Beyond ESG
Last April, two important events concerned the development of the Circular Economy as a content of sustainability in the context of investment and financing activities.
Globally, UNEP FI has issued guidelines (Guidance on Resource Efficiency and Circular Economy Target Setting - Ver. 2) which identify the transition to a circular economy as the scope of application of the Principles for Responsible Banking. The 325 signatory banks of the Principles can now identify in the financial and advisory support to client companies towards the circular transition one of the two areas of application required by the Principles to generate a positive impact towards the achievement of the sustainability objectives set by the SDGs and those envisaged by the Paris climate agreement.
At EU level, the European Commission, within its Environmental Taxonomy, has published the draft of the Technical Screening Criteria (hereinafter TSC) relating to the four objectives, among which there is "transition to a circular economy" added to the ones relating to climate change; the enactment of the Delegated Act is scheduled for June. The establishment of the TSC is the last step necessary to enable the Circular Economy as a content of the taxonomy also for the purpose of calculating the performance indicators required of the financial industry to measure their degree of compliance with principles of sustainable finance, among which the GAR (Green Asset Ratio) stands out for the banking industry.
Still within the EU context, the most "strategic" element, however, consists in observing that rh is evolving from an environmental issue included in the Commission's Priority 1 (European Green Deal, 2019; Circular Economy Action Plan, 2020) to a fundamental element of the EU's industrial policy, indicated by Priority 2 (A Europe fit for the digital age - Digital future agenda & a new industrial strategy - digital & net zero, 2020), through the progressive development of typical circular economy issues such as the correct management of stocks of finite pristine resources and their replacement with renewable and/or regenerable resources (e.g. Critical Raw Material Act, 2023).
The scenario that is emerging requires a reflection on the contents of sustainability in the financial sphere. In fact, ESG (UN, 2005) was adopted on the assumption of the existence of a nexus of financial materiality, focusing first on the returns of shares (e.g. Eccles et al, 2014) and then on environmental and climate risks (e.g. ECB, 2020). However, the most recent literature (e.g. Bruno et al, 2021) is increasingly in agreement in indicating a decline, if not an absence, of outperformance of ESG strategies and assets, at least in terms of excess returns, questioning the effective permanence of its financial materiality.
Furthermore, the need to develop dynamic materiality is emerging: sustainability must be able to combine financial/ESG performance with impactful results that are relevant for stakeholders other than financial investors; think, in this regard, of the financial investment products under art. 9 of the SFDR in the field of asset management. ESG, which was not conceived with a view to pursuing double materiality, shows strong limitations in this sense.
On the contrary, the research conducted within the Bocconi GREEN Research Center, developed with the support of the ISP Group, highlights the presence of financial materiality for the Circular Economy at the level of: risk-adjusted extra returns on equity (Zara et al, 2022); reduction of risk for both equity (Zara et al, 2022) and debt (Zara et al, 2022a); and resilience to exogenous shocks (Zara et al, 2023). Furthermore, having an economic content that is pervasive with respect not only to environmental but also geopolitical and social issues, a circular-economy approach is able to pursue impact objectives that are material with respect to the interests of non-financial stakeholders.
Ultimately, the Circular Economy stands as an evolutionary line of the sustainability content of mainstream ESG and is capable of channeling the impact that can be generated within ESG categories, by becoming an accelerator itself for ESG strategies of banks and other investors.