SMEs Should Embrace Sustainability

SMEs are key players in the global economy. Globally, they create two-thirds of all jobs and contribute more than 50 percent of the GDP in OECD countries. As environmental, social and governance (ESG) reporting becomes mainstream, SMEs shall align their operations to comply with local and international laws. Various stakeholders now want these smaller companies to treat ESG reporting on par with operational and financial considerations. Read on to know the challenges and opportunities staring at the doorstep of SMEs.

According to the International Labour Organization (ILO), small and medium enterprises (SMEs) account for nearly 70 percent of all jobs created globally. SMEs' collective influence and impact far outweigh their size and perceived impact. In several countries, most enterprises can be categorized as SMEs. More than 50 percent of gross domestic product (GDP) in Organization for Economic Cooperation and Development (OECD) countries is contributed by SMEs.

Though the contribution of SMEs differs from sector to sector, it is more pronounced in the service industry, where SMEs account for more than 60 percent of GDP in almost all OECD countries. Likewise, SMEs are known for hiring groups with slimmer chances of finding employment, including workers, young people, and older workers.

Famed German Mittelstand

Germany is one of the prime examples of the power of SMEs in a country. Mittelstand, small and medium German companies, are renowned for driving the European export powerhouse's economy.

Mittelstand companies account for more than half of Germany's economic output, 60 percent of jobs, and 35 percent of all sales, including vocational training for almost 82 percent of apprentices in the country.

Famous for innovation and technology, Mittelstand companies continue to drive the success behind the 'Made in Germany' trademark. The German economic model derives its strength not just from a small set of dominant companies, industries, or industrial regions but also from a diversified range of SMEs spread across the country.

Mainstreaming of ESG Reporting

As the world is focused on attaining UN Sustainable Development Goals (UNSDG) and the ILO's Decent Work Agenda, SMEs have a key role to play, considering their essential nature for future work, employment creation and economic growth.

With each passing day, businesses face increased pressure to incorporate ESG reporting into their operations. This pressure emanates from various stakeholders. A recent survey outlined that 88 percent of institutional investors consider ESG at par with operational and financial considerations for their prospective investments.

Another survey highlighted that 60 percent of employees prefer to choose a workplace matching their values and beliefs. And, 58 percent of consumers buy or advocate products in line with their beliefs and thought processes. ESG expectations from stakeholders are not much different for large corporates or SMEs.

However, it is not as easy for SMEs to incorporate ESG reporting into their business models. The high cost of ESG compliance makes it an aspirational undertaking for everyone other than large corporations.

According to Joao Vieira de Almeida, Chairman of VdA Legal Partners, one of Europe's most innovative law firms, "things are moving fast" with respect to regulations. He noted that "a broad legal package is now in place imposing specific obligations."

Almeida highlighted that new regulations like the Corporate Sustainability Reporting Directive or Corporate Sustainability Due Diligence Directive are poised to be implemented. Other sets of legislation are expected to follow suit.

Incidentally, Europe is adopting a whole value chain approach where larger companies, which happen to be the clients of smaller companies, are increasingly scrutinizing the entire supply chain with new parameters.

Financial Challenges for SME Sustainability

The OECD has highlighted that ambitious climate-related targets envisaged in the Paris Agreement cannot be accomplished without taking SMEs along. The intergovernmental organization pointed out that SMEs are not only critical actors in global climate efforts but also as drivers of technological change, adopters of green business models, and practices aimed at cutting environmental footprint.

However, enabling SMEs, which are not deep-pocketed, to finance their green transition needs participation from a range of actors, including private and public financial institutions, regulators, rating agencies, and others.

Besides providing the money, financial institutions must play the critical role of offering non-financial support such as awareness and practical tools for SMEs to achieve net zero, thereby bolstering these companies' demand for green financing and investment.

SMEs and the Pandemic

According to the World Economic Forum (WEF), 'SMEs tend to be largely represented in business sectors that have been most affected by Covid-19'. SMEs have smaller cash buffers, lower adoption of digital tools & technologies, and weaker supply chain capabilities compared to larger peers.

Likewise, recent findings cited by the WEF have highlighted that smaller firms continue to fall short when it comes to societal impact. Even though 69 percent of more than 300 CEOs surveyed claimed to have incorporated sustainability into their mission statements, only 51 percent have done so in their business plans. And 21 percent have linked executive pay to their organizations' social and environmental sustainability performance.

Internal change and adaptation in the direction of sustainability are not easy while maintaining a passive approach. Also, continuing with the status quo cannot be an option.

Data Difficulties

Accessing accurate and comparable data on SMEs' ESG performance is a challenge faced by public and private financial institutions. It adversely affects their efforts to facilitate the former's green transition.

Other complexities include the absence of common and aligned methodologies and frameworks for ESG integration in risk management and investment strategies. Regulatory uncertainty is an added challenge for banks and financial institutions. Availability of sustainable finance and development of financing instruments are incumbent upon demand.

OECD Platform for Financing SME Sustainability

On the sidelines of the United Nations Climate Change Conference 2021 or COP26, the OECD launched a platform, Financing SMEs for Sustainability, which provides a forum to further knowledge sharing, data and analytical work and policy dialogue on sustainable finance for SMEs.

This platform endeavors to bring together financial institutions, fintech companies, governments, SME representatives, and regulators to bridge existing knowledge and awareness gaps. It will develop innovative solutions and good practices for finance providers, SMEs, and governments.

These efforts aim to accelerate SMEs and financial institutions' green transition, with financial institutions standing a chance to harvest key benefits from enhanced policy dialogue with public financial institutions, regulators, and governments.

Moreover, peer-to-peer learning can help implement effective solutions to power SME awareness and demand for sustainable finance products.

Larger Companies Chipping in for SMEs to Build ESG

Since SMEs have lagged larger companies in incorporating ESG norms, some of the latter are chipping in for them to build their ESG capacities.

Eni, the Italian energy giant, is one example of this trend. Constantino Chessa, head of procurement at Eni, observed that ESG compliance has emerged as a pain point for many companies, prompting organizations such as Eni to join forces with BCG and Google Cloud to offer Open-es, a digital platform open for all.

With this partnership, the Italian energy major aims to improve the corporate sustainability profile of smaller firms that are linked to its supply chain. Eni is offering smaller firms the capabilities to gauge their sustainability performance by looking up Forum's Stakeholder Capitalism Metrics for consistent, shareable, and comparable reporting.

Meanwhile, within a year after its launch, Open-es has witnessed an excellent uptake, with more than 4,000 companies, nearly 80 percent of them SMEs, using the platform.

These companies came from 76 disparate countries, operating in 62 different industries. These SMEs are reaping the benefit of a social network approach offered by Open-es with features such as scouting for new partnership opportunities in the supply chains for a faster sustainable path.

The innovative open platform Open-es was created to facilitate collaboration between companies along production chains that are dedicated to accomplishing energy transition

Sustainability: The Next Wave of Good Management

Tensie Welhan, Director of the NYU Stern Center for Sustainable Business, observed that "sustainability is becoming de facto next wave of good management", driving innovation, operational efficiency, risk mitigation, and employee engagement.

Therefore, it is important to view sustainability as a management approach for long-term success instead of being a compliance issue.

Sustainability Unlocks Newer Opportunities

Pivoting to sustainability has benefits, such as finding new opportunities that can prominently raise a company's impact. It includes offering possibilities for diversification to aid disparate industries in turning green.

A case in point is OPTEL, a Canadian traceability provider which discovered newer opportunities beyond the pharmaceutical industry. Though it was initially not easy to diversify, even the company's employees and financial backers were not impressed by this move.

OPTEL's new intelligent supply chain solutions now help track more than six billion products a year in the pharmaceutical industry and for global giants such as Coca-Cola, AB InBev and other top players in the agrochemical and mining industries.

Following these diversification efforts, OPTEL Group raised its revenue in the consumer packaging goods market by over 200 percent in the past three years, demonstrating a business model of environmental sustainability.

Future-ready SMEs

Future-ready SMEs embrace opportunities that present themselves with a focus on social and environmental sustainability. This new stream comes with several value-creating routes to address SMEs’ challenges, including growth and expansion, talent acquisition, retention, funding, and access to finance.

Social and environmental focus will also offer reputational benefits to champion sustainable strategies.

SMEs in the Indian Context

Under the revised classification applicable from July 1st, 2020, SMEs in India are classified as per the composite criteria of investment in plant, machinery, equipment, and annual turnover.

Besides offering employment opportunities to the masses in India at a lower cost, SMEs chip in by industrializing rural and backward places. It narrows regional imbalances and helps more equitable national income and wealth distribution.

As complementary entities to large industries, SMEs act as ancillary units, contributing to the socio-economic development in India.