Environmental, Social, and Corporate Governance (ESG)

Environmental, Social, and Corporate Governance (ESG)

Sustainable investing takes off, but SMEs need to catch up or lose out

A company’s positive impact on society and our environment is no longer just nice marketing angles. SMEs looking for vital growth funding are being closely scrutinised and those coming out tops on their ESG ratings are now enjoying more financing options than their less sustainable counterparts.

Environmental, Social, and Corporate Governance (ESG) refers to the pillars used to measure the sustainability and societal impact of an investment. While still looking for positive returns, the long-term impact on society and the environment form a key part of ESG investment criteria. Investors also look at the overall sustainability of the organisation, with a focus on accountability and good corporate governance.

“We are seeing a growing number of funds looking for high ESG ratings before they invest or lend. Certain Developmental Finance Institutions (DFIs), are even pushing for their clients to be carbon neutral by 2025. While this may sound daunting, sometimes it takes just a few strategic operational shifts to significantly bolster ESG ratings and increase your access to finance,” comments Gary Palmer, CEO of Paragon Lending Solutions.

The global growth of sustainability investing, sometimes also spoken of alongside responsible or ethical investing, has taken off in the last few years.

According to the OECD Business and Financial Outlook 2020, the number of signatories of the UN Principles of Responsible Investment, (an instrument that calls for the integration of ESG factors), had grown to over 2,300 as of 2018, managing over $80 trillion in assets. What’s more, surveys of investors revealed that they consider ESG information “…increasingly important to determine whether a company is adequately managing risk and aligning its strategy to achieve long-term returns.”

According to Palmer, there is now also a growing focus on ESG from local funds aimed at SMEs, with requirements that they should at least have sustainability on their radar.

“Traditional lenders like the banks ask for the basic supporting documents, like financials and business plans. However, many funds are now raising money from international markets, pension funds and other trustee managed institutions, all of which have responsible lending requirements. As a result, we have seen most investor mandates require clients to submit documentation showing they are ESG compliant or at the very least ESG progressive,” Palmer explains.

Funding lines availables for sustainable SMEs

While the focus on ESG is about sustainability, this does not mean investors are not driven by profits.

“Investors are still very interested in a company’s ability to turn a profit, the key difference is that many funds are now interested in backing companies that will still be delivering solid results further down the road. To achieve this, they need to take a long-term view on how the organisation interacts with the environment around them, the communities they work in and how they treat their staff and other stakeholders. Much like choosing the right life partner means looking beyond the first blush of youth and finding someone who you will still be compatible with into your old age, choosing a good investment means looking beyond the first two or three reporting periods to find a company that will deliver steady returns without compromising on ethics and which won’t destroy the environment and society which helps support it,” Palmer explains.

Palmer says the reward for companies prepared to put in the legwork and get their reporting in order, are substantial.

“There is a perception that funding is scarce at the moment, but we are seeing big pockets of money for companies that meet requirements. As a SME non-bank lender, Paragon is actively working with its funders to develop increased awareness with its clients about ESG reporting as well as developing mechanisms that will help SMEs become more compliant. With the right guidance, a few strategic changes and some additional administration, local SMEs could access substantially more investment finance,” Palmer says.