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On the pathway to sustainability reporting – Part II: Opportunities and challenges for small and medium-sized companies

In the first of our series of three articles on sustainability reporting, we provided information on the legal foundations and the future changes at the national and European levels. Here, in Part II, there is an examination of the opportunities and practical challenges for small and medium-sized companies and, moreover, recommendations are provided for the specific structure of sustainability reports.

Opportunities from the perspective of stakeholders

Sustainability is the order of the day – also in the case of businesses. There is therefore hardly any business that does not at least present the issue of sustainability on its website. Moreover, empirical studies have shown that the number of sustainability reports is likewise steadily increasing – particularly in the case of small and medium-sized companies – and that these reports are becoming ever more extensive. 

This is not surprising because social and environmental aspects are now assuming ever greater significance in the decision-making processes of (future) employees, customers and capital providers. While, previously, the salary and the company car were the primary factors that were decisive when choosing an employer, these days, flexibility, diversity and short-distance public transport season tickets for employees are more likely to be prioritised. What do you then need a car for in a big city if you have a good public transport network? And if it is nonetheless still necessary then the car should at least be eco-friendly. Furthermore, customers are taking an ever-greater interest in the conditions under which clothing is produced. In cases of doubt, people would rather choose a product that is ‘Made in Germany’ than one from a country where the working conditions meet with their disapproval, or are they not able to make an assessment of them. In times where the product offering is limitless, customers wish to ensure that their consumption is compatible with their personal conscience. 

Moreover, capital providers – whether in the form of private investors, institutional investors and/or banks – are also mindful of the sustainability of their capital investments. For example, investors now have the option of making investments that are explicitly sustainable and, for the banks, the EU Commission will make it an obligation that when extending loans, in the future, the banks will also need to look at the use of the loan. 

Please note: The consequences in practice will be that, in cases of doubt, the loan interest rate for a zero-emission vehicle will be lower than for the same vehicle with a combustion engine.

Implementation in corporate governance

From a corporate governance perspective, actively dealing with these requirements early on means ensuring the sustainability of your own business model and your competitive position. Transparency and credibility are important here because otherwise there is a risk of ‘greenwashing’, which could cause damage to the image of a business. 

Even though the implementation of sustainability measures will initially be associated with costs, eventually, you will be on the winning side. This is because using natural resources responsibly generally results in the discovery of savings potential or the start of innovative developments – such as for example, replacing gas with hydrogen – that can provide long-term benefits. In addition, the reputation of your own business will be enhanced along with the above-mentioned benefits for employees, customers and capital providers. In the long term, a more sustainable corporate governance will lead to the development of a positive impact with respect to climate protection and climate change – which will benefit subsequent generations, too. 

Interim conclusion: Therefore, striving for sustainability or sustainability reports that provide information about this harmonise perfectly with the sense of responsibility, ingenuity and the long-term perspective of German small and medium-sized companies, in particular, family enterprises.

Challenges in the context of sustainability reporting

Regulatory momentum and first steps

It can be anticipated that sustainability reporting – which is already partially enshrined in law – will grow in importance. This will entail huge changes for many businesses at the procedural and strategic levels. The momentum of the regulatory requirements for sustainability reporting constitutes one of the most fundamental challenges. Therefore, it may be useful – particularly also for small and medium-sized companies – to proactively tackle the requirements that are already foreseeable. These include, for example, an evaluation of business divisions, products, planned investments and expenditure with regard to their environmental sustainability as well as an up-to-date materiality assessment in order to determine the relevant ESG topics. Here, the reciprocal effects of the company on the environment and on society have to be taken into account. 

In this regard, it is advisable to have a dialogue with various stakeholder groups in order to ensure the relevance of sustainability reporting. This is because, at the end of the day, the report will be written for interested members of the public and not for your own use. From a ‘bird’s-eye perspective’ it is possible to identify potential topics for the sustainability report and to find answers to the question concerning the greatest impact as regards sustainability. 

Recommendation: Sustainability goals should thus also be an explicit element of the business strategy so as to be able to communicate clear objectives for employees and other stakeholders.

Possible reporting standards

Within the framework of the legal requirements for sustainability reporting it is currently possible to freely choose the set of reporting standards. This then serves as a guideline and provides orientation for drawing up the report. Established standards that are frequently used by small and medium-sized companies are the German Sustainability Code or the Global Reporting Initiative (GRI) standards. 

In view of the heterogeneity of the current standards, the EU Commission assigned the role of developing reporting standards in conformity with the Directive and with the taxonomy regulation to the European Financial Reporting Advisory Group. In addition, the International Sustainability Standards Board is developing reporting standards where the main focus for the assessment of enterprise value is on the investors’ perspective. Ultimately, all reporting standards – existing as well as future ones – cover three issues, namely, environmental, social and governance so that there will be no fundamental differences here. 

Recommendation: Given that even future reporting standards will adopt elements from existing concepts it would be altogether advisable to focus on this topic now already.

Development of ESG metrics

Sustainability goals as well as goal achievement play an important role in the reporting process (for an overview of the so-called ESG criteria please see the graphic in the previous issue). Providing metrics is of relevance in order to underpin these goals and their development over the course of time. Here, the selection of possible metrics will depend on the sector and the business model. Yet, there is a large number of universal metrics that are already being collected in many companies. These include, for example, information on gender diversity, employee turnover, on energy and water usage, on internal controls and the whistleblower system as well as about the number of data protection and compliance training sessions.

A widely used example from the field of environmental factors is the measurement of CO2 emissions. Besides measuring own emissions, the biggest challenge here is the inclusion of the entire value chain. For the purpose of subdividing emissions in the context of reporting, frequently, companies draw on the so-called Greenhouse Gas Protocol that provides for the classification of the CO2 emissions that have been caused into three scopes:

  • Scope 1: Direct emissions
  • Scope 2: Indirect emissions from the generation and purchase of energy
  • Scope 3: Indirect emissions along the value chain (e.g. purchased materials, business trips and transport).

What matters here is not just the creation of internal evaluation options but also getting information from suppliers.

Besides the goals that a business has to determine for itself and the appropriate metrics that have to be derived in this regard, for entities subject to the reporting obligation – currently these are capital market-oriented companies – the EU taxonomy provides for the mandatory reporting of three metrics. These are, in each case, 

  • the percentage of net turnover,
  • the percentage of capital expenditure and
  • the percentage of business expenses 

in relation to assets and processes that are linked to business activities that should be classified as being environmentally sustainable. 

Please note: The calculation of these metrics will require a detailed analysis of the company’s business activities and possibly some limited restructuring of the cost accounting.

The structures needed for reporting

Given that the information frequently has to be supplied by various business divisions and that sustainability cuts across many aspects of a business, it will be essential to assign responsibilities and to form interdisciplinary teams (production, sales, legal, purchasing, marketing, HR, finance, technology, quality management, research & development, etc.) so that information can be successfully pooled early on and presented in a standard format. This will require comprehensive data collection and reporting systems as well as monitoring tools. In the sustainability reports, presenting information in graphical and tabular forms will simplify the preparation of complex data and ensure the transparency with regard to developments. Moreover, references to sections in the sustainability and annual reports would enable readers to find and link information more easily.

Conclusion and Outlook: In view of the regulatory momentum and the changes that will ensue for businesses as a result, it would be advisable to prepare for future reporting requirements early on and to make adjustments to existing structures in order to avoid the time pressure that might otherwise occur. In the next and last part of this series of reports, we will provide practical insights into the preparation of sustainability reports for SMEs. 

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