‘Money makes the world go round’, the new report on financing the circular economy, gives directions for overcoming financial barriers that circular businesses encounter. Answers lie in collaboration in the value chain and creating financial instruments to invest in a chain or network of businesses rather than in a single business. This way, risks and rewards can be shared and the incentive arises to collaborate with the aim of creating a circular chain in which all participants earn a piece of the pie.
PGGM took the lead in organizing the working group FinanCE, consisting of PGGM, Intesa SanPaolo, Rabobank, ING, ABN AMRO, EIB, EBRD, Circularity Capital, RSM Erasmus University, Ellen MacArthur Foundation, KPMG Luxembourg, Banking Environment Initiative of Cambridge, Circle Economy and Sustainable Finance Lab.
The FinanCE working group was founded in order to understand the implications of the circular economy on business models and corresponding financing of circular business. The motivation behind this is the need for funding of circular business in order to take off and accelerate the transition. The report identifies opportunities for financial institutions to learn how to recognize and to invest in the winners of the future. The most important opportunities are
- increased profitability through higher asset utilization,
- risk mitigating potential of circular businesses and
- long-term relationships that increase margin stability
As part of Nederland Circulair! the researchers from Sustainable Finance Lab and Circle Economy conducted various case studies in order to understand the financial barriers that various circular businesses face. The circular economy consists of a number of new business models, which they found to be easily categorized into three categories:
- Circular Innovation Models focus on the developing phase. Products and materials are designed to make them long-lived and-/or easy to maintain, repair, upgrade, refurbish, remanufacture or recycle.
- Circular Use Models focus on the use phase by optimally using the product and its added value. These business models make it possible to retain ownership of the product (e.g. by servicing a product rather than selling it) and/or take responsibility of the product-lifetime (e.g through maintenance services, or add-ons to extend the lifetime of a product).
- Circular Output Models focus on the output and its added value after the use phase. In these business models revenue is generated through transforming waste into products or useful resources.
All business model categories have their own financial consequences. The report specifically addresses financing issues in Circular Use Models, in which the earning model consists of retaining ownership of the products and selling the service of using them. The issues that were found concern the need for increased working capital (i.e. buying machines with a longer pay back period), which challenges cash flow-based financing. Additionally, contract-based financing becomes very important with these shifts in ownership and responsibility. What makes these business models different from already existing product-service-systems is the shift in underlying products (for example low capital (non-) consumables) and B2C markets. Consequently, there exists a need for financial solutions and ready to use product-as-a-service contracts for low capital products and B2C markets. Moreover, predicting the success of this new product-market combination is difficult, meaning the risks for investors are unclear and therefore perceived as high.
Sustainable Finance Lab and Circle Economy believe this report is just the beginning. Now that the challenges are clear, the aim is to make those first circular deals by creating the necessary conditions and financial- and legal structures to invest in circular business and chain collaboration. Support by a more diverse financial landscape is crucial and can be increased reinventing equity- and debt instruments and by including innovative financial technologies (blockchain, peer-to-peer lending, crowdfunding platforms etc.). We believe it is time to pave the way by designing financial structures that elevate long-term thinking and chain cooperation.
The full report can be read/downloaded here.