SustainaWeekly -Will SMEs hamper the transition to Net Zero?

• The EU is implementing climate disclosure requirements for firms, with the idea that additional transparency will spur progress

• As it stands, the requirements will not apply to most SMEs, while the German government appears to be pushing for the legislation to exclude even a proportion of large firms

• Surveys suggest that SMEs are behind larger firms in their progress towards developing decarbonisation strategies…

• …While SMEs are responsible for more than 60% of emissions, so are vital for a successful transition

• Although SMEs are not covered by the regulation, their importance to banks and corporates that are, means that the these larger institutions effectively need to play a key role in the SME transition

The EU Corporate and Sustainable Reporting Directive (CSRD) requires businesses to regularly disclose information on their societal and environmental impact and the sustainability risks they are exposed to. This is part of a plethora of measures to encourage a timely transition to Net Zero, with the idea that increased transparency is the first step to spur progress. The rules will start to apply from next year for companies with over 500 employees (with reports due the year after) and will be extended to all large companies (more than 250 employees though some supplementary financial metrics are also used to define this category) from 2025. This means that SMEs will largely not be covered (except those that are listed from 2026, though they can opt out until 2028).

Last week the CSRD was in the news as the Financial Times reported that Germany is seeking to exempt even more companies from the regulation by seeking to raise the threshold for companies covered from 250 to 500 employees (see here). Smaller companies are typically excluded from all kinds of regulation due to the costs and bureaucratic burden, so of course it is a fair discussion. However, it does raise the issue of the exemption of SMEs from climate regulation more generally and the impact this may have on the transition to Net Zero. We explore this subject in this note.

SMEs are lagging behind when it comes to climate ambitions

There is evidence that SMEs are lagging behind in rolling out their climate and decarbonisation strategies compared to larger firms. The EIB’s Investment Survey (see here), which took a deep dive into European firms and climate change, points to this discrepancy across a number of indicators. For instance, a significantly lower proportion of SMEs had set climate targets, had dedicated climate staff, had conducted an energy audit and/or invested/planned to invest in climate change or energy efficiency (see charts directly below).

Does it matter if SMEs do not do too much to decarbonise given their small size? The answer, as we will show in the next section, is a resounding yes. They might be small, but there are a lot of them.

SMEs are vital for the transition

It has often been said that small businesses are the backbone of the economy. This is more than just a platitude often heard by politicians. The statistics bear this out. They are a crucial importance on the basis of a whole range of economic indicators, while it also logically follows, they are therefore also responsible for significant emissions. As can be seen in the chart below on the left, SMEs dominate large firms in terms of employment share and are roughly equal in terms value added. How this translates exactly into emissions requires making estimates as emission data are typically estimated on a country and sector level. Such estimates have been made by the European Commission (see paper here). The research notes that the average SME emits only 67 tons of CO2 and 75 tons of greenhouse gases compared to respective emissions of 20,027 and 22,345 from the average large enterprise. However, due to their large number, the collective share of SMEs in total enterprise emissions is high at 63.3% of all CO2 and greenhouse gas emissions by enterprises.

Banks and large corporates play a key role in SME transition

So SMEs are responsible for a lot of emissions, whilst at the same time, they are excluded from some important climate regulation, does that mean they will hamper the transition to Net Zero? Not necessarily, as there will very likely be impetus for SMEs to take steps from banks and large corporates that are subject to disclosure requirements, as well as other climate regulation and pressure from their stakeholders. This is because the carbon footprint of SMEs is essentially part of the carbon footprint of banks and large corporates. Bank loans to SMEs make up a significant part of total outstanding business loans (see chart on the left), while SMEs play a key role in value chains across sectors (see chart on the right). Scope 3 emissions for both banks and most large corporates are the dominant part of their carbon footprint, so they will not be able to report on the climate objectives without knowing the carbon footprint of SMEs and they will not be able to decarbonise if their SME clients/partners do not do so.

Steps to help the SME transition

Although SMEs are excluded from climate disclosure regulations due to the costs and administrative burden, as they still need to move in this direction in any case, this does not really solve the barriers they face to make the transition. Indeed, Germany’s apparent proposal to exclude even more firms would not be a step forward. A more constructive approach is to help remove the obstacles companies face to decarbonise.

SMEs often lack the tools and financial resources needed to reduce their carbon footprint. The SME Climate Hub - a non-profit global initiative that aims to empower SMEs to take climate action – conducted a survey of SMEs to understand the barriers small businesses face and what they need to be successful (see here). The top reasons stated as preventing SMEs from taking action were skills and knowledge (58%), lack of funds (55%) and lack of time (44%). To take greater action, companies noted that they need tools for measuring and monitoring emissions (61%), financial support (60%) and network of peer companies to reach out to and learn from (54%).

Banks and larger corporates can and already are providing support in providing SMEs with support in these areas as are governments. The SME Climate Hub – and other organisations - provide educational, measurement and reporting tools. However, given the results of this and other surveys, there appears to be a need for the various actors to go further. For instance, the sustainability consultancy BSR recommends (see here) an independently-led data repository of Scope 1, 2 and 3 emissions jointly accessible to banks, corporates, and SMEs to avoid duplication of reporting efforts and allow SMEs to focus on climate action as well as other knowledge solutions.