ESG for small caps – turning a regulatory burden into a competitive advantage

With mandatory ESG reporting and climate-related disclosures rapidly approaching for listed companies of all sizes, small-caps should invest ahead of the curve to turn a regulatory burden into a competitive advantage.

As the body of empirical evidence mounts linking environmental, social, and governance (ESG) principles with long-term financial performance, the impact on valuation is beyond question.

Consumers are voting with their wallets by supporting sustainable businesses, while companies increasingly demand compliance from their suppliers.

Access to capital is also being impacted, with more than 5,000 investment firms globally having signed up to the UNPRI (United Nations Principles for Responsible Investing), affirming their commitment to incorporate ESG issues into investment decision-making.

While larger companies can devote substantial budgets to incorporating ESG metrics into their business operations and reporting practices, smaller companies should recognise the opportunity to differentiate themselves from their peers by investing ahead of the curve.

Local regulation looming on the horizon

Internationally, sustainability legislation has become mainstream, with the European Union leading the way. While Australia is late to the party, the impact of local regulation will soon be felt by listed Australian companies of all sizes.

The International Sustainability Standards Board's (ISSB) sustainability disclosure standards (IFRS S1 and IFRS S2) were officially released in June this year, and companies can already voluntarily align their disclosures with the standards. Treasury has recently outlined a comprehensive plan to enforce the adoption of these standards by all listed companies from 2025.

While implementation of the new standards will commence with larger companies, smaller entities will be directly impacted as they are required to provide information to meet the requirements of their larger counterparties. This is likely to begin with disclosure on carbon emissions, particularly as part of scope 3 emissions calculations.

While small-cap companies may not have the resources of their larger peers, there are pragmatic, actionable steps that can be taken to differentiate a company on its ESG performance.

Understand your material ESG exposures and choose appropriate metrics

Identifying ESG issues that are important to a business and its stakeholders and choosing appropriate metrics to address them is critical. Undertaking a materiality assessment, incorporating relevant ESG metrics and benchmarking against peers and industry data demonstrates a commitment to ESG, without the need for a full sustainability report.

Establish good governance

Assigning responsibilities for sustainability to board members and disclosing the structure in the Annual Report depicts how ESG considerations inform board decision making and strategy.

Align with established reporting frameworks

IFRS S1 establishes how companies should disclose the effect of material sustainability-related risks and opportunities on the entity’s financial position, financial performance and cashflows. Companies can align their reporting with relevant industry-specific topics from the Sustainability Accounting Standards Board (SASB) for comparability with peers.

Surface the information

Some of the quickest wins can be achieved by acknowledging that many ‘business as usual’ activities are ESG-related. Examples include a commitment to good customer service, responsible energy and water use, or a focus on cyber security. Aggregating relevant ESG information in a single location will improve the level of transparency and ease of evaluation by external parties.

ESG and sustainability are no longer a ‘nice to have’ for small-cap companies. As the regulatory landscape continues to evolve, companies must take pragmatic steps to enhance their ESG disclosures or face their cost of capital increasing due to failing to meet institutional investment criteria.

To discuss the comprehensive suite of financial communication, investor relations and ESG advisory services provided by Citadel-MAGNUS, now part of Morrow Sodali International, contact a member of the investor relations team at ir@citadelmagnus.com.