Commentary

SMEs and the Future of European Sustainability Reporting Rules

Small businesses deserve the clarity needed to address the sustainability challenge, according to Filip Gregor, Head of Responsible Companies at Frank Bold.

Small businesses are the lifeblood of our economy. They are the biggest source of innovation, employment and represent growth opportunities towards a sustainable and low-carbon economy. The transition is already underway. It is essential that SMEs are not left behind and are considered adequately in the discussions.

Until now, SMEs have largely been left out from sustainability reporting. However, this will change dramatically. European banks and investors, as well as companies at the top of value chains, are rapidly realigning their strategies to avoid risks posed by the climate transition. SMEs form the majority of their clients and suppliers. It is important that small businesses understand the implications of such changes, and the role they can play in this debate, to ensure a positive contribution.

The European Commission is already proposing a new framework to simplify and better focus disclosure of sustainability data with the presentation of the Corporate Sustainability Reporting Directive (CSRD). The reform should be adopted in law in early 2022 and enter into force in 2023.

Meanwhile, the EU taxonomy, which will provide a framework to realign investments and loans to support sustainable activities will become applicable already in 2022, supporting the estimated additional €500 billion needed annually to achieve the Green Deal objectives. The public Covid-19 recovery programmes will also be focused on sustainable transformation determined by these tools.

The EU initiatives are meant to bring down costs and other barriers facing companies and ensure meaningful data is available for banks and investors. However, concern remains that smaller companies may be left out of the system.

What are the stakes for SMEs; how can they engage with upcoming changes and developments in legislation, and how can policymakers help them.

The SME case for transparency

Economic transformation brings unparalleled market opportunities, and it is vital for SMEs to be able to harness them. The Business Commission for Sustainable Development reported that meeting the UN Sustainable Development Goals (SDGs) would create market opportunities of €10 trillion per year by 2030. Similarly, as shown by a CDP study from 2020, the value of low-carbon opportunities such as higher demand for electric vehicles and green infrastructure identified by 882 European companies reached €1.22 trillion, more than six times higher than the investment cost of €192 billion.

SMEs’ ability to work with sustainability data will be key for acquiring new customers, embracing technological changes necessary for succeeding in this rapidly evolving environment and avoiding legislative shocks.

Many SMEs do already embrace sustainability opportunities. Such outstanding businesses have a huge head start, enabling them to harness the opportunities presented by the transformation and advance their business models to the next stage. They also benefit from reduced costs through optimisation of energy and resource use, attracting and retaining talent as employers or being better placed in terms of seeking loans or investment.

The cost of excluding SMEs

The recent European proposals already seek to involve small businesses for the first time. Previously, the EU Non-Financial Reporting Directive applied only to large listed companies, banks and insurers with more than 500 employees, thus limiting its impact to 2,000 companies EU-wide. With the new draft on the table, reporting obligations will involve SMEs listed on stock exchanges, as well as all large companies (both private and listed) as is already the case in Denmark, Greece, Iceland, Spain and Sweden

But is this sufficient to properly involve small businesses within our economy? Even if the change in scope appears to be significant, it still affects fewer than 1% of companies in the EU. Left out of the scope is another 6%, which are considered private SMEs (and then 93% of microenterprises that are too small to be subject to reporting legislation). Investors, accounting organisations and NGOs raised two concerns in this area.

  • Significant impacts of companies on the environment and society do not depend on their size or legal status.
  • Redirection of investments to support the transition to a low-carbon economy is not limited to assets listed on stock exchanges.

If this situation is not addressed, SMEs not covered by the legislation will be disadvantaged compared to larger competitors and listed SMEs that will instead be covered by the new rules. Needless to say, it is important to have a level playing field for SMEs for the whole of Europe going forward.

Meanwhile, many SMEs find themselves in sectors facing major technological and regulatory changes and needing to secure finance for transformation, including in energy, construction, metallurgy, and agriculture. To be competitive and secure future funding, SMEs understand that they will need to invest into their own transformation. The EU plans to mobilise €1 billion public investments annually for this purpose. Yet, harnessing these opportunities will also depend on SMEs’ ability to provide the right data on sustainability.

Any divergence of rules between listed and non-listed companies also risks adding another barrier to small businesses seeking to expand – companies who are considering raising capital by listing their shares or bonds on stock exchanges. It is important to avoid introducing such disincentives – both for SMEs themselves and for the operation of our capital markets. Reducing the burden for SMEs.

Reducing the burden for SMEs

Data from the Global Reporting Initiative shows that only 10-15% of companies using their standards are SMEs. This is understandable, given the complexity of existing reporting frameworks – which combined propose over 5,000 KPIs – and competing demands for data from customers and financial institutions. All of this makes sustainability data gathering extremely challenging and costly for SMEs with limited financial and human resources for such overheads.

The EU initiative rightly seeks to address this problem by providing clear reporting standards that identify which data companies – and banks and investors – should focus on. More broadly, standards will provide a map and compass allowing companies to understand and navigate through the storm of technological development, market demand and regulatory changes on the horizon. Small businesses stand to benefit most.

Proposals for simplified standards for SMEs

The European Commission proposed that a simplified standard for SMEs should be developed. Such a standard will go a long way in making it easier for SMEs to report on sustainability and reduce administrative costs.

To achieve this goal, the standards should specify essential sustainability indicators that can be reasonably reported by SMEs, and – critically – supporting methodologies and tools allowing their easy calculation. This concerns in particular:

  • greenhouse gas emissions,
  • energy intensity,
  • information concerning activities and use of resources linked to heightened risks of impacts on climate, biodiversity and deforestation,
  • clear guidance for reporting on climate transition plans and sustainable activities,
  • human rights due diligence,
  • meaningful workforce indicators (large companies often require a plethora of social data and confirmations on compliance with fundamental labour rights from their suppliers, but the requested information is often of questionable value).

SME standards are indispensable to ensure proportionality of reporting requirements to contain the risk that companies at the top of supply chains will simply pass on the costs and data gathering requirements concerning the deeper level of the supply chain to their next-in-line suppliers.

However, due to their non-binding status, standards alone will not be sufficient to provide safeguards against such externalisation of costs of reporting by large companies. Such safeguards can be only achieved if the standards are supported by a legislative mandate for SMEs, clarifying their reporting obligations vis-a-vis the obligations of large companies.

Securing your sustainable future

A tipping point has now been reached from an older approach of simply exempting small business from sustainability reporting rules, to one today which recognises the positive advantages of ensuring SMEs are not left behind. Small business cannot avoid the major forces transforming our economies towards a low carbon future – and needs to embrace them or risk disappearing altogether. The cost of sustainability reporting is seen to pay itself back to the company by up to six times. Sustainability data is already essential for companies to benefit from a sharply rising proportion of all investment funds, including Covid-19 recovery finance around the world. Without relevant sustainability reporting, small businesses find themselves at a competitive disadvantage, missing new market opportunities, and being prevented from accessing resources for development of new technological solutions. Only by becoming part of the sustainability transition, will SMEs be the source of sustainable growth for the future.

The European Union’s new Corporate Sustainability Reporting Directive has recognised these arguments, involving small business for the first time, but ensuring that only simplified standards would apply to SMEs. The interest of small businesses would be better served by extending the scope of the Directive and providing them with certainty vis-a-vis larger companies by laying down safeguards and clear simplified standards.

For every small business owner across Europe today, it is important to recognise how many of your fellow SMEs are adopting these practices and are succeeding by doing so. You have won the argument that new EU requirements must be proportionate to your ability to meet them – but it is time to add your own voice to ensure all small businesses can be included, to secure your own place in a sustainable future.

The full original article was published as a part of Frank Bold’s series of 2021 monthly briefings focusing on sustainability reporting. It can also be accessed on the Alliance for Corporate Transparency website.

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