The acronym ESG is often used as a synonym for responsibility or sustainability. But what are the elements it consists of and how are these elements visible and handled in SMEs?
Environmental
“E” is often the best-known and easiest-to-understand part of ESG. “E” represents “environmental impact”: GHG emissions, air quality, water & wastewater, waste, hazardous materials, biodiversity, and land use (MSCI). Some lists also include energy management since that is an inevitable part of environmental impacts (SASB). What is worth mentioning is that the business opportunities around green and clean tech can be treated as part of “E” (MSCI). This is logical since if you grasp and scale business opportunities in green tech, you can create a clear positive impact on the environment.
Naturally, the most regulated areas – waste handling, hazardous materials, and wastewater – are usually part of “E” which are handled most effectively by SMEs. Other traditional factors such as energy management are also managed well since companies have had the opportunity to buy energy from renewable sources for a long time and already fulfill their responsibility and green values in these areas. These are also factors that are most often measured on a detailed level because of their direct financial impact.
Nowadays, gladly, more and more SMEs calculate their greenhouse gas (GHG) or CO2 emissions. Here it is important to understand the nature of CO2 emissions calculations. As interesting and compelling as it would be to compare CO2 emission “scorings” to other companies, the available background data and the nature of the calculation process often make the CO2 emissions report results hard to compare with other, external results. This is sometimes disappointing to SMEs, especially when there has been a lot of excitement and expectations regarding the results of the calculations process. The most important part of calculating CO2 emissions is to improve your own results, and for this, the current methodologies are an excellent tool. Communicating about your results and improvement goals is a great way to announce that your company is climate-aware, and to push competitors to improve their climate impact, even if the main target wouldn’t be about the comparison.
In environmental matters, some SMEs find the lighter versions of environmental management system tools helpful when starting more systematic environmental work, and when gathering the information for internal use and external reporting.
Social
“S” can be described to stand for “stakeholder relationships” (CFI): employee relations and impact on society (Nordea). When you take a closer look at what stakeholder relations and impact on society can mean, there are many more topics than just human capital and human rights: for example, product liability (MSCI), fairness of marketing, and data security issues (SASB). The human capital parts consist of e.g., labor practices and relations, employee health, safety & wellbeing, diversity and inclusion, recruitment & HRD, and compensation (SASB).
MSCI talks about environmental opportunities (such as clean tech or green building), but why would there not also be social opportunities? I think a representation of social business opportunities has been the significant growth of e.g., whistle-blowing services or supply chain rating tools, to name a couple of very simple examples.
In employee matters, SMEs have traditionally performed very well. In general, SMEs are often considered good employers, since in many SMEs, especially family companies, the employee relations are deep in the values and there are very long-lasting employment relationships. Also, when it comes to the impact on the stakeholders and society, SMEs often (but of course not always) have tight and long-lasting relations with their suppliers and other stakeholders. In this sense, SMEs should at least be aware of their supply chain, even if the supply chain audits and management wouldn’t be done in a formal manner. Many SMEs are active in the charity sector, too. So, at least traditionally, SMEs can be treated as high scoring in “S”.
Governmental
“G” stands for “Governance” or “Governmental”, which basically means good governance. The factors that are used to review good governance are mainly related to power and control structures (independence of the board, directors, and CEO, and lack of corruption), financial matters (tax transparency, accounting, payment transparency), risk management, and sometimes also the wider corporate behavior, which goes already in the direction of social matters, such as supply chain management (governance), or business ethics (MSCI, SASB).
Surprisingly for me, Standard & Poor mentions gender diversity and generally includes social responsibility as one of the key governance issues, rather than listing it only under stakeholder issues: “S”. This is because the board and executive choices, e.g., compensation programs, are governmental matters, even if they are an inseparable part of employer relations too.
Governance is often found boring and compulsory. What would be the governmental innovations or opportunities? Please tell me if you have good examples on your mind!
In the governmental component of ESG, SMEs vary a lot from bigger companies. Where many extensive reporting and governance practices are required from larger or public companies, privately owned SMEs can still choose their way in most of their governance.
The governmental part for SMEs is two-fold: in many of the comments from the field the SMEs identify themselves as highly responsible and successful in “G”, since they pay their taxes, they claim themselves free from bribery, they are punctual in their reporting requirements, and in other ways are good corporate citizens in general. This tells the story only about the external part.
On the other hand, the internal governance model of SMEs can be fairly loose or strongly reliant on individuals. This is often caused by double or triple roles in the ownership, board, and management team. The loose governance model allows trust, freedom, and practicality, which are extremely good motivation and engagement factors, but it can also easily leak and leave issues hidden due to the lack of systematic oversight. When the governance is personalised it can naturally enable strict governance (“teollisuuspatruuna” / ironmaster model), but this creates a significant risk of one person’s opinion being the law, and therefore prevent critical feedback by or even apathy in the rest of the organization.
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Naturally, there is as wide a range of manifestations of E, S, and G in the SME sector as there are companies. I would be very happy to hear about great examples of world-class success stories from the SME sector on the categories E, S, or G, or on separate granular issues.
What has your experience been? In which areas has achieved success been the easiest? Which areas of ESG are the vaguest for you or the most difficult to get a grasp and solid understanding of?
If you are interested in reading more on this topic, please read the article no 1 in this series: “ESG in SME sector” via this link.
Sources
SP What is the “G” in ESG? | S&P Global (spglobal.com)
Nordea What is ESG? | Nordea
SASB MMap-2021.png (1758×866) (sasb.org)
MSCI ESG Industry Materiality Map – MSCI
CFI ESG (Environmental, Social and Governance) – Overview and Framework (corporatefinanceinstitute.com)
