Enabling the circular economy through a new type of commodity funds : "eLLe funds" ( leasing raw material to circular value chains)

?The unexpected profitability of long-term investments through material circularity:?

Authors; Romain POULLES, Jeannot SCHROEDER, Vincent-Emmanuel MATHON

?How to transition from a short term to a long-term finance system through the systematic use of the product circularity data?

Introduction?

"Nothing comes into being nor perishes but is rather compounded or dissolved from things that are": this quote from Greek philosopher Anaxagoras, later reasserted by French chemist Lavoisier in the eighteenth century as "nothing is created, nothing perishes, everything is transformed" (rien ne se perd, rien ne se crée, tout se transforme) describes the way nature unfolds.

Nature can create new organisms from elements released by previously perished and disintegrated organisms, using a minor influx of (renewable) energy only.

The actual economy itself follows Anaxagoras’ principle during the creation of products. But in the end, the products become waste and cannot be re-integrated into a new production cycle, where, contrary to nature, waste does not exist. Besides, the linear economy is still highly dependent on fossil fuels. On a finite planet, this model is not sustainable over an extended period of time.

The current economic model does reward short-term value creation whilst ignoring systemic long-term adverse effects.

The change to a better economic system requires?two challenges to be addressed:

·??????rewarding low (and renewable) energy consumptions

·??????making long-term environmentally healing or regenerative investment strategies more profitable than short-term destructive investment

This article presents an alternative economic model based on circular economy to address both those challenges.

We start by analysing linear and circular economic models by considering them as games. We will then see how to shape a long-term, highly profitable investment strategy using standardized product circularity data (PCDS.lu: Product Circularity Data Sheet) as a systemic tool. We will finally study how this new investment strategy can inspire a new philosophy regarding the long-term management of raw materials.

I) Analyzing linear and circular models based on the theory of games

The linear model

A linear economy can be compared to a non-cooperative game, between human beings on one side and environment on the other side, with a finite number of moves (a move being every economic transaction requiring resource consumption) and where the equilibrium of Planet Earth is at stake. Maximizing profit in the short-term has been the main driver of such moves by humans. For decades after World War 2, this system enabled a steady growth of our global and national economies. High-Frequency Trading (HTF) is the ultimate result of such a short-term minded behaviour.

The linear economy rests on obsolescence whether programmed or desired: products must be continuously replaced after a given time to sustain the business model based on sales of products. Growth means that the moves must succeed with increasing pace since the sole source of profit is generated by selling products.

At a macroscopic level, this growth is requiring increasingly high levels of energy and materials.

This model does not take nature into account to work profitably.?It is a negative-sum game as human profits do not match the long-term environmental losses.

As awareness about this issue is rising, environmental regulations get more challenging. Nature then enters the system as a constraint, financially speaking, thus reducing pay-off for human beings.

The circular model

The circular model aims to turn the non-cooperative game of linear economy into a positive-sum cooperative game. By postulate, the moves generate economic added value and are regenerative for nature. Moves are no longer based on resource consumption but the continuous use of resources.

This model breaks with obsolescence as a necessity and short-term visions. It implies that pay-off will not result from the consumption of existing products but on those products' very use. Stock management will be the key to success in this game.

In an ideal circular model, retaining resources increases human pay-off while improving the damaged environment. The moves of such a game consist of transforming resources whilst preserving them for future use. Each move creates an economic added value for human beings.

This cooperative game also implies that all consumed energy comes from the sun. Hence, we will switch to an entirely renewable energy scheme.

II) The importance of trustworthy product information in a circular economy

In a linear model, the added value created during production and commercialization is lost once and for all after the products are discarded. They then become waste, and all the pieces of information linked to their manufacturing and their intended use are lost as well.

If, however, this information is stored correctly, one can then plan an alternative future use for this product (or its components) after its initial use.

For instance, metal beams embedded within a temporary parking lot structure could later be inserted into the metallic frame of a future building. Therefore, all information on the beams, their assembly, their composition, and their engineering process are readily available over time.

The Product Circularity data sheet (PCDS) initiative (ref: www.pcds.lu ) aims to fulfil this purpose by tracing, for each product, the chain of human added value from raw materials to the completion of the product, throughout the whole manufacturing process. It is a universal frame of reference, valid for all industries.

For each labelled product, one can trace back all the manufacturing steps – respecting intellectual property rights, of course –, the respective circular potentials and their threat to the environment if released into nature. The PCDS thus allows assessing the requirements to maintain, repair, reuse and recycle into a high-quality product.

The industry agonistic standard will lower the data generation cost along the supply chains. This set of data will be used to quickly and effectively evaluate the circular potential based on the PCDS received for all product components. Besides, the PCDS will help product designer to improve the overall circular performance of the products.

The added value of existing products is thus preserved, allowing the creation of a virtuous circle of continuous use of our resources. Subsequently, all PCDS-stamped products will have a higher market value, depending on their potential future use. This automatically generates a future market for PCDS products. A new market means new opportunities for investors.

An opportunity for the finance industry

Alternative investment funds with PCDS-stamped products as assets are therefore conceivable. This type of investment would follow the scheme of Private Equity, i.e., non-liquid assets kept long enough to reach maturity.

The difference is that such assets would not be a portfolio of stakes in corporations but a collection of physical products or materials. These products, designed for disassembly and reuse, could be easily transformed into new applications once the initial use is over, thus cutting down manufacturing costs. Such PCDS-based funds could reach significant yields in the long run.

They can be considered a brilliant way of long-term investing in raw materials. Here it is essential to notice that fundamental indicators (like the quality of extracted ores or the average energy need to extract a barrel of oil) clearly show that the 20thcentury with always cheaper raw materials is over and that in the future raw material prices will go up.

Like for each economic model, seed investments will sustain the transition from a linear to a circular economy. This trend is already underway with specialized funds, investing in renewable energy and impact investing, as examples. More recently, the first circular economy funds have been created. Yet this remains a niche.

In the future, the alternative funds with PCDS-stamped products will become mainstream investment vehicles, as they are versatile enough to adapt to all types of industries and sectors.

III) Reshaping the financial philosophy of raw materials

Based on circular data, this investment strategy enables quantification. It optimizes added economic value of products in the manufacturing process and during their use.

But the logic of the PCDS has also consequences on the way raw materials will be valued.?The PCDS can track all portions of raw materials used for a given product. Hence, the entire stock of raw material used in PCDS-stamped products can be traced.

Should the PCDS be widespread enough to be significant, one could conceive a new philosophy for raw materials investment.

Today, an investor in this sector will buy a stock of raw material and store it before selling it to a third entity with a profit. The final detailed product that will use the raw material is not of significant importance to the investor. This can lead to speculative attitudes as investors can deliberately choose to stockpile raw material with the sole intent to sell it at the right time to maximize profit. By so doing, they will deprive humanity of resources that have already been extracted from Planet Earth.

Let us suppose that instead of selling raw material, an investor would keep it and rent it to manufacturers that would use it for a circular product, documented with the corresponding PCDS. With the correct tracking technology, the position and amount of raw material would be precisely known. Therefore, the quality and use of the material is guaranteed overtime. Such an investor would generate a profit when rental income is higher than the PCDS and tracking cost (Potential risks, like material loss or poor future handling, have to be taken into account when calculating the rental fee). In addition as the majority of the material quality is preserved there is a guarantee for a continuous long term revenue stream.

This new philosophy of investment in raw materials is virtuous for the environment because it stimulates the permanent use of material by inserting them and maintaining them into a system of circular value.

Furthermore, the added value of a product will come from engineering and manufacturing only, not from the raw materials (separately owned) used for its assembly. This further deters speculative moves on raw materials.

This paves the way for alternative types of commodity funds. These will lease raw materials – and not sell them, contrary to traditional commodity funds – for the purpose of maintaining them in circular value systems. They will be the basic elements of the circular value chain.

Let us call this alternative type of funds, eLLe-Funds, for eLementary Lease funds.

An <eLLe> Fund will lease portions of raw material placed in circular, PCDS-stamped products and will thus have as assets a stock of raw materials plus product-related data to each item of this stock.

The entities (real estate landlords, factories) who will use this raw material will pay a rent because they will not possess raw materials. Thus, for each given unit of time where a portion of raw material is used (hence valuable), value is created for the <eLLe> Fund.

On the contrary, for each given unit of time where this portion remains unused, stored in a warehouse, or lost, the <eLLe> Fund will not generate regular earnings. This logic stimulates a continuous use of material and prevents losses and waste (resources and time). The users of raw material – the Tenants – will not own it. They will, however, benefit from the entire PCDS ecosystem and will be able to have their assets valued under a PCDS investment fund (as described above in part II).

For instance, a real estate landlord will not be the owner of the metal of its building. Instead, he will rent it (for a small monthly fee) from the <eLLe> Fund.?In return, the building's metal pattern will be clearly labelled and traced under the PCDS system.?So, a part of the building will be an asset of this PCDS-based fund as this building will integrate components that are PCDS-stamped and PCDS-valued.

The yield of the <eLLe> Fund will in the long run be higher than standard ‘simple’ raw material funds because in addition to stay owner of the material, the rental income, even if small, will generate an additional guaranteed level of income over time.

Even if for short periods of time, part of the underlying asset does not generate rental income - this happens when raw material is not effectively in use. This is a strong incentive to use the whole stock of raw material under management rather than to store it for speculative purposes.

The <eLLe> Fund will trigger a new vision where raw materials, and more generally, all extracted resources, will be considered a continuous stock of materials enabling human activities, yet permanently tracked and designed for continuous loops : “from cradle to cradle”.

Conclusion

To address the challenge of the circular model – namely a shift from the actual linear economy, that is a non-cooperative game against nature, to a new circular, restorative economy that will be a positive-sum game – we need to generate and handle high-quality standardized product data over the whole product cycle (from the design through to the end of use). A method is to document and trace, via a PCDS frame of reference, the added value and circular potential associated with the manufacturing of products.

PCDS-stamped products are perfect assets for new long-term investment funds, <eLLe>?(eLementary Lease) Funds. <eLLe> Funds will rent raw materials within circular product use cycles. Raw materials will then be considered as long-term stock that must be traced and that will be preserved for subsequent use. They are no longer considered mere commodities used for speculative short-term purposes only.

?eL