Circular Economy Taxonomy: Why we need to speak the same language

There is a myriad of barriers to the circular economy transition which present themselves in different ways depending from which perspective being viewed. But one cross-cutting theme is the apparent lack of a common definition, common criteria, and common metrics.

The story of the Babel Tower told us how joint ambitions will deteriorate without a common language. If all organisations (both public and private sector alike) speak different languages or use different dialects with respect to the circular economy transition, it will be very difficult to make progress.

It is progress, however, that is urgently needed to conserve our natural resources, protect and preserve our biodiversity as well as drastically reduce carbon emissions.

The barriers differ from sector to sector, from public authority to private enterprise. Ultimately, however, the more barriers that exist the less the inclination to invest in the circular transition, be that public finance or private investment. Below some barriers are outlined from the perspective of a promoter of a circular initiative/project and from the perspective of an investor or financier. The list of barriers is far from exhaustive more demonstrative of the challenge we face.

Project Promoter

Investor

It is evident that there is a need for one shared definition and sectoral specific criteria defining what indeed it means to be circular in a specific sector but also how to measure. But who should take the lead? More importantly, who has the authority to not only create a common language but to make it standard?

The EU Taxonomy

It might not be an official ‘lingue franca’ but close enough; the “EU Taxonomy Regulation” will require most European financial institutions and non-financial companies to outline the environmental sustainability of their economic activities.

What is more - in this context - the taxonomy has circular economy as one of six key areas. Given that the first EU Taxonomy disclosures are due by the end of 2021 and throughout 2022, and that it is a quite complex and extensive framework, it is key to start aligning with the EU Taxonomy as soon as possible. Apart from rhyming, what difference will the circular economy taxonomy make? Let’s open the circular economy taxonomy box.

Circular Economy Taxonomy

The EU has shone a spotlight on the circular economy in recent years with the three documents aside playing an important role to both prioritising circular economy but also defining it. The EU Taxonomy Regulation, which entered into force in July 2020, has drawn upon these publications to define how an economic activity shall qualify as contributing substantially to the to the transition to a circular economy.

The core criteria as to how an economic activity will substantially contribute is outlined below in six headlines. The Delegated Act, which is expected to be published in the coming months, will outline specific criteria with specific metrics, thresholds etc. in line with these core criteria.

Resource Efficiency: Use natural resources, including sustainably sourced bio-based and other raw materials, in production more efficiently.

Durability & Repairability: Increase durability, reparability, upgradability or reusability of products, in particular in designing and manufacturing activities.

Hazardous Substances: Substantially reduce the content of hazardous substances and substitute substances of very high concern in materials and products.

Secondary Raw Materials: Increase the use of secondary raw materials and their quality, including by high-quality recycling of waste.

Prolong Use: Prolong the use of products, including through reuse, design for longevity, repurposing, disassembly, remanufacturing, upgrades and repair, and sharing products.

Prevention & Reduction: Prevent and reduce the generation of waste from the extraction of minerals and waste from the construction and demolition of buildings.

The delegated act will lay out specific criteria for enterprises that are part of, for example, agriculture, energy and manufacturing as well as transport and construction & real estate. Clear descriptions of activities will be provided as well as technical screening criteria. For the circular economy, this will really be a defining moment.

Embracing the Opportunity

There is so much more to the EU Taxonomy than “mere” alignment. From the perspective of the transition to a circular economy, a proper taxonomy, once and for all, puts circular economy at the forefront of the sustainable finance agenda, moving it from the periphery very much to the centre. But to maximise the opportunity, efforts need to be made now, opportunities both identified and exploited.

There is enough information and guidance to provide a reasonable indication as to what it will mean to substantially contribute to the circular economy transition. Illustrating that a financial institution or non-financial company significantly contributes to the circular economy transition presents an opportunity in many shapes and forms.

There are of course many organisations that will significantly contribute to the climate objectives that will also contribute to the circular economy transition. But what of those that do not contribute to mitigation or adaptation? What does it mean for “enablers” or indeed SMEs? What opportunity does a circular economy taxonomy present for the investment community?

Non-financial companies that do not contribute to the climate objectives

Many non-financial companies do not significantly contribute to climate mitigation or adaptation. However, the ability may present itself for such companies to illustrate contribution to the green transition and illustrate taxonomy alignment via activities that contribute to the circular transition.

For example, a manufacturer that can utilise higher percentages of secondary raw materials may find themselves with the ability to illustrate contribution to the green transition via the circular economy, a manufacturer that may struggle otherwise to illustrated a positive contribution to the green transition. Such companies will now have a framework within which to track and communicate positive progress and contribution, enhancing brand and overall company/product value.

The Enablers

The circular economy transition, more so that any of the other EU taxonomy objectives will rely heavily upon enablers. Be it digital platforms that enable sharing or material technologies that are catalysts to remanufacturing, a circular taxonomy presents a significant opportunity for such enablers to be classified as not only central to the circular transition but key to the overall green transition.

The ability to attract investment but also to be deemed relevant to the sustainability agenda is a significant opportunity. However, enablers need to both recognise that they are indeed now relevant and to also clearly communicate this, both to attract investment, enhance brand and potentially broaden their customer base.

SMEs

It will not be obligatory for SMEs to align with the taxonomy in the short term (although extending the obligation to SMEs is expected in the medium term). However, SMEs that can illustrate contribution to the circular economy transition will find access to green finance easier to come by.

Alignment will also be a powerful communication tool to enhance overall brand and green credentials. This will of course apply even more so to SMEs that may not contribute to other objectives. SMEs that illustrates alignment with the circular economy taxonomy will be a more attractive supplier proposition than their peers especially if entities/clients that an SME supplies are legally obliged to align with the Taxonomy.

The Investor

The investor is concerned about both brand and alignment of the portfolio but also the risk of investment. Investigating and identifying investment opportunities now based upon existing and expected taxonomy language provides an investor with an expected greater return upon investment in the circular economy rather than waiting until 2022 by which time the circular investment opportunities will also become very attractive to other investors, thus pushing up the cost of investment.

Moving Forward

It is clear that a circular economy taxonomy will not be perfect, but it is even clearer that it is necessary. It is necessary to define what circularity is, to identify baselines and points of reference, it is necessary to instil confidence in the financial world but it is also necessary to communicate to stakeholders in a consistent vocabulary.

There will be those that are either not included or will struggle to align. In creating definitions and building a common language, it is inevitable that some parties may not initially be included. However, it is important to note that this is the first attempt to create a common language and there is clear acknowledgement from the EU that this is a “learning by doing” process. Feedback will be provided, lessons will be learned, the language will be refined, and the list of relevant parties extended.

Above all, however, it is now clear that the transition to a circular economy will gain momentum as a direct result of a circular economy taxonomy. A circular economy taxonomy will set definitions and descriptions specific to economic activities, criteria will be outlined - and even more importantly - metrics and thresholds will be set.

Those that prioritise both taxonomy alignment and the circular transition within their own enterprise or financial institutions will not only gain a market advantage but will also clearly play an important role in the green transition.