Circular finance guidelines set the tone

This summer, ABN AMRO teamed up with Rabobank and ING to launch the Circular Economy Finance Guidelines. Jan Raes, a sustainability advisor at the bank, talks about what these guidelines mean and how they came about.

The circular economy is on the rise. Simply put, circular enterprise is an innovative approach to design, production and sales ensuring that as many products and raw materials as possible are reclaimed and reused. The aim is to use fewer materials, create less waste, generate fewer carbon emissions and consume less water. This new way of doing business is also pumping new life into the economy. Plus the business models underpinning circular enterprise are different from mainstream linear models.

Standard financing just won’t cut it

All this requires a new mindset, though. Jan Raes explains: “Our economy is largely based on a linear paradigm: we extract raw materials, use and then dispose of them – take, make, waste. And we all know that waste is one of the major problems inherent in our current economic model. The good news is that we’re living at a time when there are a lot of entrepreneurs out there who are motivated to rethink that model. ABN AMRO, for its part, is keen to provide financing to support the transition to the circular economy. But the issue facing the bank and entrepreneurs with circular business models is that ‘standard’ financing either isn’t as effective or just doesn’t fit the bill.”

Looking forward in a rear-view mirror

Raes gives a few examples. “Before granting a loan, a lender first looks at a business’s track record. That’s a healthy, critical approach, as it challenges entrepreneurs to achieve consistent, healthy operating results. Circular initiatives – like subscription-based clothing services or recyclable, plant-based alternatives to plastic packaging – are often new and groundbreaking. The simple truth is they lack historical results, but have real economic potential to transform a given market. Lenders, too, want to look further ahead. It’s just that their job has always mainly been about looking backwards.”

A focus on service offering, not sales

Often the client approach is different, too, when a circular model is involved. “We’re now seeing the emergence of all sorts of new subscription-based service offerings,” says Raes. “It’s no longer about the one-off sale of a product, but about the relationship and interaction with the consumer becoming the key focus. Take clothing, for example. You can either sell a garment once, or you can sell a subscription to an entire wardrobe. Obviously, that subscription will include additional services, like a warranty on repairs and dry cleaning. From the perspective of the entrepreneur–client relationship, it’s a healthy and very exciting model: it fosters client loyalty to the supplier, so there’s a better chance of a longer relationship with the client, as well as greater insight into what they want. But when we look at cash flow, we see a major difference: the supplier’s turnover is no longer generated at the beginning as a result of a sale. Instead, turnover is spread out over a longer period in the form of subscription fees. Plus there are other risk factors. On the one hand, this type of subscription provides stability and security, but on the other, it takes longer for entrepreneurs to recoup their investment. Not to mention that if a client cancels the subscription halfway through or fails to treat the product with care, the entrepreneur has a problem. This means the entrepreneur will have to assume the role of service provider rather than vendor, which requires both a better understanding of what motivates clients and a shift in focus from the short to the longer term. Lenders, too, will have to start looking at things differently, assessing more closely the service proposition rather than a one-off sales proposition.”

Reverse logistics is king

Another aspect that has an impact on financing is product retrieval. Raes says, “If a business owner is committed to circular enterprise, there needs to be a scheme in place for raw material recovery, since those materials will have to be returned for processing either by the supplier or by a specialist. Let’s say you run a clothes shop. What are you going to do with all the used textiles you get back? Where does all the used packaging go? And is the scheme generating raw materials? Take ABN AMRO’s circular pavilion Circl. What will happen to all those beams and used materials? All this requires reverse logistics, and that means added costs. Still in its infancy, reverse logistics involves collecting, storing, processing and reselling materials. In the linear economy, there’s been little or no demand for reverse logistics. Those tackling this issue will be creating a revenue model, and the quality of this process could, in turn, be a determining factor in the bank approving the loan.”

FinanCE working group

Raes posits that changes in business models will mean changes in financing. He says, “The bank doesn’t want to invent this wheel all by itself, which is why ABN AMRO, ING and Rabobank are teaming up. Some time ago, we joined an international working group initiated by the Ellen MacArthur Foundation and PGGM, called FinanCE. The result is a set of generally applicable guidelines for financing circular initiatives, following on from the success of green bonds. The Circular Economy Finance Guidelines, as they’re officially known, provide guidance to lenders and investors alike. The guidelines are a straightforward, convenient tool providing a common framework for lenders to identify circular business models and assess their impact so they can then finance them.”

Circular Netherlands attracts interest at the UN

This summer, ABN AMRO and the other banks presented the guidelines to Stientje van Veldhoven, State Secretary for Infrastructure and Water Management. Those attending the 2018 High-level Political Forum on Sustainable Development at the UN in New York also showed great interest in the Dutch circular transition plans to which these finance guidelines are linked. The Circular Economy Finance Guidelines are publicly available. In fact, ABN AMRO, ING and Rabobank encourage financial institutions around the world to avail themselves of the right-to-copy principle. By drawing up the guidelines, they are calling for a uniform vision and methodology to be developed throughout the financial world. Raes says, “The guidelines should be seen as an appeal which has garnered wide support. It’s simple: society will benefit if more money goes to circular business models.”

Picking up the pace with constructive feedback

But the guidelines aren’t set in stone. “It’s a feedback loop,” Raes explains. “The aim is to help businesses come up with viable circular business plans. We’ll be learning many more lessons in the years to come. And with all the feedback we get, we’ll be honing the guidelines continually together to help pick up the pace of circular enterprise.” The Circular Economy Finance Guidelines​ (PDF 6 MB) are available here.