By ESG Analyst June Hee You
For the last few years, the concepts of “ESG” and “sustainability” have become scorching hot topics amidst the increasing concerns regarding the planet’s future. The transition to a “greener” future has begun, and with it, many large corporations have implemented changes to become ESG-compliant, particularly with the development of robust reporting standards. With time, this transition has gained rightful momentum and has spread further into the business world, trickling into the day-to-day of some enterprises. Throughout this piece, I will share my experience with the ESG transition in the corporate realm, and more specifically looking into how small to medium-sized businesses (SMBs) adopt ESG measures and the slow pace of these adoptions due to a “trickle-down compliance-driven” approach. This could be read as an informal report on my personal experience of working with companies to tackle the ESG enigma.
The reason the letters “E-S-G” have such a strident sound to them is because of the complicated nature of integrating the factors representing the acronym. Every single letter represents a trade-off between maintaining the status quo or breaking free from it by making “better” and more sustainable decisions. The complicated reality of ESG stems from that decisional aspect: people are “forced” to take action and/or make a decision which is not necessarily welcomed by all. Environmental activists and reporting boards have succeeded in transforming “E-S-G” into a pressure-inducing acronym that every corporate servant shivers at the sound of. This is something I have noticed, ever so subtly, while attending conferences, during work meetings, or just day-to-day office chatter. ESG was an elephant in the room that people were not necessarily approaching as a motivating topic, but rather as a complicated and unexciting assignment. This is the “compliance-driven” approach that’s apparent in the corporate world: an approach where people and organizations make decisions (despite the fact these decisions may be positively impactful) only for the sake of being compliant with external demands.
In the case of the ESG transition, large corporations have been prompted to adopt financial and newer, non-financial reporting standards. These standards place their decisions under diligent scrutiny now more than ever. In fact, a survey has found that 94% of CFOs feel pressure to prioritize reaching their ESG goals. This pressure comes from the public, investors and stakeholders but originally, this pressure stems in large part from the environmentalists and the activists who demanded companies to change and to act on environmental matters. As climate-change activists pushed their agenda on lawmakers and on corporations, the concept of ESG has gained more traction and has spread across various industries and companies. The top-down (or trickle-down) movement begins with large corporations making operational and financial decisions to be compliant with the public’s opinion and the stakeholders’ demands.
Due to ESG considerations being present in all spheres of a company, these decisions range from supply chain sourcing to packaging to advertising. When making these decisions, large corporations outsource some components of their value-creation and often do business with SMBs. This is the trickle-down effect in ESG integration: the largest companies are at the top of the pyramid and their decisions affect the smaller companies. The trickle-down effect is highlighted in the BDC’s 2023 study titled: “ESG in Your Business: The Edge You Need to Land Large Contracts”. The study found “that the proportion of major buying organizations that require their suppliers to disclose ESG information is expected to reach 92% in 2024. Over the next five years, these organizations will also increase the number of ESG criteria suppliers are required to report on.” SMBs are therefore “forced” to adhere to certain ESG and reporting standards, in order to stay in business. Like anything, nothing works at its best when forced and ESG integration is no exception. Therefore, a shift in how ESG considerations are implemented within companies and markets could be beneficial and result in making the subject a source of motivation, rather than one of compliance.
My experience in sustainable investing revolved more around the post-investment journey of a portfolio company rather than the initial investment process. This allowed me to work with boards and C-suite executives of companies my firm has invested in. I contributed to supporting the portfolio by training and guiding companies throughout their ESG integration journey. While working with these SMBs, I noticed how late smaller companies were to follow the trend. While SMBs do not see capital influx like large corporations or publicly traded companies, they still account for over 50% of the value added to Canada’s GDP. Now, the term “SMB” usually represents small-medium businesses that have less than 500 employees, but the valuation of those companies could vastly vary. SMBs could very well refer to a local mom-and-pop bakery or represent a national transportation company: SMBs are omnipresent. Accounting for 99.8% of all businesses in Canada and contributing to the economy by employing 10.7 million Canadians, SMBs are a non-negligible force and they are not getting enough attention for their level of contribution to the economy. While the scrutiny should revolve around the businesses that present the most risk, which are usually bigger public corporations, the ESG transition has trickled into the SMB level of the economy and they are barely answering the call. The aforementioned feeling of dissociation from the ESG agenda is a prominent reason why smaller companies have been slow to act and the compliance-driven approach exacerbates this slowness. The old adage rings true here: “There is strength in numbers.” Representing over 99% of the companies in Canada, SMBs have a sizeable impact that should result in a sizeable effort to simply become “better companies”.
An ESG-forward company is one that has taken action to simply be better. Whether it is “better” for society, the environment, or the employees is not the main concern, but rather how innovative and impactful the actions are. Some might argue that “better” could be a relative concept especially when regarding companies, however, the idea of “better” is instinctive. One can clearly tell between a good and a bad company; there is very little nuance here. A company that truly integrates ESG considerations is one that has oriented its objectives to ensure not only its success but also the success of others. These types of companies are difficult to find at the SMB level since early-stage companies will have the instinct to prioritize their own success initially. However, small yet collective actions could be positively impactful and balancing between focusing on internal and external impact, although difficult in the early stages, will be fruitful in the long term.
For smaller companies, ESG integration translates into keeping records of business-related fuel consumption, collecting employees’ opinions about their roles, and creating a governance process. Compared to large companies, the actions are at a smaller scale (since the company is smaller), however, the impact is as important. A bottom-up (or trickle-up) approach should be the norm; smaller companies (the demand) can establish ESG structures and initiatives that larger companies (the supply) need to abide by. This would complement the top-down approach currently adopted. Not all SMBs are suppliers of larger corporations (the buyers), therefore ESG compliance is not a real concern for these types of SMBs. Thus, reporting standards need to be adapted to cater to SMBs’ realities (or new standards should be adopted) and structures need to consider the smaller size of these companies. SMBs need to realize their potential to become drivers of change and take a proactive stance to shape the next steps of the ESG movement. This reformed approach could increase the speed at which SMBs become ESG-integrated or ESG-forward; in other words, this approach could create better companies, faster.