Introduction
Investing with a long-term perspective requires an understanding of what systematic changes we may see in the future, and making educated guesses about when they may occur. The climate crisis is already here and the urgency to reach net zero carbon emissions and limit global warming to 1.5°C has never been greater. Countries across the globe are experiencing the consequences as weather extremes and disasters are becoming more frequent due to climate change. Within only the first 10 months of 2022 costs associated with climate change-related weather disasters like Hurricanes Ian and Fiona, flooding in Pakistan, South Africa, and Australia, and droughts in Europe, Brazil, and China, reached nearly $40 billion dollars, and damages in many places will take years to repair1. Models and predictions of what the climate and weather of a warmer world will look like are frequently seen in the media, but the extent of changes we must make in our economies to avoid worst-case scenarios is less straightforward. The 1987 WCED Bruntland Report2 defines sustainable development as, “…development that meets the needs of the present without compromising the ability of future generations to meet their own needs”, and while the term has become much more nuanced and comprehensive over the years this definition still serves as a foundation for understanding sustainable development. In 2015 global goals for sustainable development were set to help achieve long-term sustainable development3. To limit climate change we will need to live sustainably, achieve a fossil-free system, and stop our extractive and wasteful habits which have led to us exceeding the planetary boundaries4,5. To live within these boundaries, we must use fewer resources, and use what we do have with consideration and care. Sustainable living through circularity will be built on new kinds of business models and innovative approaches to complex and multifaceted challenges. As investors, we will need to re-frame our ideas about cost and waste, and what growth means, and be prepared to approach evaluations with a fresh mindset.
Circularity, Sustainability and the Sustainable Development Goals
Increasing human impact on biodiversity, water, and climate means we must fundamentally change the way we think about resources and the impact our behaviors have on the planet. The concept of planetary boundaries, which was first developed by Rockström et al. (2009)5 describes “quantitative planetary boundaries within which humanity can continue to develop and thrive for generations to come… Crossing these boundaries increases the risk of generating large-scale abrupt or irreversible environmental changes”
93% of the materials in today’s economy are wasted, lost, or unavailable for reuse.9 We already consume more resources than the planet can sustainably provide, and we are aware that the transition to renewable and green energy sources will require significant amounts of primary resources which will inevitably come at an ecological cost. How can we make the necessary green transition to limit warming without further violating the planetary boundaries? This is where sustainability and circular economy come in.
A circular economy (CE) is perceived as a sustainable economic system where economic growth is decoupled from the resources used by reducing and recirculating resources and materials10. CE activity can reduce resource consumption by focusing on efficiency, value-retention processes, and waste minimization and in so doing drive changes in production patterns and/or consumer behavior11. However, CE alone is not enough to achieve living within the planetary boundaries and often does not encompass the social aspects of sustainability. The transition from a linear economy where only 7.2% of our resources are cycled back into the economy at the end of their useful life9 to a CE where we think about circularity from the get-go should, therefore, help us build a more sustainable world that is in line with planetary boundaries. It's important to note that CE and sustainability are separate concepts, but CE can be a valuable tool in transitioning towards a more sustainable society12.
Circular Economy Basics
The concept of a circular economy(CE) is based on three main elements: designing out waste and pollution, circulating materials at their highest value level for as long as possible, and regenerating natural systems10.
In a CE system, every step in a product,material, or service is approached with the goal of designing in circularity and designing out waste (Figure 2). This involves changing how we view raw materials and resources, and what we see as the lifespan of a material or product and ensuring that waste and pollution are minimized throughout the entire product life cycle. To capture value includes ensuring that a product is easily refurbished, can be broken down into components that can be returned to the original manufacturer, repaired, and reused even if the original product is not serviceable – a process known as re-manufacturing.
Done well, a circular design could mean that the phone you own is created with zero waste and pollution, can be easily repaired and remade, and that after an extended high-value lifespan in the use economy, the components could be fully recycled without loss of materials. Today, we can see some circular economy principles enacted by companies like Patagonia and Adidas. Patagonia embraces circular design by offering lifetime repair of its products and offering a trade-in program which reduces the need for new resources. Similarly, in 2021, Adidas launched its Futurecraft Loop shoe which exemplifies designing out waste and pollution by being entirely recyclable. The shoe is made from a single material, TPU, eliminating the need for glue and making it easy to break down and reuse all its components. Even the stitching is done with TPU thread to ensure full recyclability. Adidas aims to create a closed-loop system where it collects the shoes from consumers, grinds them into pellets, and uses those pellets to create new shoes. This reduces waste and pollution, promotes continuous reuse of products, and minimizes the environmental impact of production.
The third element of CE, regenerating natural systems, encompasses both the biological and technical cycles. In their natural contexts, biological materials are recovered, captured, and returned to their basic components to maintain system health. For instance, when leaves and trees fall in a forest, they decompose and become organic material that enriches the soil. The nutrients in the soil are then utilized by bacteria, plants, animals, and new trees during their own life cycles. However, the materials we use, such as food, plants, wood, and organic materials like cotton and linen, are often grown in one place, transported to another, used or wasted, and then discarded. As a result, the biological component does not usually return to its place of origin, leading to a transfer of nutrients away from the places where resources are needed. This necessitates replenishing the soil with chemical fertilizers to maintain soil productivity and drives transgression of the biogeochemical planetary boundaries6,8. To reduce the use of chemical fertilizers, we must ensure that biological materials are returned to biological systems instead of being treated as waste. Additionally, regeneration involves adopting agricultural practices that naturally rebuild soils and increase biodiversity.
Investing in the regeneration of natural systems can feel like a very long-term perspective for venture capitalists, but it is likely to pay off. For years, industries like agriculture, forestry, and textiles have competed mainly on cost and price in commoditized markets. However, as climate change increasingly affects these industries, the costs of production become less predictable, making it imperative for companies to adopt sustainable practices and mitigate their impact on the environment if they wish to ensure future production. At the same time, environmentally conscious consumers are growing in number, and are looking for truly sustainable products. Companies can adopt regenerative practices by changing their procurement process to prioritize sustainable materials, proactively seeking partnerships, and committing to longer-term sourcing commitments. The current decade presents a critical opportunity for companies to embrace regenerative practices and shape the market to their advantage, and in doing so, promote a more sustainable future for all.
How Circular Economy and Sustainability fit together
The Sustainable Development Goals (SDGs) provide a framework for addressing key environmental, social, and economic challenges3. They were set by world leaders in 2015 as a global roadmap toward achieving long-term sustainable development by 2030. A circular economy (CE) will be crucial to achieving several SDGs, including SDG 6 (Clean Water and Sanitation), SDG 7 (Affordable and Clean Energy), SDG 8 (Decent Work and Economic Growth), SDG 12 (Responsible Consumption and Production), and SDG15 (Life on Land).
The connection between CE and these particular SDGs lies primarily in reducing resource extraction and limiting the use of new primary resources. However, even in cases where the link between CE and the SDGs is less clear, there is still potential for CE to mitigate negative effects where two SDGs require trade-offs. For example, SDG 8 aims for economic growth and SDG 9 promotes industrialization and infrastructure, while SDG 13 focuses on climate protection and SDG 15 on biodiversity. By adopting a CE mindset when approaching goals 8 and 9, we can also make progress toward achieving goals 13 and 15. Schröder et al. (2018)13 highlight the importance of addressing trade-offs among different SDGs to ensure a comprehensive and sustainable approach toward achieving the SDGs.
While pursuing a circular economy can bring numerous benefits, we must also be mindful of potential negative impacts that could undermine progress toward achieving Sustainable Development Goals. Without addressing the social component of the SDGs, a CE could in a worst-case scenario contribute to existing inequalities and impede progress towards targets such as safe working environments, human health, and access to employment. We must ensure that our sustainability efforts do not perpetuate power imbalances, inequalities, or injustices, as has been the case with some past environmental actions14.
Investors and innovators must consider these concepts on a broader scale than the end user of a product or service. This requires a shift of focus from individual purchases to entire value chains and the long-term impacts of practices like downcycling and burden shifting. By taking a holistic approach and considering the social, economic, and environmental impacts, it is easier to ensure that pursuing a circular economy aligns with the SDGs and helps build a more sustainable future. In the European context, the EU Taxonomy has made CE thinking a priority for all.
EU Taxonomy
In 2020, the EU approved the European Green Deal, setting policy initiatives to make the EU climate neutral by 205015. One important aspect of this plan is the EU Taxonomy, a classification system of environmentally sustainable economic activities. By creating a common language and criteria for assessing sustainability and making comparisons more transparent, it aims to reduce greenwashing and help investors make greener choices.
The framework defines the concept of sustainability and provides rules for when a company can claim that is operating sustainably. There are six EU environmental objectives: climate change mitigation, climate change adaptation, sustainable use and protection of water and marine resources, transition to a circular economy, pollution prevention and control, and the protection and restoration of biodiversity and ecosystems. To meet the criteria for operating sustainably a company must contribute to at least one objective and also not negatively impact the other objectives, meet minimum safe guards to prevent negative social impacts (i.e., UN Guiding Principles on Business and Human Rights), and comply with technical screening criteria developed but the EU Technical Expert Group. By providing clear definitions and principles, the EU Taxonomy is expected to promote better investment opportunities for companies with greener sustainability profiles and lower environmental risks associated with their practices and technologies. As a result, the EU Taxonomy has the potential to accelerate the transition to a more sustainable economy, as envisioned by the European Green Deal.
CE and Investment Decisions
Investors should consider incorporating the circular economy into their investment strategies, even if they are not focused solely on impact or climate tech-related investments. The EU Taxonomy will require that companies operating sustainably do not negatively impact the transition to a circular economy, and it is likely that more national and global policy initiatives are likely to follow suit. Regulation, technical advances, and what consumers want are increasingly shifting to greener and more circular practices even when CE is not an explicit goal. The circular economy transition extends beyond specific sectors, such as recycling or agriculture, and involves almost all industries and value chains on a global scale. Recognizing that industries with traditionally large environmental footprints also have the possibility to make the most rapid and impactful transitions can provide the basis for prime opportunities in investment and growth. These industries will benefit greatly from new and innovative approaches and new thinking regarding solving problems and bridging the gap to a circular economy. Investment in these sectors can help address environmental, social, and climate-related risks associated with linear economy practices, so building CE thinking into all processes will prepare alignment for sustainability and climate outcomes. Early adopters of CE-focused strategy will be better placed for the opportunities on offer and take a position in a growing green market.
Crunching the numbers
To begin to approach circularity as an aspect in consideration for investing having the background of what and how CE functions is fundamental, but then comes the challenge of enacting circularity in practice. Circularity measurement indices are used to determine the circularity degree of a system by analyzing the main properties of the system, such as the proportion of recirculated materials in a product while considering both biological and technological aspects. Measuring the circularity of the inflow would entail specifying the proportion of renewable (non-first use) content in each material component of a specific product, and the outflow would look at what amount of the material would be recyclable, considering the actual recycling rate of the material (not what is possible under ideal conditions, but what is likely). This concept maybe applied to water and energy use and builds on the idea of Material Flow Analysis which looks at the state and changes of each material flow of a system by the calculation of mass balances over time within a defined space. This tool was first applied to cities metabolisms and pollutants research in specific regions in the 70s and has been applied in many other fields over the last decades16. Flows are measured in terms of their mass which gives information on the number of materials used, but not about the quality of the material (e.g. down cycled plastic) or the scarcity of the material resources. To better understand the contribution of circular strategies to the principles of CE, circularity assessment metrics may be used17. There are many to choose between, and they can be focused on the environmental or economic impacts of the circular strategy rather than the circularity of a specific product, service, or system. Many ways of measuring circularity are possible depending on what the product, process, or service is, and so developing an idea of which metrics would be relevant is needed before embarking on potentially costly data collection. Tools like the Global Reporting Initiative for waste reporting (GRI 306), Material Circularity Indicator (MCI), and self-assessment frameworks like Circular Transition Indicators (CTI) are useful places to start. Ultimately, embracing circular strategies is not only about reducing the environmental impact but also about innovative approaches and creating a sustainable and resilient economy. As such, determining the relevant metrics for measuring circularity is crucial for businesses to succeed in the long term, and requires an approach that considers end-to-end impacts and how smart resource use can help future-proof investments.
Conclusion
Being prepared for big changes to the Take-Make-Waste economy is less about being an activist and more about pragmatic long-term thinking. The climate tech sector represents more than 25% of every venture dollar invested in 202218. The transition to a circular economy will require significant changes to the way businesses operate and the products and services they provide. Leaders in sectors like renewables and electric vehicles have proven that investing far before cost parity is achieved can lead to success. As we have seen, circular economy principles are increasingly being incorporated into policy and regulation at both national and international levels. Investors, in particular, will need to take note of these changes and incorporate circular thinking into their investment strategies to ensure long-term sustainability and profitability. Despite less favorable economic conditions, the climate tech sector has seen significant growth in recent years demonstrating the interest and potential for investments in the sector. As demand for green materials is set to outpace supply this decade, companies must strategically invest in innovative ideas that can solve real problems through circular economy approaches. Finally, we must be prepared to adapt to a green economy in the long term. In the past, the market had more room for a green premium on sustainable products but as consumers become more aware and the transition to circular, green, and sustainable practices goes from being the exception to being the norm these premiums will no longer be supported. To invest in green products and services, companies must rethink their strategies and adapt to a new market environment, creating a sustainable future. By addressing environmental, social, and climate-related risks associated with linear economy practices investment from venture capital can help position innovative new solutions for success in a growing green market. Clearly, the circular economy is a loop we cannot afford to be left out of.
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