COP26: How Small and Mid-Caps play their part in the fight against climate change
24 November 2021

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Corporate GovernanceESG

 

We are already witnessing the various detrimental impacts of climate change. For some, it has increased the risk of impoverishment and conflict by exacerbating existing social, economic and environmental threats. For some species, in some regions of the world, it is already too late as a culmination of factors has led to irreversible damage and extinction.

Government, finance and industry across the world need to align in order to achieve the agreements set out in the 2015 Paris Accord which binds nations to commit to limit global warming to well below 2, preferably 1.5, degrees Celsius. Yet, it is industry that will take on the practical steps in order to achieve this.

Our role at the QCA is to ensure that small and mid-sized quoted companies have a voice and are equipped with the right tools when it comes to any regulation that affects them; this includes climate policy.

A symbiotic effort is in process. Governments are enforcing regulation that either incentivises green developments - for example by providing grants for initiatives that support a reduction of greenhouse gas emissions (GHGs), or increasing penalties for the most polluting actors, including those in the form of carbon taxes. For companies who are quoted on the financial markets, governments and other regulatory bodies look towards regulation, enhancing mandatory reporting requirements to ensure business activities are mindful of their climate impact. Financial institutions are increasingly directing their investments into sustainable organisations, often using ESG metrics to assess suitability. Trends to divest from unsustainable industries, such as fossil fuels are also on the rise. But it is industry itself that will need to not only adapt its existing processes to be more sustainable, but create and innovate for a sustainable future too.

During the early stages of COP26, the Chancellor of the Exchequer, Rishi Sunak, set out how targets to mobilise finance to support climate change included not only public finance, but private finance too. He highlighted how the Glasgow Financial Alliance for Net Zero has brought together financial organisations with assets worth over $130 trillion, to be invested into a low carbon future. Yet this development is not just about the financial capital available, but the initiatives and processes in place that will be needed to ensure transparency and   accountability to support investment decisions. Such initiatives include sovereign green bonds and proper climate risk surveillance as well as mandatory sustainability disclosures and stronger global reporting standards.

Climate-related disclosures have been in development for some time.  They are a way to ascertain a company’s sustainability, environmental impact and risk. In March 2020, the Financial Conduct Authority (FCA) consulted on a new Listing Rule for commercial companies with a UK Premium Listing to promote better disclosures about how they are managing climate-related risks and opportunities. In December of that year, they confirmed the release of the new rule, for accounting periods effective from January 2021, that will require all Premium Listed companies to state in their annual report (as referenced by the Chancellor), on a comply or explain basis, whether they have made disclosures pursuant to the Task Force on Climate-related Financial Disclosures (TCFD) recommendations. The FCA has since released, and we are currently awaiting the outcome of, a similar consultation for Standard Listed companies. A further consultation was also released by the Department for Business, Energy and Industrial Strategy looking at the reporting obligations for certain AIM-quoted companies, specifically those with over 500 employees.

The QCA has responded to all three consultations, and whilst we are supportive of climate action & policy developments in this field, we also believe that it is important to look at the detail and consequences of any mandatory requirements. Consideration of how quoted companies, and in particular small and mid-caps are affected by them (and subsequently, how these impacts will support or hinder their innovation) is especially important. This was a key highlight in our recent response to the TCFD consultation on climate-related disclosures.

"A situation must not arise whereby small companies, and investors in these small companies, cannot comply with the TCFD disclosures, and as a result of this, investment is steered away from such companies. This would be a perverse outcome, as it is often smaller, more innovative companies that contribute products and services that help provide solutions to the climate change challenges being faced." QCA Response to FCA's consultation on climate-related disclosures

More recently, in October 2021 the TCFD published its fourth status report which highlighted the greatest progress made to date on TCFD adoption. The TCFD also released new guidance for companies to disclose their plans for a net zero transition in line with the Paris Agreement, including disclosure of seven categories of cross-industry metrics like Scope 1, 2 and 3 GHG emissions.

As well as these mandatory climate disclosures, quoted companies may choose to disclose their strategy and report on their wider social and environmental goals, collectively known as “ESG” - Environment, Social & Governance. Anecdotally, whilst climate change is an issue that is primarily focused on limiting greenhouse gases, sustainability also looks at the wider impacts on society and even the economy. Therefore, it is increasingly important that businesses look to integrate all aspects of sustainability within their business model. Whilst governance has been a focal point for some time, environmental and social considerations are still at an early stage, with the latter much more so

What is ESG ?

ESG is about reporting on a variety of factors, including sustainability, in a way that market participants can examine and compare for purposes of investment. Some examples of commonly used ESG reporting standards in the UK and Europe include United Nations Sustainable Development Goals (UNSDG), Streamlined Energy and Carbon Reporting (SECR) and Global Reporting Initiative (GRI) standards by sector. Other global standards include the Sustainability Accounting Standards Board (SASB), Climate Disclosure Standards Board (CDSB) as well as the aforementioned TCFD.

Investors are increasingly interested in ensuring their money is channelled into sustainable businesses, and with the collective movement in recognition of the need for action, ESG reporting has become increasingly relevant. It is a worthwhile opportunity for small and mid-sized quoted companies to embrace this development wholeheartedly in order to reap its rewards.

What is the status of ESG reporting for Small and Midcaps ?

However, in a report produced in collaboration with Henley Business School, we found that there are still many company leaders who are unclear about ESG. Gaps in understanding include what it entails, how to integrate it into strategy, how to quantify it and its impact on performance as well as how to communicate to all stakeholders. In particular, small and mid-caps tend to have a low adoption of ESG standards, in part because they are seen as unsuitable for this segment and its specific needs in terms of growth and innovation. But it is possible, and as COP26 highlights yet again, necessary for us all to take action now.

It is also important to note that some of the most innovative companies that have the potential to create real solutions to climate change may not necessarily have the strongest ESG metrics. Such innovative companies frequently score badly on ESG-related, or other, metrics and ratings. Green technology companies provide multiple examples of this. Their scores are often skewed relative to their revenue or market capitalisation as their revenue and valuations are often very small because they are near start-up stage. For instance, in 2020, one such company was building the largest factory of its kind in Europe, which would allow it to become a major supplier of electrolysers to convert renewable energy into hydrogen that can be used for energy storage or be added to the gas grid. However, its metrics alone show high and deteriorating GHG emissions despite being a company that will play a critical role in helping manufacture products to store green electricity as hydrogen. This is a recurring theme for smaller companies, and so there needs to be consideration of the impact of climate-related disclosures on their financial needs verses their potential.

For companies who are just getting started with ESG, or would like more support for their current processes, we have produced the QCA Practical Guide to ESG which can be accessed on our website. This guide provides practical steps for small and mid-caps to integrate ESG into their strategy. No company is too small to start looking at how it can play its part in a more sustainable future.

"ESG initiatives need to be embedded within the values of the company to be really effective." Finance Director, ESG in Small and Mid-Sized Quoted Companies: Perceptions, Myths and Realities

We, at the QCA, also want to see a future where people and the planet thrive sustainably. But we also want to ensure that actions are meaningful, proportionate, and most importantly, that efforts towards our collective climate goals do not hinder the very growth and innovation that is needed to create real change in support of the future of our planet. By equipping our members with the information and tools needed - as well as campaigning on their behalf - we hope that we are able to collectively achieve a more sustainable future for people, the planet and our collective economy.