Integrating the circular economy into a taxonomy presents unique challenges compared with other environmental objectives. The taxonomy’s overall structure, its ease of use and the wider policy landscape must all be considered.
This chapter presents a series of lessons and considerations drawn from the EU’s process of integrating the circular economy within its Sustainable Finance Taxonomy. These considerations are divided into three main themes:
(i) architecture; (ii) usability; and (iii) the enabling policy environment.
3.1 Architecture
The structure of a taxonomy plays a critical role in its success. Given the cross-cutting nature of the circular economy, the integration of circularity across a taxonomy’s architecture remains one of the biggest challenges.
3.1.1 Setting the ambition level
The EU circular economy objective is highly ambitious, aiming to decouple economic growth from extraction of non-renewable resources and to reverse depletion of the stock of renewable resources by 2030. However, there are considerable procedural and political challenges to realizing those ambitions – including some that are unique to the circular economy transition.
Lack of international agreements on circular economy
The ambition level of an environmental objective should ideally be based on binding international agreements. For example, the climate mitigation objective in the EU Taxonomy is based on the goals and targets of the Paris Agreement, which is an international agreement with standardized approaches to measuring and reporting on progress.
However, to date, no multilateral or regional binding agreement exists on either global resource use or the transition to a circular economy with which to align ambitions with. Rather, the global transition is becoming increasingly fragmented, with each individual country pursuing its own unique version with little alignment or harmonization.
The difficulty of benchmarking the circular economy objective against legal targets or international agreements increases the ambiguity of the ambition, making it more difficult to develop clear and objective TSC. For example, in linking the ambition to EU-specific targets, it becomes increasingly challenging to ensure harmonization with other non-EU taxonomies, which may hold different levels of ambition.
Questions also remain about the precise terminology to be used when setting a circular economy ambition, given the lack of international agreement in that area. For example, the EU ambition is that ‘economic growth is decoupled from extraction of non-renewable resources’. Yet, there is much ambiguity surround the term ‘decoupling’. Does it refer to achieving absolute or relative decoupling, in terms of scale? Does it mean local (i.e. within the EU) or global decoupling? Is that decoupling permanent or temporary? Such nuances in terminology and interpretation can result in significant differences in levels of ambition and scope, and therefore need to be strictly defined.
Another challenge is that the targets outlined in the EU Taxonomy’s circular economy ambition – such as reducing the EU’s material footprint by 50 per cent by 2030 – will not be achieved by the Taxonomy alone. Rather, hitting those targets requires the introduction of ambitious legislative measures that would likely go well beyond the current measures outlined in the CEAP 2.0. Another challenge that has received little attention is the fact that achieving such an ambition in the EU requires the simultaneous transformation of global value chains, thereby requiring multilateral coordination and collaboration on capacity-building and technology transfer between governments and industry.
Cross-cutting nature of the circular economy
As mentioned above, achieving circularity requires the transformation of entire value chains. Therefore, circularity cuts across all sectors and geographical regions. Yet, by nature, a taxonomy is structured on the atomization of individual economic activities – which, in some cases, can limit efforts to encourage more transformational developments over multiple activities or along value chains.
The cross-boundary nature of global value chains means that it will be necessary to achieve a certain level of harmonization or mutual recognition between all taxonomies.
A circular economy also involves new economic activities not traditionally classified under existing codes. As such, there have been calls to move towards a more systemic approach which allows for value chain-wide transformation, rather than activity-based action. But how such an approach could practically be structured has yet to be articulated. The cross-boundary nature of global value chains means that it will also be necessary to achieve a certain level of harmonization or mutual recognition between all taxonomies – an example being the Common Ground Taxonomy pilot between the EU and China. Harmonization between taxonomies would be made easier through mutual recognition of circular economy policies and legislation.
3.1.2 Developing TSC
There are two areas for consideration when developing TSC to determine substantial contribution to a circular economy: (i) the development of science-based consumption targets; and (ii) accounting for circular hierarchy.
Embedding science-based targets for circularity in legislation
Unlike climate mitigation or pollution control, which have definitive and objective metrics and legal requirements for measuring and comparing activities (such as gCO₂ or biological oxygen demand levels), the circular economy does not yet have such clear metrics from which to develop TSC. In fact, the EU Technical Working Group identified that ‘[the circular economy]… is the most challenging environmental objective because it is a relative new concept in scientific literature.’
A lack of robust metrics makes it difficult to determine which economic activity results in greater ‘circularity’ than another. Given that substantial contribution to the circular economy cannot be simply measured through one metric, current TSC in the EU Taxonomy incorporate a range of different criteria (as outlined in Section 2.2.2). Such diversity in substantial contribution could ‘lead to inconsistencies when monitoring transition plans and evaluating the share of economic activities aligned with the Taxonomy.’ This lack of objective metrics also means there is no easy way to assess whether the cumulative benefits derived from each TSC amount to realizing the overall objective ambition. It also makes the processes of ensuring TSC compliance difficult.
To maintain the claim that the EU Taxonomy represents a science-based approach, additional effort is required to systematically and scientifically evaluate whether the changes resulting from the TSC align with the ambition. This necessitates the development of new approaches to disclosure and reporting at the business level, as well as macroeconomic modelling and evaluation of material flows underpinned by robust and harmonized standards.
Accounting for the hierarchical nature of circularity
In its current form, the structure of the EU’s circular economy objective and its respective TSC do not easily allow for adequate embedding of the waste hierarchy principles (to reduce, then reuse, then repair, remanufacture or refurbish, and finally recycle). For example, several circular economy TSC outline that ‘the activity would need to satisfy only one of these options (x, y, z) to be deemed to be making a SC [substantial contribution]’. This would encourage an organization to aim to meet only one of the criteria options, when the greatest impact would be achieved via a combination of activities along the value chain that would need to be coordinated and synchronized.
Take the economic category ‘wearing apparel’ as an example. Currently, it is recommended that to meet substantial contribution for wearing apparel, organizations would only need to comply with criteria for one of the following four activities:
- Design and manufacturing of new apparel;
- Repair or refurbishment of apparel;
- Design and implementation of a business model that extends lifespan in practice; or
- Sale of second-hand apparel.
Yet, it is logical for the design of new apparel (1) to be driven by the extent to which repair or refurbishment (2) is prioritized, or by the business model that extends lifespan in practice (3). Hence, if organizations only aim for minimum compliance with one of the above criteria, rather than being incentivized to address them holistically, suboptimal circular solutions could emerge.
To achieve the ambition of the circular economy objective, organizations must be better incentivized to ‘race to the top’ of the waste hierarchy – i.e. towards activities that offer greater material and energy efficiency gains and reduced environmental impacts – while maintaining a systems perspective. If companies are not sufficiently incentivized, there is a risk that companies will be encouraged to align with less transformative activities at the bottom of the waste hierarchy (such as recycling) to maintain the status of substantial contribution with minimum effort. Companies investing significantly in infrastructure and other assets with which to align with these lower-level activities may also risk being locked in to a situation whereby it becomes increasingly difficult and costly to move up the hierarchy. However, it is not reasonable to expect companies in most cases to be able to reach the top of the hierarchy immediately. As such, incentives for progression may be considered through a transition lens.
An alternative challenge is the potential for trade-offs between numerous TSC and the need for companies to navigate these in their value chains. For example, by manufacturing a smartphone to be easily dismantled for upgrading or repair, a company may conversely reduce the item’s durability by abandoning the use of glues to maintain water resistance and shock absorbance.
3.1.3 Do no significant harm
As outlined above, DNSH is a critical safety net component in the EU Taxonomy. However, in their current proposed format, many DNSH criteria for the circular economy within the Taxonomy are inconsistent and opaque.
In 2022, the European Environmental Bureau (EEB) undertook a detailed review of the DSNH criteria for the transition to the circular economy in the adopted Delegated Act on climate mitigation and adaptation, as well as in the draft Complementary Delegated Act on gas and nuclear energy. The study found current DNSH for circular economy to be inadequate in terms of clarity and ambition, thereby risking significant harm to the circular economy in pursuit of other environmental objectives. It should be noted that the PSF proposed much more complete DNSH criteria in their recommendations, but these were often not adopted by the Commission in the Delegated Acts.
