Insights from ESG Evaluation for Circularity Assessment

Abstract

Sustainability and circularity co-exist and both encompass environmental, social, and economic aspects. In the past few years, we have witnessed ESG reporting gaining traction and with it, a fast rise in the market for sustainable finance and development. Developed countries are coming up with regulations governing the ESG reporting standards and performance, which has been a voluntary action so far. Several ESG reporting standards have been developed across the globe, typically containing many metrics related to circularity in both environmental and social aspects. In this chapter, several such global standards are discussed and one national implementation by the Athens stock exchange is detailed. Later in this chapter, current and upcoming regulations regarding ESG reporting in developed countries are provided. The European Union is the most advanced body of regulation on this topic and is covered in more detail. Trends in the sustainable finance and bonds markets are also presented at the end of this chapter, a market that will finance projects and developments towards circularity and sustainability. The chapter concludes with a call to incorporate a clear circularity assessment within ESG reports. Standard definitions of practices considered circular and how to best measure them need to be further developed.

1 Introduction

Where Chap. 1 introduced the generic concept of circularity assessment and its standardization, this chapter will consider circularity assessment within the wider framework of ESG reporting. ESG reporting finds its origin in a stronger push for CSR, specifically the will to embed non-financial responsibilities in a company’s governance and to create more ethical business models [1]. Especially the environmental category of ESG reporting metrics typically contains information related to a firm’s sustainability. An UNCTAD report showed that over half of the global top 100 listed companies report on $\text {CO}_2$ emissions, water consumption, waste generation, the reuse of waste, and energy consumption in their ESG reporting [2].

CSR strategies were originally considered as a tool to repair a tarnished brand name. The concept evolved a lot in the earliest 21st century when the financial sector faced a lot of scandals [1]. Over time, it proved that a good CSR performance led to increased access to financial markets and enhanced financial performance of firms, and consequently saw a broader adoption as well as gained governments’ interest [3, 4]. Recent studies show similar results for ESG reporting [5].

If ESG indicators have a higher strategic relevance, investors are more willing to invest in a company [6]. According to a study on companies that are enlisted in the Hong Kong stock exchange, ESG initiatives are better received by the market than other sustainability initiatives [7]. Especially, socially responsible investors are greatly enabled by good ESG reporting [8], often serving as a proxy for sustainability scores. One particular study in Japan found that ESG policy adoption creates indirect value creation for companies by first increasing their capacity to innovate, which in turn increases that company’s financial performance [9]. Listed companies with a high market capitalization benefit more financially from ESG disclosure than companies with a smaller market capitalization [10, 11]. In contrast, Chinese A-share firms do not show significant positive financial performance with a good ESG rating [12]. In another developing country, Bangladesh, there was a positive correlation [13]. ESG disclosure is most crucial for short-term profits while taking action to improve ESG ratings is more important for long-term financial performance [14].

In addition to ESG metrics correlating with a firm’s financial and economic performance (with a better ESG performance generally leading to a better financial and economic performance), the metrics also have strong interdependencies amongst the ESG metrics themselves, with environmental, social, and governance metrics enforcing each other [15, 16]. These interdependencies differ sector-wise. For example, for the consumer non-cyclical, healthcare, technology, telecommunications, and utility sectors, it is better to mainly focus on social performance. For basic materials, consumer cyclicals, and financial sectors, it is best to focus on environmental performance first to get greater overall sustainability [15]. The travel and leisure industry and the pharmaceutical industry seem to benefit most from a good governance performance [17, 18].

Despite the increasing evidence that ESG reporting has positive economic and financial effects on companies, it is still not exactly clear how to best motivate firms to report their ESG performance. S &P 500 companies, i.e., 500 of the largest companies listed on stock exchanges in the US, tend to differ a lot in their levels of disclosure [11]. S &P 500 firms are most likely to disclose corporate governance information and least likely to disclose environmental information (including CE metrics). One study in Italy found that high diversity in the board of directors has a significant correlation with ESG disclosure [19]. Having women on the board of directors shows a positive correlation in a majority of studies with large sample sizes [11, 19,20,21]. Linking executive compensation to ESG performance also shows a correlation with better ESG disclosure [11] (Fig. 2.1).

Fig. 2.1

Design adapted from a template; Copyright PresentationGO.com

An overview of the relationship between ESG regulations and standards (for reporting), ESG performance of businesses, and sustainable finance. The way businesses report their ESG performance is dependent on the government regulations and the standards set by stock exchanges and/or other organizations. The reporting also provides insights to the business stakeholders to improve their ESG performance and consequently get better access to sustainable finance. This can lead to more innovation and better profits.

In the following section, efforts taken towards standardizing ESG reports amongst firms and the potential of aggregating ESG reports useful for macro-analysis and policymaking are discussed. To further push ESG reporting, and indirectly, sustainable finance, governments have started to enforce ESG disclosure through regulations, which are discussed next. ESG metrics suffer from a lack of transparency and do not show enough convergence [8]. The lack of transparency leads to ‘green washing’, meaning that companies define products and processes as green/sustainable while in reality, they aren’t. The lack of convergence makes it harder to compare the available reports. The growth of the sustainable finance market, a market heavily reliant on ESG reporting which is growing at a rapid rate, is discussed. The chapter concludes with a summary of the lessons learned in this chapter.

2 Non-financial Reporting Standards

As previously mentioned, there are no universal standards for ESG reporting. Currently, regulated standards are being developed in the EU [22, 23]. Firms do have some established guidelines to adhere to, specifying what metrics to report on. In this section, some of the established international guidelines and one nation-specific reporting guide provided by the Athens stock exchange are discussed.

2.1 International ESG Reporting Guidelines

2.1.1 The GRI

The GRI is one of the most used reporting frameworks. Through better support to organizations, the initiative aims to make sustainability reporting a standard practice. The GRI provides the guidelines as two sets—(i) universal standards (set of basic metrics) and (ii) topic-specific standards (economic, social, and environmental metrics) to choose as per their needs of reporting.¹ Furthermore, GRI provides sector-specific standards. The disclosure topics covered by GRI are provided in Table 2.1. The GRI standards are continuously updated. For this reason, the standards have a modular approach to make it easier for companies as they do not have to completely overhaul their reporting when new standards are published. However, this does lead to increased discrepancy between the reports of different companies. The GRI tries to make the guidelines universally applicable to large and small, public and private companies. It provides such basic metrics with the aim that every company can report on them and more in-depth metrics for companies that have more resources to spend on sustainability reporting. The metrics are meant to better support internal organization policies and strategies as well as to help external stakeholders to evaluate an organization.

Table 2.1 List of disclosures provided by the GRI. Adapted from globalreporting.org

2.1.2 The Value Reporting Foundation (VRF)

In June 2021, the IIRC merged with the SASB into the VRF. As the results of this merger are yet to materialize, we will discuss the IIRC and the SASB separately. The IIRC provides guiding principles for reporting, while the SASB provides industry-specific disclosure topics. Taken together, the VRF hopes to harmonize the reporting processes and create comparability between reports.

The IIRC provides a framework that helps develop integrated reporting, linking financial, manufacturing, human, intellectual, natural, relational, and social capital. It aims to furnish better information to providers of financial capital, promote more coherent and efficient reporting, enhance accountability and stewardship, understand the interdependencies between different types of capital, and support integrated thinking from the short to the long term. The latest version of this framework (at the time of writing this chapter) has been released in January 2021, this was the first revision since the original release in 2013.

The SASB is a US-based NGO that provides industry-specific metrics for sustainability reporting. Currently, SASB covers 77 industries and provides the ESG metrics most relevant for financial performance in each of these industries. The focus of SASB on metrics that affect financial performance most, is what sets SASB apart from GRI. SASB metrics are important for investors and integrate well with financial reporting.

2.1.3 Carbon Disclosure Project (CDP)

The CDP provides a set of questions for companies to assess their progress in minimizing climate change risks under the four categories: climate change, supply chain, water usage, and forestry management services [1]. The CDP aims specifically at companies, cities, and states or regions, and tries to also help its clients to align with regulations and the G20’s Task Force on climate-related financial disclosures. Standards for measuring carbon footprint relevant for ESG reporting are provided by the CDP.

2.1.4 Task Force on Climate-Related Financial Disclosure (TCFD)

TCFD is a voluntary and market-driven initiative [2]. It provides recommendations to improve the disclosure of climate-related information in existing financial reports. TCFD’s objective is to help companies better identify risks and opportunities that come from climate change, which ultimately helps investors to make better decisions. The recommendations are categorized into the following four areas: governance, strategy, risk management, metrics, and targets. TCFD also provides further principles and recommends climate-change scenario analysis.

2.2 The ATHEX ESG Reporting Guide

In recent times, many stock exchanges have chosen to self-regulate the ESG disclosures of the listed companies and provide a voluntary reporting guide on what metrics to report. The ATHEX [3] is one of them, inspired by the UN SSE initiative in 2018. The guide offers both a suggestion of metrics to report on and offers practical guidelines on how to disclose them. Other stock exchanges around the world offer similar guidelines. The objectives of ATHEX ESG Reporting guidelines ² are as listed below.

• To create more awareness on why ESG disclosure is important and highlight opportunities arising from it.

• To make it easier for companies to disclose ESG information.

• To improve the quality, comparability, and availability of ESG information provided by firms listed with ATHEX.

• To enhance the image of Greek companies.

• To improve information flows between companies, investors, and other stakeholders.

• To help investors better utilize ESG data in their decision-making.

While the reporting guide is mainly aimed at companies listed with ATHEX, it also aims to be relevant for other companies, small and big, and in all sectors that want to voluntarily disclose ESG data. It provides best practices for both companies that already do ESG reporting and companies that want to do ESG reporting for the first time. While the guide is for voluntary reporting, it aligns with requirements from the EU’s active Non-Financial Reporting Directive (which applies to Greece as the country is an EU member). The metrics provided are increasingly important to investors for both listed and non-listed companies. The expected results of following the guidelines, according to ATHEX, are as follows:

• Better access to capital

• Compliance with future regulatory changes

• Better corporate performance

• Better stakeholder engagement

• A better reputation.

2.2.1 Core Metrics

The ATHEX guide provides some core metrics (listed in Table 2.2) that it advises for all companies. They are deemed the most important metrics and universal across the entire economy and applicable to companies in all sectors.

Table 2.2 Core metrics for ESG reporting provided by the ATHEX (see Footnote 2)

2.2.2 Advanced Metrics

The advanced metrics (listed in Table 2.3) should help companies that perform well in ESG areas to showcase their good performance, attracting more investments.

Table 2.3 Advanced metrics for ESG reporting provided by the ATHEX (see Footnote 2)

2.2.3 Sector-Specific Metrics

Sector-specific metrics are not relevant to all companies, but only to a subset of companies listed with ATHEX. These metrics are listed in Table 2.4 mostly highlight ESG-related risks that are relevant to specific sectors (e.g., the management approach to the use of critical materials for the technology and communication sector or environmental and social management in manufacturing companies).

Table 2.4 Sector-specific metrics for ESG reporting provided by the ATHEX (see Footnote 2)

3 Non-financial Reporting Regulations in Different Regions of the World

This section will detail several regulations related to ESG reporting that currently exist or are in development. Harmonized regulation on both ESG reporting, ESG performance, and defining circular practices will lead to a further thrust for the adoption of the CE, as investors and firms get more security on their investments. Special focus is given to regulation in Europe as Europe is by far the largest market for sustainable finance products and currently influencing regulations worldwide.

3.1 The UN Global Compact

Through the UN Global Compact, the UN provides a voluntary scheme for ESG reporting. By becoming a participant or signatory, companies commit to following ten principles laid out by the UN Global Compact [1]:

• 1. Businesses should support and respect the protection of internationally proclaimed human rights.

• 2. Businesses should make sure that they are not complicit in human rights abuses.

• 3. Businesses should uphold the freedom of association and the effective recognition of the right to collective bargaining.

• 4. Businesses should uphold the elimination of all forms of forced and compulsory labor.

• 5. Businesses should uphold the effective abolition of child labor.

• 6. Businesses should uphold the elimination of discrimination in respect of employment and occupation.

• 7. Businesses should support a precautionary approach to environmental challenges.

• 8. Businesses should undertake initiatives to promote greater environmental responsibility.

• 9. Businesses should encourage the development and diffusion of environmentally friendly technologies.

• 10. Businesses should work against corruption in all its forms, including extortion and bribery.

So far, over 12000 companies and other entities have committed to the UN Global Compact worldwide. These participants and signatories must report annually on the progress they make regarding the ten principles outlined above. Adopting ESG measures through the UN Global Compact provides both financial and non-financial benefits to the firms [24]. Points 7–9 are most relevant to material circularity. The depletion of natural resources is deteriorating the environment, especially in the case of fossil fuels. By achieving circularity, societies put a much smaller strain on the environment. As a first step, businesses, especially those involved in the production of goods, should be geared towards circularity and take responsibility for their operations and their supply chain. However, currently available technologies are too limited to achieve circularity while maintaining our standard of living. Thus, innovation toward more environmentally-friendly circular technology is necessary. The other principles aid in boosting the social aspect of circularity.

3.2 The EU and EEA

The member states of the European Union, together with the members of the European Economic Area have the most developed non-financial reporting regulations [1]. The first regulations to create EU-wide reporting standards targeting large undertakings and groups were the 2013 and 2014 directives regarding the disclosure of non-financial and diversity information [25]. These directives have been adopted in national law by all EU and EEA member states as well as in the United Kingdom (which at the time was still a member of the EU). Under the directives [2], large companies are to provide public information on:

• 1. Environmental matters,

• 2. Social matters and treatment of employees,

• 3. Respect for human rights,

• 4. Anti-corruption and bribery, and

• 5. Diversity on company boards (in terms of age, gender, educational, and professional background).

The EU directives did leave some room for interpretations which caused some differences between the national laws. Differences are mainly found in which companies have to comply with the reporting regulations, which formats have to be used for the disclosure, and which penalties are given for non-compliance [22]. 64% of EU stock exchanges publish guidelines for ESG reporting for the listed companies in an attempt to standardize ESG reporting, which can be followed by the companies voluntarily [22]. In practice, the voluntary action has resulted in only 17% of the EU’s large companies publicly reporting on environmental regulation as per the directives in 2019 [22]. Roughly 88% of the large EU companies that publish environmental governance information address the topic of waste, and 73% address the use of natural resources [22]. The increasing number of reporting requirements and frameworks is leading to an increasing amount of inconsistencies between companies, or even within a company when it comes to reports from different years, on what is reported, the used definitions, and the scope. The regulations and frameworks are often hard to comply with for SMEs in particular [22]. While SMEs are not directly obligated to report on ESG publicly in the EU and EEA countries, large companies increasingly ask for ESG reports from SMEs in their supply chain as they need the information for their reports.

Sustainable finance is considered to play a key role in realizing the EU’s vision for a sustainable future as outlined in the European Green Deal [1] and to comply with international commitments such as the Paris agreement [26]. A separate action plan on sustainable finance has also been released [2] as well as a strategy for financing the transition to a sustainable economy that relies on sustainable finance [3]. The European Commission is currently working on several directives, regulations, and other instruments to further develop ESG reporting requirements and standards.

3.2.1 Corporate Sustainability Reporting Directive

In April 2021, the European Commission proposed a new Corporate Sustainability Reporting Directive [23]. The proposed directive would task the EFRAG with developing the draft of standards for ESG reporting. EFRAG will publish their first version of the draft by mid-2022 and will consider external expert advice for the same. Besides, the European Commission will task the Member States Expert Group on Sustainable Finance as well as the European Securities and Markets Authority with providing consultations and feedback to the commission. The European Commission will also ask the European Banking Authority, the European Insurance and Occupational Pensions Authority, the European Environment Agency, the European Union Agency for Fundamental Rights, the European Central Bank, the Committee of European Auditing Oversight Bodies, and the Platform on Sustainable Finance to provide inputs to improve the draft. One of the missions given to EFRAG is to comply with existing international (voluntary) standards that have seen broad adoption. Furthermore, the proposed directive aims to build on the EU Taxonomy regulation. The proposed directive—

• 1. will make ESG reporting mandatory for all large companies as well as all companies listed on regulated markets (except listed micro-enterprises),

• 2. compel the audit (assurance) of reported information,

• 3. will extend the reporting requirements with more detailed provisions that include following EU sustainability reporting standards, and

• 4. requires companies to digitally tag the reported information, so it is machine-readable and compatible with the European single access point which is developed for the capital markets union action plan ³ [1].

The new directive is being developed as the old directives on the disclosure of non-financial and diversity information were deemed insufficient [23]. Company reports often do not contain all the information investors and other stakeholders increasingly look for. Furthermore, it was difficult to compare information between companies as there were no enforced standards. Investors in the EU and EEA need accurate information on the non-financial performance of companies to comply with the EU regulation on sustainability-related disclosures [27].

The new directive puts a special focus on SMEs. A separate reporting standard is proposed for SMEs so that they do not lose too many resources on creating ESG reports but can still use standardized ESG reports to enable better access to the sustainable finance market. Listed SMEs will be required to follow this simplified standard, non-listed SMEs can follow the standard voluntarily according to the proposal.

3.2.2 The EU Taxonomy Regulation

In 2020, the EU approved the EU taxonomy regulation, allowing for delegated acts that establish a taxonomy to facilitate sustainable investments [28]. In July 2021, a delegated act of the EU Taxonomy was released that obligates firms to publish specified key performance indicators on their turnover, capital, and operation cost linked to environmentally sustainable economic activities, with the act further specifying what counts as such activity [1]. The taxonomy is compliant with the existing non-financial reporting directive as well as the proposed Corporate Sustainability Reporting Directive, it applies to the companies specified by those directives. The delegated act, through defining sustainable activities, harmonizes ESG reporting and helps investors to decide on what is a sustainable investment. Companies are aided in being able to better communicate their non-financial performance and try to outcompete competition as the equal reporting standards create a fairer market. The focus of this first delegated act was mainly on climate mitigation and climate adaptation activities.

In 2022, the European Commission is expected to launch a delegated act for the EU Taxonomy Regulation that defines what products/processes qualify as CE activities as well as for the sustainable use and protection of water and marine resources, protection and restoration of biodiversity and ecosystems, pollution prevention and control, as well as providing a few additional specifications for the climate change mitigation and adaption activities. In August 2021, a draft report was published by the EU’s Platform on Sustainable Finance with their work to date [1, 2]. The sectors covered in the draft are:

• 1. Agriculture, Forestry, and Fishing,

• 2. Construction and Buildings,

• 3. Information Communication Technology, and Emergency Services,

• 4. Mining and Processing,

• 5. Manufacturing,

• 6. Energy,

• 7. Transport,

• 8. Restoration and Remediation, and Tourism, and

• 9. Water supply, Sewerage, and Waste Management.

For each of the sectors, technical specifications are presented to define what qualifies as circular activities. This provides a clear understanding of what is considered part of the CE, harmonizes reporting on these activities, and better enables sustainable finance to fund these activities; ultimately speeding up the transition to a CE.

The EU Taxonomy Regulation provides the following definition of the CE–

An economic system whereby the value of products, materials, and other resources in the economy is maintained for as long as possible, enhancing their efficient use in production and consumption, thereby reducing the environmental impact of their use, minimizing waste, and the release of hazardous substances at all stages of their life cycle, including through the application of the waste hierarchy.

The taxonomy regulation also specifies if an activity qualifies as contributing substantially to the transition to a CE. The draft of the delegated act proposes to categorize CE-related activities into one of four categories (listed below) and related issues, based on a yet unpublished report by the EU’s Joint Research Centre titled ‘Development of the EU Sustainable Finance Taxonomy—A framework for defining substantial contribution for environmental objectives’.

• 1. Circular design and production

  • Lifetime management

  • Material choices

  • Design for end-of-life management

  • Closed-loop production processes.

• 2. Circular use

  • Life extension

  • Use intensification.

• 3. Circular value recovery

  • Preparation for re-use (e.g., resale, repair, remanufacturing, etc.)

  • Recycling

  • Recovery.

• 4. Circular support

  • Enablers of solutions to the above issues (e.g., digital tools, consulting, predictive maintenance, etc.)

  • Enablers at the interface between activities (e.g., waste trade, charity shops, IS, infrastructure, etc.).

Companies can list their activities if it complies with the provided screening criteria by the EU through an upcoming delegated act [1]. Though, these activities should not harm any of the other objectives set out in the EU’s delegated acts of the taxonomy. They also have to comply with a set of basic social safeguards. If these conditions are met, then a company can, and should, list that activity as sustainable in their non-financial performance reports and they are eligible for sustainable finance.

3.3 The United States

While the United States has one of the most advanced financial reporting systems, the country is falling behind in the area of non-financial reporting [29]. The US SEC is a government agency which is responsible for protecting investors and should ensure that they are provided with material information to make informed investment decisions. The SEC has issued some mandatory disclosure on corporate governance, such as pay ratio disclosure. However, when it comes to voluntary disclosure, the US has a relatively large number of provisions to report on. Over half of the voluntary provisions are on environmental governance. The Chair of the SEC appointed in 2021 has directed staff to consider mandatory provisions on data disclosure if sustainability claims are made [1].

3.4 Canada

In Canada, compared to the US, there are more mandatory provisions to report non-financial information. However, the majority of these provisions go to requesting authorities and not to the public mainstream (annual) reports [29]. Information that has to be publicly disclosed is often corporate governance-related. Reporting to authorities in most cases concerns environmental provisions, such as the use of pollutants, emissions, and environmental incidents.

3.5 Japan

Japan (with its non-financial reporting regulations) is not among the best-performing countries, but is quickly improving [30]. Currently, Japan has a ‘comply or explain’ model for environmental disclosure. However, the country’s financial regulator, the FSA, has created a working group with the mission to create mandatory provisions on ESG disclosure with more options to enforce it [2, 3]. The FSA is also working on a certification for ESG funds with further provisions to avoid greenwashing. Voluntary ESG reporting amongst listed firms in Japan has proven to correlate with higher abnormal returns on the stock market [31].

Fig. 2.2

Adapted from UNCTAD [5]

Sustainable assets under management in billions of USD, split by region.

Fig. 2.3

Adapted from NN Investment partners and UNCTAD [5]

Size of sustainable bonds market, split by type of bond.

3.6 China

China’s mandatory non-financial reporting provisions have so far focused mainly on corporate governance. However, since 2020, the CSRC is drafting new rules for listed companies in the area of environmental and social governance while also streamlining corporate governance reporting. At least two consultation rounds on the topic have been concluded in 2021 [1, 2]. A mix of mandatory and voluntary provisions is proposed in the draft. Currently, the proposals contain low penalties for breaches and are thus, not seen as a strong motivator. However, it is expected that the penalties will be increased in the coming years. China aims to have a nationwide environmental disclosure system by 2025 that will be a driving force in achieving sustainable growth and reaching emission targets. China’s goals for introducing non-financial reporting regulations seem inspired by the large growth of China’s ESG debt market in recent years. Sustainable bond volumes in the Asia-Pacific region have shown over 200% year-on-year growth recently. This is in part due to recent green bond innovations in China [3]. The lack of non-financial reporting regulation has scared off major investors from the Chinese ESG debt market [4]. Companies with good ESG profiles and good ESG reporting have shown both higher returns and reduced credit spreads in China [32, 33].

4 The Importance of ESG Reporting for Sustainable Finance and Bonds Markets

As previously mentioned in the introduction of this chapter, ESG reporting is beneficial both financially and non-financially to companies and other organizations. Good ESG performance is known to lead to better access to financial markets [3, 4, 6]. ESG initiatives are better received by the market than other sustainability initiatives [7]. ESG policy adoption also increases innovation, for example by providing better access to finance for research and development [9]. ESG metrics also enforce each other through complex interdependencies [15]. Besides direct performance, ESG reporting is also increasingly required for public procurement/tenders, to attract subsidies, and to get access to the rapidly growing market of sustainable finance.

The UNCTAD estimated that the market for sustainability-dedicated investments for 2020 amounted to 3.2 trillion USD, an 80% rise over 2019 [5]. Figure 2.2 shows the historic growth of sustainability funds and assets from 2010 to 2020 (numbers for 2020 are as of June 30). The largest market by far, for sustainable financial products, has been Europe for the last decade. Other regions, especially the US, have recently shown a large growth in the ESG market as well and might gain on soon as the sustainable finance market matures [5].

Sustainable bonds are much like regular bonds, but with the additional commitment from the issuer to use the money towards sustainable investments. Sustainable bonds, totaling 1.5 trillion USD, represent only 1.26% of the global bond market. However, this financial product shows an average annual growth rate of 67% [5]. The UNCTAD expects this market to still be in its early growth stage, expecting the market to grow to 6 trillion USD (5% of the global bonds market). This growth is facilitated by the increased adoption of ‘green exchange markets’ by stock exchanges. 37 stock exchanges offered such markets as of July 2021, with the first one opening in 2011. Sustainable bonds can be categorized into green bonds, social bonds, and mixed-sustainability bonds. Green bonds first emerged in 2014 but since then have become a 300 billion USD market by 2021, as can be seen in Fig. 2.3. The Green bond growth was lower than expected in 2020, which is likely caused by deferred projects because of the onset of the COVID-19 pandemic [5].

Banks play an important role also through the issuance of green loans and ‘sustainability-linked loans’. Green loans are specifically used to finance green projects and assets, and sustainability-linked loans are tied to a borrower’s ESG-rating, not specifically to how the money is used. Sustainability-linked loans are a relatively new financial product that came into existence in 2018 with the establishment of the Green Loan Principles. Later on, sustainability-linked loan principles were published by the Loan Market Association, an interested group of banks [33]. Sustainability-linked loans saw a meteoric rise in 2018 and 2019 as can be seen in Fig. 2.4. Such loans are primarily issued in the EMEA region, but the North America and Asia-Pacific regions have been catching up lately.

Fig. 2.4

Adapted from UNCTAD [5]

Size of green loan and sustainability-linked loan markets, split by region for 2019 and 2020.

The adoption of ESG reporting, because of a lack of regulated standards and requirements, is mainly driven by stock exchanges trying to push non-financial reporting through self-regulation. The number of stock exchanges engaged in promoting ESG has risen considerably in the last decade [33]. ESG reporting and other non-financial regulations are increasingly attracting the interest of government regulators in recent years, pushed by a need to transition to more sustainable economies and increasingly realizing the financial benefits of sustainability reporting.

The seeming concentration of sustainable finance in Europe, and the fact that European regulation is, or soon will, surpass the depth of regulation in other markets, creates the risk that the EU will set a global standard for sustainable finance regulation. Within the regulatory competition, a so-called ‘race-to-the-top’ means that companies try to make their products comply with the toughest regulations, even in markets where such regulations are not in effect. An example of this would be the Brussels Effect [34,35,36] caused due to the European regulation. The risk here is that the regulation coming from the EU is often designed with a very Euro-centric mindset. Indigenous methods in developing countries that should be considered circular, might not be covered by the European taxonomy on circularity and thus not eligible for sustainable finance and/or properly covered in ESG reporting. This might lead to underdeveloped sustainable finance markets in those countries, and a slower transition towards the CE.

5 Lessons Learnt from ESG Metrics and Reporting

ESG reporting is gaining traction, evidenced by increased adoption by corporations and regulation of reporting standards. ESG reporting serves a number of purposes. Mainly, it indicates the sustainability performance of a firm to a wide range of stakeholders and provides access to a growing market of sustainable financial products, from loans to bonds and investments (a market that shows a strong annual double-digit growth and is expected to reach a market cap of 6 trillion USD globally by 2025 according to UNCTAD). Subsidies and public procurement tenders are increasingly relying on ESG reports as well. Another interesting development is the emergence of ESG rating agencies and the closely linked sustainability-linked loans.

ESG reporting provides valuable information not only for investors but for many other (external) stakeholders such as policymakers. When a significant part of a local/regional/national/supranational economy is covered in ESG reports, that information can be used effectively by policymakers to tailor their work. To be able to aggregate the data from those ESG reports, it is important that many firms/organizations publish them and that they follow the same reporting standards. Currently, many countries have systems in place to aggregate data on $\text {CO}_2$ emissions, but this is only done for a few other ESG metrics. A problem with aggregating ESG reports is that reports typically present consolidated data for the entire company/organization spread over different parts of the world. This consolidation can make it hard to localize the impacts of ESG issues, making it less valuable to policymakers. The next step in ESG reporting could very well be the disclosure of localized ESG reports, that form a subset of the consolidated companywide ESG report, to better inform employees and local policymakers about specific conditions in a specific area of interest.

Besides the standardization and mandatory enforcement of ESG reporting, the European Union plans to standardize the digital reporting of both financial and non-financial (including ESG reports) information to better aggregate such data for macro analysis. These efforts are part of the creation of a single capital markets union [1,2,3,4]. In addition, a single point to access this digitally disclosed information is also created for the benefit of investors, analysts, asset managers, consumers, NGOs, data vendors, credit risk assessment entities, and banks amongst others [6, 7].

A big step to consider in the coming year is the standardization of ESG reports. Right now, ESG reporting suffers from a lack of consistency. The results of different firms are hard to compare with each other, and even within organizations, the results from one year to the next can be hard to compare. Standardization has so far been driven mainly through self-regulation, often organized by stock exchanges. Several NGOs have provided principles and standards that are being increasingly adopted globally. Regulators are still working on enforcing reporting standards, the first comprehensive regulation in this area is expected to take effect in Europe in 2023.

5.1 A Call for Clear Circularity Assessment Within ESG Reporting

Current voluntary ESG reporting standards have metrics relevant to the CE, such as the metrics related to the use of critical raw materials and water. However, many aspects of the CE are yet to be properly captured in current best practice ESG reporting metrics. Partially, this is due to the lack of a clear universal definition of what accounts for sustainable circular practice and what doesn’t. Therefore, there is a need for the integration of ISO standards for circularity assessment with standardized ESG reporting in the future. Since the 2015 Paris agreement, countries have agreed to create binding taxonomies on what counts as sustainable and what doesn’t. In coherence with this agreement, the European Union will release a taxonomy specific to CE practices in 2022. This must be tied to ESG reports to enable clear comparisons between organizations on how circular they are.

Sustainable finance forms a considerable driver for firms to become more sustainable. With specific taxonomies defining which circularity-related practices are considered sustainable, this funding will also become available for companies transitioning towards a circular business model. With the expected growth of the sustainable finance sector, investors- both institutional and individual, will increasingly provide a push to enhance circularity. For this reason, it is also crucial that a company’s circularity be reflected in its ESG reporting, allowing investors to make better decisions and creating a further driver for companies to become more circular. ESG regulation and sustainability taxonomies (including circularity) thus provide a powerful tool for governments to steer the market towards investments in the CE.

In Part II of this book on measuring circularity, we provide the indicators currently used for assessing various systemic levels from macro to the nano, most of which have relevance to comprehensive ESG reporting.