Why a circular economy is vital for ESG
Investments in ESG funds hit a record $649 billion in 2021. But finite resources threaten returns on investment as prices are pushed up. The answer is to shift to a circular economy, which can counteract resource depletion, increase resilience and improve risk management.
Climate change and sustainability are attracting growing attention in the financial sector. And investments in environmental, social and governance (ESG) funds have more than doubled over the past two years. Reuters declared 2021 as “the year of ESG investing” after data from Refinitiv Lipper revealed that global ESG funds received a record $649 billion, up from $285 billion in 2019. ESG funds now account for 10% of worldwide fund assets. This boom has led to companies of all sizes making ESG-scoring a major factor in how they do business.
“ESG is the current mainstream of sustainability in the financial sector,” explains Claudio Zara, a researcher at the GREEN research centre at Bocconi University. “This is because policymakers have adopted this framework and are promoting it in order to steer financial capital toward a more sustainable economy.”
Aside from the policymakers’ regulations, there are three other reasons to consider ESG factors in investment decision-making: risk, consumer demand and resilience. Investors and corporations realise that climate change-related disasters and worsening social issues come with several risks for their business, among them the risk of depleted resources, the risk of supply-chain breakdown and the risk of an unhealthy or uneducated workforce. Another danger of failing to adopt ESG values is damage to their reputation, as consumers increasingly seek out companies that reflect responsible values.
Companies that score well on ESG metrics are believed to better anticipate future risks and opportunities. Thus they are more likely to attract green investors and those looking to diversify their portfolios. While future investment and innovation are likely to trigger a growth in the supply of sustainable resources, the current rapid rise in demand is likely to outstrip supply, increasing competition and pushing up prices. The pressures of finite resources can be addressed by shifting to a circular economy, which is an essential part of delivering on climate change and ESG issues.
Moving from a traditional, linear business model based on “take, make and dispose” to a circular model based on reusing resources and keeping them in the economic cycle longer and with more intensity can not only counteract resource depletion but also reduce pollution, increase resilience and improve risk management. “By laying the foundation of new and better growth, the circular economy is the economic engine of ESG,” says Zara.
“It is also crucial because it can target important mega trends which are accelerating the shift – such as demographic trends, urbanisation, digitisation, and changing customer’s demands as they become more aware of environmental and social issues.”
Zara led a study by Bocconi University, in close collaboration with Intesa Sanpaolo, which aims to define the relationship between the circular economy and the financial sector. One of the key findings is that the circular economy can help reduce a company’s financial risk and improve risk-adjusted performance. The research also found evidence that adopting circular business models can make the economy more resilient to external shocks.
“Companies that are more circular suffered lower negative performance and volatility during the Covid-19 pandemic and regained their original conditions more quickly post-pandemic,” says Zara. Shifting to circular systems is a strategic priority for post-pandemic recovery. Intesa Sanpaolo is a lead player in the financial sector, with around €115 billion committed to the green transition in its 2022-2025 Business Plan. The integration of ESG factors into its investment process plays a key role in this transition, as the framework ensures transparent, sustainable business practices that can be measured and reported.
Both the circular economy and ESG are crucial to financial services in terms of de-risking investments, delivering on climate commitments and capitalising on new forms of better growth.