Rising temperatures and dwindling resources created the global climate for environmental, social and governance (ESG) reporting. Now small businesses in Australia should accelerate their ESG strategy to keep pace with the worldwide competition. Environmental, social and governance standards are more than reporting boxes to check. A company's ESG performance is increasingly a dealbreaker for customers and investors too. Find out what ESG covers, the challenges and opportunities involved and how to get your ESG strategy on track.
What is ESG?
Although the notion of corporate social responsibility is decades old, specific reference to ESG first appeared in the 2006 United Nations Principles for Responsible Investment (PRI) report. This required companies to include ESG criteria in their financial evaluations, with the goal of driving sustainable investments. The 2020 Davos Manifesto subsequently established 22 metrics to provide a more consistent reporting framework. These are aligned with United Nations 2030 sustainable development goals.
Ultimately, ESG aims to hold companies to account - publicly and transparently - and to replace gestural “green” initiatives with meaningful, long-term commitments. Both ASX 200 corporations and Australian small to medium enterprises (SMEs) alike are now expected to show performance and progress in the following key areas:
With net zero emissions as the target and United Nations 2030 and 2050 pledges to meet, investors are increasingly putting pressure on companies to disclose their carbon footprint, waste management, renewable energy, and clean technology performance (among others). As the deadlines loom, expect capital to flood those businesses that are pioneering change, and reduce to a trickle for legacy industries that couldn't innovate.
Brands often like to broadcast the role they play in their customers' lives. Now they are expected to prove it at a community level. Investors and customers want to see evidence of ethical trading and sourcing, sustainable finance, data protection and employment legislation compliance. They're also ready to call out those that lag behind on diversity and gender pay equity.
Internal corporate structures are under closer scrutiny, and businesses held to a higher account. Investors are paying closer attention to risk management and taxation arrangements, while customers and media are monitoring executive compensation, bribery and corruption or lack of diversity at board level.
Measuring these criteria does not end at the business walls. Given the globalised nature of modern business, progress needs to extend throughout the entire supply chain too, including overseas partners and suppliers.
Why ESG is important from a business perspective
An enduring perception, particularly among Australian small businesses that are still recovering from the worst of the pandemic lockdowns in 2020 and 2021, is that ESG represents yet another cost to assume. Enthusiasm is tempered for now, with just 33% of small businesses in Australia identifying ESG as a priority.
Those that will thrive, however, have already recognised the opportunities ESG presents. After all, ESG establishes a transparent framework for measuring one of the most powerful currencies and commodities any business can receive - trust. By implementing an ESG strategy now, businesses can develop risk reduction and reputation management as competitive features. There's no time to lose, either. Consumers themselves are setting the pace and they expect companies of any size to have a clearly articulated position on sustainability.
What are the key challenges?
Small businesses in Australia don't typically see themselves as de facto pioneers of addressing climate change. Many are simply struggling to stay afloat after the turmoil of recent years. In fact, just 41% of family businesses consider themselves responsible, according to research by PwC, an Australian consulting agency.
With profit margins already tight and supply chains stressed, SMEs may well argue that they lack the financial or logistical resources to uproot or transform processes to accommodate ESG goals. Switching to sustainable energy sources, for example, requires significant capital investment that only big corporations can cover.
There are external challenges too. Although the World Economic Forum is leading the global initiative, there is still no single internationally recognised model for reporting metrics. While bigger corporations can hire expensive consultancies to assist with reporting, for smaller businesses it will typically mean an existing employee or team doubling up on their current job function.
Why Australian businesses are struggling with ESG
Unlike financial reporting, ESG reporting is not compulsory (for now). Not surprisingly, almost a third of Australian companies are falling short on ESG reporting and performance. Progress is noticeably slower than in the United Kingdom, for example, where the Financial Conduct Authority (FCA) drives momentum, or in the United States, where the Securities and Exchange Commission (SEC) can take the lead. The Australian Prudential Regulation Authority (APRA) certainly plays a role in the financial sector, but ultimately it is left to the investor community to drive change.
How Australian SMEs can use ESG to their advantage
ESG reporting may add an administrative burden, but it also presents a platform for small businesses to showcase community involvement, one of their most compelling features. Some 57% of Australian SMEs regularly contribute to their local community and ESG provides a transparent tool for businesses to highlight the positive, long-term impact they are making.
No longer is the benchmark for a good business down to how many local jobs it provides. The quality and equality of those jobs, as well as the long-term carbon footprint of the business activity, is up for analysis too.
By taking an early stand on ESG and positioning achievements as a branding tool, Australian businesses can woo investors and customers alike. The issue is particularly salient with issue-driven millennials, who make up a quarter of Australia's consumers and workforce.
ESG reporting essentials
Although ESG is not part of mandatory financial reporting according to Australian Accounting Standards, it should be treated as no less important from here on. The clock on 2030 is ticking and consumers will crank up the pressure on brands and businesses to demonstrate progress.
The initial priority for any SME is to put a reporting framework in place to measure the most relevant metrics (not all will necessarily apply). That means taking into account diversity, equity and inclusion (DEI) goals, auditing supply chains fully to include third-party partners overseas, and exploring funding opportunities for investment in renewable energy, smart warehousing or greener waste management, for example.
For the time being, consumers and investors will forgive lack of progress as long as whatever measures have been put in place are communicated transparently and in full. Tolerance has been exhausted, on the other hand, for anything that resembles “greenwashing”, hollow claims or plans without action.
Crucially, ESG works best when ownership is shared. It is not a top-down initiative that management imposes on the business. Rather, the spirit of ESG is that input should be equal, equitable and pragmatic. In that sense, ESG is partly changing not just the purpose of business, but the way companies function, setting a benchmark for sustainable, ethical operations.
This information is correct as of May 2022. This information is not to be relied on in making a decision with regard to an investment. We strongly recommend that you obtain independent financial advice before making any form of investment or significant financial transaction. This article is purely for general information purposes. Photo by Harry Cunningham on Unsplash.