Holland Circular Hotspot

Financing the Circular Economy

Developing business opportunities, new business models, useful propositions and financial solutions which drive the transition towards the Circular Economy energizes Joost van Dun.

As Circular Economy Lead at ING Sustainable Finance he supports ING’s clients in their transition journey towards the Circular Economy by providing financial solutions. Within ING he is enabling collaboration across business lines and business units, structuring efforts and creating focus on the Circular Economy.

“Every company, even circular companies, has to create viable business models that should be profitable in the long term. And there we see some challenges, as the circular economy has to ‘compete’ with the linear status quo. So, how can we unlock this potential? Why isn’t the development of the circular economy proceeding at a higher pace? Are we as a bank geared to support this transition?” States Joost van Dun in his blog ‘Financing the circular economy’.

Read further to learn more about how he sees the financing of the circular economy!

Disclaimer: Holland Circular Hotspot publishes opinions on CE from a wide range of perspectives in hopes of promoting constructive debate about consequential questions about Circular Economy.

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Financing the Circular Economy

As circular economy lead for ING’s Sustainable Finance team, I have the privilege to work on the further development of the circular economy daily. As we all know, in essence the concept of the circular economy is about rethinking how we use our (scarce) raw materials and resources to create a sustainable economy free of waste and emissions. It’s about retaining value. It means shifting from the current linear model of ‘take, make, waste’ to an economy where we ‘reduce, reuse, recycle’.

And this is much needed. Earth overshoot day – the date every year when the world’s demand for ecological resources and services that year is more than what earth can regenerate in that year – has moved from 11 October in 1990 to 29 July in 2019!

But we can do something about it. The circular economy will bring solutions for this challenge.

What I like about the circular economy is that it is related to sustainability, innovation and economics.

Sustainability
The circular economy plays an important role in solving the problems our planet is currently facing: resource scarcity and global warming. By rethinking how we can optimise the usage of scarce materials, we can lower the amount of raw materials extracted and lower the amount of raw materials being used to produce new products. This will ultimately lead to lower CO2 emissions.

Innovation
Thinking about how we can reuse scarce raw materials means creating new circular business models. This could mean new technologies to substitute virgin materials with recycled or renewable materials; technologies to improve the recyclability of plastics; platforms to facilitate the sharing of assets; or manufacturers who offer their products as a service or in a subscription model, becoming responsible for the product during all phases of the lifecycle (see also my blog on subscription models here).

Economics
The circular economy is about decoupling economic growth from resource consumption. New business models will unlock new opportunities. Several studies have estimated what the size of this business opportunity could be. Although there are multiple estimations that each show different figures, the general consensus is that the circular economy represents a multi-trillion-euro business opportunity. Every company, even circular companies, has to create viable business models that should be profitable in the long term. And there we see some challenges, as the circular economy has to ‘compete’ with the linear status quo.

So, how can we unlock this potential? Why isn’t the development of the circular economy proceeding at a higher pace? Are we as a bank geared to support this transition?

Circular economy isn’t only about sharing or recycling. It’s more. It’s about change. Our clients have to rethink how they design differently, produce differently and sell differently. We as a bank have to value differently, treat risk differently and finance differently.

Let me explain.

 

What makes financing the circular economy different compared to our current way of financing?

1) New business models.
Circular economy and innovation go hand in hand. As we have to rethink how we use our scarce raw materials, we have to reinvent how we design our products, how we can extend their lifetime, how we can make use of recyclable components or renewable materials to replace virgin or non-renewable materials, how we can improve the recyclability, how we can optimise reverse logistics processes, how we can make use of new technologies and much more! Subsequently we see the rise of new business models, such as sharing platforms and products as a service (PaaS).

Each of these business models has its financial challenges. For PaaS models for example, it’s about finding financial solutions for delayed cashflows, balance sheet extension or credit risk assessment of the users of the service.But in general it boils down to a more forward-looking approach where we can’t always rely on historical performance data anymore. So as a bank we have to shift from assessing historical figures to assessing future cashflows. How realistic are the assumptions, how robust are the calculations and the forecasts, is data available to underpin the assumptions and the forecasts, are there identified and committed off-takers? These are the questions we have to focus on.

2) Collaboration.
Circular propositions are not invented behind a desk, by one single person. Creating a circular proposition requires collaboration between several partners in a value chain or with partners from other value chains. The waste or by-product from company A might be input material for company B. Also, when products are offered as a service, multiple parties might be involved in delivering this service. For example, coffee as a service for consumers: you have the company who delivers the coffee machine, the one who is responsible for the maintenance, the one who delivers the coffee(cups), etc.

As a bank we have to make the switch from financing single entities to financing partnerships between several companies while also facilitating a proper risk – reward distribution between the parties involved.

3) Virgin materials vs recycled materials.
In the circular economy we focus on reducing the usage of virgin materials. We want to keep our raw materials in the loop as long as possible. However, using recycled or refurbished materials begins with a ‘rough’ start: you have to take them back first. Depending on the infrastructure in place, there are (high) costs involved. The same applies to further processing of these components. If you compare this with the relatively low prices of virgin materials, you’ll see the business case for using recycled materials may not yet always be in favor of recycled materials, which makes the overall business case also more challenging.

4) Value & Marketplaces.
Retaining value is a key element of the circular economy. However, in our current linear economy we depreciate assets to a certain value or scrap value, while in the circular economy we want to keep products and materials in the loop as long as possible. So we need to rethink our depreciation rules regarding the ‘retaining value’ principle of the circular economy. For a bank, these rules are a basis for financing, but rethinking them is more the domain of accountancy. However, we’re happy to see that accountants’ associations are picking up this challenge!

Related to this is the importance of marketplaces for used materials. To make the circular economy work properly, there should be a demand for and supply of used materials. And when there’s a transaction taking place on such a marketplace platform it’s a) a confirmation of a need for used materials  and b) a ‘confirmation’ of the value, an important determiner to ‘calibrate’ the value.

 

How should we continue?

As a bank, we’re supporting our clients in their transition towards circular business models. We have specific instruments available for them, not only regular loans, but also our ‘green products’ like green loans and green bonds, where the use of proceeds are related to circular economy adapted products, production technologies and processes.  For financing the more challenging (new) circular business models, we are building knowledge in specific project teams. We can rely on our Sustainable Investments team and our Sustainable Structured Finance team to provide risk-bearing capital and specific structuring knowledge.

Circular economy is about collaboration, also for us. As a bank, we cannot finance everything. We have a certain risk appetite, since we are also responsible for our clients’ savings, for example. Financial institutions must also collaborate, such as in combining several sources of funding depending on the risk (seed/venture capital, private equity, banks, institutional investors, public capital). Capital is available for funding, it’s more about deploying the right type – long and short, low- and high-risk – to a specific initiative.

When financing circular business models, we noticed that the market currently lacks guidance on how to uniformly apply circular economy thinking in the process of providing debt and equity finance.

Therefore we took the initiative to publish the Circular Economy Finance Guidelines, together with ABN Amro and Rabobank. With these guidelines we’ve developed a joint framework regarding financing the CE. Because if you’re working with multiple parties, there’s a big advantage to all speaking the same language and using the same definitions! You can find then here.

But we also saw that there are some challenges where circularity has to compete with some linear principles. To make this a more level playing field, we need some help from other parties as well. I already mentioned accountants with regard to rethinking the concept of depreciation related to the ‘retaining value’ principle of the circular economy. But I think the government has a role to play here as well. Besides embedding circularity in their own procurement, acting as the ‘pilot’ customer, providing grants and subsidies, the government could also play a role by rethinking their taxing rules.

In the circular economy we want to keep our materials in the loop as long as possible. This means we also focus on expanding the lifecycle of products by focusing on repairing them (instead of throwing them away), refurbishing or remanufacturing them. By doing this, we keep our products and thus materials longer in the loop and we reduce the pressure on the use of (scarce) raw materials and natural resources.

However, these activities require labour. And labour is expensive, also due to taxes. These taxes on labour are important for governments. In Europe, a bit more than 50% of the government budget is based on labour taxes, while only a very small part of tax revenue is based on for example natural resource use. In the circular economy it’s completely the other way round: more taxes should be raised on the use of natural resources to stimulate the use of non-virgin materials while the tax on labour should be lowered to stimulate repair, refurbishment or remanufacturing!

Once we have a more level playing field for circular business models, it should become easier to scale these activities. And scaling may lead to lower costs for the infrastructure needed to collect and return materials for further processing, more proven technologies to improve recyclability of materials, more repairs, more products offered in a service model and more sharing.

So let’s make it a goal to move earth overshoot day back to August to start with!