ESG for SMEs – a new report from the QCA and Henley Business School

In this article, we review a recent report published by the QCA in conjunction with Henley Business School entitled “ESG in Small and Medium-sized Quoted Companies: Perceptions, Myths and Realities”.

ESG (which to remind readers stands for “Environmental, Social and Governance”) has received huge coverage recently, which may have worn the patience of many readers but it is an important topic.  So far, however, focus has concentrated on larger companies.  Smaller quoted companies have not received as much attention.

To prepare their report, the QCA and Henley conducted 30 interviews with companies and investors, followed by a survey which produced 100 completed responses from companies and 50 from investors.  Nearly half (47%) of companies surveyed had less than 250 employees.  17% of companies were listed on the main market, 83% on AIM.

The report recognises that customers, employees, suppliers, competitors, the Government and regulators are drivers of ESG. Whilst it urges Boards to ask what ESG means to all their stakeholders and which of their company’s stakeholder groups are driving ESG, it emerges clearly that ESG is often seen as an issue principally between a company and its investors.  Perhaps because other stakeholder groups were not interviewed, much of the report appears to concentrate on what investors think, what companies think investors want and what companies can do to meet investors’ perceived requirements.

The report identifies a lack of clarity about the meaning of ESG.  Some companies may see it as a compliance exercise or risk management tool, whilst, for others, ESG is a way of accessing capital or gaining competitive advantage.  This may be because ESG is a composite of different elements.  A company’s approach to “E” and “S” should reflect the nature, culture, values and strategy of the business and their impact on society and the environment. That approach will differ from company to company. “G”, on the other hand, is driven by the company’s reaction to an established, if evolving, set of common external principles set by regulators.

Among the issues raised in the report are the integration of ESG into all aspects of the business (including strategy, business model and executive remuneration) understanding the meaning of ESG and communication with stakeholders.  Research indicates that ESG metrics are far less common in long-term incentives than they are in annual bonus plans, which may give some support to a concern among investors, highlighted in the report, about a perceived conflict between the need to keep the business going in the short-term and the contribution ESG can make to enhancing the sustainable long-term financial performance of the business.  Remuneration policy has an important role to play in encouraging the behaviours needed to maintain focus on ESG and to recognise its contribution to both the short-term and long-term financial performance of the business.

The emphasis placed by stakeholders on ESG will vary, as not all stakeholders will have the same priorities.  One striking statistic from the QCA/Henley Business School report is that 58% of investors give limited consideration to ESG issues when deciding whether or not to invest in SMEs.

So, a key challenge for small and medium-sized companies is to work out what ESG means to them and to compose their own ESG story for all their stakeholders, not just investors.  The challenge for stakeholders, particularly investors, is not to regard ESG exclusively as a compliance issue and, if possible, to take an holistic view of the company’s ESG story, trying not to focus solely on their specific perspective – a difficult call, perhaps.

Conclusions reached by the QCA/Henley Business School report include the following:

• There is a need for greater clarity about the meaning of ESG
• Pressures come from different sources, not just investors but investors need to do more to become agents of ESG
• All stakeholders need to help SMEs create the conditions and clarity required for ESG to work for small companies.

A key recommendation is that any intervention by government or regulators should be based on principles, education and support, not linked to extensive compliance or a one-size-fits-all solution.  We would agree with this.

ESG should be a material consideration for all companies but it is at risk of becoming a compliance millstone for SMEs.  A greater understanding is needed of what ESG means, how to integrate it into all aspects of the business, including remuneration policy, and then communicate the company’s story to stakeholders but the answers will differ from company to company. The work should start from within the business. Outside help is likely to be needed, particularly by SME’s whose resources are stretched.

For more information or to discuss any points arising from this article, please contact paul.norris@mm-k.com.

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