How to finance the transition to a circular economy

Recovery from the coronavirus crisis could provide an opportunity to accelerate the transition to an inclusive circular economy but more finance is needed.

Patrick Schröder and Eilis Lawlor, 19 July 2021

Eti Mine Works, where lithium will be produced from boron sources

Transitioning to a circular economy is becoming an increasingly urgent issue for governments, businesses and society at large, not only to deal with the ever-growing mountains of waste – such as the plastic pollution crisis of our oceans – but also to ensure a reliable supply of many critical materials, including lithium, cobalt and rare-earth metals, all of which are required for key technologies to mitigate climate change.

Financial institutions, too, are increasingly seeing the circular economy as a strategy for sustainable development as they face growing pressure from the public, as well as from shareholders, to act on climate change.

The finance sector has gradually been adopting circular economy approaches through different private financial mechanisms over the last two years. These include circular economy-themed ‘green bonds’, and other financial instruments, as well as the use by investment fund managers of the circular economy as an approach to thematic investing.

Our research assesses the current government and corporate investment landscape

In an analysis of these developments in circular economy finance as part of an ongoing Chatham House project, Building Transformative Alliances for an Inclusive Global Circular Economy, we have assessed the current investment landscape.

We have calculated estimates of the current value of government and corporate spending on circular economy initiatives in selected sectors and in value chains with high material intensity and have also outlined emerging circular economy business models and how these relate to developments in financial products and services.

The circular economy and SDG financing

Our research also examines international development finance with particular emphasis on overseas development assistance (ODA) spending in the context of the Sustainable Development Goals (SDGs). This all is important in demonstrating how the circular economy can be financed.

Previous research has shown that the circular economy can contribute to achieving several of the SDGs including SDG 12 on responsible consumption and production, SDG 14 on life below water, SDG 15 on life on land and more.

However, the SDGs most directly associated with the circular economy are currently severely underfunded with financial support being mainly limited to waste management and recycling projects.

For the circular economy to make more substantial contributions to the realization of the SDGs, there must be a significant increase in financing for higher-value circular economy opportunities across value chains and support of scaling up circular business models.

New developments in financial instruments and other tools to finance the circular economy could provide opportunities to contribute to the SDGs through specific circular economy solutions across a range of different sectors including textiles, plastics, packaging, renewable energy, water and sanitation, electronics, automobiles and food and drink.

Policy instruments are key

Our research confirms that policy instruments are key to incentivizing financial investments for circular economic development. Instruments – such as blended finance and investment guarantees – that support public–private collaboration and financing of the circular economy offer a wider range of possibilities to scale up circular economy investments.

But our findings are both encouraging and sobering. Despite recent growth, circular economy spending remains small in comparison to other green finance and other spending in the current linear economy.

Indeed, existing levels of spending are too low to drive a global circular economy transition at scale and, so far, economic stimulus packages being rolled out in response to the COVID-19 pandemic have predominantly been allocated to support the linear economic system rather than investing in transformation towards a sustainable economy.

Recovery from the coronavirus crisis could provide an opportunity to accelerate a ‘just transition’ to an inclusive circular economy but financing it will require financial institutions to internalize both the principles of a circular economy and of a just transition into their operational processes. More work needs to be done to scale-up finance and move hopes of realizing a a just circular economy forward.