Money makes the world go circular: how the finance industry will promote the transition to a Circular Economy
“Circular Economy” is a term increasingly used – but increasingly misunderstood. The Ellen MacArthur Foundation has developed a definition, but what is important to specify is that it goes beyond merely recycling and renewable energy towards deep systems change all the way along the value chain.
In a circular world, non-renewable resource-use is minimised, material is safe and non-toxic, waste is eliminated, and natural systems are regenerated. There is an increasing collection of resources and research on this topic. However, one essential topic is only just coming into the spotlight: how do we finance a circular economy?
Investing in a Circular Economy
A circular economy requires several alterations to product designs, regulatory incentives, and behaviour. But one evolution of critical importance is the investment of capital to redirect business practices and make the circular economy a viable one.
“Circular Economy Finance” is still very much in its nascent stages. Across 2019 to 2021, just 40 bonds issued had a circular-economy focus. By 2021, only 9% of Impact Fund managers targeted circular economy as a theme. In 2019, the European Investment Bank launched an initiative to target EUR 10 billion of investments into the Circular Economy over the next five years.
Whilst this is a strong step in the right direction, it is still insignificant compared to the EUR 1.8 trillion annual benefits that moving towards a circular economy could yield in Europe alone by 2030, resulting from scaling across industries, creation of jobs, increasing resilience of supply chains, and delivering massive economic growth potential. Not only does this represent a significant financial benefit, but also has the potential to reduce greenhouse gas emissions by 39% by 2050 compared to 2019 levels, which puts the world on track to meet the 1.5-degree pathway.
Setting up your business for a Circular Economy
Moving to a Circular Economy requires businesses to narrow, slow, close and regenerate material and energy flows (see this article for more information). These new business models in turn require new methods of financing, new risk assessments, and new allocations of value. Financiers must open their eyes to truly recognise what minimisation of risk to maximise return signifies, with due consideration for the sustainability (and circular) transition.
Supporting companies that are successfully developing circular opportunities and avoiding those that present “linear risks” (like “stranded assets” such as coal plants when considering the energy transition) will become the new paradigm.
For instance, product-as-a-service is a business model with circular principles. It slows loops by keeping products in use for longer due to more durable designs, improved maintenance, and repairs. It closes loops by using products again once its useful life to one consumer is over and ensures the return of materials at end-of-life for recycling.
These models have different cash-flow profiles and balance sheets to traditional “transfer of ownership” models. Value must be sought in the assets, the stability of the contracts and the residual value of products over the long-term, rather than the immediate revenues, margins, and liquidity.
The Future for a Circular Economy
A shift in mindset must occur where material is seen as inherently valuable rather than an endless resource, collaboration is cherished, and one person’s trash is viewed as another’s treasure. Innovation and creativity can be applied to tweak and transform the current array of financial products to cater to circular business models.
Financial institutions can use factoring, circularity-linked loans and bonds (for more information on sustainability-linked loans, check out our blog), equity and debt hybrid facilities, leasing arrangements, supply chain financing, new risk and pricing models, and several other enabling products to support the circular transition. Financial tools and frameworks can formalise the circular economy via measurement, KPIs, approval processes and reporting.
Bridging the gap between circularity and finance
Embracing circular economy principles in finance holds the key to a sustainable future. Financial institutions can catalyze this shift by supporting businesses with circular models. Investing in technologies that facilitate waste reduction and recycling, they play a pivotal role in advancing the circular agenda.
Mitigating environmental risks, circular practices align with robust risk management strategies. Financing circular supply chains and adopting circular metrics ensure a comprehensive approach. Staying abreast of regulatory changes and collaborating across sectors foster a supportive ecosystem.
Consumer finance can drive change by promoting circular choices. Tailoring financial instruments for circular initiatives, such as green bonds or circular-focused investment funds, attracts capital to sustainable projects. This integration not only meets rising demands for responsible finance but also contributes to global sustainability goals. Bridging circularity and finance signifies not just an economic evolution but a commitment to a resilient and regenerative future.
Any questions?
At Sustainable Capital Group, we understand the complexities of a Circular Economy and EU regulations in sustainable finance, and our sector experts are here to assist you. For personalised guidance, simply fill out our contact form, and we’ll be in touch with you shortly.
