ESG - why SME's need to pay attention now

Posted: 20/09/2022

The concept of environmental, social and governance (ESG) has been on the business agenda for several years now and business owners will have come across it in some way or another.

While the government has enacted various legislation to force large companies to be more transparent on their ESG credentials for issues such as modern slavery reporting and climate-related financial disclosures, small and medium sized enterprises (SMEs) have largely been left alone.

So why do SMEs need to pay attention now to their ESG credentials if there is no legal obligation for them to do so? The answer is that, by failing to take ESG responsibilities seriously, businesses could face very real risks.

There has been a significant shift in public opinion in recent years and an increasing focus on improving ESG credentials. The news is constantly peppered with articles on various ESG-related incidents from greenwashing and pollution to discrimination. Although many of these cases relate to big corporates, there is clearly a significant reputational risk for any business that fails to act. SMEs could also gain a real advantage against their competitors if they can demonstrate their own ESG credentials.

To read more about identifying and mitigating ESG risks and the issues that can arise from greenwashing, see our articles here and here.

Aside from the obvious benefits to the world, improving ESG performance can make good business sense for a number of reasons. Penningtons Manches Cooper has developed a series of articles looking at how ESG factors can affect businesses, particularly SMEs. This article looks at just a few of the benefits for SMEs that are focusing on and improving their ESG credentials.

Access to funding and investment

Funding and investment can be critical for SMEs to help them grow and develop. As part of any investment opportunity, investors need to ensure that the businesses they are going to be working with have a business model that will generate growth for the future as well as the present. We are seeing investors place a greater emphasis on ESG criteria than they have done traditionally. Businesses scoring highly on ESG credentials are therefore more likely to be attractive to investors.

Contract tendering and supply chains

Increasingly, the public sector is requiring businesses they work with to adhere to various ESG criteria as part of the tendering process. The Birmingham Commonwealth Games is a recent example of such practices.

To read more about how the Commonwealth Games addressed ESG in its procurement process, see our article here.

Businesses that make no effort to improve their ESG credentials could see themselves prevented from tendering for public sector contracts. By making improvements now, businesses could be ensuring they stay in line with, if not ahead of, their competition.

We are also seeing a growing number of organisations using their influence to require that the businesses they work with follow various ESG practices, even when contracting outside the public sector. While this is particularly prevalent in construction and property development, it is also starting to permeate into other industries as well.

Similarly, customer and supply chain pressures are now driving the message of ESG down the supply chain of larger organisations, requesting reference to ESG strategies from their SME suppliers, to ensure that the products and services being provided help to meet ESG targets further up the chain. SMEs need to proactively address ESG to secure commercial opportunities as regulators and investors will demand it.

Cost reductions

Increased prices coupled with rising inflation are a big concern to a number of businesses at the moment. Although improving ESG credentials cannot shield businesses from this completely, it could help to soften the blow.

Moving away from volatile fossil fuels and switching to renewable energy sources can provide more stable energy prices, along with fewer concerns around the availability of supply in both the short and long term. Paying more attention to resource efficiency will not only reduce waste but will also reduce the need for re-ordering and the associated costs.

The ‘S’ in ESG focuses heavily on the consideration of employees and improvements in their wellbeing. By improving employee happiness, it has been shown that staff productivity and retention rates can increase significantly, leading to increased profitability and a reduction in expensive recruitment costs.

Insuring against ESG-related risks such as the effects of climate change and business continuity has become a higher priority for a number of businesses and is likely to start becoming standard practice for insurance providers. As a result, insurers are looking at ESG factors when calculating premiums and are likely to start asking more detailed questions of businesses about their ESG practices. Failure to demonstrate good ESG credentials may well lead to increased insurance premiums.

Increase in legal and regulatory requirements

With SMEs accounting for approximately 95% of businesses in the UK, it is only a matter of time before the government shifts its focus to them.

The Better Business Act (BBA) movement, which seeks to implement changes to the Companies Act 2006, has recently been gaining momentum, particularly among MPs. The BBA seeks to amend the fundamental piece of legislation that governs the management of companies in England and Wales by ensuring that companies are legally obliged to consider the wider impact of their business decisions rather than just their profit.  

The consequences of this would mean a significant shift in the duties of directors and could lead to more opportunities for litigation against both companies and their individual directors who fail to take into account broader stakeholder issues when making decisions.

The government has made it clear in the past that it intends the UK to be a world leader in climate-related reform so, with other countries already leading the way with similar provisions, it may only be a matter of time before the UK sees a draft bill.

Where should SMEs start?

ESG covers a very broad range of topics from recycling initiatives and carbon emission reductions to employee welfare and the fundamental principles on which an organisation is governed. Starting a wholescale review of an organisation’s ESG credentials may therefore seem like a daunting task.

At Penningtons Manches Cooper we understand the challenges that businesses can face when deciding to tackle ESG as our firm has been through a similar process. We have developed an ESG checklist to help organisations identify which factors are most important to them and to assist them in identifying changes that can be made from a legal perspective.

Please get in touch if you would like to receive a copy of our ESG checklist or to discuss any of the points raised in this article.

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