Why should SMEs care about ESG?
Businesses are faced with increasing pressure to integrate environmental, social and governance (ESG) reporting into their practices and business models. This pressure comes from multiple stakeholders. According to a recent poll, 88% of institutional investors put ESG on par with operational and financial considerations when making investment decisions; 60% of employees choose a place to work based on their beliefs and values, while 58% of consumers buy or advocate for brands based who match their beliefs.
The focus of regulators, consumers and investors tends to be directed at large and public multinationals. In large part, this is because they are visible and have significant impacts as well as resources. As a result, many of the world’s biggest corporates have had to move quickly and are already committed to shifting their practices and being transparent about their ESG performance.
Small and medium sized enterprises (SMEs) represent 90% of all firms globally, contribute to roughly 70% of employment, and drive up to 70% of global GDP according to the International Labour Organization. Notwithstanding, they often lag very far behind large corporates in integrating ESG factors into their strategy and publicly reporting on their ESG performance overall. This is not only a bad thing for sustainable outcomes, given the combined impact of SMEs, but is also bad for business.
So, why should SMEs care about ESG? Here are three key reasons.
While still largely voluntarily, corporate disclosure regulations are on the rise at a global scale. ESG regulations and standards have doubled globally in the last five years, and mandatory ESG regulation efforts in the European Union, the US, and Asia are picking up pace.
In the EU, the leading regulatory market, about 11,700 large public interest companies are already required to report on non-financial matters since the adoption of the Non-Financial Reporting Directive (NFRD) in 2018. This directive is now being updated into the new Corporate Sustainability Reporting Directive (CSRD), which expands the scope of the requirements and apply them to 50.000 public-interest and listed companies. Notably, the CSRD adopts a whole value chain approach, requiring companies to report at the level of their subsidiaries. What’s more, the EU plans to require the same level of reporting from listed SMEs from January 2026.
National governments and regulatory bodies are also increasing their regulatory efforts. For example, stock exchanges around the world are adopting ESG reporting rules and pushing companies to publish ESG performance data. Of the 120 exchanges in the UN-backed Sustainable Stock Exchanges (SSE) initiative, 33 have mandatory ESG listing requirements and 67 provide guidance on ESG reporting for listed companies. Several countries like Brazil, Hong Kong, Japan, New Zealand, Singapore, Switzerland, and the United Kingdom have also announced requirements for domestic organizations to report in alignment with the TCFD recommendations.
At a more global scale, the ongoing development of the International Sustainability Standards (ISSB) and the European Sustainability Reporting Standards are two very strong signals of what is to come – technical, auditable, and in-depth mandatory corporate disclosure on a range of ESG issues across industries and business sizes. But a clear and measurable focus on social and environmental sustainability creates opportunities beyond compliance.
Changing consumer demands
Consumer behaviour is changing rapidly and while customers used to look at big, established brands as guarantors for quality, small businesses and local products are the new fashion. Customers – Millennials (born between 1981 and 1996) in particular – tend to turn to local brands with an interesting story and strong ideals.
Consumers are also increasingly favouring brands that act responsibly and demonstrate commitments to social and environmental goals. In 2019, nearly one-third of the world’s population belonged to Generation Z (born between 1997 and 2012), a target group that prioritizes social justice, action against climate change, and who let their individuality shape their purchasing behaviour. This literally translates to changes in the balance sheet. According to a McKinsey study focusing in the fine jewellery industry, 20 to 30 percent of global fine jewellery sales will be influenced by sustainability considerations by 2025, from environmental impact to ethical sourcing practices. This is equivalent to as much as $110 billion, which is a 3 to 4 time increase in sustainability-influenced purchases since 2019.
The customers of tomorrow are likely to hold companies accountable for their environmental and social impact and expect businesses to ’walk the talk’ contribute positively. To show consumers that they are credible and sincere about driving environmental and social progress, SMEs will need to improve their sustainability “walk” (performance) and “talk” (reporting).
Access to finance
ESG-oriented investing has experienced a meteoric rise, with global sustainable investment now topping $30 trillion—up 68% since 2014 and tenfold since 2004. Similarly, ESG lending activity around the world has grown exponentially during recent years—from $6 billion in 2016 to $322 billion in 2021—becoming an important segment of the global loan market.
With investors increasing relying on sustainability reporting to guide their funding decisions, SMEs who fail to share transparent and reliable information could be denied vital financing, stifling growth and innovation. According to a Eurobarometer survey, more than a quarter of SMEs that have undertaken activities related to the circular economy reported difficulties in accessing financing due to a lack of clarity about their overarching sustainability strategy.
Today, many ESG financing initiatives are still designed for larger companies, but the SME community is a sizable untapped segment for ESG financing, and SME-tailored programmes are expected to grow. For example, one of Asia's first ESG-focused structured finance programmes for SMEs - the $60m Incomlend ESG Invoice Financing Programme - will assess SMEs' ESG plans using established international standards, such as the United Nations (UN) Principles on Business and Human Rights and the UN Sustainable Development Goals (SGDs). This alternative financing initiative will provide SMEs that meet the ESG criteria with quick turnaround invoice financing solutions.
As investors' interest in ESG continues to grow, it will inevitably lead to the emergence of more ESG financing programmes. As pressure from investors and the financial sector grows, the risk of inaction is clear – access to capital will be more difficult and more expensive.