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PA OPINION

Winning with the circular economy

The pressure on financial services organisations to become more sustainable is growing. The public now expects business to both be sustainable and support sustainability. Investors have recognised the opportunity for increased returns from environmental, social and governance (ESG) best practice. Governments, central banks and regulators are putting pressure on companies to act. And employees are looking for meaning in their work, with purpose becoming a vital part of how employers attract and retain talent.

The drivers of sustainability go beyond these external factors, however. According to the Business & Sustainable Development Commission, achieving the UN Sustainable Development Goals (SDGs) could unlock an estimated $12 trillion of market opportunities.1 Sustainability isn’t only about doing good, it’s good for business. The SDGs are a collection of 17 goals and 162 targets that cover climate change, biodiversity, health and wellbeing, and gender equality. They can be thought of as statements of what the world needs by 2030. Yet the UN estimates there’s a $2.5 to $3 trillion annual financing gap to deliver the SDGs.

To achieve these goals requires not just money but ingenious solutions, re-thinking how to preserve and create value. Financial institutions need to respond to the demands of both their corporate and consumer clients by re-evaluating their current products and services to incorporate sustainability, as well as creating new ones to leverage this emerging economic paradigm.

Banks are taking advantage of Circular Economic thinking

Circular Economic thinking is gaining traction as the way to achieve many of the SDGs as it aims to increase economic productivity while decreasing carbon emissions by recovering value from waste. The financial sector needs to understand and assess these circular business models and strategies to select the right clients and projects to finance.

So far, much of the activity has centred around the capital markets, both debt and equity. On the debt side, green bonds have been wildly successful, with more demand than supply.2 Danone issued a €300 million social bond using International CMA Social Bond Principles, setting a standard for others to follow.3 And Nasdaq launched a global green, social and sustainability bond platform to improve transparency in the sustainable bond market.4

On the equity side, sustainable investing has reached $30 trillion in 2018, with the proportion of sustainable investing relative to total managed assets over 50 per cent in Europe, Australia and Canada.5 Asset managers are grappling with how to best incorporate sustainability objectives, with many investments using relatively simple techniques such as negative screening and ESG integration. More complex strategies, such as impact and themed investing, are still nascent, although BNP Paribas and BlackRock both launched Circular Economy targeted funds in 2019.

Project finance is another obvious opportunity for banks. Citibank has committed to finance and facilitate $100 billion, over 10 years, towards environmental solutions and activities that reduce the impact of climate change. While Intesa San Paola created a €5 billion Circular Economy credit facility to support businesses adopting circular models.

Similarly, lease financing is becoming a foundational product to support circular business models. For equipment and consumer goods, trends that move ownership from consumers to producers and incentivise preserving value and providing a service, rather than serial sales, are supporting the move to circularity.

On the consumer side, Ålandsbanken was a pioneer in the Nordics.6 In 2016, they launched a biodegradable credit card and partnered with the World Wildlife Fund to show customers their carbon footprint and easily make offsets. In 2019, Nordea launched green mortgages and car loans, as well as a CO2 footprint calculator in their mobile wallet.7 And Netherlands FinTech challenger bunq is planting a tree for every €100 its customers spend on their green debit card.8

“The most advanced financial institutions aren’t just being opportunistic with sustainable services and products, they’re systematically starting to embed sustainability throughout their organisation.”

Embedding sustainability

The maturity of sustainable thinking in the financial sector is still in the early stages and the potential opportunities are still largely untapped. Today, banks are on a journey to identify where they can best create value within the Circular Economy, defining breakthrough sustainability strategies, developing sustainable products and services, and delivering sustainable organisations. They’re also adjusting credit and risk models to cater for sustainability and a circular approach, mitigating the risk of a linear bias in models.

The most advanced financial institutions aren’t just being opportunistic with sustainable services and products, they’re systematically starting to embed sustainability throughout their organisations. This means working from the top, with strategy, to create supporting governance structures that ensure the right balance between innovation and control. Also important is identifying and prioritising geographies and business areas to target with sustainable solutions. Like any transformational exercise, moving to sustainability requires a case for change, a group of stakeholders and evangelists, defined goals and quick wins, all embedded into systems, incentives and ways of working at every level of the organisation.

Regulations incentivising change

Regulations are both incentivising and forcing change. Arguably one of the most important is the EU regulation requiring listed companies to disclose ESG factors, which came into force in 2018. With an increasing foundation of data, it’s possible to measure, value and evaluate sustainability. Building on this, the EU has proposed a variety of regulations pushing a sustainability agenda. For example, Institutions for Occupational Retirement Provision (IORP) II says pension schemes should disclose how they consider ESG factors in investment.

And a proposed amendment to IORP II would force pension providers to integrate and assess all sustainability risks and disclose how they consider adverse impacts. And in the UK, the regulators have been extremely vocal about wanting financial institutions to assess and respond to climate-related risks.

Financial institutions must incorporate climate risk into governance, risk management, scenario analysis and disclosure, and start to consider how they assess, measure, track and disclose sustainability risks. As more data becomes available, the regulatory pressure will increase, so forward looking institutions have the opportunity to get ahead of the game while providing their clients and other stakeholders with more transparency.

Financial solutions for circular business models

As businesses move to the Circular Economy, banks need to be ready to assess the value and risks of these new business models. One potential change is the close cooperation between several suppliers and partners, which may require different ways of looking at credit, market and legal risk. The financial sector is heavily regulated when dealing with third-parties and outsourcing. This means efficient structures and controls need to be in place to ensure compliance when new partnerships and eco-systems are established, as well as for the ongoing monitoring of such relationships. Banks can also help to find creative financial solutions that leverage the value of embedded assets, such as funding the future value of refurbished materials in buildings at the end of life.

The demands of sustainability are a challenge and opportunity for financial institutions. Bringing sustainability into the strategy of banks can help make them more attractive to employees. Innovating products and services can differentiate banks and create value for their increasingly circular clients. Putting systems in place to measure and track sustainability will allow financial institutions to follow increasing regulatory demands. And transparency throughout all these processes will create shareholder value.

By quickly responding to the needs of their stakeholders – be it customers, investors, employees or regulators – financial institutions will be well positioned as our linear world turns circular.

  1. http://report.businesscommission.org/report
  2. https://www.pionline.com/esg/demand-green-bonds-crimped-lack-supply
  3. https://www.danone.com/content/dam/danone-corp/danone-com/investors/en-social-bond/2018/socialbond/Danone_2018_Social_Bond_Reporting.pdf
  4. https://www.nasdaq.com/articles/nasdaq-sustainable-bond-network-builds-a-framework-for-a-sustainable-future-2019-12-10
  5. http://www.gsi-alliance.org/wp-content/uploads/2019/03/GSIR_Review2018.3.28.pdf
  6. https://www.alandsbanken.fi/sv/nyheter/alandsbanken-foerst-i-vaerlden-med-miljoevaenligt-betalkort-med-vilket-du-kan-maeta-din-miljoepaverkan
  7. https://www.nordea.com/en/press-and-news/news-and-press-releases/news-group/looking-back-at-green-year-en.html
  8. https://www.finextra.com/newsarticle/35195/bunq-customer-spending-in-two-months-sees-40000-trees-planted

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