To meet the goals of the Paris Agreement and address the biodiversity crisis, the flow of global investment needs to be rapidly redirected from unsustainable to sustainable economic activities. Yet it remains difficult for governments, investors and businesses to determine what a green economic activity is.
One of the key strategies for reducing environmental pressures, the circular economy, is one of the toughest nuts for sustainable finance to crack. This dialogue series explores different challenges of defining ‘sustainable’ and ‘circular’ with emerging regulation in the European Union (EU) and UK as case studies. Recordings from past events are available, upon registration, on Conference+.
Dialogue 1, held on the 16 September 2021, focused on green finance taxonomies which provides a transparent and common language framework of sustainable economic activities to help guide investors, business and public sector alike. The recording for this event is available on Conference+.
Dialogue 2 was held on 23 February 2022 provided an update on global developments in corporate sustainability reporting and the role of circular economy therein.
Dialogue 3 is being held on the 5 October 2022 and will explore how the taxonomy will work in practice. How are market players reacting to the taxonomy, what support do they need and does the taxonomy need to be extended to have a wider impact?
Finance is an essential enabler for the transition to a net zero and circular economy but investment in sustainable economic activities remains far below the necessary level.
Out of $14.6 trillion of COVID-19 recovery spending by 50 leading economies in 2020, only $368 billion was directed to green activities.
Green financial taxonomies offer a promising tool to redirect the flow of capital by providing a common classification system for activities, assets, and projects that deliver on climate, social and sustainable objectives.
A common classification system also creates security for investors, protects against ‘greenwashing’, helps companies become more climate-friendly, and mitigates market fragmentation.
Several countries including China, Bangladesh and South Africa have developed green finance taxonomies while others are in the process of developing their own, including the UK and EU.
However, concerns have been raised that country or region-specific taxonomies could hinder a global green transition due to varying methodologies, structures, and localized technical screening criteria (TSCs).
Circular economy and green taxonomies
There are clear challenges in efforts to apply the circular economy to taxonomies.
First, unlike pollution control, the circular economy does not yet have clear metrics with which to develop TSCs. In many cases it is difficult to determine which activity results in greater ‘circularity’.
Second, achieving circularity requires the transformation of the entire economy and should therefore cut across all sectors and activities. However, the EU taxonomy only defines “circular” for a small set of sectors, with criteria that only the most ambitious companies and investors can attain. Unless the taxonomy describes circular transition activities for the wider economy, and it is complemented with strong industrial policy, it risks becoming irrelevant to most market players.
Third, unlike climate change, there is no overarching legal requirement for states or market players to achieve circularity, nor even a legal definition of the circular economy.
Fourth, the Chatham House report on financing an inclusive circular economy highlights that circular economy solutions are rare and remain severely underfunded.
Corporate sustainability reporting
The accelerating climate and biodiversity crises mean there are growing demands on companies for transparent reporting on sustainability-related impacts and risks.
Companies are expected to disclose information on ever more environmental risks and impacts against new sustainability definitions (taxonomies), while conducting rigorous environmental due diligence on their suppliers. With sustainable finance regulations evolving rapidly, several of these reporting elements are moving from voluntary approaches to mandatory requirements.
Whilst there is a push for international harmonization (such as via the newly formed ISSB for sustainability disclosures), requirements in different markets will inevitably diverge. The EU’s Corporate Sustainability Reporting Directive (CSRD) and the UK’s Sustainability Disclosure Requirements (SDR) are two major frameworks under development, but questions remain regarding their potential alignment.
Circular economy reporting
In parallel to sustainable finance developments, the circular economy is also increasingly recognized as an essential strategy to build resilience against growing environmental and economic risks.
Circular economy holds the potential to provide companies with an overarching framework for reducing resource-mediated environmental risks and impacts, but the concept is only starting to make its way into mainstream standards and regulation.
More and more companies are embracing circular economy reporting tools and standards, such as GRI’s updated 306: Waste standard, WBCSD’s Circular Transition Indicators, and the Ellen MacArthur Foundations Circulytics. However, there remains a significant capacity gap among businesses to meaningfully monitor and report on circularity.