INSIGHT by Jóhanna Wium Pálmarsdóttir. The article was first published by the Nordic Circular Hotspot.
The transition from a linear to a circular business model is gradually getting easier — and the key to that transformation is financing. What is the current state of financing circular economy? What do you need to keep in mind when looking for green funding on capital markets? And how can venture capital act as an engine for environmental, social, and corporate governance?
| Sustainable financing and the circular economy
Sustainable financing is an umbrella term for climate and social impact financing, along with many other specific topics. The circular economy is a subset falling under this umbrella term. Circular economy financing came alive in the 2000s and has been slowly growing ever since. From 2012 onwards, it has been gaining momentum, although the activity is still relatively low in comparison to other sectors of the financing world.
Tomas Zimmermann, the Head of Sustainable Finance Transformation at Swedbank, gave an overview of the current state of sustainable financing at the Nordic Circular Summit 2022 session ‘Financing Circular Business Models’.
>> click to zoom in | Slide from Tomas Zimmermann’s presentation on ‘How to fertilise the ground for more circular economy investments?’
Environmental, social, and corporate governance (ESG) is a framework that can be planted into an organisation’s strategy that takes into account the needs and ways of generating value for all stakeholders of the organisation. ESG is increasingly used by investors during their analysis to identify material risks and growth opportunities. The current market dynamics show that they are shifting towards ESG-aligned debt and equity, driven by the risk-return ratio. This can be seen when the Dow Jones Sustainability Index (which covers a number of equities rated with a strong performance on the ESG) is compared with the Dow Jones Industrial Index. In 2019, the sustainability index started to outperform the industrial one and has continued to do so.
“The current market dynamics show that they are shifting towards ESG-aligned debt and equity, driven by the risk-return ratio.”
A similar pattern can be seen on the debt side. As ESG becomes more relevant for investors and financiers, this drives the supply for it in the market and it has been growing over the last few years. Regardless, ESG-related bonds make up only 2–3% of the total bond market. However, a study shows that in Q2 of 2022, this has continued to grow steadily since the summer. If this growth trend continues on, the share of sustainable finance of the total debt market will most likely rapidly increase, said Tomas.
Another indicator that shows the increased interest and demand for sustainable financing is the number of mentions of sustainability agendas during earning calls with organisations’ management calls across the globe. Earning calls are conference calls where the financial results of a reporting period of a public company are presented by its management team. A study done by Accenture showed that in 2018 around 30% of topics discussed during earning calls were on the sustainability agenda of the company. Another study done by NASDAQ showed that during 80% of earning calls of the 3000 largest organisations in the US, topics around sustainability came up.
| Corporate spending and barriers to scaling financing circular economy
According to Tomas, it is challenging to get a clear picture of how big sustainable financing is, and how much is being invested in the circular economy, from the data that is available — since not all is reported today. The available data show that around 2,5% of total corporate spending is being invested in new circular business models, which is not considered to be a huge share. Another indicator of how much finance is being dedicated to the circular economy is through the green bond standard, where circularity is one of the domains that are eligible for green bond financing. Out of the total green bonds, the circularity domain makes up 4%.
“The available data show that around 2,5% of total corporate spending is being invested in new circular business models.”
>> click to zoom in | Slide from Tomas Zimmermann’s presentation on ‘How to fertilise the ground for more circular economy investments?’
Even though these numbers do not give the total picture of the activities going on within sustainable financing, they give an indication that the circular economy is an emerging theme within finance and within corporations in general. Additionally, according to Tomas’ personal experience working in this field, much is happening and a lot of finances are being put into the circular economy which can not be seen in green bonds or green loans.
But what are the barriers to financing sustainability? Tomas mentioned policy barriers and financial barriers as the two major roadblocks. How we consume, and how we relate to goods, is very focused on business. We need policy actions to set regulations for supporting this transition and give certainties to investors and financiers that sustainable business models are here to stay. If that is not clear, they are too risky. The financial barrier can be summarised as; 9 times out of 10, linear business models are more profitable than circular ones. The circular economy is long-term and about transforming — and that usually requires a large volume of capital.
“We need policy actions to set regulations for supporting this transition and give certainties to investors and financiers that sustainable business models are here to stay. If that is not clear, they are too risky.”
| Capital market funding and circularity
According to Bjarni Herrera Thorisson, one of the Managing Partners of Nordic Circular Hotspot and the COO of Cicero Shade of Green, the role of the financial markets in the circular economy transition is very important. There is a lot of discussion going on, investors are increasingly trying to get more exposure to the circular economy, and it is believed that this trend will continue to grow. Bjarni explained the main things companies need to prepare and keep in mind when making the transition to circularity, and what investors expect in return.
There are a number of important regulations and legislations from a financing circular economy perspective, such as the EU taxonomy and other global examples, according to Bjarni. These regulations need to be kept in mind from the beginning when designing circular economy strategies and projects if the intention is to get funding or go to the capital markets for funding later on. Today, there are many opportunities across sectors, and for all sizes of companies, such as smaller and immature companies.
“Regulations need to be kept in mind from the beginning when designing circular economy strategies and projects if the intention is to get funding or go to the capital markets for funding later on.”
When looking into financing circular economy, a circularity project or transition of a business strategy, companies need to do a thorough internal analysis and answer questions such as what is their product or service and its purpose, said Bjarni. With that in mind, they need to start by thinking about the criteria they need to fulfil. There are numerous technical criteria that need to be met when applying for green financing on the capital market, referring to for example issuing green bonds or going into the stocklist on green indices. These criteria are made to assess both the positive opportunities and also take into account other transitional and physical risks.
| Venture Capital as an engine for ESG
Venture capital (VC) is a type of private equity financing that is supplied by venture capital funds or firms to startups and small emerging companies which are suspected to have high and long-term growth potential. Investors, investment banks, and other financial institutions are the usual sources of venture capital. According to Virginia Vegas, the Director of Startup Norway, venture capital can act as an engine for ESG. The Nordics are deemed to be an emerging VC ecosystem with 60 new first-time funds being launched in the last 4 years, and it is expected that we will see 10–15 new funds being launched every year.
But why do we need more VC funds in the Nordics? According to Virginia, new emerging VC managers cover the funding gaps in the market and are driving the change both in terms of the sustainability topic but also in terms of gender change. In the near future, we will also see more EU regulations on the definition of sustainable funds. In the Nordics, less than 20% of funds are classified as sustainable funds, with 80% of them being first or second-time funds — meaning that in the future the new fund managers will mostly be in sustainable funds.
The lack of women in venture capital has been discussed widely. Overall in the Nordics, 36% of all funds are gender inclusive, meaning they have at least one female General Partner (GP), and only 15% have all-female teams. GP is someone who has investment decision-making power and ownership and rewards in the fund. Most of these women-inclusive funds are emerging funds, and they also happen to be growing sustainable funds. Here we can see an emerging connection.
| ESG accelerator wheel
According to Virginia, if we help more first-time funds to succeed, we will see more sustainable funds and more gender-inclusive or balanced funds, which will lead to more investment into women-led startups (since women are twice more likely to invest in other women), and sustainable startup companies. More capital will lead to more success stories in the sustainability and gender fields, which, in turn, will bring more entrepreneurs, more investors, more funds and more everything. This is the ESG accelerator wheel. We can accelerate the sustainability and green transition by working with emerging VC funds.
“If we help more first-time funds to succeed, we will see more sustainable funds and more gender-inclusive or balanced funds, which will lead to more investment into women-led and sustainable startups.”
>> click to zoom in | Slide from Virginia Vegas’ presentation on ‘Venture Capital as an engine for ESG’.
| Where to begin with financing circular economy?
So, if you are a company embarking on a circular economy adventure, transitioning to a circularity strategy, a startup possessing new circular solutions, or even an investor wanting to invest in the circular economy, we recommend you to do your homework. Try to gain a better understanding of the landscape of sustainable financing, the available and upcoming regulations, standards, markets and, most importantly, your values and goals. It can be a jungle out there, but reading this short introduction to sustainable financing and financing of the circular economy is a great start!
| about
Nordic Circular Hotspot is a network and facilitator that aims to accelerate the transition to a sustainable and circular economy in the Nordics. Circular economy is an economic system that designs out waste and pollution, keeps products and materials in use as long as possible, and regenerates natural systems.
| All opinions expressed are those of the author and/or quoted sources. investESG.eu is an independent and neutral platform dedicated to generating debate around ESG investing topics.
