Publicly traded companies and their service providers are carefully reviewing the Securities and Exchange Commission’s newly proposed climate-related disclosure rules issued on March 21, 2022, which would for the first time impose mandatory reporting obligations on publicly traded companies in connection with their climate-related risks. The proposed rules require larger companies to disclose greenhouse gas (GHG) emissions from upstream and downstream activities in their value chains, include reports from independent attestation service providers covering direct and indirect GHG emissions, and provide information related to each company’s climate goals, risks, and plans. Institutional investors, insurers, and private equity funds already scrutinize the voluntary ESG, sustainability, and corporate social responsibility reports companies currently make available and welcome greater uniformity in ESG measurement and reporting to facilitate comparison of ESG performance between companies. Without universal objective standards, some argue that businesses have been tempted to engage in ESG “greenwashing,” leaving investors, consumers, and stakeholders dubious as to the value and reliability of current ESG disclosures.
Although the nexus between ESG and circular economy aspirations has not garnered much attention, the potential exists for ESG reporting to accelerate the move from a linear economy (extract, manufacture, consume, dispose) to a circular economy (reduce, repair, reuse, recycle, repurpose, and design more durable products). In a circular economy, waste is eliminated, natural resources are used regeneratively, and products and materials are circulated at their highest value (avoiding waste). A focus on circular economy advances will also address other global problems like biodiversity loss, climate change, and pollution.
Progress towards creating a circular economy has been painfully slow, especially with respect to the sustainability of the manufacture, use, and disposal of consumer goods. Even in the European Union, with the world’s most stringent eco-design, waste reduction, and recycling standards, the linear economy still prevails. This article examines the connection between ESG reporting and investments, the movement towards a circular economy, and the role “nudge” theory—a species of behavioral intervention—combined with ESG reporting, might have in dramatically accelerating progress towards a circular economy.
Many globally recognized ESG reporting frameworks incorporate key components of a circular economy—from “Business Model & Innovation” aspects within Sustainability Accounting Standards Board (SASB) criteria to “resource efficiency” themes in the Task Force on Climate-related Financial Disclosures (TCFD) to three of the 17 UN Sustainable Development Goals (SDGs) covering Innovation and Infrastructure, Responsible Consumption and Production, and Partnerships for the Goals. Specifically, SDG-9 (Industry, Innovation and Infrastructure) includes the 2030 target to upgrade infrastructure and retrofit industries to make them sustainable, with increased resource-use efficiency and greater adoption of clean and environmentally sound technologies and industrial processes. SDG-12 (Responsible Consumption and Production) includes 2030 targets to achieve the sustainable management and efficient use of natural resources; reduce waste generation through prevention, reduction, recycling and reuse; and promote public procurement practices that are sustainable, in accordance with national policies and priorities.
Companies that disclose their progress toward UN SDGs have a clear tie to circularity objectives through SDG-12, Responsible Consumption and Production, and may include other circularity ties for other SDGs. Equally important to circular economy outcomes is SDG-17, Partnership for the Goals. Classic circular economy best practices include using one industry’s waste as another industry’s feedstock. Local circular economy success requires an attitude of pursuing beneficial partnerships for the greater good of sustainability goals to identify opportunities for sharing resources for mutual benefit. SDG-17 (Partnerships for the Goals) includes a 2030 target to enhance the global partnership for sustainable development, complemented by multi-stakeholder partnerships that mobilize and share knowledge, expertise, technology, and financial resources, to support the achievement of the sustainable development goals in all countries, especially developing countries.
With over 90% of the S&P 500 companies providing sustainability reports on their websites, one might suppose that most companies have been reporting on ESG for long enough that circular economy objectives and goals have been developed by industries and are prominently represented in their company sustainability reports. This is not necessarily the case. Annual sustainability reporting typically only includes the status of a company’s ESG targets and goals, with many companies tracking progress toward bold carbon reduction milestone dates—as carbon net zero goals have, for many industries, been the dominant focus of their ESG efforts. However, the progression of these goals and targets will soon move from the primary focus of GHG emissions reduction to the more complex questions of resource use and environmental improvements across the company’s entire value chain. Circularity objectives can rise higher on the priority and project list as a company’s sustainability strategy advances.
At the UN Climate Change Conference in Glasgow (COP26), the International Financial Reporting Standards (IFRS) Foundation announced the creation of the International Sustainability Standards Board (ISSB). ISSB is currently drafting a global standard for company disclosures to be published in the second half of 2022. The upcoming ISSB global standard includes input from SASB and TCFD, among others, and can be used to streamline the plethora of national, private, and nonprofit standards. With its international influence, the IFRS can promote one widely shared standard and provide crucial clarity to ESG disclosures, as more finance becomes ESG finance. As this transition continues, the boundaries between financial and sustainability reporting may become increasingly blurred, and companies will need to promptly diagnose and correct ESG performance deficiencies or risk losing project investment and support.
As the SEC finalizes its rules for ESG and sustainability disclosures, annual sustainability reporting will become more prevalent and the spectrum of what is an acceptably detailed and transparent sustainability report may crystalize in accordance with SEC requirements. Collectively, investor and consumer markets will nudge companies toward greater emphasis on circularity. What should companies strive for in transparently disclosing strategy and progress toward circular economy? Consider the following recommendations that take on greater importance, given that ESG reporting rules provide flexibility in measuring and reporting circularity:
First, the “Think Global Act Local” movement can turn over stones in each locale to identify creative circular synergies. When new infrastructure comes online to meet renewable energy targets, a community can benefit from surplus material from legacy operations or antiquated equipment. For example, a new solar farm north of Anchorage, Alaska, was built on support structures made from recycled oil drilling pipe. Landfill-derived methane can be manufactured into renewable natural gas to fuel city buses in San Antonio, Texas, just one of several innovative renewable natural gas projects occurring in the United States.
Second, companies may need to be more open in transparently disclosing nonproprietary operational information that describes inputs and outputs, thereby inviting circular synergy toward supply from renewable sources and/or waste diversion toward beneficial uses. Furthermore, as companies collectively move away from greenwashing and toward transparent and clear disclosures, there is much room to innovate on bite-size summary information for consumer stakeholders. Many consumers yearn to know and likely would make purchasing decisions based on the ESG scores of a company and its products or services, even though such information would be far less detailed than what an institutional investor might require.
Third, greater membership and participation in corporate citizenship coalitions or groups that support SDG-17 (strengthen the means of implementation and revitalize the global partnership for sustainable development) can lay groundwork to support local connections with municipalities, industries, and stakeholders; such collaboration can yield circular economy benefits. For example, members of the American Chemistry Council collaborate on circularity for plastics, with many member companies becoming Responsible Care Certified. Similarly, the Alliance to End Plastic Waste has made strides in advancing plastics circularity, with 40 member companies and projects across 29 countries—yet they acknowledge in their 2021 Progress Report that much more needs to be done to better manage waste globally.
Fourth, companies can individually make commitments to circularity reporting, such as the World Economic Forum, Measuring Stakeholder Capitalism, which recommends that companies report the most appropriate resource circularity metrics for the whole company and/or at a product, material, or site level as applicable to assess progress towards a circular economy.
Companies need to anticipate the ESG disclosures that will be required tomorrow. Innovation beyond what is currently standardized for ESG will create competitive advantage. As sustainability reporting and ESG program leadership require skills across the full gamut—from diversity and inclusion to zero emissions and circular economy—companies will likely need support from multidisciplinary teams with the technical and managerial acuity to embed ESG into their DNA.
While much of the focus of responding to climate change has been on energy usage and renewables, according to the Ellen MacArthur Foundation, a switch to renewable energy will only address about 55% of global GHG emissions, while a significant portion of the remaining 45% can be addressed through widespread adoption and implementation of circular economy practices. The circular economy push is coming from several angles—including regulation and policy initiatives such as the 2019 European Green Deal that included transition to a circular economy as a major building block as well as private investment and responding to market pressures.
While government incentives and mandates—the “carrots and sticks” of policy and regulation—can steer companies toward adopting circular practices, the private sector is also responding. Although investment strategies generally focus on linear economic activities, investment that targets businesses in the circular economy has seen significant growth in recent years. The circular economy provides a lens through which to focus on the “E” in ESG, and, as investment in the circular economy moves to the forefront, it will become a significant mechanism to achieve environmental targets.
One example of investment focus on the circular economy is BlackRock’s launch of a circular economy public equity fund in 2019. The fund, called the BGF Circular Economy, invests at least 80% of its total assets in the shares of companies globally that contribute to the advancement of the circular economy. The fund started with $20 million in seed money in 2019 and has grown to over $2 billion in 2022. BlackRock is not alone in its efforts. Other entities with similar investments include Credit Suisse, Cornerstone Capital, and Goldman Sachs.
So-called impact funds have been launched with singular focus on supporting the circular economy. For instance, the European Union initiated the European Circular Bioeconomy Fund, which solely supports businesses pursuing circular economy goals in the European Union. In February 2022, the fund announced that it had exceeded its funding goal of €250 million by raising around €300 million. The fund has already made several investments, such as the Dutch company Protix, which produces insect-based ingredients to produce feeds for pets, livestock, and other animals. These are just two examples of the growth and opportunities for investment in the circular economy.
As more companies report on setting and meeting circular economy goals, and investments in circular economy becomes mainstream, the increased need exists for a standardized mechanism to accurately measure, report, and compare a company’s circular economy performance and “score.” How can companies—let alone investors—set goals to meet circularity principles if no agreement exists on what those principles are and how success will be measured? How can investment groups compare one company’s claims on ESG and circularity without understandable and comparable metrics? To fill this void, various measurement systems and definitions are being developed so that companies are using the same language to report, and investors can accurately assess the company and investment. These more uniform approaches are increasingly being used to assess and report progress.
The EU has made a significant step toward creating a common language to assess circular economy in its “EU Taxonomy” adopted in 2020 as a way to bring money to businesses and technologies that are focused on sustainability. The EU Taxonomy seeks to provide a framework and common definitions to assess sustainability of an economic activity and sets a “transition to a circular economy” as one of its six environmental objectives. Put simply, the EU Taxonomy consists of a green classification system that promotes specific economic activities and investments consistent with the EU’s climate and environmental objectives. One of the six EU Taxonomy objectives addresses aligning circular economy metrics across a wide spectrum.
The EU Taxonomy is not the only metric, however. Other metrics are being developed and used to measure and disclose circularity. The World Business Council for Sustainable Development released the “Circular Transition Indicators,” or CTI, that provide an online program for companies to assess their circularity performance, set goals, and track progress. Similarly, the Ellen MacArthur Foundation developed a free circularity assessment tool called Circulytics. Over 1,250 businesses have signed up for a Circulytics assessment. While the United States may lag behind the EU in formally adopting circularity principles as part of an overall policy object, the U.S. Chamber of Commerce Foundation, an affiliate of the U.S. Chamber of Commerce, also has developed a Circular Economy Toolbox available on its website.
Companies are not limited to these circular economy–specific metrics, but can utilize broader reporting frameworks, such as the SASB and the Global Reporting Initiative (GRI) that are integrating circularity concepts. For example, in 2020, GRI released a standard for companies to measure and report waste, with a focus on circularity concepts.
As with ESG reporting generally, the standardization of circular economy definitions and metrics is an important step to allow for the financial industry to assess accurately whether a company is truly meeting circularity principles. While the development of metrics and disclosure frameworks provides opportunities for assessing circularity, the varied nature reflects the need for a common language. SEC and ISSB aspire to bring needed standardization and common ground to ESG measurement and reporting. But how will ESG standardized reporting change consumer behavior, and how can consumers nudge manufacturers and vendors to embrace the circular economy?
Despite some progress, we still live in a throwaway society. According to the Ellen MacArthur Foundation, consumer goods comprise approximately 60% of total consumer spending, 35% of material introduced into the economy, and 75% of all municipal waste generated. Cell phones have planned obsolescence of two or three years. Single-use nonrecyclable packaging has grown, while plastics choke our oceans. How can nudges be used to accelerate progress towards a circular economy, especially with respect to the manufacture, purchase, consumption, and disposal of consumer goods? How can consumers become aware of and factor in a company’s ESG performance and a product’s circularity into purchases of consumer goods, especially as ESG scores and product circularity scores discussed above become more widespread?
The traditional levers for changing behavior include shifting incentives (increasing or decreasing cost, time, or effort), mandating standards and regulations, and providing education and information. Nobel Prize behavioral economist Richard Thaler and Harvard law professor Cass Sunstein teamed up to publish several popular books on “nudge” theory, a behavioral intervention using “choice architecture” to alter people’s behavior in a predicable fashion without forbidding options or significantly changing economic incentives. Thaler and Sunstein consider nudges to be “libertarian paternalism” in that choice is preserved (libertarianism), but choices are structured to help people make better decisions (paternalism) despite and even because of their bias, procrastination, and herd mentality. Nudge contrasts with “shove”—the traditional command-and-control prescriptive regulatory approach based on mandates, restrictions, and penalties. Thaler and Sunstein argue that both nudge and shove are needed to tackle pressing environmental and other complex societal problems.
Nudge interventions work because they reduce effort to achieve a beneficial outcome. For example, to encourage participation in retirement savings plans, employees are automatically enrolled rather than required to fill out extensive paperwork and must opt out in order not to save. “Default nudges” have proven successful at encouraging clean energy. A green energy default choice in Germany resulted in almost 70% of consumers sticking with more expensive green energy supply contracts while only 7% opted in when given the choice. Mere information to consumers can result in green behavior such as the 6.2 million U.S. households receiving home energy reports with their monthly bill who reduced their energy consumption by an average of 2% per household when the reports showed their neighbors consumed less energy. In Halifax, Nova Scotia, after residents were required to use clear curbside garbage bags, making the contents visible to neighbors, the volume of garbage sent to the landfill decreased by 31%. Nudges often appeal to our ethical values, altruism, identities, and sense of shame and competition (“priming nudges”), and desire to conform to the behavior around us.
Public disclosure of environmental information can result in voluntary reduction of emissions and use of toxic substances, as occurred after enactment of the Emergency Planning and Community Right-to-Know Act and Toxic Release Inventory requirements. As the effects of climate change become more salient (flooding, forest fires, droughts, and prolonged poor air quality), Thaler and Sunstein anticipate that GHG inventory disclosures would have a similar voluntary effect to reduce emissions if they must be reported.
ESG reporting and investing may nudge both businesses and consumers to make greater strides toward a circular economy. However, a consumer is unlikely to read a manufacturer’s or vendor’s ESG report prior to making a purchase of a consumer good. To influence an investor or consumer, ESG data must be readily visible, objective, and easy to understand at a glance. To consumers, perhaps more important than the ESG data included in an ESG report is the ESG “rating” or score distilled from the data that allows investors, consumers, and organizations themselves to assess and understand how well the company is performing. Because no uniform ESG rating standard exists, rating agencies have developed their own ESG rating criteria. Some use a numeric scale (e.g., 1 to 10 or 1 to 100), others a letter scale (e.g., AAA to CCC). Some ratings are based entirely on ESG risk severity (e.g., negligible, low, medium, high, and severe), while others consider dozens of factors, giving weight to each. Nudge theory teaches that the rating scale itself may be of critical importance and will be effective only if accessible and simple. A rating based on A+ to D− may be more useful, with “A” indicating excellent ESG performance and high degree of ESG reporting transparency, with “D” indicating poor relative ESG performance and poor reporting transparency. Even more helpful could be the simple five stars used by Amazon, Trip Advisor, and other websites to rate goods and services.
Would a consumer of electronic products prefer to purchase a product with an objective A+ or five-star ESG product rating, all other things being equal? ESG product ratings could be based on goods manufactured without toxic chemicals that can be recycled, reused, or biodegradable; shipped with eco-friendly packaging, etc. Nudge theory suggests many would even pay a premium to purchase such products. Amazon recently introduced third-party sustainability certifications and created its own certification (“Compact by Design”), to identify products that have more efficient design and packaging. Currently Amazon’s sustainability certifications are relatively difficult to find on its website, and Amazon offers too many overlapping certifications (12 are currently listed with links to the respective rating and certification services that may or may not provide easily understandable explanations of the rating methodology).
Would a consumer value the product from a manufacturer with an A+ or five-star ESG rating? How could this be effectively and easily communicated to consumers? Again, Amazon’s model may hold the answer. Amazon’s success comes in large part from ease—a search on its website lists available products, manufacturer, cost, and consumer ratings. Under the product description and vendor/manufacturer name, Amazon also could include the product’s green rating and the manufacturer’s ESG score. Amazon’s ESG score could factor in existing corporate sustainability ratings systems, such as the Dow Jones Sustainability World Index. Amazon already allows vendors to highlight a company’s sustainability practices, such as Tide detergent’s campaign to encourage washing clothes in cold water (“Switching to cold water for one year can save enough energy to charge your phone for a lifetime”). Vendors could include additional company or product ESG information, but those refusing to provide information regarding the product’s green rating or ESG score could simply be given a D− or zero stars for lack of transparency.
Adding company ESG ratings and product scores to Amazon product listings could incorporate the nudge and choice architecture needed to allow consumers to factor in the sustainability of each product’s manufacture, design, and use, as well as the vendor’s ESG rating, as easily as they now consider product cost and consumer ratings. Could Amazon become the de facto clearinghouse of products that favor a circular economy and the vendor’s ESG practices? Absolutely! Companies that engage with their consumer stakeholders to articulate the ESG value their products and services provide, locally and globally, demonstrate ESG innovation that investors and consumers will reward with their collective purchasing power. This assumes companies, investors, and consumers will remain interested and curious about the ESG impacts and opportunities they control.
ESG reporting is here to stay. As uniform standards develop, consumers and investors will have access to more high-quality information and will demand more transparency and progress towards sustainability goals and circularity. While some progress has been made towards a circular economy, market pressure arising from ESG company and product rankings combined with regulatory mandates may provide the nudges needed to create a more sustainable future. Readily available ESG ratings may be just an Amazon click away.
