SME reporting: a mirror of the regulatory reporting in financial sector and requirements in big corporations

SME reporting mirrors the regulatory reporting in the financial sector and for large entities. That is why the ESG agenda may not only be a license to operate in the future but also a way for SMEs to attract finance. Looking at the SME reporting framework from Efrag, the disclosures are directly linked to the reporting that goes on in big corporations and the financial sector. SMEs should embrace this standard (draft) as it will not go away. They can either embrace reporting requirements or wait for their investors and clients to ask questions about their ESG-related data.

Great ESG performance marks that the company is choosing sustainable growth by taking a risk-based approach to their impacts and risks. Growth is most often related to the core business. Expanding the core is often directly related to growth strategies as companies expand their service offerings or product portfolio. McKinsey statistics claim that 80% of growth comes from maximizing the core. By laying out impacts, risks, and opportunities, companies can transparently show their growth areas (2024).

SMEs must look at their value chain to build a resilient core and to really understand their impacts, risks, and opportunities in their own business activities. Utilizing the specific ESG data generated through regulatory ESG reporting will be the main driver of success in the coming years for SMEs, as they will be overwhelmed by data demands from shareholders and clients. ESG as regulatory reporting must pivot to innovation and product development. ESG cannot substitute growth strategies. Companies that are good at pivoting their ESG-related impacts, risks, and opportunities will win. It takes courage to build resilience and it takes continuous effort to uphold value creation. Strengthening ESG performance points to these central three aspects of driving business.

Access to capital improves ESG performance and enhances SMEs' attractiveness to investors who prioritize sustainability. This can lead to increased access to capital through avenues such as green bonds, impact investing, and socially responsible funds.

The VSME ESRS (DRAFT) Standard aims to assist micro-, small-, and medium-sized enterprises by promoting their contribution to a more sustainable and inclusive economy. It focuses on enhancing their management of environmental and social challenges, such as pollution and workforce health and safety, to support their competitive growth and long-term resilience. Additionally, the Standard aims to provide information that meets the data demands of lenders, credit providers, and investors, facilitating better access to finance for these enterprises. Moreover, it addresses the data demand requirements of large enterprises seeking sustainability information from their suppliers.

Demonstrating a commitment to ESG principles can bolster the reputation and brand value of SMEs. Positive ESG performance can attract environmentally and socially conscious consumers, leading to increased customer loyalty and market share. Depending of the company construction, number of employees and sector the SME are to decide the level of reporting. No reporting is without cost, but it is up to the SME to decide this granularity.

Operational efficiency and cost reduction may be the biggest driver for companies that see advantages in taking a more sustainable approach to their business strategies. However, the immediate costs related to the transition are often high. Adopting sustainable practices often leads to greater operational efficiency and cost reduction in the long term. Measures such as energy efficiency, waste reduction, and resource optimization can result in lower operational expenses, thereby improving profitability for SMEs.

Risk mitigation and resilience: Integrating ESG considerations into business operations helps SMEs identify and mitigate risks associated with environmental, social, and governance factors. Proactive risk management enhances resilience to external shocks, regulatory changes, and reputational damage, thereby safeguarding long-term viability.

Access to new markets and business opportunities: Strengthening ESG performance can open doors to new markets and business opportunities. Many large corporations and government entities increasingly prefer to work with suppliers and partners who align with their ESG values, providing SMEs with opportunities for collaboration, contracts, and expansion into new sectors.

The European Parliament’s recent adoption of the Corporate Sustainability Due Diligence Directive (CSDDD) signals a pivotal change in corporate governance and responsibility. This directive mandates that companies actively respect human rights and mitigate environmental impacts within their operations and supply chains.

With extensive global value chains, companies in diverse industries will be impacted by this legislation and will need to meet specific requirements. Non-compliance could result in sanctions from national administrative authorities, including fines of up to 5% of global turnover, potentially affecting operational capabilities and overall business viability.

Understanding CSDDD’s broader impact on all business activities including SMEs

Upon approval by the Council of the European Union and implementation by Member States, large companies across various sectors must identify, prevent, mitigate, and remedy human rights and other sustainability impacts in regards t environment and business conduct throughout their global value chains. Companies will also need to formulate and execute a transition plan aligning their business models with a 1.5-degree Celsius global warming scenario.

Businesses should prepare in advance for the directive’s enforcement due to the extensive requirements on their processes and obligations to act. CSDDD is designed to create a trickle-down effect by mandating large companies to perform comprehensive due diligence on their subsidiaries, business partners, and value chains. This includes business process designs that upholds and controls human rights and environmental statements and commitments. Moreover, in their operations controls and track the effectiveness of the actions put in place. This will have a huge impact on SMEs supplying larger entities on their services and products.

Non-compliance with the directive can lead to civil liability and compensation claims if a company’s negligence or misconduct causes damage for large entities that are required to conduct due diligence (+1000 employees). The directive requires companies to map their operations, subsidiaries, and business partners – a complex task given the intricacies of global value chains. Companies must consider their entire operations, from carbon emissions in production and shipping to the ethical conduct of activities like clinical trials. Since the world's largest entities are to conduct this due diligence and have an obligation to act, this will create not only a trickle down of data demands but also controls, external audits of suppliers, stricter supplier controls and funnels as well as new reporting regimes.