This article explores the impact of recent European Union legislation on ESG reporting for SMEs.
EU ESG Reporting Overview and Legislation
To increase transparency about sustainable practices and fight greenwashing, the European Union has approved legislation that will substantially increase the scope of mandatory ESG reporting and make it subject to more stringent standards. At the moment, the EU has purposefully chosen to have by far the most all-encompassing sustainability reporting standards in the world, also as a way to spur the green transition, starting with the CSRD (Corporate Sustainability Directive). While larger companies started facing mandatory reporting of ESG information, SMEs have so far remained largely exempt.
Challenges and Solutions for SMEs’ Sustainability Reporting
SMEs are expected to be indirectly affected by the newly introduced mandatory sustainability reporting requirements through the so-called “trickle-down” effect. Large companies and banks that fall within the scope of these reporting requirements will have to gather information from their value chain and client basis to be able to report, particularly on the results achieved by their own ESG policies and commitments involving recipients of loans and their value chain. Because of that, SMEs have been increasingly receiving several requests to disclose ESG information from various counterparts, according to different formats. To reduce this chaotic reporting burden, the EU has been working on a voluntary ESG reporting standard for SMEs to streamline reporting and compliance.
Balancing Requirements and Costs
Finding a balance between meeting various users’ demands and managing costs for preparers poses a challenge, particularly for SMEs. The SME world has remained largely not exposed to sustainability reporting practices so far because under limited pressure from the public and financial markets to voluntarily disclose ESG information. For this reason, voluntary ESG reporting standard for SMEs is currently under public consultation. To help EFRAG and the European Commission achieve this balance, Syntesia is preparing a cost-benefit analysis of the voluntary ESG reporting standard for SMEs.
Rising Costs and Potential Benefits
The ESG reporting costs for SMEs are rapidly increasing and can easily reach several thousand euros, also depending on the different national and sectoral setting and the attitude of corporate clients and banks. While costs are significant, these should be fully justified by the benefits an SME could gain, such as increased awareness, better management, but also prospective
access to green markets (including green public procurement). However, this would require a radical cultural change in a short period, which is only starting to occur. Hence, sustainability reporting is more often perceived as an imposed duty that is typically subcontracted as such to external consultants.
Moving Forward
For the time being, a market for SME sustainable financing and green procurement remains at an early stage of development in several national contexts, and therefore SMEs are at odds in finding sufficient monetary benefits to justify the expenses. When these exist, they are more likely to be framed as “negative incentives” in terms of threats of losing important contracts or access to credit. Only when SME sustainability reporting will result in adequate “positive incentives”, it can be expected to produce the societal benefits it was designed for.