By Reynir Atlason, Director of Sustainability at Creditinfo Group
ESG data has become crucial for businesses to meet stakeholder demands for more transparency on their sustainability commitments. In recent years, these considerations have become a priority for investors and financial institutions. New policies and international agreements, including the 2015 Paris Agreement on climate change, the 2020 EU Taxonomy and the Corporate Sustainability Reporting Directive (CSRD) regulation, have forced businesses to take responsibility and be transparent about their ESG impact.
ESG data is widely considered as one of the most accurate ways to do this; however, a clear disparity remains around the sizes and types of businesses with access to accurate ESG data on demand.
The SME data blind spot
Unlike larger enterprises, SMEs are subject to little-to-no regulatory pressure to prove their ESG impact. In Europe, for example, SMEs are not currently required to comply with EU Taxonomy, so a widening data gap has appeared despite the fact that they make up 90% of businesses globally.
Access to primary data is the main problem. Larger enterprises can draw from various data sources, including securities filings, voluntary business disclosures, academic research, and government databases. However, SMEs will struggle to draw on such a wide range of accessible data. While multiple methods exist for SMEs to calculate their ESG score, the results can vary dramatically in their accuracy because they don’t have access to the relevant primary data.
The result of this ESG data gap? Accessing finance will become difficult for SMEs. As investors become more concerned with sustainability, many have begun to use ESG risk as a risk indicator when deciding on where to invest.
The green bond market
In 2008, the World Bank became the first institution to issue a green bond, raising funds from fixed-income investors to support climate-focused projects. Between then and 2021, the cumulative green bond issuance globally has surpassed $1.5 trillion, driven by investor demand and regulatory pressure. The dramatic growth of the green bond market has been a strong indicator of the importance of sustainability in investor decision-making.
An increasing number of sustainable bonds are available to investors (green, social, transition, etc.), with ESG data used to determine if a project is worthwhile pursuing. ESG data is also used after issuance to prove that a project has met the terms laid out in the bond agreement, as laid out in the EU Green Bond Standard.
So, for SMEs who do not have access to accurate ESG data, these types of credit options are becoming less and less accessible.
Future regulatory changes
SMEs that stay on top of ESG considerations will likely gain a competitive edge. With high-quality and accurate ESG data, SMEs can improve their ability to access finance and ensure they are prepared for future regulatory changes.
It would not come as a surprise if the EU’s Taxonomy will be issued in a form to include smaller enterprises in its framework as governing bodies and stakeholders look for wider sustainability practices among businesses. Those businesses that already have accurate ESG data to hand will be able to respond to changes in regulation quickly and effectively when they happen, with speedy compliance to ensure continued operational efficiency.
The key to improving ESG data availability for SMEs
While SMEs aren’t required to invest in ESG reporting, financial institutions can get a good grasp of their ESG score by harnessing a range of alternative data sources. These might include legal records, media and court cases or annual business reports.
Although this data is often hard to collect and analyse effectively, technologies such as AI and machine learning can be used to automate this process and build a rounded and accurate ESG profile for small businesses. The benefit of making use of these technologies is that SMEs or financial institutions won’t have to depend on having access to extremely high-quality or large quantities of data.
ESG concerns aren’t going to disappear. With increasing consumer and investor demand for transparency. SMEs, therefore, need to stay ahead of the curve and use the resources available to them to prove their ESG impact. Using technology to analyse alternative data sources can help to level the playing field and ensure compliance with increasingly complex regulations.