The close relationship between sustainable finance and the circular economy

What does circular economy mean in 2022? At this moment in history, caring about circularity is a business opportunity that cannot go unnoticed: the market has always been seen as a major contributor to the climate crisis. Now it is trying to change course by investing increasingly strongly in the circular economy and sustainability.

The circular economy presents a significant potential for the financial sector to fulfil its climate obligations and other ESG goals while also using new and improved development opportunities for long-term wealth generation. We now have the means to combat both climate change and the loss of biodiversity thanks to the circular economy. With a tremendous economic development potential estimated at 1.8 trillion EUR annually in Europe alone, it can scale quickly across sectors to provide value and employment while boosting the robustness of supply chains.

The financial industry has a crucial role to play in tackling the climate catastrophe at a time of exponential expansion in debt and equity instruments associated to the circular economy. In the collective imagination, it has always been perceived as a world that is purely and only motivated by the logic of profit, unconcerned with the detrimental effects of its investments on the climate, and the object of several campaigns by environmentalists.

However, the financial sector is tentatively beginning to realise how much and what opportunities there are: indeed, recent experiences have shown how a circular strategy can create value for asset managers, banks, and other financial services firms. Many investment funds have recently been interested in sustainable finance, which is founded on the concepts of ESG research, as they have come to understand the financial advantages of emphasising the circular economy.

Moreover, considering the global economic crisis related to the COVID-19 pandemic, it is the unanimous view that recovery can, indeed must, be “transformative,” that is, based on the adoption of a sustainable, circular economy-based development model: this momentum can turn into a real opportunity to move away from a linear economic model, which is not sustainable in the long run, and confidently embrace circular solutions in all sectors.

This is why we are starting talking about circular finance, instead of sustainable finance and circular economy as separated fields.

However, circular finance is not risk-free, and one of the more concerning related threats is the so-called “greenwashing”, the cosmetic environmentalism of those who communicate good intentions that they do not intend to pursue in practice, for which the financial field is particularly emblematic. This is a risk that financial and political institutions are also well aware of: for instance, Consob, the independent administrative authority that controls the Italian stock exchange, in 2021 has denounced it in its notebook “Finance for Sustainable Development.”

Specifically, in the most frequent cases of greenwashing, the communication has no timely information or data to support its assertions; information and data are claimed to be certified when in fact they are not recognised by authoritative bodies; individual features of what is communicated are emphasised; information is generic to the point of consumer confusion; false or counterfeit labels may be used; and, finally, untrue environmental claims are made.

H&M, Coca-Cola, Wilkinson, Walmart: these are just a few names of companies that have recently been accused of greenwashing.

On April 6, 2022, the European Commission set out in a draft delegated regulation the regulatory technical standards (“RTS”) to be used by financial market participants when disclosing information related to sustainability, effective January 2023. The new Delegated Regulations specify the content, methodology, and presentation of the information to be disclosed to ensure its quality and comparability. Under the new regulatory technical standards, financial market participants will provide detailed information on how to address and reduce the possible negative impacts their investments may have on the environment and society at large.

What to expect, eventually, for sustainable finance to come soon? With the publication of the Sustainable Finance Roadmap 2022-2024, circulated last February by the European Securities and Markets Authority (ESMA), areas of intervention and actions to be taken to coordinate a development, legal and consistent ESG markets within the states of the Union, are put on paper.

The purpose of the plan is twofold; on the one hand, to ensure timely interventions by ESMA, which is tasked with protecting investors and ensuring balance within the ESG market, and on the other hand, to measure ESMA’s own progress and, where necessary, adjust priorities for intervention in light of developments in new and old ESG market phenomena.

With these kinds of initiatives, the European Union is striving for a climate-neutral Europe by 2050.