A voice for small and mid-caps on ESG

In this article Lorence Nye, Head of Policy at the Quoted Companies Alliance, discusses the journeys and challenges of small and mid-caps in regards to ESG.

The environmental, social and governance (ESG) agenda still has a long way to go. It has been necessary for companies, regulation and the financial markets to come together to achieve a more sustainable and ethical world, yet for many small and small and mid-sized quoted companies ESG remains a difficult acronym to pin down.

Investors are increasingly focused on channelling their funds towards sustainable companies and use ESG metrics as a clear indication of performance in this field. However, companies – particularly the smaller quoted companies – may struggle to compete with their larger competitors. This should not be seen as a failure of a sustainable strategy and therefore justification for a reduction of investment, sometimes this is purely an outcome of the economies of scale.

At the Quoted Companies Alliance (QCA) we often see regulation that is targeted with the largest quoted companies in mind. But the reality is that 93% of quoted companies actually fall within the small and mid-cap space, whether they are listed on the Main Market, AIM or AQUIS. The difference between these companies can be as large as 500 times. Using the metaphor of time, this is the equivalent of one day compared to 1.4 years – what can you achieve with this difference alone?

’A situation must not arise whereby small companies, and investors in these small companies, cannot comply with the Task Force on Climate-Related Financial Disclosures (TCFD), 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.

Clarity is being achieved around ESG as the government and regulators establish quantifiable standards and targets for companies to aim for. For small and mid-caps however, the challenge is to work out what to apply, how to comply and what timelines to adhere to while remaining profitable and delivering shareholder value. This is increasingly difficult to achieve if the standards themselves are designed with larger corporations in mind.

For such businesses, the attempts to make good practice more tangible and quantifiable do not create the best path to improving ESG performance in reality, nor the ultimate goal of a more sustainable world. Therefore, investment is driven towards larger organisations.

Even though many small and mid-sized quoted companies may not be able to access or provide the data that larger companies record, they nevertheless still focus on embedding good practice within their business. As such they are able to provide qualitative and descriptive disclosures. We therefore believe it is important that this is recognised within the investor community, and that investors should take the time to look into the companies in which they invest. While ESG performance is a useful metric, it does not tell the full story.

Many recently established businesses have sustainability and social impact embedded within their purpose. Sometimes the very nature of their business may create positive external impacts, for example by using sustainable technology or recycled materials. However, the way their activity is required to be reported can mean that their statistical performance against regulatory benchmarks suffers. It is also often the smaller, newly established businesses that are driving the innovation that is needed to create positive social and environmental impact and they need investment to grow.

The challenge for small and mid-sized quoted companies is that they exist within a wider societal context and their influence is limited in terms of being able to drive near-term change. This is not to say they do not have the potential to do good for the environment and society, but they do need to focus more on qualitative information rather than hard statistics and this needs to be recognised by regulators and investors.

This nuanced approach to the growth and innovation of smaller companies is required so that long-term reform can be realised rather than stifled.

Lorence Nye, Head of Policy at the Quoted Companies Alliance

In April 2022, Lorence Nye, Head of Policy at the Quoted Companies Alliance will be leading a breakout session looking specifically at the ESG journeys of small and mid-caps at CGIUKI's ESG Summit . He will also be looking at the application of the QCA’s Practical Guide to ESG and research from analysis and interviews with their members which highlights some of the common issues faced by these companies and which are often overlooked.

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