SMEs could face a cancel culture over credit

SMEs may struggle to get credit if they don’t start embracing Environmental, Social and Governance (ESG) goals.

It is in everyone’s interests to incentivise SMEs to aim for net zero, and a stronger focus on sustainable lending in 2022 could nudge them in the right direction.

Large businesses are already busily working on ESG goals. But SMEs seeking credit are expected to come under increasing pressure to demonstrate that they, too, are setting ESG targets.

Law firm Addleshaw Goddard (AG) has researched business leaders and financiers across the UK, France, Germany and Netherlands, and discovered that finance could be more difficult to obtain within three years if businesses do not develop a sustainable strategy.

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Decarbonisation on the horizon

Legal Director Natalie Hewitt said SMEs need to embrace decarbonisation sooner rather than later because lenders are poised to tighten their funding criteria.

“SMEs do not currently have to show they are decarbonising to get finance, but banks will take this into account when looking at their loan book,” she said.

Indeed, banks and asset managers have realised they can make their biggest contribution to climate change through their loan books and investment portfolios.

We are already seeing pension funds repositioning their investment portfolios in more sustainable ventures.

AAT’s pension provider Scottish Widows, for example, has set out its stall to act as a responsible steward of the assets and aims to halve the carbon footprint of its portfolio by 2030. It is using its influence to marshal businesses to develop a long term plan – and when they don’t, it has a system of escalation to achieve change or cause it to pull funds.

Sustainability Disclosure Requirements

At the back end of 2021, the UK government announced the Sustainability Disclosure Requirements (SDR) to ensure investors have the information they need to make informed decisions about where to put their money. Businesses must start disclosing their environmental impact and demonstrate how their activities are aligned with net zero ambitions.

Hewitt added that lenders will soon expect SMEs to identify where their business has a negative impact from an ESG perspective, and how that impact can be improved.

“This clearly takes particular skills, bandwidth and time,” she said. “Lenders will then want to agree metrics that are suitably stretching. These may require independent verification at the outset with the business’s strategy needing to stand up to independent scrutiny.”

The feeling is that lenders will demand that the targets SMEs set themselves are relevant and ambitious.

Business as usual?

“The whole purpose is that targets are not reflective of business as usual. They must lead to material ESG improvements that can be measured,” said Hewitt.

The finance sector, via the supply of capital, certainly has an important role to play in the transition to a green economy.

Jess Mager, product and growth manager at VC Innovation, a fintech start-up and organiser of the FTT Lending 3.0 event in London in March, said SMEs must adapt to what is happening.

“Lenders may soon link borrowing outcomes or even the cost of capital to demonstrable ESG goals and criteria,” she said. “There is a feeling that adding some pressure to hit certain targets in order to receive a green loan provides a financial incentive for SMEs.”

She added there will be other incentives too.

“SMEs will have to meet the changing needs and expectations of customers and suppliers who want evidence companies are decarbonising. This is also a chance for an SME to reduce its energy costs and improve efficiency.”

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SMEs are not ready

Leading accountancy and business services company Azets supports thousands of SMEs and recently polled 235 SME business leaders on the subject of ESG.

It discovered that 23% had not reviewed their business model in the past year and just 10% said climate change and ESG is most likely to have an effect on their business model in future. This was behind staffing (34%) and the economic recovery (27%).

Yet head of growth at Azets, Donald Boyd, said ESG is already having an impact on funding decisions.

“SMEs need to wake up to the fact that setting ESG goals is not just the right thing to do but is now fundamental to business,” he said. “People are talking about it, but not actually doing something about it. SMEs may see it as a cost but in future, it will be as important as meeting health and safety or employment law.”

He agreed that it won’t be long before SMEs have to demonstrate their ESG credentials as a condition to receiving a lending offer.

“Lenders will come under pressure not only because of regulation but because their shareholders want to see green credentials when it comes to investments,” he said. “It may be that regulation is ramped up if things do not happen quickly enough. SMEs should start drafting an ESG strategy now.”

According to think tank NewClimate Institute, the financial sector has a central role to play in bringing about systemic change and helping the economy reach net zero targets. Supporting and nudging SMEs is part of this responsibility, said the Institute’s climate finance specialist Aki Kachi.

He said that while SMEs are still exempt from a lot of ESG regulation, they are affected now because financial companies are having to disclose their investment and lending activity.

He felt there is a business opportunity for accountants to support SMEs who are terrified by the debate and fear the extra reporting they will have to do. Many perceive the additional forms they will have to fill in to get a loan as daunting.

“But they will need to act because awareness of the impact of climate change is growing. The UK’s hosting of COP26 in November highlighted this,” said Kachi. “You basically have a large number of banks and financial institutions, asset owners and asset managers coming together to say that considering climate risk, when it comes to considering finance decisions, is now mainstream. We are not quite there yet, but this thinking will be implemented soon.”

AAT advice on sustainability

AAT’s Head of Responsible Business Adam Williamson (pictured) believes members should be advising their SME clients on the potential impact of more lending decisions being based on sustainability strategies and targets.

Clients should be made aware of the emerging trend regarding obtaining investment and future credit. The launch of the Sustainability Disclosure Requirements (SDR) designed to help lenders, investors and consumers make clear decisions and avoid companies greenwashing, is likely to accelerate the change in approach among lenders.

“We could see SMEs being asked for their decarbonisation targets or to show they have a sustainability plan if they want to engage with government contracts, for example,” said Williamson.

He added that lenders will make more considered decisions on where money is invested and there will be a growth in products such as green bonds.

“Reporting will become crucial, with SMEs having to show valid up-to-date and verifiable information so people can make informed choices. Lenders and pension funds in particular are looking long-term in this area.”

The AAT is doing its bit by moving to new offices in Canary Wharf in early 2022 to reduce its carbon footprint and reach net zero by 2030. The organisation achieved carbon neutrality in 2021.

The AAT is also working closely with the commercial organisation Net Zero Now to help accountants on their decarbonisation journey. Williamson said there are some easy wins for accountants looking to decarbonise, including finding ways to reduce energy use and adjusting travel policies.

Steve Hemsley Is a journalist, media trainer, and podcast presenter. .

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