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ESG for SMEs: what if you do nothing?

Author: ICAEW Insights

Published: 15 Aug 2023

SMEs are lagging behind in the corporate quest to implement formal ESG practices, according to recent research – but they are inviting heavy penalties.

The majority of SMEs view environmental, social and governance (ESG) programmes as an unnecessary expense and don’t see the benefits, according to the World Economic Forum (WEF).

It cited UN research showing that fewer than half of businesses with a turnover under $25m are reporting on their sustainability performance. Among companies with revenues above $1bn, the figure is 94%.

UK-specific data is hardly more encouraging. A survey of more than 1,100 UK business owners from ID Crypto Global showed that just 19% of respondents are aware of what ESG is. Only 12% are implementing formal practices.

However, for many ESG experts, businesses are increasingly running out of excuses not to be playing their part.

Great expectations

For Crowe UK Head of Sustainability Alex Hindson, the demand for reporting is spurred by governments and regulators seeking to deliver on global commitments – such as the Paris Agreement – to keep a 1.5°C cap on temperature rises linked to man-made climate change.

“That overall objective has led to a series of legal, listing and regulatory requirements to implement ESG reporting, particularly on greenhouse gas (GHG) emissions,” he says.

Hindson also points to an increasingly wide range of stakeholders – including investors, customers and employees – expecting organisations to set improvement targets and report on progress against them. “A growing trend is for boards to link executive remuneration to the delivery of those targets, in alignment with stakeholder expectations.”

In the assessment of Luma Saqqaf, CEO of Middle East and North Africa (MENA)-focused advisers Ajyal Sustainability Consulting, legislation is the driving force – particularly the EU’s Corporate Sustainability Reporting Directive. “Its standards are so wide ranging,” she says, “they will force many non-EU companies to reassess their ESG strategy if they want to trade in the EU.”

Reporting is also helping investors to understand companies’ ESG outlooks, thereby enabling the rollout of coveted green or sustainable finance products. “That’s helping banks to achieve better disclosures on their green ratios – an area in which they are keen to improve,” Saqqaf says.

Independent Sustainability Consultant Jose Hopkins takes a more macro-level perspective on the importance of formal ESG policies. “Extreme weather is here,” he says. “We forget that the engine of every organisation is its employees. They’re one of the key stakeholders – and the human body can’t work in wet bulb temperatures above 35°C. The increased frequency and magnitude of extreme weather isn’t waiting for new regulations, or for you to reduce your emissions. It’s already affecting your staff – and, importantly, your supply chain, too.

Energy efficiency for business

The Department for Energy Security and Net Zero has launched a campaign to support business in improving their energy efficiency, including: no-cost and low-cost options, as well as potential longer term investments.

Department for Energy Security and Net Zero has launched a website supporting businesses to improve their energy efficiency.

Smarter choices

Hopkins sees a direct connection between the role of ESG reporting in tackling climate change and its facility for enabling businesses to enhance their operations and boost productivity.

“Preparing an ESG report with a double-materiality approach will help you to address business challenges you may never have previously considered,” he says. “On the ‘S’ side, that ties into mental health issues affecting employee productivity. It’s a great opportunity for you to step back and evaluate questions such as: where are we on wellbeing? What nutrition information are we providing our employees? What are the gaps in our people strategy?”

For Hindson, addressing ESG challenges through GHG reporting – particularly on emissions linked to utilities usage and business travel – will lead companies to make smarter choices. “Energy saving programmes, plus increased use of technology to reduce the need for travel, will help you cut not just your organisation’s carbon, but its cost base, too,” he says.

He also highlights benefits for staff attraction and retention. Factors other than pay are increasingly important to those evaluating where they want to work, he notes. “Having a strong, authentic narrative around sustainability – in particular around diversity and inclusion – can help to differentiate your organisation.”

ESG reporting can help businesses reframe challenges as opportunities, Saqqaf says. “In the MENA region, large global corporates are increasingly telling our clients that they are more likely to do business with them if they take care of issues such as emissions.”

Learning the language

Turning to the role that accountants should play in ESG reporting, Saqqaf points out that the 26 June rollout of new disclosure standards IFRS S1 and S2 underlines the notion “that an ESG strategy must be connected to business strategy and, therefore, financial planning”.

Hindson suggests that accountants can support sustainability professionals by imparting the disciplines required for preparing public reports that are fit for external scrutiny.

“In addition,” he says, “stakeholders will increasingly expect independent assurance over these non-financial reports – and firm-based accountants are well placed to work alongside sustainability professionals to deliver that provision.”

With accountants set to play a vital role in ESG reporting going forward, Hopkins urges them to grasp the relevant terminology. “Accountants and auditors I speak to often don’t understand the differences between concepts such as market, physical, chronic and acute risk,” he says. “Even in agricultural organisations with significant water use.”

He advises accountants to get to grips with the language of ESG. It will involve using terms that are not traditional in accountancy – but the Task Force on Climate Related Financial Disclosures, for example, has a range of workshops you can explore to build that knowledge. “Issues such as extreme weather and climate risk will affect your impairment testing, assumptions and judgments, so training yourself is key.”

Monitoring disruption

All three experts foresee serious challenges for companies that are either not looking into ESG reporting at all, or plan to do so only under legislative pressure.

“Choosing whether to be an early or late adopter is a crucial risk appetite decision for any board or senior team,” Hindson says. “A principal factor is the reputational impact of getting it wrong and being left behind, should your competitors see value in proceeding and gain advantages through new talent and clients.”

As building a robust ESG strategy takes time, Hindson stresses, employees would view management procrastination as a lack of buy-in – and perhaps move on accordingly. At the same time, Saqqaf notes, companies may miss out on valuable investment opportunities from financiers who are actively seeking to expand their ESG asset portfolios.

Hopkins says: “For me, it’s about capturing when your business is experiencing climate disruption to its operations and supply chains, monitoring that disruption and understanding it. For example, your business may have data centres that are at risk above 40°C. So, what happens when London hits 40°C every summer?”

Hopkins points out that some companies may be forced to overhaul their operations dramatically if they are unable to obtain key financial services because of where they are based – and that challenge would have to be reflected in their ESG reporting.

“In June,” he explains, “US-based insurer State Farm said it would no longer cover homes in California because of wildfire risks. The following month, Farmers Insurance said it would no longer cover homes or cars in Florida because of hurricane risks. This is real. It is happening.”

Climate for SMEs

Climate change is affecting businesses of all sizes. ICAEW is aiming to cut through the noise by providing tools and resources for small to medium sized businesses to build resilient business models and get to grips with ESG.

Support for SMEs on getting to grips with the impacts of climate change and ESG.

Monitoring disruption

All three experts foresee serious challenges for companies that are either not looking into ESG reporting at all, or plan to do so only under legislative pressure.

“Choosing whether to be an early or late adopter is a crucial risk appetite decision for any board or senior team,” Hindson says. “A principal factor is the reputational impact of getting it wrong and being left behind, should your competitors see value in proceeding and gain advantages through new talent and clients.”

As building a robust ESG strategy takes time, Hindson stresses, employees would view management procrastination as a lack of buy-in – and perhaps move on accordingly. At the same time, Saqqaf notes, companies may miss out on valuable investment opportunities from financiers who are actively seeking to expand their ESG asset portfolios.

Hopkins says: “For me, it’s about capturing when your business is experiencing climate disruption to its operations and supply chains, monitoring that disruption and understanding it. For example, your business may have data centres that are at risk above 40°C. So, what happens when London hits 40°C every summer?”

Hopkins points out that some companies may be forced to overhaul their operations dramatically if they are unable to obtain key financial services because of where they are based – and that challenge would have to be reflected in their ESG reporting.

“In June,” he explains, “US-based insurer State Farm said it would no longer cover homes in California because of wildfire risks. The following month, Farmers Insurance said it would no longer cover homes or cars in Florida because of hurricane risks. This is real. It is happening.”

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