Sustainability reporting and SMEs – lessons from South Africa

IDU’s Kevin Phillips explains why he expects sustainability reporting is coming for SMEs, and what their accountants should be thinking about today.

The thing about kicking the can down the road is that you eventually run out of road. And so it is for sustainability-related financial reporting. First delayed by the pandemic, then by geopolitical instability and escalating fuel prices, sustainability reporting is starting to see the light of day. (Although in the US, the Securities and Exchange Commission’s amendments requiring listed companies to report climate-related information were recently stalled due to legal challenges a month after their promulgation.)

Most reporting activity involves obligations for listed and/or large companies to disclose and report on environmental, social and governance (ESG) impacts and actions. But before small and medium-sized companies, and their accountants, heave a sigh of relief, sit back and focus on other pressing issues thinking this doesn’t impact them, they might want to reconsider.

Cascading obligations

I’d suggest that ESG reporting requirements are likely to cascade down to smaller businesses. Even if the business has no intention to list, or to grow above a certain size, as long as it wants to supply its goods or services to larger, listed companies it could be impacted.

I’m drawing this conclusion based on how Broad-based Black Economic Empowerment (BB-BEE) legislation rolled out in South Africa. BB-BEE obligations apply to private-sector companies supplying goods and services, and entering into other commercial agreements with South African government and state-owned enterprises. However, because a significant proportion of the overall BB-BEE score for each company comes from its supplier selection, the reporting obligation starts cascading down through the supply chain.

So, if your customer is a larger company in South Africa that requires a good BB-BEE score to keep its government clients, you’ll need to contribute to that score. This means that mid- and smaller-sized companies, pitching for business, have an out-of-proportion admin burden and cost placed on them to supply their BB-BEE score, just to be considered for the contract.

There’s no penalty, as such, for non-compliance. But if you want to stay in business and grow your revenue as an SME, you need to comply.

What does this mean for sustainability reporting for SMEs in the UK?

A large part of the environmental aspect of ESG reporting is reporting on greenhouse gas (GHG) emissions. These are what matter when considering the Paris Agreement targets for climate mitigation. Globally, the target is to reduce emissions by 45% by 2030, and reach net zero by 2050.

GHG emissions are grouped into three types: scope 1 and 2 are emissions from things the company can control: their manufacturing processes and the power they purchase, for instance. Scope 3 emissions, on the other hand, are a result of activities that are not owned or controlled by the business. These emissions are from up and down the supply and value chain and include activities such as employee commuting and travel, waste disposal, and investments. Depending on the industry, scope 3 emissions can make up a significant proportion of overall emissions, and the pressure is on to set targets and report on them. 

This is where we find the parallel with BB-BEE scoring in South Africa. Big companies need input from their supply and value chain to adequately report all their GHG emissions. This means their reporting obligations will likely cascade up and downstream to their service providers. And if you are a service provider to a large, listed company, you will inherit these reporting obligations as one of the costs of doing business with it.

Now what?

The first thing is to recognise that this is coming down the line for your SME clients and to start educating them about the implications.

Next, it is unfeasible for most SMEs to spend time and money on specialist consulting firms to report accurately on their GHG emissions. So there will need to be a smarter, quicker way to report emissions data that is still trustworthy, auditable and accurate.

How your SME clients source the data to input into their reports is an interesting question.

Will we see the emergence of online directories offering benchmark data for emissions – as we do with the cost of travel for salespeople, rates per mile/kilometre, per diems allowances, etc? Perhaps carbon footprint indicators based on headcount, location, industry, expense type and so on are a thing of the future.

Or is this conundrum an ideal use case for artificial intelligence, where data that already exists, or is easy to measure, is used as a proxy to calculate personalised, accurate emissions data for each SME?

Looking at the bigger picture, this information needs to exist alongside or integral to traditional financial data, and reporting, budgeting and forecasting. If we budget for ESG numbers, we can start seeing trends in the relative score, which is important both to the SME itself, but also to their clients, who roll these scores up into their reporting. I’m envisaging a scenario where an SME’s clients start taking a view on their suppliers in the context of their current and forecasted ESG status.

Hence this is not a one-time exercise but needs to be integrated into budgeting, forecasting and reporting processes. In doing so we need to, as far as possible, avoid duplicating systems and effort, or creating data siloes. We need to ensure any solution is quick, easy and accessible to avoid adding time to business processes that are already under pressure.

Sustainability reporting for SMEs is both imminent and still has a lot of the details to be figured out – if it is to be workable. But the fact that it is coming is unavoidable and, as accountants, we should be preparing for how to assist our SME clients with this.

 As published AccountingWeb - May 2024