We know what to do and have the means – and we have the money

Sustainable finance can put circular economy on high speed

Circular economy means a paradigm shift from linear economy to a closed-loop circular economy. This entails new business models and innovations, new ways of producing and using the goods. All this transformation needs money, both private and public investments in R&D for new innovation and emerging technologies, and for new business models.

The next Sustainable Finance Strategy could be the answer.

260 billion euros are needed annually in the EU by the end of this decade in order to reach climate and energy targets. A common misconception is that this will require drastic additional investments.

On the contrary, tools, resources and money already exists. Total assets under management in Europe in 2019 were estimated at 23 trillion euros. The global assets under management are around 90 trillion dollars.

Corona recovery measures in the EU and Member States reached 3 trillion euros within just a few months, even before the planned Recovery Package and Commission’s proposal for Recovery Instrument, Next Generation EU.

In this perspective, the annual 260 billion seems rather achievable. Moreover, sustainable transition makes financial and economic sense.

Overall, the Global Commission on the Economy and Climate has estimated that climate action in broad stands a chance to deliver over 26 trillion dollars in economic benefits and to generate more than 65 million new jobs by 2030. The return on investment in carbon neutral and circular technologies and infrastructure is estimated to be multifold, over 7 trillion dollars by 2030.

The transition to low-carbon and circular growth model is therefore an economic opportunity. Investments in sustainable projects and activities make economic sense.

At the same time, it is becoming clear that sustainability risks have a financial impact on assets. By 2100, expected financial losses could amount to over 4 trillion dollars in present value terms, according to a study conducted by Economist Intelligence Unit in 2015.

A 6°C scenario could put 13.8 trillion dollars at risk, threatening 15 percent of global assets under management, and therefore posing a risk to the financial system as a whole. More recent studies hint that the systemic risk might put in risk a third of the financial markets.

In order to integrate sustainability risks and impact within investment decisions and portfolios, or for public authorities to decide on large-scale projects or public procurement tenders, there is a need for a robust toolbox to assess risks and to measure impact.

The newly adopted EU Taxonomy is a revolutionary step towards correcting the way financial sector and the real economy can price in environmental externalities. The sign-off of the landmark regulation in June puts the EU in the forefront of global sustainable finance agenda.

The EU Sustainable Finance taxonomy, a classification system, will to help determine the sustainability of an investment and an economic activity.

The first EU standards under Taxonomy regarding climate mitigation and adaptation will be published at the end of this year and will apply as of 2022. Further environmental indicators will be developed by the end of 2021, regarding biodiversity and circular economy among others.

Taxonomy represents the third and last piece of the first sustainable finance legislation presented in May 2018 by the previous Commission. Together with the Disclosure Regulation and the Regulation on Climate Transition and Paris-Aligned Benchmarks, the EU Taxonomy will provide transparent and comparable information on environmental impact and risks, helping channel investments into more sustainable projects.

Disclosure rules for institutional investors and financial intermediaries came into force at the end of last year. First technical standards are underway and as of spring 2021 will soon oblige large financial institutions employing 500 persons or more to disclosure the environmental impact of their activities to the end investor. Smaller entities will need to either follow the same course or provide an explanation why such disclosure is not provided.

This is a significant step towards transparency that will incentivise financial institutions towards a change. By correcting the current incentives of market actors, we can shift financial flows from environmentally harmful activities to activities that support the needed transition.  Greening the financial sector is becoming an urgency in order to make investment decisions that affect years and generations to come.

What is needed is comparable sustainability data based on robust standards built on harmonised sustainability indicators that measure key aspects of sustainability of an economic activity, measured using a common methodology.

While the relevance of each indicator varies from one industry and sector to another, the core environmental calculation system should consist of measuring key aspects of production, consumption and resource efficiency: use of resources, water consumption, direct and indirect land use, emissions including CO2 emissions, production and treatment of waste, and the impact of an activity on biodiversity.

Such environmental accounting already exists and is used by various institutions, including the Eurostat, the European Environmental Agency, OECED and the World Bank. The key is to translate the environmental language to financial and vice versa and to build a common, unified metrics.

The next step in the upcoming Sustainable Finance strategy should be the development of integrated reporting and accounting standards that equip different stakeholders, from corporates planning investments in the real economy to financial intermediaries making investment decisions or managing assets on behalf of asset owners, to end investors, public authorities and the civil society, with tools to make informed decisions regarding where money is spent.

As we prepare for an unforeseen economic recovery following the Covid19 crisis, tools for assessing the environmental impact of an investment and public spending are today needed more urgently than ever was thinkable when the EU taxonomy proposal was first proposed.

It is a necessity to ensure that these trillions are directed to a recovery that is sustainable in the long term. No euro should be spent on unsustainable economic activity or businesses. Otherwise we will be leaving to future generations both public and climate debt.

The Recovery Plan after the Corona pandemic and the upcoming follow up to the EU Sustainable Finance Strategy are an opportunity to speed up the necessary transition into a sustainable economy.

Paradoxically, Covid19 and the recovery financing can be a virtue in the vice. Circular economy and sustainable finance – a match made in heaven.

Sirpa Pietikäinen
Member of European Parliament

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