The importance of ESG for SMEs

• Climate change is a key risk for businesses, but also represents opportunities for SMEs who can embrace sustainability early in their lifecycle.
• Embedding sustainability from the beginning means it grows with you, develops and evolves along with the company.
• SMEs who invest in sustainability will likely find a competitive edge, as well as future-proofing the resiliency of their business.

There was a time not too long ago when environmental, social and governance (ESG) issues were a niche concern for businesses and indeed, for the wider public. But in recent years, we've seen a lot of key developments when it comes to ESG. The 2015 Paris agreement on climate change set the stage for sustainability to become part of the public consciousness. In the intervening years, extreme weather events have shown the impact of failing to curb global warming. And that comes with an urgency to act, not just on climate change, but on social impact and governance issues as well.

Activists have campaigned on a range of issues and a global pandemic has pointed out to us all how important the S in ESG is. We’ve seen rising global awareness of issues from plastic pollution to biodiversity, and from social inequity to work/life balance. We have more listing rules, stewardship codes, and governance codes, and there's been a lot of pressure on companies, especially listed companies, to disclose how they’re acting. Climate change is at the fore here, but we are also beginning to see a convergence of standards, and a growing demand that companies act sustainably for all stakeholders.

When businesses first begin to think about their responsibility to the environment, what often gets missed is that climate change should not only spur them to embrace sustainability, it will also have direct effects on their business operations. Every company, from the largest to the smallest, needs to address adaptation and build resiliency into their business and their strategy. Those who do will find that they are future-proofing their business and building resiliency and a competitive edge into their operations.

Firms should assess risks and vulnerabilities, as well as opportunities, at a country level. There are transition risks, policy changes and technology changes, and there are also physical risks, from extreme weather events and dwindling resources.

The Earth’s water resources, for example, will alter with climate change. Precipitation will become more frequent and more intensive in some regions, and businesses need to be ready with flood defenses at key locations. Assets or operations below a certain height above sea level, often as little as five metres, will be at risk. Similarly, ports and surrounding infrastructure may be at risk, affecting your supply chain. If you’re in a water-intensive industry, you need to think about how water availability may change. In agriculture, you need to think about sea rises.

Net-zero targets will need to be backed up with methodologies for implementation. Carbon pricing will become more prevalent, starting with larger companies, but moving down the emission thresholds with time. Some jurisdictions, including Europe and the US, are considering carbon border taxes that will require products and services to be below a certain common threshold. These trends will eventually affect all companies, but even initially, it will be important for smaller companies along the supply chain to conform to the standards of larger corporations. Small firms may actually find that their products gain a competitive edge if they build in sustainability from the start. Larger companies may find it difficult to pivot an entire product cycle towards sustainability, but by starting out sustainable, small firms will already be in a prime position to benefit.

For SMEs, sustainability should be woven into your mission statement and your purpose as a company. Embedding sustainability from the beginning means it grows with you, develops and evolves along with the company. Not all ESG issues will apply to all companies, so look for where your company can really make a difference. Are you more involved in the environmental side? Should you be more focused on climate change or pollution? Do your operations affect water and soil or plastics? Or are you a services company? What are the effects in terms of your employment quality, or health and safety?

There’s also significant overlap among the environmental, social and governance factors. Climate change issues that affect people tend to become social issues, for example. Environmental issues are managed at a corporate level, and that’s part of governance. Bad governance can also affect people again, bringing it back to a social issue. It’s clear that the silos of E, S and G are not always helpful – instead, you should think about sustainability issues as a whole.

When looking for a place to start, the 17 UN Sustainable Development Goals help to capture that overlap. They cover many different areas of sustainable development, often from the human perspective, but also natural capital, biodiversity, and related issues. They range over poverty, global hunger, equality, education, clean water, affordable energy, and much more, offering a useful framework to help you prioritise your businesses’ sustainability goals.

The SDGs are also recognisable and aligning your ESG goals to such a well-known standard will help others to benchmark your business.

There are many drivers in embracing sustainability; protecting the company reputation, customer satisfaction, improving stakeholder relationships, responding to investor pressure or simply a sense of responsibility and concern. These drivers are present for large and small enterprises, and whatever the size of business, it must be recognised that sustainability is a journey.

Many firms look at internal operational sustainability first – for example, using less energy or less paper, or producing less waste. As sustainability develops within a company, it will encompass risk management and the needs of stakeholders, from customers to suppliers to investors. And eventually, sustainability becomes strategic. It becomes an integral part of your corporate strategy, so that every single part of a decision at a corporate level has sustainability in mind.

As regulators make first voluntary and then mandatory rules on disclosure for listed companies, other businesses will need to follow. There are already countries writing ESG-related amendments to legislation, such as the Companies Act in the UK. This signals a shift that will embed ESG across the whole economy, as governments strive to reach national targets.

Journeying towards sustainability is challenging, but it is also rewarding. Companies that don’t make ESG an integral part of their mission will find it difficult to compete, but those that do will have a sustainable business that is forward-looking and resilient.

To find out how HSBC could support your sustainability goals, speak to your relationship team.