How to unleash investment in the circular economy

How to unleash investment in the circular economy

Frido Kraanen is Principal Director Societal Impact for Dutch pensions service provider PGGM [https://www.pggm.nl/]. He was a speaker at the 20th European Forum on Eco-innovation, which took place in Tallinn, Estonia on 26-28 October 2016. Here, he discusses lessons learned by PGGM in redirecting investment towards more circular and resource-efficient business models.

How can PGGM promote investment that emphasises sustainability?

Frido Kraanen: We work for pension funds in the Netherlands, including the healthcare and social services pension fund, which has approximately €180 billion under management. Of course when looking for returns, investors always say it’s finance first, but we look into how we can include sustainability targets.

In this respect, there is a range of instruments. Companies or even sectors can be excluded from investment portfolios. For example, a few years ago we excluded the whole tobacco sector, which was very stupid from a financial point of view, but for a healthcare fund it would be rather strange to put the pensions into the tobacco industry. Investors can also engage with companies on sustainability, or seek to influence them through voting. Through engagement strategies, funds work with companies on ambitious targets.

We also look at how we can work with other investors or banks or insurance companies. It could be in platforms like the Principles for Responsible Investment [https://www.unpri.org/], or on specific topics. For example, we have started a working group on the circular economy looking at how we can be more conscious of eco-innovation and what we can do in this respect.

How do investment funds view the circular economy?

Frido Kraanen: It always comes back to weighing all the risks. All innovation brings with it the risk of newness. For example, at the moment we don't really know how circular economy subscription models will affect business, but on the other hand there is also a risk of doing nothing. Increasingly, the failure to be sustainable will cost you revenue, especially in the long term – and we are long-term investors. Thinking about the circular economy helps to understand the new economy – it helps understand the sharing economy or if some sectors are more vulnerable than others to linear risks.

One example we see is that a more circular approach is leading to more car-sharing platforms. One analysis found that if car sharing becomes more common in society, new car sales could drop 40%. Currently, people buy cars but there is a usage inefficiency. With car sharing and more online tools so people can see where cars are and how they are being used, they will also see that their costs of car usage will drop, and in the end they will buy fewer cars. One study found that people on average buy a new car every 9.5 years, but if four people shared a car, they would buy a new car every six years, because of course it is used more. But overall, new car sales would go down. This example shows how changes to the economy have impacts on different sectors and different companies. This is why we need to understand the new economy.

In terms of linear risk – or circular opportunities – we see for example in the carpet industry that they have lowered their costs because now they retrieve and recycle or even reuse material. Those companies are more profitable in the long term.

However, one of the difficulties for large pension funds is they only invest with big stakes, and innovation often starts small. Nevertheless, there are now some dedicated circular economy funds, while two years ago there were none. They are now raising money or they already have the capital committed for the first phase. One example is Circularity Capital [http://www.circularitycapital.com], a private equity fund. It is a £15 million fund. But we only start at €100 million, for cost reasons. Nevertheless, there is always money when it is a good idea, no matter if it is an eco- or non-eco innovation. And capital was never as cheap as it is now.

If finance for new ideas is not an obstacle, what is holding up the more rapid development of the circular economy and eco-innovation?

Frido Kraanen: There are three reasons why eco-innovation is not speeding up more. The first is that governments still subsidise linear and fossil-fuel models. Not necessarily directly, but if you look at the circular model, one of the design concepts is reverse logistics of the resources and the products – you need to get them back – whereas from a linear perspective, you throw them away. And throwing away is for free most of the time. The cost price of the linear end-of-life is often zero, but in a circular model, for the producer or for the retail company, there is no cost-free end-of-life of products. End-of-life in the linear model might be zero, but there are externalities, so in the end there is a kind of unfair competition between linear and circular models. There is no level playing field. Linear is the default in our system and therefore it gets an advantage.

The second big barrier is still the consumer mindset. Consumers need to play a part, for instance in the reverse logistics or in taking good care of products, or maybe in investing some money up front in new approaches that prevent waste. Consumers tend to be very lazy and the consumer mindset doesn't give circular companies a head-start. They need to work very hard to engage consumers because consumers need to be more engaged in the circular model compared to the linear model.

The third barrier is the financial industry. They tend to look at risk from a more linear perspective. It is important to overcome these barriers. If we solve these issues, I think eco-innovation really will speed up. For example, for the financial industry it's rather difficult to finance or give credit to a circular company when you know the market conditions for this company are worse than for linear competitors. That's one of the things to solve first, because there is a logical order in the transition path to a more eco-conscious society.