Can SMEs succeed with wider ESG impact?

Studies have shown that small and medium enterprises (SMEs) succeed if they consider their broader impacts, particularly their environmental and social impacts. I examine how the currently ubiquitous term ESG came about and how it relates to SMEs.

Two publications are credited with launching the term ESG (environmental, social, governance) into the public awareness. The first was entitled Who Cares Wins, in 2004, under the auspices of the UN Global Compact.

Former UN secretary general Kofi Annan had invited 50 CEOs of major financial institutions to find ways of integrating ESG dimensions with financial markets. A year later, in 2005, a second important report by the UN was published, this time a collaboration by the UNEP Finance Initiative and the law firm Freshfields Bruckhaus Deringer. It was entitled A Legal Framework for the Integration of Environmental, Social, and Governance Issues into Institutional Investment.

The first report recommended that all financial market actors should integrate ESG factors into their financial analyses, because that would lead to better investment markets as well as to the sustainable development of the planet.

The second report examined whether the inclusion of ESG dimensions into investment policy (asset allocation, portfolio construction, and stock-picking or bond-picking) was to be voluntarily permitted, legally required; or whether law and regulation might be a hindrance. The report concluded that since the link between ESG factors and the focus of conventional investment value analysis, specifically financial performance, is increasingly recognised, and that financial performance could be more reliably predicted when ESG factors are included in the analysis, “it is clearly permissible and is arguably required in all jurisdictions” (that were included in the analysis for the report).

These reports were the foundation upon which the Principles of Responsible Investment (PRI) were launched in 2006 and the Sustainable Stock Exchanges Initiative (SSEI) was launched in 2007.

In 2014, I introduced the stock exchanges of Barbados, Jamaica, and TT to the SSEI, and the Jamaican stock exchange became one of SSEI’s growing list of 110 partner members. The total number of signatories to the PRI and size assets under management continues to grow at an increasing rate.

What about SMEs?

The original intention of those who introduced the term ESG into the public discourse focused on leveraging the power of large financial institutions and institutional investors towards the UN’s definition of and goals for sustainable development. The aim was to have institutional investors include ESG dimensions in their analysis. Companies that the institutional investors invest in would then be required to report on ESG dimensions.

This means that a first link exists for companies in which responsible investors would like to invest.

Both the Jamaica and TT stock exchanges have junior or SME segments that they are actively promoting and there are a lot of funds that seek to invest in companies that perform well on ESG dimensions.

There are two more links – both of which make stronger connections between ESG and SMEs in the case of the Caribbean.

The second link comes from other forms of capital-raising by companies – specifically, international development finance institutions, private equity, venture capital, and banking. All three forms are very well resourced in the Caribbean and there is a lot of available capital for firms that can demonstrate strong ESG performance.

In the case of banking, we are still at the beginning with the TT-headquartered Republic Bank Holdings Ltd as the first and only Caricom-based bank to have signed the UNEP/FI Principles of Responsible Banking.

The third link has the widest applicability for SMEs and holds the real key for success for all others as well: ESG-driven sustainability impact as a competitive and collaborative differentiation strategy. There is a lot of hyperbole, hype and hot air in the ESG discourse. Study after study purports to show that companies that perform well on ESG dimensions outperform their peers in financial returns as well. More rigorous studies show that this is not quite true for all – but their conclusions are critical to understand and apply, because they do lead to sustained and sustainable success!

Dr Axel Kravatzky is managing partner of Syntegra-ESG Inc, vice-chair of ISO/TC309 Governance of organizations, and the co-convenor and editor of ISO 37000 Governance of organizations – Guidance.

Disclaimer: the views presented are those of the author and do not necessarily represent those of any of the organisations he is associated with. Comments and feedback that further the regional dialogue are welcome at axel.kravatzky@syntegra-esg.com