Circular economy transition must accelerate to meet sustainability targets

Circular economy

Circular economy transition is being held back by market uncertainties, a lack of standard regulation and the high cost of investment.

Circular economy targets are a vital building block for achieving the Paris Climate Agreement, Sustainable Development Goals and EU Taxonomy for sustainable activities which must be applied by financial institutions starting in 2023.

New research from Frankfurt School of Finance and Management show how financial instruments can help overcome major challenges hindering the transition, and how development cooperation could contribute to closing the financing gap for the circular economy in low- and middle-income countries.

Substantial economic benefits are emerging from the circular economy which has gone largely unexplored, the report found. For instance, the Circularity Gap Report 2021 estimates the additional economic output for circular businesses to be USD 4.5 trillion by 2030. However, only 8.6 percent of the global economy is currently described as circular.

The barriers stopping governments and firms from transitioning to the circular economy are complex, say the authors. A number of barriers trigger financial market imperfections, including large upfront costs, a lack of available blending instruments, market uncertainties, political uncertainty, and insufficient regulatory environments.

All of these barriers can lead to market imperfections, which halt circular transition by causing unpriced positive and negative consequences of the investment, such as societal costs, imperfect capital markets, lack of information for private actors, and other market distortions such as corruption. In essence, the return on a circular economy investment is always connected to an environmental, social and, in the end, developmental return on investment, which is hardly addressed in the current dominating “take-make-dispose” economy.

“Prevailing linear production and consumption practices lead to an immense waste of resources, pollution, loss of natural ecosystems and biodiversity,” said Michael König, project manager at Frankfurt School – UNEP Collaborating Centre for Climate & Sustainable Energy Finance. “The core principle of the circular economy stands in opposition to the linear economy, and now, more than ever, it is increasingly important, not only from an environmental but a financial perspective, to make the transition to this circular economy.”

The demand for financial products facilitating green and circular projects has risen sharply in recent years. Though there are many barriers to entry, a sustainable and circular finance practices can transition to a circular economy, including resource efficiency by focussing on value preservation and keeping product cycle at the highest value possible.

The researchers also studied a number of industries and the specific barriers they are facing in terms of transitioning to the circular economy. The study offers specific approaches to overcome these challenges, including the development of circular procurement policies, extended producer responsibilities (EPR) regulations, life-cycle costing approaches, or eco-Special Economic Zones.

Additionally, the authors used the example of five low- and middle-income countries – Albania, the Dominican Republic, Colombia, Rwanda, and Vietnam – to show to what extent established and innovative financing mechanisms such as sustainability-linked bonds, circular credit-lines, or product and financial leasing can be used more intensively. With the obtained results the authors derived recommendations for the German development cooperation. The study was published at the UN environment conference, Stockholm +50, in June 2022.

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