|
|
|
|---|
|
Government
|
636
|
|
Government (less stimulus)
|
510
|
|
Corporate
|
858
|
|
Finance
|
46
|
|
Total
|
1,540
|
|
Total (less stimulus)
|
1,414
|
Source: Lawlor and Spratt (2021), Circular investment.
Although it is not meaningful to compare circular with linear economy spending in every sector, it can be useful to put these figures into context. Global government spending in 2019 was about $13 trillion, suggesting that 4 per cent of government spending is circular (rising to 5 per cent when stimulus spending is included, based on an annual estimate). The value of spending by the corporate sectors included in the calculation is about $35 trillion annually, suggesting that the circular economy’s share of this is only about 3 per cent each year. The finance sector is more difficult to compare, as annual investments are not a meaningful metric. However, to put the above circular economy estimate in context, the total value of financial assets managed by the 500 largest asset managers alone was more than $100 trillion in 2019.
Investors are becoming aware of the high levels of risk inherent in unsustainable supply chains and the requirement that organizations tackle those risks effectively. The growth in both public initiatives and corporate spending on circular initiatives in key sectors, and in circular economy funds in the finance industry, are indications that the circular economy is here to stay. However, investment levels in the circular economy are still well below where they would need to be to deliver real change.
The growth in both public initiatives and corporate spending on circular initiatives in key sectors, and in circular economy funds in the finance industry, are indications that the circular economy is here to stay.
Two key challenges for financiers are, first, that linear risks are not priced properly into risk models, and second, that the positive impact created by circular business models is not rewarded. In addition, a lack of – and widespread unfamiliarity with – circular economy data continues to constitute a major barrier that has limited the implementation of strategies to promote the circular economy and the scaling-up of financing for circular business models and pilots. Financial risk models are based on historical track records, and when no such track record is available, it is more or less up to the risk managers themselves to estimate the risk. Risk committees of financial institutions generally lack sufficient experience to assess circular economy datasets. The connection to the whole value chain also introduces new data requirements on subscription volumes, balance sheet extension, inputs, outputs and the origin of virgin or secondary resources, that can often not be fulfilled.
Addressing the lack of standardized and comparable data and metrics is therefore one of the key challenges for the finance sector, especially when it comes to assessing the risk/return ratio for circular economy financing that is geared towards SMEs and start-ups.
Making an economy-wide move from a linear to a circular economy would require significant shifts in investments in key sectors such as electronics, construction, food and agriculture, textiles and garments, automotive and plastics. Linear sectors of the economy will also likely need to apply the ‘reduce’ principle of the 9Rs and shrink to change the composition of the economy towards a model based on higher degrees of circularity, with reduced material throughput. Companies that launch circular economy initiatives and business models that aim to slow down or reduce material throughput still encounter many financial, organizational, operational and legal barriers. The structure of finance and the role of accounting must change in order to accelerate the circular economy transition. While it is beyond the scope of this paper, accounting is the primary tool that defines a company’s value, and consequently defines the main rules governing investment decisions, activities and financial management. Without normative accounting rules that include natural and social capital, most financial and economic decisions will never effectively improve global public goods. It is necessary to broaden the traditionally narrow scope of financial accounting frameworks to capture non-monetary values.
The authors make the following recommendations to accelerate the shift to a circular economy, facilitated through finance and investments:
- Turning regulatory pressure into commercial opportunity. In the short term, policymakers and regulators need to ‘nudge’ the finance sector towards circularity through clear policy directions. Policy instruments such as circular economy roadmaps, EPR initiatives and tax reforms provide the necessary policy signals to the finance sector. Long-term institutional investors will then be able to build effective coalitions and investment vehicles to accelerate the transition to a circular economy. While the early adopters of circular economy finance are primarily based in Europe, major players in North America and Asia are beginning to adopt the concept and principles into their lending and investment criteria. Leadership in finance that champions the integration of circular economy principles into a long-term value creation strategy will be crucial. Those companies and investors that are able to acknowledge and study circular economy-related regulatory pressures, and convert these pressures into investment strategies, will monetize their obligatory compliance costs into increased commercial activity.
- Incorporating ‘linear’ risks into financial decision-making. This includes thoroughly analysing the long-term risks of linear investments and developing incentive-compatible solutions to counter short-termism on investment decisions. Additional evaluation metrics will be needed to account for and reduce the risk of stranded assets linked to linear sectors. Adoption of the existing EU taxonomy for sustainable finance, which establishes a common classification system for sustainable business models, will be an increasingly important reference point for investors. Initiatives such as EU Ecolabel for retail financial products can guide investors to identify the right investment products. Also, ongoing government initiatives such as the UK’s Green Taxonomy provide an opportunity to create binding and commonly adopted financial standards and guidelines for circular economy investments.
- Leveraging circular economy finance to support SDG implementation. Circular economy finance can make a contribution to achieving a range of SDG targets, but development finance needs to catch up. Several existing private finance mechanisms have already started to include circular economy finance and could potentially be adapted to fit the international development context. The circular economy can provide an opportunity for actors to collaborate closely to ‘build back better’ in the context of international development finance. Coordination among DFIs will be critical to make circular economy finance work towards the SDGs. Intergovernmental bodies, like the Technology Facilitation Mechanism of the Addis Ababa Action Agenda and the Inter-agency Task Force on Financing for Development, that provide global frameworks for development financing are in a good position to advance investment for the SDGs, and, in turn, investment for the circular economy. While ODA alone will not be sufficient, public finance can play an important role in de-risking private sector investment in circular economy businesses. Instruments such as loan guarantees, risk insurance and blended finance will be crucial to de-risk circular economy finance in developing countries and markets.
- Building back better through investments in the circular economy. Multilateral platforms and partnerships – such as Global Alliance on Resource Efficiency and Circular Economy (GACERE) – can be used to leverage private investment for circular economy solutions, especially across priority value chains such as electronics, textiles and garments, plastics packaging, batteries, and food and agriculture. Supporting suppliers and SMEs in these value chains will be crucial to achieve more circular outcomes. Initiatives such as the G7 Build Back Better World (B3W), which aims to leverage billions for infrastructure investments in low- and middle-income countries, will need to have circularity principles built into investment decisions. Similarly, the G20’s Infrastructure Working Group (IWG) has identified sustainable infrastructure and circular economy as one of its priorities and will need to develop appropriate financing instruments.
- Financing a just circular economy transition. Financial institutions need to internalize both the circular economy and the principles of just transition into their operational processes. Questions for investors engaging with companies in the just transition include how to mitigate risks and create opportunities for consumers, employees and workers along the value chain, as well as managing risks for communities affected by changes in economic composition and industrial restructuring over the short, medium and long term. Furthermore, it will be crucial to establish links between governments, donors and investors to ensure the necessary technical cooperation in this emerging area of development finance becomes available.
Finally, based on the findings from the research paper, we identified a set of research questions that require answers in order to move the circular economy forward.
- As interest in circular economy finance and investments continues to grow, how does one ensure that circular economy finance is aligned with achieving the objectives of an inclusive, regenerative circular economy?
- What needs to be done to prevent ‘circularity washing’ by the financial industry?
- What role will the EU taxonomy play for circular economy finance and investments? How can wider uptake of the framework beyond the EU be facilitated?
- How will finance be integrated into and benchmarked against achieving national or supranational resource consumption reduction targets, and the UN’s SDG targets in the wider sustainable development context?
- In the context of the energy transition, new technologies such as batteries, fuel cells and renewable energy technology will continue to shift the future material volumes within the circular economy. How will finance volumes follow these changes?
- What types of innovation/reform of the financial system are needed to finance circular economy solutions that achieve absolute reductions in waste and resource consumption for developed countries, and relative decoupling for low- and middle-income countries?
- Looking beyond investment opportunities, what are the costs of the circular economy transition, and how will the transition be financed to ensure socially equitable outcomes?
- Can all ‘linear finance’ become circular, or will it be necessary to shrink the overall size of finance and investments? What would be the strategies and approaches for achieving this?
- What learning can we apply from the climate finance journey, e.g. disinvestments from fossil fuels? How would disinvestment strategies from business models of planned obsolescence be managed?
