identify drivers for cost internalization
Demand better data from companies
Consider the potential future natural capital risk that a company may face
Capitalise on changing market demand for more sustainable goods and services
Help customers transition to a more resource efficient and sustainable business model
They can use the data in this report about the natural capital intensities of key sectors and regions to map their investments and identify hotspots within their portfolios which require further assessment.
Looking at scale, speed and strength of drivers for each individual investment under different scenarios
Investors can use their position to demand better data from companies, either through management engagement as an equity investor or in the due diligence process for a corporate lender.
because this can impact on the current valuation of an investment
These companies should be more insulated from their sector’s risks and could deliver better returns.
This could be in the form of project finance, working capital solutions or advisory services for customers operating in or exposed to natural resource sectors. In so doing, investors can be central to supporting the transformation to a more sustainable and financially resilient economy.

34. Questions