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REDD+ and the Green Economy; pricing economic risk

Quantifying environmental risks in monetary terms may be necessary to convince the majority of corporations to reduce their dependency and impacts on the environment.

Reducing Emissions from Deforestation and Forest Degradation (REDD+) is a mechanism being defined by Parties to the United Nations Convention on Climate Change (UNFCCC), and which is on track to become part of global climate agreement.

Over the past few years I’ve visited numerous corporate sustainability conferences around themes such as water, REDD+, climate change and biodiversity. The same corporate leaders are often present at such meetings — Coca Cola, Unilever, Akzo Nobel and Rabobank. These and other leaders regularly top indices such as the Dow Jones Sustainability Index (DJSI), which measure the environmental, social and economic sustainability of their direct business operations and increasingly, also indirect impacts through their supply chains. But what about their sector peers?

The challenge

There are around 45,000 listed, publicly owned companies globally and an unknown number of privately owned companies. The DJSI World Index includes 309 best-in-class companies out of a total sample of 2,500 largest in the S&P Global Broad Market Index. Other data and index providers typically track around 3,000 companies, which mean that only 5 to 6 percent of all listed companies are being tracked on their environmental and social performance, and that less than 1 percent can be considered "best-in-class" in terms of their environmental and social performance. This shows a need to track the 80 to 90 percent of listed companies (notwithstanding the countless privately owned small and medium enterprises).

But why do some companies take environmental issues seriously, but the majority don’t? The reasons differ within and between private sectors, but can include pressure of non-governmental organizations, shifting consumer preferences for sustainably sourced products, investor demand and stricter environmental and social regulatory requirements by governments around disclosure, procurement and certification.

To date it has proved to be difficult to calculate the efforts, or lack of efforts, that companies are conducting to reduce their environmental impact and dependency in monetary terms. But — apart from government regulation — developing methods that directly price corporate environmental risks in terms of higher or lower costs or earnings may be a major way to convince the larger majority to follow suit.

Pricing environmental risk: What does that mean?

Many companies directly or indirectly either depend on environmental services such as water, fish and timber or affect the environment through deforestation, greenhouse gas emissions, water and air pollution. Corporate environmental risks are related to the probability of any of these impacts or dependencies to affect standard financial metrics such as EBIT (Earnings Before Interest and Tax) and costs.

Ultimately, the value of a company — whether publicly listed or privately owned — should be adjusted for the financially material environmental risk in Profit & Loss (P&L) statements, corporate balance sheets and in the share price. This could and should be in positive and negative sense in order to stimulate innovation.

Is pricing a panacea?

No. Tropical deforestation and forest degradation, depletion of fishing stocks and degradation of coral reefs are serious environmental concerns but it may be too technically difficult in some cases to price the risks for companies affected by it, or it may turn out that the risks are not significantly material for a company to adjust its business model. At the same time, building models to price climate change risks through "carbon budgets" for fossil fuel companies what CarbonTracker and Bloomberg (PDF) are doing or have done, or pricing water risk for corporate bonds or public equities what the NCD, GIZ and Bloomberg are working on, eventually may stimulate or convince a greater number of companies to reduce environmental impacts and dependencies.

This article originally appeared on the United Nations Environment Programme's REDD website. 

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